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Stock Market Investing is a Game of Pain Control

Financial advisers usually show all sorts of charts to clients but rarely ones that reflect pain, which is understandable otherwise they would be harming their own business. Do they tell clients they are getting into a game of pain control?

Usually clients are shown annualized returns and related metrics, often risk-adjusted, and also expected returns for various time horizons, which by the way may not even be close to past returns but this is another chapter. Some advisers  maybe use the “if you have invested” fallacy and show charts with spectacular gains from stocks like Amazon and Microsoft since IPO. All these of course are for the purpose of convincing the client to invest in stocks. So far so good, investing in stocks may turn out to be quite rewarding. But there are some important factors to consider.

Below is a chart of AMZN with the total return shown since IPO.

The total return hit 100,000 last year meaning that $1 invested in the stock had grown to $1,000. This is spectacular but is is questionable whether many investors ever realized even remotely close this return. This is an illusion due to charts as discussed in one of the most popular articles in this blog  “Only Speculators Would Have Held Amazon Stock Since IPO“.

Below is the AMZN drawdown chart with some useful statistics:

Maximum drawdown was in excess of 95% and the stock has stayed 20% or more below all-time highs nearly 54% of the time. It is quite reasonable to assume that most investors in the stock at some point hit uncle point. Anyone who shows an AMZN chart to a prospective client for the purpose of convincing them to invest in the market is probably naive.

Below is a list of stocks and indexes and the percentage of time they have stayed in a drawdown larger than 20%.

Stock/Index Percent of time in larger than 20% drawdown
NFLX 61%
MSFT 50%
AAPL 49%
INTC 67%
AMZN 54%
S&P 500* 20% 
DJIA* 17%

*Data since 1960. Stock data are since IPO. 

Stock market investing is a game of pain control. Probably investors in Dow 30 had  less pain to deal with in last 60 or so years but the idea is the same. Those who invest in a stock index ETF, such as SPY,  may be facing “bear market” behavior 20% of the time. Dealing with this pain if the most important aspect of investing. Investing in individual stocks and especially technology stocks could mean facing drawdown for long periods of time. This game has a lot of pain.

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Charting and backtesting program: Amibroker


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