The idea of
choosing stocks that are rising quickly and then ditching
them when they slow down in favour of other fast-risers
is very seductive. It is like the old pony express
riders who would hop onto new horses when the ones
they were riding began to tire.
If only it was that easy. There are
a number of things that make this highly unlikely
in practice. First of all, just because a stock price
rises quickly over a period of time such as a month
is no indication that it is going to continue doing
this over the next month. At the same time, it is
no indication that it is going to do the opposite
over the next month.
Actually it is a little more
complicated than this. One large scale study showed that,
on average, stocks that outperformed the market for a month
tended to underperform over the next month whereas outperformers
over 12 months continued to outperform over the next month.
But these effects are small and vary enormously between
Large scale studies in the USA
show that investors who try to time the market earn less
In other words, it is very difficult
to know whether a pony is really tired and you should change
to another, or whether it is just having a breather while
getting ready for the next charge. For example, from 1996
to 2002 the return on Cochlear was an average of 50 percent
per year. Then it took a dive, but over the last twelve
months the return has jumped back to 70 percent.
The average total return for
Cochlear since it floated at in December 1995 has been 30
percent per year. At the same time the company has restored
the hearing of tens of thousands of people around the world.
Another thing that makes it difficult,
according to a number of studies, is that on average when
investors sell a stock to take a profit they end up putting
their money into another stock that underperforms the first
one. In other words, it is not just a question of “taking
a profit”, but also what you are going to do with
What is the answer? I think of
buying stocks as similar to getting married. You do all
the decision making before the event with the intention
that you are getting married for the rest of your life.
It may not end up that way, but that is your intention.
You need to resist the temptation
for any stock market one-night stands or short-term flings.
At the same time, as Warren Buffett says, if you “put
together a portfolio of companies whose aggregate earnings
march upwards over the years, then so will the portfolio’s
Warren Buffet has been tremendously
successful and you can get some of his investment strategies
and methods in a free report by going to www.buffettreport.com.
John Price is CEO of Conscious
Investing. Email firstname.lastname@example.org.