Shankar Sharma
To keep investors’ mind balanced and sound, they have to accept controlled and limited losses. For this we have to understand why uncontrolled losses occur in most of the cases. The reason for this is simple: excessive attachment to a stock and inability to take an aggressive stance on liquidating it. Generally, it is not the nature of a human being that if someone points out the same mistake, he should accept it easily. Our ego always overpowers our good intellect.
loss control formula
For this, investors will have to diversify their portfolio and include at least 35 stocks in it. If you have 50 to 100 stocks in your portfolio, it would be even better.
Attachment Per Stock (APS) Ratio
The biggest benefit of this diversification will be that it will reduce the most dangerous investment ratio – attachment per stock ratio (APS ratio). If you have just a few stocks in your portfolio, your APS ratio per stock is extremely dangerous. If you have 50 stocks in your portfolio, your APS will be quite low. It’s a bit like having 40-50 girlfriends in your harem. You don’t get sad because of one, two or five losses.
If your APS ratio is low, you can easily control such losses, as your loss per stock will be much less and its share in your portfolio will be limited. You will certainly suffer losses, but your ability to tolerate such losses will increase dramatically.
You should always keep in mind that if you have more than 35-40 stocks in your portfolio, your hit rate will generally be between 50 to 60 percent. This means that you will have at least 40% stocks in which you will incur losses. Obviously it is impossible for you to achieve a better strike rate than this for a long period of time. So, if you have a portfolio of 50 stocks, 20 stocks can cause you loss.
(The author is a well-known investor.)