Best of the Week
Most Popular
1. US Housing Market House Prices Bull Market Trend Current State - Nadeem_Walayat
2.Gold and Silver End of Week Technical, CoT and Fundamental Status - Gary_Tanashian
3.Stock Market Dow Trend Forecast - April Update - Nadeem_Walayat
4.When Will the Stock Market’s Rally Stop? - Troy_Bombardia
5.Russia and China Intend to Drain the West of Its Gold - MoneyMetals
6.BAIDU (BIDU) - Top 10 Artificial Intelligence Stocks Investing To Profit from AI Mega-trend - Nadeem_Walayat
7.Stop Feeding the Chinese Empire - ‘Belt and Road’ Trojan Horse - Richard_Mills
8.Stock Market US China Trade War Panic! Trend Forecast May 2019 Update - Nadeem_Walayat
9.US China Trade Impasse Threatens US Lithium, Rare Earth Imports - Richard_Mills
10.How to Invest in AI Stocks to Profit from the Machine Intelligence Mega-trend - Nadeem_Walayat
Last 7 days
Why are Central Banks Buying Gold and Dumping Dollars? - 23rd June 19
Financial Sector Paints A Clear Picture For Stock Market Trading Profits - 23rd June 19
What You Should Look While Choosing Online Casino - 23rd June 19
INTEL (INTC) Stock Investing to Profit From AI Machine Learning Boom - 22nd June 19
Here’s Why You Should Drive a Piece of Crap Car - 22nd June 19
How Do Stock Prices React to Fed Interest Rate Cuts? - 22nd June 19
Gold Bull Market Breaking Out! - 21st June 19
Post-FOMC Commentary: Delusions of Grandeur - 21st June 19
Gold Scores Gains as Draghi and Powel Grow Concerned - 21st June 19
Potential Upside Targets for Gold Stocks - 21st June 19
Gold Price Trend Forcast to End September 2019 - 21st June 19
The Gold (and Silver) Volcano Is Ready to Erupt - 21st June 19
Fed Leaves Rates Unchanged – Gold & Stocks Rally/Dollar Falls - 21st June 19
Silver Medium-Term Trend Analysis - 20th June 19
Gold Mining Stocks Waiting on This Chart - 20th June 19
A Key Gold Bull Market Signal - 20th June 19
Money Saving Kids Gardening Growing Giant Sunflowers Summer Fun - 20th June 19
Investing in APPLE (AAPL) to Profit From AI Machine Learning Stocks - 20th June 19
Small Cap Stocks May Lead A Market Rally - 20th June 19 -
Interest Rates Square Minus Zero - 20th June 19
Advice for Financing a Luxury Vehicle - 20th June 19
Stock Market Final Blow Off Top Just Hit… Next Week Comes the FIREWORKS - 20th June 19
US Dollar Rallies Off Support But Is This A Top Or Bottom? - 19th June 19
Most Income Investors Are Picking Up Nickels in Front of a Steamroller - 19th June 19
Is the Stock Market’s Volatility About to Spike? - 19th June 19
Facebook's Libra Crypto currency vs Bitcoin: Five Key Differences - 19th June 19
Fed May Trigger Wild Swing In Stock Index and Precious Metals - 19th June 19
How Long Do Land Rover Discovery Sport Brake Pads Last? - 19th June 19
Gold Golden 'Moment of Truth' Is Upon Us: $1,400-Plus or Not? - 18th June 19
Exceptional Times for Gold Warrant Special Attention - 18th June 19
The Stock Market Has Gone Nowhere and Volume is Low. What’s Next - 18th June 19
Silver Long-Term Trend Analysis - 18th June 19
IBM - Watson Deep Learning - AI Stocks Investing - Video - 18th June 19
Investors are Confident, Bullish and Buying Stocks, but… - 18th June 19
Gold and Silver Reversals – Impossible Not to Notice - 18th June 19
S&P 500 Stuck at 2,900, Still No Clear Direction - 17th June 19
Is Boris set to be the next Conservation leader? - 17th June 19
Clock’s Ticking on Your Chance to Profit from the Yield Curve Inversion - 17th June 19
Stock Market Rally Faltering? - 17th June 19
Johnson Vs Gove Tory Leadership Contest Grudge Match Betfair Betting - 17th June 19
Nasdaq Stock Index Prediction System Is Telling Us A Very Different Story - 17th June 19
King Dollar Rides Higher Creating Pressures On Foreign Economies - 17th June 19
Land Rover Discovery Sport Tailgate Not Working Problems Fix (70) - 17th June 19
Stock Market Outlook: is the S&P today just like 2007 or 2016? - 17th June 19
US China War - Thucydides Trap and gold - 16th June 19
Gold Stocks Bull Upleg Mounting - 16th June 19
Gold Price Seasonal Trend Analysis - Video - 16th June 19
Fethiye Market Fruit, Veg, Spices and Turkish Delight Tourist Shopping - 16th June 19
US Dollar Gold Trend Analysis - 15th June 19
Gold Stocks “Launch” is in Line With Fundamentals - 15th June 19
The Rise of Silver and Major Economic Decline - 15th June 19
Fire Insurance Claims: What Are the Things a Fire Claim Adjuster Does? - 15th June 19
How To Find A Trustworthy Casino? - 15th June 19
Boris Johnson Vs Michael Gove Tory Leadership Grudge Match - Video - 14th June 19
Gold and Silver, Precious Metals: T-Minus 3 Seconds To Liftoff! - 14th June 19
Silver Investing Trend Analysis - Video - 14th June 19
The American Dream Is Alive and Well - in China - 14th June 19
Keeping the Online Gaming Industry in Line - 14th June 19
How Acquisitions Affect Global Stocks - 14th June 19
Please Don’t Buy the Dip in Nvidia or Other Chip Stocks - 14th June 19
A Big Thing in Investor Education is Explainer Videos - 14th June 19
IRAN - The Next American War - 13th June 19
Boris Johnson Vs Michael Gove Tory Leadership Grudge Match Contest - 13th June 19
Top Best VPN Services You Can Choose For Your iPhone - 13th June 19
Tory Leadership Contest Betting Markets Forecast - Betfair - 13th June 19
US Stock Market Setting Up A Pennant Formation - 13th June 19
Which Stocks Will Lead The Cannabis Rebound? - 13th June 19

