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3 Ways to Increase Your Wins in Investing

3 Ways to Increase Your Wins in Investing

If you have invested for long enough, people will tell you that investing is a game of probability. The objective is to achieve more winners than losers in your portfolio. So how can investors like you increase your win odds in investing? Before we move on, we have to understand the expectancy formula:

Expectancy = (Win Probability X Average Win) – (Loss Probability X Average Loss)

Expectancy is mostly used by traders and it can be helpful for investors to understand this formula as well. Let me explain expectancy through a coin toss game:

Imagine tossing a coin. If the coin shows heads, you earn $2. If it is tails, you lose $1.

Question: After 100 tosses, what are your odds of being profitable at the end?

Take your time to think about it.

The answer is 100%. That means after 100 tosses, you will end up profitable all the time.

Why?

Based on probability, your chance of getting a heads or tails is 50/50. After ten tosses, you might get eight tails and two heads. If you do the math, you'll realize that you're losing $4 at this point. You might even start questioning whether the odds are really 50/50 since you are losing money.

But you have to understand that in order for the odds to even out, you must have a much larger sample size. Ten tosses is too small a sample size. But after 100 tosses, the law of averages will kick in.

So let's input the data into the expectancy ratio:

Expectancy = (50% X $2) – (50% X $1) = $0.5

This means, on average, you expect to earn fifty cents per coin toss. After 100 tosses, you will earn $50. If you don't believe this, flip a coin a hundred times in your free time and note down the results. You will always end up profitable after 100 tosses.

The point is that the vast majority of people have a natural tendency to want to be right all the time, but from we have already seen, what truly matters is your expectancy. Even if you right only half the time, you can make money over time as long as your expectancy is positive. Hence, the goal here is to increase your overall expectancy.

Here are 3 ways to increase the expectancy in your investing:

#1 Increase Your Win Probability

In the coin toss game, the win probability for every toss is 50%. No matter how a person tosses, the odds are always 50/50. But with investing you have far more control over your win probability.

You increase your win rate by simply investing in companies that are fundamentally and financially strong, have good growth prospects, and led by a team of talented managers. By investing in great companies, you increase the probability of your investments being profitable.

#2 Invest in Optimal Risk/Reward Situations

The other factor that affects your expectancy is your average win and loss. In the investments you make, you always want to ensure that your average win is greater than your average loss. This links to the risk/reward ratio. If you expect a risk/reward ratio of 1:2, which means you will only invest when the reward is worth double the risk

A great way to achieve this is to invest in a stock when its price is 50% below its intrinsic value. The cheaper you buy a stock (assuming it's a great stock!), the higher your potential upside and the lower your potential losses.

#3 Be Consistent With Position Sizing

In order for your expectancy to be consistent, your position sizing must also be consistent. This means if you have ten companies to invest in, you should invest 10% of your capital in each stock equally. If your win probability is 70% and your average win is greater than your average loss, you will definitely make money overall.

However, if your position sizing is inconsistent and you assign 50% of your portfolio to one stock and the rest to the remaining nine stocks, your results can now be skewed. If something disastrous happens to that one stock, it will hurt you badly and take a long time for you to recover from your losses. This is also why many investment professionals recommend investors to diversify your stock portfolio and not bet everything on a single horse. So keep your position sizing consistent.

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This is not a recommendation to purchase or sell any of the securities mentioned on this site. The information contained herein are the opinions and ideas of the authors and is strictly for educational purposes only. This information should not be construed as and does not constitute financial, investment or any form of advice. Any investment involves substantial risks, including complete loss of capital. Every investor has different strategies, risk tolerances and time frames. You are advised to perform your own independent research or to contact a licensed professional before making any investment decisions. There are no warranties, expressed or implied, as to the accuracy, completeness, or results obtained from any information set forth herein. Fifth Person Pte. Ltd., its related and affiliate companies and/or their employees shall in no event be held liable to any party for any direct, indirect, punitive, special, incidental, or consequential damages arising directly or indirectly from the use of any of this material.

 
Robin Han
Victor Chng

Victor Chng is an equity investor and the co-founder of the online investment magazine The Fifth Person. He is also the co-creator of The Investment Quadrant, an online multimedia stock investment course where students can learn how to invest profitably in the stock market. Victor has been featured multiple times on 938LIVE as a guest expert on MoneyWise and is also the co-author of Value Investing in Growth Companies which is internationally published by Wiley, Inc. The book can be found in all major book stores worldwide and on Amazon.com, Amazon.co.uk, Barnes & Noble and Apple's iBooks. If you're interested to learn more about stock investing, you can join The Fifth Person Newsletter and receive free weekly insights on how you can generate higher returns and dividend income from the stock market.