According to experts, the Covid-19 pandemic is a Black swan event. But what exactly is that? How does it occur? How can you trade during a Black swan event?
In this article, we will try to answer all the above questions and more. Stay with us to discover the secrets behind one of the most exciting topics: Black Swan events.
What is a Black Swan event?
Investopedia.com describes a Black swan as an “event beyond what is normally expected of a situation and has potentially severe consequences." Black swan events are rare, tough to predict, and can irreversibly alter the course of history.
Where does the term Black swan come from?
Nassim Taleb, a finance professor and ex-Wall Street trader, first used the term "Black swan" in his 2007 book “The Black Swan: The Impact of the Highly Improbable." The expression derives from the ancient Western belief that all swans are white, a theory which was proven to be false when black swans were discovered in Australia.
According to professor Taleb, all Black swan events share the three following characteristics:
• They are so rare that even the possibility that they could happen is a mystery.
• They are explained only after they occur as if they were predictable.
• Their impact is drastic and can change the world's economies and/or societies.
Interesting fact: Black swan events can have either positive or negative consequences in the financial markets. The arrival of the Internet is an example of a positive Black swan event, giving a tremendous boost to online trading.
Other famous Black Swan events
The dot-com bubble
The dot-com bubble spanned over six years (from 1997 to 2003). During this time, traders pumped money into newly launched Internet companies hoping these startups were going to be worth millions in the future.
Unfortunately, many of these companies became unprofitable and even went bankrupt, causing massive disruptions inside the markets. Nasdaq also crashed in the early 2000s, sending thousands of employees on the streets.
A bubble bursts when the price of an asset (like a stock, bond, commodity, or currency pair) rises fast before falling abruptly. This usually happens when prices are overinflated.
The 9/11 terrorist attacks
The terrorist attacks cost thousands of human lives, but they also profoundly impacted the United States financial centers. Both the New York Stock Exchange and the Nasdaq did not open until September 17. This was the most extended period they were closed since the Great Depression of the early 1900s.
The major American indices all fell, with Dow Jones plummeting more than 7%. It took some more months before the markets started the recovery process.
The 2008 economic crisis
The global financial crisis of 2008 is another example of a Black swan event. The crisis started earlier in 2000, when U.S. banks were selling a ridiculous number of mortgages to satisfy the growing demand for mortgage-backed securities. Those were times when virtually any American citizen could get multiple loans to purchase numerous houses, no matter his financial profile.
When the U.S. housing sector crashed in 2006, the American economy was shocked. Plenty of large financial institutions, including Lehman Brothers, were suddenly finding themselves on the brink of bankruptcy.
The ripple effect went through the markets like a lightning bolt and even hit most of the world’s biggest economies on a global scale.
The Covid-19 pandemic
We cannot ignore the present-day situation. As the Covid-19 pandemic continues wreaking havoc, more and more people call it a Black swan event. And truth be told, it ticks all the boxes: it came from nowhere impacting everything in its way and changing the history as we know it.
Covid-19 has disrupted the global economy, causing financial-market collapse not seen in over 10 years. It raises concerns that the global economy might be nearing a recession. The pandemic has also ended the longest-running stock bull-market in the entire U.S history.
How can you trade Black swan events?
Black swan events are unpredictable, forcing traders to react promptly in many cases. Here are some strategies people use when dealing with such occurrences in the financial markets:
• Hedging and diversifying your portfolio
Hedging is a strategy that can help you minimize your investment risks during unforeseen market conditions. Together with a diversified trading portfolio, it is worth considering for both beginner and more advanced investors.
• Turn your attention to blue-chip companies.
Blue chips are the stocks of high-valued and financially powerful companies. Investors often see these stocks as reliable and profitable in both good and bad times, as they boast market capitalizations of billions of dollars and are usually market leaders in their sectors.
Examples of blue chips stocks: Microsoft, Unilever, Vodafone, Exxon Mobil, JP Morgan.
Blue-chip stocks tend to offer a sense of security and are known to “survive” during market meltdowns.
• Avoid big positions
Black swan events can send the markets into bear territory. But because of their sheer unpredictability of the whole thing, experienced traders advise against opening significant positions. Instead, they agree that trading small might be a safer approach. In case the markets move against you, you can avoid damaging your account too much.
Trading Black Swan events could be tricky if you’re not careful and don’t use the appropriate risk management strategies. Picking the right broker for you is also vital. Start trading with us at CAPEX.com, and enjoy investing with a fully regulated broker providing safety & security during your entire journey in the financial markets!
Sources: Investopedia.com, thebalance.com, babypips.com
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