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.

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/

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.