Fooled By Randomness

“I think the market is going to go up today, but I’m betting against it.”

You might think that statement is a little contradictory, but as Nassim Taleb explains, in Fooled by Randomness: The Hidden Role of Chance in Life and in the Markets, that it is perfectly reasonable to expect that on most days the stock market will go up a little bit, but on the rare-but-still-expected day it will decline by an amount that exceeds all the gains.  This is because of the asymmetry (or skewness) of market behavior and outcomes – the probabilities and payoffs are asymmetrical.  There’s a good Wikipedia article that explores the concept.

Taleb spends many pages lamenting that financial pundits and talking heads can’t seem to grasp that simple concept (along with several others).  

Taleb established his credibility in this area because he developed his perspective in the late eighties and has successfully put his money behind it ever since:

His 20-year trading career has been marked by jackpots (like when he lucked out in trading options during the stock market crash of 1987) followed by long dry spells.  “If you lose money on a steady basis and then make money in a lumpy way, people think you’re crazy,” he says.

– Bloomberg Profile

There are a couple of great insights encased in the general disorganization of this book.  Skewness is one.  Another is the fact that traders who employ a strategy suited to the current economic temperament will outperform (in the short and medium term) traders who employ more generally robust strategies.  And furthermore, of traders who employ more robust strategies, luck is going to produce some big winners – who the financial press are going to profile and study and praise their perceptivity.

Taleb raises the point that there are many praiseworthy necessary conditions for trading success, but that these are insufficient, and that luck is also necessary.  [Aside – I always love it when people address the issue of necessary and sufficient conditions – I think it should be part of the highschool curriculum]

Some people will find the core ideas in this book obvious.  Others will point out that the you can’t disprove a thesis that says: “You’re underestimating uncertainly and in the long run I will be proven correct.”  

The main problem of the book is that too much ink is spent remarking upon the general stupidity of traders, commentators and pretty much everyone else.  But fortunately, he informs us, he doesn’t pay any attention to any of them.  One particularly redeeming feature of the personality that spills out onto the pages, is that he seems to know that he’s being disorganized, anecdotal, perhaps a little petty – and he doesn’t care.  He’s self-consciously unrepentant.

It also important to note that this book was written in 2001.  Although now all the rage, Taleb should get credit for being an early advocate of the ideas and research of Kahneman and Tversky.

Taleb is most-closely associated with the concept of the Black Swan – a rare, impactful, and unpredictable event.  During the bubble and global financial crisis of 2007/2008 – an event which reportedly earned him a multi-million dollar fortune – Taleb released The Black Swan: The Impact of the Highly Improbable, which carries on his discussion of skewness and uncertainty. And most recently he has published Antifragile: Things that Gain from Disorder, where he tries to provide “a blueprint for living in a Black Swan world.”  I haven’t read either of these but I look forward to both of them – I just hope that his critical success will have caused him to focus a little more on the clear articulation of his ideas, and a little less on stupidities and foibles of others.


About brendansterne

Sr Director, Product Incubator
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2 Responses to Fooled By Randomness

  1. Pingback: Entrepreneurship: The Coin-Flipping Biathlon | Brendan Sterne

  2. Wen Ge says:

    I read this book 2 years ago, and it has had a profound impact on my life and my views on investing.

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