Fooled by Randomness (Nassim Nicholas Taleb) 1 comments

Nassim Nicholas Taleb was a former options trader who was inducted into the Derivatives Strategy Hall of Fame and now operates his own trading firm. This book, however, is not a narrative about his trading experiences, but rather an exploration into the role of randomness and probability in trading markets, and how humans often fail to appreciate these.

There are a few points which are constantly explored throughout the book: one, that successful traders' skills are often overestimated while the role of randomness is underplayed; two, that one should often be cynical about statistics and think about them more analytically; three, that humans are NOT genetically predisposed to consider decisions in probabilistic terms and often make errors in probabilistic thinking; and four, that a consequence of point three is that the probability of rare events occurring is often underestimated (in fact, he has made a career out of this fact by buying out-of-the-money options on improbable price actions transpiring).

To elaborate on these main points, NN Taleb covers a vast number of concepts in the book. He describes the probability distribution skewness, which leads to him seeking out "low probability, high return" bets rather than "high probability, average return" ones. There is the problem of induction, which states that theories can only be disproved but cannot be proven; hence the "black swan" problem, where a theory that "all swans are white" can be disproved straightaway by discovery of one black swan. The survivorship bias, which might be well-known to seasoned unit trust investors, is explored in detail: one corollary of this is that we should be careful about picking unit trusts based on their past records because out of a large sample size of funds there are always going to be a small proportion that will have made money consistently over the last few years, simply by virtue of probability and randomness rather than strong elements of latent skill being involved. And quite a number of human behavioural tendencies which are detrimental to trading are discussed: path dependency of beliefs, causality, tendency to interpret noise as information. Readers will appreciate that he describes these qualitatively with no excessive recourse to quantitative mathematics, and he uses a lot of examples to illustrate his point.

The fact that one can tell he believes fervently in his subject makes the book an even better read. However, his style of writing suggests that he is not one to suffer fools gladly. He is contemptuous of traders who trumpet their gains or those are married to their points of view, scientists who cannot adjust their viewpoints once they have formed them even in the face of new evidence, even the mass media whom he accuses of constantly being unable to analyse statistics intelligently.

All in all, this is a good read to get a proper statistical and probabilistic perspective of not just trading, but life in general.