Black Swan is a phenomenal book that everyone should read. It discusses about the unexpected, and the impact that it has to our lives.
We should be more aware of unexpected events, as they bear significant consequences comparing to expected events. If we are aware that they can happen, we will tread more carefully in everything we do, especially in our investments.
The book can be yours here.
What is a Black Swan event?
The term “Black Swan” was coined by Nassim Nicholas Taleb, in his book of the same name. A Black Swan event is an event that rarely happens. So rare that most people do not expect, or think that it is impossible to happen.
The inspiration of the term dates back to pre-colonial age. During that time, people believed that all swans are white. The belief was solid for hundreds of years. Then when the British came to Australia, they first encounter a swan with black feathers.
Black Swans (source: birdlife.org.au)
This discovery forfeited the belief that all swans are white, and completely unexpected. But it happened.
The same thing had happened in the past so many times, each time caused magnificent consequences. The “11 September”, GFC, and this Coronavirus health crisis, etc. are considered Black Swan events. All of them just happened, hardly nobody expected them, and bear (terrible) consequences.
To be classified as a Black Swan event, one must be completely unexpected. If we already know of a certain “risk”, it becomes a “Gray Swan”. For example we know that a plane crash is unlikely to happen, the chance is minimalistic. In this case, a plane crash is a Gray Swan event.
Why we should ignore the Gaussian bell curve?
A Gaussian Bell curve represents the standard distribution of certain events. Statisticians use it to classify risks of various matters, from Casino machines to complicated financial products.
However, this model will never be able to handle extreme outliers, which normally bears the most consequences. The chance of such outlier is unbelievably small, and most of us will never see all beans tilt to the far left or the far right of the board above.
Let’s say a casino assessing risks for the business. They figured out the most harmful events that could happen are cheating, so they upgrade their machines, install cameras and other measures to prevent customers to play dodgy. This could save them, say a few millions of dollars a year. However, there are events that potentially screw up their profit, things like a staff accidentally pour water to the on-premise servers, causing the casino to shut down for a day; or a terrorist just happen to detonate a bomb inside the casino. These events are, like the managements say, impossible to happen. But when it happens, the whole business suffers, and can go bankrupt because of a single such event.
How do we become more aware of such events?
These events, as the definition says, completely unexpected. Therefore we can only be aware of something harmful could happen. We do not know exactly what, just need to open our minds that such events can happen.
When we are open to the concepts, we will be more careful to the things that we do. Sometimes redundancy is a good thing. Sometimes optimization exposes us to these Black Swans. Executives are prone to maximize their company profits, via various methods. One of which is optimizing operating cost. Let’s say they cut costs and only employ 1 person to do multiple things, the workload may be enough for 1 person. But if that person goes on leave, or be sick, then the whole optimization concept is exposed to certain consequences.
How do we capitalize on positive Black Swan events?
Not all Black Swan events are bad. Some are positive and can be capitalized upon. Considering a venture capital, they are the prime example for capturing the benefits of Black Swans. They know, statistically, that 95% of startups fail. However, they focus on the remaining 5%. Let’s say they fund 100 startups, they are exposed to the chance that 1 to 5 of them can be successful. And if they are, the venture capital fund can recover all the losses from the other 95 failed investments.
Black Swans can be subjective
An event can be a Black Swan to us, but may not be to others.
Considering this, a chicken that get fed everyday for 60 days. On the 61st day, it gets butchered. To the chicken, being killed is a Black Swan. Since all historical data points towards the prediction of being fed on the 61st day. However, to the butcher, it is not even considered an unusual event.
Being aware of Black Swan events can help us in our lives. We do not need to be too scared to do something, just because it potentially causes harm to us.
If you want to buy the book, you can get a copy here.
“Always hope for the best, but prepare for the worst.”
By Tuan Nguyen