The Probability of Loss

Risk means different things to different people. We most commonly refer to it as the probability of loss. It is important to know ahead of time what your ability to withstand loss is. For example, no one is going to realistically invest money with the possibility of losing everything. Instead, they will invest with a percentage of assets they feel comfortable risking.

How do you know how much to risk? If $10,000 was invested, you might decide you could reasonably withstand a $1,000 loss, therefore you would have a ten percent risk. This then becomes the foundation of your exit plan. If you are close to losing ten percent of your money, you have already decided this is the point when you leave that particular investment. This concept is the same for investments that increase in price as well. If you have a nice gain on paper, you simply apply the same percentage to the price increase. If your original $10,000 investment increases to $20,000, your new amount of money at risk would likely be $2,000 or ten percent of the new price. There are other factors to consider such as the overall value of an investment relative to your total investments and whether you have already recaptured your original investment capital in a previous transaction, but the concept is that you establish the exit parameters ahead of time and you pre-determine how much of an investment is at risk at any given time.

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