All We Know Is That a Black Swan Is Coming

13 | By Shah Gilani

Last week I wrote to my trading service subscribers that most of the hurdles facing the stock market were out in front of us, that we could see them, and that as long as the market climbs that “wall of worry” the path of least resistance for stocks, for the moment at least, appears to be up.

However, the known worries aren’t what worry me – it’s the black swans.

That led to a lot of people asking, “What black swans?”…

They’re Out There

There are plenty. But the nature of black swans is that we supposedly don’t know what they are.

I don’t buy that, nor or any of The Black Swan author Nassim Nicholas Taleb’s other theories, for that matter.

The whole black swan thing is about real black swans.

Forever and a day, everyone thought all swans were white. It was a given. There’s no such thing as a black swan.

Then, sure enough, black swans were discovered in Australia. Now we know there are black swans. That’s the thing about black swans – they’re not out there, until they are.

Black swan events aren’t unpredictable.

Take the markets, for example. We know that things we expect to work sometimes stop working.

The May 6, 2010, Flash Crash is an example.

My biggest black swan market fear is that terrorists, jokesters, or something in-between – like a mad nation-state to prove it can – “black-swans” the market.

We know it can happen. It happened in the Flash Crash. I’m not saying that was a cyberattack. I don’t think it was. But it could have been. We don’t really know what caused it.

The regulators have never come out with an explanation.

That’s what worries me. They know what went wrong and they’re not telling us.

What triggered the 1,000-point Dow Jones Industrial Average drop in a matter of seconds is secondary, though I’ll come back to that.

What’s important is that regulators can’t come out and say why what happened was possible in the first place.

There’s a difference – and it’s very important.

Whatever triggered the drop is secondary to the fact that stocks fell 1,000 points because systemic changes in how markets operate, mechanically, made it possible.

The long and short history of those changes has to do with the proliferation of electronic trading networks, competing exchanges, decimalization (trading in one-penny increments), high-frequency trading and the “unintended consequences” of other mechanical changes in markets.

So, the 2010 Flash Crash happened because it’s a possibility now. That’s what’s scary.

There are real ghosts in the machinery.

All it takes is a trigger to turn currently benign friendly market ghosts into black swans.

So, yes, a cyberattack could trigger a market crash. Because the black swans in the markets are actually sinkholes that we’ve let settle into the market’s foundation.

Sure, there are “circuit breakers” and all kinds of safety switches that will slow markets or halt trading if bad things happen.

But if a building can collapse because its foundation has been undermined, outside supports can only last so long.

Our markets are prone to cyberattacks, and our markets are mechanically unstable.

That’s the biggest black swan I can see.

And I’m not the only one who can see it.

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13 Responses to All We Know Is That a Black Swan Is Coming

  1. Anonymole says:

    Taleb’s premise was that there are unknown unknowns. That’s all. And one would be a fool to not recognize this and go balls deep into a market without the knowledge that something bad, something unknown bad, could happen.

    • Mark Young says:

      The black swan that you mention is coming, because the 1% are manipulating the stock markets with their greedy ways. Instead of sitting on the stock and and letting it gain in value, because the companies do good in the arena and people then buy the products and more stock is sold because the companies are showing a profit, no they make the stock moves to look good and then panic and sell off if they might loose a few dollars. There are to many shaky commodity trades and shaky hedge fund deals, its like trying to beat solitaire, by cheating. Sooner or later the deck has to be reshuffled and you start over.

  2. fallingman says:

    No. Those are identifiable risks. The term “black swan” becomes meaningless when conflated with known risks.

    A black swan is, by definition, something unforeseeable.

    An example is Corzine stealing from supposedly segregated customer funds at MFGlobal. A client had no way of seeing that coming, even if they knew Corzine was a sleazeball.

    On a macro scale, the discovery that Goldman arranged to hide the true extent of Greek debt or structured the Abacus home mortgage backed CDO to intentionally fail. No way to identify those as risks, even if you know how sleazy Goldman is.

    Or the Macondo spill. Or the archduke getting shot.

    Black swan = out of the blue.

  3. Helmut says:

    Does the instability of the system only cause a potential drop in the DJIA or could it also cause a spike of 1000 points in one second?

  4. Richard Reed says:

    When our administration aligns with Iran and allows them to become Nuclear; it can and will be recognized as a building block of great consternation for Israel. When Israel attacks Iran; The World and its markets will yet again blame our Jewish Brothers.
    This act of self preservation is not unexpected and it is not unwarented. What is difficult to understand is the economics of it. And how could it not create incredible ups and downs in the market.
    So, it begs the question, Who will profit from this Black Swan?
    And, this thought make one ponder if in fact Black Swans just happen or are they orchistrated for the express purpose of massive transfers of wealth?

  5. Ken says:

    My biggest fear is that most of the trading now seems to be done by machines.
    Another aggravating thing is that they have access to my trades before they are
    executed and they have a nanosecond to react to my disadvantage.
    Please. Prove to me that I am mistaken and the things I have read are pure,
    unadulterated B.S.

  6. D. Symonds says:

    Since the flash crash I have attempted to protect my stocks by having stops only become active during a short period during the day. Unfortunately that means no protection at other times should there be bad news on the stock – but it does get me out, automatically, to prevent a small loss becoming a large one.

  7. fallingman says:

    There seems to be some lack of understanding what a black swan is … by definition … and then there’s the swipe at Taleb. This is really surprising to me.

    If you want to contest what he has to say, fine, but represent it correctly and then offer some substantive argument for why you reject his premises. As it stands, it just makes you look ignorant and dismissive.

  8. Pal says:

    I don’t trade stocks, only FX, so I got no dog in this show. From what I have read over the last two years when the market goes down. it will someday, the first 20% or so movement will be so quick with the HFT algo traders hitting stops and triggers that the retail trader will have no chance to sell until it’s run down race to the bottom. Jajaja When the retail crowds puts in their sells ‘at market’ they will be jaw gapped to see that their market price was roughtly the bottom. I take not enjoyment from that…’Just the facts, Mamm.’ When the algos start dumping the retail trader will be toast..burned toast to be exact. My prediction is that no one will ever forget it once it happens.

  9. Dennis King says:

    Should we be concerned by when a cyber black swan will strike or the damage it will do? We couldn’t transmit or even trade our shares because there wouldn’t a line to do that. We HAVE to protect our cyber resources immediately if not before. Come Hell or high water we have put our safely out of black swan category.

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