Tuesday, 31 January 2012

Counter-thought - A process

Most of us do not think of how or why our investments can fail. While buying, we either look at the fundamentals or consider technical charts or do a mix of both and then buy. However, we are sometimes fooled as something that we may not have considered in our analysis takes place and our investment goes down in value. For this it is critical to have, what I term, as Counter-thought.

In counter-thought, you do a sort of crystal ball gazing and think that you are one year from now and your investment has turned you a loss. Now looking back you have to point out the reasons why it did not work out as you had planned or hoped it would. Looked at it from this perspective, it is much easier to figure out the major risks that can result in a loss. For example, if you are buying a company based on its ability to rent out its real estate (e.g. Nesco), then one loss-case can be a natural disaster like earthquake/flood/fire which destroys the primary asset. Another one can be a overall slump in industrial and trade fairs and reduction of demand. If you sit down with a pen & paper (notepad on a computer would do just fine as well), then you can chalk out multiple similar scenarios.

Once you have these items in your investment risk list, you can categorize them based on probability of occurrence and its possible impact. Again, taking the same example, a natural calamity at the primary convention center for Nesco is a very remote probability event but with extremely high impact (i.e. its effect is potentially catastrophic for the company).

So, before you put in your money in a stock next time, do spend a bit of time on counter-thought.

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