Why Do You Always Make Small Profits and Then Lose Everything? Taleb Explained It with 'Asymmetric Leverage' Twenty Years Ago

Author: UNICORN

Why do you always make small profits and then suffer a big loss that takes away your principal and those small profits?

Taleb wrote about this twenty years ago.

He called it asymmetric leverage, which refers to the fact that the same amount of money behaves differently in terms of gains and losses.

Taleb, a Wall Street options trader for over twenty years, is the author of "The Black Swan," "Antifragile," and "Asymmetrical Risk," and he doubled his investments during the 2008 financial crisis through tail hedging.

In March 2020, during the market crash, 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, let's look at the shapes.

Concavity: Your profit curve bends downward.

You make small profits bit by bit, but when you lose, there’s no bottom.

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

Convexity: 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 explode?

1/ Probability deceives you.

When making small profits, the win rate seems very high and stable.

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

A 90% win rate with 1 to 10 odds will lead to long-term losses.

If that 10% happens just once, it wipes out all the previous 90 wins.

Repeated betting will eventually lead to the tail.

2/ In a multiplicative world, losses are asymmetric.

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

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

A 100% loss means permanent zero; even a tenfold gain won’t help.

The profits 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 profits come in repeatedly, and the curve rises steadily, giving you a sense of control.

Thus, you increase your position until one trade wipes out everything before it.

This structure is designed to build confidence first and then liquidate all at once.

Common examples include:

• Selling options to collect premiums
• High-yield financial products and Ponzi schemes
• Leveraging single stocks without stop-losses
• Short-term trading based on win rates, taking small profits and holding onto losses

How does Taleb suggest solving 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 on the downside and no cap on the upside.

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 before discussing profits.

Set your own loss limit; don’t leave it to the market and liquidation prices.

4/ Use a barbell strategy, not a compromise.

One end is extremely safe, and 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/ Shift the channels for making small profits to act as insurance premiums.

Cash flow, content, commissions, and small communities provide stable income.

Their purpose is not to make you rich but to ensure you have bullets 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 used large margins and positions to make small profits and then exited, which created a structure of continuous small profits followed by a significant loss.

Gradually, I changed to a small position, small margin, and significantly increased the holding period and corresponding profit-taking, forming a structure of making big profits with small capital.

Reverse the structure of making small profits and losing big.

Make big profits with small investments.

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