Many people will look at the day to day fluctuations in the stock market, and ultimately base their mood off of the market’s behavior for the rest of the day.
I generally check the stock market about once per week, if that. I know that day to day price fluctuations don’t deserve nearly the amount of weight they are given. Conversely, a friend of mine will watch stock price movements every day and plot opportunities for gain through short term technical analysis.
A few months ago, I had gotten into a debate with this friend of mine over long term versus short term investing.
At the time of this discussion (in February, I believe), the stock price for AIG was hovering around $0.65 – 0.80. I argued that a long term investment in this stock would yield safer, higher and more reliable returns rather than a short term trade.
If one were to purchase $10,000 worth of shares of AIG while it was trading at $0.65 per share, and the price were to increase to a modest $3.00 over five years, the investment would be worth $46,000, equaling an annual return of 36%.
My friend argued that with proper timing, an investor could reap huge sums of money within the time span of less than a week.
He explained that one could sell $46,000 worth of shares a few days prior to this discussion, when the stock price was several cents higher. Then, a couple of days later, purchase the same amount of shares when the price was lower. This would result in a gain of 44% in three days, equalling an annualized return of 11000% per year.
11000% is certainly a big number, but also pretty meaningless. Firstly, it requires you to time the market–you’d have to predict where the stock price was headed over the next few days, which is literally impossible.
Secondly, the stock price could go up a few pennies, or it could go down a few pennies (or more). Just like you could gain 44% in three days, you could just as easily lose 44% in those three days, giving you a tremendous loss.
Thirdly, annualizing a return such as this proves pointless, since stock prices fluctuate in both directions throughout the year. A three day period could, in fact yield a 44% gain, however the next day could deliver a 44% loss, eroding your returns.
Short term investing is nothing more than a gamble. Like gambling, you’re really only relying on luck to deliver you an expected outcome. Day to day fluctuations in the stock market are considered by academics and professionals to follow a “Random Walk”. If that’s the case, betting on a stock price tomorrow is no different than betting on a roll of the dice.