By Chad Blais - Financial Adviser.
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.
Courtesy: buyshares.org
http://forum.srilankaequity.com/
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