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

This book is great and should be a compulsory reading for everyone at college. Lots of people do not realize how much chances and coincidences play roles in our lives. This book is about learning to appreciate the vast number of variables in common life which are not controlled by anyone.

The ideas in this book have created more controversy than they deserve, and it might have something to do with the title of the book. Given the number of people who equate "random" with "equiprobable", "Fooled by Probabilities" would have been a more appropriate title for the book, though not as provocative as "Fooled by Randomness". There is a finite chance that there is a black cat in every dark room, but when you switch the light on, there is no black cat in the room. Both are correct statements - mathematically and practically. This book must be read in the same light.

It seems to me that the transition from an average to good investor (probabilistically speaking) happens as soon as you internalize the concept of expected values and invest by it. My favorite story from the book is where Taleb is asked which way the market is expected to go next week, and he says slightly up with a high probability (70%). Then someone intervened that Taleb had just made a big bet on the S&P going down next week, and he said that indeed he did. The one lesson this book teaches is that the two statements are not inconsistent with each other. 70% chance of a +1% change and 30% chance of a -10% change sums upto -2.3, a strongly negative expected value. Good investors always shadow the expected value (trend and magnitude), although market sentiments are always driven by either the expected trend of upward or downward movement, or expected magnitude of upward and downward movement.


Four key insights that I received from the book about how we all get fooled by probabilities in our everyday lives are the firehouse effect, survivorship bias, endowment effect and Wittgenstein's ruler. Firehouse effect is characterized by a clique of people with much downtime (firemen) who end up strongly agreeing with each other about things that would seem incorrect to any rational observer - something that many investors suffer from. The survivorship bias talks about exclusion of failures from "objective" after-the-fact performance studies - something that many business books suffer from. Endowment effect suggests that people value something more after they own it or get familiar with it - something that many businesses suffer from. Wittgenstein's ruler says that when an unreliable ruler is used to measure a table, the table is measuring the ruler and not the other way around. Reliability of the ruler determines what is being measured - something that consumer reviews and stock recommendations suffer from. For these and many such, read Fooled by Randomness.

This is by far the smartest book I have ever read. As a PhD statistician I thought I was pretty sophisticated about randomness. Wrong, this book made me think about it in ways that I had not before. Every student of life or mathematics must read this book before they can consider themselves educated.

"Fooled by Randomness" may not make you a better person or even a better Wall Street trader, but it is fun to read. I took a couple of the typical Statistics courses in college and understood enough to realize that statistics was being misapplied by lots of academics (and others).

It is really pretty subtle and easy to make mistakes.

Taleb is now a personal hero of mine. My hats off to someone that can make a living from the market with seemingly so little effort.

I've always thought it was funny for some executives whose company lost major amounts of money to say something like: "so and so, unexpected event occurred, and we lost money. (It's not my fault), just look at all my competitors (who also lost money)". How is this a justification? Did your mother tell you don't jump off the bridge just because everyone else is going to? Don't drink that poison Kool-aid!

Whether it's the dot-com meltdown, the mortage meltdown, the Enron collapse, the Arthur-Anderson accounting scandals, Katrina, Andrew, or 9-11 leading to terrorist wars, when one looks into history, there was always someone who did calculate for such risks factors. They were always overruled by some then-high-flying executives who denied such possibilities. These events are the black swan of reality.

The book is fun and informative book. The author throws his sarcastic personality into this book tells amusing stories of how a finance occupation with a great deal of randomness in success rate produces all kinds of successful incompotent characters. Frequently, as Taleb points out, even after a black swan, these once-successful characters still walk away with millions of dollars or other successes. As for example, the not-indicted Enron executive with $98 million, the Arthur Anderson execs who still had tens of millions, Mayor Nagin of New Orleans, the dot-com and mortage-related companies that kept their money, etc. It's not just the financial market--it is life in general, as Taleb notes.

Most reviewers here find his views narcissitic because he knocks so many occupations and people; I actually think he's just sarcastic; and it is evident he is also highly self-critical. The way he knocks these others is very entertaining. Everything from Russian scientists to MBAs to zero-risk traders to aggressive traders and to himself.

Anyhow, what can one learn from this valuable book (other than be cautious assumming that those who are successful are compotent):

1. If one is in an occupation where there is luck (randomness) involved, the occupation will produce a large number of lucky and unlucky people.
2. People aren't very good at remembering or assessing the percentage of luck in their decision process, and the lucky will be fooled into thinking their luck was skill. Therefore one will meet a large number of successful lucky incompotent people.
3. We as human beings cannot be rational; and thus, one's feelings, and incompotentence about one's luckiness still has to be expressed, understood as luck, and limited in one's decision-making impact.
4. People thinking processes frequently exclude the occurrence of the black swan events.

Taleb is saying more than how this applies to the market. He's saying that human beings are not good mathematical decision calculators, and as such, in recognizing this, one will see differently others and self.

As for financial markets, Taleb is saying something similar to Malkel's (sp?) Random Walk Down Wall Street (first edition). It's actually a great follow-up--the psychology, characters, and black swans of Random Walk.