Fooled By Randomness The Hidden Role Of Chance In Life And In The Markets

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Good book on probability, biases and for those interested in trading / investing

I had skipped this, assuming I received the full contrarian worldview from Black Swan and Bed of Procrustes. But it’s a different beast, more playful and modest, with less of his latter-day overstatement and invalid ad hominems. As anti-disciplinary provocateur and writer of empirical art he is unbeaten (I rank him with Nietzsche for delightful arrogance and hard-ass enculturation.) Still, these ideas (from cognitive science and applied statistics) are hard: one needs several runs at them. Taleb is a great introduction, then Kahneman and Gigerenzer for the calm conservative estimate.

This book is amazing. I'd listened to audiobooks of Taleb before and have been exposed to some of his ideas, but reading his words is a lot better. His writing style is highly enjoyable, oozing an attitude of 'why is everyone so stupid except for me?' The gist of the book is that survivorship bias leads us astray not just theoretically but is all around us—we shouldn't take advice from rich and successful people because you don't see the 10 others that took the same path but failed on the way. The other big idea of the book is that (in the financial trading profession) many people take risks that give them a steady return until a 'one in a billion' event happens that wipes them out. The thing is that many one in a billion events happen every year, which is a mathematical fact. Nice book!

Interesting applications to entrepreneurship and startup success and failure.

Great insights although repetitive over the course of the book. Taleb is quite narcissistic which is unbearable at times

Some people can get offended by this book because of how the author labels virtually everyone who we, the mortals, kind of admire and think of authority figures. He calls financial economist charlatans and says that journalism is just noise and a waste of time. Personally, I’m happy to read smart people ranting about things and dismissing the accepted by society ideas as long as they’re not taking themselves too seriously. And that’s exactly what Nassim Nicholas Taleb does in this book. Actually, he’s quite sincere about his limitations and his flaws – making the book even more enjoyable. If you’re considering reading the book, keep in mind the following: If you’re know-it-all smarty-pants you’ll surely hate the author but at least you might reconsider some of your hardcoded beliefs about the world. My personal takeaway? Don’t rely on past events and on social norms to make a decision. Always look for new sources of information, preferably different from your current stance. This will give you a fresh perspective and potentially save you from being fooled by randomness. Read more: https://durmonski.com/book-summaries/...