Market Oracle FREE Newsletter

Gold Price Trend Forecast Summer 2019

Wall Street's Secret to Investing Success

InvestorEducation / Learning to Invest Apr 10, 2009 - 01:32 PM GMT

By: Money_Morning

InvestorEducation Best Financial Markets Analysis ArticleKeith Fitz-Gerald writes: Studies show that most investors - even ultra-wealthy ones - lose money over time because they don't, or can't, stick to a well-defined set of rules. For some, this is driven by reckless personal behavior in search of profits. For others, it's the constant shift between bad decisions and bad advice that creates whopping errors and poor performance.


But most of the time, investors incur these losses simply because they've never had what I'm about to explain to you explained to them - the concept of the Gambler's Ruin.

Most investors are unfamiliar with Gambler's Ruin. But they need to understand it for two simple reasons, especially now. First, Gambler's Ruin can represent the difference between long-term financial success and outright failure. Second, the negative outcome it produces is a foregone conclusion from a mathematical standpoint - unless you know the secret to beating it.

The Anatomy of the Road to Ruin

Imagine that two players (Player One and Player Two) each have a finite number of pennies. Now, flip one of the pennies (from either player), with each player having 50% probability of winning and taking the penny after correctly calling heads or tails. Repeat this process until one player has all the pennies.

If the process is repeated indefinitely, the probability that one of the two players will eventually lose all his pennies must be 100%. In fact, the chances that players One and Two (P1 and P2, respectively) will be rendered penniless are:

P1 = n2 / (n1 + n2)
P2 = n1 / (n1 + n2)

In plain English, this tells us that if you are one of the two players, your chance of going bankrupt is equal to the ratio of pennies your opponent starts out with to the total number of pennies the two gamblers have between them. While there are some wrinkles in the theory, the basic concept is that the player starting out with the smallest number of pennies has the greatest chance of going bankrupt.

Most folks who have been to Vegas understand this at some level. They also understand that the longer they stay at the tables, the greater the probability that they'll lose.

But what most people fail to understand is that Gambler's Ruin also applies to the stock markets. That's because the casinos (or the investment houses, hedge funds, and large private investors and other big institutions that together comprise Wall Street) typically have more pennies than their individual patrons (retail investors), meaning they can play the game longer. And that's why, more often than not, the big guys come out ahead.

The little guys get wiped out - or just give up.

The other thing that most people don't realize about the Gambler's Ruin is that unless you have a means of protecting your assets, you will eventually give them all up - no matter whether you are at the gambling tables or in the markets .

Losses will do most of the damage. But fees will do their part, too. If the markets start out with more money than you do, and if you don't change your behavior accordingly, this outcome is preordained. It may well take several generations to achieve actual ruin but that doesn't invalidate the math.

Readers frequently ask me why I'm such a vocal critic of Wall Street's approach to diversification . And now you see why.

