BIG IDEAS #3: BLACK SWAN THEORY (PART 1/2)

flickr photo by Paul Stuart Iddon http://flickr.com/photos/nodditect/70300595 shared under a Creative Commons (BY) license

flickr photo by Paul Stuart Iddon http://flickr.com/photos/nodditect/70300595 shared under a Creative Commons (BY) license

When someone breaks your heart for the first time, if feels as though someone has pulled a lever and the ground on which you stood has evaporated. Everything you took for granted, all those little judgements and assumptions that everything was fine turn out suddenly to be wrong, all those tiny signs you missed; that things were headed south seem so obvious in the aftermath. If only you’d done this or that to please the one you loved. If only you had some warning that your world was about to fall apart.

Hindsight is a terrible thing. If you only take one thing from black swan theory that would be it.

When the financial crisis struck in 2007, Nassim Taleb made money. When stock markets around the world were crashing, the author of the theory from which this blog is named saw the value of the money he’d invested, at a time of the greatest crash since the 1920’s, go upwards.

How? We’ll get to that.

WHAT TO DO WHEN THE UNLIKELY HAPPENS

flickr photo by cliff1066™ http://flickr.com/photos/nostri-imago/4428688046 shared under a Creative Commons (BY) license

flickr photo by cliff1066™ http://flickr.com/photos/nostri-imago/4428688046 shared under a Creative Commons (BY) license

When the unthinkable occurs it is in our nature to try to make sense of it. Our brains find it too hard to accept that something terrible or wonderful can simply drop out of the sky without warning. There must have been clues, there must have been signs.

Most of us remember where we first heard that the 9/11 bombings had happened. In the wake of such a senseless tragedy, commentators and telly-box talkers of every persuasion queued out the door to try and explain what had just happened and why.

It’s important in such times to keep a clear head they said. To study the facts, to look for signs and patterns and to work out what happened, how and why.

And, we are always told, things of such weight should never be allowed to happen again. Next time we need to be ready. Next time we must be able to predict it before it happens.

But that, says Mr Taleb, is exactly where we are fooling ourselves.

UNSPILLING THE MILK

The truth is, he says, that human beings have a tendency to see many things as predictable AFTER they have happened.

We come up with a story AFTER things have gone wrong in order to help ourselves make sense of it and this makes it seem as though it could have been prevented. This re-writing of our individual and shared histories allows us to feel reassured about the future when all we have really done is to prepare ourselves for if the past repeats itself exactly.

It is therefore important to judge things based upon the information that you had AT THE TIME that you made the decision.

INDUCTION (AGAIN)

For those of you who remember last week’s blog on induction, you’ll know that I wrote about how we tend to assume that patterns in the past will repeat themselves in the future. The problem with this assumption is that it can lead to huge miscalculations about our ability to predict future events.

Knowing that you’ve reached the age of fifty without having had a deadly car crash unfortunately does not necessarily prove that you won’t die from one in the future, even though you’ve spent many thousands of hours in a car without a single fatality.

Which brings us back to how Nassim Taleb actually made money during the financial crash of 2007…

CLICK FOR PART TWO

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