As obvious as this may sound, math proves that the best way to beat the stock market is to avoid large losses.
Traders who want to beat the market can benefit by re-examining this truth.
Of course, avoiding losses isn’t easy. Deciding when to sell is a difficult decision.
Then, deciding when to buy back is equally challenging. Not to mention, traders also need to think about how much to buy.
Each of these questions is important to consider. But first, investors should understand why avoiding large losses is so crucial to a portfolio’s success.
Let’s take a look at that now.
The Proof Is in the Numbers
In mathematical terms, losses matter because they’re asymmetrical relative to gains. This means that losses have more impact on returns than gains.
Consider a portfolio that suffers a 10% loss, falling from $1,000 to $900. To get back to even, the portfolio needs an 11% gain, which is a $100 gain on the $900 balance.
As losses increase in size, the amount of the required breakeven gain grows even larger.
In order to break even, a 25% loss requires a 33% gain, a 50% loss requires a 100% gain and a 90% loss requires a 900% gain.
Here’s a chart that shows the exponential effects of losses.
(Source: Crestmont Research.)
Understanding the asymmetric impact losses have is the first step in managing a strong portfolio.
To beat the market, you need to define sell levels and adopt buyback rules. Also, you should calculate the size of each trade position based on risks or other quantitative factors.
These are all significant points to consider, especially with valuations being at historic extremes after a strong one-year market gain that’s unlikely to repeat.
Shield Your Portfolio Against Exponential Losses
With all these risks, now’s an ideal time to prepare a mathematical strategy that can help you avoid the damage of the inevitable bear market that lies ahead.
TradeStops offers tools that use precise formulas to help investors beat the market.
All the necessary algorithms are carefully built in to provide traders with the timely buy and sell signals they need.
This trading system works for everything, from stocks and mutual funds to exchange-traded funds, commodities and cryptocurrencies.
You can learn all about it in a special rebroadcast of The 4X Stock Accelerator Summit presentation.
Michael Carr, CMT, CFTe
Editor, One Trade