It becomes exponentially more difficult to make up for losses as they increase. A loss of 90% would need a gain of 900% to recover from it. Cutting your losses is important so that you don’t fall into the trap of an exponentially larger hole.
This isn’t just in finance (though it’s easier conceptually to internalize)—it happens in setting personal goals (falling behind and trying to make up for it in one massive effort), managing work (crunch time for a big launch), and people management (taking action of poor poor performance).
See also:
- People have difficulty internalizing power law relationships and compounding
- Loss aversion explains why people wait too long to cut losses
- Adapting to Endure discusses cutting expenses to avoid a death spiral in a downturn and being able to break even
Links to this note
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Compounding Is Unintuitive Because the Initial Curve Feels Flat
I’ve always wondered why the nature of compounding and any exponential relationship feels unintuitive. That is until I read this quote from Paul Graham’s essay How to do great work.