The benefits of long term trading – Overcoming the psychological effects

The stock market is always uncertain as many factors come into play, both macroeconomic and microeconomic. Many traders look to time the stock market and take advantage of short-term stock movements, a lot of traders are not prepared however for the psychological effects that come with trading.

Short-term trading is risky but also brings higher returns to traders. Historical results suggest that traders looking for quick gains lose more money than they make.

Long-term investing brings higher profits and sustained growth for many reasons. Investing and holding yield better results if done properly. Although it doesn’t imply mean investing for the long-term and forgetting it altogether.

Let us walk you through the basics of long-term investing and how to overcome the psychological barriers with trading.

What is Long-Term Investing?

Long-term investing involves investing and holding money in an underlying asset for a year or longer. On the other hand, any investment strategy that looks for quick gains is termed a short-term trading strategy.

Taking a long-term route with investing is the most successful way of creating wealth. However, long-term investing also involves careful planning, portfolio creation, choosing investing strategy, and timing the plan for perfect execution.

Investors must clearly define their long-term financial objectives first. They can then set a benchmark to achieve these financial objectives. For instance, many investors look to match S&P 500 returns in the long turn.

During the long-term investment horizon, investors would suffer short-term losses. It’s important to bear such losses to fully harness the long-term capital gains. Short-term trading policies can affect your trading psychology as well. It will eventually change your trading style.

Strategies for Long-Term Investing

Long-term investing begins with careful investing planning. You should first evaluate the long-term financial objectives such as retirement planning, buying a home, or investing in a business.

Once you have clear goals in mind, you can plan to invest and build a portfolio that gives you the required return.

Here are a few tips for your long-term investing planning.

Set a Time Horizon

Aligning your financial goals by setting a clear time horizon will help you chose the right type of investment strategy. For instance, if you want to achieve a certain amount at the time of retirement, it will require different planning than buying a home in a 5-years.

Choose your Investing Strategy – and Stick to It

Choosing the right investment strategy is as important as following it consistently. Long-term investment requires considering different options than short-term trading.

You can choose between:

  • Growth Investment
    • Involves investing companies that grow faster. These companies do not pay dividends and your returns will be in the form of capital gains.
  • Value Investment
    • It involves investing in undervalued stocks. You should carefully evaluate the fundamentals of stock for value investing.
  • Dividend Investment
    • It involves investing in established companies that pay dividends. Reinvesting dividends can increase your long-term returns by manifold.

Diversify your Portfolio

Perhaps it is the most tried and tested tip for investors. You should always diversify the risk. Construct a portfolio that consists of stocks, bonds, Mutual Funds, and ETFs.

You can change the portfolio mix according to your risk appetite. However, it is wise to create a mix that brings balance to your risk-reward returns.

Keep Trading Costs and Tax Implications in Mind

Trading costs such as overnight interest, commission, brokerage fees, and account administration costs can be overwhelming at times. Long-term investing saves you trading costs big times.

Long-term investments also bring tax benefits. Capital gains are taxed at lower rates than short-term trading profits.

Avoid Emotional Investment

Emotional behaviors can affect your investment returns. Most investors follow emotions and buy what looks like a lucrative investment. For instance, investing in penny stocks attracts many investors for their low share prices. Investors anticipate share price appreciation that never happens and loses money.

Consider the Broader Context of Investing

Follow the experts’ advice and always look into the broader context of investing. Evaluating fundamental metrics of stock remains pertinent for any type of investment strategy. Thus, look for assets that are fundamentally strong and show signs of improvement in the long run rather than quick price adjustments.

In a nutshell, planning for long-term investing requires thinking broadly. Following market sentiments for quick gains cannot yield sustainable gains in the long run.

Psychological Quirks Affecting your Trading Results

Investors do not trade rationally all the time. Often, traders want more profits from an investment than it can actually offer; it is greed in terms of psychology. Similarly, some traders fear a loss of investment than it brings, it is termed fear in psychology.

Many investors make decisions based on short- and medium-term price swings and market sentiments. Following emotions and trading bias can hamper your long-term gains.

Here are a few psychological and emotional barriers that you should always avoid with long-term investments.

