Saturday, 8 September 2007

What to do about black swans?

In the book, "The Black Swan", by Nassim Nicholas Taleb, the Black swan is the name given to an event that is expected to not happen or to be judged as less likely to happen than it really is. The reason it is called a black swan is after the idea that people only believed white swans existed as no one had seen a black swan yet, but it only takes one black swan to break that belief. So, in the stock market, no one thought the chances of a crash were worth considering as it was treated as a black swan. When a black swan event happens in a market, prices move quickly, e.g. a stock market crash or some totally unexpected event knocking a favourite out of a competition.

In the football under 2.5 goals markets, I have started thinking about goals as a kind of black swan event. The price drifts downwards over time, but in the event of a goal it jumps right up and then continues drifting down again. Taleb says that there are two approaches to black swans: 1) Treat black swans as if they will never happen and risk losing your stake (e.g. backing, then waiting and laying again, in under 2.5. goals without watching the game in-play) 2) Assume a black swan is likely to happen (determining that you believe a game will have a goal and then laying the under 2.5 goals market and sitting and waiting for it to happen and the price to jump up so you can back). Okay, so its not a perfect use of the analogy but the idea of the black swan can be a handy one to have in the back of your mind when you are considering risk. Is the event that could lose your stake or make your bank empty, as unlikely/impossible as you really think and can you mitigate against it, or, is the event that everyone else thinks will never happen actually more likely than they think and so there is a value opportunity.


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