It's All About Risk

Why is investing so hard?  Why is it so difficult to know how any investment will perform?

The answer is simple: Investors and traders are paid, if they are paid at all, for assuming risk, and risk precisely means that you don't know what is going to happen. Investors and traders perform a service to society by providing money for potentially productive projects and thereby absorbing financial risk. For their services they are offered only the potential for profits. Their risk is the possibility of not getting paid, or of even losing money.

Risk by definition means you don't know what is going to happen. If you knew what an investment was going to do, then there would be no risk, so there would be no reason to expect payment. Riskier investments offer to pay more precisely because their outcomes are more uncertain. The dumbest investment is one that is very risky but doesn't pay much, like going on Wipeout for $500.

But if you don't know what is going to happen, why make an investment? The answer is because you have determined that the probabilities are in your favor. Note: Probabilities, not certainties. So that means the key to investing and trading is learning how to handle risk, not pretending you know for sure what the outcome of the investment will be. The former is doable, the latter is impossible.

To handle risk you must define risk. That is you must consider the probabilities and decide how much you are willing risk to find out if a certain idea works out. Most investors and traders don't do this. They just throw their hat full of money in the ring and hope for the best, with no plan for what to do if the investment doesn't work out. This usually means they lose more money than they vaguely planned to lose, precisely because their plans were vague.

You can't know for sure what any investment idea is going to do. But you can plan for what you will do when it does whatever it does. You should always have a plan for what you will do when it works and when it doesn't.

All success in life is based on taking some kind of risk. Nowhere is this more true than in the financial markets. Never forget that there you are being paid to assume risk, which means risk will always be a factor. The key then is to research the probabilities, define beforehand what you are willing to risk, design an action plan for all outcomes, and, only then, take on the risk.