The Harder A Stock Falls The Tougher It Is To Recover Losses

One of the important strategies to follow for success in equity investing is the willingness to cut losses and moving on. To become successful with investing in stocks is to accept that not all stocks one holds in a portfolio will be winners. In fact, there will some that will perform average over the years and a few that will completely crash and end up worthless. However in a portfolio of say 50 stocks, if 3 become worthless it is no big deal as long as the portfolio is well diversified and the portfolio’s assets are not most allocated to those stocks.

When a stock falls hard it is even harder to recover the losses. For example, if a stock trading at $10 falls by 50% to reach $5, an investor needs the stock to jump by 100% (going from $5 to $10) to break even. of course, it very rare for a stock to shoot up by 100% or double in price easily.

The following simple chart explains this mathematical concept:

Click to enlarge


Source: How to Win More by Losing Less in Today’s Markets, Blackrock Blog

Here is an example. Brazilian oil giant Petrobras (PBR) reached a peak of $72.34 in early June 2008. Since then the stock has plunged consistently year after year to reach $4.08 on Friday. That is a decline of about 94% according to Yahoo Finance. In early 2001, the stock traded at around $4. So from $4 it went all the way over $72 and then came back to $4. For an investor who bought it at the peak, the stock has to increase by nearly 1800% to break even.

PBR Long-term chart

Source: Yahoo Finance

Disclosure: Long PBR

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