It was the prospect of day trading that first brought me to the stock market. The concept of making thousands – or even millions – in a span of weeks completely blew my mind. Day traders who work at the biggest of firms can bring down millions of dollars per year. Who wouldn’t want that?
While I found day trading seductive, short-term investing isn’t all it’s made out to be.
What’s wrong with short-term investing?
Short-term investing isn’t inherently bad. However, retail investors like you and I have very little chance at developing an edge.
High frequency traders can buy and sell 50 times before we get the chance to buy. We can hardly justify a $6,000 a month subscription just to get early economic reports. When you’re moving thousands of dollars, not tens of millions or billions, profitable short-term trading is a very difficult way to make money.
I think it’s important to differentiate between short- and long-term investing. Short-term “investing” relies on the concept that something will be worth more a day, a week, or even a month from the time you buy. Long-term investing is rooted in the idea that eventually what you buy will be worth more than what you pay.
Margin of safety
What if your investment thesis is wrong? What if your expectations don’t prove true?
One of the greatest investors, Benjamin Graham, always said that investors need a margin of safety. That means buying a stock, bond, or any financial asset at a significant discount to what you think it is worth.
Remember, companies are priced based on the future. As we know, the future can be difficult to predict.
Graham always wanted sizeable margins of safety. He wanted to buy companies at a 30% or greater discount to what he declared them to be worth. The beauty of a discount is that if you’re wrong, you can still make money. If you can remove bad investments from your portfolio, you don’t need world-class performance from the “good” investments to beat the market.
Why short-term “investing” is hard
Short-term investors or traders are not out to make 50% returns on a stock. They’re out to make two or three percent – a 10% day would be a heck of a day.
That’s what makes short-term investing so hard. Suppose you analyze a stock and believe it to be worth $50 a share. If you buy at $48, then you cannot afford any errors in your analysis. A single revision to the company’s earnings 10 years from now might send the company’s value from $48 per share to $45.
That’s what makes short-term investing so hard. You’re buying a company based on years and years of earnings and cash flow but hoping to sell it within a very short time frame.
Sometimes the market can go against you. Take a look at a chart of Apple. Last year it sold for $700 per share, traded at 15 times earnings, and was highly-regarded as the growth stock trading at an earnings multiple at or around the multiple of slower-growing S&P 500 companies. Today it floats around $400 per share and analysts worry growth may stall – or it may come in negative.
Being as well-known as it is, Apple is prone to routine speculation. Speculators bet on its next new phone, tablet, or computer, hoping to make a quick buck if the share price goes up.
What happens today or a week from now is largely irrelevant to what the company is worth, however. If you bought Apple at $700 hoping to sell it at $710 a week later, you’d be very, very disappointed.
I don’t want to say that short-term investing cannot be profitable. There are plenty of traders making seven figures year after year. But for most of us, investing for the long haul affords much more opportunity than short-term trading. It’s much easier to have an edge over long periods of time than over short periods of time. For that reason, individual investors should think for the long haul.
Ask yourself if you wouldn’t own a stock for 10 years, why would you own it for 10 minutes?