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3 great short-term trading skills
Uma Shashikant, Outlook Money | December 07, 2006
"Does investing have to be only long-term," someone who loves his Internet trading portal despite the losses he made in the recent past, asked me. What's the harm in short-term trading?
Sure, there are several levels of engagement people have with the stockmarket, and there is no single best strategy. Different skills are needed for short-term and long-term investing, and both have their challenges.
While long-term investing requires a thorough understanding of the fundamentals of the business, short-term investing requires a high level of agility and ability to manage capital prudently.
I have seen that several investors who direct their savings into short-term trading, further augmenting it by borrowings, fail because they mix the two issues. They end up masking their short-term losses, rechristening them as long-term investments.
1. The first skill in short-term trading is speed of execution. While buying in, the focus is on the price, driven by the expectation of an immediate price rise. Then the focus has to remain on the price and the probability that it can rise as well as fall. The urgency seldom returns if price falls instead of moving up.
When the price fluctuates, several short-term investors lose focus and seek other information. Some refuse to accept that the stock has fallen from favour. Some wait, hoping for a revival. Others are so fixated on their acquisition price that they are oblivious to the fall, as long as the current price is above their cost.
A good short-term trader always couples his buys with a stop loss, and simply moves out if the price fails to oblige.
There is no seeking of explanation or looking around for approval, but a quick admittance of error, leading to an exit. Agility in entry and exit is not about the speed of the trading portal, but about the investor's willingness to accept loss and quit without question.
2. The second skill is about learning to leverage a given amount of capital. At all times, a short-term trader is asking if there is a better deal which can run faster, so that his money is better deployed. There is always the understanding of the cost of money and the need to generate more than that at all times.
I have seen many new investors speaking about their trades in isolation, focussing on the winning ones, side-stepping the losing trades. Every trade that does not make money drains capital and is not worth it. The return on the aggregate position across stocks is more important than large wins on portions of it.
To book out of winning positions is to release capital for other uses, carefully considering returns at each stage.
3. The third skill is to ensure that long-term concepts and short-term strategies are not mixed. Value trades and Warren Buffett are for the long term. Choosing one multi-bagger that will make good other losses is for private equity investors who are willing to wait patiently for years.
Long-term investors need not book profits frequently since they do not use borrowed capital. They can take short-term losses in their stride. Short-term traders have to bear the costs of frequent trading and the losses from booking out too early. They chase momentum and will have to be willing to ensure that all their horses are running for them.
There is no point in converting short-term positions that make losses into long-term buys only because it sounds good.
To be able to take short-term losses not only requires money, but also attitude. Most learn this from bouts of losses rather than from profitable trades. The question, therefore, is not whether short-term trading is better or worse than long-term investing.
The former is about the stomach and the latter is about the head and the twain never meet.
The author is chief R&D officer, Optimix, and can be reached at email@example.com.