Fooled by Randomness

This book is already more than 20 years old, yet the content still rings true. Written just after the dot-com crash, it feels as if the financial system is ever melting and Taleb offers a credible explanation for this feeling.

Although the book is all about the financial markets, and about financial traders, it is not about how to invest. Rather it is a personal account of how the writer, a trader himself, has spent his life trying to to avoid being fooled by randomness. Randomness is everywhere, and humans are very bad at spotting it. Taleb is offering the following type of insights. Given the number of active financial traders in the financial industry, hundreds of thousands, there are always traders having streaks of luck (think Bernoulli trials/coin tosses) or traders being in sync with temporary market developments. These traders invariably get promoted, and according to Taleb, mostly 'blow-up': loose more money than they ever gained. Fooled by randomness.

Taleb connects the statistical woes of the financial industry to philosophy of science. It is hard to run scientific experiments in economics or the financial markets. As a result there is a lot of dubious extrapolation going on. One could for example (not in the book), model data on economic growth in the UK in the period 1985 to 2005 using a Gaussian curve, and come to the conclusion that large swings in growth are 'improbable'. As history has shown a few times, large swings are possible. This is what Taleb calls the fat tail problem: extreme values are far more probable than many conventional models are suggesting.

Extrapolation goes by the philosophical name of induction: the act of generalizing results form a small sample of data to overarching principles. This problem is also known as 'Hume's Problem'. It is also central to work of Karl Popper, well known for his falsification principle: either a theory has been refuted, or a theory has withstood refutation until the current day. But theories are never true. Poppers views match well with the type of forecasting Taleb is invested in, but at large do not represent current thinking in philosophy of science as far as I know.

One of the nice things is that Taleb conveys how many of his insights are based not on mathematics, but on Monte Carlo simulations. Seemingly Taleb has a knack for modeling his domain in simulations. And he is getting quite some mileage out of it. Not only does he recount how he is a man of leisure at the beginning of this century, in 2023 he is still active as a principal scientific adviser at Universa, an investing company. And today, the financial markets are again in unknown territory. Universa's performance over the next years will add to the tale.

One of the lesser nice things about the book is that Taleb is not interested in really educating the public on his views. His pay-off, self-confessed, is in making his views less obscure, therefore more bankable, without spilling the beans. Although rich in often personal anecdotes that do offer real insights, this, and his writing style, including the from his standpoint obvious excursion into philosophy of science, add significantly to a feeling of self-mystification.

Randomness itself though is a big creator of mystery. So this might just be the way.

I can't really call something written in this style an essay, it's more like propaganda, a call-to-arms. It's closer to the tone of some samizdat than to scientific articles.

And yet, it's about very real things summarized mostly in examples and short stories that makes the book itself lengthy though it could be shorted into a few points.

1) People judge observations from too little amount of samples.
2) People mistake noise to signal because of the urge to explain events.
3) People mistake luck to skill based on superstitions alone.
4) People tend to arbitrarily adjust their scales to measure values.
5) People tend to trust inductive thinking if it fits expectations.

Taleb doesn't offer real solutions, and he doesn't even say anything new to readers educated atleast with a basic level of mathematics (eg. combinatorics) or philosophy (eg. positivism) and yet his book is very recommendable because it's like meditation on probability. While reading through the book, some of these ideas solidify on a reasonable level, it's also a subject that certainly needs paying attention to and worth reading or writing books about.

He mostly suggests ways to ignore people employing these fallacies too often, that certainly makes you feel better but could be doubtful if it helps anyone else. Despite the tone and strange closing thoughts it's an important read for everyone.