Fooled By Randomness: Conclusion

The following summary was written by Frank Voisin, who regularly writes for Frankly Speaking. Recently, Frank sold four restaurants and returned to school to complete a combined LLB/MBA.

Key Takeaways from Fooled by Randomness:

• Recognize the role of randomness in your life. Err on the side of assuming your success is based on randomness, and always work diligently to reduce the variability of your strategies.
• Recognize your own biases, and think critically about the conclusions you draw, rather than relying on common sense.
• Ignore the noise, chase the signal. Determine what matters to you (in your decision making of a particular theme) and don’t pay attention to the madness of the markets or the popular opinion.
• Remain skeptical of all of your long-held beliefs, lest you become married to a position and ignore its faults (surely to your own future detriment).
• Set up both contingency and prophylactic systems to encourage your rational thinking in the face of emotional upset. These will protect you from the frustrations associated with making emotional decisions devoid of critical thought.
• Conduct your affairs with personal elegance, because the only thing randomness cannot control is your behaviour. (If you get a chance, read pages 194 - 195 on personal elegance. They are superbly written and are of great value)

Fooled By Randomness: Chapters 13 and 14

The following summary was written by Frank Voisin, who regularly writes for Frankly Speaking. Recently, Frank sold four restaurants and returned to school to complete a combined LLB/MBA.

Recognize the dangers of becoming married to a position. If you have invested a great deal of time into formulating a position, or have held a position for a long time, then you will have built up a strong loyalty to that position which acts as a barrier to considering its faults. This is extremely dangerous as failure to reconsider things will prevent you from properly adapting as the situation changes.

The Japanese have a word for this - Kaizen - which is used often in their successful manufacturing process philosophies. It is the constant review of all processes, even those that are successful, always seeking a better process.

The reality of life is that we are dominated by odds. Randomness will occur. The best we can do is plan for contingencies so as to reduce our downside exposure.

Taleb closes by urging us to not abandon our emotion, but instead “Just listen while shaken by emotion but not with the coward’s imploration and complaints.” It is not wrong to have emotions, but it is wrong to follow the path that ignores probability and odds.

Fooled By Randomness: Chapter 12

The following summary was written by Frank Voisin, who regularly writes for Frankly Speaking. Recently, Frank sold four restaurants and returned to school to complete a combined LLB/MBA.

Taleb admits to being just intelligent enough to understand that he, like all people has a predisposition to being fooled by randomness. However, he is neither smart enough, nor strong enough to cast away his emotions and deal with pure probabilities, nor does he suggest that you or I do so.

Gamblers’ ticks are those habits picked up by gamblers that are thought to bring them added luck, such as a lucky shirt, or a certain phrase. The problem is that many of these ticks are more severe in real life than lucky shirts - causing us to react to events in certain ways based on our past success with that kind of reaction.

The trick is to recognize your own ticks and set up systems to deal with them, such as preventing access to information which is filled with noise, rather than signal (e.g. the 24-hour financial news networks) if these cause you to react in a superstitious manner rather than a logical manner.

Fooled By Randomness: Chapter 11

The following summary was written by Frank Voisin, who regularly writes for Frankly Speaking. Recently, Frank sold four restaurants and returned to school to complete a combined LLB/MBA.

You are diagnosed with cancer, but have a 72% chance of surviving the next 5 years. You are overjoyed, but why? After all, you have a 28% chance of death. But people do not look at things this way. Our brains are wired to think of one state only. So rather than thinking of yourself as 72% alive and 28% dead, you think of yourself as 100% alive. We are probability blind which causes all of the biases we have discussed previously.

Taleb discusses the many biases that affect our ability to understand probability, including the difficulty in determining causality (and our likely use of the post hoc ergo propter hoc fallacy), and filtering out noise (rather choosing often to interpret the noise!).

As a great man GI Joe said, knowing is half the battle. By being aware of our biases, you can think critically about your decisions, interpret information more clearly, and formulate better decisions.

Fooled By Randomness: Chapters 9 and 10

The following summary was written by Frank Voisin, who regularly writes for Frankly Speaking. Recently, Frank sold four restaurants and returned to school to complete a combined LLB/MBA.

Taleb uses this chapter to illustrate the Survivorship Bias in several different common situations.
Two important things come from the examples in this chapter:

1. A large group of poor performers will eventually yield a few performers that appear to be quite skillful due to their success. This is simply volatility from the norm, but is often confused for skill.

2. Success is more greatly correlated with the number of people in the original pool than the skill of the players (since, the larger the pool, the longer the survivors had to survive, and the more successful they will appear as a result.)

Life is unfair in a nonlinear way. Small advantages often translate into disproportionately large payoffs, or simple randomness can lead to the same thing without any advantage at all.

