The mathematics of investment losses

Here are the maths of losses in an investment that may help you make better informed decisions.

In the battle for investment survival, you can learn a lot from Kung Fu. The first and most important lesson in that martial art is the same for the stock market today  - damage control.

Kung Fu masters begin not by learning how to throw, but how to fall. They practice this skill until it's as natural as breathing. No matter how many times they're flipped, they can rise to fight again.

Highly successful stock pickers go through similar training: They must learn how to cut their losses short. 

Sounds simple, but many investors have learned the hard way how difficult it is to master the most important rule in investing.

Here are the maths of losses in an investment that may help you make better informed decisions.

Formula to restore loss percentage

The mathematical relationship between losses and gains is a reciprocal one.

Formula for required % gains to restore loss:

((1 / (1 % loss)] 1) * 100

[ Source: investopedia.com ]
 

• After a 75 per cent fall, the gains have to be 300 per cent.
• After a 50 per cent fall, the gains have to be 100 per cent.
• After a 35 per cent fall, the gains have to be 54 per cent.
• After a 25 per cent fall, the gains have to be 33 per cent.
• After a 15 per cent fall, the gains have to be 18 per cent.
• After a 10 per cent fall, the gains have to be 11 per cent.

Example: 

Lets use a 75% fall in a Apple stock

= ((1/(1-75%))-1)*100

=300%

Thus apple would need to gain 300% in order for you to break even. 

Selling a loss making investment needs careful evaluation and should never be on an ad-hoc basis. 

However, knowing the maths for a loss to recover into gains may help you in making a decision. If you still have conviction for the stock or fund to recover over time, it could be better to add at the lower levels.