Saturday 18 April 2015

Share price fall versus share price rise

Water-palace, Jaipur, India

Now that the stock market is dropping and we are hoping for new contrarian moments there are more and more articles being written regarding bubbles, market tops, market corrections, jumping in and out of the market etc. etc.

One of the comments, that I keep seeing more and more often and that keeps annoying me are: "You need a 100% share price increase to regain a 50% loss." Is this true?

If you look upon it as two points in a time schedule then yes, it is true but in every other case that statement is more to bring in needless fear. When did one of your stocks drop 50% during one day? If you unfortunately have a stock that has dropped 50% then usually that happens over weeks or months. Of course it can happen but it is rare.

So if we then think about the normal case which is a more extended decrease of share price then the truth is simply that compounding works both ways. What I mean by this is that the lower a share price is the lower the effect will be of a 2% decrease and inverse, the higher the share price is the higher the impact will be of a 2% increase, of course based on the initial price you paid.

To put this into numbers. We start with a share price of 100 and we have a daily decrease of 2% then it will take 34 days to reach a share price of 50 which would then, from point A to B, mean a 50% overall decrease.

So going the other way... We start with a share price of 50 and look at a daily increase of 2% then it will take 35 days to reach a share price of 100 which would then, form point A to B, mean a 100% overall increase.

If you do not believe me then please make the compound calculation in Excel yourselves.

I do not fear a 100% increase after a 50% loss. Neither do I find a 2% decrease or a 2% increase that happens over 35 days with some days of 0% in between to be a big deal. There is simply no reason for why it should take a longer time to gain it then what it takes to lose it so please ignore such statements that bring in useless fear or even useless thoughts.

Back to the markets. Looking at last week I personally dropped more than a monthly net salary and it is of course never fun but hey, markets go up and down and right now it is going down. I hope that a new contrarian situation will open up like in October 2014 which made me pick in an excellent DAX company in my portfolio (BASF) and I would not mind getting some more of them!

Keep Stocks and Carry Long!

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