** spoiler alert ** Brilliant read. Taleb's aphorisms on randomness, probability and uncertainty are enlightening and entertaining. Without further tainting the beauty of this work of art, here are a few quotes I found interesting. Fooled by Randomness: The Hidden Role of Chance in Life and in the Markets Nassim Nicholas Taleb Aut tace aut loquere meliora silencio (only when the words outperform silence). ***** You can mispredict everything for all your life yet think that you will get it right next time. ***** A red convertible Porsche, driven at several times the city speed limit, abruptly stopped in front of the entrance, its tires emitting the sound of pigs being slaughtered. ***** That day Nero Tulip was hit with what the French call a coup de foudre, a sudden intense (and obsessive) infatuation that strikes like lightning. ***** What he likes most about proprietary trading is that it requires considerably less time than other high-paying professions; in other words it is perfectly compatible with his non-middle-class work ethic. Trading forces someone to think hard; those who merely work hard generally lose their focus and intellectual energy. In addition, they end up drowning in randomness; work ethics, Nero believes, draw people to focus on noise rather than the signal ***** Heroes are heroes because they are heroic in behavior, not because they won or lost. ***** (Note that the risk of dying from food poisoning or in a car accident on the way to a restaurant is greater than dying from mad cow disease.) This sensationalism can divert empathy toward wrong causes: cancer and malnutrition being the ones that suffer the most from the lack of such attention. ***** I remind myself of Einstein’s remark that common sense is nothing but a collection of misconceptions acquired by age eighteen ***** While we know that history flows forward, it is difficult to realize that we envision it backward. ***** I will repeat this point until I get hoarse: A mistake is not something to be determined after the fact, but in the light of the information until that point. ***** A more vicious effect of such hindsight bias is that those who are very good at predicting the past will think of themselves as good at predicting the future, and feel confident about their ability to do so. ***** If there is anything better than noise in the mass of “urgent” news pounding us, it would be like a needle in a haystack. People do not realize that the media is paid to get your attention. For a journalist, silence rarely surpasses any word. ***** it is just that prominent media journalism is a thoughtless process of providing the noise that can capture people’s attention and there exists no mechanism for separating the two. ***** Fashionable Nonsense: Postmodern Intellectuals' Abuse of Science ***** The Selfish Gene ***** Visibly, the statistic that 90% of all option positions lost money is meaningless, (i.e., the frequency) if we do not take into account how much money is made on average during the remaining 10%. If we make 50 times our bet on average when the option is in the money, then I can safely make the statement that buying options is another way to go to the palazzo rather than the poorhouse. Mr. Jim Rogers seems to have gone very far in life for someone who does not distinguish between probability and expectation ***** In his book The Nature of Rationality he gets, as is typical with philosophers, into amateur evolutionary arguments and writes the following: “Since not more than 50 percent of the individuals can be wealthier than average.” Of course, more than 50% of individuals can be wealthier than average. Consider that you have a very small number of very poor people and the rest clustering around the middle class. The mean will be lower than the median. ***** For instance, the statement The market never goes down 20% in a given three-month period can be tested but is completely meaningless if verified. I can quantitatively reject the proposition by finding counterexamples, but it is not possible for me to accept it simply because, in the past, the market never went down 20% in any three-month period (you cannot easily make the logical leap from “has never gone down” to “never goes down”). Samples can be greatly insufficient; markets may change; we may not know much about the market from historical information. ***** it is just that reality does not have the same closed and symmetric laws and regulations as games. ***** Sadly, I learned quite a bit from Niederhoffer, mostly by contrast, and particularly from the last example: not to approach anything as a game to win, except, of course, if it is a game. ***** I suddenly felt financially insecure and feared becoming an employee of some firm that would turn me into a corporate slave with “work ethics” (whenever I hear work ethics I interpret inefficient mediocrity). ***** There are only two types of theories: 1. Theories that are known to be wrong, as they were tested and adequately rejected (he calls them falsified). 2. Theories that have not yet been known to be wrong, not falsified yet, but are exposed to be proved wrong. ***** Indeed the difference between Newtonian physics, which was falsified by Einstein’s relativity, and astrology lies in the following irony. Newtonian physics is scientific because it allowed us to falsify it, as we know that it is wrong, while astrology is not because it does not offer conditions under which we could reject it. Astrology cannot be disproved, owing to the auxiliary hypotheses that come into play. Such point lies at the basis of the demarcation between science and nonsense (called “the problem of demarcation”). ***** Accordingly, I will use statistics and inductive methods to make aggressive bets, but I will not use them to manage my risks and exposure. Surprisingly, all the surviving traders I know seem to have done the same. They trade on ideas based on some observation (that includes past history) but, like the Popperian scientists, they make sure that the costs of being wrong are limited (and their probability is not derived from past data). ***** They are hidden away, as one sees only the winners—it is natural for those who failed to vanish completely. Accordingly, one sees the survivors, and only the survivors, which imparts such a mistaken perception of the odds. We do not respond to probability, but to society’s assessment of it. ***** A similar misconception of probabilities arises from the random encounters one may have with relatives or friends in highly unexpected places. “It’s a small world!” is often uttered with surprise. But these are not improbable occurrences—the world is much larger than we think. It is just that we are not truly testing for the odds of having an encounter with one specific person, in a specific location at a specific time. Rather, we are simply testing for any encounter, with any person we have ever met in the past, and in any place we will visit during the period concerned. The probability of the latter is considerably higher, perhaps several thousand times the magnitude of the former. ***** The late astronomer Carl Sagan, a devoted promoter of scientific thinking and an obsessive enemy of nonscience, examined the cures from cancer that resulted from a visit to Lourdes in France, where people were healed by simple contact with the holy waters, and found out the interesting fact that, of the total cancer patients who visited the place, the cure rate was, if anything, lower than the statistical one for spontaneous remissions. It