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?

  • 3
    If you were "investing" at a roulette wheel, you would need a Martingale system...
    – DJohnM
    May 4 at 6:56

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."


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.

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