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Loss of Opportunity is Preferable to Loss of Capital
If you accumulate some capital, the most important thing you can do is not lose it. Whether you want to be a long-term investor like Warren Buffett or a shorter-term trader like Alexander Elder, capital preservation is vital.
Warren Buffett prefers to make what he calls “mistakes of omission” rather than “mistakes of commission”.
A mistake of omission – such as not buying a stock that goes on to perform well is irksome. It does not destroy your capital and endanger your ability to make a future profit.
Making mistakes of commission, however, and seeing your account fall in value by, say one-third, means you have a lot of catching up to do just to break even. (To return to break even after a one-third fall in the value of your investments requires a fifty percent gain!)
You must preserve your capital so you must select your stocks or trades with care. If in doubt, stay out! Another opportunity will always present itself.
For those seeking to trade rather than invest, Alexander Elder, in Trading for a Living, says:
“A trader who wants to survive and prosper must control his losses. You do that by risking only a tiny fraction of your equity on any single trade. Give yourself several years to learn how to trade. Do not start with an account bigger than $20,000, and do not lose more than 2 percent of your equity on any single trade. Learn from cheap mistakes in a small account.”
Van K. Tharp, in The Harriman Book of Investing Rules says:
“A simple strategy that will work for everyone is to risk a small percentage of your equity on every trade, such as 1% or less. If you have an account that is worth $100,000, then risking one percent would mean risking $1,000. (This is not the amount of money you enter the trade with; this is the amount of money you are prepared to lose before exiting the trade.)
In the same publication, Joe DiNapoli echoes Buffett’s sentiments, saying:
“There was a time when I felt it was my duty to be personally involved in every wrinkle of the S&P. I’ve traded this market since its inception in 82. It took quite a while for me to realise that picking safe, readable, and high probability winning trades was the way to go. Loss of opportunity is preferable to loss of capital.”
Emphasising the care needed before making investment decisions, Robert Hagstrom reports Warren Buffett saying:
“An investor should act as though he had a lifetime decision card with just twenty punches on it. With every investment decision, his card is punched, and he has one fewer available for the rest of his life.”
The money you want to invest has been hard won. Holding onto it can, at times, be even harder than earning it in the first place. Select your investments carefully and if in doubt, stay out.
