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

by Nassim Nicholas Taleb

It certainly takes bravery to remain skeptical; it takes inordinate courage to introspect, to confront oneself, to accept one’s limitations—scientists are seeing more and more evidence that we are specifically designed by mother nature to fool ourselves.

Probability is not a mere computation of odds on the dice or more complicated variants; it is the acceptance of the lack of certainty in our knowledge and the development of methods for dealing with our ignorance.

this business of journalism is about pure entertainment, not a search for truth, particularly when it comes to radio and television.

In addition we seem to have evidence that what is called “courage” comes from an underestimation of the share of randomness in things rather than the more noble ability to stick one’s neck out for a given belief.

we need to take into account the costs of mistakes; in my opinion, mistaking the right column for the left one is not as costly as an error in the opposite direction. Even popular opinion warns that bad information is worse than no information at all.

it is our inability to think critically—we may enjoy presenting conjectures as truth. It is our nature. Our mind is not equipped with the adequate machinery to handle probabilities; such infirmity even strikes the expert, sometimes just the expert.

(most disasters come from the fact that individual scientists do not have an innate understanding of standard error or a clue about critical thinking, and likewise have proved both incapable of dealing with probabilities in the social sciences and incapable of accepting such fact).

“The observation of the numerous misfortunes that attend all conditions forbids us to grow insolent upon our present enjoyments, or to admire a man’s happiness that may yet, in course of time, suffer change. For the uncertain future has yet to come, with all variety of future; and him only to whom the divinity has [guaranteed] continued happiness until the end we may call happy.”

“it ain’t over until the fat lady sings.”

that which came with the help of luck could be taken away by luck (and often rapidly and unexpectedly at that). The flipside, which deserves to be considered as well (in fact it is even more of our concern), is that things that come with little help from luck are more resistant to randomness.

it does not matter how frequently something succeeds if failure is too costly to bear.

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.

Psychologists have shown that most people prefer to make $70,000 when others around them are making $60,000 than to make $80,000 when others around them are making $90,000.

Clearly, the quality of a decision cannot be solely judged based on its outcome, but such a point seems to be voiced only by people who fail (those who succeed attribute their success to the quality of their decision).

There are some (though very few) who will call you to express their gratitude and thank you for having protected them from the events that did not take place.

both risk detection and risk avoidance are not mediated in the “thinking” part of the brain but largely in the emotional one (the “risk as feelings” theory). The consequences are not trivial: It means that rational thinking has little, very little, to do with risk avoidance. Much of what rational thinking seems to do is rationalize one’s actions by fitting some logic to them.

This is one of the many reasons that journalism may be the greatest plague we face today—as the world becomes more and more complicated and our minds are trained for more and more simplification.

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

Mathematics is principally a tool to meditate, rather than to compute.

is impossible to assess the quality of the knowledge we are gathering without allowing a share of randomness in the manner it is obtained and cleaning the argument from the chance coincidence that could have seeped into its construction.

(it is pseudoscientific because it draws theories from past events without allowing for the fact that such combinations of events might have arisen from randomness; there is no way to verify the claims in a controlled experiment).

people fail to learn that their emotional reactions to past experiences (positive or negative) were shortlived—yet they continuously retain the bias of thinking that the purchase of an object will bring long-lasting, possibly permanent, happiness or that a setback will cause severe and prolonged distress (when in the past similar setbacks did not affect them for very long and the joy of the purchase was short-lived).

Every man believes himself to be quite different, a matter that amplifies the “why me?” shock upon a diagnosis.

When you look at the past, the past will always be deterministic, since only one single observation took place.

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

A more vicious effect of such hindsight bias is that those who are very good at predicting the past will think of themselves as good at predicting the future, and feel confident about their ability to do so.

Bad trades catch up with you, it is frequently said in the markets. Mathematicians of probability give that a fancy name: ergodicity. It means, roughly, that (under certain conditions) very long sample paths would end up resembling each other. The properties of a very, very long sample path would be similar to the Monte Carlo properties of an average of shorter ones.

