Investors usually fall into one of two categories; there are those who invest for short term gains and others who invest for the long term. Both strategies have benefits and drawbacks and while in the UK the tax consequences are the same, in the United States each strategy has different tax implications. However, that aside, the strategies involved in short term investing versus long term investing can net quite different results.
What is Short Term Investing?
Short term investing generally refers to holding any particular investment for less than one year. Many investors take this to extremes, however. Day traders aim to hold any one investment for less than one day, opening positions each morning and closing them before the market shuts down for the day. This is a completely separate strategy than just short term investing. Day trading is a difficult skill to master and takes a lot of study, time and practice to even make profitable for most people.
This article will compare short term investors not only in the definitive sense of holding an investment for fewer than 12 months, but as investors who may trade shares after holding them for several weeks, months or even a year or two. Long term investors on the other hand will often hold an investment for five, ten or even twenty to thirty years at a time.
Buying Low and Selling High
The goal of any investor is to grow your invested capital: to make money. This is why we do what we do and it is accomplished simply by buying low and selling high. If it only it was that simple! Investors who trade on shorter time-lines aim to buy a stock when the market is low or if a stock has been beat up and represents a good value. They then try to sell the stock in a few days, weeks or months when it has recovered and can show a profit. In theory, this is exactly what we should all be doing. However, as with nearly everything involved in investing, it is not as easy as it sounds.
The only way to really maximize your profitability with the short term strategy is to time the market just right. That means, to buy a stock at its lowest point and sell it at its highest, before it drops again. If you sell too soon, you are missing out on potential gains. On the other hand, sell too late and it could be a disaster. To time the market just right, professional traders use very advanced technical analysis to predict trends. For instance, if they are following a certain stock, ABC, they would look at historical pricing charts and try to find trends. They might create a true value for the stock, what they think the stock is actually worth, and compare it to the current price. They might then note historical values and one example might be if a stock gets to X% below its true value, it tends to jump to X% above its true value. With this information they make a trading plan. When the stock gets to what they see as the low point, they will initiate a buy, with a sell point at the top of their expected trend chart.
The problems arise when the shares do not follow the expected trends, which they often do not. Sometimes, a stock will hit its bottom and the trader will initiate a buy, only to see the shares continue to fall. He is then left with the decision to try to wait it out or to sell at a steep loss. As we mentioned, the other side of the coin can happen as well. The trader will buy, then sell at what he thinks is the stock’s ceiling, only to see it rise further, taunting him with lost profits.
The other issue with short term trading is the number of trades it takes to constantly open and close positions. Even with discounted trading charges it can get quite expensive and many traders find themselves struggling just to break even after fees.
Benefits of Long Term Investing
Conversely, long term traders incur much fewer trading fees, since positions are held for a long period. Short term traders see long term investing as boring, and quite frankly, that’s just fine for most traders, especially inexperienced investors. However, even many very experienced and professional investors buy in to the long term strategy. In fact, American investor Warren Buffett (the richest man in the world) has said that his preferred time to hold a stock is, “forever.” He is also quoted as saying, “Only buy something that you’d be perfectly happy to hold if the market shut down for 10 years.” In other words, Buffett believes in long term investing. He sees market fluctuations as opportunities and he has made billions by purchasing stocks of strong companies that everyone else was selling out of fear and holding them for a long time.
Long term investors should seek out companies that have a proven track record of stability and growth. While newer companies can still be good options for long term growth, there is less risk involved when a business already has a proven track record. Another good option would be a stock that has a history of paying dividends, especially one that increases dividends on a regular basis. These types of companies have proven their commitment to dividends and typically will continue to pay back their shareholders every quarter just as they always have.
Many investors will benefit from the relative stability that long term investing offers. New investors should definitely focus on long term prospects rather than watching every little fluctuation in the market. This is not to say that you should buy a stock and hold it for twenty years no matter what. If something substantially changes with the company or the market as a whole, then you should adjust accordingly. However, trades should be made with your overall market strategy in mind, not just the day to day ebb and flow of the market.
Conclusion Based on Historical Data
Before the year 2000, the stock market had not had a negative 10 year period since the 1930’s. Since 1950, there has never been a negative 20 year period. This is why long term investors need to keep in mind the real goal and a truer definition of “long term.” For those who can master the practice, however, short term trading can be very profitable. Some people make careers and millions of dollars from trading stocks in as little as a few minutes. The key to short term trading is lots of research and forming a solid plan, then following through. For the average investor, there simply is not enough time to properly research, create and implement a proper short term investment plan. Trying to guess what the market will do is a recipe for financial disaster. If you are considering short term investing, please do so with only a small portion of your overall portfolio capital and do so with extreme caution. But for most investors, a longer term approach is absolutely the way to go.