Black Swans stock trading

Hello everyone,

I want to share with the community my experience of picking stocks based on the Black Swan concept. I am sure most of you are already familiar with the title and must have heard of Nassim Nicholas Taleb, the author of the book "The Black Swan - The Impact of the highly improbable". I must say Mr Taleb is one of the sharpest thinkers of our age and his thoughts helped shape my trading mentality.

I will not go for long about the idea of the black swan, but I will elaborate it in the trading context:

Black Swans hit the companies that belong to Extremistan (the land of the extremes: the extremely big and the extremely small)

Negative black swans hit the relatively big companies that belong to Extremistan: their history will be constituted of numerous small gains followed by a massive loss that wipes all their gains accumulated. (attachment: negative_black_swan.png is an example)

Positive black swans hit the relatively small companies that belong to Extremistan: their history will be constituted of numerous small losses followed by a huge profit that will cover all the losses accumulated. (attachment: stocks_evolution.png is an example which is my own portfolio)

You may notice that they are opposite situations.

My portfolio:
Between Mai and June 2010 I have picked tens of cheap stocks on Investopedia's Simulator ( they were priced under $10), my expectations were the following:
There will be many loosing companies, possibly most of them will be losers.
There will be few winners that will cover all the losses accumulated and make extra profits.

Now, one year later the portfolio behaved as I expected (as of June 13 2011):

Out of 60 stocks 32 were losers (53%), including 2 companies that went bust.
The overall lost amount is around 136K.
One company and only one company made over 244k, not only it did cover all the losses accumulated it made on it's own over 108k in net profits, the company is Insmed Inc (NASDQ:INSM).

The overall won amount is 379k. The net growth of the portfolio is over 35%.

See attached graphics.

About Insmed: it is a biopharmaceutical company specializing in some sort of protein development, I bought that stock for the following reasons:
1. It is a development company, which is basically on the edge of Black Swans: researchers and scientists are among the first to cause big and massive changes in the world. Also Protein development is an open field in which we never what they might make, so we are open and ready for big positive changes (positive Black Swans).
2. Proteins are very much needed in the Biopharma sector, I don't need to tell you it is one big sector.

Statistical anomalies:
If you pick randomly a large set of penny stocks chances are there will be few companies that will randomly rise and make big growth that might cover all the losses accumulated, so is my portfolio just like that case ?
No, because:
1. The set of my picks isn't very large: only a few tens of stocks.
2. My picks aren't random.

I already know that the Black Swan's concept is often misunderstood or not understood at all. I am already familiar with some of the common comments but it won't stop me from opening the discussion and being open to your comments.

I thought black swan was sharing his 4 indicator magical setup.
Got my hopes up.


edit: Don't you dare edit that bad word out of this, lightning mcqueer

@Chartsy
No need to be mad, if you read some book and still don't get it don't beat up yourself too much I'm sure there are too many other books you won't understand

Chartsy said:

I thought black swan was sharing his 4 indicator magical setup.
Got my hopes up.


edit: Don't you dare edit that bad word out of this, lightning mcqueer

Click to expand...

Had you not noticed he doesn't moderate any longer

I took the liberty of editing out the bad word

the link to the detailed portfolio on my blog has been deleted so I will upload the screen shots.

Not sure that these results are that representative. You say the portfolio went up by 35% over the year but from June 1st 2010 to June 1st 2011 the S&P went up by 23% in any case. Despite the good overall market still 32 of of 60 stocks lost money.

Looks to me that the results are a combination of having one big winner of over 1000% and a strong market. Doesn't mean that it doesn't have potential however. Try it over another period and see what happens when the market is not so strong.

Shanghai said:

Not sure that these results are that representative. You say the portfolio went up by 35% over the year but from June 1st 2010 to June 1st 2011 the S&P went up by 23% in any case. Despite the good overall market still 32 of of 60 stocks lost money.

Looks to me that the results are a combination of having one big winner of over 1000% and a strong market. Doesn't mean that it doesn't have potential however. Try it over another period and see what happens when the market is not so strong.

Click to expand...

As a Black Swan trader I count on the stocks that make huge profits, doesn't matter if they are few, because the growth opportunities are limitless while the losses are limited, in this aspect the number of winners VS losers is irrelevant.

Badi perhaps you should put in the money only when the main indexes are going strong? That should dramatically slow down number of companies showing losses or atleast reduce them for example put money in between september to april and remain out from may to august.

In a strong market every stock good or bad holds up well.

I think this is one of those strategies that works very well on paper only because of the issues in trading small caps. Small caps tend to have very wide spreads (cutting into your actual net gains) and their stock is often illiquid just when you want to dispose of it (as when it's a serious loser, and everyone else wants to sell at the same time). To make a convincing case involving small caps your model has to recognise the serious spreads and costs involved.

badi said:

As a Black Swan trader I count on the stocks that make huge profits, doesn't matter if they are few, because the growth opportunities are limitless while the losses are limited, in this aspect the number of winners VS losers is irrelevant.

