Why do most retail investors who play contracts for a long time ultimately end up dropping to zero?

Author: BroLeon from Down Under, Source: X, @BroLeonAus

Recently, when the market is sluggish, it's a good time for systematic learning. Yesterday, I picked up Taleb's theory of “Antifragility” and found it quite useful for explaining the phenomenon of the topic. I would like to record my thoughts and hope it can inspire everyone.

If you play contracts and win or lose but end up losing a lot over time, it may not be a technical issue, but rather you have fallen into the trap of “non-ergodicity.”

Taleb mentioned a famous “revolver” thought experiment in “Fooled by Randomness”. This story not only explains what risk is but also reveals why ordinary people who play contract betting for a long time are destined to end up at zero.

The experiment is as follows: Imagine there is a perverted billionaire who gives you a revolver, 6 chambers, and 1 bullet. You pull the trigger against your own head once; if you don't die, you get 10 million. Based on probability, your survival rate is 83%, and your death rate is 17%.

Many people believe: it's worth a shot for 10 million.

From a purely probabilistic perspective, the probability of surviving a one-time gamble is 5/6 (approximately 83.3%), while the probability of dying is 1/6 (approximately 16.7%). Many people might feel that risking a 16.7% chance of death for a chance to win 10 million dollars seems “worth a gamble.” However, Taleb points out that this line of thinking is flawed.

The so-called “traversability” simply means that “collective probability” can be equated to “individual time probability.” In this game, you cannot traverse. If you gather 100 people to play this game, about 83 people will get rich, and 17 people will die. On average, the gains are huge.

For you personally, you only have one life. Once that 1/6 small probability event occurs, the game is forever over for you. You cannot enjoy the “average” results. The joy of those 83 successful individuals has nothing to do with you; you are just one of the 17 tombstones.

As long as there is even a small probability that could lead to your complete elimination (death or bankruptcy), in the long run, this risk is almost certain to occur.

In addition, Taleb proposed another upgraded version of the gun experiment, which is more in line with the current situation in the cryptocurrency space:

What if you play this game once every day, giving 1 million each time?

As long as you play long enough, the probability of that bullet appearing will approach 100% infinitely. In this game, it doesn't matter how many times you win, because you can only lose once. Once you lose, the game is over, and so are you.

Back to the cryptocurrency contract. Many people open high leverage, pursuing short-term profits. It's like that person spinning a revolver. You might win 9 times in a row (there are no bullets in the gun), your account has multiplied dozens of times, and you think you are a stock god, with a perfect strategy. But this is just survivor bias; you just haven't hit that bullet yet.

Why is it bound to go to zero? The financial market will always have “black swans” – that bullet.

Pin insertion, exchange downtime, extreme market conditions. For spot traders, this is volatility; for high-leverage contract traders, this is “catastrophic risk.” No matter how much you earned before, as long as there is a risk of “liquidation means exit,” with an increasing number of trades, going to zero is not a “possibility,” but a mathematical “inevitability.”

You might think that the 1011 coin disaster was an unexpected “black swan” event, and that encountering it was just bad luck or some other objective issue. But in fact, veterans in the crypto world know that the situation during 312 was very similar to that of 1011, and it has only been 5 years since it happened; newcomers who entered the market after 2020 simply haven't experienced it.

This time, most of my friends around me who opened contracts with 1011 and did not encounter any issues are seasoned traders who have experienced the 312 baptism and have psychologically prepared for the worst-case scenario of 312.

The value derived from Taleb's wisdom is:

Do not take unlimited (destructive) risks for limited gains. As long as there is a possibility of “liquidation and exit,” your mathematical expectation in the long run is zero. Want to survive in the market? The first principle is not to make money, but to ensure that you are never hit by that bullet.

This is consistent with my long-standing emphasis on being cautious, not exposing oneself to excessive risks, and not leaving the poker table.

Should retail investors use leverage tools?

Of course, I am not mindlessly opposed to using leverage. In my opinion, if there really exists an opportunity like “taking a 16.7% risk of death to win 10 million dollars,” many people in reality would be willing to try it, after all, it's too difficult to earn capital.

The biggest appeal of the crypto world is still the presence of numerous opportunities to leverage a small investment for a large return, with high leverage being one of them. However, most retail investors face two problems:

1. One won't just fire a shot; after surviving the first shot and getting 10 million, they will feel like the chosen one and continue to fire shot after shot until they encounter a bullet.
2. There is no strict trading discipline, especially with stop-losses. Using the entire margin without setting a stop-loss and not preparing for the worst-case scenario is basically the prelude to a total loss.

Final Summary

For any game that has “catastrophic risks”, the first thing to consider is whether you can accept the loss in the worst-case scenario (when the bullets are fired), rather than how high the potential gains are.

Risk must be within an acceptable range for you, and treat each contract trade seriously, as if pulling the trigger on Russian roulette.

I personally find Taleb's theories quite helpful for me. If you have time and are interested, you can go read them.