BLACK SWAN - To be or not to be...

Long before the discovery of Australia, Europeans thought that all swans were white, and it would have been “impossible” for them to imagine any swan of any other color. “Have you ever seen a black swan?” was a common reply you would hear whenever someone wanted to say “impossible”. (Empiricism– I hope we may have a chance to talk about it someday). At the first sighting of a black swan (Cygnus atratus) in Australia in the 18th century, where black swans are rather common, Europeans were astonished.

The moral of this story is very simple. There are things out there that simply cannot be predicted or expected. There are things out there hidden from our imagination and are simply waiting to be discovered. The “Black Swan Theory” is a metaphor used by the Lebanese thinker Nassim Taleb. There are three conditions that would qualify an event to be a Black Swan:

1-The event is a surprise

2-The event has a major impact

3-After its first recording, the event is rationalized by hindsight, as if it could have been expected

Taleb explains it in the New York Times as follows:

“What we call here a Black Swan (and capitalize it) is an event with the following three attributes. First, it is an outlier, as it lies outside the realm of regular expectations, because nothing in the past can convincingly point to its possibility. Second, it carries an extreme impact. Third, in spite of its outlier status, human nature makes us concoct explanations for its occurrence after the fact, making it explainable and predictable.

I stop and summarize the triplet: rarity, extreme impact, and retrospective (though not prospective) predictability. A small number of Black Swans explains almost everything in our world, from the success of ideas and religions, to the dynamics of historical events, to elements of our own personal lives.”

So what can be qualified as a Black Swan? The first event that would pop on your mind is the economic crisis of 2008. This is a perfect Black Swan;

-It had a surprise effect (not only for traders) – It’s typical nowadays to see in biographies of market “analysts” that they predicted the economic crisis. I personally stay away from these scammers. If they lie in their biographies, then they simply don’t have any important achievements they can talk about. Back in 2008, I was a trader and my economical analysis showed me that the system “may” fall (I was one of many that shared the same view) but that doesn’t mean I predicted the economic crisis. I didn’t know for sure if it was going to happen or when was it going to happen and most importantly how it was going to impact the markets. If anybody had that information at that time, they would have made billions overnight. On a personal level, if I knew that information back then, I wouldn’t be writing this article right now nor would I be trading these markets. Instead, I would have been simply enjoying the huge amount of earned money from this event for the rest of my life. I can’t stress how important it is to stay away from these “analyst”.

-It had a major impact on almost everyone in the entire world – The surprise effect should be on the observer/receiver, for example the economic crisis is not a Black Swan for a primitive tribe member living in the deepest forests of the Amazon. The event simply didn’t come as a surprise (if he heard of it) and didn’t dramatically impact his life.

-After the fact, “Analysts” appeared on TV explaining how this was predictable (retrospective). Everything looks logic afterwards; would we have an economic crisis in 2008 if everybody was expecting it? Can you imagine our actual world if the Nazis won the World War II? We simply think that the allies had to win because they were the “good” ones but we would have thought the exact same thing if the Nazis won…

How to avoid Black Swans in trading?

Nassim Taleb makes it very clear; a Black Swan is an event that has a “major impact”. What is commonly known as a “major impact” is an event that would affect people on a large scale like an earthquake or a war, but he clearly state that black swans are surprises for the observer. Which means that if you are living in the USA and an earthquake hits Japan, you will have a normal day at work even if you feel sorry for the victims. This is simply not a Black Swan for you.

From the above we conclude:

-A sharp move in the markets is not a Black Swan for a trader if he was out of the market and wasn’t affected by this move.

-A sharp move in the markets is not a Black Swan for a trader if his losses were limited.

-A sharp move in the markets is a Black Swan for a trader if his losses were substantial.

-A sharp move in the markets can be a Black Swan for some traders but at the same time it’s not a Black Swan for others.

So what makes it relative for every trader? It’s simply the effect it has on your trading account. Let’s face it, yesterday we had a huge spike caused by a joint Central Bank liquidity injection. Let’s put all the possibilities in a table:

Traders…
   

Black Swan?

Generated substantial profits
   

YES (but positive)

Generated few profits
   

NO

With no positions in the market
   

NO

Lost a little
   

NO

Substantial losses (or Margin Call)
   

YES

 

So what makes the difference between those who lost a little (which is a very normal process traders experience everyday) and those who got margin called? Money Management!

I’ll say it again... MONEY MANAGEMENT

It’s the most important factor that would determine whether you are a successful trader or simply a gambler. If the spike we experienced yesterday significantly hit your account, then you are using a bad money management. You should stop trading and start building a solid money management system for your trading. You can have the best trading strategy that ever existed, but if you don’t apply a good and solid money management, you will go bankrupt sooner or later.

Finally, I won’t comment too much on what happened yesterday as it will be the topic of our next weekly update. I won’t be trading today because the markets are not clear for me. The aftermath reaction of this central bank injection is not very clear. I would say it will be short-lived and every single currency pair that went up yesterday will sooner or later go down, but I won’t make any trades based on this today.

I’m not the kind of person that can wake up in the morning, take a pen and a paper and start writing something brilliant. Nobody I know can do this (if you know somebody that can, I would be very interested to talk to him).

Moreover, I’m not writing here just to push readers to take trades so that estocks get more commissions on the spread. I see analysts for other brokers giving out trades every hour (I find it amazing how they can have an opinion on the future moves of every single financial instrument that exists). These are people that have only one thing in head; push you to over-trade so that they get more money from your trading.

This is not what we do here at estocks. I have refused many interesting offers from other brokers to work for estocks because they had only one thing in mind; create a genuine trading community to HELP traders become better traders. In opposition to other brokers that have one thing in mind; make more money from you (note: I won’t get a bonus for saying this). We are committed to bring you the best trader-broker experience and I can personally guarantee that the day this concept changes, you won’t see me here.

That said, I would encourage you to talk with our support team or to me personally for any question you have or just to say “hello”. We simply don’t care if you are a client or not!

If you haven’t read Nassim Taleb’s books, I encourage you to start reading them immediately. If I had to burn my private library and just save the most important ten books, “Black Swan” and “Fooled by Randomness” would be two of the books I’d save. It really changed the way I think in general and the way I trade.

George Dagher

Chief Market Strategist

Estocks.com