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Minyan Mailbag: Reducing Risk by Taking Profits

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I still think gold is going higher in the long run, but may pull back..

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Prof Succo,

You might also mention that in the scenario you developed, Japanese wealth would be destroyed as well.

By the way, thanks for the recommendation on "Fooled by Randomness," I am really enjoying it.

I noticed that you reduced your gold holding. Nice call right at the top, but it seems risky to not be in significantly going forward.

Great stuff… I read every one of your articles.

Minyan Mark

MM,

There is a fine point in trading my gold position that sheds light on managing risk.

I still own gold. I have only sold a portion of gold equal to my profits; I am left with a notional amount equal to my original position when I bought it at $250 an ounce.

When you gamble and are a good player, so you think the odds are slightly in your favor, you want to play as long as possible to have those odds work for you (probabilities work over long periods of time). In order to do this, you must conserve a finite amount of capital. So in general you bet less when you have losses and more when you have profits. But in addition to this, after a run, you must have a system of taking some of those profits off the table. In essence this means that you "pocket" some of the profits and pretend that you are starting the game all over again with the same capital you came in with.

That is all I did. I still think gold is going higher in the long run, but may pull back. The point is that the risk in gold has increased due to a higher price (this point escapes the modern day investor: that risk increases with price), so I reduced my risk by selling some profits.

If gold continues to rise I am still long my original amount. If gold falls, I can re-invest my profits at a lower price. In essence, this is like compounding, which is the golden rule of investing.

-Succo

Position in gold

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