risk
Black Swan Blindness
The rule
A rare, huge shock missing from the record can drown the whole result. Its absence so far is not proof it is safe, only that it has not shown up yet.
Where it flips
Over-applied, this turns into hiding in cash forever, terrified of a disaster, and losing decades of ordinary growth. So insure against ruin, do not flee all risk. Protect the downside, so you can stay invested through the normal weather.
The biggest events in a market are usually the ones nobody had in their sample. A crash, a default, a freeze. They can matter more than everything that came before. Because they are rare, the calm years lull you into thinking the danger is gone. Really it has just not shown up yet. So do not ask 'has this ever gone wrong?'. Ask 'what would one bad day do to me?'. Then size your bets so a single shock cannot end the game.
A worked example
Vikram trades on 4x borrowed money through three quiet years and calls it safe. Then one gap-down morning erases the whole account. The calm was never proof the shock would not come. [illustrative]
How to spot it
- ·'this has been calm for years'
- ·borrowing justified by a short quiet history
- ·no answer to 'what does one bad day do to me?'
Nassim Nicholas Taleb · Fooled by Randomness