The Math of Averaging Down

Test your math.

What’s the difference between a -80% loss and a -90% loss?

50%.

If the answer came to you immediately, you can stop reading.
In years gone by, you probably would have made good profits by spotting arbitrage opportunities!
But now, its a lot harder with high frequency trading and all…

Show me, show me!
For the rest of us mortals, let me illustrate:

  1. You bought a stock at $1.00
  2. At -80% loss, the market price is $0.20
  3. At -90% loss, the market price is $0.10

Still want to average down when price is at $0.20?
Price so low oredi, surely it can’t go any lower?
Well, a “small” additional decline of $0.10 is now a 50% loss for your 2nd entry!!!
Now you know why people capitulate (sell) at crazy super low prices.
Especially to the “iron teeth” (stubborn) ones who will continue to average down a third time at $0.10 price.
See what happens when price drop further to $0.05 cents?


Don’t try this at home

Of course you were banking the reverse would happen when you averaged down.

  1. You invested $10,000 into stock XYZ at $1.00
  2. At market price of $0.10, you average down another $10,000
  3. When price “recovers” to $0.20, you sell both tranches with a big sigh of relief…

First tranche: Entry at $1.00; exit at $0.20 = -$8,000 loss
Second tranche: Entry at $0.10; exit at $0.20 = $10,000 profit

Hey! All in all, you’ve made a $2,000 profit!!!
Really? Risking all these money just to “break-even”?

Tip: Don’t play Poker or Mahjong with real money – you lousy with risk/reward odds.

What?

You still got the cheek to “advise” people not to gamble…

Be honest now

Which is the likelier scenario to play out?

How good is your entry skill?

You did buy at $1.00, remember?

What makes your such an expert market timer now so super sure $0.10 will be the turning point?

And more importantly, you did let a $1.00 position slide all the way to $0.10 – that’s not saying much about your exit skill, does it?

Do you honestly believe you will exit everything when the price hits $0.20?
Or maybe you are the white-haired demon girl (白发魔女); you changed completely in one night.

If you can do so, I clap my palms before you. And bow.
Namaste (I salute the holiness in you)


Singapore Man of Leisure (welcome to my blog; just google it!)

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