Short-term investments are assets that can be converted into cash or can be sold within a short period of time, typically within 1-3 years. Common instruments for short-term investing include short-term bonds, Treasury bills, and other money market funds. Short-term trading or day trading entails a significant degree of speculation and, consequently, substantial risk.
Advantages of Short-Term Investing
Short-term investing offers flexibility to the investor as they do not need to wait for the security to mature in order to get cash. On the other hand, long-term investments can be liquidated by selling in the secondary market, but the investor earns lower profits.
Investors can make substantial profits in a very short amount of time.
It is less risky as money invested per transaction is substantially lower.
Disadvantages of Short-Term Investing
Short-term investing comes with high costs due to a high transaction volume and their corresponding brokerage commission fees. Taxes and inflation also reduce the returns earned via short-term investing.
It involves a certain level of expertise and time, as investors must closely monitor price movements and identify purchase and/or sale spots.
Strategies for Short-Term Investments
1. Identifying the right trade
It is important to seek out trades that involve minimal risk. Extensive market research is important to recognize potential candidates efficiently. The process includes the following:
Monitoring the moving average of the price of a given stock over a period
Typically, the cycles include 15-, 50-, 100-, and 200-day periods. A stock with an upward sloping moving average can be bought, while those with a downward sloping or flattening curve can be shorted.
Market cycles and trends must be closely monitored. Negative trends suggest little buying opportunities and vice versa.
External situations can exert a huge effect on stock market prices. Thus, it is important to follow and take cues from business-related news, such as lawsuit settlements, new regulations, scandals, and changing political environments.
Diversification is a method of controlling or mitigating risk while maximizing returns. It involves a mixture of different types of assets with varying risks and returns. Diversification works only in situations where the types of assets invested in are mutually exclusive. For example, a portfolio that includes investments in multiple securities in the same industry, i.e., that are correlated, is not considered diversified.
Hedging is a process that seeks to eliminate all the risks associated with an asset. Derivative financial instruments such as options, futures, and swaps (that derive their value from an underlying asset) allow investors to insure against the risk associated with the asset in question.
4. Exhausted selling
Exhausted selling is a niche strategy that is usually only employed by experienced day traders. It is usually done in the aftermath of periods of panic selling induced by recession alarms or other external threats. Investors may buy at the unusually low prices and earn a profit soon after. It is possible because the low prices created due to panic selling do not reflect the real underlying value of the asset, which may be much higher.
5. Real-time forex trading
Real-time forex trading is a form of speculation where an investor bets on the future price movements of a given currency. It uses technical indicators to gauge expected changes in the exchange ratios of currencies. It is a form of algorithmic trading, which means it cannot be done without the use of sophisticated software.
Thank you for reading CFI’s guide on Short-Term Investments. To keep learning and developing your knowledge of financial analysis, we highly recommend the additional resources below: