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What is Passive Trading? Know Here in Detail!

01 Sep 2023

Introduction 

Passive trading is the exact opposite of active trading. Active trading aims to make quick gains based on short-term price movements. However, passive trading involves buying financial instruments to hold them for long periods. It does not focus on short-term price fluctuations and hence does not require constant watch on the stock market

What is passive trading?

Passive trading is an investment strategy for long-term investment horizons. Its goal is to maximize profits with minimum buying and selling. Passive trading is also known as the ‘buy and hold’ strategy, where you buy and hold assets for long periods to generate long-term gains. You need to resist the temptation of anticipating or reacting to every price fluctuation. The basic assumption behind the passive trading strategy is that the market delivers positive returns over time. 

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Passive trading helps avoid the drawbacks of frequent trading, like high transaction costs and making decisions based on short-term price movements. It can be an ideal investment strategy if you prefer a low-cost, less risky, hassle-free approach to building wealth. 

As a passive trader, you can buy shares of companies in equal proportion as they appear in a given index. You can invest in Exchange-Traded Funds (ETFs) or other index funds. Index funds try to match the performance of an underlying index like Sensex or Nifty. These investment vehicles stick to their benchmark index no matter what happens in the market. They can also help you achieve diversification with less management costs. Another option in passive trading is to do your research and buy shares of promising companies. You can hold these shares for one year or longer to make profits. 

Advantages of passive trading

Here’s a list of advantages of passive trading: 

  • Lower investment costs

You do not have to buy and sell stocks through passive trading constantly. You can hold the stocks longer and avoid costs related to several transactions. Lower fees and charges, brokerage and commissions result in lower investment costs and earning potential. 

  • Lower risks

Most index-listed companies are expected to grow over the long term despite their share prices being volatile in the short term. Investing in shares listed in an index thus lowers investment risks.  

  • Less expertise required

Passive trading requires less expertise in technical analysis, formulating strategies, and predicting price movements. 

  • Less involvement 

As a passive trader, you don’t need to constantly involve yourself in checking news and stock prices to make quick gains. You can passively hold your investments, let them grow over time and dedicate your time to other activities. 

Disadvantages of passive trading 

Passive trading comes with the following disadvantages:

  • Less possibility of beating the market 

Based on your research, you may not constantly monitor the stock market, whether tracking indices or buying and holding stocks. As a result, you miss out on critical opportunities to capitalise on the drops and rises and not generate a profitability level that beats the market.

  • Lack of liquidity 

Passive trading focuses on building wealth gradually. If the share price does not reach or falls, you must hold the investment until the target price is achieved. Consequently, your funds may get locked in for long periods. 

To sum it up

Passive trading is a suitable investment strategy for long-term investment horizons. It helps avoid the hassle of monitoring short-term price movements and buying and selling instruments frequently. This type of trading approach is cheaper, less complicated and usually produces high returns over the medium to long-term horizons. 

However, every trading strategy has its own set of risks. Passive trading is no exception. So, evaluate your risk-taking capacity and financial goals before opting for this strategy. It is advisable to conduct thorough research before committing your funds to avoid losses.

 

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