Know your trading term

A lot has been written about an investor ‘knowing the term’ of any position that they take in the market. For example, when a long term ‘buy and hold’ position is taken, the investor must be prepared to ride the ups and downs of the market but must also be prepared to accept a lower compounded annual return from that investment. Typically, the ‘buy and hold’ approach will require less time, effort and knowledge on the part of the investor and hence is viewed more as a ‘passive investment approach’.

The main problem with the passive ‘buy and hold’ investment approach is that the investor may sit on losses for long periods of time before their investment starts returning profits. Stocks can be out of favour for many years. During that time the investors’ capital is not working well but may eventually return a profit. If an investor grows impatient and sells while the stock is in loss territory, it may return a significant loss and every now and then a total loss in that trade.

In addition, investors can watch frustratingly as their hard earned profits rise and fall over the years with cyclical and ‘defensive’ stocks that move sideways in wide trading bands. The problem is most investors do not have the knowledge to actively time their entries and exits. Hence long-term ‘buy and hold’ investors have no choice but to tolerate the ups and downs and the sub-index returns that result.

Investors who are prepared to put in a little extra effort for a better potential return may adopt a medium-term trading approach. This way, the potential pitfalls of the ‘buy and hold’ approach can be avoided, like the large loss trades, and sustained profits can be more readily assured.

Likewise short-term traders must be fully aware of the term they are trading. The short-term trader can undergo extreme stress and psychological pressures in their endeavours to trade volatile swings in the market.

Short-term trading is a far riskier venture that can return large profits but can also return large losses and, in fact, can even wipe out the inexperienced trader. Short-term trading requires:

• Multiple hours of daily attention and effort.
• Extensive knowledge of markets.
• Extensive experience in using technical analysis to trade.
• Immunity to stress caused by market volatility and illogical and inexplicable movement of share prices in the short-term.
• The ability to differentiate between the characteristics of equities and instruments that lend themselves to short-term trading and those that do not.
• Psychological strength to deal with extended periods when more loss trades than profit trades occur.

If you wish to become a short-term trader, one way of reaching the ranks is through medium-term active investment. That is, gain experience and knowledge while exposing yourself to a lower risk of losing your capital with less effort requirement. Then slowly build from there.

Most short-term traders manage medium to long-term portfolios anyway, as the two are not mutually exclusive. The successful short-term traders apportion only a small part of their trading capital to short-term trading because of the risks and stress involved. Only a fool will constantly deploy all their investment capital to short-term trading.

I believe that the medium-term approach suits the greater majority of private active investors in the market with the potential to achieve the best balance between risk and reward as well as effort and reward. Specifically medium-term is a suitable period for new active entrants to the market.

When a stock is purchased for a particular portfolio (and therefore investment period) you need to be consistent through the ownership period of that stock. For example do not convert a stock you have bought for medium-term trading to long-term simply because the price has dropped and you have missed the exit signal! Equally if the stock price has increased by 50% do not employ a short-term strategy of taking the profit on what is meant to be a medium-term trade. Again, be consistent.