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'Bollocks de Jour'

 
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Old 23-06-2011, 10:11 PM   #1
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'Bollocks de Jour'

Occasionally whilst sitting waiting for breakfast after working out I will stare aimlessly about and happen to read bits of the paper over someone's shoulder to find out what the bollocks de jour is.
I briefly spied a headline that stated that the market had made up all its losses from last year. More important matters – namely toast and vegemite, then promptly distracted me.

The theme of the article stuck in my head so that when I got home I looked it up on line and the basic gist of the argument was that since the annual performance of the ASX was equal to the their losses from the year before.
All was right in the world and babies could sleep soundly at night.
The only problem was that the author had no understanding of how financial mathematics worked.

If I lose, 50% one year then make 50% the next year I am not back, to where I started. I am still in a hole, albeit a slightly smaller hole but it is a hole nonetheless.
As an example, if I start with $100,000 and lose 50% I now have $50,000.
If make 50% the next year on my remaining $50,000 my account balance goes back up to $75,000 not $100,000.
A simple way to remember this is that a 10% loss cannot be replaced by a 10% gain on the remaining equity – it takes 11.1%.
These gains to loss curve gets much worse as it goes along so that if I lost 50% I would need a 100% gain to return to my starting point.

The theme of the original article highlights two important points.
Firstly, the paucity of knowledge of those who report on financial matters. Secondly, that money once it is gone is hard to replace.
This is why we harp on endlessly about controlling your losses.

Amateur traders talk about how much they are going to make, professionals talk about how much they are prepared to lose.
- Chris Tate
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