Fooled By Randomness (2001), Nassim Nicholas Taleb - Book Summary

Fooled By Randomness (2001) is a collection of essays on the impact of randomness on financial markets and on life. Through a combination of statistics, psychology, and philosophical reflection, the author outlines how randomness rules the world.

This book is for

  • Investors and financial professionals who think they understand the nature of risk and performance;
  • Anyone interested in human decision making;
  • Anyone read newspaper every day to get valuable information.

About the author

Nassim Nicholas Taleb is a researcher, author, and investor who has dedicated his life to understanding the true nature of luck, uncertainty, and knowledge. His later book, The Black Swan also became a bestseller, and he is considered one of the leading intellectuals on the planet.

The author wrote Fooled By Randomness based in part on his own experiences and interactions as a Wall Street trader.

We often confuse luck with randomness in terms of skill and determinism.

We are often fooled by randomness, which means we underestimate the impact of luck and random things in our lives. We use terms like "skill", and "determinism" when "luck" and "random" are mentioned. Nowhere is this distinction more evident than in the stock market, where the “capable investor” should be replaced by “lucky idiot.”

In some professions, one cannot succeed without skill: It is very difficult for a plumber or dentist to have a long career without knowing what he is doing.

Unfortunately, the inherent randomness of the stock market means that, like millions of monkeys typing on typewriters for a long enough time, Shakespeare, and investors, can eventually be created. Unskilled can also obtain many great achievements. In fact, some people are capable of doing so..

For example, a group of about 10,000 investors are, for the sake of argument, incompetent: each year they have only a 45% chance of making a profit. In other words, you basically benefit from an investment based on randomness.

However, despite the lack of skills, after 5 years based on probability alone, we can expect almost 200 of them to be profitable per year. They will boast of impeccable achievements and be praised for their exceptional skills.

Of course, in the long run, the randomness that once facilitated these “successful random fools” will turn against them. Wall Street has seen many traders who, after years of success, have had devastating quarters of the year where they lost everything in a big deal.

Often their short-lived success is simply because they happened to be in the right place at the right time, by luck.

We often confuse luck with randomness in terms of skill and ability to make decisions.

We can never be sure that every theory is correct – things are constantly changing and subsequent observations may prove us wrong.

The basis of all experimental sciences is a process called induction: we infer the nature of the world based on our observations. Hence when we see hundreds of white swans, we can infer (erroneously) that all swans in the world are white.

Unfortunately, this approach carries an inherent problem, illustrated by the famous example of black swans as the philosopher John Stuart Mill declared: “There is no critical number of times. Observation of any white swan may permit the inference that all swans are white, but the observation of a single black swan is sufficient to disprove that conclusion.

This is called the problem of induction, and it means that no theory can be proven true, but can only be proven false (by a single “black swan”). Hence theories are constantly being proven wrong and replaced by better ones.

A similar mindset is to exercise caution in investing: Always consider the possibility that your hypotheses and assumptions could be proven wrong, and examine how such developments will affect your portfolio. How are your investments?

A financial risk manager who ignores this advice will probably say, “This has never happened before, so it won't happen tomorrow either,” will likely see any doubt one day.

In fact, he also erroneously assumes the past is an example that is related to the future. What if things had changed? How can you infer anything about a swan's color if its pigment is constantly changing?

Wherever there are people involved, like in the stock market, there is constant change through adaptation. For example, if stock prices always rise on Mondays, investors would buy stocks on Sundays, thereby changing market capacity and eliminating the effect.

We can never be sure that every theory is correct – things are constantly changing and subsequent observations can prove us wrong.

Life isn't fair and doesn't follow a straight line: The best don't always win.

There is a very popular belief that evolution is always the survival of the fittest. In fact it just means that on average, the organisms that are suitable for the conditions will survive. A few creatures are lucky, unfit but will still tolerate, at least for a short time.

The same is true for many things in life. Consider conventional keyboards: how did the odd layout of keys (called QWERTY) eventually become the near-universal standard in typing?

Rather than being the ultimate solution, it's actually designed to avoid getting stuck like an old-fashioned typewriter. However, because people were too lazy to switch to another type of keyboard, this ultimate solution prevailed.

This is called a path-dependent outcome: if we start from scratch, we won't end up with a QWERTY keyboard.

Similarly, even unfinished products can dominate the market if they pass the so-called peak. Take Microsoft for example: When enough people started using Microsoft products, it created a positive feedback loop where new customers bought exactly Microsoft products because people they knew used them. they. After a product has passed the peak, it has a very strong position.

