With this short-term investing strategy, you may be missing out on long-term profits in favour of giving short term profits to your broker

If you try to profit by relying on the short-term investing strategy of acting on market predictions, it will likely cost you money and hurt your investment returns.

This strategy is centered around “taking money off the table”.

Investors may try to improve their returns by taking money out of the stock market when they feel risk is high. They often get this urge after a few weeks or months of bad financial news or unsettling political developments.

By then, however, the market may have already dropped far enough to offset any negative developments. Often, these temporary sellers wind up buying their way back into the market when the news has improved and stock prices have gone well above the price where they sold.

All too often, brokers encourage this short-term investing strategy. They may advise clients to “take some money off the table,” setting up a false analogy between investing and gambling. That’s in a broker’s interest, but not yours.

Every sale generates a commission, which goes to the broker. It also gives the broker the opportunity to sell the client something new and make another commission.

The investor may re-invest in a product that’s more profitable for the broker—selling the proceeds of a stock sale to buy an annuity or a universal life insurance policy, say. However, investors at discount brokers also manage to sell low and buy back high, without any broker encouragement.

Dalbar, a Boston-based financial-research firm, published a pioneering study of U.S. investor returns in 1994, covering the previous decade. In the latest update of its study, it found that the average investor in all U.S. stock funds earned 3.7% annually over the past 30 years. That’s around one-third of the 11.1% annual return that the S&P 500 stock index achieved in the three full decades of that period.

Investors underperformed the index mainly by selling or staying out of the market when they saw the outlook as risky, and then getting back in when things looked better to them. By then, prices were generally higher. We suspect a similar study of Canadian investors who follow this stock strategy would come to a similar conclusion.

Don’t misunderstand. You need to use a short-term investing strategy and a stock strategy that suits both your goals and your temperament. For you, that may mean holding six months’ worth of income in a money market fund.

Holding cash reserves generally cuts your long-term returns. That’s because six-month interest rates are generally well below the average long-term return in the stock market. But you’ll lose far more if you try to cut risk or improve your returns by moving in and out of the market in response to market predictions (yours or anyone else’s).

To succeed as an investor, you need to get used to the idea that short-term declines come along unpredictably. These declines are common enough that investors continually think about them. But they are far less common than the predictions that the next one is right around the corner.

Investors need a healthy sense of skepticism for both good and bad news—but not to the point when they react to that news as a short-term investing strategy. Being too quick to sell or buy can cost you long-term profits.

If you want to be a more profitable investor, use our three-part Successful Investor philosophy:

No matter how you invest for retirement, you should take care to spread your money out across the five main economic sectors: Finance, Utilities, Consumer, Resources & Commodities, and Manufacturing & Industry.

By diversifying across most if not all of the five sectors, you avoid overloading yourself with stocks that are about to slump simply because of industry conditions or investor fashion.

You also increase your chances of stumbling upon a market superstar—a stock that does two to three or more times better than the market average.

What stock strategy has proven useful to you? Have you ever sold a stock too quickly? Share your short-term investing experience with us in the comments.