Chris Burgess here, and welcome back to another Market Insights blog! Today, I'm continuing the series I started in our last blog on formulating a trading plan which you can read here. Next, we'll explore the second step of a trading plan: determining your time horizon and trading style and how those decisions impact your trading plan.
Much like the goals that you set for your trading account in our last blog, our next step is going to come down to personal preference and style. It's important to understand that there is no right or wrong answer here. However, there are some guidelines that I can give you to help you determine the best course of action for the outcome that you desire.
The first thing to understand about time horizon and trading style is that these fall along a spectrum. Imagine a gradient like the image below, with day trading on one end and long-term investing on the other:
Very short-term trading occurs on the left side of the spectrum. This is all intra-day trading, which could include everything from high-frequency trading bots to day traders and scalpers. Trades on this end of the spectrum are held for several milliseconds up to several hours, but not overnight. On the opposite end of the spectrum is where buy-and-hold investing lives. This is a very long-term focus. Trades on this end are held for many years.
In between these two extremes is every other time frame. The swing trader tends to hold onto trades for several days to weeks, and the positional trader may hold onto trades for up to several months. Intertwined with this difference in holding time is the amount and type of research that the trader needs to do at each level.
For example, a day trader simply does not care about the fundamentals of a company. The day trader is looking for a quick move in the stock, in and out, often scalping just a few cents in the change of the stock price. Because of this, the day trader is glued to charts, with fast-moving indicators that give him a statistical edge, ready to pounce as soon as an opportunity presents itself. The day trader is basically staring at his screen all day long because a good trade opportunity may come and go in an instant, and he has to be ready.
On the other hand, a long-term investor cares very little about the day-to-day price movement of her positions. Instead, she is focused on the bigger picture. She cares if the company she's invested in has a winning growth strategy. Are they dominating their industry, does the management team have a strong track record, do they reward their investors with regular dividends, etc. Because she has been saddling her capital to this company for many years, she has to know the ins and outs of the company very well before taking any risk by buying its shares. The long-term investor rarely checks in on her portfolio, though she may rebalance her holdings once per year or so.
A positional trader might blend the two approaches, knowing the basic fundamentals of the business enough to ensure that he's putting his capital towards a strong company with growth potential and then relying on technical analysis to help time his entry and exit points. The positional trader might check in on his stocks once or twice per week, for the most part letting them do their thing and adjusting when necessary.
Of course, these approaches are just paradigm examples, and there may always be exceptions to every scenario. They are there to give you an idea of what to expect at different points on the spectrum. All of these approaches can make money, and they can all lose money. Each requires a different mindset and a different set of skills to master.
Ultimately, you have to decide where you want to sit on the spectrum. And this isn't something that is set in stone; you're free to take a variety of short and long-term positions as opportunities arise. However, it's best to pick one approach and stick with it until profitable when you're still learning.
As the old saying goes: "F.O.C.U.S.":
Once you have proved that you can consistently make money over one-time horizon, then you can experiment with adding another to your repertoire. If you're just beginning to formulate your trading plan, I don't recommend that you start with short-term trading. Generally speaking, the shorter your time horizon, the harder it is to make money.
This is because of market dynamics; the market has tended to go up on average over the long term. So the longer you hold something, the greater the chance that it will go up eventually. But on a one-day basis, the chance that any particular stock goes up or down on an average day is basically a coin flip, hence why at-the-money options have a Delta of 0.50.
As teachers and mentors at T.S.U., we've found that students become much more successful if we can just get them to start holding their positions overnight. In fact, Josh has some cool data to back this up. In summary: overnight returns of the S&P 500 from close one day to open the next day are far greater than daily returns from open to close of one day. That means, if you just switch from trading intraday to trading overnight, your chances of making money go up dramatically!
Now, that also doesn't mean that you have to be a long-term investor. I know many people, myself included, aren't keen on the idea of waiting for years and years to see a return on their money.
I've found that the sweet spot when you're starting out is a time horizon of about 1-3 months. This gives your positions plenty of time to make decent returns while also providing enough wiggle room for the stock to recover in case your timing isn't perfect, as I know my timing is far from impeccable.
Of course, this doesn't mean that you will always be in every trade for the exact same amount of time. Far from it! By all means, cut your losers early, and hold on to your winners for as long as they keep winning. The time horizon you decide upon is simply an average of how long you expect to be in your trades to hit your targets.
So decide where on the time horizon you want to sit and which approach sounds the most appealing to you. From there, you will have a better idea of which types of strategies will best fit your chosen approach.
That is it for today's blog; next time, I'll begin diving into the different archetypes of strategies that will eventually fill your trading plan. So stay tuned!