Events that do not follow any rules are like peaks, which are difficult for us to predict. It is in our nature to assume that a continuous feed, like adding a grain of sand to a sandcastle, will produce the same result. In real life, though, one continuous incremental change can have a huge impact: a single grain of sand can cause an entire castle to collapse unexpectedly.

For example a scientist can work for years without any visible progress until an unexpected breakthrough occurs. Going more miles and still reaping disproportionate rewards, but without visible progress most people give up before they get to the rewards.

Life isn't fair and doesn't follow any straight line: The best doesn't always win.

Our argument is context dependent and largely experimental.

Humans are ill-equipped to deal with the probabilistic reasoning required by today's information environment. Regardless of what we may believe, our mind is not a sophisticated thought machine, but a patchwork of rules and shortcuts known as heuristics. and the test was there.

The discoveries made through this method have evolved to help us make quick decisions when needed instead of overthinking: If you come across a tiger in the woods, it's best to just run and not ponder. details of the situation at the time.

Unfortunately, the price we pay for using these lazy shortcuts is that our arguments become irrational and punctured by what psychologists call bias. For example, due to allocative bias, we tend to deny success to our abilities, and dismiss failures with “bad luck.”

Our thinking also becomes pre-existing, which means that the route that leads us to a given situation controls how we think about it.

For example, if you win $5 million today and lose $4 million tomorrow, you might not be happier than if you only made $1 million tomorrow, even though the end result is the same. identical.

Relying on a pre-existing rut also means that we cling to our current opinion. Scientists and politicians tend to stick to the ideas they support and refuse to change their minds even in the face of conflicting information.

From an evolutionary perspective, we feel connected to things in which we have invested a lot of time and effort, for example, our children, but this tendency can also backfire. Therefore, it is acceptable to change your own thinking and contradictions at will.

Our arguments are context-based and largely dependent on simple empirical and empirical solutions.

Emotions can help us make decisions, but they also overwhelm our reasoning abilities.

Some researchers believe that emotions are real shortcuts in decision-making, "the lubricant of reason". Without emotion to show us a bit of absurd hypnosis, we will suffer endlessly in petty decisions.

Consider the example of Buridan's donkey: An equally hungry and thirsty donkey stands between food and water. If to optimize the choice of what to do in the most reasonable way, it would theoretically die of starvation, unable to decide whether to choose food or water first. A little randomness helps clear the mind, the same way you flip a coin to help solve an impasse. Emotions are fundamentally not rational enough to stop us from procrastinating.

Smart people also need to realize that their ability to reason logically can easily be overwhelmed by emotions. In fact, neuroscientists have found evidence to support the notion that we first feel emotions, then try to argue for an explanation for those emotions. This means that emotions have a stronger influence on rational thinking than other factors.

When Ulysses sailed his boat over the alluring but deadly mermaids, he poured beeswax into his men's ears so they wouldn't hear their songs.

Likewise, in some cases we may choose to avoid our intrusive emotions in order to defend our reasoning. For example, an investor who knows he or she has a tendency to act irrationally when there is a loss may choose to simply not look at the performance of his or her portfolio unless it triggers a specific alarm. , is predefined.

Emotions can help us make decisions but also overwhelm our reasoning abilities.

When we look back at old records, we always find laws, causes and explanations for past events, but this is hardly helpful for predicting the future.

Learning from history does not come naturally to humanity.

Even after many “completely unexpected” crashes in the stock market, many traders believe that the next crash will not happen or will be detected in advance. This is due to the backward trend: when based on older records, events that occurred seem to be more predictable than when they actually took place.  

In fact, if any historical data were adequately analyzed, certain rules would emerge: one author even claimed that he could make predictions for world events. past by examining biblical statistical anomalies. Like our ancestors, who foretold the future by examining the organs of birds, we tend to find patterns and cause-and-effect relationships where there might not be. .

The choice of gamblers is the manifestation of this effect, for example a trader, who wins on a day when he wears glasses and a green shirt, will start wearing the same outfit more, even unconsciously wearing it.

Some traders continue to look for rules in the stock market and use backtesting means to see how certain trading rules are, e.g. “Always sell when the stock price is X% above average”, must have happened historically.

Of course, unleashing modern computing power on large amounts of data will inevitably find many such rules, but the past "success" of these rules has been due to pure randomness. , and anyone who blindly believes in the rules is very likely to have their investment ruined.

When we look back at old records, we always see laws, causes and explanations for past events, but this is hardly useful for predicting the future.

We are inherently poor at understanding the impact of rare events.

When hedge funds announce losses, they are often referring to large and unexpected events, factors for which their risk management models are completely unprepared. These views ignore the fact that things that have never happened before actually happen all the time, and are always unexpected.

