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Book Review: Fooled by Randomness

I read Nassim Nicholas Taleb’s book ‘Fooled by Randomness’ a while back and thought it was great. Below are my notes and thoughts on book excerpts:

In expectation, a dentist is richer than a rock star

You cannot consider the success of a profession without taking into account the average of all the people who enter it. Do not just include the sample that succeeded. Take into account both the observed and unobserved possible outcomes to get a full picture.

A mistake is not something to be determined after the fact, but in light of information until that point. People overestimate what they knew at the time of the event due to subsequent information learnt after the event

Believe in process not outcomes, and be aware of hindsight bias. Having a decision journal helps with this, and I’ll be writing about journalling in the future.

Understand ergodicity - how under certain conditions, very long sample paths end up resembling each other

Understanding when a system follows ergodicity vs when it doesn’t is key to know whether you can have more confidence in extrapolating based on existing conditions. I’m not well versed in this concept, so any help explaining is appreciated!

The scaling property of randomness is misunderstood. e.g. If you assume a security with 15% returns and 10% standard deviation, that translates to 93% probability of successful outcomes in a year, but only 50% per second

I’m not sure how the math works, but I think the broader point is more important. He follows this up by stating that over short time periods, you observe variability of your portfolio and not returns. Real randomness does not look random.

Traits shared by people fooled by randomness include:
Overestimation of the accuracy of their beliefs in some economic or statistical measure
Tendency to get married to positions
Tendency to change their story, i.e. thesis creep
No precise game plan ahead of time on what to do in event of losses.
Absence of critical thinking when revising their stance or denial

This is why I like process and lists. Having a plan and being able to revise it critically is important.

The longer you go without experiencing a rare event, the more vulnerable you will be to it

Something related to think about is the Minsky moment concept whereby stability breeds instability.

Taleb tries to benefit from skewed bets, e.g. Rare events that do not repeat frequently, but give large payoffs when they do occur

In other words, avoid the stereotypical “picking pennies in front of a steamroller” and be on the other side of that trade instead.

There are only 2 types of theories:
Theories that are known to be wrong and have been falsified
Theories that have not yet been known to be wrong. A theory cannot be verified
Absence of evidence is not evidence of absence

This is a good reminder to stay humble about what we think we know.

We do not understand confidence levels. Your activity in the market should depend less on where you think a variable is going to go and more on the confidence interval

I’m not sure how to get better at this though.

Taleb’s epiphany came when he understood he was not intelligent or strong enough to fight emotions, but intelligent enough to understand he has a predisposition to be fooled by randomness
There is nothing wrong with emotions, but what is wrong is not following the dignified path
Similar to how just knowing of behavioural biases doesn’t help much in stopping them from happening, as Kahneman himself describes

Awareness of bias is not enough; you need systems and humility to manage your own psychology.

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