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May 18, 2024 - May 10, 2025
It is as if there were two planets: the one in which we actually live and the one, considerably more deterministic, on which people are convinced we live. It is as simple as that: Past events will always look less random than they were (it is called the hindsight bias).
This text is a series of logical thought experiments, not an economics term paper; logic does not require empirical verification (again there is what I call a “round-trip fallacy”: It is a mistake to use, as journalists and some economists do, statistics without logic, but the reverse does not hold: It is not a mistake to use logic without statistics).
CHAPTER SUMMARIES
This book is about luck disguised and perceived as nonluck (that is, skills) and, more generally, randomness disguised and perceived as non-randomness (that is, determinism).
We are faulty and there is no need to bother trying to correct our flaws. We are so defective and so mismatched to our environment that we can just work around these flaws.
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.
Mild success can be explainable by skills and labor. Wild success is attributable to variance.
Intellectual contempt does not control personal envy.
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.
People have often had the bad taste of asking me in a social setting if my day in trading was profitable. If my father were there, he would usually stop them by saying “never ask a man if he is from Sparta: If he were, he would have let you know such an important fact—and if he were not, you could hurt his feelings.”
Heroes are heroes because they are heroic in behavior, not because they won or lost.
As a derivatives trader I noticed that people do not like to insure against something abstract; the risk that merits their attention is always something vivid.
Ce qui se conçoit bien s’énonce clairement Et les mots pour le dire viennent aisément
I remind myself of Einstein’s remark that common sense is nothing but a collection of misconceptions acquired by age eighteen. Furthermore, What sounds intelligent in a conversation or a meeting, or, particularly, in the media, is suspicious.
Monte Carlo simulation methods were pioneered in martial physics in the Los Alamos laboratory during the A-bomb preparation. They became popular in financial mathematics in the 1980s, particularly in the theories of the random walk of asset prices.
Indeed, I have two ways of learning from history: from the past, by reading the elders; and from the future, thanks to my Monte Carlo toy.
While we know that history flows forward, it is difficult to realize that we envision it backward. Why is it so?
A mistake is not something to be determined after the fact, but in the light of the information until that point.
Indeed it is difficult to ascertain whether they seem depressed because they are reading the newspaper, or if depressive people tend to read the newspaper, or if people who are living outside their genetic habitat both read the newspaper and look sleepy and depressed.
There are hordes of thoughtful journalists in the business (I would suggest London’s Anatole Kaletsky and New York’s Jim Grant and Alan Abelson as the underrated representatives of such a class among financial journalists; Gary Stix among scientific journalists);
Gray hair signals an enhanced ability to survive—conditional on having reached the gray hair stage, a man is likely to be more resistant to the vagaries of life.
If an event is important enough, it will find its way to my ears. I will return to this point in time.
The same methodology can explain why the news (the high scale) is full of noise and why history (the low scale) is largely stripped of it (though fraught with interpretation problems). This explains why I prefer not to read the newspaper (outside of the obituary), why I never chitchat about markets, and, when in a trading room, I frequent the mathematicians and the secretaries, not the traders.
My sole advantage in life is that I know some of my weaknesses, mostly that I am incapable of taming my emotions facing news and incapable of seeing a performance with a clear head.
We look after our customer’s interests / the road ahead / our assets are our people / creation of shareholder value / our vision / our expertise lies in / we provide interactive solutions / we position ourselves in this market / how to serve our customers better / short-term pain for long-term gain / we will be rewarded in the long run / we play from our strength and improve our weaknesses / courage and determination will prevail / we are committed to innovation and technology / a happy employee is a productive employee / commitment to excellence / strategic plan / our work ethics. If this
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Let us remember that economists are evaluated on how intelligent they sound, not on a scientific measure of their knowledge of reality.
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.
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.
In other words, history teaches us to avoid the brand of naive empiricism that consists of learning from casual historical facts.
Psychologists recently found out that people tend to be sensitive to the presence or absence of a given stimulus rather than its magnitude. This implies that a loss is first perceived as just a loss, with further implications later. The same with profits.
In the markets, there is a category of traders who have inverse rare events, for whom volatility is often a bearer of good news. These traders lose money frequently, but in small amounts, and make money rarely, but in large amounts. I call them crisis hunters. I am happy to be one of them.
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 (the argument, phrased in a very mathematical form, earned him the Swedish Central Bank Prize in honor of Alfred Nobel).
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.
Another logical flaw in this type of historical statement is that often when a large event takes place, you hear the “it never happened before,” as if it needed to be absent from the event’s past history for it to be a surprise. So 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?
Why is a theory never right? Because we will never know if all the swans are white (Popper borrowed the Kantian idea of the flaws in our mechanisms of perception). The testing mechanism may be faulty. However, the statement that there is a black swan is possible to make.
The major problem with inference in general is that those whose profession is to derive conclusions from data often fall into the trap faster and more confidently than others. The more data we have, the more likely we are to drown in it.
A small knowledge of probability can lead to worse results than no knowledge at all.
The survivorship biases (a.k.a. monkeys on a typewriter) arising from the fact that we see only winners and get a distorted view of the odds
“Too Many Millionaires” and “Fry an Egg”), (b) the fact that luck is most frequently the reason for extreme success
“Loser Takes All”), and (c) the biological handicap of our inability to understand probability
Aside from the misperception of one’s performance, there is a social treadmill effect: You get rich, move to rich neighborhoods, then become poor again. To that add the psychological treadmill effect; you get used to wealth and revert to a set point of satisfaction. This problem of some people never really getting to feel satisfied by wealth (beyond a given point) has been the subject of technical discussions on happiness.
The concept presented here is well-known for some of its variations under the names survivorship bias, data mining, data snooping, over-fitting, regression to the mean, etc., basically situations where the performance is exaggerated by the observer, owing to a misperception of the importance of randomness.
January effect (stocks have gone up historically during January).
I have to decry some excesses in backtesting that I have closely witnessed in my private career. There is an excellent product designed just for that, called Omega TradeStation, that is currently on the market, in use by tens of thousands of traders. It even offers its own computer language. Beset with insomnia, the computerized day traders become night testers plowing the data for some of its properties.
Wall Street analysts, in general, are trained to find the accounting tricks that companies use to hide their earnings. They tend to (occasionally) beat the companies at that game.
Chaos theory concerns itself primarily with functions in which a small input can lead to a disproportionate response.
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.
