At the Motley Fool Singapore, we are long-term investors. There are good reasons why that’s so: Investing with a long time-horizon helps stack the odds of success in our favour. Here are four good factual examples of why I think frequent and/or short-term trading isn’t the way to operate in the stock market. 1. A study has shown that the ones who trade the most end up performing the worst Finance professors Brad Barber and Terry Odean once studied the trading records of 66,465 households in the US for the period stretching from 1991 to 1996. What Barber and…
At the Motley Fool Singapore, we are long-term investors. There are good reasons why that’s so: Investing with a long time-horizon helps stack the odds of success in our favour.
Here are four good factual examples of why I think frequent and/or short-term trading isn’t the way to operate in the stock market.
1. A study has shown that the ones who trade the most end up performing the worst
Finance professors Brad Barber and Terry Odean once studied the trading records of 66,465 households in the US for the period stretching from 1991 to 1996.
What Barber and Odean found was that in that six-year block, investors who traded the most earned a return of 11.4% per year on average. That sounds good until you realise that (a) the market actually grew by 17.9% annually over the same period, and (b) the average investor had earned an annual return of 16.4%.
2. It is easier to make long-term forecasts in the stock market than it is to make short-term ones
In his book The Signal and the Noise: The Art and Science of Prediction, statistician and political forecaster Nate Silver asked the question: “How could stock prices be so predictable in the long run if they are so unpredictable in the short run?” When he asked the question, he was referring to a few charts he showed in his book. I’ve reproduced the charts below:
Source: Robert Shiller’s data; author’s calculations
The charts, which uses data going back to 1871, compares the annual returns of the S&P 500 against the index’s starting valuation for a holding period of 1 year and 10 years. With a 1 year holding period (the chart on the left), the stock market is essentially a crap shoot; cheap stocks can easily fall and become cheaper while expensive stocks could just as likely go roaring on and become even pricier.
But when we extend the holding period to a decade (the chart on the right), a much clearer theme emerges: Buy stocks when they’re cheap and you’d likely end up with a good outcome; buy them when they’re pricey, and you’d have poor odds of ending up with a profit.
3. A study has shown how day-traders can’t make a profit
Barber and Odean also once collaborated with Taiwan-based finance researchers Lee Yi-Tsung and Liu Yu-Jane to find out how Taiwanese day traders fared. (A day trade is made when a stock market participant buys and sells the same share on the same day)
They studied the records of thousands of day traders over a five-year period and found that as a group, the day traders’ “profits are not sufficient to cover transaction costs.” Furthermore, “in a typical six-month period, more than eight out of ten day traders lose money.”
4. The longer you hold your stocks, the higher your odds of making money
Here’s a chart showing the odds of making losses in the Straits Times Index (SGX: ^STI) from 1 May 1992 to 12 January 2016 for different holding periods (the returns do not include dividends and inflation):
Source: S&P Global Market Intelligence; author’s calculations
As the chart shows, the longer you hold your stocks, the lower your odds of making a loss. For the timeframe under study, a holding period of one day leaves us with a 48% chance of suffering a loss. But if our holding period is stretched to 10 years, the odds of making a loss has historically been just 17%. If the holding period is extended still further to 20 years, the Straits Times Index has never delivered a loss.
Former Motley Fool writer Morgan Housel also once looked at more than 140 years of market history in the US and came to the conclusion that “the odds of success grow perfectly with time. If you hold for five, 10, 15 years or more, the odds of earnings a positive return on stocks after inflation quickly approach 100%, historically.”
Financial advisor Nick Murray once wrote that “Time in the market will be your greatest natural advantage.” I agree with him. Do you?
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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore writer Chong Ser Jing doesn't own shares in any company mentioned.