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Buy-and-hold strategy is losing its grip on traders

Bear market losses are causing some individual investors to embrace risky moves.

August 25, 2009|Walter Hamilton

NEW YORK — Stung by punishing losses in the bear market, some individual investors are souring on traditional buy-and-hold investing in favor of aggressive trading aimed at scoring big gains.

Trading at online brokerages has soared in recent months as investors have tried to capitalize on rising securities markets. But individual investors increasingly are embracing strategies that carry outsized risks.

In some cases, for example, investors have ventured into a relatively new type of investment product designed to magnify the movement of the underlying markets. That can sometimes yield big gains if investors bet correctly but bruising losses if they don't.

To critics, the push into aggressive trading is the equivalent of doubling down at a casino to recoup earlier losses.

"It would be a terrible tragedy if people try to recover from the devastation of the financial crisis by creating even more devastation in their personal investment accounts by taking on risks they don't understand and can't afford," said Barbara Roper, director of investor protection for the Consumer Federation of America.

Financial experts have long preached portfolio diversification, caution and patience when it comes to long-term investing. Still, some individuals feel they have no choice but to take matters into their own hands.

Two brutal bear markets -- after the bursting of the dot-com bubble in 2000 and the housing bubble two years ago -- have decimated portfolios and left many people poorer than a decade ago.

Some have grown disillusioned with losses incurred by mutual funds and stock brokers, and figure they can't do any worse on their own by darting in and out based on market conditions.

"The equity markets have not been steady long-term gainers for a long time now," said Nicholas Colas, market strategist at BNY ConvergEx Group, a New York brokerage. "There is a growing sense of frustration, and [investors feel that] if you do want to play in equities you have to have a shorter time frame."

Susan York was fed up with the dismal performance of her 401(k) retirement account. Then her husband saw a Sunday morning infomercial in January touting the benefits of trading options, which give an investor the right to buy or sell stocks and other securities at pre-determined prices.

The 50-year-old from Naples, Fla., had limited investment knowledge but attended several seminars before starting to trade in May. So far, York said, she's up an average of 40% a month and is trading full time.

"It's the best job I've ever had, not just for the enjoyment but from the compensation standpoint," said York, who previously sold telecom equipment. "I've replaced a significant six-figure income."

Trading activity at online brokerages jumped in the second quarter as the stock market began rebounding in early March from its deep sell-off. Compared with a year earlier, activity was up 28% at E-Trade Financial Corp. and 36% at TD Ameritrade Holding Corp.

Frenetic trading also is rising among Wall Street professionals.

So-called high-frequency trading, which involves souped-up computers trading stocks in milliseconds, makes up at least half of total trading volume, according to some estimates.

Among individuals, activity is picking up in some risky areas.

Currency trading by so-called retail investors, for example, is expected to jump to $125 billion a day this year from $100 billion last year, according to Aite Group, a research firm. It has risen steadily from $10 billion in 2001.

Some individuals recently have jumped into one of the newest and riskiest investment products, known as leveraged exchange-traded funds. ETFs are mutual funds that trade like stocks and can be bought and sold throughout the day. A leveraged ETF is like a regular fund on steroids. It gives two to three times the return of an underlying stock index. For example, if financial shares rise 2% on a given day, a fund could jump as much as 6%. Some leveraged funds move in the opposite direction of an index. If an index rose 2%, an inverse fund could fall up to 6%.

Leveraged funds are one of the fastest-growing products on Wall Street. Total assets surged to $32 billion at the end of June from $11 billion 18 months earlier, according to State Street Global Advisors. The first leveraged fund debuted three years ago. There are now 126.

However, there is mounting concern that small investors don't understand the risks of leveraged funds. In some cases, critics say, they have suffered sharp and unexpected losses.

According to a lawsuit filed this month by a Connecticut stock broker, one fund was supposed to return two times the inverse performance of an index of real-estate stocks. Thus, the ProShare Advisors' UltraShort Real Estate Fund should have risen if the index declined, according to the suit.

But even though the index sank 39% through much of last year, the fund also fell, by 48%, according to the suit.

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