Navigating Black Swan Events
Financial literacy: preparedness for the unpredictable
Black Swans in the Age of Enlightenment
Once upon a time, all swans were white. Black swans existed only as an expression of impossibility. That all changed when a Dutch sea captain sighted a black swan off the coast of Australia in the late 18th century. Having lost its explanatory power, the expression was forgotten for several centuries. Until famed investor and author Nicholas Nassim Taleb resurrected the idea in the title: The Black Swan: The Impact of the Highly Improbable. The expression again came into common currency, though the meaning has changed.
What is a Black Swan Event?
The Black Swan analogy is now used to describe an unexpected, rare, and highly impactful event. After a black swan event, we must understand how and why we should have been prepared.
A prominent example is 9/11 because it was unexpected with a huge impact. In retrospect and with the unavoidable hindsight bias, human nature compels us to discover how this could have been avoided. After the fact, a better system for keeping the pilot’s cockpit locked does seem obvious.
My favorite black swan example is the 1859 Carrington event. That’s when a bigger-than-usual solar flare was sun-blasted directly onto Earth. The strength of the solar flare was more than the electrical grid could handle. Telegraph operators got electrocuted from the induced current. Some infrastructure even burned down because of the sparks from the overwhelming electrical current. A swan event is rare and high impact, but the event needs to be unimaginable for the swan to be black.
Subsequent terror attacks and solar flares were not called black swan events, because the past had made them conceivable, and thus, foreseeable.
In this painting
As people should know how to safeguard their investments from such events, representing the cataclysmic scale of a black swan event was a priority for our financial art collection.
I asked the talented artist, Kervens Fils, to paint this important financial concept, and it has been a wonderful experience. I was amazed to see the captivating effect this oil painting has. Almost like it has a magnetic pull on the passer-by.
Defend your savings!
An entire portfolio of investments can be devastated by a black swan event. Modern investment strategies will not protect you if you do not have a hedge counteracting black swan events. Of course, diversifying and evaluating risk has value. But, It still won’t shield you from sharp economic disasters. Even if preparing against black swans only protects your life savings once, it’s worth it.
Making your investments resilient to black swans can shelter your portfolio from sharp market crashes. A proven strategy is to include small periodic bets that are in a contrary relationship to the core holdings in your portfolio. Options are a type of sophisticated financial instrument well suited for this purpose.
When you decide on an investment strategy to profit from a black swan event you have to consider the consequences. Even a well-designed strategy can fall victim to randomness. Beyond an active commitment and consistency in your approach, spending too much time on this will not yield better results. Because of the random nature of a black Swan, the usefulness of overthinking is limited. Anyone contemplating using complicated financial products should understand how they work as their misuse could easily be worse than doing nothing.
Of course, if all of this sounds like too much work there are always firms willing to do it for you. Whether or not they can properly hedge your portfolio is another question entirely. When it comes to black swans there is no certainty.
Can you predict a black swan event?
No. If it were predictable, then it would no longer be a black swan event. The abundance of data we have is deceptive. We think it makes us smarter than those who came before us, but the last few financial crises suggest this is far from the truth.
Theory on economic cycles combined with the study of historical changes can help us understand the present and might even make your general predictions about the future more reliable. But this won’t help you catch a black swan.
Reflecting on how historical events can repeat in the future while considering what is different this time is a worthwhile process. These reflections might help predict things like the next inflationary cycle or even the changing world order. This process does not apply to predicting a black swan event.
Black Swan Unfolding?
Let’s take a look at the start of a black swan and see if we can trade it for a profit. As black swan events are rare and unique, there are few opportunities to practice. But practicing quick reactions to prevalent opportunities can be done anytime.
In the summer of 2016, the Brexit referendum polls were extremely tight. Few imagined Brexit would actually happen. But I knew the polls had a demographic bias because the older population actually voted more than the younger population who were against Brexit. I was pleasantly surprised how profitable that trade was.
Before you dive in, some isolation exercises can build competence and knowledge. One exercise could be scanning the economic calendar for just-released data with a significant difference from the expected results. For added difficulty, try understanding the resulting market correction from this divergence.
Consider that the value of impactful information can rapidly decrease. As more people react, the information becomes priced into the markets. A good shortcut gets clogged by its popularity. That’s what happens to arbitrage opportunities. Why not take action when you see a black swan unfolding? If you have liquidity and the necessary tools. Why not try to make a profit?
The black swan hides in the unknown
Hopefully when the black swan surges from the unknown, the appropriate safeguards will be erected. Preparing for a black swan event is more important than ever. The value of something you don’t know is so great it’s worth searching for it.
This painting is a reminder that sooner or later chaos from an unexpected source will surprise us despite all our brilliant technology. Our world economy is riddled with randomness. It’s crucial to expect the unexpected.
Sharing this article is encouraged. Together, we can empower more individuals to take control of their financial futures.
Special thanks to Aurelian Basa and Peter Landecker for their constructive feedback.
DISCLAIMER: While I did my best as the author of this article to ensure the accuracy of the information provided, I make no guarantees or warranties of any kind. Please note that the information in this article is based solely on my personal experience, research, and knowledge. The information provided in this article is for general informational purposes only and should not be considered professional financial advice.
The reader is solely responsible for their own financial decisions and should seek the advice of a qualified financial professional before making any financial decisions. Myself, my associates, and any company I own are not liable for any damages resulting from the use of the information provided in this article. The reader should also be aware that the financial industry is always evolving, and the information provided could become outdated or inaccurate over time.
“Copyright Notice: This painting/artwork is the intellectual property of Sacha Landecker, and all rights are reserved. The copyrights have been transferred from the artist Kervens Fils to Sacha Landecker. Unauthorized reproduction, distribution, or use of this painting/artwork or its derivatives without permission is strictly prohibited. Any violation of these rights will result in legal action.”
