Why Warren Buffett will never trade shares quickly

How long do you hold on to your shares?

An hour, a day, six months, a decade, or Warren Buffett’s favourite holding period – forever?

Chances are that if you are a recent market entrant, your investing horizon is very short term – measured in days rather than years.

Indeed, holding periods have been falling for many years and during the COVID-19 pandemic it has shortened yet again.

The volatile markets and wads of stimulus seem to have made people nervous about sitting on any investment for too long.

US holding times are down dramatically

US calculations using New York Stock Exchange data show the average holding period for US shares was just 5.5 months in June, down from 8.5 months at the end of 2019.

That is even lower than the previous low of six months that was hit just after the 2008 financial crisis.

And remember, it is an average so when many people will have held on to their shares for the entire period, some others must have been trading continuously very quickly.

Europeans caught the bug too

The picture in Europe is similar, with holding periods shrinking to less than five months, from seven months last December.

Here in Australia, the same trend is evident and has been exacerbated by a flood of new entrants, with Australian Securities and Investments Commission (ASIC) figures finding that more than 700,000 new share trading accounts opened last year.

Innovative research by Angel Zhong, a senior lecturer in finance at RMIT University, has revealed many of these new investors – and particularly those who trade frequently – have been losing money.

The more you trade, the more you lose

Dr Zhong calculated that a typical loss per day among small investors trading regularly was $1.90 for each $1,000 invested in the first wave of the pandemic at the start of last year, when trading activity jumped suddenly by 25%.

A lot of that activity was buying into safer stocks in which earnings were expected to hold up well during the crisis, such as the big banks and defensive stocks, although the market was in the process of plunging to a new low which it hit last March.

Since then, the gradual arrival of vaccines, a continuing flood of stimulus and plenty of available time due to lockdowns pushed up the risk appetite of investors, with technology, travel, healthcare and retail stocks some of the favoured destinations.

Even as the market rises, many traders lose money

Overall, the share market recovered most of its losses by the end of 2020 but not so the rapid traders, with Dr Zhong estimating trading activity rose 92% in the second half of 2020 but became even less successful.

Even as the market overall rose, the rapid traders accelerated their losses, shedding $6.50 for each $1,000 invested a day.

Focus groups of investors aged 20 to 30 were also interviewed in research conducted by Dr Zhong, Natalie Hendry at RMIT and Benjamin Hanckel from Western Sydney University.

The research found younger investors mostly rejected the idea that their trading activity was similar to gambling.

However, when asked to elaborate on the appeal of trading, their habits shared many similarities with gambling: they talked about addiction, a rush to invest and the fear of missing out.

Social media and online forums were also used frequently – which corresponds to ASIC’s recent and belated focus on stamping out online pump and dump schemes and to curtail the influence of dodgy and unlicensed ‘finfluencers’.

So how could so many short-term traders lose so much money at a time when the overall market was on the way up?

Most traders fail to keep up with market rises

It is actually not that much of a mystery, with studies consistently showing that most short-term traders fail to outperform the overall market.

It is the reason why the majority of active fund managers fail to outperform the index despite all of their expensive research, although substituting inexperienced newbies for experienced fund managers tends to exaggerate the downside dramatically.

Short-term trading in many cases is more akin to gambling than long-term investing and it exhibits many of the same characteristics.

Short-term traders tend to magnify their wins, try to win back their losses and ignore trading costs and taxes.

So, what is the alternative to continually jumping on to the next big thing?

Buffett shows how it is done

Well, Warren Buffett is the world’s best investor over a very long timeframe, who has averaged around a 20% return every year, so it is wise to learn something from his holding times for shares, which are on the long side.

Buffett’s actions show that his preferred holding period of forever is more of an aim than reality – remember him selling out entirely of big slabs of the US airlines including positions in United, American, Southwest and Delta Air Lines?

That fast sale of stakes that were assembled for around $5.5 billion and sold at a loss show that Buffett is not afraid to act decisively when circumstances change.

However, when he finds a good company and builds up a large stake, he is also not afraid to hang on to it for the very long term.

A lot to learn from Buffett’s approach to Coca Cola and Apple

Take Coca Cola, which Buffett first bought into in about 1988.

Buffett’s Berkshire Hathaway is still sitting on those shares and the same can be said for a more recent but similar style of acquisition – Apple shares – which were purchased back in 2016.

If a company is still performing well and circumstances haven’t changed dramatically, Buffett has no problem sitting on the shares even if their value has grown by many multiples of the original investment – in this case six times for Apple and more than 15 times for Coca Cola.

Profound difference between Buffett and traders

The difference between the Buffett approach and that of the traders could not be more profound.

Buffett is making money slowly and consistently by backing the long-term ability of large and growing companies to earn returns well above average.

He is also happy to ride out short-term volatility and will not sell at the first sign of a downturn, as long as he is confident about the quality of the investment.

Traders are often just backing a hunch, a tip, momentum or a theory to turn a quick profit and while there are some disciplined traders who make a very good living from that approach, the majority get chewed up and spat out again.

It is important to note though that Warren Buffett is NOT just a buy and hold investor.

He does sell out of positions quickly when situations change so that his original investment idea is no longer appropriate.

However, Buffett is an example of someone who buys and sells at appropriate times and is not scared to let a shareholding run for a long time.

As investors globally invest for shorter and shorter time periods, Buffett is a counter-cyclical example to take careful note of.