What Are Short Term Stocks

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HFA Staff
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Short Term Stocks

Handling investment horizons can be tricky, especially if you are new to trading in the stock market. Investment horizons are categorized into the short and long term. Whether you prefer long-term or short-term investing depends on your goals and strategy. From there, one question that often pops up: What are short term stocks?

Short-term stocks are part of a trading strategy that encompasses one year between buying and selling a security. The end goal of this type of short term investment is to earn capital from price fluctuations.

Some benefits of short term trading are opportunities for quick profit, investment flexibility, and income diversification. On the downside, short term trading demands more time committed to the investment process, combined with high risk in volatile market conditions. In the rest of the article we will go through all the necessary information regarding short term investments, so if you are up for it, stay with us a bit longer.

Key Takeaways

  • Short Term Stocks are used as a part of a one to three-year investment strategy that aims to earn from price fluctuations.
  • Common short-term securities are corporate and government bonds, certificates of deposits, treasury bills, and equity shares.
  • The upsides of short-term stock investing are low risk, liquidity, and potential for quick returns.
  • A major downturn is a low return from these investments.
  • Short-term equity trading comes at higher risk, combined with higher potential gains.

Defining Short-Term Investing

Short-term investing is also called marketable securities or temporary investments. One of their key characteristics is that they can be easily converted into cash within a one to five-year period.

Holdings in a portfolio that are bought with the intent to be sold within a year are also called short term investments.

Short term investing offers relatively low risk, and high liquidity rates, offering investors a chance to quickly pull out their investment capital. On the other hand, they come with low interest rates and can come with a cost in a case of a market downturn.

Common examples of short term investments are:

  • Certificate of deposits
  • Commercial papers
  • Treasury bills
  • Corporate bonds
  • Government bonds
  • High yield savings accounts
  • Equity shares.

Short term investing is a preferred strategy for day traders, swing traders, and companies that focus on short term goals.

Types Of Short Term Investments

Treasury Bills

Treasury bills are short-term debt obligations issued by the United States government and backed by the Treasury Department. Due to these characteristics, this type of investment comes as a low risk investment type.

The value at which the bills are traded is determined at auctions. The income from this investment option is a difference between the market value of the security at the time of its maturity, and the purchase price determined at the auction. Investing in treasury bills usually results in moderate returns.

Treasury bills are divided into three groups by the date of their maturity:

  • 91-day treasury bill
  • 182-day treasury bill
  • 364-day treasury bill.

Commercial Papers

Commercial papers are short term debt obligations issued by companies to raise capital. Compared to other rather safe investment options, commercial papers are unsecured and can take an impact from market trends and fluctuations.

When deciding to invest in commercial papers investors should check the creditworthiness of the company issuing them. These investment options are traded in the stock market.

Commercial papers are highly liquid short term investments that mature quickly. The maturity period ranges between a few weeks and nine months.

Certificate Of Deposits

A certificate of deposit (COD) is a type of savings account that delivers a fixed interest rate. The length of the savings account is agreed at the beginning of the investment and can vary. It can be issued by banks and other financial institutions.

When compared to other types of savings accounts and money market accounts CODs offer a higher interest rate. On the other hand, CODs are more conservative in comparison to stocks and bonds. Their rate of growth is lower, but the risks are almost non-existent.

Before investing the investor should check all available options and look for those that come with the highest rates. In the best case, CODs can deliver three or four times higher returns than the national average.

The time horizon for CODs issued from commercial banks is anywhere between seven days to a year. Other financial institutions offer CODs with longer terms, usually in a period between one and three years.

Equity Shares

Depending on the investment strategy, equity shares can be used as a short term investment instrument. Equity shares are traded in the stock market and come with the highest risks as a short term investment option.

Since they are traded in the stock market they are prone to all benefits and potential pitfalls that come with it. The volatility of the market can cause price downfall, especially for short term traders. In case you quickly need cash, you may end up selling them below the investment price.

Another downside of short term stock trading is short-term capital gain. It is taxed for all stocks traded in a period under a year and is taxed at higher rates. When creating your investment plan you should include this fee because it can eat a solid portion of your gains.

Corporate Bonds

Corporate bonds are considered to be the most secure form of fixed-income investment plan. Bonds are issued by companies to raise capital. It is a highly liquid short-term investment option that delivers lower returns over time.

In comparison to government bonds, they deliver higher returns. Corporate bonds come in different time frame options, with those short term maturing in up to three years. Liquidity is high and investors can always sell them before the maturity date. If you decide to sell bonds before their maturity date you will end up with a lower price.

Commonly corporate bonds are used to constantly deliver steady income influx. After they mature the investors sell them and often reinvest the capital into new bonds.

Choosing between a classic savings account and investing in corporate bonds is a tricky predicament. A bit higher returns can tip the scales in corporate bond favors even in the short term.

Government Bonds

Choosing to invest between government and corporate bonds is a frequent dilemma. Both are rather safe ways to invest in the short term, but several factors set them apart. Government and corporate bonds are both highly liquid with slight differences in risk levels and potential returns.

Since government bonds are backed by the treasury, they are certainly a safer bet. This doesn’t mean that corporate bonds are risky, but they are not in the same category. As a result of almost non-existent risk, government bonds will deliver lower returns.

If you want a safe and steady income over the short term, government bonds are an all-around good short term investment.

High Yield Savings Accounts

High yield savings accounts are safe, liquid, accessible, and offer competitive returns to investors. As a short-term investing strategy they offer a good mix between risk and reward.

