The Black Swan

This book, by Nassim Nicholas Taleb, is difficult to review. It represents such a non-conventional way of thinking (and acting) and covers so much material it’s hard to do it justice.

Taleb defines a “Black Swan” as an event with the following characteristics:

• It is an outlier.
• It carries an extreme impact.
• It has retrospective predictability.

He also believes that “A small number of Black Swans explain almost everything in our world…” Events like market crashes and major wars are very good examples of what Black Swans are all about – they are rare in occurrence, have a widespread impact and are subject to postmortem analysis as to why they happened (even though the analysis is usually wrong or incomplete). Taleb states that the bulk of the historical gain of the stock market is due to these Black Swan-type events.

A good part of the book is a lesson against overusing Gaussian bell-curve analysis, especially for social issues like economics, psychology and sociology. Bell curves assume linear relationships, whereas real life demonstrates non-linear characteristics. Mandelbrot’s work in chaos theory is heavily emphasized as having particular relevance to the real, empirical world. My own study of chaos theory confirms many of Taleb’s arguments.

Predictability, or actually non-predictability, is another main focus. It’s very, very difficult to predict anything because of the non-linear nature of most activities. However, plenty of people claim to be able to predict things (economists, meteorologists, et al) by extrapolating historical data. Well, we’ve all seen how well that works. Predictions may be successful in the very short term, but inevitably those Black Swans jump in and mess everything up.

My biggest question while reading the book, however was “How am I supposed to live my life in Extremeistan (Nassim’s name for the world of Black Swans)?” Obviously, it’s not by following the conventional wisdom and predictions we routinely see in our daily lives, since Black Swans ruin much of that wisdom. Taleb suggests that we look at everything critically and skeptically. Don’t blindly follow the advice of so-called “experts”, especially when their “expertise” is in volatile fields. One particularly useful piece of specific advice the author gives is using the so-called “barbell” investment strategy (Taleb was a securities trader for many years), which calls for simultaneous investment in hyper-conservative securities and in hyper-aggressive securities. That way the bulk of your investment is secure (85-90%), while the remainder can take advantage of positive Black Swans (securities that may increase in value dramatically).

The sheer quantity of information in this book is staggering (although sometimes a bit repetitive), and I can’t begin to do it justice, so reading it carefully will take some time for most people, even though it is only 300 pages long. It’s well worth the investment of time, however. I found it to be a very mind-opening experience.