Nassim Taleb's five ways to beat black swans
Author and former trader Nassim Taleb, who shook the financial world with his best-selling book on risk The Black Swan, recently spoke at an RBS Insight dinner for clients in Milan. Here, he shares his thoughts on handling the unpredictable.
1) Accept unpredictability
There are two ways to think about things. Some like to know exactly what they are looking for and need to predict their environment with a lot of precision. Others accept that random events can interfere with what they are doing.
The issue is that our environment is fundamentally unpredictable. At a company, not only can you not predict your own sales, you could never predict the sales of all your competitors.
There are people who want to rigidly follow a map to get them through life and those that realise they need a structure that allows them to take a wrong turn and still survive. You want to turn every random event that befalls you into opportunity. That’s antifragile.
2) Always have a cash cow
Around 70, 80, perhaps even 90 per cent of what you do should be low risk – a cash cow or safe game will close to zero the probability of ruin. You can then afford to use the rest of your energy focusing on what’s going to make you rich. It is better to have a dual strategy with high risks coupled with low risks, ensuring survival while seizing large opportunities.
3) Small is beautiful
Large companies are far more vulnerable to unforeseen events than small firms. It’s not just about the size of the business but the size of the economic decision unit. Companies that make cars or planes will have different exposure to those that make books. It’s about being small within the boundaries of your particular line of work.
This goes for systems too. A country that has lots of bits and pieces is vastly more robust than one that is too concentrated. Systems that survive find sweet spots between economies of scale and diseconomies of risk. This risk, after all, grows much faster than size if things go wrong.
Italy and Germany have found this sweet spot, benefitting from corporate sectors that are quite fragmented.
4) Have the right kind of luck
I believe in luck, but it’s very clear that there are two different kinds of exposure.
There are random events that can help you a lot or harm you very little. And there are those that can harm you a lot or help you very little.
If a pharmaceutical company introduces a new drug, the worst that can happen is that it does its job, but it might turn out to be the cure for something else.
On the other hand, if you get on a two-hour flight there is no random event that can get you to your destination much faster, but you could be severely delayed. Obviously in a case like that we have to do it anyway, but where we can, we should be mindful of taking risks with little upside.
This is the ability to be opportunistic. Nokia has done this very well and has been quite aggressive in changing its business over the years. It started out making paper and rubber boots before entering the cellular phone market.
5) You cannot predict the next black swan
I am often asked what the next big black swan will be. It’s a question that misses the point of my ideas of focusing on robustness instead.
Black swans are what you perceive to be highly improbable, but others may feel differently – Christmas is a black swan for the turkey, not the butcher, because the turkey doesn’t know what’s coming.
There’s no point trying to predict which black swan will happen, that’s impossible. All you can do is ensure you have good risk management in place and options to take advantage of such events. Since they happen, let’s embrace them with strategies that have high upside potential.
Nassim Nicholas Taleb was the guest speaker at an RBS Insight Event for clients in Milan.
The ex-trader’s warning
Nassim Nicholas Taleb’s 2007 bestseller The Black Swan was hailed by the UK’s Sunday Times as one of the 12 most influential books since World War II.
It looks at the impact of hard to predict, rare events on science, finance and technology. Taleb believes that modern life is so complex these “black swan” events are inevitable.
The book, which sold three million copies worldwide, foresaw the 2008 crisis, criticising the finance industry for structuring itself around models that try to predict extreme events and warning that, if one bank fell, they all would.
Taleb’s follow-up – Antifragile: Things That Gain from Disorder – argues that there are things that not only benefit from chaos but actually need it to survive and flourish. The former Wall Street trader says that, just as human bones get stronger when subject to stress and tension, many things in life benefit from stress, disorder, volatility and turmoil.
Taleb, a former derivatives trader, is currently Distinguished Professor of Risk Engineering at the Polytechnic Institute of New York University.
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