Every investment is secured up to $250,000 by the FDIC which makes it a safe investing option. Another upside is that an investor can always pull their money without penalties. While other investment options come with lock-up periods, and offer easy access to capital. This feature comes as a great benefit for investors looking for short term gains.

Between other short term investments like bonds, bills and saving options, high yield saving accounts provide higher competitive returns. The downside of this option is that it doesn’t guarantee returns since interest rates can fluctuate over time.

Choosing a high yield savings account is a great option if the investor is looking to park an excess amount of capital. It can generate solid returns until the investor can find a better or alternative way to use it or invest it.

Strategies For Choosing Stocks For Short-Term Investment

Stock Choice Based On Fundamental Analysis

Choosing stocks based on fundamental analysis is identifying undervalued stocks. To achieve this investors follow a specific stock over some time. Indicators to watch out for are the company’s financials, its position in the industry, and the potential outlook of the sector.

When conducting fundamental analysis be sure to go through the balance sheet, and cash flow statements. Other crucial economic data that can show the condition of the company are price to price-to-earnings ratio and its earnings per share.

Companies with incoming events that can trigger their price rise are good options for short term investing. Events to look for are the launching of new products or services, changes in operational management, or influx of new investor capital.

However, short term stock trading can be risky, so you should plan risk mitigating strategies. Utilizing stop-loss orders to minimize potential losses is often a preferred approach in these situations.

Mind the overall risk, and start small. You do not want to lose all your investment in one go. Gain experience with smaller trades, and then build your positions. To achieve this plan you need to be disciplined and to avoid relying on your emotions.

Stock Choice Based On Technical Analysis

Employing a technical analysis when choosing short-term stocks, can prove to be resourceful if done correctly. Technical analysis with its tools is designed to analyze past performance of the stocks, market trends, and price valuations.

Indicators like the relative strength index, moving averages, and Bollinger Bands are used to analyze past price movements. Based on those analyses you can define potential entry and exit points from the position.

Other elements of the technical analysis like head and shoulders, double top/bottoms, and breakout patterns can point to potential price movements. They are essential in timing your investment.

Swing Trading

Swing traders employ both technical and fundamental analysis to identify stocks that can have a short term momentum. In the heat of market volatility, there are swings in the price that these traders want to catch.

This approach applies to investors who do not have large amounts of time on their hands to focus on everyday trading.

Day Trading

Trading stocks with a day trading approach is based on buying and selling stocks during one day. To successfully day trade investors heavily rely on technical analysis to predict price shifts.

Day trading demands a substantial time commitment. Traders constantly need to monitor the price fluctuations and make decisions in the heat of the moment. This approach is considered to be highly risky, especially for investors with a low risk tolerance.

Who Should Invest In Short-Term Stocks

Short-term stock investment is an optimal ground for investors with different goals and preferences. Four major groups can benefit from this type of investing:

Individual investors looking for short term returns to cover expenses

When an investor is missing capital for a potential expense that is out of his reach, short term investing can help you to accumulate additional capital. Building an emergency fund or downpayment for a house or a car is a good enough reason to go down this path.

Investors that prefer fixed income securities that come with low risk

In contrast to long term investments, investments in the shorter time frame allow individuals liquidity and quick access to capital. In case you are in dire need for cash you can pull out your investment and redirect that money elsewhere.

Liquidity combined with the low risk of most of these investment plans is a winning approach for a rising number of individual and institutional investors.

Investors that have an excess amount of cash and need to utilize it in a safe way

In a situation when an investor has cash that doesn’t need at the moment he can redirect into short term investing. Instead of capital remaining idle, an investor can put it to good use, and earn a certain benefit.

While the capital is “parked” the investor can take his time on analyzing his potential moves.

Experienced short term and day traders

Investors with excess experience in short term trading made from this approach their career. These professionals usually have a higher tolerance for risk but also have a better understanding of the market.

Advantages Of Investing In Short-Term Stocks

Short term investment options come with a unique set of advantages that cannot be found in long period investments. These advantages include factors like:

Potential for quick returns

Short term investing is in most cases focused on under a year. In some situations, it can be prolonged to three years, but in every case that is considered to be a short investment horizon.

In that short period, investors can count on relatively safe returns with regular interest gains. After a date of maturity, investors get their principal investment back with an option to reinvest it.

High liquidity of the investment

Due to its short trading horizon, these investment options are usually highly liquid. In reality, this means that you can pull out your investment at any moment, without losing any part of it.

Low risk

In the case of investing in bonds, bills, and CODs short term investments come with a low risk. On the other hand, when trading equities in this time frame, the risk rises, together with potential gains.

Disadvantages Of Investing In Short-Term Stocks

Low income

When trading treasury bills, bonds, and other securities an investor should not expect to make high gains. Due to low risk and high liquidity, these investment options are also not very lucrative.

High risk

In contrast to short term bonds, trading equities in the same time frame tends to bring high levels of risk. If it is taken seriously short term investing can take solid chunks of the day just to have all the current information.

Final Thoughts

Short-term investing is something that many saw as an exit from their not-so-great financial situation. However, if you are planning to get rich from short trading, you should think twice. The only two ways to earn with this approach are to collect interest from bonds, bills, and CODs, or to venture into high risk short equity trading.

For those who are looking for a steady and safe source of income, corporate bonds, or treasury bills could be a way to go. In case you are planning to enter a short-term market trading arena, arm yourself with confidence and knowledge.

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The post above is drafted by the collaboration of the Hedge Fund Alpha Team.