Both read the same newsletter. Both followed the exact same advice and purchased shares of BubbleNet, Inc. Yet, John lost a small fortune while Bob made a small fortune. How did this happen?
This could happen to John if he:
(1) invested on margin
(2) was not well capitalized
(3) simply got scared of a correction and sold
(1) When margin is used to buy securities, the account equity must remain above a certain value otherwise the positions are liquidated. In this case for example, John used margin to buy the shares but Bob used cash. When a significant correction took place in the stock price, John’s position was liquidated by the broker at a loss. On the other hand, Bob’s position recovered and made a significant profit when the stock price recovered.
(2) Jonh’s position risk was 50% of his bankroll. For example, John had 10K in his account, the stock price was $30 and he bought 333 shares. When the stock fell to $15, John was losing 50% of this account. A stop-loss was triggered and John got out only to watch the stock recovering fast after that. On the other hand, Bob had $100,000 and he purchased 1333 shares. His risk was 20% of bankroll. When the stock dropped to $15, Bob was losing about $20,000 and could wait for a recovery.
(3) This is the most common reason of divergent fortunes although the investments are identical. When prices started to fall, John got scared after reading some technical analysis published by an “expert” based on some “chart patterns” that the bottom was at $5. He thus sold everything to save what he could. On the other hand, Bob stayed cool. He has learned to avoid paying a lot of attention to analysts. Although they have both invested $1 million in this stock, when it fell to $15 from $30 John sold but Bob got some more because he believed in the company’s future. After 2 years Bob made a fortune (taking into account also a generous dividend payment) while John lost 500K. Of course, the opposite could have happened and Bob could have lost more but in this example we are looking at the former case.
To summarize, similar investments could lead to completely different outcomes and fortunes based on investor purchasing power, risk management and emotional state.
