FOOLED BY RANDOMNESS

Fooled by Randomness: The Hidden Role of Chance in Life and in the Markets is a book by Nassim Nicholas Taleb that deals with the fallibility of human reasoning.  He published the book in 2001. Taleb’s other seminal work is The Black Swan   which was described in a review by the Sunday Times as one of the twelve most influential books since World War II and was published in 2007 around the sub prime crisis.

Most Indian’s believe in something called “destiny”, to Taleb’s mathematical mind destiny  is “chance”.  He postulates that when seen through the prism of a sample data base all hardworking, disciplined and conscientious people do NOT become successful.  For every one million people who went into business, only one or two become Dhirubhai Ambanis. But we only remember the success stories and then weave tales around them. Nobody thinks that it was chance, fortune or sheer coincidence that led to some of his actions resulting in explosive growth for Reliance.

Taleb sets forth the idea that humans are often unaware of the existence of randomness. They tend to explain random outcomes as non-random. We overestimate causality, e.g., we see elephants(or something else) in the clouds, like Rorschach’s ink blots instead of understanding that they are in fact randomly shaped clouds that appear to our eyes as elephants;

He then extrapolates these observations to the stock markets and tells us that we tend to view the world as more explainable than it really is. So they look for explanations even when there are none.

Most of the Technical Experts who appear on the financial channels in the electronic media, try to find meaning in a garbage of data. Give a man a computer and piles of data and he shall find a pattern. Something like, the Chaos theory proponents say about “the butterfly effect”, wherein a  small change at one place in a deterministic nonlinear system can result in large differences to a later state. Taleb states that we get fooled by such random happenings because someone finds a pattern in them.

To take a military example, do all hard working, disciplined, equally qualified WestPoint graduates end up becoming Generals? No. It implies that apart from the requisite qualities, those who became Generals had something else going for them. Was it the death of a competitor? Was it the chance to be posted under a superior who was from his Regiment? Was it expungement of an adverse remark in his Confidential Report by a sympathetic friend of his father-in-law? Was it a sudden increase in the number of vacancies of Generals by the President? Was it participation in a battle which was thrust upon the nation due to a random terrorist event on 9/11? 

If one sits down and analyses, one will realise that random events occur around us all the time and a lot of our lives are products of those random events, and we get fooled by them by attributing the successes to our capabilities and our failure to the random happenings.

In financial markets, day traders often make daily or weekly profits like chicken food but their losses are like elephant dung. Therefore, never rule out the possibility of a random event leading to a huge downside in your investment decisions and never attribute a huge profit in your investments to just your intelligence. Don’t be fooled by randomness.

Go read this book  to understand how stock markets focus usually on data and noise and then they try to find a pattern in that noise. Build a foundation of KNOWLEDGE for your stock market investments. 

Fooled by Randomness: The Hidden Role of Chance in Life and in the Markets 1st Edition