Short term traders try to make a profit by buying or shorting a stock over a limited time frame. Every time a stock is sold, there is a tax implication. Traders need to examine those implications and their impact on the profitability of the trade.
Unlike some fixed investments, stocks tend to fluctuate. A stock can go up or down several points in a day, more than that over a long time frame. Investors can buy and sell at any point during that time.
Making Smart Investment Decisions
For example, let’s look at the day ending prices for a mythical stock, XYZ Corp:
March 1 - $10
March 2 - $11
March 3 - $ 9
March 4 - $10
March 5 - $11
March 6 - $12
Investor A prefers the buy and hold strategy, and avoids taxes. He buys 1,000 shares on March 1 and sells on March 6 or a $200 profit. Assuming commissions of $10 per transaction and 30% taxes, his net profit is $126. ($200-20=180 – 54 in taxes)
Investor B prefers to buy when the price drops and sells when it goes up. She buys on March 1, sells on March 2, buys on March 3 and sells on March 4. She makes no moves on the 5th and 6th. She has the same gross profit, but she pays more in commissions. Since commissions reduce the amount of taxes, her net profit is $112.
Clearly, the additional trading brought less profit in this case.
When Taxes Matter in Investments
Consider what can happens if Investor A continues to hold. If the price goes back down to $10 on March 7, investor A has successfully avoided tax by losing all of his profit. His choices now are to sell for the same price he bought, less commission, or continue to hold the stock.
Investor B has bought and sold in order to maximize her profit, regardless of the tax implications. She still has her $112 profit, and has the resources to buy again on March 7. She does owe taxes of $48, but this is win/win situation for her and the government.
She may not be happy about having to pay the taxes at all, but she does have the profit from which to pay them.
Making Investment Decisions Based on Taxes
No one can see the future to know what the stock price will be, but traders should consider aspects of the purchase and sales when making a decision. Basing the entire decision only on tax avoidance can lead to loss of profits.
