How not to fall prey to the Black Swan

The black swan is a sudden unpredictable event with enormous consequences - this is a brief description of this term, which became widespread in the media after the crisis of 2008, which was its live example. What this term really means and how to protect our savings from the destructive effect of Mr. Chance will be described in this review.

“Before the discovery of Australia, the inhabitants of the Old World were convinced that all swans were white. Their unshakable confidence was fully confirmed by their experience ... [this example] shows in what rigid boundaries of observation or experience our training takes place and how relative our knowledge is. A single observation can cross out the axiom bred over several millennia, when people admired only white swans. One black bird was enough for its refutation.”

This is how the book “The Black Swan” begins, written by the author of this term, Nassim Nicholas Taleb, an American trader and scientist whose interests are focused on chance and its impact on society, in particular, on world financial markets. The book was published in 2007 shortly before the global financial crisis, which became a living embodiment of the ideas presented in it. Subsequently, many experts will say that they predicted the crisis before it started, but in reality for the vast majority the collapse of the financial system was unexpected and caused serious consequences. The crisis has become a real "black swan" for the global financial system.

“Human nature forces us to come up with explanations for what happened after it happened, making the event, which was initially perceived as a surprise, understandable and predictable,” Taleb explains, pointing out that in reality the vast majority of events in the financial world are unpredictable and exclusively retrospective explanation.


Briefly, the "Black Swan" can be described as follows:

  • its appearance cannot be predicted, since it has never appeared before or has been observed extremely rarely;
  • when it appears, the consequences are very significant.

In the financial market, the investor is constantly facing the unknown: geopolitical, economic, market, system, operational, currency risks. Risks of interest rates, liquidity, good faith of the counterparty and the “human factor” - a combination of all these things, often unpredictable due to the complexity of the relationships, makes meeting any investor with their personal “black swan” only a matter of time.

A rather alarming picture is being formed. Despite all the skills, experience and talent of an investor, one random event can cross out the whole result of long efforts to grow capital. How to avoid or at least smooth out losses from such force majeure?

How to protect yourself from a black swan?


In the next book, “Anti-Fragility”, Taleb offers his own version of how to protect yourself from black swans. He calls his decision “barbell strategy”. By analogy with barbell pancakes located on opposite sides of the bar, Taleb offers the investor to place his funds at the opposite ends of the yield / risk curve, avoiding the average values.

As part of the “bar strategy”, most of the funds are allocated in extremely conservative instruments, which can be government bonds, state-insured deposits, cash or long-term tangible assets, such as residential real estate.

The rest of the money is invested in aggressive instruments with a growth potential of hundreds of percent. In other words, a bet is made on the black swan. Most likely, it will be unsuccessful, and the investor will suffer minor losses, which he will compensate by the income from the conservative share of the portfolio. But if the black swan is realized and the bet plays, then the profit will be very substantial.

“If venture capital enterprises flourish, it’s not at all thanks to the stories that have settled in the heads of their owners, but because they are open to unplanned, rare events,” the author of the strategy notes.

Taleb himself during the crisis of 2007-2008 earned at the expense of a bet on a black swan about $ 500 million, 97% of which he received in just one day. During the sharp fall of the S&P 500 index in the fall of 2008, the profit on “Out-of-the-Money” Option (OTM) could reach thousands of percent. Taleb did not know when the crisis would break out, but he was sure of the fragility of the financial system at that time. For two years he bought put options and lost money on them, until one day he became rich. Due to the fact that the risk / profit ratio was about 1: 10000, he was able to implement such a strategy and not go broke ahead of time.

In addition to options, futures, unpopular third-tier stocks, venture projects, active speculative strategies or alternative investment instruments can also be used as a bet on a black swan.

The “barbell strategy" can be used in a variety of ways. For example, 90% of the capital is used for conservative investments in bonds, and the remaining 10% is used for intraday futures trading. Or another example: 85% of the capital is invested in blue-chip shares, and the remaining 15% is invested in own business projects or alternative investment instruments.

The strategy is applicable in the context of personal finance. For example, 70% of all working time a person works for a fixed salary, which allows him to provide himself and his family with the necessary minimum. And he devotes another 20% of his time to his personal projects, for example, trading on the exchange, which could potentially make him rich.

For active traders, the “bar strategy” has a separate application in the form of recommendations for risk management. The profitability of intraday traders is measured in hundreds of percent, but the risks are often equally high. In such circumstances, risk management is of fundamental importance.

It is very important to divide situations when a trader risks his own capital, and when he risks already earned profit. At the beginning of the trading day, the trader should be as conservative as possible: focus as much as possible on the most effective patterns and severely limit losses. Risk can be increased only when profit appears on the account. Increasing rates as profits arrive can provide exponential growth in returns with limited risk of losses.

With this strategy, most of the time the trader will be content with very modest results, avoiding significant risks. And on good days there will be a chance to hit a really big jackpot.

The strategy works at the level of one individual transaction. This concept is well known to traders in the popular expression "quickly cut losses and let profit grow." About 60-70% of transactions turn out to be unprofitable and close with a small loss due to a short stop loss. But the remaining 30% due to the high profit / risk ratio covers the entire loss and provides a positive result. In fact, a single speculative transaction is also a kind of bet on a black swan.

If desired, you can find other successful ways to apply this concept. The main principle here is that in case of the realization of some unpredictable, but probable event, the investor will be in a significant plus, and the rest of the time just do not lose your money. This approach will tame uncertainty and make it work for investor capital, not against it.

Author: Kate Solano, Forex-Ratings.com
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