Short-Run Holders Should Care About the Long Term Too

Short-Run Holders Should Care About the Long Term Too^[2]

A firm announces its one-year plan, but you don’t care because you’re planning on selling the stock in one day. Actually, because anticipated future events affect today’s stock price, even short-term day traders should worry about their investments’ long-run prospects.

You consider buying a stock on Monday and selling it Tuesday. Should you be concerned about what could happen to the stock on Friday? Yes, because it will affect the price received on Tuesday.

If the person you sell the stock to is one of those boring buy-and-hold people, then obviously he will care about what happens on Friday. What he is willing to pay on Tuesday will be influenced by what he suspects will occur on Friday. But let’s say that you sell the stock to another short-term trader who plans to sell it on Wednesday. Even if this buyer intends to sell to another person with a short time horizon, either that next buyer will care about Friday, or she will sell to someone who does. What she is willing to pay will be affected by what is supposed to happen on Friday. When a trader sells a stock, the price he gets is determined by what the next buyer will pay, which is affected by what the next buyer will pay, and so on. Consequently, not wanting to hold your stock for the long run does not mean that the long run doesn’t have a hold on you.

Short-term traders should care about the future exactly as much as long-run investors do. If this were not true, short- and long-term traders would place different values on the same stock. If the short-run people valued the stock less, they would never buy the stock, and the market would rightly ignore their preferences. Market prices would then reflect long-run evaluations. If short-term traders valued it more, then they would be in trouble because if the short-term investors paid more than the long-run investors thought the stock was worth, then the short-term investors would be able to profitably sell the stock only to other short-run investors. But since short terms become long runs, these traders would eventually have to sell for a loss.

What if, however, it’s known that a stock’s price will go up to $90 today and go back to $80 tomorrow? If this kind of situation arose, then short- and long-run investors would indeed have different perspectives. This situation, however, should never manifest itself. A stock’s value is determined by what someone would pay for it. Why would anyone pay $90 today for something that is going to be worth only $80 tomorrow? Perhaps because they will sell it to someone before the price goes down. But then why would this second buyer pay more than $80?

^[2]CNBC.com (April 25, 2000).