So, let’s begin. What is most important for any investor? Someone will say that it is profitability and he will be right! Of course, profitability of a financial instrument is important, but let’s examine an example.
Let’s assume that our financial instrument yields 100% per annum. In other words, for each dollar invested, the investor receives a dollar profit in one year. It is a cool instrument, but the an attentive reader might suspect a catch. Indeed, there is another parameter to consider — the probability of getting that return.
Let us assume that there are a hundred identical financial instruments in the market. Each of them can be bought for a dollar and each one should give a return of one dollar in a year — i.e. it should be worth two dollars. Because of the market risks, only 40 of the 100 instruments achieve the declared result, while the remaining 60 bring the investor a loss of $1, i.e. their value in a year is zero. What is the average return that 100 investors who buy all 100 instruments will get? Obviously, investors will invest $100 and in a year they will receive only $80 — i.e. they will have a loss of 20% per annum.
Of course, you can count on the fact that you will be the lucky one to be among the 40 investors who will get a return of 100% per annum. However, the probability (here we come to that notion) of such luck is 40/100=40% i.e. less than half. Try dropping an ordinary coin. It falls with an eagle with 50% probability. So, your winnings will fall even less often. Would you invest your dollar under these conditions? Probably not, unless a fortune teller told you that you would become a millionaire.