Long-Term Trading Strategy | Backtest And Example Analysis
Some people hold their trades for short periods, even as little as a day, while others hold theirs for quite a long time. While the former is known as short-term traders, the latter are called long-term traders. But what does a long-term trading strategy mean?
A long-term trading strategy refers to a style of trading where a trader holds a position for an extended period of time. Depending on the type of asset, the holding period can be as little as one year or as long as 30 years or more. While there is no upper limit to how long an asset can be held in long-term trading, for tax considerations, it has to be held for, at least, one year to be considered a long-term trade.
In this post, we take a look at the long-term trading strategy. We go one step further and make a backtest of how you can invest in a long-term trading strategy and how you can supplement it with short-term swing trading strategies.
Long-term trading strategies
We have written many other long-term trading strategies:
- The Best Performing Stock Markets In The World Since 1900
- Long-term strategies — What Is It? (Backtest)
- Fundamental Analysis Trading Strategy (Backtest And Example)
- Bull Market Signal Strategy – How To Predict A Bull Market (Backtest)
- How likely are you to go broke as retired or FIRE? (Sequence risk, diversification, and withdrawal rate)
- Dollar cost averaging vs. lump sum investing backtest – sequence of return risk (luck, skill, or magic?)
- Lump Sum Investment Strategy (Buy & Hold, Example, Performance, Returns)
- How does war affect the stock market historically?
- Long-Term Trading Strategy (Backtest And Example)
- Positional Trading Strategy (Backtest And Example)
- Do stocks outperform Treasury Bills? (Not what you expected)
- Buy the Dip Strategy — What Is It? (Backtest And Example)
We also give you a humble reminder that we have written about hundreds of different trading strategies.
Key takeaways
- Long-term trading refers to a style of trading where a trader holds a position for an extended period of time – most likely years.
- For most people, a passive long-term strategy of buying and holding is the best option to create wealth. You have to find out what is best for you.
- Short-term swing strategies can be an excellent diversification tool for your long-term strategies.
What is long-term trading?
Long-term trading refers to a style of trading where a trader holds a position for an extended period of time. Depending on the type of asset, the holding period can be as little as one year or as long as 30 or more years. There is no upper limit to how long an asset can be held in long-term trading. For tax considerations, a trade has to be held for, at least, one year to be considered a long-term trade (in the US – it might be different depending on your residency).
The term, “long term”, can mean different things to different people, but it is generally thought to be in the range of 5 to 10 years of holding time. However, once a position is held for more than one year, it is already considered a long-term trade by tax authorities (in the US). Profits from long-term trades are often taxed differently than those from short-term trades (lasting less than a year).
In stock trading, for example, if you buy a stock and hold it for more than a year it is considered a long-term investment and any profit you make from the trade would be taxed based on the long-term capital gain model, which is much lower (5-15%) than what is charged on short-term gains (20-30%).
Typically, a long-term trader can hold a stock for many years and benefit from dividends and the power of compounding if the stock keeps appreciating. This way, they can gradually build wealth over the years.
Another interesting thing about long-term trading in stocks is that you don’t need to monitor the price action actively, so it is comparatively less stressful and less time-consuming than short-term trading.
However, as with other types of trading, you need to master it before you can trade successfully this way. You have to learn how to thoroughly research a stock and make analyses based on the company fundamentals and the general macroeconomic trends at play. Some of the fundamental parameters to master include measurable factors like earning growth, debt-equity ratio, P/E ratio, and the dividend yield of the stock, as well as non-measurable factors like management, industry competition, and so on.
One more factor for successfully implementing long-term trading is having the right personality. Patience is key in this type of trading. If you lack patience, you will find it difficult to hold on to your position for as long as necessary — you may end up exiting at a 2x profit when you could have made a 10x.
Related reading: Trading System
Is long-term trading good?
Every form of trading is good for the right market and the right trader. Long-term trading works very well in certain markets and may not work as well in some other markets. Similarly, it may be suitable for certain types of traders and not suitable for others. We will explain shortly.
Long-term trading can work very well in stock and real estate markets because such markets have historically risen more than inflation and build on each economic cycle.
On the other hand, the strategy may struggle in commodity and forex markets, which tend to move in cycles without any long-term direction. So, while a suitable trader can successfully trade a long-term trading strategy in stocks, he would find it hard to make money with a long-term strategy in commodities and forex.
As we stated earlier, a long-term trading strategy can be very successful when used by the right trader. But who is the right trader for a long-term strategy? The truth is that we all have different personalities. Some people can be patient enough to hold a stock for 20 years and accumulate 100x profits while some may not be able to hold through a day with a 10% profit, as they would be afraid the little profit would be eroded. The long-term trading strategy is for the patient trader, not the trigger-happy trader.
