Statistical expectation to calculate the risk

The world doesn’t work with absolute certainty, however, the strategic decisions we make affect future outcomes in some way. The irony seems to be amplified with those who understand little about statistical expectation. Having a proper understanding of this topic makes you a more informed investor for any business or personal desire.

The concept is simple.

E = Expectation

P(w)= Probability of winners

S(w)= Average size of the winner

P(l)= Probability of losers

S(l)= Average size of loser

my = [P(w)*S(w)]-[P(l)S(l)]

For example, let’s take a look at New Zealand finance companies. They commit to providing retail investors with an interest rate slightly higher than that of government bonds as long as their own investments do not experience corrections or reductions. Historically speaking, credit markets are positively correlated with the general economy and the world has experienced at least 2 years of recession every decade, or 2 out of every 10 years. From this we can conclude that these companies will not end every year profitably.

That is, the approximate probability of a losing year is then 2/10 = 0.2 or 20%, and the probability that they finish each year profitably is 1-2/10 = 0.8 or 80% in The best case. They offer retail investors annual rates of about 9.x% (I’ll round that up to 10%) in years when they set performance targets, and in a down year the average investor expects to lose between 30% and 10%. 70%. , with an average of 50%.

So can the average retail investor “expect” to make long-term profits using these companies?

Probability of a profitable year: (80% or 0.8)

Average investor profit: (10% or 0.1)

Probability of a bad year: (20% or 0.2)

Average investor loss: (50% or 0.5)

E= (0.8)(0.1)-(0.2)(0.5)

E=0.08-0.1

E= -0.02

A negative expectation suggests that a long-term net loss is likely to occur. In fact, the average roulette player has a less negative expectation than before; In other words, he is likely to lose less money playing roulette at the casino than investing with finance companies.

To make a profit or receive a higher reward on a consistent basis, you need to have the odds on your side. Having a positive expectation is still one of the few ways to verify that. So learn the math and make wise decisions.