"Why You Keep Losing Money on Great Stocks-The Trend Chasers Dilemma" by Fred Carach

Investment attitudes have changed greatly since I broke into the investment world in 1961. In those days, everyone was a conviction investor. You bought a stock because it was a great stock and you believed in the company. As long as you believed in the company, you held on to the stock. After all, why would you sell a stock in a company that you believed in just because it was temporarily declining in value? If you were right about the stock, it would turn around and head upward in due course. You were by definition a long-term investor. After all, great stocks remain great stocks for years. They don't become dogs five minutes after you buy them. Today the conviction investor with his long-term holding pattern is an endangered species.

The day trader, the momentum player and the trend chaser have replaced him. By definition, these players are short-term stockholders. Their iron conviction is not that you should buy great stocks and hold them. But that you should only buy stocks that are going up. After all, if the stock is not going up why would you want to own it no matter how great it is? And if the stock is going down how great can it be? I can remember when I thought this was so wise that it should be carved into the sides of mountains in granite.

It took me years of painful losses to learn the error of my ways. When you have been around for a while, you learn a very inconvenient fact. Stocks rarely go up more than 15%-20% without having a correction and that correction can eat up 50% or more of the prior advance. Indeed, it often eats up the whole prior advance and more.

This results in the trend chasers dilemma. After all, he is not a conviction investor. The only reason he bought the stock was that it was going up. How does he keep his profits from turning into losses? The answer is a sell discipline. It is called a stop-loss order. The stop-loss order is an automatic sell order that your broker executes to sell your position if your stock falls to a predetermined sell point. Depending on what the trend chasers tolerance for losses is it will almost always be set at one of three selling points. It will be set at either 5%,7.5% or 10% below the current market price. Setting the loss at 10% is the most common sell discipline by far.

The sad truth of the matter is that trend chasers don't do nearly as well as advertised. The reason is that the market refuses to cooperate with their stop-loss orders. You see, "the boys" have a pretty good idea of where the stop-loss orders have been placed. Their favorite game is to blow the trend chasers out of their positions by hammering the stock down 15%-20%.This false decline that they have created blows all the trend chasers out of the water. As soon as they stop selling the stock returns to its old trend line this time with "the boys" on board. This is called "painting the tape." The trend chasers just never wise up. It is truly remarkable how many times they can have their head handed to them on a silver platter and they can never figure it out. Then again most of them are punch drunk from all the 10% losses they are being hit with.

To get an idea of just how flawed the short-term trading strategies of the day-trader, and momentum player are let's see what happens when we apply it to some of today's super stocks.

Let's start our analysis with Research In Motion, largely because I have just read Fortune Magazine's article on the 100 fastest growing companies not just in the United States but in the world. Research In Motion is ranked number one with a three-year average annual earnings per share growth rate of 84%. During the last five years, this stock with its titanic growth rate has risen from $20 a share to $75 a share. An increase of 3.75 times. A $10,000 investment in the company would have grown to $37,500. During this run, it had 9 declines of 10% or more. Three declines of 10%, one decline of 20%, one decline of 22%, two declines of 25%, one decline of 32% and one horrific decline of 70%.

Our next high-powered dream stock is Google, a darling of the momentum players with fantastic relative strength. If there is any stock that would make trend chasing work this is the stock. In the roughly five years that Google has been listed, it has risen from $85 a share to it s current price of $469 or an increase of 5.52 times. A buy and hold investment of $10,000 in this stock would have risen in value to $55,200. Of those lucky and wise investors who bought the stock when it was issued at $85 I would estimate that only about 5% still own the stock and all of them are buy and hold, conviction investors. There are no trend chasers who still own the stock. How do I know this, by following the price action of the stock? In the five years that it has been traded, This super stock in spite of its fantastic relative strength has had an amazing 15 declines of 10% or more. It has had 6 declines or 10%, two declines of 12% and one decline of 15%,17%, 19%, 22%, 27%, 30% and 40%.

Apple is another high flier of repute. In the last five years the stock has risen from $17 to $174 currently. A rise of 10.24 times. A buy and hold investment of $10,000 would have risen to $102,400. During this time, it has had 14 declines of greater than 10%. Apple's declines are as follows: one decline of 10% and 11%, two declines of 12%, one decline of 14% and 15%, two declines of 16%, two declines of 20%, two declines of 26% and one horrific decline of 40% and 45%.

Our last jewel is Amazon in the last five years this stock has gone from $38 to $84 an increase of 2.21 times, which would turn an investment of $10,000 into $22,100. This stock has also had 14 declines of 10% or more. I was surprised at the consistency in the number of declines for each stock. I was expecting more deviation. Amazon has had five declines of 12%, one decline of 14%, 20%, 22%, 24% and two declines of 27%, and one decline of 35%, 38% and 42%.

Now let us examine the S&P 500 index. I think it did the job it was created to do. Diversification worked. There were only four declines of more than 10% in the five year period. There was one decline of 11%, 18%, 22% and 32%. In addition, all of these declines occurred after September 2008 when the market crashed.

People have very delusional expectations of what kind of return they can expect with these super growth stocks. I reached that conclusion close to forty years ago and have been a conviction investor of contrarian-value plays ever since.

If you can stand the pain, I am sure that buy and hold is the best strategy for growth investors. However, I doubt if more than 5% of buy and hold investors can stand the pain and zero percent of trend chasers. What invariably happens is that the trend chasers are repeatedly blown out of their positions with 10% losses each time.

When you stop to think about it how many 10% losses can you take?

Fred Carch is the author of Forty Years A Speculator.