Charts Can Make Pain Look Like Gain

Source; Wikipedia

Article originally appeared in Price Action Lab Blog

Charts can impose many illusions besides the formation of regular patterns. One of the most serious is the illusion of high buy and hold returns. The stock of Microsoft is a good example: $10,000 invested in IPO would now worth about $10 million but that is an illusion imposed by geometric growth in a dividend adjusted chart.

The stock of Microsoft (MSFT) rose 4.8% this week to an all-time adjusted high on solid earnings growth. Capitalization topped half a trillion to match 2000 levels.

Below is a tweet from StockTwits

In theory this is true. In practice also, company officers, including the founder, have realized the high returns. But is this true for MSFT IPO investors?

To start with, a dividend adjusted chart demands that dividends are reinvested. This is the least of the problems. The most serious problem regarding investor returns is the horrendous drawdown profile of the stock, as shown in the chart below:

After about one year from the IPO, the adjusted price of the stock fell more than 40% and stayed below -30% for about two years. That was sufficient to cause many investors to sell and get out. Actually, the stock fell because many IPO investors sold it.

Then, for a period of 14 years starting in 2000, the drawdown fluctuated between -30% and -70%. This prolonged period of severe underperformance probably caused many investors to sell. Actually, investor sold and this is one reason for the prolonged drawdown.

As you can see, the high return since IPO was probably realized only by company officers and possibly by a few investors who ignored the horrendous drawdown profile. But for the majority of investors, this stock meant a lot of pain.

Charts can impose many illusions and one of them is making pain look like gain. This may sound paradoxical but it is how things work in hindsight.

If you have any questions or comments, happy to connect on Twitter: @mikeharrisNY

Disclaimer: No part of the analysis in this blog constitutes a trade recommendation. The past performance of any trading system or methodology is not necessarily indicative of future results. Read the full disclaimer here.

About the author: Michael Harris is a trader and best selling author. He is also the developer of the first commercial software for identifying parameter-less patterns in price action 17 years ago. In the last seven years he has worked on the development of DLPAL, a software program that can be used to identify short-term anomalies in market data for use with fixed and machine learning models. Click here for more.

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