Thursday, November 28, 2013

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Upside and Downside: the Story of a Dimwit

 Here is a nice story of a dimwit who plays the wrong way with upside and downside.

Watch these episodes of Alif Laila from 2.13 to 3.9. In those good old days the tv shows were popular based on the quality of the language, character portrayal rather than masala grinding done nowadays. In this series and in Shaktiman I found how nicely the characters speak their language, Hindi/Urdu.

Alif Laila Vol 2.13

Alif Laila Vol 3.9

Once upon a time there was a fisherman who is poor and goes to fishing everyday. His wife and kids are suffering from hunger and poverty as he is not able to get enough fish from his fishing endeavors. The reason for this? This dimwit made a rule that he will use his net to fish only 4 times in a day and settle with whatever he gets from that.

Alas, what a real dimwit he is. Let us say sometimes he catches enough fish to survive the day. Then no problems. Say sometimes he catches just little more than enough to survive (after all how much more will he catch with his small net with the max. limit of 4 trials per day?). And rest of the times he catches less or no fish at all. So what happens is he progressively keeps getting poorer by the day.

On good days nothing to complain. On bad days he may incur debt or keep his wife and children hungry. He doesn't save some amount from good days either as there is only so much he can fish with a limit of 4 trials. What a real dumbwit he is.

But this kind of dimwit nature exists in stock traders as well. This is where it might hurt their ego. There are traders who sell their stocks for little profit without regard to potential upside it might have. In case the stock falls, they wait it out till it recovers and just sell at break-even or little gain again and watch later to see it go higher and higher.

Now this is not going to look like a big problem at all, apparently. Once they hit on bad luck, that is a bunch of losing stocks filling the portfolio and capital stuck in them for a long time without hope of recovery then they realize.

The problem is they limit the upside while not limiting downside. Rather one should limit downside and not limit the upside. Not limiting upside is not an easy thing to do. But this is where a trader differentiates himself from the herd. It is those unlimited gains that can help compensate and overcome the losses from unexpected string of bad luck trades.

Do not limit your upsides without giving much thought. Often it pains most when the stock goes up immediately after you took a hasty decision to get out. If it was a well thought out sale, you would've prepared for alternative scenarios.

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