Nonlinearity is the disproportionate result resulting from a proportionate increase in force. Adding sand to a sandcastle tower, growing at a linear rate, until suddenly one extra grain of sand causes it to all come crumbling down - that is the nonlinear result.

The reason life is nonlinear is that past success increases the probability of future success, due to a multitude of reasons (network externalities being one). Each step on our path is not independent

The nonlinearities of life cause us to confuse sucess with skill. Nonlinearities allow tiny amounts of randomness to build ever greater success (or failure), confusing us into thinking that the tiny amount of randomness was ineffectual.

Fooled By Randomness: Chapters 7 and 8

The following summary was written by Frank Voisin, who regularly writes for Frankly Speaking. Recently, Frank sold four restaurants and returned to school to complete a combined LLB/MBA.

The problem of induction may be phrased as follows: “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.”

Recognize that inductive reasoning (statistics) is not perfect. Use it to make decisions, but do not use it to manage risks and exposure!!

The survivorship bias, as discussed earlier is the failure to consider those that followed the same path as the people we are analyzing, but failed to reach the same success (or be successful at all). It is extremely difficult to view these people, since history does not record them. To correct for this bias, we may want to adjust the success of those we are considering to take into account the effect of those that failed to survive.

We tend to mistake one realization among all possible random histories as the most representative one, forgetting that there may be others… The survivorship bias implies that the highest performing realization will be the most visible. Why? Because the losers do not show up.

Conclusion: Taleb’s point is that survivorship bias is a chronic syndrome affecting most people. We naturally ignore the data we do not see, so we must work hard to counter survivorship bias.

Fooled By Randomness: Chapter 6

The following summary was written by Frank Voisin, who regularly writes for Frankly Speaking. Recently, Frank sold four restaurants and returned to school to complete a combined LLB/MBA.

Median figures are not very valuable, because they mask all sorts of information. For example, the fact that the average patient lives 8 months is useless when you find out that those that live beyond 8 months tend to live a long and regular life, whereas those that live less than 8 months tend to die very quickly. This is asymmetry. Asymmetric outcomes mean that payoffs are not equal, and differ from the average by a wide margin.

Asymmetry can be countered by considering the expected values. This means multiplying the probability of an event by the value of its outcome to get the expected value of the event, and then adding up the total of the expected values. This will give you a figure which lets you know what you expect the entire scenario to result in. Usingthe patiente example above, it may show you that the expected lifespan with that illness is quite a bit longer than 8 months!

Taleb introduced the Rare Event Fallacy, which is the failure to account for extremely rare events. The problem is that such events are extremely difficult to detect. As we take more samples, we only very slowly learn about the relative infrequency of the rare event, however as soon as one happens, our knowledge improves quickly.

Fooled By Randomness: Chapters 4 and 5

The following summary was written by Frank Voisin, who regularly writes for Frankly Speaking. Recently, Frank sold four restaurants and returned to school to complete a combined LLB/MBA.

Chapter Four: Randomness, Nonsense, and the Scientific Intellectual
Simulators can create beautiful things that appeal to our senses (e.g. abstract artwork and poetry). Why is this important? What motivates us in some things (e.g. poetry) is not rational and scientific.

Conclusion: We do not need to be rational and scientific in all things - only in those that can harm us and threaten our survival. Taleb says that modern life invites us to do the opposite: become realistic and intellectual when it comes to matters such as religion and personal behaviour, yet irrational when it comes to markets and matters ruled by randomness.

Chapter Five: Survival of the Least Fit - Can Evolution be Fooled by Randomness?
In this chapter, Taleb discusses the characteristics that make someone a fool to randomness:

1. An overestimation of the accuracy of their beliefs
2. A tendency to get married to positions. Loyalty to ideas is not a good thing!
3. The tendency to change their story.
4. No precise game plan ahead of time as to what to do in negative events.
5. Absence of critical thinking.
6. Denial.

Fooled By Randomness: Chapter 3

The following summary was written by Frank Voisin, who regularly writes for Frankly Speaking. Recently, Frank sold four restaurants and returned to school to complete a combined LLB/MBA.

Taleb uses this chapter to introduce Monte Carlo simulators which repeatedly run simulations of a scenario with the different variables changing based on their associated probabilities. By running these simulations millions of times, you can look at the characteristics of the set of results and generate incredibly useful inferences. For example, by considering the variability from the average result, you can determine the impact of randomness in the scenario being analyzed. The less variability, the more resistant the situation is to randomness.

Taleb suggests Monte Carlo simulators allow us to learn from the simulated future which is superior to learning from the past, because the past has a survivorship bias, and we also tend to denigrate the past by claiming misfortune had by others will not happen to us.