Diversification, as it is typically presented (at least to retail investors), is nothing more than spreading the pennies around. In reality, it's how you concentrate your money and what specific steps you take to protect your assets along the way that matters most.

Most people think they have this covered, which is why during my worldwide speaking engagements I often ask my audience to try this simple - but very telling - experiment: Call your broker or financial planner and ask at what point on the Standard & Poor's 500 Index they would have you go into total protection mode. Chances are good that the response you'll receive is either a stunned silence or some sort of bumbling reply. Not all the time, maybe, but I'll wager it happens often enough to suggest that not one in 10,000 investors has thought this through.

While some would consider that a blessing, I think it's a curse because it suggests that the vast majority of investors are still taking risks that are hugely disproportionate to their potential gains - even at this stage of the game, when the S&P and other major indices have staged the strongest four-week rally we've seen since the early 1930s.

So how do you dodge the Gambler's Ruin?

Beating the Street at its Own Game

Any seasoned gambler will tell you the only way to consistently beat the house is to not play the game. But when it comes to investing, that's obviously not practical. Longer term, history suggests beyond a shadow of a doubt that we need to invest in the markets in some form to help secure our financial future.

Wall Street is acutely aware of this, which is why everything from its asset allocation models to its research - and even its commissions and fees - is set up to keep you in the game. The last thing Wall Street wants you to do is stop playing because that would rob its advantage from the Gambler's Ruin principle.

That's why savvy investors should take matters into their own hands.

One of the simplest - but most effective - ways to do this is to establish a properly structured portfolio like the 50-40-10 allocation we advocate in The Money Map Report , the monthly newsletter that's published by this company. I developed this portfolio structure to minimize risk as much as possible so that individual investors can stay in the game while minimizing the risks of loss posed by the Gambler's Ruin. The way out of this problem is not, as I say so frequently, from being right all the time, but rather from the principle of “positive expectancy” that is a byproduct of the 50-40-10 discipline.

If you've never heard the term, positive expectancy means how much money an investor can expect to make for every dollar placed at risk. This is very different from the concept of how often you win, which is how most retail investors are programmed to think about their money. They are more concerned about winning a certain percentage of the time when what really matters is that they win more money than they lose over time - no matter how many times they lose.

Most investors who have never thought about investing this way are shocked to learn that the best traders or investors may make winning trades only 40% of the time, yet still rack up huge gains consistently. They do this because they have a positive expectancy .

For more-experienced investors, there's also the ability to use a technique known as “ fixed fractional sizing .” Fixed fractional sizing can further help increase returns and minimize risk by varying position sizes based on the risk associated with each trade. The simplest explanation here is that fixed-fractional-position sizing helps increase investment size and return potential when on a winning streak, while reducing it accordingly when conditions or results aren't so great.

No matter which path you choose, the thing to understand is that by taking steps to protect your assets and improve your expectancy, you can overcome the Gambler's Ruin. But you have to make sure you stick to your discipline all the time - and not just when it's convenient.

[ Editor's Note : Ten trades. All profitable. Since launching his Geiger Index trading service late last year, Money Morning Investment Director Keith Fitz-Gerald is a perfect 10 for 10, meaning he's closed every single one of his trades at a profit. And he did this in the face of one of the most-volatile periods since the Great Depression. Fitz-Gerald says the ongoing financial crisis has changed the investing game forever, and has created a completely new set of rules that investors must understand to survive and profit in this new era. Check out our latest insights on these new rules, this new market environment, and this new service, the  Geiger Index .]

Money Morning/The Money Map Report

©2009 Monument Street Publishing. All Rights Reserved. Protected by copyright laws of the United States and international treaties. Any reproduction, copying, or redistribution (electronic or otherwise, including on the world wide web), of content from this website, in whole or in part, is strictly prohibited without the express written permission of Monument Street Publishing. 105 West Monument Street, Baltimore MD 21201, Email: customerservice@moneymorning.com

Disclaimer: Nothing published by Money Morning should be considered personalized investment advice. Although our employees may answer your general customer service questions, they are not licensed under securities laws to address your particular investment situation. No communication by our employees to you should be deemed as personalized investment advice. We expressly forbid our writers from having a financial interest in any security recommended to our readers. All of our employees and agents must wait 24 hours after on-line publication, or 72 hours after the mailing of printed-only publication prior to following an initial recommendation. Any investments recommended by Money Morning should be made only after consulting with your investment advisor and only after reviewing the prospectus or financial statements of the company.

Money Morning Archive

© 2005-2019 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Post Comment

Only logged in users are allowed to post comments. Register/ Log in

6 Critical Money Making Rules