Black Swans, New Normals and Why History Matters to the Investor

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You hear these statements a lot from investors:

“I’m going to be ready for the next black swan.”

Or…

“Past performance is not indicative of future results.

I’ve even said them myself.

But, as cool as it sounds and as much as the media wants to taut these as official catchphrases for investors, it doesn’t make a lot of sense, according to Ken Fisher. In fact, Fisher teaches quite the opposite in his book ' target="_blank">Markets Never Forget. But People Do.

We’ll start with the slam on past performance one first.

Most people think that past performance means the future price movement is absolutely unpredictable. But that’s not absolutely true and it leads to rash investment decisions, according to Fisher.

Fisher quotes investor John Templeton’s warning against the belief that “This time, it’s different.” The media expresses this as “the new normal.” Fisher uses reams of statistical evidence to prove that there is no such thing as a new normal–investment and economic patterns are pretty consistent throughout the past few hundred years.

The market remembers. People forget. And the pattern continues.

When the media shucks this line on the new normal, they’re telling the investor, throw out the rule book, this situation is totally different. The investor can not use probability to guide him or her through these new, treacherous shoals.

Indeed, you can’t use past performance to precisely predict the future, but you can use history, as Fisher says, as a range of possible outcomes. This narrows down probabilities–and that’s all the wise investor needs to make money.

Black Swans

Black Swans — unexpected economic events — are not wildly unpredictable events as you might think. Take the real estate meltdown. Is it so hard to believe that when real estate prices swing wildly up, that they might one day swing wildly down?

The key phrase is “one day.” The event itself wasn’t terribly unpredictable, but the timing of the sudden downswing is harder to predict.

But, you don’t need to find a Black Swan, or figure out exactly when the Black Swan will arrive, if you pay attention to history.

You don’t need to sell at the exact top to preserve money.

You don’t need to buy at the exact bottom to make money.

Near top and near bottom are fine for the astute investor.

Understanding the probability of future events and preparing yourself for that likelihood will improve your chances of buying low and selling high, or selling short and buying low.

If anyone else has read “Markets Never Forget. But People Do,” I’d like to hear your opinion.

Related posts: Black Swans, Complexity, And Government InterventionWhen You See The Black Swan, Ride ItWas Yesterday a Black Swan Event?Finding Black Friday DealsAwesome Investment Book: The Dhandho Investor

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Posted in: Black,History,Investor,Matters,Normals,Swans