Fooled by Randomness

The book as the title suggest Fooled by Randomness brings out the role of chance and luck over widely proclaimed qualities marketed more often in the world of randomness. It lays an alternative perspective to various aspects like luck, probability, theory etc. As Taleb proclaims in the preface “my motto is to tease those who take themselves and quality of their knowledge too seriously”. Being a mathematician and an long standing advocate of probability theory Taleb does not refrain from trolling the concept of “certain knowledge” and its practitioners. Qualities like perseverance, persistence and doggedness may be necessary but not enough  in order to win. The prologue gives brief outline regarding the flow of the book and what does it stand for. It lays down the “Table of confusion” covering the central distinctions used in the book.

Part 1 - Solon’s Warning

Solon the Greek legislature warns Croesus, the rich king, about luck and happiness. Taleb uses the story to explain the nature of randomness and skewness which the king faced.

How Solon warned the king about the fact that and I quote “that which came with the help of luck could be easily taken away by luck and that which comes with little luck are more resistant to randomness”

Chapter 1 If you're so Rich, why aren't you so smart !

The story in chapter 1 discusses Nero Tulip, Coupe De infatuated by trading profession to become an effluent risk manager, thinking in probabilities. The chapter ponders upon the fact that we are resistant to randomness while randomness is quite evident in every day life right from leadership abilities to getting success. The concept of mild success and wild success had discussed as mild success can be explained by skills and labor wild success is attributable to variance and randomness.

A new character John from being an exuberant trader living a life an extravagant style looking down at Nero like an educated loser to blowing up his account.
“Myths particularly well aged ones as we saw with solon’s warning can be far more potent then plain reality.”

Chapter 2 A Bizarre Accounting Method

It gives a more wider view of watching success. It explains the analogy of alternative histories using the example of Russian Rowlett and extrapolating results, some seen, while most of it unseen. Different points like alternative histories, proverbs galore, epiphenomena (one has illusion of cause and effect -like by “watching” your risks are you effectively managing them?) have been discussed.

Taleb describes his nightclub visit and his meeting with Kenny (conservative in look but ticking time bomb) and Jean Patrice (hyperagressive but had wits of Solon). How looks can be deceptive and wits can be packed in any form. Kenny had successful while Jean had difficult career.

“Masters of the Universe demeanor, they suddenly look pale, humble, and hormone deprived.”

Chapter 3 Monte Carlo Simulation 

A combination made out of Monte Carlo’s realism and mathematical intuition.

Monte Carlo simulator is way to create artificial history and connect it with present. Methods - Alternative sample paths – explained using bird analogy (We are not just concerned with where a bird can end up tomorrow night but rather all places it can possibly visit during time.)

Random Sample path – succession of virtual historical events during a time period (random does not mean equiprobable)

Stochastic - having a random probability distribution or pattern that may be analyzed statistically but may not be predicted precisely.

These three together create Monte Carlo Simulator.

Taleb critiques journalists, historians and financial managers, differentiates noise and meaning out of noise, risk knowing and risk management and lays out recreating and degenerating history to distill out our thinking which fools us by randomness. A negative pang cannot be offset by positive one. Daily exposure to high degree of randomness without much control will have psychological effects on traders.

“Those who were unlucky in life in spite of their skills would eventually rise over the long run. (ergodicity)”

Blownup traders think that they knew enough about the world to reject the possibility of the adverse event taking place :There was no courage but ignorance in taking that risk.

Over short time increment, one observes the variability of portfolio not returns. What one observes is combination of variability and returns.

Chapter 4 Randomness, nonsense and scientific intellectual.

Quite short chapter talks about scientific and literary intellectual and tune it with randomness in each paradigm. Taleb critiques Hegel as father of pseuothinkers and mocks the negation of negation concept.

Turing test as the test in which a computer can be said intelligent if it can fool a human into mistaking it for another human and converse is as true. Taleb basically points out at how often we get fooled by randomness and attribute it with rationality while in reality, when using data and Monte Carlo simulator Taleb brings out randomness from literary works to business talks.

Chapter 5 Survival of the Least fit - Can evolution be fooled by randomness?

The chapter starts with Emerging market bonds and their boom in late 1990s and rise of new market wizards.

