Black Swan
A Black Swan event is very rare and unpredictable statistical indicent. As a natural scientist, mostly of us agree and can prove that most natural processes are log normally distributed. Like the plot below, when likelyhood of an event occuring can be plotted against its frequency of occurance. If we plot it as a curve, a Black Swan event must occur at the extreme tail end of this distribution.
Nassim Taleb's famous book on the subjuct list 3 different criteria for a Black Swan Event:
- The event has to be a surprise, or a statistical outlier in finance-speak
- It has to have an extreme impact
- Despite it being unpredictable beforehand, we spin a narrative that makes it seem completely predictable in hindsight
I find the third point quite funny. But frankly speaking there has been a lot of fundamental research done on the topic to predict the tail end of a log normal distribution. Basically to predict the unpredictable. It is not a complete folly. Significant part of my academic and professional life I have spend trying to understand the tail end of multiple log normal distributions. They are very hard to predict.
Example from the Stock Market
After a decade of a Bull market and the pending uncertainity around the general election in the United States, there have been a growing chatter that a Black Swan Event in imminent! Before I rule it out, let us see what a Black Swan Even might look like in the stock market. Then we can talk about if it can happen on not happen.
Above is a MONTHLY chart of S&P 500! Yes, Monthly! Meaning each bar is a Month. The left of side of the chart is 1970, and the right hand side of the chart is present day! Yep, it is 50 years! That is more than the working life of most humans. How many Black Swan event do you think we have on this chart? Please look at Taleb's defition again. Perhaps only one: The 2008 Financial Crisis. May be you can also argue the 2000 Tech Bubble burst, but the vertical axis of this chart is logarithmic, in terms of drop (which is the measure of impact) it doesn't even retrace any meaningful part of the 1988-2000 bull market. Oh and 1987 crash is just a blip.
2007-08 Financial Crisis does retrace the entire gain of the previous bull market, and then some! That is significant. Its impact was global. Its severity most people, even the central banks, with the depression scholer like Bernanke in the lead couldn't predict in the beginning. That is by definition a Black Swan. Perhaps the only Black Swan in this chart.
With that analogy what would another Black Swan Event should look like:
It must be unpredictable; so if I say it need to wipe away all the gains of the last bull market, no one should belive me! :) Yes S&P 500 at 700 by 2022! LOL
It must have extreme impact! Well S&P 500 at 700 (currently it is at about 3300), will be a 78% drop of the global financial market! Yep, that would be extreme don't you think?
Yeah, so that is a Black Swan Event. Chill, that won't happen. I am not predicting that will happen. I think that is impossible. Hey, by definition, that is a Black Swan Event.
So chill! Please don't call a 1000 point drop in S&P 500 a Black Swan. Please, those who knows the markets, will likely roll their eyes! :)
Disclaimer: This is NOT professional advice, this is all just my own opinion and experience. I am NOT a Certified Financial Adviser. Consult professionals for any financial, accounting or legal related questions you have.
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