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Monday, March 08, 2010

Nassim Taleb's Fooled by Randomness

A few years back I read a book called Millionaire Next Door which when distilled had 7 or 8 bullet points which go like spend less than you earn, make a budget and stick to it, choose a profession you like, don't show off your wealth, etc. At the end of it, I thought, wow, this must not be hard. Then I realized that my parents and relatives and many of my friends' parents all have practiced most of the attributes mentioned in the book for most of their lives but they're nowhere near half as rich as the one's in the book. It wasn't hard to deduce - the authors of the book just looked at what the rich guys were doing; they weren't social scientists investigating the financial health of all of the cross-section of the society that had those millionaire attributes. While you could be persevering, smart, living well below your means and materialistically modest there are still pretty good chances that you could end up not becoming a millionaire. And I thought at that time what if a book dwelt on this aspect - where the author exposited in great detail that you could be doing all the right things successful people do and still remain not successful[1] enough all your life - the book would bomb at the marketplace. Who'd want to read a dejecting theory? Apparently, many. Taleb's Fooled by Randomness does exactly that and much more.

Taleb is a Wall Street trader and a professor in risk engineering in addition to many other things. He's well read and the range of references he makes here almost make me wonder if he were simply showing off his diverse education. The crux of the argument he makes in this book is that blind luck or chance occurrence is discounted by most, especially the successful people. His area of expertise is in the markets and he extensively draws analogies from the life in Wall Street to pound the idea home. He talks about the human nature to fit everything into a seemingly logical order and hence we fall into a narrative fallacy of explaining rare events (he calls them black swans) after they've occurred. Taleb effectively informs us that random (or rare, if you will) events will always be part of the human cycle and our historians and journalists should stop glamorizing them by fitting them into a logical flow and establishing a fake order retrospectively.

Once you accept that not everything follows a pattern, at least when it comes to the world of finance, then the expertise of a successful trader is called into question. That's what the author does - he claims to not know the how or where or what or when of markets - and in openly expressing his ignorance he also claims his superiority over many other traders who think they've somehow struck a golden forumla whereas in reality they're just deluded. Taleb even writes about a trading company that had Nobel prize economists[2] but crashed spectacularly in spite of their knowledge of the markets. Funnily, it looks like these economists referenced Taleb's papers on black swans after they went bust to absolve themselves - another attempt by these people to explain their losses and successes.

I'm terribly uninformed of what goes on a trading floor and I'm willing to take most of Taleb's theories at face value. But he extends most of his theories to life and I'm not too comfortable with his condescending tone here. Of course the rich and famous and successful guys did some right things at the right time - they either sat next to a venture capitalist in a long flight or were experts in a social phenomenon whose time has arrived because of technological breakthroughs or were married into a business/political family that had connections.... This interpretation of doing the right thing at the right time is something only time can confirm. It is appropriate to acknowledge the role of luck in making big. But Taleb gave me the impression that hard & smart work doesn't get you anywhere without luck and I don't warm up to that idea. In fact, he uses the example of dentistry as a stable profession through most of the book, and explains the low stress associated with a steady growth as opposed to a fund manager who is invariably stressed every minute of the day and has a high risk of crashing down. But he doesn't seem to imply dentistry as a successful profession by itself.

At some point I wanted to drop the book because it was getting redundant. He was just providing different use cases to illustrate his central theme; but at least he kept issuing nuggets from diverse fields such as philosophy, poetry, history & mathematics which kept me going. (With all that, I read only 13 out of 14 chapters). If you have a pragmatic view of life this book is not going to enlighten you - you already know that chance does things that smartness alone can never do. But that degree of unpredictability in our markets, as painted by the author, unsettled me a bit. In spite of its redundancy it's not a bad book. It was like having a cup of tea with your well educated, well traveled uncle - he repeats some jokes, but he tells them interestingly. So you sit and listen without fussing.

[1] Success in this context is mainly by money. The author cites a scenario where constant exposure to the ups and downs of market arrows takes a high toll on health and then goes on philosophical introspections on what good is money without good health.

[2] There's no such thing as Nobel prize in economics. The award is presented by the Swedish Central Bank and doesn't come from the Nobel fund. Taleb repeatedly points this out. He somehow can't get himself to place economists who predict and create patterns along with scientists.

PS: I'll take a 10 day break before I start my next book - Alan Sokal's Fashionable Nonsense.

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