It will be interesting to see how this week unfolds. It is the end of the quarter, and there will be some powerful motivation to keep the markets up. Yesterday seemed to be a bit of post-Bernanke euphoria hangover. Lots of chatter about how the markets will blast off into the stratosphere because of central bank infusion and contrary chatter that the sky is falling. Naturally, what we experience will be somewhere in between.John Mauldin had an interesting letter about Black Swan's and mentioned in detail Talem's book, The Black Swan: The Impact of the Highly Improbable.
Our friend, Russell, is so well read on all of this stuff. I don't think that I've mentioned a book (either market related or otherwise) that he has not had some passing experience with. In a nutshell, there is an "accepted" body of knowledge based on what is derived, divined, devised from what one can observe in a Gaussian Curved universe. If you wish to see a number of different Gaussian Curves, please click here. I've lifted one for you. I chose it for beauty and functionality, and you will recognize it instantly as the "bell curve" . There's an equation, too, that's the functionality!
But, and the but is a big one, in the tail of the these curves are the events that have small probabilities, but could have a big impact. In pharmacy it's the renal failure or cardiac event caused by a medicine. Sure, they might be low probability, but when they happen, they are literally life changing.
The Black Swan attribution comes from the thought that all swans were white. In the observable universe, which at the time did not include Australia, each and every observation--by those chronicling and opining on the nature of swans was white. Then trekking to Australia, those c'ing and o'ing on the nature of swans found a black one. Now, finding the black swan was not akin to suffering a cardiac event, but it was a shock to one's perception on the color of swans.
While in real life, in order to accomplish a thing, we have to systematize and build a structure of understanding that fits neatly under the curve. One cannot live his/her life fearing the black swan. Nevertheless, it is a useful to think about your endeavors and what the nature of the black swan that might paddle into view on that serene pond or lake that you call your life.
8 comments:
And when price diverges from the internals.....
. . . it is bye, bye, birdie!
Black Swan author Taleb noted in a long interview this past weekend on Book TV that most Black Swan events are positive. I think most of us (my hand is raised) lost sight of that.
Most medical discoveries, for example, are black swans, said Taleb. (The discovery of penicillin is an example.) Really, really good researchers are alert to anomalies that signal a possible Black Swan.
Note studies have shown that bell curves applied to the financial markets tend to have "fat tails". The probability of an outlier or rouge wave is much higher than the standard bell curve dictates, based on empiracle data.
I do find the two sigma bollinger bands quite useful in my analysis.
Oops... that should read "empirical data."
Went wayyy long Yen call options today, and in the IRAs dropped FXC in favor of FXY. Sold FXE but still holding FXF and FXA. Dumped the GDX too (yesterday), for a better entry later.
Of course I have read Taleb. He is one of my favorite authors/philosophers.
Taleb does give recommendations on how to deal with black swans (positive and negative) in his book.
One of his thoughts is to operate within areas where the black swans are likely to be positive. An example I (not the author) would use would be stocks versus commodities. Oddly enough, contra to of their reputation commodities have a track record of good surprises: stocks do not.
Another point he makes is not to let go of opportunities lightly. People often feel that "the timing is just not right, and another opportunity will come along." Real opportunities come along very infrequently, and should be seized upon at every chance possible.
So is this SubPrime mess out of everyone's minds. The markets sure seem to be calm....any thoughts?
Thanks for pointing out the positive and the negative surprises.
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