As traders embark on their trading journey, they embark on a voyage of self-discovery and a lifelong learning process. To be successful, they have to develop the discipline to build good habits and master their emotions. But as the ancient Chinese proverb states:
‘A journey of a thousand miles begins with a single step.’
Choosing a trading strategy is the first step in a trader’s journey to grow a small trading account. A well-defined strategy acts as their constitution and guides them through market implied volatility and unforeseen circumstances. As the trader evolves, their strategy’s rules, formulas, and signals like candlestick patterns for entry and exit will develop in parallel. A reliable trading strategy gives traders an edge and empowers them to generate profits from the market rather than being swept away by exit liquidity.
Defining a strategy begins with determining the time period. Traders use various strategies, indicators, schools of analysis, and time frames. This article will focus on the differences between short-term and long-term trading, two of the most common trading styles.
Short-term traders operate within a time frame that ranges from minutes to days, and their trading decisions revolve around price action and technical analysis. Short-term trading is a fast-paced activity that can be emotionally stressful due to the need for quick decision-making based on rapidly changing market conditions.
Long-term traders operate within a broader time frame that can range from weeks to years, and their decisions are based more on macroeconomic trends and fundamental analysis. Long-term trading requires less focus on charts as traders who have entered a position – typically because they believe the asset is undervalued or trending – do not need to extensively monitor short-term market noise or volatility.
Information is critical in trading, and self-awareness is often an overlooked element in achieving success. As you read this article, take the time to reflect on which trading strategy aligns more with your personal style and interests. This awareness can serve as a signal to delve deeper into the techniques and practical strategies within the time frame that resonates with you.
Short-Term trading takes advantage of small fluctuations in price and typically involves leverage over a short time frame, allowing traders to maximize returns from smaller price movements.
The most common type of short-term trading is day trading, where a trader will enter and exit a position, often several, within a single day.
Swing trading is another short-term trading strategy that takes advantage of an asset’s price action between swing lows and swing highs and can last several days, sometimes even weeks.
Technical analysis governs this approach, and short-term trading sees an uptick during periods of market volatility, for example, with company earnings releases and FOMC meetings.
An Example of News-Based Short-Term Trading
The Semiannual Monetary Policy Report was held on 07 March 2023, a committee hearing where Jerome Powell addressed Congress- a prime trading event for short-term traders. Powell stated that recent economic data had come in stronger than expected, further suggesting that the ultimate level of interest rates would be higher than anticipated.
This means higher rates for longer, debt is more expensive, disposable income decreases, and company earnings fall. The markets interpreted Powell’s hawkish tone as bearish, and short-term traders could have taken this hawkishness as a signal for entry, and traders could have shorted large companies such as APPL.
Short-term trading is a challenging endeavor, which also makes it an attractive option for many traders. Successful short-term trading demands a high level of emotional resilience, quick decision-making, and the ability to cut losses short. It is a fast-paced trading style, and many people are drawn to it. These are the three main benefits of short-term trading:
Quick returns. Traders can make money anytime, anywhere, from a laptop or smartphone with an internet connection. Short-term trading strategies enable traders to realize gains within hours.
Capitalizing on market volatility. Events can be very profitable trading periods for short-term traders who can take advantage of large intraday swings driven by news and global events. Whereas long-term traders watch passively, short-term traders are active and engaged with the market, therefore, are presented with more opportunities to profit.
Technical analysis abilities. Technical analysis is the foundation of short-term trading. Short-term traders rely on technical analysis to identify trends, patterns, and signals for entry and exit points. With sufficient time and practice, traders who opt for this time frame can become highly skilled in technical analysis, enabling them to make informed decisions about their trades.
Trading over short periods is not easy, it is highly stressful, and statistically, many people lose money. Retail traders will be going up against institutional traders using Bloomberg terminals, where they can see order flows and other real-time financial data. Several other disadvantages include:
Higher transaction costs. Like any enterprise, trading incurs costs, and the more trades a trader makes, the more expenses they accrue. Traders must pay commissions, spreads, foreign exchange fees, and if using leverage, a borrow fee. These costs can rapidly eat away at a trader’s profits and must be factored in.
Higher risk. Short-term trading is a career and should be treated as such, not something people should engage in as a passing fancy. This applies, especially if they are accessing leverage. Even for seasoned investors, day trading is complicated and requires a well-planned risk/reward strategy.
Difficulty in predicting market movements. Markets have always been and always will be prone to bouts of irrationality, and no matter how tightly a trader has placed their stop loss and taken precautions, the market can swing unpredictably. A single loss also has the potential to eat up prior profits.
Long-term trading outlines a trade where the trader holds an asset for one year or more. There are some nuances between long-term investing and long-term trading. A long-term investor seeks to buy stocks or other assets and hold them to increase their wealth. Long-term traders exit positions when the trend peaks in their favor. A classic example of a long-term trade would be holding a stock through a multi-year bull market and selling when the bear market begins.
