Tuesday, February 2, 2010


I'm going to tell you a story about a fella I once knew. He was a young lad, full of confidence ...full of testosterone :)

During his first trip to Vegas this young man discovered a brilliant way to "beat the odds". He figured out that if you can continue to double down on your bet you will always walk out of the casino with a profit.

Here's an example let's say you bet $5 on blackjack and you lose your first hand. Your next bet is $10. If you win that hand you will recover your loss from the original bet and make $5. The same logic applies whether your bet is $10, $20, $40, etc. As soon as you win a hand you will increase your stash by $5.

And let's face it how many hands can one lose in a row? Maybe 5 or 6 if you're really unlucky?

Well as you can guess his initial foray into the blackjack pits was successful, wildly so. He tripled his money in almost no time at all.

Then he got to thinking why in the world am I playing $5 chips, that's going to take me forever to make a fortune. He had visions of owning the strip by this time :) $25 chips would get me where I want to go much much faster.

You probably see where the story is going by now. It didn't take very many losses before our young hero was down $1000, which at the time was a lot of money. At that point he ran out of money and had to retire for the night.

Completely dejected that his fool proof system had let him down so badly our hero decide to buy a deck of cards and run a little test. He wanted to see just how often one runs into a large losing streak, one that would be deeper than his pockets could cover.

To his amazement he discovered that in blackjack one will run into a 15 hand losing streak about every hour or two.

Now if you hit a 15 hand losing streak and are playing $5 chips you have to be willing to bet $163,000 to make a measly $5.

Our hero just learned his most valuable lesson in leverage and odds on that day in the casino.

Now when I hear about these fantastic returns traders are making I know they are in the casino. They're doubling down (leverage) and at some point the market is going to take the system, that they believe is fool proof, away from them (large losing streak). When that happens the massive leverage is going to destroy their account in the blink of an eye. And if they are really leveraged like 20-1 it doesn't take 15 losing hands in a row to do it. You can easily blow out in 4 or 5 trades.

Now let me say this, if and this is a critical if, you are young you could take a very leveraged bet. Knowing that if you are wrong you have the rest of your life to recover from your mistake.

If that bet pays off then you have to be satisfied and return to sound investing principles for the rest of your career. That's the only way you are going to be assured of keeping those gains.

For us older folks there's just no way we can take that kind of risk. We don't have enough time to recover from a fatal mistake.

So when you hear these fantastic tales of monstrous profits take it with a grain of salt. I've heard it all before. And I can tell you that not one single trader who chose this path was able to step off the path after a big score. Once the dark side gets it's claws in you, it's very hard to shake loose. Not one single one of the "big winners" is still around. The odds always get them.

That young man by the way, in case you haven't already guessed, was me.