Tip of the Week #94
Go to the Prior Tip Jack:
Straight from the Gut
Fooled by Randomness: The Hidden Role of Chance in the
Markets and in Life
Go to the Next Tip Markets, Mobs & Mayhem
by Robert Menschel
Return to MaxValue Home Page
by Nassim Nicholas Taleb, 2001, TEXERE Publishing Ltd, London and NY, hardback,
203 pages, ISBN 1-58799-071-7, US$27.95.
People tend to underestimate randomness. Nassim Taleb has made a
good living in trading options, betting on rare events that are sometimes
under-priced in the market. The book takes the reader on a philosophical
and somewhat auto-biographical tour of the author's thinking about risk.
Anecdotes abound where people have mistaken fundamental concepts in probability
- Excellent performance or track records are often insignificant
statistically. Traders and mutual funds that claim great performance
can be explained by "survivorship bias," where only the good ones
are left. People often mistake luck for skill.
- The rule of pecking order (p. 20): People prefer to make $70,000
while others around them are making $60,000 than to make $80,000 when others
around them are making $90,000 [this finding attributed to psychologists
Kahneman and Teversky]. Also, "there is a difference between
wealth reached from above and wealth reached from below. The
road from $16 million to $1 million is not as pleasant as the one from 0 to
$1 million." (p. 77)
- Most traders seem unaware of the "blow up" or "black
swan" problem. You can be making money well enough for a long
time, then suddenly things go horribly wrong. The outlier event can
put you out of business or end a career.
- Because of emotionally weighing bad outcomes more heavily than good
outcomes, most investors would feel better to rarely examine their
portfolio. Check account statements only monthly or, better,
yearly. There is lots of noise that is not meaningful. With
about the same number of good and bad weeks, days, and hours, most investors
tracking their stocks end up feeling poorly.
- When examining two events, we have a tendency to form opinions about
relationships. We have a bias toward seeing patterns where perhaps
none exist. "Scientists know that it is emotionally harder to
reject a hypothesis than to accept it. (p. 179)
Despite that he wrote this book, Taleb's wish is for investors in
general to remain fools of randomness so he can trade against them (p. 39).
This book is short on quantitative methods and long on philosophy.
Taleb does manage to explain quite a few ideas , woven into the many stories in
the book. I enjoyed the book and recommend it.
From the dustjacket: "I really like this book. We need
a book like this, that helps us deal with our hard-wired human tendency to
underestimate randomness. It is fun to read, refreshingly
independently-minded and at the same time playful." Robert
Shiller, Yale University, author of Irrational Exuberance.
John Schuyler, October 2002.
Copyright © 2002 by John R. Schuyler. All rights reserved. Permission to copy with
reproduction of this notice.