Small losses versus Big losses. They are different stories.

Small Losses

Small hits or losses are alright, so long as they aren't persistent or don't last forever.  That said, we cannot take 10% or even 5%, losses ongoing and forever.  Even if we under-perform the markets by a few percentage points, we can lose out on considerable gains once the power of compounding sets in.


Big Losses

Big losses are a different story.  We can tolerate the 10% corrections and even ignore the 10% twitter, but if we are exposing ourselves to 50% losses on individual investments - or worse, on substantial portions of our portfolios - look out!  It will take a lot to turn that ship around and get it back to where it went off course.


Fluctuations, minor corrections and bear market

There is a big difference between fluctuations, minor corrections (considered to be 10% pullbacks by most market professions), and an all-out bear market, usually considered a plunge of 20% or more.  The prudent investor senses the difference between fluctuations, corrections and the more destructive bear markets.


The high cost of an untimely hit.

Volatility can be expensive, especially, if it goes beyond normal investment noise into creating a significant downturn, especially at the beginning of an investing period.

The principles and effects of compounding makes a difference not just how much we succeed but also WHEN we succeed in the markets.

The general principle is that the more we can earn SOONER - to unleash the power of compounding to a greater degree over a longer time - the better off we are.

Conversely, if our investment capital takes a hit in the early going, it takes a lot just to get back to even, let along to get ahead.

Trading Losses - Why It's So Hard To Get Back To Breakeven

Don’t Let Your Losers Become Big Losers

Don’t Let Your Losers Become Big Losers

So with my Trailing Stop Strategy, when would I have gotten out of the failing muscle-shirt business? You already know the answer.

Remember, the shares started at $10 and fell immediately. Instead of waiting around until they fell to $6 as the business faltered, using my 25% Trailing Stop, I would have sold out at $7.50. And think of it this way – if the shares fall to $8, you’re only asking for a 25% gain to get back to where they started. But if the shares fell to $5, you’re asking for a dog of a stock to rise 100%. This only happens once in a blue moon – not good odds!

Take a look at how hard it is to get back to break even after a big loss...

You’ll Never Recover
Percent fall in share price	Percent gain required to get you back to even
10%	11%
20%	25%
25%	33%
50%	100%
75%	300%
90%	900%

So what’s so magical about the 25% number? Nothing in particular – it’s the discipline that matters. Many professional traders actually use much tighter stops.

Ultimately, the point is that you never want to be in the position where a stock has fallen by 50% or more. This means that stock has to rise by 100% or more just to get you back to where it was when you bought it. By using this Trailing Stop Strategy, chances are you’ll never be in this position again.

http://www.dailywealth.com/1041/Don-t-Lose-Money-The-Most-Important-Law-of-Lasting-Wealth

Smart Investing: Don’t Lose Money!

We’ve all been told that in order to create wealth we must take risks and invest, invest, invest. Between stocks, bonds, mutual funds, 401(k)’s, IRA’s and so forth, people are feeling the pressure to invest because they have been taught that it’s the only way to wealth. The problem is many people are losing money. And, though some recover from losses (and some never do), losing money has a much greater negative impact on your wealth than gains do. Let me explain.

Impact of Losses vs. Gains

First, some basic math. I want to show you how losses hurt much more than gains help. Many people are under the impression that if they have a 20 percent loss one year and a 20 percent gain the next, then everything is okay and they’re back to their original investment. Unfortunately, this isn’t true.

Let’s say you invest $100,000. The first year, you lose 20 percent. You’re left with $80,000. The next year you make a 20 percent gain. How much do you have? Remember the “gain” must be calculated from the current value of $80,000, so a 20 percent gain on $80,000 would take your value up to $96,000. You’ve still lost money.

But what if you had a gain first and then a loss, would that make any difference? Let’s see: Again, you start with $100,000. Only, this time, you gains 20 percent off the bat. Now you have $120,000. The next year you lose 20 percent, leaving you with $96,000. There is no difference whether you gain first or lose first; the loss can happen at any point and will still have a greater impact than the gain.

Don’t Lose Money!

Remember the most important rule in
creating wealth, “don’t lose money.” 

