Last Updated on October 10, 2022 by Oddmund Groette
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 are known as short-term traders, the latter are called long-term traders. But what does a long-term trading strategy mean?
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 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.
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.
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. 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.
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 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.
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 the 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%.
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, while 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