Fooled by Randomness by Nassim Taleb - Nassim Nicholas Taleb has
written a mind-blowing book! Totally contrarian and terrifically clear
in explaining the fallacies followed by journalist, investors, traders
and, sadly, many scientists.
Example: Failing to notice the difference between probability and
expectation, famous commodity trader/investor Jim Rogers made this
"I don't buy options....90 percent of all long options lost money." ~
Rogers confused probability with expectation.
By itself, the 90 percent number means very little. What you need to
know before making a decision is the expectation. If that winning 10
percent of options yielded a lot of money, then options might actually
carry a VERY good expectation of making money. See chart below:
Event Probability Outcome Expectation
Option Lost $ 90% -$1 -$0.90
Option Gain $ 10% $100 +$10.00
But don't let the numbers delude you into thinking such a scenario can
be predicted. The chart illustrates the idea. Does the idea exactly
match reality? Never. So what is one to do?
The best description of my lifelong business in the market is "skewed
bets," that is, I try to benefit from rare events, events that do not
tend to repeat themselves frequently, but, accordingly, present a
large payoff when they occur.
I try to make money infrequently, as infrequently as possible, simply
because I believe that rare events are not fairly valued, and that the
rarer the event, the more undervalued it will be in price."
~ Nassim Taleb, FBR, p.103
So Taleb goes beyond defending himself against negative Black Swan
events. Instead, he actually tries to benefit from the rare events by
placing bets with a large payoff when those rare event occur. But how?
He's not very specific, but it almost certainly (pun?) involves
In the book he illustrated the point by describing a meeting he
attended where they asked him where the market was going. Though he
generally doesn't answer such questions, he ultimately said he
believed it was going up--that the probability it would go up was
high. But the traders countered that he placed bets that would only
payoff if the market went down (put options on S&P 500); how can you
say it's going up yet bet it's going down?
Because of expectation. Yes, at that time, most estimates
(meaningless?) would declare high probability of the market going up.
But IF it went down--if that rare event occurred--Taleb's bet would
payoff big. So while he may have thought the market would probably go
up, he placed bets to benefit huge if it went down. That's betting on
expectation and not probabilities.
This bet, presumably, took the form of some long-term derivatives (put
options). With such an investment(?), the potential (and likely)
losses are relatively small (the cost of the option) but the payoff
potentially huge. The idea is that you expect to lose most of the
time, but when you win, you expect to win big.
So as long as your numerous losses are small, and the unexpected event
does in fact occur, you can get win big. Of course, there are no
guarantees. You could bleed to death (hold lots of expired options)
while waiting for the black swan, which is why Taleb stresses to keep
most of you money in the safest investments possible (Government
Only use a small portion of your nest egg for chasing black swans.
So Nassim Taleb's best investment advice is to keep most of your money
absolutely safe, but for a small percentage, chase black swans.
Nassim Nicholas Taleb - Investment Advice
In Fooled by Randomness, Nassim Taleb offers some compelling, counter-
intuitive ideas on what action to take. Absolutely riveting.
Fooled by Randomness - Amazon Reviews
I really liked these reviews I found on Amazon. Hits the book's
If the prescriptions for getting rich that are outlined in books such
as The Millionaire Next Door and Rich Dad Poor Dad are successful
enough to make the books bestsellers, then one must ask, Why aren't
there more millionaires?
In Fooled by Randomness, Nassim Nicholas Taleb, a professional trader
and mathematics professor, examines what randomness means in business
and in life and why human beings are so prone to mistake dumb luck for
This eccentric and highly personal exploration of the nature of
randomness meanders from the court of Croesus and trading rooms in New
York and London to Russian roulette, Monte Carlo engines, and the
philosophy of Karl Popper.
Part of what makes this book so good is Taleb's ability to make
seemingly arcane mathematical concepts (at least to this reviewer)
entirely relevant in evaluating and understanding everything from the
stock market to the success of those millionaires cited in the
Here's an articulate, wise, and humorous meditation on the nature of
success and failure that anyone who wants a little more of the former
would do well to consider. Highly recommended. ~ Harry C. Edwards
This one is wonderfully critical of Taleb's approach. I found it quite
Read the other reviews to get the flavour of the book. I'll only add a
few points that haven't been mentioned.
