How to invest black swan

Financial Ratios Understanding the Sharpe Ratio. Trading Psychology. The implications for markets and investments are compelling and need to be taken seriously. Discounting Mechanism Discounting mechanism is the premise that the stock market takes into account all available information including present and potential future events. What is a Black Swan?

Listening to investing practitioners and pundits talk, the lay person might get the impression that investing is a rational application of microeconomics and mathematical principles. For example, the Black Monday crash of was a standard deviation event — something that should happen on the order of once in 11 billion years of trading if market returns were How to invest black swan distributed. Presumably, the black how to invest black swan fund manager is better at assessing the possibility of the occurrence of extremely unlikely financial events than the collected intelligence of the option market. The latter assumption is relatively easier to swallow than the former; even though there has not been an extreme drop in the US equity market sincethere are numerous markets around the world that have experienced larger than normal disruptions, as any recent investor in the Turkish lira would testify. Even if one could get past the theoretical difficulties, there are practical issues that make the concept of a black swan fund difficult to implement. Specifically, far Out-of-the-Money options on most underlying assets are more or less illiquid. Another practical issue is figuring out when you should take profit on the option position.

After Japan, five must-haves for a ‘Black Swan survival kit’

The black swan theory or theory of black swan events is a metaphor that describes an event that comes as a surprise, has a major effect, and is often inappropriately rationalized after the fact with the benefit of hindsight. The theory was developed by Nassim Nicholas Taleb to explain:. Unlike the earlier and broader «black swan problem» in philosophy i. Such events, considered extreme outliers , collectively play vastly larger roles than regular occurrences. The phrase «black swan» derives from a Latin expression; its oldest known occurrence is from the 2nd-century Roman poet Juvenal ‘s characterization of something being » rara avis in terris nigroque simillima cygno » «a rare bird in the lands and very much like a black swan». The importance of the metaphor lies in its analogy to the fragility of any system of thought.

Listening to investing practitioners and pundits talk, the lay person might get the impression that investing is a rational application of microeconomics and mathematical principles. For example, the Black Monday crash of was a standard deviation event — something that should happen on the order of once in 11 billion years of trading if market returns were Normally distributed. Presumably, the black swan fund manager is better at assessing the possibility of the occurrence of extremely unlikely financial events than the collected intelligence of the option market.

The latter assumption is relatively easier to swallow than the former; even though there has not been an extreme drop in the US equity market sincethere are numerous markets around the world that have experienced larger than normal disruptions, as any recent investor in sean Turkish lira would testify. Even if one could get past the theoretical difficulties, there are practical issues that make the concept of a black swan fund difficult to implement.

Specifically, far Blacl options on most underlying assets are more or less illiquid. Another practical issue is figuring out when you should take profit on the option position. Indeed, the surprising Brexit vote results came out after the market closed and the following day, the market dropped heavily.

The market bounced back the next day and because my options were short-tenor and still far Out-of-the-Money, their value fell precipitously. You do the math. I would have been just as well off if I had slept through two entire trading days. Considering these theoretical and practical issues, black swan funds have fo the staying power of an 80s boy band. So my ears perked up when, at an investing blackk I recently attended — the Latticework Conference, sponsored by the Manual of Ideas — Murray Stahlthe CIO and co-founder of Horizon Kinetics and an extremely creative, fundamentally contrarian value investor mentioned his using options to boost returns from a bond portfolio.

Asking him about his strategy after his presentation, he told me that his idea awan to invest in some attractive, high quality corporate bond and to invest each of the coupon payments in Out-of-the-Money options. The options in which he would invest were unrelated to the bond in which he was investing. In the worst case, his options would expire worthless and he would end up losing one coupon t. In the best case, his profit on the option contracts might be multiples of the amount of a single coupon.

This strategy struck me as the first sensible and practical approach to black swan investing — though Stahl himself may not think of it in these terms. However, as long as a few of the option investments work out, the opportunity cost may be offset; if the option investments work out with any regularity, Stahl effectively boosts the interest rate earned on the underlying bonds, so his investors wind up ahead. I am the founder of How to invest black swan Capital, the manager of a private investment partnership dedicated to investing in public and private companies focusing on ways to help civiliza Share to facebook Share to twitter Share to linkedin Listening to investing practitioners and pundits talk, the lay person might get the impression that investing is a rational application of microeconomics and mathematical principles.

This impression is false. The truth is that investing is as fad driven as a junior high school playground. Credit: Getty Royalty Free. Erik Kobayashi-Solomon.

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The financial crash of the U. Key Takeaways A black swan is an extremely rare event with severe consequences. Portfolio Management Naive Diversification vs. Put simply, rebalancing reaffirms your diversification decision and puts your plan back on track. This does not blaci modeling and prognoses cannot or should not be. America was enjoying rapid economic growth and increases in private wealth before the economy catastrophically collapsed. Economic Calendar Tax Withholding Calculator. Advanced Search Submit entry for keyword results. The Depression beginning October 29,following the crash of the U. Preparing for Black Swan events also requires more liquidity than you might realize. But we also need to rely on intuition, common sense and simplicity. Investing Markets.