Short Term Vs. Long Term Traders: Does It Matter?
Investing is often related to gambling in that one takes a risk with an uncertain outcome and hopes that their money will increase as a result. To be fair, many would argue that investing and gambling are not the same thing at all, given that investments are structured to increase in value over time, while gambling is structured to advantage the house over a long period of time. That being said, we all know that the goal of the activity is to increase wealth. So, is it better to think of yourself as a short-term or long-term trader? Is one better than the other? We want to explore these questions with you and help provide useful definitions of what each means.
There is not a single definition of what “short-term” means when applied to trading. For some people, this could mean holding an investment for mere minutes; for others, it could mean trading out of something after holding it for just a few years. Given the broad definitions that different people have of what short-term investing is, we feel it is appropriate to use what would fall under the legal definition of a short-term capital gain as explained here by the Cornell Law School. This is to say, for our purposes, we will define short-term trading as an investment held for under one year.
Modern traders sometimes view short-term trading as highly valuable and perhaps even the only appropriate way to play the market given the rising volatility in markets in recent years. They point out that people who engage in short-term trading are more likely to stay up-to-date with the latest market news and to react swiftly to changes in market conditions as they deem necessary.
To bolster their case, short-term trading advocates will point to some of the events that took place in stocks like GameStop and others in early 2021. Wired.com details the situation that unfolded there:
LAST JANUARY, A growing group of retail investors congregating on a subreddit called r/wallstreetbets took to the zero-commission trading app Robinhood and bought stock of GameStop en masse. Despite the ailing video game retailer’s dubious fundamentals, they catapulted its price from $17.25 at the beginning of the month to over $500 by January 28. The event sent shockwaves across the world’s trading floors, made headlines, and caused a lot of general bemusement.
This was the kind of move that very few saw coming, but a significant number of people in the public benefited from it. It was the ultimate short-term style play as there was little case to be made about the long-term fundamentals of this company. It didn’t much matter though as traders eagerly piled into the stock and drove its price sky-high. Those who reacted to the short-term volatility in this stock profited handsomely from it. That is something that long-term-only-minded traders didn’t get to take advantage of.
While stories like that are exciting, they don’t paint the full picture of the risk that short-term traders take. They have to put all of their chips on the line for small movements over a period of hours, days, weeks, or perhaps a few months. If they are wrong in their predictions, then they can lose their funds just as quickly as they can make them. Are you the type of person who is comfortable potentially losing money on that scale? If you are, then the allure of the high risk/high reward nature of short-term trading might be right for you. Otherwise, steer clear.
Most people are more familiar with long-term trading. This is when someone routinely puts money into investments with the hope of selling them at some point years down the road for a profit. It is what people do every time they contribute to their 401(k) or when they make a play in stock with the hope that the stock will be higher in value years or even decades into the future.
It doesn’t necessarily sound as exciting to be a long-term trader as it does a short-term trader, but the reliability and consistency that one can get with long-term trading is sometimes worth the trade-off to certain people. They recognize that they may have to exert a lot of patience to stick with their investments over the long run, but they also can absorb a lot more volatility as they are not too concerned with where the price is today or tomorrow. They are only thinking about where it might be many years down the road.
If you are someone who has a low tolerance for risk, or simply someone who wants a more reliable ability to increase your wealth over time, then long-term investing might be right for you. Although you should definitely do some research on the front-end to make sure you know what you are putting your money into, you don’t have to worry as much about tracking the day-to-day wiggles of the market. The market is going to do what it is going to do. It is up to you to stick to the plan and enjoy your profits at the end of the journey.