So, a patient trader can be successful with a long-term strategy when trading the right market, but an impatient trader may not find much luck with the strategy even when trading a broad market index ETF (SPDR S&P 500 ETF (SPY), for example), which historically tends to go up in the long term.
That said, most stocks go on to fail. Statistics show that the median stock performs poorly and it’s only the very few stocks that go on to make most of the gains. Are able to spot those stocks? Most likely not, and thus you are better off buying mutual funds or ETFs. Please read more about the statistics in these two articles:
Is long-term trading the same as position trading?
No, position trading is somewhat shorter. What some people classify as position trading can still be considered short-term play by tax authorities and, therefore, taxed on the short-term capital gains model. According to popular definition, position trading refers to the strategy of holding a trade for more than several weeks — often three months and above.
So, a trade that lasts up to three months or eleven months is considered a position trade. Obviously, this does not qualify as a long-term trade, going by our definition — a trade held for at least more than one year — which is the duration considered in capital gain tax. In other words, a position trade can qualify for a long-term trade only if it lasts more than one year.
One more thing about position trading is that it is mostly based on technical analysis, even though some position traders also consider fundamental factors when taking their positions. Such traders combine technical analysis with fundamental analysis, but their target is to ride the trend on a daily timeframe. Long-term trading, on the other hand, is based mostly on fundamental and macroeconomic analysis and is, in fact, just another name for investing.
Is long-term trading the same as swing trading?
No, swing trading is a form of short-term trading, so it cannot be the same as long-term trading. Swing trading is a style of trading where the trader leaves his trade for several days up to a few weeks. The aim of a swing trade is to capture the individual price swings on the daily chart.
Lasting just a few weeks, this type of trading is considered short-term by tax authorities, so any profits made from such trades are taxed based on the short-term capital gain model, which can be as high as 20-30%. Long-term trading, on the other hand, must last more than a year and is taxed based on the long-term capital gains model, which is much cheaper at 5-15% (in the US, it might be different depending on your residency).
Also, swing trading is mostly based on technical analysis of price and volume data. A swing trader just wants to capture the individual price swings on the daily chart, so they base their trading on chart analysis. In long-term trading, decisions are based on the analysis of the stock’s fundamentals and the general macroeconomic trends.
Is trading better than investing?
While the aim of both trading and investing is to grow your wealth, they require different time commitments and have different risk profiles and likely outcomes. In trading, you try to time the market and generate multiple small profits, which can add up to a lot. Investing, on the other hand, is about making a few trades and holding them for a long time for the capital to compound. Which is better depends on the trader’s personality and goals.
However, trading offers the following advantages over long-term investing:
- For small individual traders, it is more scalable, as you can build scale either via automation or increased size via leverage.
- With a profitable strategy, trading offers a more steady income, unlike investing, which can have huge drawdowns during bear markets. During the 2008/2009 bear market, the S&P 500 index fell by 55%. A short-term trader would have prevented that with a stop loss and the ability to trade in either direction.
- Since trading is scalable, with a profitable strategy, one can get wealthy much faster than by long-term investing
But to succeed in short-term trading, you must have the skills to create automated profitable strategies and be very good at risk management. Long-term investing doesn’t require all those specialized skills — an average Joe can invest in stocks, mutual funds, and ETFs and watch his money grow over time.
Is long-term trading the same as buy and hold?
No, they are similar but not exactly the same. Both strategies aim to hold their position for “a long time”, but long-term trading has a broader scope. Long-term trading can be to the long side or the short side, although traders rarely hold short positions for a really long time. In essence, buy and hold is just a form of long-term trading that focuses only on the long side of long-term trading.
Another little difference is that long-term trading is often based on specific research and analysis. In contrast, most buy-and-hold players simply base their approach on the general stock market’s tendency to rise over the long term.
Long-term trading strategy backtest
We end the article by showing how a portfolio of trading strategies performs vs a long-term buy and hold strategy (buy and hold vs trading).
First, let’s show how a buy-and-hold portfolio has performed:
We start by assuming you bought SPY (S&P 500) at its inception in 1993. SPY is still the oldest ETF still trading (read more here: SPY ETF trading). The simplest strategy you can do is just buy SPY and do absolutely nothing. This is not as bad as it might sound to many. If you do that, you will beat most professional managers and almost all of your fellow retail traders! The great majority of both pros and retail traders fail to beat the major indices. The best approach might be to dollar average (see our dollar average backtest).
