“Black swan” is an event with a very low probability of occurrence and when it happens, it will create catastrophic consequences. Black swans are terrifying for every economy, especially in stocks and cryptocurrencies. So what is a black swan, and how have black swan events in history occurred, please see the detailed information right below.
Contents
- 1 What is a Black Swan Event? Black swan events that have occurred
What is a Black Swan Event? Black swan events that have occurred
What is a Black Swan event?
Previously, it was thought that only white swans existed on earth and there were no black swans. White swans are a symbol of beauty and nobility. However, in 1697, a Dutch explorer named Willem de Vlɑmingh discovered that black swans actually exist when he set foot in Australia.
This changed people’s perception, however, because black swans are rare, a professor from New York University named Nassim Nicholas Taleb named his book after them:
The Black Swan: The Impact of the Highly Improbable, roughly translated as Black Swan: The Impact of the Highly Unlikely.
This professor described a black swan event as having 3 characteristics:
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Very hard to predict: the possibility of their occurrence lies outside the normal range of predictions.
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Causes serious consequences: has a significant impact on the economy, finance, or even politics.
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Ability for retrospective prediction: We often find clear explanations for the black swan incident after it happens and can find ways to prevent it in the future.
How does a Black Swan event work?
The common premise of the black swan theory is that unpredictable events can cause serious consequences for the financial market or the economy. The important thing is that events can be unpredictable due to the accumulation of similar experiences and repetition.
According to Taleb, the original black swan issue is:
How can we know the future with our knowledge of the past?
In other words, how can we draw general conclusions from our specific experiences when we have not experienced everything? Just because we only see white swans doesn’t mean that black, pink, or any other colored ones don’t exist.
Taleb illustrates the excessive dependence on past experience with the example of a turkey being raised for Thanksgiving. Throughout the life of the turkey, it is fed every day, creating the expectation that in fact, it will be fed the next day. Each day the turkey is fed, its belief is reinforced until Thanksgiving, when it must “reconsider its belief”.
This is a simple and easy-to-understand illustration of the black swan phenomenon. As we continue to experience the same thing, such as only seeing white swans or being fed daily, we tend to believe that will be our experience in the future.
Black Swan events that have occurred in finance, stocks
2001 Dotcom Bubble
The stock market soared to unprecedented heights in the late 90s and early 2000s due to overvalued and overhyped technology companies. The 3 characteristics of a black swan event are shown in the 2001 Dotcom Bubble as follows:
Completely Unexpected: Investors poured money into technology companies from the mid to late 90s, causing tech stock prices to soar to record highs and creating an overvalued bubble. The high valuations were overlooked as investors were convinced that the internet had changed everything during this period. The high level of investment proved that people did not expect the tech sector to suffer such a significant devaluation.
Significant Economic Impact: On Monday, March 13, 2002, the bubble burst, and Nasdaq dropped by 78.4% by October 2002. This led to a significant increase in unemployment in the tech sector, with up to 17.8% of workers in the field losing their jobs by 2004.
Retrospective Predictability: Since the bubble burst, blame has been attributed to irrational investors driving up prices, the abundance of venture capital, or the Federal Reserve’s monetary policy slowing down the economy.
The 2008 Economic Crisis
The subprime mortgage crisis that began in 2008, also known as the Great Recession, is referred to as one of the worst economic periods in American and global history since the Great Depression of the 1930s.
The 2008 economic crisis exhibited all three characteristics of a black swan:
Utterly Unexpected: Economic policymakers, especially at the U.S. Federal Reserve (FED), largely did not anticipate the subprime mortgage crisis. In fact, Alan Greenspan, then-chairman of the Federal Reserve, later said in an interview with David Rubenstein:
You cannot have a crisis of this nature without it being a surprise.
+ Significant Economic Impact: Unemployment rates doubled during the Great Recession, peaking at 10%. There were also nearly 3.8 million homes foreclosed from 2007 to 2010, and the investment bank Lehman Brothers filed for bankruptcy, resulting in 25,000 job losses.
Retrospective Predictability: The Great Recession has been extensively studied and discussed. Now, most economists and even casual observers clearly see that the loose lending policies in the subprime market were the main cause of the 2008 mortgage crisis. These policies included lending to less creditworthy borrowers beyond their ability to repay, often with adjustable-rate mortgages, and the securitization of these loans to be resold in increasingly complex deals.
Black Swan Event – The 2010 Flash Crash
Flash Crash is a term used to describe a rapid and steep decline in stock prices. This black swan event occurred in 2010, caused by a British futures trader named Navinder Sarao who manipulated automated trading algorithms.
The characteristics of this black swan event are:
Element of Surprise: There was no plan for the Flash Crash. It was an unexpected event that no one anticipated.
Significant Economic Impact: The stock market lost nearly 1 trillion USD in just one day. The Flash Crash also led to the implementation of stricter trading regulations, specifically the establishment of “circuit breakers” to temporarily halt trading when stock prices exceed certain limits within a predetermined timeframe.
Retrospective Predictability: Sarao manipulated the market in his favor by mimicking demand with “spoof orders,” causing the incident.
Black Swan Incidents in the Cryptocurrency Market
Black swan events in the cryptocurrency market in 2022 include:
The Collapse of the Terra Ecosystem in May 2022 led to the cryptocurrency market losing hundreds of billions of USD in just a few days. The price of Bitcoin also plummeted uncontrollably from 39,000 USD to 29,000 USD.
Cryptocurrency bank Celsius declaring a halt to customer withdrawals and then bankruptcy took the cryptocurrency community by surprise. This event plunged the cryptocurrency market into crisis as Bitcoin’s price fell from 28,000 USD to just 19,000 USD in one week.
Most recently, the rapid collapse of the FTX cryptocurrency exchange – once the world’s second-largest cryptocurrency exchange after Binance – is also considered a black swan event in cryptocurrency. This led to billions of USD of investors’ money on FTX being unrecoverable and caused a sharp decline in Bitcoin’s price, specifically from 21,000 USD to just 15,000 USD.
Is COVID-19 a Black Swan Event?
COVID-19, being a large-impact and also unexpected event, has been classified by some as a black swan. However, Taleb disagrees that the COVID-19 pandemic is a black swan event as it does not fit the first characteristic of a potential black swan event.
Epidemiologists and other public health officials do not consider major pandemics as random, unforeseeable events but as inevitable occurrences.
What Should Investors Do to Mitigate Risks of Future Black Swan Events?
From the concepts, characteristics, and occurrences of black swan events in the past, it is evident that future black swan incidents will definitely occur, but we don’t know when and where. Therefore, investors looking to minimize losses from black swan events can implement measures such as:
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Diversify Investments: not just in stocks, but also in gold, real estate, and cryptocurrencies, for instance.
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Appropriate Asset Allocation: don’t put all your eggs in one basket, for example, if you have savings, consider distributing them across different banks. Or, when opening cryptocurrency trading accounts, don’t keep all your money in just one exchange but spread it across several.
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Capitalizing on Black Swan Opportunities: Black swan events often cause the value of certain assets to plummet drastically. If you can seize these opportunities to buy into good company stocks or promising projects, you could earn substantial profits after the market recovers.
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Always be mentally prepared that black swan events will definitely occur, and plan for the worst-case scenarios.
See more related useful information:
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Through this, we hope you now understand what is black swan event as well as what black swan events have occurred in history. Black swans are something no one desires, but life always presents challenges that we need to overcome. If you are well-prepared, when a black swan event occurs, you might not suffer significant losses and may even find opportunities to prosper. Wishing you success as an investor.
