Fooled by Randomness: The Hidden Role of Chance in the Markets and in Life, First Edition
by Nassim Nicholas Taleb

Feb 2002

This black swan is a ten star event

If you are a dyed-in-the-wool fundamental analyst, a puffed up CEO, a financial journalist, or a swaggering institutional trader, then odds are fair that you will hate this book with a passion, and feel equal parts loathing and resentment for its author. I am surprised that there are not more condescending or vicious one star reviews than the few I saw, seeing as this book is bound to offend just about every traditional Wall Street type there is (and they are not the most forgiving type).

Being thousands of miles away from Wall Street in both mentality and location, I found this book to be effortlessly brilliant… one of the most insightful I have read in years. It comes across in the style of a casual coffee shop chat with an intelligent friend. Taleb does not assault your brain with new math or doctorate level concepts; rather, he points things out with such casual ease, you wind up wondering how you could have missed the clarity before. It is a case of adding valuable depth, rather than breadth, to knowledge of probability.

I bought the book assuming Taleb would spend a lot of time arguing for the random walk theory of markets, when in fact the practical result appears to be the opposite. His thesis, as I see it, is that trading opportunities exist largely because man is genetically and societally programmed to be fooled by randomness, yet remains willfully oblivious to this fact... and thus the crowd creates exploitable market distortions through an ongoing series of irrational acts.

The elements of humor and insight in this book are numerous, and I can't resist highlighting a few favorites. Taleb's observation of the "lucky fool" made me chuckle because I have come across, or heard of, so many lucky fools already over the course of my young career (like the friend of a client who turned 400K into 12 million pyramiding gains on a single tech stock in 1999, but then went bust on the ride back down because he was too naive to distinguish between skill and luck).

Taleb's use of the "dentist's certainty" as a statistical average in comparing potential outcomes over numerous sample paths was very instructive, as were the final outcome examples of myopically aggressive traders John and Carlos in comparison to the cautious Nero Tulip. The powerful point is that it is easier not to be jealous of a mega-successful peer when it is known that the bulk of that peer's accomplishment was to be in the right place at the right time, suggesting the nature of their success—fortuitous gain from a random cycle or event—is of such ephemeral nature that it can disappear at any point (insert flashback to Nasdaq bubble here).

Taleb's observation on the correlation between market observation and emotion was also excellent and original (to me at least). The lesson that even a high probability strategy will likely have negative emotional expectation over the short run, due to the exaggerated impact of negative emotions over positive ones, has many implications for those obsessed with watching every tick of their portfolios.

In his thorough and methodical destruction of probability blind journalists, flavor of the month gurus and retrofitted market theorists, Taleb also highlights how the explosion of commentary and data in the information age arguably makes for worse trading decisions overall—and confers an advantage to the trader who can restrain himself from drowning in data. The way he watches CNBC also made me laugh out loud (read the book to find out why).

He does not spare fund managers either, popping their balloonlike egos with a sharp argument based on the talented coin syndrome. Morningstar will not like his undeniable point that the majority of good track records taken from a large sample pool are based more on luck than skill… and that sudden and heavy advertising of such a track record only increases the likelihood that it is a statistical variance.

Finally, I appreciated the way Taleb stresses firmly and repeatedly that one of his greatest strengths is knowing that he is weak. Humility is a sign of wisdom, and the proud generally have a shorter life expectancy, especially in markets. That, too, could be considered a central theme of this book.