Fooled by Randomness: The Hidden Role of Chance in Life and in the Markets

by Nassim Nicholas Taleb

Past events will always look less random than they were (it is called the hindsight bias).

Luck is democratic and hits everyone regardless of original skills.

Clearly risk taking is necessary for large success—but it is also necessary for failure. Had the author done the same study on bankrupt citizens he would certainly have found a predilection for risk taking.

Delivering advice assumes that our cognitive apparatus rather than our emotional machinery exerts some meaningful control over our actions.

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;

Nero believes that risk-conscious hard work and discipline can lead someone to achieve a comfortable life with a very high probability.

Mild success can be explainable by skills and labor. Wild success is attributable to variance.

The idea of taking into account both the observed and unobserved possible outcomes sounds like lunacy.

Clearly, it is foolish to think that an irrational market cannot become even more irrational;

I remind myself of Einstein’s remark that common sense is nothing but a collection of misconceptions acquired by age eighteen.

epiphenomenalism,

In other words, I need people to remain fools of randomness, but not all of them.

Stochastic is a fancy Greek name for random. This branch of probability concerns itself with the study of the evolution of successive random events

By drawing a circle inside of a square, and “shooting” random bullets into the picture (as in an arcade), specifying equal probabilities of hitting any point on the map (something called a uniform distribution). The ratio of bullets inside the circle divided by those inside and outside the circle will deliver a multiple of the mystical Pi,

congenital denigration

A mistake is not something to be determined after the fact, but in the light of the information until that point.

negative pang is not offset by a positive one (some psychologists estimate the negative effect for an average loss to be up to 2.5 the magnitude of a positive one);

an event, although rare, that brings large consequences cannot just be ignored.

Psychologists recently found out that people tend to be sensitive to the presence or absence of a given stimulus rather than its magnitude.

Where statistics becomes complicated, and fails us, is when we have distributions that are not symmetric, like the urn above. If there is a very small probability of finding a red ball in an urn dominated by black ones, then our knowledge about the absence of red balls will increase very slowly—more slowly than at the expected square root of n rate. On the other hand, our knowledge of the presence of red balls will dramatically improve once one of them is found. This

Note that the economist Robert Lucas dealt a blow to econometrics by arguing that if people were rational then their rationality would cause them to figure out predictable patterns from the past and adapt, so that past information would be completely useless for predicting the future

No amount of observations of white swans can allow the inference that all swans are white, but the observation of a single black swan is sufficient to refute that conclusion.

A brief summing up at this point: I showed how we tend to mistake one realization among all possible random histories as the most representative one, forgetting that there may be others. In a nutshell, the survivorship bias implies that the highest performing realization will be the most visible. Why? Because the losers do not show up.

Again, one word of warning: All deviations do not come from this effect, but a disproportionately large proportion of them do.

I am fitting the rule on the data. This activity is called data snooping.

The reason is something called “spontaneous remission,” in which a very small minority of cancer patients, for reasons that remain entirely speculative, wipe out cancer cells and recover “miraculously.” Some switch causes the patient’s immune system to eradicate all cancer cells from the body.

THE SANDPILE EFFECT First we define nonlinearity. There are many ways to present it, but one of the most popular ones in science is what is called the sandpile effect, which I can illustrate as follows.

The Tipping Point,

It is better to have a handful of enthusiastic advocates than hordes of people who appreciate your work—better to be loved by a dozen than liked by the hundreds.

Satisficing” was his idea (the melding together of satisfy and suffice):

It is worth stopping, at this juncture, and discussing the distinction between normative and positive sciences. A normative science (clearly a self-contradictory concept) offers prescriptive teachings; it studies how things should be. Some economists, for example those of the efficient-market religion, believe that our studies should be based on the hypothesis that humans are rational and act rationally because it is the best thing for them to do (it is mathematically “optimal”). The opposite is a positive science, which is based on how people actually are observed to behave.

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.

Those heuristics that we said were “quick and dirty” to the psychologists are “fast and frugal” to the evolutionary psychologists.

Emotions affect one’s thinking. He figured out that much of the connections from the emotional systems to the cognitive systems are stronger than connections from the cognitive systems to the emotional systems. The implication is that we feel emotions (limbic brain) then find an explanation (neocortex).

There is a simple test to define path dependence of beliefs (economists have a manifestation of it called the endowment effect). Say you own a painting you bought for $20,000, and owing to rosy conditions in the art market, it is now worth $40,000. If you owned no painting, would you still acquire it at the current price? If you would not, then you are said to be married to your position. There is no rational reason to keep a painting you would not buy at its current market rate—only an emotional investment. Many people get married to their ideas all the way to the grave.

Beliefs are said to be path dependent if the sequence of ideas is such that the first one dominates.