Why do you always make small profits and then lose everything? Taleb explained it twenty years ago with "asymmetric leverage."

Author: UNICORN

Why do you always make small profits, then take a big loss that wipes out your principal and those small profits?

Taleb wrote about this twenty years ago.

He called it asymmetric leverage, which means that the same amount of money has different effects in the upward and downward directions.

Taleb, a Wall Street options trader for over twenty years.

Books like "The Black Swan," "Antifragile," and "Asymmetry of Risk" are all written by him. He doubled his investments through tail hedging during the 2008 financial crisis.

In March 2020, during the market circuit breaker, the fund he advised gained over three thousand percentage points in a single month.

Most people spend their lives stuck in the concave side, thinking it's just bad luck.

First, look at the shape.

Concave: Your profit curve bends downward.

When you make money, it's in small bites, but when you lose, there's no bottom.

The greater the volatility, the worse it is for you, because your losses on the left side are open-ended.

Convex: The curve bends upward.

When you lose, there's a cap, but when you gain, there's no cap.

The greater the volatility, the more you benefit.

In the same market situation, falling into two different structures leads to two different outcomes.

Why will this structure eventually blow up?

1/ Probability deceives you.

When making small profits, the win rate is very high, appearing stable.

But what determines long-term results is the probability multiplied by the odds.

A win rate of 90% with odds of 1 to 10 means you're doomed in the long run.

If that 10% occurs once, it wipes out all the previous 90 times.

Repeated betting, the tail will eventually arrive.

2/ In a multiplicative world, losses are asymmetric.

If you gain 10% and then lose 10%, you are left with 99%.

If you lose 50%, you need to gain 100% to break even.

A 100% loss means permanent zero, and even a tenfold gain won't help.

Profits accumulated from ten small gains can be wiped out by one big loss.

3/ This way of playing forces you to guess correctly every time.

Losses have no upper limit, so you must predict which time will be the exception.

Taleb's original words are that fragile things need to be predicted.

Once you start relying on predictions, you've already lost.

4/ The most insidious part is that it rewards you.

Small amounts of money come in repeatedly, and the curve rises steadily, giving a sense of control.

Thus, positions grow larger and larger until one trade wipes out everything before it.

This structure is designed to build confidence first, then clear everything in one go.

Common examples include:

Selling options to collect premiums.

High-yield financial products and Ponzi schemes.

Leveraging single stocks, holding positions without stop-losses.

Short-term trading based on win rates, taking small profits and holding losses.

How does Taleb suggest we solve this?

1/ Reverse the structure and first ask about the worst-case scenario.

If this money goes to zero, can you still live normally?

If yes, then continue discussing the odds.

2/ Only buy things that have a floor when they drop and no ceiling when they rise.

The lower limit is supported by cash flow and consensus, while the upper limit is everyone’s emotions.

Emotions have no upper limit.

3/ Cap single losses first, then discuss profits.

Set your own loss limits, don’t leave it to market conditions and liquidation prices.

4/ Use a barbell strategy, avoid compromise.

One end is extremely safe, the other end is extremely aggressive.

The middle part is the most fragile; assets that seem stable with a bit of leverage can disappear entirely if something goes wrong.

5/ Redirect channels for making small profits to serve as insurance.

Cash flow, content, commissions, small communities—these incomes are stable.

Their purpose is not to make you rich but to ensure you have ammunition during the worst times.

6/ Keep a portion of cash.

Cash doesn’t earn money, but it allows you to act when others are forced to sell.

I personally climbed out of this structure.

When I first started trading,

I would use large margins and large positions to make a small profit and then exit, which created a structure of continuous small profits followed by a significant loss.

Slowly, I changed to a small position, small margin, and significantly increased the holding period and corresponding take-profit levels, forming a structure of making large profits with small capital.

Reversing the structure of making small profits and taking large losses.

Betting small to win big.