Disclosure: Our content isn't financial advice. Do your due diligence and speak to your financial advisor before making any investment decision. We may earn money from products reviewed. (Learn more)
Accurate financial predictions are difficult at best. This is because uncertainty and risk are inherent characteristics of free markets. Fortunately, you can sway uncertainty in your favor by finding highly asymmetric investments and trading opportunities.
Asymmetric investing or trading have a favorable upside position relative to its downside. Investments with an asymmetric risk-reward profile imply that there’s more to gain than there is to lose on a trade due to market inefficiencies.
In this article, I’ll introduce you to the concept of asymmetrical trading. Then, I’ll point you in the right direction if you want to start making money with asymmetric investing.
What Is A Highly Asymmetric Investment?
Symmetry is attractive in art and aesthetics, but not in investing. Expert investors avoid balance and actively hunt for asymmetrical investment opportunities.
Asymmetric investments are those for which the possibility of loss is small relative to the possibility of gain. These are trading situations that have at least one of two qualities:
- High winning percentage (i.e., the odds of success)
- High reward relative to risk (i.e., the magnitude of success)
Therefore, risking $1,000 on the chance of earning $1,000, with an equal likelihood of either outcome, is an example of a perfectly symmetrical trade because it risks the same amount one stands to gain at equal odds.
Far too often, investors are duped by guarantees of a “100% upside” and will, in pursuit of maximizing its upside, eventually ride a stock to zero. That’s a 100% downside on a 100% potential upside or, in other words, a perfectly symmetrical bet.
You can think of asking someone on a date as a form of asymmetric investment. What’s the downside loss? If you’re rejected on the date, then your life and schedule fail to change and you carry on with your life as it was. If the special someone accepts the offer for the date, then a potential lifelong bond might come of it. Huge upside, limited downside.
Examples of Asymmetric Investments
Life insurance is an example of a highly asymmetric investment. When you buy the policy, you pay a relatively small premium compared to the payout if the worst happens. Or you can think of selling life insurance policies as going long on the unlikely event of one policyholder’s death.
Insurance companies sell thousands of life insurance policies, knowing that only a few will result in the untimely event of death. So, they have a very high upside and a limited downside, which is a perfect example of asymmetric investing.
Another example of an asymmetric investment is a catastrophe bond. These types of high-yield bonds are issued to insurance companies to mitigate the risk of a natural disaster such as an earthquake or hurricane. You can think of catastrophe bonds as a form of an asymmetric debt instrument whereby the reinsurer is taking a long position on an unlikely natural disaster not occurring.
Equities in the natural resources sector tend to offer highly asymmetric reward profiles. As one of the market’s most volatile sectors, natural resource stocks undergo rapid boom and bust cyclicality.
For instance, oil futures experience some of the highest degrees of volatility due to their inherent responsiveness to short-run shocks to supply and demand. Look no further than the year-over-year movement of West Texas Intermediate (WTI) crude oil prices over the past four years:
- 2016: +45.03%
- 2017: +12.47%
- 2018: -24.84%
- 2019: +34.46%
- 2020: -31.87%
- 2021: +55.01%
- 2022: +46.91% (as of publication date)
Given the inherent cyclicality of crude oil prices, the commodity presents an asymmetric investment opportunity if you assume that the chance of the commodity’s price increasing is greater than the chances of it staying the same or lowering.
Finally, investing in bitcoin (BTC) during its infancy presented an asymmetric trade opportunity because the downside risk of losing $9.35 USD (the price of one BTC in July 2012) was dwarfed by its upside potential in the likely event of mass adoption. Widespread adoption would occur in the years following, as depicted by the chart below, with the price of bitcoin hitting an all-time high of $19,891 in December 2017.
Source: Doug Casey’s International Man
Asymmetrical Trading
When traders consider whether or not they should be getting into the market long or short they will usually assess the probability of the trade going in their favor versus the probability of the trade generating a loss.
Clearly, they want to enter a trade with the highest possibility of becoming profitable, and that aspect in itself is a form of asymmetrical trading. However, the asymmetry should also continue with the amounts of profit and loss the trade could generate.
When a trade setup has the same potential profit and loss, the trade fails to be an asymmetric trade. Even if you believe it has higher possibilities of winning than losing. If a trade has a profit target of 10 percent and a stop loss of 10 percent, then the trade risk and reward ratio creates a symmetric trade.
To implement asymmetric trading both aspects of the trade; win probability and risk-reward ratio need to be skewed for a positive result. When both factors are skewed in favor of a win, then you have an asymmetric trade. Many traders will place a trade with a risk-reward ratio of 1 to 1.
This means traders will only be profitable when they place more winning trades than losing trades. However, if your risk-reward ratio is say 2 to 1, you can still have a profitable trading strategy even if your win rate is lower than 50 percent.
