Ask Colin

What do you think of buying a stock as a long term core investment, but trading in and out of it as well on a short-term basis?

There are several aspects to this question that need to be thought through.

The first issue is taxation. Unless such trading and investing is properly structured, it may be that the ATO takes the view that your long term investment is really part of your trading and disallows the capital gain concession when you sell it, taxing it fully as a trade. It would be well to get some professional advice on this, which I am not qualified to give.

The next issue is why someone would want to do this. I can think of a couple of valid reasons.

The first reason would be as a form of hedging. The stock could be sold short when it looks like going into a correction. If it is only a correction, the short may be profitable. If it is more than a correction, the profit on the short would to some extent compensate for the losses on the investment. Short selling requires a different orientation to buying, is complicated in the Australian market and is more risky than buying. See my article on short selling on the Articles page of my free access web site www.bwts.com.au

The second reason would be that the investor is not sufficiently disciplined, confident or risk tolerant to sit through corrections in a trend. They could therefore try to have a large position in the upswings, but take a lot of it off in the corrections. The problems with this are the costs of doing it. There will be significant brokerage, GST and slippage costs. Unless the upswings are substantial. it may be difficult to make good profits. The best book I have read on such swing trading is Dr Alexander Elder's Come into my Trading Room. This could be used as conceptual basis for building a swing trading method that suits such a person.

The third reason is not unrelated to the present one. This is that the investor has got to know the stock very well. They may feel that they know it well enough to trade it in the short-term as well, not in the shares, but in derivatives - options, futures, warrants or CFDs. These are dangerous games and I suggest that anyone who is thinking of this should read Dr Elder's comments on options in Come into my Trading Room before they try this. Derivatives could also be used to effectively hedge the investment position as described above.

The third issue is whether it is possible to successfully be an investor and a short-term trader. I lot of people talk with me about this and, with no experience at either, intend to start doing both. To do both requires extremely clear thinking and discipline. The psychological challenge of managing one position in a stock is difficult enough, but it is quite a lot more difficult to do two things at once. My usual advice is to start with one job and wait until you can develop a sound track record in it before taking on the second job. I have seen some people do this successfully. One of the good ones has very strict discipline. He only ever considers his investment portfolio on the weekends. He takes all decisions then and acts on them early in the week. Then during the week he only thinks about his trading. If you think this sounds easy, you don't know much about trading yet.

In conclusion, it should be remembered that the big money is made on the big moves. Staying in a big trend captures all of the profits without continual transaction and slippage costs entailed in short-term trading. To make short term trading work versus trend investing requires a high level of skill so that the internal compounding of the small short term gains gets near the investment return. I meet a lot of people who suffer from the common psychological trap called overconfidence. They vastly overestimate their ability to make accurate decisions.

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