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 stocks.
Large scale studies in the USA show that investors
who try to time the market earn less than inflation.
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
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