Is There A Way to Prepare for a Black Swan Event?

The financial world is famous for its fast pace and hectic nature. Modern finance has branched into numerous sectors, including stocks, forex, commodities, crypto, etc. Each of these industries is pulling its weight in the global economy, with millions of active traders striving to grow and reap profits. However, this enormous industry is sometimes too big and complex for its own sake. 

With the exponentially increased variables, market players and external factors, it sometimes might seem like a miracle that everything works like a well-oiled machine. But sometimes, that is not the case, and the financial systems break down spectacularly. Such an event is called a black swan event, and it is the biggest fear of every diligent investor. 

Black swan events are characterised as extremely rare, unpredictable and completely catastrophic events that can have global ripple effects. The 1930s US recession, the 2000s Dot Com bubble, and the 2008 housing crisis are significant examples of black swan events unravelling in the financial markets. Each of the above-outlined events had a massive impact on the global economy. 

The financial sector is still feeling the effects of the 2008 housing crisis, which destabilised numerous currencies, caused massive unemployment and increased the gap between household prices and annual income. Even after fifteen years, multiple countries are still dealing with the ramifications of this colossal event. 

Thus, black swan events are cataclysmic for any industry they occur in. By definition, They are unpredictable, meaning no apparent signs or patterns could explicitly signal their occurrence. Usually, black swan events do not have any evident links between them. Hence, there is no obvious way to utilise the experience of one black swan event to prevent or even combat the next one. 

This is caused by the fact that black swan events represent a conceptually new phenomenon every time. They are something that has never happened before. Thus, preparing for them might often be futile. However, Professor Nicholas Taleb, responsible for creating a black swan event theory, advocates for staying vigilant. Nicholas states that we should always expect a possible black swan event and maintain professional scepticism regardless of the circumstances.

COVID-19, unfortunately, is a perfect example of this phenomenon since it showcases that black swan events can come in many shapes or forms. Black swan events are not tied to financial movements or mechanisms. Such an event can be political, social, economic, regulatory and even natural. In the case of COVID-19, the world was unprepared for the colossal global epidemic. 

The entire human population was forced to adopt self-imposed quarantine, unable to perform their work outside their domicile. Naturally, numerous industries suffered immeasurably. Millions of people lost their jobs, and, in some countries, civilians were fighting for rations. The COVID-19 situation looked bleak for several months, but humanity bounced back swiftly.

While there were some signs of impending doom, COVID-19 came out of nowhere, closing down global commerce and paralysing the worldwide economy for almost a full year. There wasn't enough government and civilian readiness to uphold all the necessary protocols. Scientists believed that they had solved the problem of simple viruses back in the 20th century. 

So, COVID-19 is a textbook example of a black swan event, occurring without any preconditions or warning signs and completely disrupting several global industries. To further emphasise the nature of black swans, the similar Covid pandemic will no longer be classified as such an event. This is because we have already learned to deal with similar diseases.

The crypto world has become a usual suspect on the black swan event watch. It is no secret that the crypto landscape is volatile and far from fairly regulated. Thus, the probability of the black swan event is higher in these circumstances since there are more unpredictable variables in the crypto field than in any other financial sector in this climate. 

Despite its young age, the crypto field already experienced a black swan event in 2018, sending ripple effects all over the financial space. This event was caused by numerous factors coming together and creating a crypto bubble that resembles the 2000s Dot Com crisis. However, predicting that the history would repeat itself was difficult since the 2018 crypto winter had completely different preconditions. 

In early 2017, cryptocurrencies took off spectacularly, exponentially increasing in value and gaining worldwide popularity. This young industry was hyped up by speculative investors and the general public who believed in the raw potential of crypto. There was a general lack of knowledge about the blockchain industry. Thus, most investors mindlessly followed the hype and thought in the sentiment that the blockchain industry was the future of finance. 

So, all major cryptocurrencies soared beyond the wildest expectations, reaching unprecedented market capitalisation. Soon, the entire industry realised that the hype train was empty, as cryptocurrencies failed to provide tangible value to support their ridiculously rising prices. Thus, the 2018 crypto winter hit hard, causing BTC, ETH and other major cryptos to fall dramatically in price. 

This question has no simple answer since the crypto industry was very young and devoid of standardisation. The core technology of blockchain was and remains excellent for global payments, decentralisation and anonymity. However, the industry experienced too much growth without ever offering a corresponding value. 

Thus, there were warning signs, and many experts cautioned against aggressive investment practices, but the overall market hype got out of control and caused the industry to implode temporarily. While the exemplary symptoms were there, the hindsight is always twenty-twenty, and it was pretty improbable to simply stop the bullish market trends due to the theoretical concerns.

As outlined above, these high-impact events tremendously influence numerous sectors. Usually, a black swan event influences employment, business profitability, interest rates, monetary policies and virtually every other major aspect of the global economy. In terms of investors, black swan events can be quite crippling and costly. 

The 2018 crypto winter caused massive losses for every substantial crypto investor, leading to massive withdrawals, bailouts and general market distress. It took two years to re-invigorate the investment considerations in the crypto field, as investors were deeply burned during the 2018 market collapse. Many traders and investors seized their crypto dealings and never returned after the 2018 debacle, causing the crypto market to lose its hard-earned momentum. 