In the end, no matter how you choose to invest your money, make informed decisions and look at all your opportunities.

Dan Thompson is a 25+ year financial expert and author of “Discovering Hidden Treasures.” He specializes in wealth creation and retirement planning.

OCTOBER 5, 2010

http://www.quizzle.com/blog/2010/10/smart-investing-dont-lose-money/

Should losses cause worry?

The Star Online
Wednesday May 19, 2010
Should losses cause worry?

PERSONAL INVESTING
By OOI KOK HWA

MANY long-term investors always look for companies that can provide consistent growth in earnings and, more importantly, stable growth in earnings. They dislike companies that appear to be “accident-prone” and have “extraordinary” losses every year or every few years.

Given that they will hold on to their investments for a very long period of time, their key returns from the companies will be highly dependent on the dividend payments.

If a company always shows high “extraordinary” losses every few years, long-term investors may not want to invest in this company since it cannot pay stable dividend payments. Nevertheless, some may still buy the company for trading rather than for long-term investment.

An earnings surprise occurs when there is a material difference between expected and actual financial results. In this article, we will look into earnings surprise as a result of unexpected huge losses incurred.

There are two main types of “extraordinary” losses:

• one is related to the recurring items or due to their normal business operations; 
• the other to non-recurring items.

Charles W. Mulford and Eugene E. Comiskey, in their book entitled Financial Warnings, defined non-recurring items as revenues or gains and expenses or losses that are not reasonably consistent contributors to financial results, either in terms of their presence or their amount. Examples of non-recurring items are

• gains and losses on asset sales, 
• foreign currency and debt retirement gains and losses, 
• foreign currency gains and losses as well as 
• the costs incurred in restructuring activities.

In 2009, as a result of low asset prices, a lot of companies reported high impairment losses on their assets. Even though high losses incurred from non-recurring items can affect the dividend payments and write off a portion of shareholders’ funds, most analysts will exclude the above losses in their earnings forecast as they are more concerned with the losses from their normal business operations.

In the computation of intrinsic value, analysts will look into the earnings power of the companies – the companies’ abilities to generate future earnings.

Analysts are less concerned with non-recurring items as the companies are not expected to incur this type of losses every year. For example, if a company incurs huge losses due to the disposal of certain assets, analysts are less worried as the company will not dispose of its assets every year. Furthermore, asset disposal is not part of its normal business operations.

Companies cannot avoid incurring losses from non-recurring items, which might be due to

• changes in economic situation or 
• changes in business cycles, 
• changes in accounting treatments or 
• some unforeseen events.

However, based on our analysis, companies that tend to show frequent losses from non-recurring items in almost every financial year are normally fundamentally unhealthy. The quality of their management is almost always in doubt.

Some companies may claim that they cannot avoid incurring these losses. However, they are unable to provide a satisfactory explanation on why their competitors do not seem to be similarly affected but are instead able to show consistent growth in earnings despite difficult business cycles or environment.

As mentioned earlier, analysts are more concerned with the losses incurred as a result of the normal business operations. If a company incurs high losses due to

• cost overrun on certain projects, 
• sharp drop in revenue or
• sudden increase in operating costs, 

analysts need to determine whether the above phenomenon is due to

• the overall country economic situation, 
• industry specific or 
• only unique to that particular company.

If it seems to be the only one that shows losses while its competitors have been performing well, we need to investigate the causes behind these losses and the effect on the bottomline of the company.

It is very important to take note of the subsequent corrective actions suggested by the companies to overcome the issues involved. Besides, we need to check the possibility of the company repeating the same mistake in the near future.

In short, besides focusing on generating higher sales and profits, the company needs to pay attention to risk management on cost control and take the necessary steps to hedge against business risks.

Companies need to understand that investors look for stability and predictability in future earnings.

● Ooi Kok Hwa is an investment adviser and managing partner of MRR Consulting.

Taking Profit and Reducing Serious Loss

Taking profit

Profit should be realised from sales of stocks in the following situations:
(I) when the stock is obviously overpriced, or
(II) when the sale of the stock frees the capital to be reinvested into another stock with potentially better return.