Click to expand...

Black Swan shares are difficult to buy because one cannot identify a bubble that does not exist. The reverse may be easier. If one can identify a bubble, shorting a fundamentally poor share can be a better prospect. However, how long a bubble is likely to last is anyone's guess.

As I understand it, a Black Swan is a totally unexpected, and often tragic event. How, for instance, could 9/11 have been forecast? However, a cool, calm and patient person could have shorted the banks. Having said that, is it worth holding shorts in expectation of a collapse rather than waiting for the bubble to burst and shorting then?

The last penny stock that I bought was, really, a takeover possibility--Gladstone. It took a couple of years to get taken over and, at one point I almost ditched it. They were picking up council contracts, though, and started in Australia, so I held them. What cost 22p was sold, two years later for 34-36p. I was hoping for more and so, I'm sure, will you guys be.

Most of the growth shares are to be found in the small capitalised stocks. A share that doubles its eps in five years and is believed to be undervalued will not be in the FT100. You and I agree on that point but are these Black Swan shares? I think that they are undervalued, good compamnies that need to be weeded out with FA. They will go up, unless the Black Swan arrives in the form of a market collapse.

counter_violent said:

Had you not noticed he doesn't moderate any longer

I took the liberty of editing out the bad word

Click to expand...

Don not modding, d'ya you want me to step in to *help*?

Chartsy said:

I thought black swan was sharing his 4 indicator magical setup.
Got my hopes up.


edit: Don't you dare edit that bad word out of this, lightning mcqueer

Click to expand...

Hahaha..what was the 'naughty' word Chartsy? Anyhow sorry to disappoint you bud, my set up is only using 2 indicators, 2 trend lines and S&R**, oh and 'sentiment'..Could PM you the set up but I know you hate all that voodoo 5hite, just buy the Black Swan EA, you'll be in a Vantage in no time..

Black Swan said:

Hahaha..what was the 'naughty' word Chartsy? Anyhow sorry to disappoint you bud, my set up is only using 2 indicators, 2 trend lines and S&P, oh and 'sentiment'..Could PM you the set up but I know you hate all that voodoo 5hite, just buy the Black Swan EA, you'll be in a Vantage in no time..

Click to expand...

In all honestly, i don't see how a setup can work on all timeframes, i know you say yours does but it just seems illogical . I think the daily close is the most important, but how the feck can something work on a 273640476 tick chart, 73 minute chart, 3 day chart etc (in regard to systems!). Oh my young mind is so open minded innit.

BUT if you feel like PMing me that money printer feel free! I would tell you about my success with pin bars but i know you hate the old dog that is price action trading. (26% in 7 months, 4% max drawdown with 1.5-2% risk!), AND i'll bet my current index strat woops your setup's butt; 76% in 6 months, 85% win with just over 2:1 r/r.

And as for you; ****-er_Violent, you are next on my list.

Chartsy said:

In all honestly, i don't see how a setup can work on all timeframes, i know you say yours does but it just seems illogical . I think the daily close is the most important, but how the feck can something work on a 273640476 tick chart, 73 minute chart, 3 day chart etc (in regard to systems!). Oh my young mind is so open minded innit.

BUT if you feel like PMing me that money printer feel free! I would tell you about my success with pin bars but i know you hate the old dog that is price action trading. (26% in 7 months, 4% max drawdown with 1.5-2% risk!)

And as for you; ****-er_Violent, you are next on my list.

Click to expand...

Ah-ha..same indicators on each TF just different tweaks..and I never trade below the hourly TF.

PA? No problems with that, trading all comes down to probabilites in my book whatever method you use. When my indicators 'line up', I get the alert, if S&R and the daily pivot are in play and the HA looks strong then kapow! I'm in. Be exactly the same result with 'PA', which you can see (often a lot easier) from a lot of the indicators anyhow.

Black Swan said:

Ah-ha..same indicators on each TF just different tweaks..and I never trade below the hourly TF.

PA? No problems with that, trading all comes down to probabilites in my book whatever method you use. When my indicators 'line up', I get the alert, if S&R is in play and the HA looks strong then kapow! I'm in. Be exactly the same result with 'PA', which you can see (often a lot easier) from a lot of the indicators anyhow.

Click to expand...

Yeh but even though you can see price patterns on an indicator,it lags price so shouldn't you just look at price anyway? By HA do you mean heiken ashi candles? And why are you trading S&P; I thought you were making 100k pips a year on eurusd. Yeh i agree anything below 1H, is really hard to read, I don't do below daily.

