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Friday, January 20, 2012

Break even misconception in Stock Market


Break even misconception in Stock Market

Investing Break even misconception
Last time I post an article about first thing to know before investing in the Philippines Stock Market. I cite the rule of Warren Buffet to be considered and follow before going into stock market because I know and I'm sure many people losses money in there. Despite the fact that this rule is not easy to be follow and apply in real life sometimes wrong decision can lead and result of losing money so it is much better to determine how much money are we willing to loss in the stock market. If we can't avoid of losing our money then we must manage to minimize the loses.

Why many people losses their money in the stock market? I believe the causes are lack of knowledge in investing in the stock market, short term plan investing or no plan/strategy at all and the worse is the breakeven misconception creating confusion to many investor in the stock market.

Many people often believe that if their shares of stocks turn into negative many don't even react or do something or most of all don't have plan/strategy on how to lessen their losses because of hoping their returns will come back soon while waiting. They believe that if their stocks loss 10% within one year it takes 10% also to break even while patiently waiting and do nothing which isn't true.

In my example last time if you have Php. 10,000.00 place in the stock market and loss 20% in first year become Php. 8,000.00, it loss Php. 2,000.00. In order to gain back the loss of Php. 2,000.00 or to breakeven to Php. 10,000.00 without doing and just patiently waiting the market to go up again, it needs 25% gain not 20% to recover the losses. 5% higher compare to recent loss of 20%. This is the misconception of many people in the stock market that's why they end up losing their money. Often they don't have plan/strategy to what to do in order to protect their money and to avoid losing. 

For me to avoid this if it happen, we must have a plan/strategy either sell the stocks and take/cut the losses or buy more stocks and do peso cost averaging. From other blogs I read they suggest, set a plan of what percentage of drop/losses to reach before make an action either take/cut the losses or buy more stocks.

The reason we should take/cut losses quickly if our stock drops even more is the ability to recover from losses. If a stock drops 10% from the purchase price, we can make it back with an 11% gain. If it drops 20% we can make it back with a 25% gain. But if it drops 50%, our stock must gain 100% just to breakeven and recover which is takes time to make it happen! Check out the table below for the sobering numbers.


Amount of Stock Drops / losses
Gain needed to Break Even and recover
5%
5.26%
10%
11.1%
20%
25.0%
30%
42.86%
40%
66.67%
50%
100%
60%
150%
70%
233.33%
80%
400%
90%
900%

From the table we can clearly see what percentage of drops are we willing to accept depends on our time horizon. For short term plan it is better set a lower percentage of drop so that we can quickly do necessary action to recover the losses in time. The higher the losses you accept, the higher the gain to break even therefore the longer time horizon we must have to recover from losses.

Now, if you have done your plan/strategy on how you going to follow the rule of Mr. Warren Buffet. I think you are ready to go now in the Philippines Stock Market. Good Luck. Happy Investing.



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