Black Swans In Investing

A black swan is simply an unpredictable event. It is a kind of outlier that goes beyond what is normally expected of a situation. However, they are known to have serious consequences.

Once upon a time, a long time ago, people believed all swans were white. If you have any challenge picturing what swans looked like, they are beautiful water birds that are basically really peaceful to look at.

In 1697, however, the Dutch explorer Willem de Vlamingh noticed black swans in Australia. It was then that the term “Black Swans” was coined. This term is one of the popular terms you will hear being thrown around on Wall Street and amongst your favorite investment experts.

A black swan is simply an unpredictable event. It is a kind of outlier that goes beyond what is normally expected of a situation. However, they are known to have serious consequences.

Unlike regular market trends, they simply cannot be predicted before their occurrence. Nassim Taleb popularized the term or event in his 2010 book titled “The Black Swan: The Impact of the Highly Improbable.”

As key features of the event, he lists that: They are outliers that are outside normal expectations; their impacts are extreme and oftentimes catastrophic, and humans simply try to rationalize these events after they have happened.

In other words, after the events have happened, they are disregarded as Black Swans and theorized in some way or the other. To determine what a black swan event is, flip through books of history to find the extremely rare occurrences that had major impacts.

While many of them might have been rationalized today, these events just could not have been predicted when they occurred. Black swans are capable of causing tremendous damage to an economy and since they cannot be predicted, the only way to be ready for them is to create strong and fortified systems that will survive in tough economic situations.

Trying to rely on normal forecasting and analysis tools will not only fail to predict their occurrences, but they will also give you a false sense of security.

So, how does this affect you as an investor or shareholder?

The idea here is that investors need to be prepared for the unexpected – especially knowing that they cannot always predict everything that happens. Many authors have described this preparation process as something of a fire drill.

In the event of a fire, you should know where the extinguishers are just as you know where the exit doors are. Simple systems like stop-losses, hedging systems, and maintaining diverse portfolios could help.

However, more than anything, investors should understand that there are certain things that the market could throw their way that they have probably never seen before.

In these moments, the most important skill is to step away from emotional or irrational impulses and seek firs to understand before making the best decision available. This is the only way to beat the Black Swan.

Written by Lawretta Egba.