The Hidden Costs of Short-Term Trading

The Hidden Costs of Short-Term Trading

Buy-and-hold investing has traditionally produced strong long-term returns. But sticking with it requires discipline, and many traders prefer to look for short-term gains from strategies that involve frequent buying and selling. With every trade, short-term-minded investors pay the price, including one hidden cost from the bid-ask spread.

In the following video, Dan Caplinger, The Motley Fool's director of investment planning, describes the bid-ask spread and explains why it has such a huge impact on investors. As Dan discusses, the difference between what buyers are willing to pay and sellers are willing to accept can be as small as a single penny per share, but with enough trades, those costs add up. Moreover, stocks with less trading volume often have wide bid-ask spreads that can amount to as much as $1 or more per share.

Dan gives some solutions for avoiding the full impact of the bid-ask spread, including sticking with the most liquid stocks and exchange-traded funds. Dan provides examples for those who want to follow the Dow Jones Industrial Average , the S&P 500 , or other major market benchmarks. For Dow investors, the SPDR Diamonds provide good liquidity and relatively low bid-ask spreads. Meanwhile, the SPDR S&P 500 tracks the S&P 500 and has rock-bottom spreads. For less liquid stocks, Dan advises caution to avoid unnecessary trading that can ramp up your bid-ask costs substantially.

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Fool contributor Dan Caplinger and The Motley Fool have no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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Originally published