Investment Strategy

Why long term investors win, short term traders lose

Floor of the New York Stock Exchange 1963

Here at OfWealth we’re all about investing. Studying and sifting to find the best assets to own for the medium and long term.

To be really clear, we’re not interested in short term trading at all. We think trading is a mug’s game. Private individuals are almost certain to lose to the professionals if they try to take short term bets. The only way that private investors can make money is by being patient long term investors.

Market prices of individual investments can swing wildly on any particular trading day. Most of the time these swings are for reasons not linked to the specific investment. But in the long run, fundamental values will win out. As Benjamin Graham, who is considered the father of value investing, said: “In the short run, the market is a voting machine, but in the long run it is a weighing machine.”

“In the short run, the market is a voting machine, but in the long run it is a weighing machine.” Benjamin Graham

In other words, anything can happen to prices in the short run. But in the end fundamentals will drive prices of assets closer to their true values. So if you want to consistently make money, buy things that have prices below their true value. Then wait.

There are the thousands and thousands of professional human traders that work at hedge funds and investment banks. They sit for hours every day, each studying and trading one tiny part of the global markets, and battling to take profits away from other traders. They have better information than you or I, delivered to them more quickly, and much better trading systems.

But there’s yet another reason to avoid short term trading. More and more trading volume in the world’s big capital markets is done by automated computer programmes. Tiny price changes are traded all day long by these “robots” or “algorithms”, which can react in millionths of a second. Once the programme has been set up and let loose on the markets there is no human involvement.

In fact, in developed markets such as the US, so called “high frequency trading” makes up between half and two thirds of all the volume of all stocks traded.

Floor of the New York Stock Exchange 1963
Brokers working at the New York Stock Exchange (1963)

Basically, between the professionals and their automated trading systems, private individuals don’t stand a chance when it comes to short term bets. We have normal lives to live and fun to have. We shouldn’t be spending all day, every day, worrying about our trades and getting drowned in information.

Even worse than that is what private individuals have to pay to trade. We all rely on intermediaries to make our investments. These are the stock brokers, investment banks, fund managers, custodians and so on that push transactions through the financial plumbing like so much water. They exist to make a profit. And just like any business they give better deals to their biggest customers.

They exist to make a profit. And just like any business they give better deals to their biggest customers.

Immediate investment costs are made up of commissions and spreads. Commissions are a percentage that you pay to your broker to make a trade. Spreads are the difference between the price you can buy something for and the price you can sell it for at a moment in time. The broker keeps the difference when he matches a buyer with a seller.

When it comes to trading stocks and shares, private individuals typically pay in the range of 0.15% to 2% in commissions. The size of this amount will depend on the broker used, whether it’s a fixed cost or a percentage of the trade size, the size of the trade and where the trade is made (which stock market).

Professional traders and investors will typically pay in the range of 3 to 15 basis points. A basis point is 100th of a percentage point, so this is the same as saying 0.03% to 0.15%. In other words, a lot less than private individuals.

A professional investors will also negotiate the best prices for themselves. They have buying power and get the best deals. So if they buy something, they not only pay a much lower commission than we do, they also get a lower price.

So remember. The professional traders that work in financial markets have better information, faster reaction times and better pricing than you. For these reasons you shouldn’t even think about trying to make money from trading.

But at OfWealth our mission is to show you how you can still profit from medium to long term investing, by which I mean 3-10 years. If you buy things when they are cheap, and are patient, the results will significantly beat mainstream strategies. In fact you’ll probably beat most of the professional traders as well.

My conclusion: you can beat the professionals by changing the rules of the game to your advantage, instead of doing what you are told by your broker. But first, you need to understand the game that is being played. More to come…

Until next time OfWealthers,

Rob Marstrand

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Rob is the founder of OfWealth, a service that aims to explain to private investors, in simple terms, how to maximise their investment success in world markets. Before that he spent 15 years working for investment bank UBS, the world’s largest wealth manager and stock trader with headquarters in Switzerland. During that time he was based in London, Zurich and Hong Kong and worked in many countries, especially throughout Asia. After that he was Chief Investment Strategist for the Bonner & Partners Family Office for four years, a project set up by Agora founder Bill Bonner that focuses on successful inter-generational wealth transfer and long term investment. Rob has lived in Buenos Aires, Argentina for the past eight years, which is the perfect place to learn about financial crises.