Investment Iron Law XI: Avoid Short-Term Trading#
The greatest enemy of investment activity is human weakness: greed, fear, and herd mentality.
The Pitfalls of Buying Low and Selling High#
Stock prices fluctuate in the short term, leading many investors to intuitively believe that profits can be made by simply “buying low and selling high.” Undeniably, the allure of price differences is strong. A limit-up day can bring thousands of dollars in profit, and buying ten lots could cover a month’s salary. However, once captivated by this temptation and engaging in the game of short-term trading, you unknowingly enter a losing battle. While luck might bring short-term gains, long-term losses are inevitable.
Stock Profits Are More Than Just Price Differences
Many stock investors hold the misconception that profits come solely from price fluctuations. In reality, the primary source of profit lies in sharing the company’s earnings, not capitalizing on short-term price swings. Stock investments generate returns because the invested companies’ earnings are ultimately distributed to investors. The immense time and effort spent researching entry and exit points, diligently watching the market, and constantly chasing trends contribute nothing to the company’s earnings.
The Taiwan Weighted Stock Index rose from 100 points in early 1967 to 6200 points at the end of August 1996, a 62-fold increase. Using the end of 1986 as a base period, when the index was around 700 points, the rise to 6200 points by the end of August 1996 represents an increase of over 8 times. The Taiwan stock market’s astonishing growth and substantial returns should have made every investor wealthy. However, the reality is quite the opposite. Few Taiwanese investors have profited from stocks, while countless have suffered losses. According to a 1988 survey by Professor Lin Quanyuan, 27% of investors experienced losses, and 78% earned returns below the market average. Private surveys suggest even higher loss rates. The question arises: “Where did the substantial stock market profits go?”
Short-Term Trading is Gambling
Short-term stock trading is speculation and gambling, both characterized by a high probability of loss. We often see short-term traders boastful after successful speculations but disappear or remain silent after losses. This creates the false impression that short-term trading is profitable. In truth, these traders usually end up losing money.
Long-term stock holding yields an average annual return of over 15%, but only if the stocks are held and not sold. The biggest problem with short-term trading is the transaction costs incurred with each trade. Investors often overlook these costs, believing they are insignificant compared to potential price differences. In the Taiwanese securities market, the transaction cost for each round trip (buy and sell) is approximately 0.6% of the transaction amount. While a single transaction cost seems small, the cumulative effect is substantial. Imagine trading more than 25 times a year, or every two weeks. The 15% annual return would be almost entirely eroded, making it worse than keeping the money in a bank. Moreover, short-term traders often exceed 25 trades per year. Factor in a few losses, and the return becomes negative. Frequent trading inevitably diminishes returns, and negative returns are no different from gambling.
Therefore, if you cannot resist the urge to chase short-term price differences, it’s best to avoid stock investment altogether and keep your money in the bank. While you may not become rich, it’s better than losing it all in the stock market.
In 1989, the total after-tax earnings of all listed companies in Taiwan were 110.3 billion NTD. In the same year, securities transaction taxes were 152.4 billion NTD, and transaction fees totaled 76.2 billion NTD. This means the combined earnings of listed companies were insufficient to cover these costs, leaving investors with an additional 118.3 billion NTD in transaction costs. It’s no wonder most stock investors suffer losses. The solution is simple: adopt a long-term holding strategy and minimize unnecessary trading. Long-term stock market investment offers high returns and lower risk. By holding long term, there’s no need for worry or fear, and wealth can be accumulated over one or two decades.
Short-Term Trading Creates Wealth for Intermediaries
To achieve investment success, one must overcome “greed during market upswings and fear during downswings.”
A book from the 1940s in the US, titled Where Are the Customer’s Yachts?, tells the story of a stockbroker taking a major client to a marina. Pointing at the luxurious yachts, the broker says, “These yachts belong to our firm’s brokers.” The client then asks, “Are any of them owned by your clients?” The broker is speechless, as none of the yachts belonged to clients. (Note: yachts were a status symbol of wealth in American society at that time).
