The term "Black Swan" emerged from Nassim Nicholas Taleb's very popular book The Black Swan. Prior to the discovery of Australia, everyone thought that all swans were white. The discovery of fresh water black swans startled the world. This is an example of how limited rare events can overturn everything we think we know.
Black Swan events in forex trading are important occurrences. They come out of nowhere. They can upend entire markets. They can wipe trading accounts out in moments. Picture a scenario involving a sudden thunderstorm. You check the weather. It says sunny all day. You plan a picnic. Then dark clouds appear seemingly from nowhere. A rainstorm comes and ruins everything. This is what Black Swan events do (or can do) to forex markets.
A great example of this is the COVID-19 pandemic in 2020. Nobody saw that coming. Stock markets crashed. Currency pairs went haywire. The US dollar first weakened then strengthened. The price of gold went up. The price of oil went negative. Traders all over the world lost millions.
Definition & Characteristics
A Black Swan event has three important characteristics: it is rare, it has a huge impact, and people concoct explanations to make it appear less rare after it happens. Think of a Black Swan event as something that has a low probability of happening but conveys a high impact. For the majority of days in Forex, the market moves in predictable ways with currency pairs tracking technical patterns and creating expected reactions to economic news. Then a Black Swan occurs and the entire market has changed in minutes.
The rarity factor means these events are not happening all of the time. You will probably see one every two or three years, and some traders go their entire careers—without experiencing a major one. This rarity becomes part of the risk of Black Swan events, and make would be risk-takers ignore the risk, thinking "it won't happen to me!"
The magnitude of the impact is what makes them dangerous. A normal news event would move a currency pair by 50-100 pips. A Black Swan event can move the same currency pair by 500-1000 pips, or more, in a single day. In fact, the Swiss National Bank (SNB) event, on January 15, 2015 moved the EUR/CHF currency pair by 1500 pips instantly.
Black Swan vs. Grey Rhino
Not every dangerous event is a Black Swan. Some risk events are not Black Swans because they should be easy to see but people ignore them. These are called Grey Rhino events. A Grey Rhino event is a high probability/high impact event that people see coming but do nothing to prepare for. Imagine a charging rhino in an open field headed directly towards you! Obviously, it is headed towards you. It's definitely going to cause damage. However, many just stand there and hope the rhino will change directions.
Black Swans are the opposite; they are low probability events that shock everyone when they appear. Nobody sees them coming. They come out of nowhere and cause massive damage.
Why models fail to predict black swan events
Models of traditional risk are great during normal market conditions. They are completely useless during Black Swan events. Understanding why this is crucial to keeping your trading account's head above water.
Most financial models make the assumption that markets behave in a normal manner. Most models rely on historical data for predicting future risks. Financial models calculate probabilities based on past events and then match those probabilities with calculated losses. This is effective in simple, everyday, market moves, but it fails completely when there is a rare event.
The Danger inside a Black Swan Event, and Where to Find Opportunities
There are both dangerous and opportunities that accompany Black Swan events. There are many savvy traders and institutions that are able to profit in extreme volatility of the market. They trade amid chaos in the markets.
Hedge funds commonly employ volatility arbitrage strategies. Generally when there is a Black Swan event volatility quickly shooting higher in the form of the VIX (volatility index) present a trip-killer for a fund with short volatility. However, for funds with long volatility outcomes may be worth dramatically higher dollars then they originally paid in.
There are other types of traders that look for Black Swan events. They purchase cheap out-of-the-money options. Cost very little when markets are calm but the worth can be exponential during crisis events. Trading a Black Swan is like having insurance that pays off after the disaster.
Final Thoughts
Black Swan events are something that will permanently exist in the forex markets. They have existed throughout the whole financial history. They will continue to exist in the future. You will not know exactly when they will happen, but you can prepare for it.
The unpredictable nature of these events creates challenges and opportunities. Traders who panic during Black Swans typically end up losing money, while traders with good risk management can make money from the chaos. The differences in outcome are preparation and attitude.
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