risk
Markets have fat tails
The rule
Big moves happen far more often than a neat curve says. A stop can jump right past your price, and a model built on 'normal' swings hides the real chance of ruin.
Where it flips
But fear of disaster can freeze you into never buying anything at all. That is its own failure. The fix is not to avoid risk but to size for the gap. Assume a stop can slip. Keep positions small enough that one rare event does not wipe you out. And respect gaps and event dates.
Mandelbrot showed that price changes do not follow the tidy bell curve most tools assume. Extreme days come far more often, and they cluster together. The hard truth is simple. A stop is only an instruction, not a promise. When a stock gaps down on news, it can open well below your level and fill much worse. Any position size that assumes moves stay 'normal' is quietly betting the rare disaster never shows up. That is exactly the bet that ends accounts.
A worked example
A reader sets a stop 4% below entry and sizes as if 4% is the worst case. Overnight the company reports a fraud probe and the stock opens down 20%. The stop fills near the open, not at 4%. The bell-curve idea said this 'should not' happen. Fat tails say it happens regularly. [illustrative]
How to spot it
- ·a stop treated as a guaranteed exit price
- ·position size that assumes the worst case is a small, orderly move
- ·an overnight or event gap that jumps past a level you thought was safe
Benoit Mandelbrot · The (Mis)Behavior of Markets