Those who were unlucky in life in spite of their skills would eventually rise. The lucky fool might have benefited from some luck in life; over the longer run he would slowly converge to the state of a less-lucky idiot. Each one would revert to his long-term properties.

People do not realize that the media is paid to get your attention. For a journalist, silence rarely surpasses any word.

The wise man listens to meaning; the fool only gets the noise.

Science is method and rigor; it can be identified in the simplest of prose writing.

On the one hand, I try to define myself and behave officially as a no-nonsense hyperrealist ferreting out the role of chance; on the other, I have no qualms indulging in all manner of personal superstitions. Where do I draw the line? The answer is aesthetics. Some aesthetic forms appeal to something in our biology, whether or not they originate in random associations or plain hallucination. Something in our human genes is deeply moved by the fuzziness and ambiguity of language; then why fight it?

We do not need to be rational and scientific when it comes to the details of our daily life—only in those that can harm us and threaten our survival. Modern life seems to invite us to do the exact opposite; become extremely realistic and intellectual when it comes to such matters as religion and personal behavior, yet as irrational as possible when it comes to matters ruled by randomness (say, portfolio or real estate investments).

“If I am going to be forced to eat pork, it better be of the best kind.” If I am going to be fooled by randomness, it better be of the beautiful (and harmless) kind.

at any point in time, the richest traders are often the worst traders. This, I will call the cross-sectional problem: At a given time in the market, the most successful traders are likely to be those that are best fit to the latest cycle. This does not happen too often with dentists or pianists—because these professions are more immune to randomness.

“noise” was mean reverting, and would likely be offset by “noise” in the opposite direction.

Losing money is something good traders are accustomed to. It is because he blew up; he lost more than he planned to lose. His personal confidence was wiped out. But there is another reason why John may never recover. The reason is that John was never skilled in the first place. He is one of those people who happened to be there when it all happened. He may have looked the part but there are plenty of people who look the part.

there is a difference between a wealth level reached from above and a wealth reached from below. The road from $16 million to $1 million is not as pleasant as the one from 0 to $1 million. In addition, John is full of shame; he still worries about running into old friends on the street.

A tendency to get married to positions. There is a saying that bad traders divorce their spouse sooner than abandon their positions. Loyalty to ideas is not a good thing for traders, scientists–or anyone.

There is absolutely nothing wrong with investing “for the long haul,” provided one does not mix it with short-term trading–it is just that many people become long-term investors after they lose money, postponing their decision to sell as part of their denial.

Darwinian ideas are about reproductive fitness, not about survival.

Darwinian fitness applies to species developing over a very long time, not observed over a short term—time aggregation eliminates much of the effects of randomness; things (I read noise) balance out over the long run, as people say.

resent the person who, without having done much homework in libraries, thinks that he is onto something rather original and insightful on a given subject matter (and I respect people with scientific minds, like my friend Stan Jonas, who feel compelled to spend their nights reading wholesale on a subject matter, trying to figure out what was done on the subject by others before emitting an opinion—would the reader listen to the opinion of a doctor who does not read medical papers?).

It is a pure accounting fact that, aside from the commentators, very few people take home a check linked to how often they are right or wrong.

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

If rational traders detect a pattern of stocks rising on Mondays, then, immediately such a pattern becomes detectable, it would be ironed out by people buying on Friday in anticipation of such an effect. There is no point searching for patterns that are available to everyone with a brokerage account; once detected, they would be self-canceling.

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.

why do we consider the worst case that took place in our own past as the worst possible case? If the past, by bringing surprises, did not resemble the past previous to it (what I call the past’s past), then why should our future resemble our current past?

markets (and life) are not simple win/lose types of situations, as the cost of the losses can be markedly different from that of the wins. Maximizing the probability of winning does not lead to maximizing the expectation from the game when one’s strategy may include skewness, i.e., a small chance of large loss and a large chance of a small win.