Known Unknown or Unknown Unknown?

Is a disaster or catastrophic event a known unknown or an unknown unknown?

Chatting with a client recently about the expected market reaction to the Paris tragedy I used the term ‘known unknown’.

A known unknown is an event that is known to occur, we just don’t know when or where.

Like a terrorist attack.

September 11 2001 was an unknown unknown. The world hadn’t seen anything like it and because the world hadn’t seen or experienced anything of that manner the market did react. The market doesn’t like uncertainty and after the Sept 11 attacks nobody quite knew what the end outcome was going to be, so the markets took a dive.

However, now that the precedent has been set, market participants know the world continues on so market reaction to new attacks will tend to be muted.

Like Spain in 2004 and now Paris. They were known unknowns.

When it comes to trading and investing we need to consider how certain events will impact our processes.

A Fed rate increase for example is a known unknown. It probably won’t have a significant impact on the market if and when it occurs.

In 1998 the trading floor of the Sydney Futures Exchange closed. All the Locals who made significant profits from the open outcry process suddenly lost their edge. Most are now out of business. That’s an unknown unknown.

In 2008 the Australian regulators banned short selling. If you had relied on a trading strategy that traded the short side, all of sudden your business was invalid. Another unknown unknown.

What are the known unknowns and unknown unknowns that may affect you?