Edit: One thing I don't like about indicators is a lot of them only take into account the closing price, rather than the range/volatility of a bar.

Splitlink said:

Black Swan shares are difficult to buy because one cannot identify a bubble that does not exist. The reverse may be easier. If one can identify a bubble, shorting a fundamentally poor share can be a better prospect. However, how long a bubble is likely to last is anyone's guess.

As I understand it, a Black Swan is a totally unexpected, and often tragic event. How, for instance, could 9/11 have been forecast? However, a cool, calm and patient person could have shorted the banks. Having said that, is it worth holding shorts in expectation of a collapse rather than waiting for the bubble to burst and shorting then?

The last penny stock that I bought was, really, a takeover possibility--Gladstone. It took a couple of years to get taken over and, at one point I almost ditched it. They were picking up council contracts, though, and started in Australia, so I held them. What cost 22p was sold, two years later for 34-36p. I was hoping for more and so, I'm sure, will you guys be.

Most of the growth shares are to be found in the small capitalised stocks. A share that doubles its eps in five years and is believed to be undervalued will not be in the FT100. You and I agree on that point but are these Black Swan shares? I think that they are undervalued, good compamnies that need to be weeded out with FA. They will go up, unless the Black Swan arrives in the form of a market collapse.

Click to expand...

wonderful comment, thanks.

A Black Swan is an unexpected event that carries massive consequences, it can be negative and it can be positive it depends on how you look at it: If you owned a bank that went bankrupt on 2007 then the financial crisis has been a negative Black Swan for you, but for the guys who shorted your bank's shares it was positive growth in their portfolio and therefor the financial crisis was a positive Black Swan for them.

I agree with you that identifying an actual bubble is easier than looking for a future bubble. The problem with short selling actual bubbles is that you don't know if they are going to burst first or are they going to double first? That can be the difference between losing and winning for you. As said earlier a Black Swan can be positive and the experience I am sharing with you in this thread is proof that you can benefit from it.

The great thing about positive Black Swans trading is that the potential of profits is limitless while the losses are limited. Picking such stocks is all about how the company approaches: the unknown, uncertainty and randomness (biopharmaceuticals involved in research are a good example), it is also about whether or not the company has the possibility of non scalable growth (growth is non scalable when the sales are not held down by the limits of investments: a good example are internet companies that can grow greatly with very little additional investments).

tomorton said:

I think this is one of those strategies that works very well on paper only because of the issues in trading small caps. Small caps tend to have very wide spreads (cutting into your actual net gains) and their stock is often illiquid just when you want to dispose of it (as when it's a serious loser, and everyone else wants to sell at the same time). To make a convincing case involving small caps your model has to recognise the serious spreads and costs involved.

Click to expand...

The problems you mentioned are usual for small caps, no argument there.
My strategy expects profits mainly from the companies that make very big growth , at that time they won't be small caps anymore and the usual problems won't be anymore.

Badi - You expect the world to match your theories. You actually plan to buy a small cap and only sell it when it's a large cap! Even if the world obliges with your idea (which I doubt), you'll still get spanked by the spread on the purchase and the real problem comes when you try to sell small caps that are nose-diving, and becoming even-smaller-caps, at the same time as everyone else who's a holder.

You're an original thinker, but get off your demo account and start trading.

tomorton said:

I think this is one of those strategies that works very well on paper only because of the issues in trading small caps. Small caps tend to have very wide spreads (cutting into your actual net gains) and their stock is often illiquid just when you want to dispose of it (as when it's a serious loser, and everyone else wants to sell at the same time). To make a convincing case involving small caps your model has to recognise the serious spreads and costs involved.

Click to expand...

It should all come out with FA evaluation.. Small cap shares have difficulty in raising loans needed to expand and are inclined to want to expand far faster than is good for them- Earnings growth must be accompanied by debt of less than 30% in these times- Perhaps, in good times, the debt level can be increased but, in my opinion, a share should be judged to be a good takeover proposition and that means having a good product that will fit into a larger rival's expansion plans.

All this takes a bit of work on the investor's part and I do not agree with anyone that it can be done by TA.

Black Swans can not be predicted.and, therefore, are a potential disaster to anyone who uses the theory for wealth improvement.

badi said:

The problems you mentioned are usual for small caps, no argument there.
My strategy expects profits mainly from the companies that make very big growth , at that time they won't be small caps anymore and the usual problems won't be anymore.

Click to expand...

I disagree with you, here. Big growth stocks come from small capitalised stocks. The larger two and three hat shares will not be found in the FT100, or 250, for that matter.

Next PLC, which quadrupled, for me, in size was a penny stock in the beginning. I did not spot it until the price went to 200 pence. This is a company that, year after year, had no debt and I, like many more, did not spot it at first. I kick myself, even today!

I, also, kick myself for selling too early!