It seems unlikely that valuable clients of brokerage firms would be wealthy. This story illustrates that while stock market profits are substantial, most are earned by intermediaries. Those who frequently trade and generate significant profits for brokerage firms rarely become yacht owners themselves.
Merrill Lynch annually has a dozen or so brokers earning over a million dollars. However, their truly valuable clients are not exceptionally wealthy individuals. Wealthy people are usually busy making money and don’t have the time for frequent trading. They wouldn’t be considered valuable clients. Only those who constantly engage in short-term trading are the major contributors to transaction fees and the most loyal customers of brokerage firms.
In 1990, a scholar wrote a bestselling book on securities investment, earning about 1 million NTD. He was overjoyed, as it was a considerable sum for a writer. However, his friend at a brokerage firm mocked him, saying, “Your three years of hard work only earned you the equivalent of one month’s salary for a broker in our company.”
Retail investors, your name is weakness.
A Losing Game#
The stock market comprises four main participants: intermediaries, major shareholders, large investors, and retail investors. Intermediaries include brokerage firms, the government, and information providers like newspapers, magazines, financial channels, and software companies. Regardless of market outcomes, intermediaries always profit, and their profits increase with trading volume and frequency. Major shareholders are company management or those with significant equity stakes. They have ample capital, resources, and information, giving them a winning edge. Large investors have more capital than retail investors, affording them a higher probability of success.
Intermediaries and Large Investors Are the Winners
The original purpose of financial markets was to channel funds from the public to businesses, which then invest and share profits with investors. However, based on the analysis above, listed companies’ earnings are insufficient to cover the costs of intermediaries, let alone distribute profits to retail investors. For retail investors to profit, they must outperform the other three players. In short-term trading, retail investors face intermediaries who always win, major shareholders who are guaranteed to win, and large investors with a higher probability of winning. In this game, retail investors have no chance.
Most short-term trading failures are attributed to lack of skill or bad luck. In reality, a calm analysis reveals a guaranteed losing game.
How to Win Without Fighting
As a retail investor, how can you navigate this game against major shareholders, intermediaries, and large investors? The simplest solution: “Don’t play!”
Listed companies, on average, generate profits annually, and successful companies grow increasingly profitable. Therefore, not investing idle funds means missing out on long-term gains. The “don’t play” strategy doesn’t advocate avoiding the stock market altogether. Instead, it encourages investing and then leaving it alone, minimizing short-term trading.
By consistently investing available funds and holding long-term, investors can benefit from both company earnings and overall economic growth. This long-term holding strategy, avoiding the trading game played by intermediaries and large investors, can dramatically shift the investment landscape. If investors buy and hold, intermediaries and major shareholders lose their advantage. Even with substantial capital and insider information, their attempts to manipulate prices won’t lure disciplined retail investors into their traps, eliminating the disadvantage faced by smaller investors. Major shareholders, large investors, and retail investors would then stand on equal footing, sharing the benefits of long-term market growth.
This “immovable mountain” strategy transforms retail investors’ disadvantage into an advantage, shifting the disadvantage to the other players, particularly intermediaries. If investors stop trading frequently, brokerage firms lose transaction fees, the government loses taxes, and financial information providers lose business. With no one to “feed” them, they might be forced to become buy-and-hold investors themselves.
The correct investment philosophy is to profit together, not to defeat others. The truly intelligent strategy is to avoid the competition. As Sun Tzu’s Art of War states, “The supreme art of war is to subdue the enemy without fighting.” The primary consideration in investment strategy should not be defeating others but maximizing profits.
How can everyone win? If every investor adopts the strategy presented in this book—“buy any stock, buy anytime, don’t sell”—and adheres to this simple principle, a win-win situation for all can be achieved.
Futures markets make casinos pale in comparison.
Avoid Futures and Margin Trading#
In 1995, a single trader’s mismanagement of futures trading resulted in a $1.1 billion loss, causing the collapse of Barings Bank, one of Britain’s oldest banks. This is not an isolated incident. With the rise of derivative financial products like futures and margin trading (forex, bond margin trading, etc.), such incidents of company collapses or personal bankruptcies due to mismanagement have become increasingly common. Several high-performing listed companies in Taiwan have also faced near-bankruptcy due to losses in futures or margin trading.