Here you can see how asymmetrical trading clearly gives traders an advantage by having a greater possibility of generating profits. The advantage is created by putting on trades with a positively skewed asymmetrical risk and reward ratio.
What Causes An Asymmetric Investment?
A highly asymmetric investment is principally caused by a form of inefficiency in the market. One of the foremost rules of investing is that inefficiencies will always rear their heads in financial markets—it’s your job as an investor to capitalize on them to make a profit or hedge against risk.
Or you can use the services of financial professionals who set up organizations that take advantage of structural market inefficiencies such as hedge funds. If your investor profile is adequate, these funds have the resources and the know-how to garner higher rates of return from asymmetric investing.
There may be structural inefficiencies imposed in the form of regulations or trade barriers that compel investors to behave in a certain way that skews the risk-reward profile of the investment. In other cases, asymmetric opportunities are caused by extremes in investor sentiment.
An extremely bullish or bearish investment usually presents a disproportionately low or high probability of experiencing a price movement. If you bet against the prevailing investor sentiment, you benefit from positive asymmetry because the downside risk is low relative to its upside.
The goal is to find asymmetric investing opportunities that still show more potential upside compared to the downside risk. And with a higher probability of success than failure.
Differences Between Asymmetrical Investing and Asymmetrical Trading
Asymmetrical investing like all investments is based on a fundamental analysis of the asset and its long-term projection. When investing in securities you should be looking at time horizons of a few years to a decade.
On the other hand, asymmetrical trading will involve short-term positions and should include technical analysis as well as fundamental. Traders typically carry high amounts of leverage, meaning they will hold positions for many multiples of the cash on their trading accounts.
While investors will hold positions for the value of their portfolio and not more. When designing the allocations of their portfolios, savvy investors will diversify across a broad range of assets. Some may perform better than others. However, asymmetry should result in some of those investments outperforming.
Whereas traders will tend to take positions in one or two assets depending on the markets they are trading. The idea is to maximize profit potential and reduce the number of losing trades, over a small period of time and for large amounts of capital.
Asymmetrical Investing Characteristics
- Long-term investment horizon H4
- Fundamental analysis
- No leverage
- Diversification of risk
Asymmetrical Trading Characteristics
- Short-term time horizon
- Technical & fundamental analysis
- High amounts of leverage
- Little to no diversification
Are Asymmetric Investments Worth The Risk?
When investing, there’s no such thing as absolute certainty. However, asymmetric investments are identifiable scenarios in which the reward inherently outweighs the downside risk. By their very nature, then, asymmetric trading and highly asymmetric investments are worth the risk.
You can amass significant wealth by making asymmetric trades, or buying into an index fund that specializes in asymmetric trading. The difficulty is in identifying trading scenarios or opportunities that, with a high degree of confidence, have a positive reward-risk ratio.
How Do I Know If An Investment Is Asymmetric?
Developing a trading system that accurately identifies asymmetric opportunities is perhaps the most difficult aspect of trading securities. Due to asymmetries of information in financial markets, you can never be sure of the precise risk of a given trade.
Without mathematical or actuarial modeling tools, such as those available to investment banks and hedge funds, savvy investors must intuit the approximate risk-reward profiles of each trade. Below, I’ve provided a basic scenario of two potential trades with approximate risk profiles.
Trade 1
- 30% chance of losing 15 points
- 30% chance of winning 10 points
Trade 2
- 15% chance of losing 15 points
- 30% chance of winning 30 points
If an investor must choose between the two trade options listed above, the second option presents the greatest likelihood of success. This is an example of an asymmetric investment opportunity because losses are contained and the margin for gains exceed potential losses. For assistance with calculating the odds of winning or losing on your investment, consider consulting the expertise of professional money managers or risk analysts.
Want To Get Started?
A successful trading and portfolio management strategy is one that creates positive asymmetry. The trick is finding stocks and other investment vehicles that offer a positive risk-reward profile.
Success in asymmetric investing often comes down to having the skill to identify and the patience to wait for lucrative asymmetrical trading opportunities. Luckily, there are services available that take the heavy lifting out of scouting for asymmetrical investments.
To get started, I suggest reading our Capitalist Exploits review. Capitalist Exploits is an exclusive, subscription newsletter written by professional money managers dedicated to finding asymmetric risk-reward investment opportunities. They offer everything from insider ideas and stock picks to access to private placement deals for savvy investors.
You cannot afford to guess when it comes to picking highly asymmetric investments. Instead, consider the expertise of professional money managers to identify the true amount of risk associated with every investment opportunity.
The information provided here is not investment, tax or financial advice. You should consult with a licensed professional for advice concerning your specific situation.
Liam Hunt, M.A., is a financial writer covering global markets, monetary policy, retirement savings, and millennial investing. His commentary and analysis have been featured in the New York Post, Reader's Digest, Fox Business, and Forbes.
