The most profitable types of trading involve a range of trading decisions that all contribute to the long-term economic interests of the investor.
For example, a short-term investor could simply invest their entire portfolio in a single short-term index fund; these short-term securities trade at a discount to the long-term S&P 500 index. This strategy gives them a higher return than an investor who invests in a portfolio of stocks instead.
Likewise a trader could use a margin call option, where he uses a portion of his margin to buy and sell securities, and also buys and sells short positions. When the short position gets filled, he then borrows additional margin, and so forth.
If there was a mutual fund for these two types of trades, we could say that those who use a margin call option tend to have a higher risk tolerance, while those who use a margin call also tend to find that their investments in equity bonds are lower risk; or, in other words that the equity bond-only investor does not tend to make the same kind of errors as the equity investor.
You may have noticed that we are talking about the stock market as opposed to the bond market here. There are, however, some similarities. Just as one person may use a margin call option while another uses a call option with a lower loss than if he had bought shares of the stock, there are some similar types of strategies that both use trading with a margin call.
We mentioned that many long-term investors use a margin call to lower their risks and increase their returns. Why? Because as a long-term investor, you are most exposed to inflation. An excessive amount of inflation can lead a long-term investor to make serious errors in decisions about whether to buy or sell shares of the stock market. In the short-term, however, the stock market tends to move in cycles and these cycles have an elasticity factor that tends to dampen inflation.
If the stock market moves below the elasticity factor, then excessive purchasing of the long-term instrument (stocks) by a long-term investor could lead to severe inflationary pressures. If the stock market moves above the elasticity factor, investors may want to sell their short-term instruments because of their lower volatility. As a result, the investor may need to increase their purchases of stocks, especially if they are invested in the “long-term” instrument (equities), as shown above.
We can illustrate with an
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