What is Taleb distribution?

It's an investment returns profile where there is a high probability of a small gain and small probability of a very large loss. Such a strategy appears low risk with steady returns, but periodically suffers huge losses. The term is named after former trader and essayist Nassim Taleb, much of whose work focuses on probability.

Where have you heard about Taleb distribution?

British economist John Kay, who helped to coin the term, has compared securities trading with bad driving, as both are characterised by Taleb distributions. Drivers can make small gains in time by overtaking but are also at risk of experiencing a very large loss in the form of a serious accident, he says.

What you need to know about Taleb distribution.

Many traders fall victim to Taleb distribution. Imagine you have £500 to invest. There’s a 99.9% probability that you’ll gain £1, but at the same time there’s a 0.1% chance you'll lose the whole £500.

If you were to trade 1,000 times during the year, you’d gain 999 times and lose once. This equates to a £999 profit and £500 loss. Most people would take the trade.

However, greed eventually takes hold, and you reach a point where you assume you always have a 100% chance of success. And what happens? You learn the hard way that no investment strategy is foolproof.

Find out more about Taleb distribution.

Read our definition of Black Swan, another of Nassim Taleb’s financial theories.