Managing Risk When The Odds Are in Your Favor

Even he is not always right (Apple Insider photo)

In my novice investor days I would always bet too much on a story stock. Usually that stock would already have been bid up, and I was one of the last suckers buyers before the fall.

But even when I became a decent stock picker I still tended to put too much in one basket. Even the best investors in the world don't hit it out of the park 10 out of 10 times; experience has taught them how to manage portfolio risk even though they're right more often than not.

The WSJ has a simple baseball simulation game in which the player wins 57% of the time and gets paid 1 for 1; if it were a true game he would have to bet nearly $3 to win $2. He has a $100 stake, and there are 10 rounds of bets. What is the strategy? (Test yourself by clicking the link above.)

Your humble blogger followed the simple rule of betting 20% of the total holdings at each round. The results weren't bad (see right). The WSJ article goes on to give the mathematically optimal formula.

As the old saying goes, pigs get slaughtered.