Stock trading is a game of probabilities.
You can’t judge a trading strategy just because of a single, profitable trade or because of the handful factors that aligned in your trading setup. There are lots of mix and match components which bring conviction that there’s no ‘perfect’ one and even if you have found your edge in the market, you still can’t be certain because there might be random occurrences that are nearly impossible to predict or what we simply call, the “Black Swan.”
Coined by Nassim Nicholas Taleb, a finance professor from NYU and Wall Street trader, black swan events are occurrences that are extremely difficult to almost impossible to predict as they aren’t your typical breakdown of support or gap up and downs. These events can have more terrible consequences on the stock that you’re holding.
There are three (3) attributes of a black swan event:
1. The event is unforeseen to the observer.
2. The event results in severe consequences.
3. After the manifestation of a black swan event, people will rationalize the event as foreseeable (hindsight bias).
For example, a government official declaring the ban on the export of goods made by a company can be considered a black swan event. A company declaring sudden destruction of their plants and factories due to acts of God is another instance of a black swan event.
Samples of black swan events that made a significant impact in the financial world
1. 9/11 Terrorist Attack
On September 11, 2001, the coordinated terrorist attacks in the USA forced their main bourses, NASDAQ and NYSE, to close trading on that same day. In the first trading week after the attack, stocks dropped significantly – incurring a loss of $1.4 trillion in stock market value.
2. 1997 Asian Financial Crisis
The crisis is said to have started when Thailand unpegged the baht to the US dollar. A series of currency devaluations subsequently followed across several Asian markets where currencies were seen to have dropped by 38% and international stocks by 60%.
3. “Dotcom” Crash
The said crash rubbed out around a trillion dollars worth of stock value because during the 1980’s and 1990’s, as internet companies sprout from almost everywhere, the value of some of the successful ones was tremendously overvalued. So from the year 2000 to 2002, lots of internet companies crashed, resulting in investors to incur huge losses. The NASDAQ composite in the USE lost 78% of its value during those times.
Black Swan Events in the PSE
1. 2GO Group, Inc.
On July 07, 2017, in the midst of a huge accounting scandal, 2GO announced that their CFO was resigning. The PSE implemented a two-day trading halt because of this misdeclaration of financial statements. Investors found themselves unable to do anything with their current position due to this. The stock opened -19.74% down on the first trading day after the trading halt, much to the dismay of investors that capitulated because the stock closed 21.93% up from the open.
2. Rizal Commercial Banking Corporation
During February 2017, a whopping $81 million was stolen by hackers from the Bangladesh Central Bank. The money was found to be wired in multiple RCBC accounts in a branch in Makati, Philippines. The BSP imposed a hefty one billion-peso fine over the laundering scam.
Conclusion
Black swan events do not only apply to adverse events, especially to markets that allow both long and short positions over security. A market catastrophically turning to the red can be useful for traders with short positions.
In the stock market, anything can really happen. This should serve as another reason why investors and traders are better off diversifying their positions.