 Emotional Trading

Many investors follow their emotions of fear or greed with their trading. It restricts your rational thinking. Many investors lose money by following their emotions rather than rational thinking.

Market volatility and changing interest rates offer risks. At the same time, investors can take advantage of these market triggers. However, that requires careful and rational planning than following emotions.

Trading Bias

Just like buyers shop with brand attachment or preference bias, traders follow trading biases. Traders suffer different types of trading biases.

For example, a trader following an old strategy by believing it will work is following a status quo bias. Similarly, an investor anticipating a price trigger that is unlikely to happen is following the gambler’s fallacy.

Randomness while Trading

Some traders can get lucky and get quick returns with a random act. Contrarily, a sound investment strategy may fail to achieve the desired results quickly. Many investors make the mistake of following such random acts consistently. Hence, they lose money rather than making profits without realizing the mistake.

Abandoning a Strategy without Evaluation

It is another powerful emotional barrier that hinders the success of many investors. Many investors devise a plan and never stick to it without careful evaluation. Many times, investors may fail to implement the strategy effectively.

Changing an investment strategy is not bad all the time. Changing a strategy without rationally analyzing it is not helpful though.

How to Overcome Psychological Barriers of Trading

Many investors lose money for chasing hot trends. They follow emotional trading decisions rather than rational planning. Psychological barriers come in many ways as discussed above. All types of investors fall prey to a psychological barrier at different stages of their investment journey.

Here are a few quick tips to overcome the psychological barriers and short-sightedness in trading.

Identify Personal Trading Traits

Successful investors identify their personality traders quickly. Analyzing your positive and negative emotional powers can help you overcome the psychological barriers of trading. You’ll become a rational investor and devise effective plans.

Improve Your Knowledge Base

Fundamental knowledge of investing is a prerequisite. However, improving your knowledge base is of utmost importance. Learn important investing strategies, one at a time. Never rely on short-sighted tips and tricks while investing your hard-earned money.

Consider the Bigger Picture with Long Term Horizon

Following quick price swings and hot trends is a big mistake that many investors make. Always look at the bigger picture with the long-term horizon in mind. Keep an eye on your investment goal and work towards achieving it. Never mind the small losses that come along in the short term.

Avoid Emotional Thinking – Think objectively

A key to building a sustainable investment strategy is to think objectively. Avoid emotional thinking and keep aside your trading biases. For instance, avoid holding on to the losing stocks for the familiarity bias. Keep an eye on the prize!

Evaluate your Trading Strategy

The best way to win is to follow a long-term strategy and sticking to it. However, you should always evaluate your trading strategy rationally. A successful trading strategy that worked for someone else may not prove beneficial to you as such.

Benefits of Long-Term Investing

Long-term investing can help you achieve your financial goals. Day traders looking to time the market look for quick profits. However, that doesn’t work for all investors.

Here are a few benefits of long-term investing.

Buy and Hold Works all the Time

The buy-and-hold investing strategy works all the time. It has been proven with historic results. For instance, look at the historic returns of the S&P 500 index. If you invest in it for a long time, there is no way to beat those returns at the same risk level.

Requires Less Time and Effort

Day trading, scalping, and other trading tools require a lot of time, effort, and huge risk tolerance. Long-term investing is often a passive investment strategy that does not require as much time and effort.

Lower Risks

Long-term investment proves to be less risky than short-term trading. It adjusts for the short-term losses with larger capital gains in the long run.

Compounding Benefits of Reinvesting

Reinvesting your yearly returns yields the benefits of compounding. For instance, you can invest in a stock that pays around a 7% dividend. If you reinvest the dividend, it will take about only ten years to double your initial investment.

Tax Benefits

Long-term capital gains are taxed at lower rates than short-term trading profits. Taxes on long-term returns are always lower than quick profits. 

Final Thoughts

Long-term investing brings sustainable profits. Investors following emotional trading can lose more money than they make. Following quick price swings and short-sighted trading strategies can prove costly. Looking at the broader picture and controlling emotional barriers can bring long-term benefits for investors.

Take a look at our article on Dollar-Cost Averaging which fits in nicely with long-term investing and is a great strategy. For an interesting read on trading psychology and overcoming it, we recommend

The Psychology of Trading: Tools and Techniques for Minding the Markets by Brett Steenbarger