The Black Swan Investing Strategy You Need To Know

January 30, 2018

The Black Swan Investing Strategy You Need To Know

One of my favorite authors is Nassim Taleb. I find his books The Black Swan and Antifragile mind blowing.

There is a lot of entertaining philosophy in his text and one must really dig deep to extract practical tools to use in this environment full of black swans, randomness, and fragility. Here are a few of his ideas that you can apply if a black swan investing strategy fits your personality.

What Is A Black Swan?

A black swan is a metaphor for an event that comes as a surprise but has a huge impact on the market and is later rationalized. For example, the 2008 housing crisis was such an event. Now it’s clear why and how it happened, but only a few saw it coming in 2007. A positive black swan would be an even that is a surprise but has a huge positive impact.

Taleb’s view is that the world is far more random than what economic models tell us and that we should always be expecting the unexpected. On that note, we should also invest accordingly.

How To Invest For Positive Or Negative Black Swans

The first thing one must do is to avoid being dependent on large-scale, harmful predictions. For example, if your pension depends on the belief that stocks will always go up and the government won’t ever go bankrupt, that’s something to really rethink because stocks don’t always go up, not even in 30 year periods. Stocks also don’t really go up when the price to earnings ratio is 30 and when we are in the late stages of an economic cycle. Further, if there is someone promising you a pension in 2040, don’t look at what the probability for that institution to deliver what they promised is, but focus on what the harm would be to you if that doesn’t happen.

The key of black swan investing is to benefit from unpredictability. What if the unpredictable happens and the S&P 500 goes to 900 points in 2025? This would be a gray swan as it’s highly unlikely now, but it is a possibility that can be anticipate as the baby boomers sell their assets to finance their pensions.

So as a black swan comes as a surprise, you can’t invest in it in a straightforward manner. The only thing we can do is to be prepared or potentially exposed to such rare but highly impactful events.

Trial & Error Investing

Trial and error investing is a strategy where you invest a little of your portfolio when there is a high probability that you could lose a big part of the investment or even all of it. However, if you invest just a small part of your portfolio, it doesn’t hurt you but in the event of a black swan, your upside is unlimited.

Most investors seek security when investing, even if that security is just an illusion. However, learning how to lose here and there allows you to expose yourself to extreme rewards that aren’t that uncommon. Let me try and elaborate on an example.

In the last financial crisis, the General Motors (NYSE: GM) went from above $40 toward the end of 2007 to below $1 in 2009.

Figure 1: GM’s stocks back in the 2007 to 2009 period. Source: CNN Money.

If something like that happens again—perhaps not to GM but to another blue chip like it—and you buy a two year out of the money put option, you can easily increase your investment by 30 times or more. However, if nothing happens, you at most lose everything.

Figure 2: GM’s current option chain for January 2020. Source: Nasdaq.

So if I buy a GM put option with a strike price of $23 dated January 17, 2020 for 75 cents and GM goes bankrupt again like it did in 2009 when the stock price went below $1, you would make 30 times your money. Of course this is an extreme case, but did something like this happen in 2009, 2000, 1987, 1974, etc.? Yes. So if you play things like in our example above in the late parts of an economic cycle, you might lose everything for 4 years, but you will make everything up in year 5.

This is the key to Taleb’s investing strategy. Find the cheapest options compared to the potential payoffs, and lose money in the meantime.

The Barbell Investing Strategy

Now, you can’t put all of your money in long term out of the money options because if you are wiped out, there is nothing left to invest.

Taleb suggests a barbell investing strategy that is hyper conservative and hyper aggressive at the same time. This means that you put 85% to 90% of your portfolio in extremely safe investments, like Treasuries, and the remaining 10% or 15% in speculative bets. This allows you to have plenty of small bets where one here or there will explode. The key is not to be blinded by one potential black swan, but to be prepared for one coming from anywhere as you can’t see a black swan ahead. So by having 15 black swan bets, you will likely hit one or more per year and have a great return.

The average risk of a barbell portfolio would be medium, but offers exposure to black swans which the traditional stocks/bonds medium risk portfolio doesn’t. Additionally, the barbell portfolio offers protection in bear markets which, again, a normal portfolio doesn’t.

Look For Black Swan Businesses

One of the reasons I don’t like to invest in banks is that they’re a negative black swan business. In the best case scenario, the bank gets its loans back and makes a profit but the bank can easily go bankrupt if the loans aren’t repaid. Thus the upside is limited while the downside is total. Positive black swan businesses are publishing, scientific research (biotechnology stocks), and venture capital.

The venture capitalist that invested in Uber 9 years ago was exposed to a positive black swan, but the pension fund or investor who invests now is more exposed to a negative black swan.

The key according to Taleb is to get extremely aggressive, as speculative and as unreasonable as possible, when the downside is little and the upside unlimited. Therefore, when you find an opportunity, make sure to seize it.


All the above has one thing in common. Asymmetry. You can read more about that here. Taleb’s take on it is that you can’t calculate the probabilities of such outcomes, but it pays to be exposed and prepared.