In his latest book, Skin in the Game, Nassim Taleb runs an interesting thought experiment where he talks about two cases of playing the casino.

Equate the first case with ‘stock market trading’ in general –

…one hundred people go to a casino to gamble a certain set amount each over a set period of time, and have complimentary gin and tonic. Some may lose, some may win, and we can infer at the end of the day what the “edge” is, that is, calculate the returns simply by counting the money left in the wallets of the people who return. We can thus figure out if the casino is properly pricing the odds.

Now assume that gambler number 28 goes bust. Will gambler number 29 be affected? No.

You can safely calculate, from your sample, that about 1 percent of the gamblers will go bust. And if you keep playing and playing, you will be expected to have about the same ratio, 1 percent of gamblers going bust, on average, over that same time window.

Now consider the second case in the thought experiment. Equate this with an ‘individual’ trading the stock market –

One person, your cousin…goes to the casino a hundred days in a row, starting with a set amount. On day 28, your cousin is bust. Will there be day 29? No…there is ‘no game no more.’

No matter how good or alert your cousin is, you can safely calculate that he has a 100 percent probability of eventually going bust. The probabilities of success from a collection of people do not apply to your cousin.

Now, you may blame the disastrous outcome of your cousin on, well, your cousin. He may have been foolish, you may think, who did not understand that the longer you play in a casino the more you stand to lose (the house always wins).

But what Taleb writes about is a nice mental model to remember when you are reading finance books or are being recommended stocks based on the long-term returns of the market. How your cousin behaved in the above thought experiment is how most people, old or new, behave in the stock market when they play the game as if it were a casino (trading, speculating, etc.).

Remember that you or me are not the market. Earning the long-term returns of the market, of the past or the future, is not in our control. Managing our risks and avoiding ruin, mostly is.

“Rationality is avoidance of systemic ruin,” Taleb writes.

Trying to avoid the ruin the stock market system enforces upon people who disregard its workings is rational. Believing that you can beat the system at it, by playing the game mindlessly, isn’t.

Someone wise once said –

People destroy themselves in unique interesting ways. Systems destroy people in uniform boring ways.

Now the problem with beating the system for some time is that we get a swelled head. We start believing that if the stock we have invested in has earned us magnificent returns over the past 2-3 months or years, it was entirely an element of our skill and no luck. Yes, that’s how the mind behaves and makes us believe.

But then, as Jesse Livermore, one of the world’s best speculators, who committed suicide after going bankrupt the fourth time, reminds us –

A great many smashes by brilliant men can be traced directly to the swelled head — an expensive disease everywhere to everybody, but particularly…to a speculator.

Now, if that’s not all, consider path dependence that in simple terms explains how history really matters – where we have been in the past determines where we currently are and where we can go in future.

As Taleb writes in Skin in the Game –

Assume that your capital is around one million dollars and you are involved in speculation. Apply path dependence to the reasoning.

Making a million dollars first, then losing it, is markedly different from losing a million dollars first then making it.

The first path (make-lose) leaves you intact; the second (lose) makes you bankrupt, insolvent, maimed, traumatized and more generally unable to stay in the game, thus unable to benefit from the second part of the sequence. There is no ‘make’ after the ‘lose.’

Anyways, ultimately, the lessons?

First, you are not the market. So, stop looking at market returns. Don’t yield into the false promise that “in the long term, you will earn a minimum of 15% because that’s what the market has earned in the past.”

Second, don’t speculate, again because you are not the market made up of people who may seem to be doing well (for some time) speculating. Also, stocks are pieces of underlying businesses. Respect that and you have a great chance of doing well over the long run. Remember Warren Buffett who said – “If you’re even a slightly above average investor who spends less than you earn, over a lifetime you cannot help but get very wealthy – if you’re patient.”

Third, if you really wish to speculate (but never with other people’s money), first earn at least a million (through hard work at your place of work, and investing) and then speculate with a small part of it so that you don’t end up in total ruin. Call this money you use for speculation as ‘sin money,’ so that mentally prohibits you from committing a lot of sins. Remember that smoking a single cigarette, like speculating just once and with a small amount of money, is benign. But their constant repetition (“just one more time”) takes you closer towards ruin.

Fourth, the only way to do well in investing is to survive. As Peter Bernstein writes in his brilliant book Against the Gods – “Survival is the only road to riches. Let me say that again: Survival is the only road to riches.”

In life and investing, I wish you survival.

Because if you survive, you will be rich, my friend.

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