An unexpected event can reduce the significance of expected events, which is why they often appear as outliers in the data and are ignored when performing analysis. risk accumulation.

For example, early climate researchers omitted the largest temperature shocks from their data because they thought they did not occur. But in fact, these mutations have added to climate change, an answer that climate model results did not anticipate.

Let's say you are playing a game where you have a 999/1000 chance of winning $1 and a 1/1000 chance of losing $10,000. The natural human tendency is to rely on “what-if” decisions, but in this case it would be a costly mistake. While you will most likely win $1, the disproportionately large loss you incur every thousand times means that the expected outcome of each round is a loss that costs $9.

Even experienced investors fall into this trap, and in fact, many traders who succeed in a short time have used trading strategies for which they usually make a small amount of money, but followed by a large loss in one go.

The opposite, less satisfying but more durable strategies often bet on rare, unlikely events with a large return. While a market crash may not happen, it is still possible to bet on it if the possible reward in such an event is large enough.

We are inherently poor at understanding the impact of rare events.

Enjoy harmless randomness and use stoicism to deal with harmful matters.

While being fooled by stock market randomness is often fatal to your resume, there are interesting instances of randomness.

While reason and correctness can be felt when dealing with problems of science and finance, one can easily be fooled by the randomness when it comes to art and poetry. shift. A scientist using prose as complex as noise to mask the fact that he has nothing of value is infuriating. A poet, on the other hand, using a similar kind of prose can turn out to be stunningly beautiful. Aesthetic forms appeal to our brains whether they are formed by chance or not.

As Yiddish says, “If I have to eat pork, it should be the best.” Likewise, if we have to be fooled by randomness, it's better than the pretty, harmless kind.

Despite our best efforts, we are all sometimes victims of adversity caused by toxic randomness (a sudden cancer diagnosis being a prime example).

In such an event, the codes of conduct we should follow are provided by the Stoics – that “all destructive emotions are rooted in errors of judgment, and that a sage People with "extraordinary wisdom and morality" will not have to experience such emotions, because they know how to control their emotions and feelings. It encourages us to follow the noble path of personal elegance, never showing pity, not blaming others, and never complaining. This approach works naturally with our individual dignity, emphasizing courage and wisdom in the face of misfortune.

Our behavior is the only means we have for dealing with randomness.

Enjoy harmless randomness and use stoicism to deal with harmful matters.

Both in the media and in the stock market, random noises are not worth hearing.

People who are obsessed with reading the Wall Street Journal every day spend a lot of effort for little reward.

Today's information environment is so cluttered with useless news, the cost of reading through all of it far outweighs the cost of missing out on a few but really valuable ones. It's like looking for a needle in a haystack about 30 hours a month.

Similarly, the movements of stock prices in the market are mostly random, insignificant noises, and there is little real change in the value of the stock. While Bloomberg journalists may try to account for and explain every little movement, stock prices actually fluctuate quite unconnected to the fundamentals they are supposed to reflect. In the long run some stocks may outperform others, but in the short term most volatility changes are merely random noise.

See how this affects an investor based on her stock portfolio, arguing that there is 10% volatility and 15% expected return.

If she checked her portfolio every minute, as many traders do today, she would mostly see only slight differences inherent in her portfolio, i.e. natural ups and downs. unrelated to stock performance. Feeling just like everyone else, she was still excited about the gain and sad about the loss. So each year she can expect to experience 60 688 minutes of pleasure versus 60 271 pain.

On the other hand, if she examined her portfolio every year, her stock's actual performance would be reduced to noise factors. She can expect to feel joy 19 years out of 20 years.

Even though her profits will be the same in the end, the minute-by-minute updates will make investors feel emotional, as losses are always more itchy than the pleasure of profits.

Both in the media and in the stock market, random noises are not worth hearing.


The main message of the book is

We are all fooled by randomness, but often misinterpret it as something deterministic.

The questions the book answered:

How does randomness rule the world?

  • We often confuse luck with randomness in terms of skill and determination.
  • We can never be sure which theory is correct – things are constantly changing and subsequent observations may prove us wrong.
  • Life isn't fair and doesn't follow a straight line: The best doesn't always win.

Why do we constantly fail to appreciate the impact of randomness?

  • Our argument depends on the context and is mainly based on how simple the search is.
  • Emotions can help us make decisions, but too much and beyond rational reasoning.
  • Looking back at the past record, we always find laws, causes and explanations in past events, but they are hardly useful for predicting the future.
  • We are inherently poor at understanding the impact of rare events.

How can randomness be dealt with?

  • Enjoy harmless randomness and use stoicism to deal with harmful problems.
  • Both in the media and in the stock market, random noises are not worth listening to.