How to survive Black Swan stock events
The crash of a major cryptocurrency exchange, FTX, has plunged the entire crypto market into chaos. The overnight collapse serves as a stark reminder of the volatility and unregulated nature of crypto.
Yet, regardless of the asset, all sectors are prone to periods of highs and lows, booms and busts.
Whether it’s GEO-political chaos, such as the war in Ukraine, or natural disasters affecting commodities, there’s a situation all traders must brace for – The Black Swan market event.
Today we look at ways to handle a crisis in the market and share valuable advice for all traders.
What are some of the signs of “Black Swan Events”
The term was popularized by finance professor and former Wall Street trader, Nassim Nicholas Taleb. He theorized about the black swan event in a 2007 book ahead of the events of the 2008 financial crisis.
Taleb argued that due to the unpredictable nature of black swan events and their extreme rarity, it is important for traders to always assume that the event is a possibility. So, how do you plan for the unexpected? By implementing good risk-management strategies.
Market crises on the scale of the COVID-19 outbreak or the 2022 Russian invasion of Ukraine are rare but can take everyone by surprise.
Nobody could have foreseen the effects of a global pandemic nor just how devastating it would be on the global economy.
3 primary characteristics of a Black Swan event:
- A market-related event that is unpredictable.
- It has severe and widespread consequences.
- After the event, analysts will rationalize that it was predictable (commonly known as ‘hindsight bias’).
Unpredictability shouldn’t be confused with volatility. Any market that experiences rapid price movements inline with a trend is a trader’s dream. Markets however that have unexpected crashes or suddenly skyrocket can have devastating consequences.
How do you know if it’s a black swan event?
A specific crash event in the stock market that exceeds six standard deviations, makes it exceedingly rare from a technical and probabilistic standpoint. This separates a Black Swan from regular bust periods in the market.
Analysts have argued that stock prices are “fat-tailed” and that such events are, in reality, more frequent than many traders would believe. Since 2020 the markets have seen major crashes and extreme rallies across a wide variety of sectors.
Major financial disasters
From the Great Depression of the 1920s to the oil crisis of 2020, throughout history, there have been several black swan events.
Here are 3 prominent disasters from the financial world:
- The 2008 Global Financial Crisis
The late 2000s can best be defined by the Great Recession which resulted in trillions being last. The global financial crisis in 2008 was caused by Lehman Brothers, one of the biggest investment banks in the world, filing for bankruptcy. The event, the largest bankruptcy filing in US history, led to more than 25 000 Lehman employees going jobless. It also wiped out more than $46 billion of Lehman’s market value. In total, more than $10 trillion was eventually wiped out in the global equity markets. It took almost a decade for markets to return to normal, resulting in millions of jobs and billions of dollars of income lost along the way.
- The “Dotcom” Crash
The Dotcom bubble is a good example of a huge boom and bust period. The global economy saw rapid growth in internet usage during the 1990s. By the early 2000s, hundreds of internet companies, including Google, were launched.
Many of these companies failed due to market saturation and the rapidly evolving technology sector. In addition, many of the world’s most successful internet companies were severely overvalued.
From 2000 to 2002, many internet companies collapsed and were forced to close, resulting in billions being lost for investors.
The 2000’s Dotcom crash resulted in nearly a trillion dollars worth of stock value being wiped out. Analysts revealed that NASDAQ Composite lost a staggering 78% of its value in the crash.
Back in 2016, a conservative British government filed a referendum to officially leave the European Union. This caught many countries and institutions by surprise. Years of negotiating and stalling the exit eventually culminated in Britain officially leaving the EU in 2020. The ‘Brexit’, as it’s commonly referred to, resulted in the British pound crashing to a 31-year low against the US dollar. It also destroyed nearly $2 trillion of value in global markets. The ongoing situation is plagued by huge infrastructure issues, trade woes, and energy insecurity.
Understanding the Black Swan
It’s easy to think of black swan events as only having a negative connotation but that doesn’t reveal the full picture. Whether the event is positive or negative is entirely dependent on your perspective. Markets are cyclical and as such are prone to highs and lows. They are also interconnected – commodities will affect the Forex market and vice-versa.
The US dollar surging in strength due to inflation is great for USD Forex traders but will, as it has in 2022, result in rate hikes by the US Federal Reserve. A disastrous day in the stock market will be seen as a positive event for traders with short positions.
6 top tips for when markets don’t go your way
1 Don’t Panic!
The first time a trade goes wrong, or you see the market drop can be stressful. So, what should you do when markets don’t go your way? Do what the experienced traders do – nothing. Don’t panic, don’t freak out. Take your emotions out of the equation. You can use logical stop-losses to help mitigate negative effects, but don’t lose sleep over it happening. What are the trends and then decide your next move?
2 Stick to a strategy
It can get quite tempting to start switching strategies or assets the first time you take a loss. Unfortunately, this will lead to more losses as you’re dealing with different markets. You’ll have a much better chance of success by implementing one trade strategy and sticking with it.
3 Have realistic expectations
Trading is plagued by unrealistic expectations, especially from inexperienced traders. Even when markets are down there are opportunities. Do your research and understand that markets are cyclical – they move up and down.
4 Don’t make too many trades at once
Experienced traders will tell you to trade smaller positions until you can handle more trade volume. It’s easier to become profitable from a few smaller trades than to risk it all on one large position.
5 Don’t over-protect with stop losses
Stop losses are a great tool for traders to protect themselves. Unskilled traders, however, usually overdo it. Many beginners place stop losses too close to the entry price. You’ll be stopped for a loss before the market has any chance to gain momentum and swing in your favor.
6 Trading is easy once you have the knowledge
Anyone can become an online trader but to be successful you need knowledge and to partner with a great broker. Fortunately, CMTrading is here to help traders of all skill levels have the best possible trading journey. From webinars to in-person training sessions, CMTrading is here to guide you to success.
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