After reading a very insightful piece by former derivatives trader and current philosophical essayist Nassim Nicholas Taleb, my eyes have been opened to how institutions should be created to better withstand volatility.
Many know Taleb for his Black Swan theory, which details the implications of incalculable, ‘surprise’ events resulting in some degree of catastrophic damage. In a Wall Street Journal op-ed titled Learning to Love Volatility, Taleb draws from his former theory, using it to derive the term “Antifragility.” The opposite of being vulnerable to volatility, antifragility was coined to describe the concept of creating institutions that won’t fall apart when they encounter black swan events.
Instead, they will be able to use these seeming disasters to improve upon themselves and continue to grow stronger.
No matter how hard we try, we can’t make something that will accurately predict a future black swan. What we can do, though, is create something that’s resilient to them. Taleb goes on to propose five rules for increasing instances of antifragility in our socioeconomic lives.
Touched upon were theories such as:
Thinking of the economy as more humanistic than machine.
Favoring businesses that progress with every failure.
Bigger isn’t always better.
Learn by doing and through trial and error.
The need for decision makers with skin in the game.
Out of the aforementioned concepts, I found the first rule, which is analogous to the need for our economy to be thought of more like a cat than a washing machine, to resonate most with me.
“Deprive your bones of stress and they become more brittle"
The theme here is that by being more human than machine, our economy and all of its moving parts might develop a means of shock absorption and adaptability to withstand pressures. This way, we can reap the developmental rewards of exposure to unfavorable circumstances, while averting any major damaging effects they could cause.
“Deprive your bones of stress and they become more brittle,” says Taleb. By constantly shielding all things from unpredictable discomforts, they will not be pushed to develop and grow stronger. Stress, discomfort, and volatility are all parts of life and using them to our advantage by exposing our (prepared) selves to them is how we grow stronger.
Foreign currency trading is a good example of an antifragile system. The FX market is over $5 trillion USD equivalent, which means many pairs can be considered some of the most liquid asset classes in the world. Also, FX is a 24 hour market and currencies are non-standardized, which means they trade OTC rather than on an exchange. This makes it more flexible in relation to other standardized markets and instruments.
Unlike other forms of investing, currencies are traded in pairs. This means one is always bought when the other is sold, so one goes up while the other inevitably goes down against it (trade impact is obviously dependent on volume, liquidity, how thinly traded the pair is, etc.). This in turn creates volatility, which is what allows traders to take advantage of exchange rate fluctuations. Compared to stocks and bonds, FX and commodities are generally considered to be a more volatile asset class. When trading, volatility is good as active pairs are what can be capitalized on.
Institutional investors control a majority of the large and mid cap portions of the stock market. These market participants are moving greater amounts of money and also have less flexibility in risk and the speed they enter and exit the market (tracking error, traders placing orders from portfolio managers, etc.). Many stock market participants are also longer-term investors rather than short-term traders looking to make a quick profit and get out. These factors all contribute to less short-term volatility.
Though the Forex market volume is also comprised primarily of institutional traders, much of it is very liquid and easier to get in and out of due to frequency of money changing hands each day.
Often times, currency trader’s returns languish during market calms. Taking antifagility in Forex trading one step further would be using options on currency futures when markets are tranquil and anticipating the return of volatility.
Another example of antifragility in the currency world is the security of the blockchain technology that underlies cryptocurrency transactions. Though it is not impervious to attacks, it responds to them and grows stronger due to the network size. Of the cryptocurrencies, bitcoin is the oldest at nine years, and thus has withstood the most societal, technical, and monetary volatility and is still here.
I agree with Taleb that the stressors of life are necessary for growth, strength, and continuous progression. Adversity does build character, after all. The only way to advance and get ahead is to push oneself out of their comfort zone. If you can operate with the agility of a cat, rather than the rigidity of a machine, not only will you be able to absorb the shock of a chance black swan, but you will also benefit and grow stronger from it.