It draws down the story of Carlos and John, two different sort of traders and their stories from riches to rags. John, as mentioned earlier, failed due to overleveraged position (or can be attributed as statistical failure whereas Carlos, bond trader of emerging markets who bought the dip of Russian bonds and lost a very large chunk from the entire capital. Both these traders had their success runs which Taleb attributes to randomness offered by the market. Common traits which they shared – overestimation of accuracy, denial, married positions, no game plan on what to do in event of losses, swinging between trader and investor.

Firehouse Effect – Fireman with much downtime talk to one another for too long come to agree on things that an outside impartial observer would find ludicrous.

“For evolution means fitness to one and only one time series, not the average of all possible environments.”

Chapter 6 Skewness and asymmetry

It talks about the way people look at data without looking at sample available- whether symmetric or asymmetric. Taleb crunches out using numbers and anecdotes, the difference between average and median, probability and expectation, history and rare events in history, science and symmetry.

Most intriguing thoughts which I found in this chapter was the Time series analysis and Rare event fallacy and how it makes a fool of us. Time series which is symmetric and devoid of randomness (which does not exist) would make prediction of events quite easy but the world we live in is full of asymmetries and randomness.

Rare event fallacy is explained quite aptly using the Black ball boy analogy, how it distorts probability and how randomness sinks in in real world. Rare events deceives the predictable patterns and makes them useless to predict the future.”

He also tries to explain his style of speculation in which the expectation out of the sample (probability time profit) matters over frequency of getting profit or the probability of being right in the market. He takes a dig at bullish and bearish stances and pronounce them as mere terms of zoology.

“How frequent the profit is irrelevant, it is the magnitude of the outcome that counts.”

“Whenever there is asymmetry in the outcomes, the average survival has nothing to do with median survival.”(symmetric sample – coin toss i. e no uncertainty to the bell curve)

Chapter 7 The problem of Induction

Hume's epistemology to Niderhoffer’s advocacy on cobweb of learning. Induction a problem largely present in field of science has travelled long to social sciences and economics largely to trading. According to Popper, the problem of induction as usually conceived is asking the wrong question: it is asking how to justify theories given they cannot be justified by induction. Popper argued that justification is not needed at all, and seeking justification "begs for an authoritarian answer".

Only two type of theories – One, theories that are known to be wrong as they were tested and rejected (falsified theories) and others not yet known to be wrong but are exposed to be proved wrong. The chapter is knit around this central idea of induction majorly by Poppers work followed by Niederhoffer and Cygnus Ayratus.

“Samples can be greatly insufficient, markets may change. They are not sample win and loss type of situations, as the cost of losses can be markedly differ from that of wins. Maximizing probability does not maximize expectation.”

Part II - Monkeys on Typewriters 

Chapter 8 Too many millionaires next door

As the title suggests, the effect of survivorship bias in millionaire story (like lucky monkey’s on typewriter)

Marc- Harvard and Yale graduate with long working hours and unsuccessful personal life. Taleb explains that the success sample differs and putting Marc with different sample (a posh locality with no so called losers) would not make him count in as successful and often leads to emotional distress. “You become rich, move to rich neighborhoods and again become poor.”

Survivorship bias occurs when only the winners are considered while the losers that have disappeared are not considered. It implies that the highest performing realization will be most visible.

The Millionaire next door a book getting to a lot of hands being critiqued by Taleb. He calls it as a book filled with survivorship biases - Millionaires look at winners by putting them in different samples-managers in sample only had survivors.

Chapter 9 Fry an egg

Survivorship bias or survivor bias is the tendency to view the performance of existing stocks or funds in the market as a representative comprehensive sample without regarding those that have gone bust.

This chapter further illustrates further about survivorship bias. Taleb talks how using Monte Carlo generator we can bring out the survivorship bias from successful fund managers (over one, two, three, four and five years)- their probability of winning over years to bring out the randomness from the data which often looks lucrative.

Other situations like Revere Survivors, birthday paradox, over dependence on past data, book jackets, back testing – without factoring in the fact that sample takes average, earnings season drama, cancer cure – where Taleb brings out how we get fooled by randomness just by merely looking at hard facts and averages ignoring the sample data or distorting exceptions.

 “I never said that rich man is an idiot and every unsuccessful unlucky, only that in absence of much additional information it is preferable to reserve one’s judgment.”

