I recently got this question from a viewer based in the United States so thought I would share my views on this, as I am sure this will also help a lot of other people.
Before I begin, I should add that personally I am in both camps, running a core long-term portfolio, which continues to purchase great businesses at the right price opportunistically as well running short and medium term trading portfolios, which are far more active in attempting to generate a much bigger reward for my efforts.
I believe it all comes down to your passion and your time commitments.
I attempt to list 5 advantages and disadvantages of each (there are of course many more but these are the main ones I believe), which should help you decide which camp you fall into;
- Biggest disadvantage is the slow feedback time which does not allow you to know if you made the right choice until months and in some cases years down the track
- Long term capital committed means potential opportunity costs where funds can’t be committed elsewhere
- Getting too comfortable and hence may lead to lack of review of investments made
- I might even add that risks are in fact higher because a company you hold may have a few bad quarters and hence its price may drop back to the level where you purchased at or even below and hence feel you have made no progress at all after all this time
- Higher volatility of your portfolio due to the daily swings of market movements. Just look at the GFC, where even the best performing long term funds temporarily lost up to half their portfolio values
- Much lower transaction costs where buy, sell and spread costs are minimal because of the inactivity of transactions
- Due to longer term nature, lower risk as timing of entry and exit of the investment is not as vital when compared to active trading
- Lesser time commitments with perhaps just a simple weekly or even monthly review is adequate
- Much easier to learn, as trading adds a new level of complexity such as entry and exit, price patterns, trade volumes, fund flows, current market conditions etc.
- Potentially a much larger payoff of multiple times your original investment because you gave the great business you invested in, time to grow to your expectations (just look at Warren Buffett)
- Lower realised profits and hence lower taxation costs
- Much higher transaction costs although this can be minimized simply through choosing the right online discount broker
- Psychologically taxing as decisions are needed to be made much more often and having to accept at times more than half of your trades being wrong and unprofitable
- Time commitments is high as you do need to be abreast of current market conditions and events and even individual stock news
- Potentially much higher risks especially at the beginning while you are still learning and you don’t really know what you are doing despite what others may tell you
- Activity may not translate to higher profits than simply holding onto a long term portfolio of great stocks
- Speed of learning is increased dramatically as feedback of trades placed can be within a matter of days and weeks, not months and years like investing
- Flexibility to enter and exit trades according to rules and market conditions and even be totally in cash if the market dictates this
- Mentally rewarding as you find that opportunities are abundant and hence you get to pick and choose only the very best that fit your criteria and rules
- Ability to lock in profits at a much faster rate and move onto other opportunities
- The biggest advantage is the potential to create much higher returns because you extract many small expected price rises or drops (if shorting) and then move onto the next before it reverses
So question is, where do you see yourself?
For those who know my story, personally, I began as a long term Warren Buffett type value investor disciple and who never even considered shorter term trading. I would even go as far as saying that I probably thought you were silly if you thought trading in and out of stocks could generate a better return based on technical analysis using nothing but charts and past price action.
However, being the learner I am, I eventually took an interest in technical analysis to see what it was all about. Although I made sense of it all, I struggled to make money from it. For one thing, I thought it was far too subjective in most cases. Deciding where support and resistance was, is it this trend line or the other trend line better, which moving average should I use etc etc.
Having said all this, I have met some brilliant pure technical traders who day trade through their entire day successfully. This suits their personality but does not for me and I believe for most people it is not either. Staring at the screen all day (besides the fear of ruining my eyesight) just did not gel with me. I have this insane desire to travel and work from anywhere around the world, mixing business and pleasure. Day trading simply will not allow me to fulfil my travelling passion and freedom I seek.
It was only when the Global Financial Crisis came and literally decimated my long-term portfolio like all other funds managers, which jolted me to consider alternatives. Hence today, I marry up technical analysis and fundamental analysis, and investing with trading.
I’ve learnt that finding and keeping long term great stocks is a great way to build wealth (just look at Warren Buffett), but at the same time, trading a diversified portfolio of strong stable stocks also generates an even greater return as money is used much more efficiently since there is no longer the opportunity cost of not being able to purchase something simply because of long term commitments.
I encourage everyone to look really hard at themselves because I simply believe that your success in the markets depends primarily on marrying your personally with your investing and trading style as your foundation to build upon.
So which camp do you belong to? Alternatively, do you belong to do both and would like to do both?
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