Capital - Risk - Knowledge

1) Capital Preservation

George Soros and Warren Buffett share one thing in common: Both of them make their billions from investing alone, and had started with nothing.

George Soros is famous for his highly leveraged trades in the forex and futures markets, whereas Warren Buffett is famous for buying businesses for less than what he thinks they are worth. Most investors and traders would say that their first goal in investment is to make a lot of money. But the number one priority for both Soros and Buffet is capital preservation.

“Survive first, and make money afterwards.” - George Soros

“Investing Rule No. 1: Never lose money. Rule No. 2: Never forget Rule No. 1.” - Warren Buffett

It may sound oxymoron to say that winning investors should try their best to preserve their capital when it comes to investing. First of all, why is it so important not to lose money? This is the logic: If you lose 50% of your capital, you have to make a 100% profit just to recoup all your losses. It is very easy to lose money, but extremely difficult to make profits. While it is possible that you eventually make enough to go back to square one, it will take a considerable amount of time to do that. And why would anyone want to spend time recouping instead of using that time to make profits?

Capital preservation must be seen as a long-term rule, and not be based on each and every trade. Limit your risk exposure to only trades that are very likely to go your way than not. Have a method to screen for these high probability trades based on your trading criteria.

2) Risk Management

There is risk in doing and not doing everything in life. Risk is unavoidable, and we can’t get around it. People tend to think that investing or trading is a very risky thing to do. This statement reeks of an absolute bias and contains an assumption. First of all, risk is not absolute; it is relative to the individual undertaking the activity. Second, it assumes that in order to make above-average profits, you must expose yourself to bigger risks.

A competent investor or trader most probably won’t find investing or trading to be a risky thing to do. An experienced pilot wouldn’t find flying a plane to be particularly risky, whereas someone without a pilot’s license would think so. While there is always some inherent risk involved, the magnitude of risk is relative to a person’s knowledge, understanding, experience and competence. Someone new to trading will think that trading is a very risky way of making money, and that is true - but to him. He doesn’t yet have a comprehensive understanding of how the markets work, how to get into high probability trades, how to manage his own emotions, and trading would definitely be very risky for someone like that to take the plunge without proper learning and experience.

As for taking big risks in order to make big profits, that may not necessarily the case when it comes to trading or investing. You can reduce risk by aiming for high probability trades or actively manage risk by monitoring and closing out your open positions if it seems that the market is not going your way. You can even completely avoid risk if there seems to be no good trades. There is risk in everything you do - whether you walk home, drive or date a stranger. It is OK to take risks. Have a risk-minimizing system in place so that you can come out profitable in the long-term.

3) Invest In Your Knowledge

There are 4 stages of learning:

• Unconscious incompetence: doesn’t know that he doesn’t know

• Conscious incompetence: knows that he doesn’t know

• Conscious competence: knows what he knows, and knows what he doesn’t know

• Unconscious competence: knows that he knows

Many new traders are in the first stage of unconscious incompetence. They are more prone to losses because they are quite unaware of what they are doing due to their limited knowledge and experience. If you are a new to investing or trading any particular asset, accept that you really don’t know much about it. Make the subject your expertise and dedicate some time to learning more about it. Once you gain more experience with investing or trading, you may not feel anymore that it is so risky to trade compared to when you were clueless about it.

As Warren Buffett says: “Risk comes from not knowing what you are doing.”

This rule states that in many aspects of business and life, 80% of the potential value can be achieved from just 20% of the effort, and that one can spend the remaining 80% of effort for relatively little return.

What does that mean? It means that of all the things that you do during the day, only 20% really matter, because those 20% produce 80% of your results. The reverse is true too, that things that take up 80% of your time and resources will only produce 20% of your results.

It has been said that the 80/20 rule exists in every field, ranging from business to people.

Sales: 80% of the sales are made by 20% of the sales team.
Work: 20% of your efforts produce 80% of the results.
People: 20% of the people you know provide you with 80% of nurturing support and satisfaction.
Focus: 20% of your activities will account for 80% of your success.

How will knowing of the 80/20 Rule help you in managing time better? First, figure out what 20% of the tasks contribute to 80% of the results that you desire, and then put in maximum concentration (means working hard) to those 20% tasks. If you are thinking of trading or investing, perhaps rethink how you can structure your time and effort around making those pursuits worthwhile. If you hold a day job, then your after-work hours (which is approximately less than 20% of your time in a day) will be very valuable in the sense that that is the only time you have for acquiring the skills and knowledge needed for entering the trading or investing field.

Don’t simply try to do more. Just do more of the right things

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