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

by Nassim Nicholas Taleb

At the center of his modus is Niederhoffer’s dogma that any “testable” statement should be tested, as our minds make plenty of empirical mistakes when relying on vague impressions. His advice is obvious, but it is rarely practiced. How many effects we take for granted might not be there? A testable statement is one that can be broken down into quantitative components and subjected to statistical examination. For instance, a conventional-wisdom, empirical style statement like automobile accidents happen closer to home can be tested by taking the average distance between the accident and the domicile of the driver (if, say, about 20% of accidents happen within a twelve-mile radius). However, one needs to be careful in the interpretation; a naive reader of the result would tell you that you are more likely to have an accident if you drive in your neighborhood than if you did so in remote places, which is a typical example of naive empiricism. Why? Because accidents may happen closer to home simply because people spend their time driving close to home (if people spend 20% of their time driving in a twelve-mile radius). But there is a more severe aspect of naive empiricism. I can use data to disprove a proposition, never to prove one. I can use history to refute a conjecture, never to affirm it. For instance, the statement The market never goes down 20% in a given three-month period can be tested but is completely meaningless if verified. I can quantitatively reject the proposi...