Either Big Wins or Big Losses
What makes futures and margin trading so dangerous? The core issue is the margin trading system itself, which has a high degree of leverage, leading to either significant gains or devastating losses in the short term. The high risk also encourages frequent trading, often multiple times a day. These transaction costs, relative to the margin, are extremely high. The combined effect of frequent trading and high transaction costs pushes the returns from futures and margin trading into significant negative territory.
A saying circulates in the US securities market: “Futures markets make casinos pale in comparison.” In other words, futures markets are even more of a gamble than casinos. After paying substantial transaction costs to intermediaries, what profits are left for investors? The author has extensively studied investment history across various countries and has personally participated in the securities market for over a decade. I have never heard of any investor consistently profiting from long-term participation in futures or margin trading. On the contrary, almost everyone I know involved in such activities has ultimately lost money.
The purpose of futures and margin trading markets is to provide hedging tools for businesses. Individual investors rarely have such hedging needs. For them, these markets become “even more of a gamble than casinos” due to the temptation of short-term trading. The author strongly advises readers to avoid futures and margin trading entirely. If reading this book leads you to stay away from these activities, then the book’s price has already been repaid, and the author’s efforts have been worthwhile.
Often a Waste of Effort
The biggest obstacle to successful financial management is not the difficulty of understanding but the difficulty of implementing what is understood. The principles discussed above are easy to grasp, but understanding doesn’t guarantee implementation. In the volatile investment world, faced with fluctuating prices, investors are often tempted by greed to chase short-term gains or driven by fear to react to price swings. They unknowingly fall into the trap of short-term trading. While the process can be thrilling, it often ends in wasted effort. The true beneficiaries of this game are usually the brokerage firms and the major shareholders manipulating the stocks, leaving retail investors with losses.
Many people invest in stocks not to build wealth but to prove their intelligence, knowledge, and predictive abilities to others. They constantly analyze and research, overemphasizing market trends and predictions. This leads to impatience, chasing rising prices and selling during dips, attempting to profit from short-term fluctuations. However, this constant buying and selling consumes time, energy, and money in the form of hefty transaction costs, while also creating opportunities for major shareholders and large investors to manipulate stocks. The ultimate result is often a waste of time and money. While knowledge and experience might increase, wealth does not.
To succeed in the fast-paced and lucrative investment world, you must cultivate self-discipline. The secret to investment success lies not in knowledge or skill, nor in intelligence or luck, but in self-control. Your investment acumen allows your assets to generate returns, and your patience in long-term holding allows the power of compounding to take you to new levels of wealth. Before succumbing to the temptation of short-term trading, ask yourself: “Which wealthy person achieved their fortune through continuous short-term trading?” and “Which successful stock market investor didn’t rely on long-term holding?”
Temporary Glory Leads to Crushing Debt
In the history of the Taiwan stock market, it’s difficult to find examples of individuals who built wealth through short-term trading. There are many who gained fame through short-term speculation, like Lei Bolong, but they often ended up heavily in debt and even faced imprisonment. This is not unique to Taiwan; the same holds true for the US stock market. The author has studied renowned American investors and has never found a prominent figure whose strategy primarily involved short-term trading. Long-term wealth accumulation through short-term trading is virtually unheard of.
Stock investment is a vital path to personal wealth creation and a crucial source of long-term capital for businesses. However, using the wrong approach can lead to financial ruin instead of prosperity. Listed companies issue stocks to raise capital, and if these funds are then misused in speculative games, it can be detrimental to individuals, society, and the nation.
Stockholders are company owners with the inherent rights to profit sharing and residual asset distribution. Therefore, the company’s profits will eventually be distributed to shareholders as dividends. With patience, the wealth generated by the company ultimately belongs to the investors.
Therefore, I urge all readers to avoid the game of short-term trading. Throughout history, no renowned investor has achieved wealth through short-term speculation. Based on the author’s observations, the vast majority of those who engage in short-term trading lose money, and many face financial ruin.
1. True profits come not from short-term trading skills but from the discipline of long-term holding.
2. In the long run, short-term traders inevitably lose. There are no exceptions.