Adam Bloom is a Content Writer, podcaster, and yield farmer based in Los Angeles.
The Barbell strategy is supported by Nassim Taleb. Here’s how it works and how it might be applied to crypto.
In summary
Nassim Taleb argues that we can’t accurately predict trading risk, and more data actually leads to worse trades.
Building on this, his barbell method implies allocating a large part of one’s portfolio to low-risk assets, a small portion to high-risk assets, and none to medium-risk assets.
This approach can make sense for crypto, but it comes with nuances.
Everything is high-risk
Nassim Nicholas Taleb has spent decades studying randomness and how we try to understand it. In other words, how do we assess risk (and are we any good at it)?
His basic conclusion is that we have no idea what we’re doing. In his opinion, we’re finding patterns where there aren’t any. We’re making predictions based on false assumptions. We’re trying to understand things that can’t be understood, and we’re trying to control things that can’t be controlled.
Taleb further concludes that the harder we try, the worse we do. We think that if we push ourselves harder, read more, consume more data, more data, more data, we can get on top of the data, master it, understand it, predict it, and make money from it. Wrong.
In fact, Taleb argues for the opposite. The more data we consume, the more likely we are to encounter bad information, see false patterns, and send ourselves down a rabbit hole based on false assumptions.
As Taleb puts it in Antifragile:
“More data means more information, perhaps, but it also means more false information.”
Instead, Taleb proposes that our strategy for trading (along with everything else) should be antifragile.
How to trade the antifragile way
Taleb says that “antifragile” is the opposite of “fragile.” But most of us think the opposite of fragile is “strong.” If something is fragile, it breaks easily. So the opposite of fragile should be something that doesn’t break easily, right? Not to Taleb.
Taleb proposes that “fragile” means something that gets weaker when injured, so the opposite is “antifragile,” something that gets stronger when injured.
Muscles work this way. When you exercise, you break your muscles down, and they grow back stronger.
Forests work this way. When a forest fire breaks out, it clears old growth, makes space for new growth, and the whole forest gets stronger.
Markets also work this way. When businesses enter the marketplace, some fail, others succeed, and the whole market gets stronger.
Of course, this only works if the injury isn’t so destructive that the antifragile thing dies. A moderate forest fire is good for the forest, but only if there are enough trees left to keep growing afterward.
Taleb proposes that you can build this idea into your portfolio by using the barbell strategy.
What’s the barbell strategy?
Taleb has two central tenets of trading:
Our market predictions are bad, and analyzing data makes them worse, so we have no idea what’s going to happen.
We want to be antifragile, so when volatility hits the market, we not only survive it but profit from it.
In other words, we don’t know when volatility is coming, but when it does, we want to be ready to profit from it. And if we screw up, we need to survive.
The barbell strategy, Taleb argues, can serve both of these needs if we sort every potential trade according to its risk level:
Low. Traders often consider cash and U.S. government bonds to be low-risk.
Medium. They often see mutual funds like the Vanguard 500 to be medium-risk.
High. Crypto, options, startups, and high-growth tech stocks are usually seen as high-risk.
Barbell trading implies lowering one’s exposure to the risks of the “medium” category. These, Taleb believes, have limited upside but unlimited downside because our risk assessments are all wrong. In that sense, “medium” risks aren’t really medium risks — they’re unknown risks with limited upside.
Next, the barbell implies stockpiling assets usually seen as low-risk, such as cash. Taleb’s reasoning is that because we can’t accurately measure risk, we need to assume that we could lose everything we invest. That’s why he recommends acquiring enough low-risk assets to survive, no matter what happens.
Finally, the barbell strategy implies pursuing aggressive, high-risk trades — with a small portion of one’s portfolio. These are asymmetrical opportunities because if our trade craters, our maximum loss is limited to that small allocation. If a favorable wave comes in, on the other hand, we could catch it and maximize our profits.
When it’s set up, a barbell portfolio looks like this —
Taleb summarizes it this way:
“Antifragility is the combination of aggressiveness plus paranoia… protect yourself from extreme harm, and let the upside… take care of itself.”
The crypto barbell
Where could crypto fit into this mix?
ETH comes with a lot more upside but also a lot more volatility (historically speaking) than a fund like the S&P 500. S&P 500 mutual funds, however, are usually considered medium-risk — not good from the point of view of the barbell strategy.
Now, trading in crypto comes with much higher risk — but also with more upside. Faced with the choice of allocating a portion of one’s portfolio either in an S&P 500 fund or in crypto, the barbell strategy would suggest acquiring a small crypto position, and staying away from the S&P 500 fund. But that’s not the end of the story: there’s a barbell within the barbell.
Crypto has been around for a while now, and some crypto assets, like BTC and ETH, have acquired something close to a blue chip status. Comparatively, smaller and newer tokens come with even more risk — but also even more upside. Applying the barbell approach, in this case, could mean allocating a large part of one’s crypto position to “blue chip” tokens, and a small portion to even higher-risk assets, such as up and coming altcoins.
Who knows what the next wave will look like?
Surf’s up.
