Sunday, September 30, 2007

The Black Swan

In Mr. Rithotz's latest week in preview linkfest, there is a link to an article in The Gaurdian that gives a quick review of a new book called "The Black Swan", by Nassim Nicholas Taleb. Here is a little excerpt from the article.

Markets tend to work on the basis that Black Swans either don't exist or appear with such irregularity that they are not worth worrying about. As a result, traders in the City of London went home on the night of August 3 1914 seemingly oblivious to the fact that a world war lasting more than four years would start the next day. Similarly, there was not the slightest suggestion on Friday October 16 1987 that the Dow Jones would lose more than 20% of its value the next Monday. The Nobel prize-winners Robert Merton and Myron Scholes, who put together Long Term Capital Management and convinced their investors that their models made it a sure-fire bet, had failed to factor in the possibility of a Black Swan - in the case of LTCM, the Russian debt default in August 1998.

I'm sorry but I simply do not agree with the author at all. To someone on Main street the crash of 87 might have come out of nowhere but not to the top players on Wall Street. Many of these players were interviewed by Jack Schwager in the first of his excellent "Market Wizards" books. The interviews took place not long after the crash and were very fresh in the minds of the traders. Almost all of them were expecting a large turn in the market and were well positioned for Black Monday. The only exception was the one trader that shunned technical analysis (he was trounced that day). I do not have time to post their comments tonight, but will try to do so in the near future.

Here is an interesting poll. In honor of the 20th anniversary of Black Monday, MarketWatch put a poll together. Although this is not scientific, I still like the fact that there is a ton of skepticism out there regarding the market's rally. While this blog is called The Novice Bear, I have been net long since September 4th after covering my shorts on August 16th. A poll like this makes me happy to be a bull.

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