• Not taking profit in the above situations can harm your portfolio and compromise its returns. 
• In other circumstances, let the winners run.
• 
  

Underperforming stocks should also be sold early.

• Hanging onto underperforming stocks is costly too. 
• There is the opportunity cost that the capital can be better employed for higher return. 
• Also, hanging onto these lack-lustre stocks reduces the overall return of your portfolio.

Reducing serious loss

When the fundamentals of a stock have deteriorated, sell to protect your portfolio. 

• This decision should be make quickly based on the facts and situations, in order to keep your losses small.

How can you improve your investment returns in stocks?

You need a 100% gain to erase a 50% loss; averaging down will help you recover faster

You need a 100% gain to erase a 50% loss

Averaging down will help you recover faster

Jonathan Chevreau, Financial Post Published: Wednesday, September 16, 2009

After recoveries of 45% or more in major stock markets since the Crash of 2008, investors may well wonder how it is they're still not back to even.

Getty Images 

After recoveries of 45% or more in major stock markets since the Crash of 2008, investors may well wonder how it is they're still not back to even.

After recoveries of 45% or more in major stock markets since the Crash of 2008, investors may well wonder how it is they're still not back to even.

There are two reasons.

• One, broad markets are still below the highs reached before the crash. 
• Two, the arithmetic of loss means a 50% loss followed by a 50% rise does not mean you're back to even.

In the current edition of Graham Value Stocks, Norman Rothery notes the bellwether S&P500 index fell 57.7% peak to trough in the bear market, not counting dividends. It has since surged 53.1% from its lows but it still must rise another 54.4% to regain that former high. Thus, it would have to move 136.4% from the bottom reached after the original 57.7% loss, a result Rothery concedes may shock those unfamiliar with "the tyranny of losses."

The math is more understandable in absolute dollars. If you invest $100 at a top and lose 57.7%, you have just $42.30 at the bottom. But any gains you enjoy subsequently are coming off a lower base. Thus, even a 100% gain of $42.30 brings you only up to $84.60 -- still $15.40 less than the $100 you started with. To get back to $100, you'd need a 136.4% gain.

This is the ruthless arithmetic that has investors 100% in stocks -- or worse, leveraged so they were more than 100% in stocks -- licking their wounds in bear markets. However, B.C.-based financial planner Fred Kirby says ruthless arithmetic can be made to work to investors' benefit if dividends are reinvested during declines. This dramatically cuts the number of years needed to recover from losses.

Opportunistic buying can be combined with rebalancing of portfolios to maintain a normal ratio of stocks to bonds. Thus, after the 1929 crash, investors who reinvested dividends and regularly rebalanced recovered in seven years, compared to 22 years for all-stock investors who did not adopt this dual strategy.

Vancouver-based financial planner and author Diane Mc-Curdy says younger investors who dollar-cost averaged into the market early in 2009 have already done very well. Older investors should be conservative and adhere to the rule of thumb that fixed-income exposure should equal their age: so a 40-year old would be 60% stocks to 40% bonds.

The more you had in equities during the crash and the more those equities were in risky segments of the market, the worse the arithmetic of loss. Here, the accompanying chart adapted from Rothery's newsletter is instructive.

In peak-to-trough terms -- with the trough in March 2009 -- the hardest-hit market was the MSCI Emerging Markets index, which fell 67.4%. By early September, it was still 36.8% below its highs, despite the fact emerging markets bounced back 93.8% from their lows. They still must rise a further 58.1% to get back to their former highs. If you're in an emerging markets mutual fund or exchange-traded fund, you're still under water. Of course, if you were prescient enough to buy more at the bottom, you've almost doubled your money on that portion of your bottom-fishing adventure.

A glance at your portfolio may reveal that if you did do what the fund companies urged and "went global" some years back, you're probably still hurting most in funds that track the MSCI EAFE Index: Europe, Australia and the Far East. While the EAFE index didn't fall quite as hard as emerging markets -- it fell a nasty 63.5% -- at this point it still has "the largest hill to climb," Rothery says. EAFE markets are still 39.1% below their peak and have retraced only 66.9%, leaving almost as much again -- 64.2% -- before unitholders feel whole again.

