Trading strategy with high probability of small profits and low probability of complete loss

Question

What are some trading strategies that have high probability of small profits and low probability of catastrophic loss? I believe there is an academic term to describe a trading system that shows small consistent profits, but with the risk of a complete loss lurking around the corner. The typical equity curve of such a strategy resembles a straight upward-sloping line (i.e. small but consistent profits), with a cliff at the end that represents a huge loss.
What is the proper term for such a trading system? Could you give some concrete examples (i.e. hypothetical portfolio constructions) that implement such a risky trading system?

0xFEE1DEAD · Accepted Answer

Not an academic term but it's colloquially called picking up pennies in front of a steamroller.
One example is selling far OTM options (Remember Wall Street’s Viral
Laughingstock, OptionSeller.com?)

In economics and finance, a Taleb distribution is the statistical
profile of an investment which normally provides a payoff of small
positive returns, while carrying a small but significant risk of
catastrophic losses. The term was coined by journalist Martin Wolf and
economist John Kay to describe investments with a "high probability of
a modest gain and a low probability of huge losses in any period."

Philip · Answer

This shape of trade generally gets bucketed into a class of trade called a 'carry' trade, although it can be built in some other ways. See here for a basic overview of carry, and this is also a interesting read if you want to go deeper.

Answered by Philip on June 28, 2021

Trading strategy with high probability of small profits and low probability of complete loss

2 Answers

Add your own answers!

Ask a Question