In my earlier blog post, I asked which animal kills more people?
Despite that the Hippopotamus emerged victorious; in truth, the animal that creates by far the greatest havoc to humankind is the Black Swan.
Because the most influential and devastating events in history are, by definition, the least anticpated. These are called “Black Swan Events”.
One of their defining facets is that they are easily explainable in hindsight, but they are nearly impossible to imagine beforehand, though we concoct explanations that make them appear less random, and more predictable, than they were.
They are, nevertheless, outlier events with extreme impacts.
The astonishing success of Google was a Black Swan, so was 9/11, and the financial crisis in 2008.
But why that strange name?
Black Swans were coined by the author Nassim Nicholas Taleb in 2007:
“Before the discovery of Australia, people in the Old World were convinced that all swans were white, an unassailable belief as it seemed completely confirmed by empirical evidence. The sighting of the first black swan might have been an interesting surprise for a few ornithologists (and others extremely concerned with the coloring of birds), but that is not where the significance of the story lies.
It illustrates a severe limitation to our learning from observations or experience and the fragility of our knowledge. One single observation can invalidate a general statement derived from millennia of confirmatory sightings of millions of white swans. All you need is one single (and, I am told, quite ugly) black bird.”
So as humans, we are inherently biased against noticing the amount of random events in our lives and their impact on us. We are hardwired to learn specifics when we should be focussed on generalities. We concentrate on things that we already know, but repeatedly fail to take into consideration what we don’t know.
The fundamental flaw of conventional wisdom is the failure to acknowledge the possibility of a Black Swan.
We are, therefore, unable to truly estimate opportunities; too vulnerable to the impulse to simplify, narrate and categorise; and not open enough to reward ourselves for taking the “impossible” into account. We mistake “impossible” for “unimportant”.
The fundamental flaw in conventional wisdom is the failure to acknowledge the possibility of Black Swan Events. Because when it comes to rare probabilities, our mind is not designed to getting things right. This is not good news, especially since we would be exposed to events that no one has yet experienced.
Still, what could you do with the knowledge that Black Swan Events do exist in our uncertain world?
1) Do not disregard probability when making financial decisions; always anticipate and prepare for Black Swan Events.
2) Do not overweight small probabilities either, because this would just increase the attractiveness of both gambles, and certain insurance policies—which would not help in growing your money in the long term, or might lead to paralysis and doing nothing.
3) Do adopt Antifragility. This means that something should not merely be able to withstand a shock, but should also actually benefit from an outlying Black Swan Event.
A favourite “Antifragility-Tool” is the Out-of-the-money Put-Option contract. For pennies on the dollar, you would be able to control huge amounts of assets. While they would expire worthless the vast majority of the time; nevertheless, when a random Black Swan Event hits the market effecting the option contract, they could return thousands of percent on capital at risk, making up for all the past small losses.
The key (for you) is very tiny bets on these trades versus your total account equity. Because tiny losses and tremendous wins are what would make the system eventually profitable.
Don’t be concerned that the above precautions might be in vain, since due to the exponential scaling of technology, Black Swan Events are becoming more common, and more influential than ever before.
Therefore, it is recommended that you build up systems (and yourself emotionally) to be “antifragile” and construct your life in such a way, so as to financially benefit from major unanticipated events.
Do, however, bear in mind that the most important aspects of investing are soft behavioral traits, like patience and an even temper. Additionally, don’t neglect this probability bias, and do resist the normalcy bias.
“Not everything that can be counted counts, and not everything that counts can be counted.” — Albert Einstein
“An idea starts to be interesting when you get scared of taking it to its logical conclusion.” — Nassim Nicholas Taleb
“The characteristic feature of the loser is to bemoan, in general terms, humankind’s flaws, biases, contradictions and irrationality— without exploiting them for fun and profit.” — Nassim Nicholas Taleb