Few factors are more important than time horizon when it comes to investing. The length of time you plan to hold stocks not only dictates your future tax obligations, but it also determines which types of trading styles can be used effectively.
Short and long-term trading are like baseball and football. Sure, some people like Bo Jackson and Deion Sanders can do both effectively, but most players are much better at one sport than the other. The same is true with trading – short-term strategies won’t be effective when applied to long time frames. Which is best? That depends on you, personally.
Overview of Short and Long Term Trading
If you want to make short-term profits through trading, you’ll have to embrace some type of technical analysis or charting system. Short-term traders don’t have time to allow fundamentals to materialize or for new products to hit the market. If you want to make quick profits, you’ll need to recognize changes in trend and sentiment, which often have very little to do with the underlying strength of the company.
Long-term traders utilize a “buy and hold” strategy when investing. This doesn’t mean a complete aversion to technical signals and charts, but a buy-and-hold investor isn’t concerned with short-term volatility. A long-term trader believes in the underlying value of the company and expects them to increase profits in the future. Profits can then be returned to shareholders through stock price appreciation and dividends.
Short and long-term traders may have different time frames and tools, but they both need to have concrete profit goals and risk thresholds. HODL is a fun thing to shout on Twitter, but trading means taking profits when goals are reached or selling when your prediction fails to materialize. How much are you willing to lose on an investment? When will you hit the cash register if your trade is successful? Put these parameters down on paper so you can refer to them later. Why write them down? So you can combat your brain when it tells you to keep holding past your own predetermined limits.
With that out of the way, short and long-term trading do require different processes. The methods used to profit on short-term trades probably won’t be as effective in the long term, and vice versa. Some investors may be able to adapt their style for both short and long-term trading, but many feel more comfortable sticking with what they know best. Here are a few factors to consider when choosing between short or long-term trading.
Length Stocks are Held
Yes, this might seem redundant, but short-term trading means holding stocks for short periods of time while long-term trading uses more of a buy and hold strategy. Groundbreaking, I know, but your holding period is crucial for several reasons. First of all, any gains booked on stocks held less than one year will be taxed at your normal income rate. Any gains booked on stocks held longer than one year will result in taxes at the capital gains rate, which is much more friendly to investors.
Short-term traders utilizing technical signals also need to understand certain restrictions like settlement dates and pattern day trading (PDT) rules. Traders using short-term strategies may hold stocks for a few days, hours, or in some cases, even minutes. Long-term traders don’t need to concern themselves with T+2 or PDT rules since they hold stocks for weeks, months, or years. If you want to trade using short-term techniques and you don’t know what PDT and T+2 mean, you have some reading to do.
Time (Level of Trading Involvement)
Time in the market matters greatly when differentiating between long and short term trading, but it’s not the only time frame to measure. One of the benefits of longer trading time frames is the amount of active work you need to do monitoring your investments.
Short-term traders must keep an eye on their stocks every day, searching for either new opportunities or potential breakdowns in their trades. Technical research is difficult and time-consuming, plus your eyes might start to hurt after staring at so many charts. Day trading is a full-time job and swing trading is a part-time job – don’t undertake them if you aren’t willing to log the hours.
Meanwhile, buy-and-hold investors don’t need to follow daily sentiment or spend hours staring at charts. Most long-term traders gather information through company documents like income statements, balance sheets, and quarterly earnings reports. Fundamental research like this is a little drier than charting or social media sentiment, but it requires much less of a time commitment too.
How much risk are you willing to endure in a trade? There’s a common misconception that short-term traders accept more risk than long-term ones, but it’s actually the opposite. A short-term trader has no appetite for losses – their goal is quick profits, which means riding winners and cutting losers quickly.
On the contrary, long-term traders have time on their side. If a company like Amazon (NYSE: AMZN) declines by 10% in a month, a long-term trader who believes in the company will be buying more shares, not dumping them. Since the profits from the trade won’t be realized for years or more, any short-term declines represent buying opportunities. Yes, buying the dip does work if your time frame is long enough.
Another misconception – short-term traders look for home runs while long-term traders profit incrementally. Backward again! Short-term traders want singles and doubles, little wins that pile up into large profits over time. Day traders especially look for these tiny opportunity windows, often entering and exiting trades after a 4-5% gain.
A long-term trader is the one actually looking for home runs. Despite what you’ve seen from AMC and GameStop lately, most trades won’t gain 100% in a week. In order to double or triple your investment, you need to be in for the long haul and not drop the shares at the first sign of market turbulence.
Short-term traders use technical analysis and charting to plot their trades. Since the goal is to predict price movement, factors like volume and volatility matter far more than gross margins or sales numbers. Think of short-term trading like playing poker – you’re playing the other people at the table just as much as you’re playing your own hand. Predicting the movements of other traders is the key here.
Long-term traders use more traditional means like financial media and company reports. Sales numbers, margins, debt levels, and future guidance are the things to pay attention to here. If a company isn’t turning a profit, it won’t be viable in the long term, no matter how hyped or parabolic they go in the short term.
Remember those PDT rules? Here’s the crucial one – if you want to make more than three day trades in a five-day window, you’ll need to have a cash account or maintain a balance of $25,000 in a margin account at all times. Day traders need to be properly capitalized because a broker can block your trades if you run afoul of PDT restrictions.
Long-term traders can start their accounts with as little as needed to buy one share of stock. In fact, thanks to fractional shares offered at many online brokers, you don’t even need that now – as little as $5 could be enough to get started. Long-term traders should seek a diverse portfolio to better temper shocks to individual stocks and fractional shares are a great way to diversify a low balance account.
A little self-reflection is needed before determining a trading style. Do you scream at the TV when your favorite sports team is losing? Or can you sit quietly and calculate the odds of a potential comeback without getting emotional? It’s not a perfect test, but the latter person may be better suited to short-term trading. Money is an emotional topic and many traders struggle to maintain their wits during short-term bouts of volatility. A long-term trading strategy can be utilized if you’d prefer to ‘set it and forget it’ and not worry about your heart overriding your brain.
Should I Short or Long Term Trade?
The answer to this depends on how you responded to the differences mentioned above. What are your trading goals? How much capital do you have? How much time can you devote to trading research? And most importantly, what type of temperament do you have when money is involved? Short-term trading requires more technical skill and knowledge of the market’s underlying plumbing. Long-term trading can be as simple as buying a Vanguard Target Date Fund and checking it once a year. Which do you feel more comfortable with?
Buy and hold or wheel and deal? Short and long-term trading strategies both have strengths and weaknesses, so the choice is up to you. If you don’t have the time to devote to a short-term strategy, don’t engage in day or swing trading. Long-term investors have been rewarded decade after decade. But if you want to earn a daily living from stocks and have the focus to learn technical strategies, short-term trading can be a long-term winner.