Thus, black swan events can heavily disincentivise investors in a particular investment field or even drive them away from the market. Since this phenomenon is extremely unexpected, investors generally become sceptical about the entire industry and develop an irrationally negative bias toward it. After all, it is hard to internalise the massive losses due to an unprecedented event ravaging a particular industry. Therefore, a black swan event might scare most investors away from virtually any field of commerce, destabilising the market for months or even years to come.

As analysed above, black swan events are inherently unpredictable and do not betray any pre-factum warning signs. However, Dr Nicholas Taleb has outlined several strategies to remain cautious in light of potential black swan disasters. While the general idea is to expect black swan events at every possible turn simply, the market data sometimes showcases interesting deviations that should not be overlooked. Let's explore the possible implications of such unusual developments.

The market data accumulation has reached unprecedented levels in 2023. Virtually every sector, industry and market has abundant data collection sources. The world of finance has never been this transparent due to the generous data distribution that describes almost every facet of this field. Thus, the industry has much more information to analyse and process, giving us a better chance to predict, or at least sense if, the black swan event becomes likely. 

Unusual market patterns are critical, as they could signal a massive underlying problem. The stock market crashes in 2001 and 2008 are perfect examples of unusual deviations being overlooked. During the housing crisis, several individuals predicted the market course by analysing CDO offerings presented by Lehman Brothers and other large banks. The unusual pattern here was the rapidly declining quality of subprime mortgages across the USA and their increased proportions in CDOs. 

Several individuals were so confident in their discovery that they shorted the entire housing market. Thus, despite the surprising nature of black swans, the increased data availability can give us unique insights regarding the problems within the industry. Unfortunately, the cautionary statements of such experts are often considered simply as overt scepticism and alarmism since there is no way to verify their concerns until it's too late.

The second most important metric is the simple pace of growth in any financial industry. The crypto boom of 2017 is a perfect example, closely followed by the crypto boom in 2021. Both events were preceded by a suspiciously fast-paced growth of the entire crypto industry. According to classical economics, exponential growth is seldom sustainable or even feasible in most cases since it requires appropriate value creation.

The growth pace that exceeds any previous metrics is undoubtedly exciting for the market players and investors as they pocket lucrative returns on investment. However, it could cause an unfortunate chain of events driven by the investors. As the crypto market became active in 2017, investors wanted to profit even more. New market entrants purchased inflated crypto tokens and strived to sell these coins with even higher premiums. Thus, the growth pace became almost exclusively supported by hype lacking any substance. 

So, whenever a given industry is soaring beyond expectations and providing unprecedented numbers, the market players should ask themselves a crucial question - Is this growth organic or a product of industry-wide opportunism of the investors? In the case of two crypto winters, the initial growth was entirely sustainable and supported by value, but the subsequent influx of investors created a pronounced bubble. That was a tell-tale sign that the crypto industry had become susceptible to a crash.

So, black swan events are both catastrophic and practically unavoidable. While their description leaves almost no room for optimism, many experts believe that scenario planning and diversification of investment portfolios might just be the trick to soften the blow. Remember, it is nearly impossible to avoid black swan events altogether. Covid-19 is a good example of a black swan phenomenon that affected even the most diligent investors. However, there are two principal actions one can take to minimise losses.

Risk hedging across any industry is the oldest and arguably most sound investment advice. The same goes for the crypto market and its ever-present volatility. There are no significant signs of black swan events since the crypto field experienced a market crash only a year ago. Despite being less likely, another wave of empty hype could overtake the crypto industry unexpectedly. 

In this case, it is essential to diversify investments as much as possible, hedging against risky investments in promising but lesser-known coins. As for Bitcoin and altcoin investments, it is essential to monitor the prices and have a healthy exit strategy to help investors significantly cut losses. The crypto sector has become more secure and value-driven in the last fiscal year, with stablecoins offering feasible risk hedging options. Thus, investors should have a healthy proportion of liquid cryptocurrencies in their portfolios. 

In the case of a black swan event, traders will swiftly exchange the liquid portion of their portfolio, which is a relatively favourable outcome considering the circumstances.

Both individual and enterprise risk management hinges on the availability of recent and unbiased data. Investors must understand market movements, market depth, recent developments and external factors that could adversely affect the crypto field. Staying aware of the substantial market events could help traders exit their losing positions swiftly and minimise losses during a black swan event. 

A great example is the downfall of FTX, which was publicised quite openly in November of 2022. The individuals and companies that closely monitored market news had the advantage of being the first to withdraw their funds and walk away relatively unscathed. Others weren't nearly as fortunate and are still awaiting the court decision on their lost funds. However, it is also important not to panic in certain cases since crypto is still very volatile and could signal a fake black swan event. In this case, exiting your investment positions could be unprofitable.

Will the black swan events occur in 2023 and beyond? The answer is, most likely, yes. Black swan phenomena are frequent in the grand scheme of financial history, with one happening almost every decade. Some black swans are simply unavoidable and will cause severe damage to investors. However, diligence and caution will still be rewarded even in dire circumstances. 

Investors who manage to properly diversify their portfolios and stay in the loop of recent market events will have a much better chance to walk away with minimal losses. So, stay vigilant and careful when dealing in the crypto market. It might just save your entire investment portfolio.