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About Active vs. Passive investment strategies

There are basically two kinds of investors - those who follow active investment strategies and those who follow passive investment strategies. (I am excluding those who trade on a daily basis, whether in the cash market or the F&O market.)

Some Active investment strategies

1. Looking for new stock ideas: constantly looking to buy stocks that are being overlooked by the market, or selling stocks that have started to drop off after a brief rise

2. Identifying sector rotation: try to outguess the market about which sector will be the next 'hot' one (in bull phases), or 'dumped' one (in bear phases) and try to buy or sell ahead of the market

3. Frequently booking small profits: every time a stock moves up or down by 10% or 20%, lock the profits and hunt for the next stock to repeat the process

4. Using a 'ladder' or 'pyramid' approach: keep buying more in stages as a stock moves up or selling more when a stock starts to fall; contrarian investors may do just the opposite

Some Passive investment strategies

1. Identifying fundamentally strong stocks: spending a lot of time in initial research to choose only those stocks that have performed well in the past through bull and bear markets, and are likely to continue to do well in future

2. Choosing sectors within 'Circle of Competence': selecting stocks from only those sectors about which the investor has in-depth knowledge about operations, competition and growth prospects

3. Booking partial profits: when markets reach near an intermediate top (or bottom), booking partial profits (or partially covering shorts)

4. Lump-sum buying or selling: buying large quantities in a few stocks near market bottoms, waiting patiently for the stocks to rise several-fold, then selling large quantities when valuations suggest a market top

Both strategies carry a certain amount of risk. An active investment strategy tries to exploit short-term market movements on a regular basis. This carries an extra risk of the stock or sector calls going wrong. There might be a tendency to become a long-term investor by default, to avoid immediate cash losses.

Passive investment strategies also carry the risk of investments not performing up to expectations even after holding for a longer period, and may have to be sold off at a meager profit or even a loss.

The kind of investing strategy you want to follow should depend on why you are investing in stocks. Saying 'to make money' is a cop-out. Every one has to make money to survive - whether he is a big-shot, or a clerk.

Stock market investing should be for long-term wealth building that complements regular income from a job or business. It is for individual investors to decide whether active investment strategies or passive investment strategies are more conducive to long-term wealth creation.

As in life, so in investing - it may be better to strike a balance between the two. As a conservative long-term investor, I prefer to follow passive investment strategies for my 'core portfolio' and active investment strategies for my 'mad money portfolio.



Disclosure: No disclosure - no stocks mentioned