Why day trading has nothing to do with investing

On days when the markets fluctuate wildly and individual equities shoot up, every investor has secretly thought: “I’ve missed out!”. But daily gains of 10% or 20% are just flukes. No one can reliably predict whether an equity or an index will rise or fall on a given day.

Anyone who bets on this anyway and engages in day trading will lose money. But why is it better to hold equities for the long term? This has to do with the nature of these securities.

Think like an entrepreneur

Imagine you are setting up a company that manufactures ballpoint pens. You need machinery, raw materials and so on. All these investments are funded from the money paid in at the time of incorporation.

Although the company sells ballpoint pens, it makes a loss in the first two years. This is borne by the shareholders. The equities, which together make up the shareholders’ equity, then fall in value. However, this rises again when profits are made from the third year onwards.

This example shows that shareholders bear the full business risk, for better or for worse, on a large or small scale. And companies do not just exist for a year or two, but for decades – provided they are successful.

Equities are therefore investments through which one places long-term trust in a company to make a profit and achieve growth. All well and good, but how worthwhile is it to share in the business risk? What factors make up the return on equities? There are three components:

• Earnings growth. If a company’s profits grow, this will be reflected in the share price. After all, rising profits mean the company can invest more, for example in future growth. The share price should reflect this. Of all three components, earnings growth is the most significant in the long term.
• Dividends. The portion of the company’s profits paid out to shareholders as dividends is the second component. Depending on the company’s business sector and the region, this can be a very significant part of the share return (see the column of 20 February, ‘Dividends: Almost Half the Battle’).
• Valuation. The stock market is not perfect. Equities are valued differently depending on the timing. This can be measured, for example, using the price-to-earnings ratio (P/E ratio). So if the earnings per share are reflected 10 times in the share price at the time of purchase and 15 times at the time of sale, the valuation has risen. Why? It is a combination of the company’s results and the expectations derived from them, market sentiment and the attractiveness of other available investments.

Ever higher?

It is striking: all three components can only come together in a way that benefits investors if you hold an equity for a longer period. That is why the assertion that equities increase in value over the long term is not wrong. It is particularly true at the level of an index.

Nevertheless, equity returns fluctuate depending on the assessment of a company’s prospects and on the prevailing market sentiment – fear or greed. To avoid such cycles as far as possible, an investment horizon of around ten years is recommended for equities. This is derived from historical data series based on indices, which show that after ten years, an equity investment is almost certainly worthwhile. But not on a single day.

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