Chapter 10 Loser takes all – On nonlinearities of Life

Sand pile effect analogy to define nonlinearity – Last grain of the sand to lead to the collapse of the entire structure- i.e. How linear force leads to nonlinear results.

Taleb, using the analogy of sandpile effect, Cleopatra’s nose, an actor serving latte, Bill Gates software tries to substantiate that life is unfair in nonlinear way i.e. the role of luck and randomness rewards someone with extreme success while others suffer to pay the bills.

The probability of winning increases after past wins and that of losing increases after past losses. Simulating such a process, one can see a huge variance of outcomes, with astonishing successes and a large number of failure (skewness) i.e. Losers take it all.

It is this non linearity which someday glides you away from basics but suddenly you can perform advanced level stuff.(Piano lesson Analogy- lesson each day results in playing perfectly overtime and Buridan’s Donkey who died of indecision due to randomness.)

Chapter 11 Randomness and Our mind

This chapter highlights the manifestations that how our brain gets blinded by probable events and think in one of the extremes –E.g. survival rate of cancer patient. Kahneman and Tversky’s work on mental heuristics (availability, representative, hindsight biases) prospect theory, normative economics, behavioral economics, system based thinking (Rational and heuristic part) has been discussed.

We do not understand probability but we react rather well to frequencies, domain specific and domain general adaptations of brain, working of brain in modules (different modules for different instances of same problem), role of emotions as “lubricants of reason”.

The later half of the chapter guides us on the biases and probability dichotomy in detailed manner and try to propose a solution to think out of these heuristics. Using stock market movement and its implications on our probability blind brain, noise generating journalism and cause effect over analysis collectively guiding us towards getting fooled by randomness over and over.

“People overvalue their knowledge and underestimate the probability of their being wrong.”

 Part III of the book suffice  how to live with this randomness

Chapter 12 Gamblers’ ticks and pigeon in box

The chapter highlights how traders act as gamblers losing the psychological well being, playing the game by heuristics and development of behavioral distortions.

Gambling is defined as the activity where random outcome gives you the thrill and you bet regardless the odds are against you. Such behavior gets build in which leads to frequent blowups.

Trader’s case study- After registering a profit of $100,000 on a given strategy – Nasim draws two conclusions –the rational one- 2% probability that it is profitable strategy vs 98% probability that it may be result of noise-whereas a gain of $1mn certifies that strategy is profitable with 99% probability. To keep the emotional aspect away, Taleb used to not have a look at its performance reports until it hits a threshold mark.

“It is emotionally harder to reject a hypothesis than to accept it.”

Chapter 13 On probability and Skepticism

It covers the story of Carneades, the Greek philosopher who introduced probability as a concept in ancient Rome and bringing in skepticism along. Probability is about the belief in the existence of an alternative outcome, cause or motive.

Probability generates skepticism (Skepticism is questioning attitude or doubt towards one or more putative instances of knowledge which are asserted to be mere belief or dogma) or as Taleb calls “Probability, the child of skepticism”. Clubbing these two concepts together leads often to self-contradiction which is often seen as a taboo in many cultures.

Endowment effect – married to your positions or belief being path dependent as in the sequence of ideas the first one dominates.

“You attribute your success to skills, but your failures to randomness.”

Chapter 14 Bacchus Abandons Antony

The title of the chapter comes from a poem titled The God Abandons Antony (from Julius Caesar). Marc Antony who lost the battle to Octavius, was forsaken by Bacchus (the God who protected him). Taleb highlights a totally new angle, more archaic softer type of philosophy to deal with randomness and lays emphasis on Stoicism. Stoicism as Taleb tells is “ the attempt by man to get even with probability.” Dignity in our behavior or grace under pressure to deal with the random world. He recommends every reader to go through the Letters from a Stoic and at last gives a few advices – Standing erect and proud, dignified attitude in victory as well as defeat, not to blame others for your fate, no self pity and exhibit sapere vivere ( “know how to live”)

“The only article lady fortune has no control over is your behavior.”

“No matter how sophisticated our choices, how good we are at dominating the odds, randomness will have the last word.”

The book ends with reiterating Solon’s warning from chapter one, and the death of Nero by helicopter crash (black swan got him). Overall, the books throws open a lot of fresh perspectives on how we think and what guides out behavior, how to look upon those facts (often filled with randomness and how to behave while living in the world where most of us are often “Fooled by Randomness.”