The mechanics: Gaining a little, often, and the question of the day it all breaks

Some strategies do not rest on an opinion. They rest on a mechanism, repeated thousands of times.

First mechanism: statistical arbitrage. Two shares that usually move together suddenly start drifting apart.

You buy the one that has fallen behind, sell the one that has pulled ahead. And bet the gap will close.

Each bet earns very little. Say a coin that lands the right way fifty-one times out of a hundred.

On a single toss, it is almost chance. Over ten thousand one euro bets, the expected gain rises to two hundred euros.

The danger: all the bets turning at once. In nineteen ninety-eight, the fund LTCM, which counted two Nobel winners, collapsed this way.

Second mechanism: merger arbitrage. A company announces it will buy another, at a set price.

For the example: the offer is fifty euros, but the target share trades at forty-eight. The gap is the risk the deal fails.

The arbitrageur buys at forty-eight and waits for the signature. If all goes well, he gains two euros, a little over four per cent.

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But if the merger is blocked, the share can fall back, say to thirty-eight. Ten euros of loss: more than twenty per cent.

Gaining a little often, losing a lot rarely. That is the profile of many mechanisms.

Third mechanism: the carry trade. You borrow where money is cheap, and invest where it pays more.

For years, investors borrowed in yen almost for free, to invest in better-paid currencies.

For the example: borrow at zero point five per cent, invest at four point five. Four points of gain a year, quietly.

But if the borrowed currency rises five per cent, the year's gain is wiped out, and more. And these reversals come all at once.

Traders have an image for it: picking up pennies in front of a steamroller.

Fourth mechanism: trend following. You buy what rises, sell what falls, by fixed rules, across all markets.

Funds that do this are called CTAs. They predict nothing. They follow.

Their promise: gaining during crises that last. In two thousand eight, many ended the year up, while shares collapsed.

The price: long flat years, losing a little on each false start. And flash shocks catch them on the wrong foot.

Four mechanisms, one lesson. Each has a small edge, and a hidden risk that rarely shows, but shows hard.

When a strategy gains a little almost every month, always ask: what could make it lose everything?