The Black Swan deals with how we interpret random events. A Black Swan is an event that is 1) unpredictable, 2) has an extreme impact and 3) we try to make explanations for its occurrence after the fact. Taleb states that almost everything around us has been brought about by Black Swans: Fads, epidemics, fashion, ideas and art genres.
John Bogle’s Thoughts on the Black Swan: Black Monday and Black Swans
"We produce thirty year projections for social security deficits and oil prices without even realizing that we can’t predict these for the next summer."
How can a Beta measure risk when the securities price is determined by factors that have no correlation with past events. We come up with pretty theory’s that will tell us what will happen in the future or what securities price should be, without realizing that much of what happens in the future is totally unpredictable and small deviations can mushroom into very large differences over time.
We focus on a small section of what we see and generalize from it to the unseen. This is called confirmation bias in psychology. We look for patterns in random information. The narrative fallacy states that we have a limited ability to look at a series of facts without weaving an explanation into it. Expressing facts as a pattern makes it easier to remember and we naturally do it.
We can always find evidence that will validate our thoughts. In science a hypothesis is made and the scientist looks for ways to prove it wrong. We will become smarter by coming up with a conjecture and then looking for disconfirming evidence.
What we can learn from it
Avoid dependance on large scale predictions (macro economic, analyst estimates, growth rates far into the future etc.)
People are ashamed of losses so they look for investments with low volatility but don’t realize that it still contains an equal chance of large losses.
Look for positive Black Swans (those where the surprises will be positive and the downside is limited). -Same as Mohnish Pabrai’s low risk high reward strategy (heads I win tails I don’t lose anything)
Understand that we don’t know what we don’t know.
Avoid the majority of forecasters