Short-term trading may seem appealing to beginning investors, but it’s unpredictable and can lead to significant losses

Beginning investors may develop an unrealistic idea of how much money they can make by delving into short-term trading. It seems obvious to them that all it takes is some good advice from an expert.

However, any true investing expert understands that random factors play a big role in short-term stock price fluctuations. That’s why these movements are unpredictable. No outsider consistently profits from them.

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In fact, there’s a lot of randomness in the stock market and a lot of conflicts of interest. You have to take that into account if you hope to succeed as an investor.

Many investors try to outperform the stock market by going in and out of it erratically, based on their assessment of risk and potential reward. The trouble is that these risk assessments rise and fall with day-to-day or month-to-month economic and business developments, which are also subject to the influence of random factors and conflicts of interest.

As a result, these investors tend to “buy on strength,” as the saying goes. That is, they do more of their buying when confidence is high and stock prices have gone up. By then, however, much of the rise they hoped to profit from will have already taken place.

They are also inclined to “sell on weakness,” when investors are generally nervous and prices have dropped. That way, they hold on to their stocks during much of the decline they hoped to avoid. They may even wind up selling at or near the bottom in prices.

It may seem like a self-evident truth, but it’s worth repeating. While it’s hard to outperform the market, it’s easy to underperform it. In fact, some investors do it almost every year.

Understanding the realities of short-term trading

Many people start out investing with unrealistic ideas of how much money they can make from short-term stock trading, and how quickly they’ll get rich.

Inexperienced investors are shocked when they learn that successful investors rarely if ever do any short-term trading. (That applies to everybody from “The Wealthy Barber” to Warren Buffett.) After all, many stockbrokers, investor newsletters, cable TV financial kibitzers and so on seem to talk about nothing but day-to-day or hour-to-hour market trends. They make it sound easy to GRQ (Get Rich Quick).

It’s easy to sort through yesterday’s investment news and pick out a reason that seems to explain why a stock or the entire market went up or down today. Trying to spot tomorrow’s winners today is vastly harder. Nobody does it consistently.

The problem is that random factors have too much influence and a big unpredictable impact on short-term market trends. They are like coin tosses or the spin of a roulette wheel. Each individual toss or spin is a random factor.

At the height of the pandemic, many beginning investors put their government stimulus cheques into so-called “meme stocks.” They bought stocks that had lots of social-media fans. Investment advice that pops up on social media is an example of the random influences that impact short-term stock prices.

Another random influence is the conflicts of interest you encounter every day as an investor. They taint the guidance you get from public sources of investment advice. This is a risk regardless of where the advice comes from—online, old-line media, or at cocktail parties.

Early on, young investors may take their stock-market gains as a sign that they were born with a gift for picking stocks. In fact, it’s a sign of weakness—of gullibility. After all, if it was that easy to get rich in the stock market, why would anybody work for a living?

If you let random factors lure you into risky investments, it’s good to have little cash to invest. Successful investors will tell you that these investments are only “suitable for money you can afford to lose,” and that’s what’s likely to happen.

Studies show that the trading of aggressive short-term investments leads to losses

Studies by the Dalbar organization in the U.S. show that if investors do a lot of in-and-out trading, they routinely make only about one-third of the return they could have earned with a simple buy-and-hold approach.

According to research on top-performing mutual funds, most of their investors lose money or make negligible returns. Why? That’s because most of the investors in a top-performing fund only buy into the fund after it has already made big gains. Investors also tend to sell former top-performing funds only after a major slump in the value of the funds’ holdings. When you chase investment performance, it’s all too easy to buy at the top and sell at the bottom.

Here’s an investor saying you should always keep in mind: “If it was easy to predict which way the market will go, why would anybody work?” In fact, it’s hard if not impossible to consistently profit from short-term trading. That’s due to the large random element in short-term market trends.

Use our three-part Successful Investor approach for all of your investments:

1. Hold mostly high-quality, dividend-paying stocks.
2. Spread your money out across most if not all of the five main economic sectors: Manufacturing & Industry, Resources & Commodities, Consumer, Finance and Utilities.

3. Downplay or stay out of stocks in the broker/media limelight.

Do you think short-term trading be considered a legitimate investment strategy or simply a speculative venture?