Understanding Tail Risk in Gambling
Gambling is a risk-taking activity—which is one of the reasons it is so exciting and many individuals find it irresistible. But sometimes, the risks it involves can go far beyond what is expected, entering tail risk territory. But what is tail risk exactly, and why does it matter in gambling?
Tail risk is a risk that falls outside of three standard deviations of the expected outcomes. Tail risk is dangerous, but not unprecedented, and those who enjoy gambling should be aware of its existence. Read on to learn everything you need to know about tail risk and how it applies to gambling.
What is Tail Risk?
Tail risk is also known as high risk—risk which is calculated to happen more than three standard deviations for the normal. These are events that can happen but are statistically unlikely to happen; when they do, they can be devastating.
Tail risk is mostly mentioned in conjunction with investing in risky investments or in crazy world events, but they also apply to gambling, in more ways than you would expect.
To help you picture this better, think of a fish. The fish incorporates all of the possible outcomes from a situation. The body, including the side and dorsal fins, are the outcomes which are expected. Of course there is still the tail fins, but these make up a very small portion of the entire fish, and as such, are not really considered when thinking of the outcomes of a situation. That being said, the fish still has a tail fin, and the tail fin can still be an outcome, one which may be devastating. This, and similar illustrations, is why we refer to this unlikely risk as tail risk.
How is Tail Risk Measured?
Tail risk follows the empirical rule that 99.7% of all variations follow a normal distribution, meaning 0.3% are outcomes which fall outside of that. This 0.3% is known as tail risk.
It is important to note that this is the same calculation most insurance companies use when calculating premiums. While it is unlikely you will break your leg, it can happen, and they pool this small bit of risk with the rest of their customers, ensuring the premiums you pay can cover any member of the pool when necessary.
Unfortunately, tail risk events are becoming more and more common as the years go by, but that’s a topic for a different article.
How Does Tail Risk Apply to Gambling?
Whether you realize it or not, tail risk is a huge aspect of our everyday lives. On one hand, the chances of you winning big at a casino are about the same, or less than 0.3%, meaning you are regularly risking everything for a tail risk. Of course, you will win small events in the meantime—enough to keep you playing, but it is critical to recognize that the chances of you winning that big are even slimer than other tail risk situations, such as the world running out of water.
But that isn’t what we are here to discuss today. Tail risk is a part of gambling in many ways just beyond the big win. It is part of every bet you make, as well as involved in a number of side bets you are given the option to take while playing.
For example, if you have ever played craps in a casino, you have likely seen the large number of bets you can make. While there are the easy pass, no pass bets, there are also ones which are so obscure you may have played craps 100x and still don’t know of them. While many are bets which give you some decent chance of winning, many are tail risk bets, meaning you are betting on an extremely unlikely event occurring, but if it does, you will win huge.
While this is an obvious example of tail risk, remember that each time you gamble, you may be taking a tail risk. You might think this sounds far-fetched, but the future is impossible to predict, and you never know when an innocent bet might lead you down a path you never intended to take, which could result in you losing everything. Yes, we know this sounds crazy, but remember, this is what tail risk is—events that are very, very unlikely to happen, but they do, every day.
Do People Get Rick Off Of Tail Risk Bets?
Yes, individuals around the globe have won big with tail risk bets, both in gambling and outside of it—like the one investor who bet on the 2008 market crash and won.
Just remember that you hear more of the wins than you ever do of the losses. So for each massive tail risk bet winner, there are far more who have bet on these unlikely events and lost. But unlike the winners, they don’t brag. Just remember how many investors lost everything in 2008. And only one man won; let that sink in.
Should You Take Tail Risk Bets?
We are of the opinion that having a strategy, good bankroll management, and knowing when to walk away, are the keys to being a successful gambler. However, we are also not in charge of your life, and many individuals are more comfortable taking large risks than others.
Like all of our other articles, whether or not you engage in risky behavior like tail risk bets is totally up to you, but we advise you not to take any bets in which you aren’t comfortable losing everything. Because, when it comes to tail risk, you are far more likely to lose than anything else.
Overall, tail risk is a slim aspect of all risk, encapsulating approximately 0.3% of outcomes. That being said, tail risk outcomes do happen, and you should be aware of their existence and impact on the future. We never recommend betting on tail risk, as it ruins lives every year—but it can also result in riches (unlikely, but it happens), so the choice is yours to make.