was lower than the average for those who did not go to Lourdes! Should a statistician infer here that cancer patients’ odds of surviving deteriorates after a visit to Lourdes? ***** Next I put the platitude life is unfair under some examination, but from a new angle. The twist: Life is unfair in a nonlinear way. ***** Popular wisdom has integrated many such phenomena, as witnessed by such expressions as “the straw that broke the camel’s back” or “the drop that caused the water to spill.” These nonlinear dynamics have a bookstore name, “chaos theory,” which is a misnomer because it has nothing to do with chaos. Chaos theory concerns itself primarily with functions in which a small input can lead to a disproportionate response. ***** Just as Nero cannot “think” in complicated shades, consumers consider a 75% fat-free hamburger to be different from a 25% fat one. Likewise with statistical significance. Even specialists tend to infer too fast from data in accepting or rejecting things. Recall the dentist whose emotional well-being depends on the recent performance of his portfolio. Why? Because as we will see, rule-determined behavior does not require nuances. Either you kill your neighbor or you don’t. Intermediate sentiments (leading, say, to only half his killing) are either useless or downright dangerous when you do things. The emotional apparatus that jolts us into action does not understand such nuances—it is not efficient to understand things. ***** Kahneman and Tversky asked subjects to estimate the proportion of African countries in the United Nations after making them consciously pull a random number between 0 and 100 (they knew it was a random number). People guessed in relation to that number, which they used as anchor: Those who randomized a high number guessed higher than those who randomized a low one. This morning I did my bit of anecdotal empiricism and asked the hotel concierge how long it takes to go to the airport. “40 minutes?” I asked. “About 35,” he answered. Then I asked the lady at the reception if the journey was 20 minutes. “No, about 25,” she answered. I timed the trip: 31 minutes. ***** Researchers divide the activities of our mind into the following two polarized parts, called System 1 and System 2. System 1 is effortless, automatic, associative, rapid, parallel process, opaque (i.e., we are not aware of using it), emotional, concrete, specific, social, and personalized. System 2 is effortful, controlled, deductive, slow, serial, self-aware, neutral, abstract, sets, asocial, and depersonalized. ***** Worse, one Harvard lawyer used the specious argument that only 10% of men who brutalize their wives go on to murder them, which is a probability unconditional on the murder (whether the statement was made out of a warped notion of advocacy, pure malice, or ignorance is immaterial). Isn’t the law devoted to the truth? The correct way to look at it is to determine the percentage of murder cases where women were killed by their husbands and had previously been battered by them (that is, 50%)—for we are dealing with what is called conditional probabilities; the probability that O. J. killed his wife conditional on the information of her having been killed, rather than the unconditional probability of O. J. killing his wife. How can we expect the untrained person to understand randomness when a Harvard professor who deals and teaches the concept of probabilistic evidence can make such an incorrect statement? ***** A test of a disease presents a rate of 5% false positives. The disease strikes 1/1,000 of the population. People are tested at random, regardless of whether they are suspected of having the disease. A patient’s test is positive. What is the probability of the patient being stricken with the disease? Most doctors answered 95%, simply taking into account the fact that the test has a 95% accuracy rate. The answer is the conditional probability that the patient is sick and the test shows it—close to 2%. Less than one in five professionals got it right. ***** Causality: There is another problem; even assuming statistical significance, one has to accept a cause and effect, meaning that the event in the market can be linked to the cause proffered. Post hoc ergo propter hoc (it is the consequence because it came after). Say hospital A delivered 52% boys and hospital B delivered the same year only 48%; would you try to give the explanation that you had a boy because it was delivered in hospital A? ***** People might ask me: Why do I want everybody to learn some statistics? The answer is that too many people read explanations. We cannot instinctively understand the nonlinear aspect of probability. ***** We can see that my activity in the market (and other random variables) depends far less on where I think the market or the random variable is going so much as it does on the degree of error I allow around such a confidence level. ***** Unless the source of the statement has extremely high qualifications, the statement will be more revealing of the author than the information intended by him. This applies, of course, to matters of judgment. A book review, good or bad, can be far more descriptive of the reviewer than informational about the book itself. This mechanism I also call Wittgenstein’s ruler: Unless you have confidence in the ruler’s reliability, if you use a ruler to measure a table you may also be using the table to measure the ruler. The less you trust the ruler‘s reliability (in probability called the prior),the more information you are getting about the ruler and the less about the table. The point extends way beyond information and probability. This conditionality of information is central in epistemology, probability, even in studies of consciousness. ***** What changed his mind? He does not feel obligated to explain it. ***** What characterizes real speculators like Soros from the rest is that their activities are devoid of path dependence. They are totally free from their past actions. Every day is a clean slate. ***** There are reasons to believe that, for evolutionary purposes, we may be programmed to build a loyalty to ideas in which we have invested time. ***** My lesson from Soros is to start every meeting at my boutique by convincing everyone that we are a bunch of idiots who know nothing and are mistake-prone, but happen to be endowed with the rare privilege of knowing it. ***** Dress at your best on your execution day (shave carefully); try to leave a good impression on the death squad by standing erect and proud. Try not to play victim when diagnosed with cancer (hide it from others and only share the information with the doctor—it will avert the platitudes and nobody will treat you like a victim worthy of their pity; in addition, the dignified attitude will make both defeat and victory feel equally heroic). Be extremely courteous to your assistant when you lose money (instead of taking it out on him as many of the traders whom I scorn routinely do). Try not to blame others for your fate, even if they deserve blame. Never exhibit any self-pity, even if your significant other bolts with the handsome ski instructor or the younger aspiring model. Do not complain. If you suffer from a benign version of the “attitude problem,” like one of my childhood friends, do not start playing nice guy if your business dries up (he sent a heroic e-mail to his colleagues informing them “less business, but same attitude”). The only article Lady Fortuna has no control over is your behavior. Good luck. --