Everyone wants to be right. It’s how we were graded in school, and it’s how most investors grade themselves: how often did I call it correctly? But in portfolio management, being right isn’t the objective. What decides the outcome isn’t how often we’re right. It’s what happens to capital when we are and when we aren’t.
Consider two opportunities. The first wins $100 nine times out of ten and loses $100 the tenth time. The second loses $100 nine times out of ten and makes $10,000 the tenth time.
The first feels better. You’re right 90% of the time, and most days you walk away with something. Its expected payoff is $80 per attempt: nine wins of $100, less one loss of $100, spread across ten attempts.
The second feels terrible. You’re wrong 90% of the time, and you’ll sit through long stretches when nothing works. Its expected payoff is $910 per attempt, more than eleven times the first.
That’s the difference between probability and payoff. Win rate tells us how often we’re right. It says nothing about how much we make when we’re right or how much we lose when we’re wrong, and the outcome depends on all three. Professional portfolio management has to account for all three, because a high win rate paired with small wins and an occasional large loss can lose money for years while feeling like it’s working.
Why the Second One Is Hard to Hold
The arithmetic favors the second opportunity, so why doesn’t everyone take it? Because the sequence is brutal. If we expect to lose nine times out of ten, a run of six, eight, or ten losses in a row isn’t evidence the strategy stopped working. It’s a normal part of the distribution, and anyone who hasn’t done that arithmetic in advance tends to quit right before the payoff arrives.
That’s what makes position sizing the control variable. We define the risk before we enter: where the position is wrong, and how much capital we’re prepared to put at risk if it gets there. Then we size the exposure so a normal run of those exits can’t materially damage the portfolio. Each exit is small enough that ten in a row is tolerable, and the capital is still there when the large winner comes.
The Payoff Still Has to Be Real
None of this makes a low win rate a virtue. Losing often is only acceptable when the winners are large enough, and arrive often enough, to more than pay for the losses. The evidence has to support the payoff, not just the story about it. A disproportionate payoff that rarely shows up is a slow way to lose.
That’s asymmetry. Not being right more often, and not predicting the future better than everyone else. It’s risking an amount we can afford to lose when the potential payoff is disproportionately larger, and surviving long enough for a favorable expected payoff to compound.
The objective was never a high win rate. It’s a favorable outcome.
Mike Shell is the founder and chief investment officer of Shell Capital Management, LLC, a registered investment adviser. He serves as portfolio manager of ASYMMETRY® Managed Portfolios, a separately managed account program with trade execution and custody provided by Goldman Sachs Custody Solutions.
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