A key rule of investing: There’s no perfect market. 90% of people lose money in the stock market because of unpredictability and inefficiency.
In this article, we look at two investment strategies, Long term and Short term, and how they perform distinctly in different market conditions.
We’ll also look at market behaviors and how to take advantage of them with the right strategy.
Without further ado, let’s get started.
Buy Low and Sell High
You’re probably familiar with the term “buy low and sell high.” That’s investing in a nutshell. But it’s not that simple.
There are two ways to make money in the markets:
- The first is to buy an asset when it is undervalued and sell it when it is overvalued.
- The second is to buy an asset and hold it until the market corrects itself.
The first strategy is more common; It’s what most people think of when they invest. You buy a stock, wait for it to go up, and then sell it.
The problem with this strategy is that it is challenging to predict when an asset will be undervalued or overvalued.
The second strategy is less common, but it can be more profitable.
With this strategy, you buy an asset and hold it until the market corrects itself. This can take weeks, months, or even years.
However, neither of the strategies is 100% efficient.
Types of Market Inefficiencies
To take advantage of market inefficiencies, you need to be able to identify them.
There are two types of market inefficiencies:
- Fundamental analysis is when a company’s stock is undervalued or overvalued based on its financials.
- Technical analysis: A stock is undervalued or overvalued based on market trends.
The best way to take advantage of these inefficiencies is to use the right strategy for the right situation.
If you’re investing for the long term, then you should focus on fundamental analysis.
If you’re investing for the short term, then you should focus on technical analysis.
Let’s go over long and short-term strategies in more detail.
Long-term Strategy
A long-term investment strategy is efficient in the long run. This means that it tries to correct for inefficiencies in the market.
The goal of a long-term strategy is to buy an asset when it is undervalued and sell it when it is overvalued.
To do this, you need to be able to predict asset value or leverage dollar-cost averaging.
This can be difficult, but it outperforms a short-term strategy due to correction and macro-stability.
The longer you hold an asset, the less volatile it becomes because the market tends to correct itself over time.
For example, a $100 stock drops to $90.
A short-term investor could sell the stock, costing $10 per unit.
A long-term investor could hold the stock because they believe it will eventually increase.
And indeed, over time, the market does correct itself. The stock eventually goes back up to $100 or more.
The long-term investor has made money, while the short-term investor has lost money.
This is an example of how a long-term strategy can outperform a short-term strategy.
Of course, there are no guarantees in the market. The stock could have continued to drop and never recovered.
Note: long-term investment strategy requires patience and discipline.
You need to be able to hold an asset for years, even if it is not performing well in the short term.
This can be difficult for some investors.
If you’re not patient or disciplined, then a long-term strategy is probably not right for you.
Now let’s take a look at short-term strategies.
Short-Term Strategy
A short-term investment strategy is efficient in the short term. This means that it can take advantage of market inefficiencies.
The goal of a short-term strategy is to leverage short market disruptions.
In this case, investments are for a short period, say a few days or weeks. You buy and sell quickly, irrespective of a major price dip or pump in the market.
To do this, you need to be able to predict when an asset is going to be undervalued or overvalued.
This can be difficult to do, which is why a short-term strategy is not always profitable in the long term. It could span over days or weeks.
However, a short-term strategy outperforms a long-term strategy in one primary way: It is more flexible.
A short-term strategy can take advantage of market conditions not present in the long term.
For example, let’s say a company is about to release a new product.
The company’s stock price will go up when the product is released.
A long-term investor might not be able to take advantage of this because they are already invested in the company.
They would need to sell their position, incurring a loss, and then buy back the stock when it goes up.
A short-term investor could take advantage of this by simply buying the stock when it goes up.
The short-term investor has made money.
This is an example of how a short-term strategy can outperform a long-term strategy.
Of course, there are no guarantees in the market. The stock could have also dropped for a short period and still recovered in the long run.
However, over the short term, the market is more volatile. This means that there are more opportunities to take advantage of.
Note: short-term investment strategy requires more knowledge and experience.
How to Take Advantage of Market Inefficiencies
Now that we’ve looked at long-term and short-term strategies let’s take a look at how to take advantage of market inefficiencies.
Identify Market Inefficiencies
The first step is to identify market inefficiencies.
This can be done by studying the prices of assets over time.
Use the Right Strategy
The second step is to use the right strategy.
If you’re trying to take advantage of market inefficiency, use a short-term strategy.
Or long-term leverage strategy to ride out the ups and downs of the market to ultimately achieve your financial goals.
The Bottom Line
The market is never 100% efficient. Prices can be too high or too low in the short term.
If you’re experienced and knowledgable, you can take advantage of short-term disruptions.
However, I recommend a long-term strategy for most investors. It is more efficient in the long run and can help you reach your financial goals.
What do you think? Do you have a short-term or long-term investment strategy? Let me know in the comments below.
Leave me a message at jared@redwoodplanning.com, I’ll respond the same day.
