What are black swans?

Black swans can be viewed in several different ways. The black swan is a large aquatic bird found in estuaries and waterways of Australia. It was once believed that all swans were white. And "Black Swan" was a recent movie which featured a ballerina.

However, in the past two decades, "black swan" has also become a financial buzzword.

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A black swan in financial markets was a term popularized by Nassim Nicholas Taleb, a finance professor, writer and former Wall Street trader.

According to Taleb, a black swan is an event or occurrence that deviates beyond what is normally expected of a situation and is extremely difficult to predict.

In addition, black swan events are typically random, unexpected, and can have catastrophic effects. (But note that, as Investopedia says, black swans can also be associated with unpredictable, extraordinary, positive events.)

Black swan events can happen in financial markets and have become more frequent.

Recent examples of black swans in the US are: the 2008 financial crisis and housing market crash; the 2001 dot.com bubble and the Long Term Capital Management (LTCM) collapse in 1998.

What recent financial events were not black swans? Examples are: the 2016 US elections, the 2016 UK Brexit, and the Greek economic crisis of 2011.

These events, although unexpected, had reasonable probabilities of occurring and financial markets were able to regain their equilibrium relatively quickly.

How can investors protect against black swan events?

  • First and foremost, it is important to diversify one's investment portfolio.

  • Second, investors should not rely solely on a single indicator of the market, be it stock returns, interest rates or Gross Domestic Product (GDP). Market forecasts are often based on mathematics and statistics, and do not account for "outlier" events such as poor judgement, criminal behavior and political turbulence. It may be better to rely on a diverse set of data which include non-quantitative factors.

  • Third, investors should limit or avoid "market timing", whereby they are in or out of the market frequently based on a bullish or bearish outlook. Excessive bullishness may lead to significant losses should a black swan suddenly appear.

 

NOTE: Information presented herein is for discussion and illustrative purposes only and is not a recommendation or an offer or solicitation to buy or sell any securities. Past performance is not a guarantee of future results.  

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