1) There is good advice on avoiding some common mistakes that lead to
"blowing up", which will prove useful to inexperienced market
2) Taleb's own (claimed) trading methodology (buying OTM options)
could easily fall victim to the "black swan" problem. A regime change
to persistently higher implied than actual volatility would result in
extended losses for his fund (unless he is bluffing us about its
3) Taleb only focuses on cases where volatility is underpriced - but
some of the best opportunities come when it is overpriced, during
market panics. Yet according to what he says in the book, one should
continue buying such overpriced volatility! As someone whose bread and
butter trade is fading market panics, I can confirm that premium
selling can be highly profitable - the trick is to sell at the right
time, and to employ risk control. Just because some practitioners are
incapable of this, does not invalidate the method, any more than OTM
options buying is invalidated because many naive speculators buy in a
panic just before the VIX is about to collapse.
4) Taleb lumps MBA and businessmen types into the "fool" category.
This misses the point. 99% of business is not about risk-assessment,
dazzling insight, or grand strategic thought, but about successful
*execution* of obvious ideas, and hard work. How many eggheads have
had great ideas, but never done anything to put them into action?
There is no point knowing that a beach bar in the Bahamas might be
destroyed every 10 years by a hurricane, if you aren't even capable of
raising capital, employing people, or working 16 hour days getting it
off the ground. Good MBAs and CEOs will in any case employ people like
Taleb to assess risk for them.
5) Taleb ignores the possiblity of using praxeological analysis (i.e.
taking a set of demonstrable a priori truths, then using a logical
train of deduction to discover what those truths necessarily imply
about reality) to avoid the survivorship bias & noise problems. E.g.
you can predict the effect of supply and demand on price without
having to test it in the real world. This technique has been used by
Murray Rothbard in economics (which has an even greater "non-
falsifiability" problem than trading), and Warren Buffett in
investing. As an example, you *can* judge if a good track record is
"skill" or "luck", by examining the methodology of the trader/
investor. If they operated solely during a period favourable to their
style, it is probably luck e.g. if they made money buying emerging
market bonds from 1994-1998. If they made a bucketload trading a style
that was *against* the market regime, then it is almost certainly
skill e.g. someone who made good returns as a shortseller of tech
stocks from 1997-2000; or someone who has successfully sold premium
during market panics. Since Taleb is a follower of Popper, and a
hardened quant, it should come as no surprise that he is ignorant of
praxeology, but it is a huge oversight all the same.
6) Taleb's scorning of Buffett as a lucky fool is ignorant in the
extreme. Buffett clearly did *not* use naive analysis of past data to
make his investment decisions, or rely on luck (he did well from
1969-82, a terrible period for equities). Rather he deduced highly
probably consequences from demonstrable truths about investment (i.e.
firms with pricing power, high barriers to entry, and low working
capital requirements are likely to perform very well), and then saw
that the market was not pricing these factors efficiently. Anyone
reading his writings can see this. And Buffett's approach is
ironically more rigorous and less dependent on luck than Taleb's
professed trading methods. To elaborate - Taleb is relying on "black
swan" events happening more often than people think. Therefore EITHER
a reduction in the frequency of these events, OR an increase in
people's expectation of them, would be enough to invalidate Taleb's
approach - clearly neither can be ruled out. Taleb thinks he is
betting on black swan events occuring, whilst ignoring the possibility
of the "black swan" of major regime change making his own system
unprofitable. Whereas with Buffet, the laws of supply and demand, and
basic investment/economics, ensure that certain business methods will
*always* work better than others.
To conclude - Taleb thinks he has a great idea, but it was already
well known by most experienced market practitioners (see the Market
Wizards books etc where multiple traders continually bang on about
rare event risk and fat tailed probability distributions). He then
goes on as if this idea is the only important thing, which is clearly
not the case. Finally, he critiques some people, such as Buffett, who
use totally rigorous methodologies, whilst himself employing a
strategy that is by no means foolproof, and relies largely on past
observation (data-mining!) to form its conclusions. All I can say is
that he better watch out for the black swan of long-term declining
volatility over the next decade!
Finally, I would just say that I found the book enjoyable, it's just
that (luckily for future my P&L) Taleb hasn't got everything worked
out just yet :) Looking forward to the follow-up Nassim!
Nassim Nicholas Taleb - On Human Memory
Fooled by Randomness: The Hidden Role of Chance in Life and in the
Markets by Nassim Nicholas Taleb
The Black Swan: The Impact of the Highly Improbable by Nassim
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* Nassim Nicholas Taleb - Interview by Russ Roberts
* Nassim Nicholas Taleb - Investment Advice
* Nassim Nicholas Taleb - Links
* Nassim Nicholas Taleb - On Human Memory
* Nassim Nicholas Taleb - Website is a Mess
* Nassim Taleb Nature Debt And Redundancy
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