Whereas short-term trading favors commodities and forex markets, long-term trading works best in markets that build on the prior market cycles, for example, stocks, real estate, and, increasingly, crypto.
Traders who speculate over extended time frames can distance themselves from the market noise and brief periods of volatility. With a fundamental approach to selecting assets, these traders do not need to make frequent adjustments and can enjoy a life unobstructed by market anxieties. There are several other benefits to long-term trading:
Lower transaction costs. Sometimes referred to as set and forget, long-term traders interact less with the market and therefore do not end up enriching their brokers.
Lower Risk. Long-term traders rely more on fundamental analysis, and they are betting on the future expansion of a real business, not minute price fluctuations driven by other traders worldwide. They are taking advantage of larger macroeconomic trends and are less exposed to how pernicious markets can be in shorter time frames.
Potential for higher (long-term) returns. Long-term traders can leverage multi-year cycles of real economic growth, exposing them to the enormous upside of trending markets compared to short-term traders who search for more minor price fluctuations.
Takes emotion out of the equation. Entering a position with the intention of holding it for a year or more removes the natural impulse of traders to make reflexive decisions based on short-term volatility. Long-term trades naturally carry a greater sense of mental security for the trader.
Tax benefits. Uncle Sam is more generous regarding capital gains taxes on assets held over a year, allowing traders to pocket more profits than those trading over narrower windows.
This trading time frame means traders are locked into their positions and will not make frequent adjustments which can come with an extensive opportunity cost. Other disadvantages include:
Limited ability to capitalize on market volatility. Market volatility can be highly profitable. One of the critical advantages of long-term trading- the investor being removed from the market- is a double-edged sword. A recent example would be the spectacular rally stocks enjoyed in the first two months of January 2023; long-term traders would have been sidelined and unable to capitalize on this short-term swing.
Limited use of technical analysis. Traders operating over a longer-time frame gravitate toward fundamental analysis, requiring extensive research into the company/ asset. Technical analysis is often ignored in favor of fundamentals. In the increasingly digitalized world where market psychology grows more critical due to increasing access to financial services, it can lead these traders to see markets too one-dimensionally.
Can’t withdraw. Long-term traders lock up their capital in their positions, which can limit their liquidity. If a trader is forced to sell their position early due to unforeseen circumstances, they may not be able to realize their gains.
Requires patience and discipline. Long-term trading requires a specific psychological profile that not everyone possesses. It requires patience, discipline, and the ability to concentrate on one thing for a long time. Many traders lack the necessary patience and discipline to adopt this type of trading approach.
An Example of a Long-Term Trade
Every 210,000 blocks, the Bitcoin network cuts BTC rewards by half, known colloquially as the halving. This event reduces supply, and if demand stays constant, this event naturally exerts upwards price pressure.
The most recent halving occurred on May 11, 2020. Following the halving, Bitcoin’s price has rallied before reaching a local top roughly a year and a half later. Long-term traders may enter a BTC position at the next halving and exit within a similar time frame.
Another highly simplified long-term trade would be going long on the S&P 500 index. Traders can analyze historical recessionary drawdowns and decide on an entry point based on their expectations.
Using the 2001 Dot Com bubble crash as a yardstick, when the S&P 500 suffered a drawdown of 49.1% over two and a half years. The S&P 500 trading at a level close to 2,400 makes it a very attractive buy for long-term traders.
The decision ultimately comes down to the individual. The core things to consider are risk tolerance, personal psychological profile, and investment goals when deciding on a trading strategy and time frame.
Short-term trading will suit many traders better, those who prefer to be plugged into markets, whereas long-term trading will favor those whose interests rest more heavily outside of markets.
Short-term trading entails greater risk and naturally leans toward a younger demographic with years of earning potential ahead of them and time to learn, make mistakes, and improve.
Long-term trading favors those who want to build wealth steadily over time and serves those who do not want to deal with high-intensity decisions all the time.
However, the decision is not binary. Traders can employ both strategies, taking long positions on assets they believe will continue to grow and develop over the next several years and using short-term trading to exploit short-term volatility. This dual strategy should be actively encouraged. The real question is one of the proportions: over which period will traders make most of their trades?
Short and long-term trading strategies offer various benefits, and the individual can employ either based on their understanding of their circumstances and goals.
It will all come down to the individual level and the trader’s self-understanding.
Overarchingly a trader should look to develop long-term trades to build wealth and profit from financial verticals they believe will expand. While using short-term trading as a hedge against rigidity and allowing them to ensure they can capitalize on market volatility.
Disclaimer: All investments involve risk, and the past performance of a security, industry, sector, market, financial product, trading strategy, or individual’s trading does not guarantee future results or returns. Investors are fully responsible for any investment decisions they make. Such decisions should be based solely on an evaluation of their financial circumstances, investment objectives, risk tolerance, and liquidity needs. This post does not constitute investment advice.
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