If you invested 100 000 in 1993 and reinvested the dividends, your long-term returns would look like this:
A long-term trading strategy of buy and hold would yield an annual return of 9.7% and your investment would be worth a respectable 1.584 million after 29 years. Pretty impressive! But the downside is that you would suffer many drawdowns along the way.
- You suffered three painful years during the bear market of 2000-2003 and your portfolio fell 45%. Ouch!
- When you expected to recover in 2007, the worst setback came: the financial crisis of 2008/09. You lost 55%! That can make most astute investor throw in the towel. In 2011 you had zero returns since 2000!
- However, if you managed to ride the course the bottom in March 2009 marked the bottom and a spectacular bull market happened.
Let’s compare this to an example of a portfolio of trading strategies:
Trading strategy backtest (vs a long-term trading strategy)
Is it any way you can improve a long-term strategy of buy and hold?
Let’s compare a straightforward trading strategy with strict trading rules and settings to a buy and hold.
We always recommend trading several asset classes and strategies. Thus, we’ll backtest many trading strategies as a portfolio. To make it simple we use three strategies we have published among our different types of trading strategies.
- Turn of the month trading strategy (SPY)
- Turnaround Tuesday trading strategy (SPY)
- Trading edge August 2021 (QQQ)
As you can see, two of the strategies are in SPY and one in QQQ. That said, we recommend trading more strategies than 3, especially in other asset classes than stocks to create some diversification.
We backtest to allocate 100% of the equity at any trading signal. For example, if we get a signal in QQQ (or SPY) and we already have a position in either SPY or QQQ, the signal will be skipped (because we are already fully invested).
The equity curve of our trading strategy backtest looks like this:
The trading statistics and historical performance are very good. The trading statistics and metrics read like this (start date is 2005):
- # trades: 426
- Average gain per trade: 0.54%
- CAGR: 13.1%
- Win rate: 70%
- Profit factor: 2.4
- Max drawdown: -19%
- Time spent in the market: 25%
- Risk-adjusted return: 51% (13.1% divided by 0.25)
What are the main differences between a long-term strategy of buy and hold vs our portfolio of three trading strategies?
The main advantage is that you are less likely to have gut-wrenching drawdowns. Your ride is simply smoother, although there are no guarantees this will repeat in the future.
Let’s go further back and set the start date to 1993. Then we get the following equity curve (the scale is logarithmic – log scale vs linear scale):
If we go further back the results are even more impressive! However, QQQ started trading in 1998. The statistics and historical performance read like this:
- # trades: 674
- Average gain per trade: 0.58%
- CAGR: 13.3%
- Win rate: 70%
- Profit factor: 2.4
- Max drawdown: -21%
- Time spent in the market: 25%
- Risk-adjusted return: 53%
Long-term trading strategy vs trading strategies
What is the main takeaway from the backtests we did in this post?
The main takeaway is that buying and holding vs trading is like comparing apples and oranges. It’s two very different strategies.
Personally, we do both trading and investing. We have a long-term portfolio of both stocks and mutual funds, but we also trade daily. As a matter of fact, our long-term investments are exclusively funded by profits from data-driven short-term trading.
We won’t bug down into details about the differences between trading and investing in this article, but rather recommend an article we wrote a couple of years back:
List of trading strategies
We have written over 800 articles on this blog since we started in 2012. Many articles contain specific trading rules that can be backtested for profitability and performance metrics.
The trading rules are compiled into a package where you can purchase all of them (recommended) or just a few of your choice. We have hundreds of trading ideas in the compilation.
The strategies are taken from our list of trading strategy types. The strategies are an excellent resource to help you get some trading ideas.
The strategies also come with logic in plain English (plain English is for Python traders).
For a list of the strategies we have made please click on the green banner:
These strategies must not be misunderstood for the premium strategies that we charge a fee for:
FAQ long-term trading strategy
Let’s end the article with some frequently asked questions:
What is short-term and long-term strategy?
A short-term strategy holds positions for only days or a max a few months, while a long-term strategy holds for years – sometimes even decades.
What types of long-term trades should I avoid?
You need to make sure you have a plan, preferably backtested. Don’t make impulsive decisions. Stay the course.
How often should you review your long-term trading strategy?
Not often – perhaps once a year.
When should you make long-term trades?
You should only make trades when the system says so.
What is the best way to develop a long term trading strategy?
The best way is to use logic and a scientific approach based on your aims and personality. What are you trying to achieve? Are you risk averse? Are you patient? Once you have determined your financial goals you must set up a plan that fits your personality so that you can follow through on the strategy at all times and avoid cognitive trading mistakes.
Long term trading strategy – conclusion
Trading requires some effort and discipline, but it’s not rocket science. But for most people, a passive long-term strategy of buying and holding is the best option to create wealth. You have to find out what is best for you.