Conclusion: When considering things, think about the results of a Monte Carlo simulator - what result do you expect would occur after a million simulations and what level of variability? This will help ignore survivorship bias and prevent you from denigrating the past by saying misfortune won’t happen to you. The Monte Carlo simulator will help you clarify your thinking and make better choices.

Fooled By Randomness: Chapter 2

The following summary was written by Frank Voisin, who regularly writes for Frankly Speaking. Recently, Frank sold four restaurants and returned to school to complete a combined LLB/MBA.

Taleb introduces the concept of Alternative Histories. When considering success, you must also consider the likelihood of success given the probability of a negative result having occurred. Failure to consider the potential for negative results and judging based only on the success witnessed is the survivorship bias, which my friends over at Barel Karsan have explored.

Consider Russian Roulette. If a wealthy man offered you $10 million to play Russian Roulette, you have one of six possible histories - one of which renders you dead, the other five render you $10 million wealthier. Only one of these histories actually occurs. If you live, and win the $10 million, you are more successful. Though you are successful only by dumb luck. If offered another $10 million to try again, you may again win, or you may die. The fact is, the success has nothing to do with you. Though external observers would see you getting $10 million richer until you are dead. Taleb argues that $10 million earned through Russian Roulette is not worth the same as $10 million earned through the diligent practice of dentistry. The first is devalued due to its dependence on randomness.

Now, in reality, there are thousands of chambers, and after we succeed past a few, we forget about the bullet, thinking we are protected by our skill (Taleb calls this the Black Swan Problem). We also tend to denigrate history by thinking the things that happen to others won’t happen to us. Additionally, most of us carry on without knowing the real odds of our demise, unlike in Russian Roulette.

Conclusion: Consider the probabilities associated with you arriving at your current post in life. Are you happy with where you are? If so, does the course you took have a high probability of leading you to where you are (considering the alternative histories!)? If you aren’t happy, then what are the probabilities things will change in the future? What are you doing to improve those odds?

Also, important for all people is the notion of embracing randomness. Consider all of the potential risks. When assessing your own success, always consider what would have resulted had things gone differently. Only when considering things in this light can you truly assess your own skills and the quality of your strategies.

Fooled By Randomness: Chapter 1

The following summary was written by Frank Voisin, who regularly writes for Frankly Speaking. Recently, Frank sold four restaurants and returned to school to complete a combined LLB/MBA.

Part One: Solon’s Warning
Solon’s warning is “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.” In other words, “it ain’t over til it’s over.”

Part one of the book discusses how the things which we have received by luck may be taken away by luck just as easily.

Chapter One: If You’re So Rich, Why Aren’t You So Smart?
Taleb introduces, by way of parable, the argument that we cannot judge a person’s success by their performance and wealth because of Solon’s warning: it ain’t over till it’s over. Just because you are successful now doesn’t mean that success wasn’t generated in an incredibly risky manner that is inherently inconsistent and will come crashing down at any moment.

Conclusion: Don’t let someone’s current success fool you into thinking they must be skilled at what they do. There is a decent chance they are the beneficiary of dumb luck, in which case their success is just as likely to disappear due to dumb luck! If you work hard and are consistent in your growth, be confident in what you do, even as others temporarily exceed you.

The Role Of Randomness

Dr. Nassim Taleb is a writer and scholar who used to be a derivatives trader. In his work, he contends that society overestimates the value of patterns from the past and underestimates randomness in attempting to predict the future. This effect had a direct impact on him as a trader, where he found his peers would rely on past data while he could find profits in taking advantage of this phenomenon.

Here he is explaining how the banking crisis was caused by false confidences in quantitative risk management:

Here is an introduction to Taleb's book, Fooled by Randomness, written by Frank Voisin and re-printed here with permission:

Prologue
Taleb starts out with the point of the book - to explore luck “disguised and perceived as non-luck (that is, skills).” So many of the successful among us, he argues, are successful due to luck rather than reason. This is true in areas beyond business (e.g. Science, Politics), though it is more obvious in business.

Our inability to recognize the randomness and luck that had to do with making successful people successful is a direct result of our search for pattern. Taleb points to the importance of symbolism in our lives as an example of our unwillingness to accept randomness. We cling to biographies of great people in order to learn how to achieve greatness, and we relentlessly interpret the past in hopes of shaping our future.

Only recently has science produced probability theory, which helps embrace randomness. Though the use of probability theory in practice is almost nonexistent.

Taleb says the confusion between luck and skill is our inability to think critically. We enjoy presenting conjectures as truth and are not equipped to handle probabilities, so we attribute our success to skill rather than luck.

The book is organized into three parts:

• Part One: Solon’s Warning
• Part Two: Probability Biases
• Part Three: Tricks To Help Ourselves

On to the rest of the chapters!