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Active Trading vs. Buy and Hold

All investors must reevaluate and refine their investing styles and strategies from time to time. As we gain investing experience and knowledge our view of the market is likely to change and most likely broaden how we envision the extent of our investing capacity. Those who want to try to outperform the market (that is realize returns greater than the market average) might consider an active trading strategy such as our style here at STHQ even if only for a portion of their portfolio. In this series this week we will explain what active trading is how active traders view the market their tools and investment vehicles and finally the risks associated with this style. 

The best way to understand active trading is to differentiate it from buy and hold investing. Buy and hold investing is based on the belief that a good investment will be profitable over a long period of time and ignoring daytoday market fluctuations. Using a buy and hold strategy this kind of investor is indifferent to the shortterm for two reasons: first because they believe any momentary effects of shortterm movements really are minor compared to the longterm average and second because shortterm movements are nearly impossible to exactly predict. 

An active trader on the other hand does not want to expose their stocks to the effect of shortterm losses or missing the opportunity of shortterm gains. It is not surprising then that we as active traders see an average longterm return not as an insurmountable standard but as a runofthemill expectation. To exceed the standard or outperform the market we realize that we must look for the profit potential in the market's temporary trends which means trying to perceive a trend as it begins and predict where it will go in the near future. 

Even though the market moves upward over time it experiences many smaller trends in both directions along the way and this is what we as short term traders try to exploit while the long term investor is content to stand pat and ride it out.  Traders are active because they want to capitalize on the markets short term movements.  For us the importance of the market's shortterm activity is magnified while the long term investor does not want to take advantage of every move.  What the long term investor does not realize is these market movements offer opportunity for accelerated gains over short periods of time. 

A greater number of trades do not necessarily equal greater profits. Outperforming the market does not mean maximizing our activity it means maximizing our opportunities. Maximizing returns or outperforming the market is not just about reaping profits; it is also about avoiding losses. In other words we traders will use technical analysis to spot any signs that the stock is about to take a turn in an undesirable direction. When these signs occur we know that it is time to exit the trade and use the proceeds in another trade.  A longterm trader on the other hand stays invested in the stock if they have confidence in its value even though it may be experiencing a downward shift.  The buy and hold investor must tolerate some losses that the trader believes are possible to avoid.

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