Understanding Gains Needed to Recover from A Loss
Most experienced investors will most likely already have these calculations to hand and know where their cut-out point is on a stock that has decided to start nosediving on them, but for the newer ones, I hope this comes in helpful
There are quite a few traders that have done extensive research on their chosen stock and are pretty sure that this will come good, and quite often it does. When a person has dedicated time and effort into running due diligence on a stock, they know what the stock is up to, potential future for it, the daily volume, its PE Ratio, if there are shares being bought by CEOs etc, the list can be quite extensive
There is nothing wrong with having that information as it does show good homework on the company, though what it can often do, is (sometimes without us even realising) put us into a mindset where we know that even though it begins to dip, armed with all our homework, we are pretty damned sure that it is going to come back up and then return some gains for us.
This leads us to another question and that is, do we actually understand the gains needed to recover from the stock’s current loss?
The best way to break this down simply would be to list it like this…
1 – £1000 – 1% = £990 + 1% = £999.90…. £0.10 loss
2 – £1000 – 5% = £950 + 5% = £997.50…. £2.50 loss
3 – £1000 – 10% = £900 + 10% = £990. 00.. £10.00 loss
4 – £1000 – 15% = £850 + 15% = £977. 00.. £22.50 loss
5 – £1000 – 25% = £750 + 25% = £937. 50.. £62.50 loss…
6 – £1000 – 50% = £500 + 50% = £750. 00.. £250.00 loss… This means that your stock would have to go up by 100% to break even.
7 – £1000 – 70% = £300 + 70% = £510. 00.. £490.00 loss… This means that your stock would have to go up by 233% for you to come close to breaking even.
Believe it or not, at 80%, you would have to see it rise 400% just to break even.
I am sure many of us have seen one of the above scenarios play out on different members across investment boards. Quite a few hang on and believe that their chosen stock is going to bounce back, but after a certain point, the odds really do start stacking against you.
Yes, of course, you could also average your stock down and keep buying as it falls, so that the overall percentage doesn’t look so bad. This is also something we see often and a few use as a strategy, though there are a number of things to think about before applying this strategy.
1, You are buying into a falling stock, how do you know if it has hit bottom or is going to consolidate for a while and then keep falling?
2, How do we know that the stock is going to return to its previous highs, as it has obviously taken a dive and may not bounce back to where it once was?
3, How long are we going to wait for our chosen stock to come back and return us a profit?
There are a few more options to add but let’s stick with those 3 for now.
They are all questions that we have to answer and put together some sort of strategy before stepping into a trade. I am not suggesting we become pessimistic but what I am suggesting is that we have a Worst-Case Scenario plan in place, just in case it ever needs to be executed.
I know the article is titled, Understanding the Gains Needed, and I have only shown the gains needs on numbers 6, 7 and mentioned the -80% scenario in the above list. I believe the rest are pretty straightforward to work out
The deeper the loss, the harder it is to pull back out from it. This doesn’t mean that it is impossible, far from it, but what it does mean is that you are going to have to put in some extra work to start pulling out some of the percentages needed, and, the more time our money is running at a loss for us.
I personally do not use a fixed percentage area such as 5% or 10%, I use an average percentage stop that is different for each individual stock. We could try to use a standard 10% or so, but each stock has its own behaviour pattern and what works for one stock, does not mean it will work on another.
The trick is to know how each individual stock performs and you work with that, you don’t try to make a stock fit within your formula as that is not how the market works.
I hope that this has helped a few, understand a little about why it can be a good idea to cut out of a losing trend stock and move onto another better trending one.
We are not here to fall for certain stocks, we are here to make money.
My methods are based on momentum trading and this is the system I and a few others use to write these guides and to help others.
The above is just a basic that is good practice for a trader, and if you wish to understand the methodology, I use to do this, then please feel free to just ask and I will be happy to send you a link to some free vids…