Everybody knows what Bernie Madoff did—hustle a lot of people out of $50 billion. But nobody's really explained how he did it. Now we're finding out his purported "strategy" was obviously fake.

Madoff told his investors he was using a pretty straightforward investment strategy involving buying stocks of major companies, then hedging those investments by buying options contracts. But people who bothered to check noticed a big problem: if Madoff had actually been managing all the billions in his entire firm in this way, the options market would have been overflowing with his firm's money. It wasn't.

"Some investment advisers steered clear of Madoff funds, in part because of discrepancies like these. 'It seemed implausible that the S&P-100 options market that Madoff purported to trade could handle the size' of Madoff's estimated $13 billion in assets, wrote James Vos and Jake Walthour of advisory firm Aksia LLC last week."

Furthermore, Madoff's popularity with investors was due to the fact that he produced not spectacularly large gains, but steady, moderate gains no matter how volatile the market. His purported strategy couldn't do that, either.

Other traders said that while the strategy, when properly used, does limit volatility, it generally wouldn't produce gains in a declining stock market.

All of which raises the question: Were these people suckers, or what? You might think that before investing hundreds of millions of dollars, you'd check and see whether, you know, a firm's strategy was just imaginary. Easy to say in hindsight, but still. Even I know that the first rule of investing is "If it sounds too good to be true, it is." Following this rule will ensure you'll never lose millions, because you will never be rich. Smarten up, richies. [WSJ]