risk
Asymmetric Payoffs
The rule
What counts is the size of a win or loss times its chance, not how often you are right. You can be right nine times and still lose if the tenth wipes you out.
Where it flips
The idea can tempt you to chase every long-shot 'huge payoff' lottery ticket, while ignoring the tiny real odds. So keep both halves of the sum together, the payoff and the chance. A big prize times a near-zero chance is still worth almost nothing.
You can be right nine times out of ten and still end up poorer. That happens if the one time you are wrong loses more than the nine wins put together. The reverse is also true. A method that loses often but pays hugely on the rare win can be excellent. So stop counting how often you are right. Start weighing what each outcome is actually worth.
A worked example
Arjun sells risky option premium and pockets ₹5,000 a month for eleven months straight. Then one crash month costs him ₹1,20,000. A great hit-rate, a terrible year. [illustrative]
How to spot it
- ·bragging about win-rate, silent on the loss size
- ·steady small gains hiding one rare huge loss
- ·'I'm right most of the time' as the whole case
Nassim Nicholas Taleb · Fooled by Randomness