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

by Nassim Nicholas Taleb

The “hot hand in basketball” is another example of misperception of random sequences: It is very likely in a large sample of players for one of them to have an inordinately lengthy lucky streak. As a matter of fact it is very unlikely that an unspecified player somewhere does not have an inordinately lengthy lucky streak. This is a manifestation of the mechanism called regression to the mean. I can explain it as follows: Generate a long series of coin flips producing heads and tails with 50% odds each and fill up sheets of paper. If the series is long enough you may get eight heads or eight tails in a row, perhaps even ten of each. Yet you know that in spite of these wins the conditional odds of getting a head or a tail is still 50%. Imagine these heads and tails as monetary bets filling up the coffers of an individual. The deviation from the norm as seen in excess heads or excess tails is here entirely attributable to luck, in other words, to variance, not to the skills of the hypothetical player (since there is an even probability of getting either). A result is that in real life, the larger the deviation from the norm, the larger the probability of it coming from luck rather than skills: Consider that even if one has 55% probability of heads, the odds of ten wins is still very small. This can be easily verified in stories of very prominent people in trading rapidly reverting to obscurity, like the heroes I used to watch in trading rooms. This applies to height of indivi...