Even the TSX composite still must rise 39.4% to get back to its former highs: something most people realize intuitively since the TSX passed 15,000 before the crash and is now just above 11,000.

Tomorrow, we'll look at what recourses investors may have to recoup losses.

jchevreau@nationalpost.com

Read more: http://www.financialpost.com/story.html?id=1998122#ixzz0eY9tf2po

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http://www.financialpost.com/story.html?id=1998122

The Problem with Big Losses

Risky situation must involve a chance of loss.

Suppose the possible returns on an investment fall into a normal distribution curve. This distribution shows this investment has an expected return of 9.5%. Standard statistical thinking tells use if we invest in this stocka nd hold it, some years we will have high rturns and some years low returns, but that, on average, the return will be 9.5%. This assumption is true, but it is also a potentially misleading result.

To see why, suppose an investor buys this stock and holds it 10 years. In each of 9 of those years, the stock advances 20%; in the other year it falls 90%. The 10-year arithmetic average return is 9%, slightly below the return predicted by the distribution. A $1,000 invesment, howver, would be worth only $1,000(1.20)^9*(0.10) = $516, less than the starting value! The compound annual rate of return is a negative 6.40%.

The lesson is that a large one period loss can overwhelm a series of gains. If an initial investment falls by 50%, for instance, it must gain 100% to return to its original value. Big losses complicate actual returns, and investors learn to avoid situations where they may lurk.

The Problem with Losses

The Problem with Losses

Big Losses

This investment has an expected return of 9.50%. Standard statistical thinking tells us if we invest in this stock and hold it, some years we will have high returns and some years low returns, but that, on average, the return will be 9.50%. This assumption is true, but it is also a potentially misleading result.

Suppose an investor buys this stock and holds it 10 years. In each of 9 of these years, the stock advances 20%; in the other year it falls 90%. The 10 year arithmetic average return is 9%
{=(9x20% - 90%)/10}, slightly below the return predicted by the distribution.

In reality, a $1000 investment, however, would be worth only $1,000(1.20^9)(0.10) = $516, less than the starting value! The compound annual rate of return is a negative 6.40%.

Learning points:

1. A large one-period loss can overwhelm a series of gains.
2. If an initial investment falls by 50%, for instance, it must gain 100% to return to its original value.
3. Big losses complicate actual returns, and investors learn to avoid situations where they may lurk.
   
   

Small Losses

Over time, even small losses can be a problem if too many of them occur.

An example will show why. Suppose the proverbial statistical marble jar contains two colors of marbles: red and green. The red marbles symbolize a 10% gain in the stock market, while the green marbles symbolize a 10% loss. If, in simulating an investment and taking a number of marbles from the jar, we draw exactly the same number of red and green marbles, how did the investment fare?

The return is negative, but there is no way to tell how badly things turned out, because what matters is not the proportion of winners to losers, but the number of losers.

As the number of draw increases, the terminal value of the investment declines.

After about 1,000 draws from the jar, the investment is nearly worthless. #

# In the stock market, such an investment could not survive. No security should have an expected return of zero. No one would buy it. Consequently, its price would fall until it offered a return consistent with its risk.

Learnng point:

Over time, even small losses can be a problem if too many of them occur.

Risk and the Time Horizon

There is an important distinction between:

• the probability of losing money and
• the amount of money that you might lose.

Suppose you model a $100 investment by flipping coins. Heads means you win $1, and tails means you lose 50 cents. After one flip, there is a 50% chance of a loss. This declines to 25% after two flips and is down to 12.5% after three flips. After 10 flips, the probability of a loss is only 0.10%.

The maximum loss, however, increases with each succeeding toss of the coin. The maximum loss after one flip is $0.50, after two flips is $1.00 and after three is $1.50.

If you define risk as the probability of losing money, then risk decreases as the time horizon increases.

However, if you define risk as the amount of money you might lose, it increases as the time horizon lengthens.

Learning points:

1. In general, the longer you hold a common stock investment, the lower the likelihood that you will lose money.
2. On the other hand, the longer you hold the investment, the greater the amount you might lose.
3. The extent of the risk depends on how you define it.