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Five Important Guidelines for Profitable Short Term Investing

June 5th, 2020

We define Short Term Investing as any venture where a single stock position is held for any period less than 1 year. An average time period is about 6 months. Traders hold their positions for even shorter durations.

Short Term investing comes with some unique challenges which can be avoided when investing is performed for the long term. For instance, in the short term entry/exit criteria become important whereas in the long term this may not be a huge determining factor. Volatility is also typically higher for an individual stock in the short term.

We believe, self-directed investors should consider these important guidelines described below which can help them succeed in this challenging but exciting venture.

Invest with the Market's Trend

Often self-directed investors are led to believe they will be profitable in short term investing if the stock they are buying has the proper characteristics. In our experience we have found this to be only partly true. It is very important for the broader market to be trending in the direction they are seeking for these individual stock setups to work. It has been found more often most stocks follow the trend of the broader market. Even strong stocks buckle when the broader market is reversing course. More often even weaker stocks get a bid when the broader market is displaying strong upside price action.

Use Both Technical Analysis and Fundamental Analysis for Stock Selection

Stock selection is a key factor in successful short term investing. Typically, most traders and investors use technical analysis predominantly to identify and buy stocks based on a variety of patterns considering support and resistance levels. It clearly makes sense to do so as investing for a shorter duration involves plenty of uncertainties and price moves are very important. But to increase the odds in the investor's favor it helps to also perform fundamental analysis on the stocks filtered using technical analysis. If the underlying fundamentals are confirming the technical setup the chances of having a profitable trade rise more.

Avoid Too Many Open Positions

In a portfolio dedicated for short term investing the number of stocks held should not be too many. Diversification in many non-correlated stocks is a wise move for long term investing but in the short term that can turn into a disadvantage as managing too many positions will become a very difficult task when the market moves in the direction not expected by the investor. As many stocks move with the broader market, these short term corrections will quickly result in higher losses for the overall portfolio. While there is no magic number of positions to hold, a small investor should initially restrict to two or three positions at most.

Cut Losses Short

This guideline is central to implementing a profitable short term investing strategy. Losses are inevitable in this strategy as uncertainty factors are much higher in the short term for quality stocks or even ETFS. Even a best growth stock can easily correct 20% to 30% if a specific detrimental news breaks out or earnings event occurs impacting that stock. So it is prudent to minimize the downside in a single position to a percentage of overall capital invested. For example, if the overall portfolio size is $25K, a policy to cut losses in a single position at 1% of that overall size will create a simple risk management strategy. Even if 3 positions turn into losses the overall capital loss will be only 3%.

Take Above Average Profits When Available

No stock can keep going higher for ever without pulling back. Even the best stock has to digest gains as profit taking at elevated levels is a normal event. The broader S&P 500 index's average annual return over the long term is somewhere between 8% to 10%. So, if a stock selected for short term investing is yielding a gain of say 10% to 15% over a time period of just a few months it should be considered a very profitable trade and there is no harm in locking in such gains.

A disciplined self-directed investor should strive to implement these guidelines in order to be profitable consistently.

Good Luck and Safe Investing!