Nassim Taleb The Black Swan

As a data-tician, someone who absorbs himself in the data of the market looking for anomolies to exploit for profit, the topic of the Black Swan is very important to me.  In fact, there’s common misunderstanding that I want to address here when it comes to the Black Swan theory.


First, let’s agree on what a Black Swan is:

1.The event is a surprise (to the observer).
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 (e.g., the relevant data was available but not accounted for).

Most people consider a black swan event to be a negative event.  I.e. a stock market crash, 9/11, WWI.   However, that’s not always true.  Things such as the Internet, Google – or even Facebook/Social Media could be considered a Black Swan.

This isn’t meant to be a synopsis of the book, which is an OK read.   The reason I’m writing about it today is that there are some great points in the book that I want to point out for traders.

Just imagine if you had the ability to point out a Black Swan Event, position for it, and profit from it.

Essentially, my trading style that I sell to others is called the stock barometer.  It’s an algorythm that moves like a sine wave and all we do is position for every move with the understanding that we DO NOT know what the market is going to do next.  But we do know that it can be only 1 of 3 things.

  1. The market goes higher
  2. The market goes lower
  3. the market goes sideways

So if you position for a move lower, and just so happen do get a Black Swan event, then by matter of skill AND luck, you will participate greatly.  Unless you position contrary to the Black Swan event.

I believe one of the biggest issues with trading is hindsight.  And that’s component 3 in a Black Swan.  And that’s the reason as much as I teach people to read charts, once they learn how to read the charts, I tell them to forget everything they see…  Easier said than done.

If trading were as easy as reading a chart, then since everyone has access to charts and everyone has access to material which teaches you HOW to read charts, then anyone can be a successful trader.

If that’s the case, then why isn’t everyone a great trader?

Because it’s more than just reading charts.  Much more…

I believe our brains are wired against our success as traders.  And as smart as you may be, and as much as you may even understand the minds reaction to the input it receives when trading, whether that input is one computer screen, six screens, CNBC on your TV, etc., you have to think contrary to your minds normal processes to be successful.

Again, easier said than done.

Our minds are wired to identify trends in everything we see and experience.  And we act upon those experiences through the mechanical functions of the brain.  Though our dopamine system which 98% of the time, we don’t even know is operating – however, it controls about 98% of all our actions.

Getting back to my main point, there’s an area of study that Taleb touched on that I’ve delveoped some material on.   In the book he uses a basic statistical test comparing two hospitals, one being larger and one having a higher percentage of boys born than girls.  Most would answer the larger hospital would have the higher percentage of boys being born, but the answer is the opposite.  It’s much more likely that the smaller hospital would experience an outlyer event.  The larger hospital would experience closer to the normal 50% with the higher sample rate.

Ok, now let’s apply that to the stock market.  When the market trades, volume fluctuates higher and lower.  So when are you more likely to have a larger outlyer event?  On low volume.

Let’s take it to the next level.  Say we’re looking at options activity on a specific issue.  We have historcal action, so we know where the relative extremes exist.  I would say one would expect you could use the options activity i.e. put call ratio, combined with the relative volume action, to identify periods where large outlyer events are more likely to occur.

Now I would never suggest that these large outlyer events could be a Black Swan, but periodically luck combines with skill to enable you to more likely be positioned for an event – before it occurs.

Stay tuned, as I publish some of this data.  And if you want access to it, simply sign up here.


Stock Barometer

Investment Research Group, Inc.