Understanding the 100 Percent Downside in Risk Management

Being an eternal optimist, one of the things I found hard to fathom was the unlimited downside risk to any transaction.

When I make a 5000 $ investment, the assumption is that the downside risk is limited to 5000 $ only. This is especially compared to the unlimited potential that any increase has. While this might be true on face value, the reality is that a 5000 $ loss on a 5000 $ investment is a 100% loss and all your investments are in this, you will be wiped out.

This important concept is very important for you to understand if you want to protect your risk and mental capital as a result.

Let's look at this with one recent example:

$USAR (USA Rare Earth)

There have been a spate of recent news around rare earths in US in the wake of the US government's interest in stakes in some of the rare earth companies such as MP materials. This is part of a broader strategy to reduce dependence on China for mining rare earths.

On the wake of news of USA Rare Earth's CEO's ongoing talks with the US government, the stock ran up from $19 per share on the 1st of October to $43.98 at its peak on the 13th of October.

As I write this article, $USAR sits at 14.49 USD. This is a 68% decline from the peak in a span of a month. Any investment made on the 13th of October, would have resulted in a disastround outcome without any checks and balances on risk.