Trainee Trader

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

No doubt you have heard about or probably even read Nassim Taleb’s Fooled by Randomness. It definitely is a classic and a must read for any trader. Taleb is an experienced derivatives trader, holds a MBA from Wharton and a PhD from the University Paris-Dauphine and is the founder of Empirica Capital LLC. Given the authors extensive technical knowledge it refreshing to read a book that is accessible to readers of any level.
The book is separated into three key parts and the contents are outlined below:

Preface and Acknowledgments
Chapter summaries
Prolouge
Mosques in the Clouds

Part One: Solon’s Warning – Skewness, Asymmetry, Induction

Chapter One: If you’re So Rich Why Aren’t You So Smart?
Chapter Two: A Bizarre Accounting Method
Chapter Three: A Mathematical Meditation
Chapter Four: Randomness, Nonsense, and the Scientific Intellectual
Chapter Five: Survival of the Least Fit – Can Evolution Be Fooled by Randomness?
Chapter Six: Skewness and Asymmetry
Chapter Seven: The Problem of Induction

Part Two: Monkeys on Typewriters – Survivorship and Other Biases

Chapter Eight: Too Many Millionaires Next Door
Chapter Nine: It is Easier to Buy and Sell Than Fry an Egg
Chapter Ten: Loser Takes All – On the Nonlinearities of Life
Chapter Eleven: Randomness and Our Brain: We Are Probability Blind

Part Three: Wax in My Ears – Living With Randomness

Chapter Twelve: Gamblers’ Ticks and Pigeons in a Box
Chapter Thirteen: Carneades Comes to Rome: On Probability and Skepticisim
Chapter Fourteen: Bacchus Abandons Antony

Epilogue: Solon Told You So

The first part of the book focuses on peoples misunderstanding of “the rare event” either the possibility of occurrence or the magnitude of its consequences. We are introduced to the 6th century Greek statesman, lawmaker and poet Solon.

“Solon gave the Lydian king some very wise advice, which however Croesus failed to appreciate until it was too late. Croesus had considered himself to be the happiest man alive and Solon had advised him, “Count no man happy until he be dead,” because at any minute, fortune might turn on even the happiest man and make his life miserable.”

Source http://en.wikipedia.org/wiki/Solon

In this first part we are also introduced to two polar opposite characters Nero and John who happen to be neighbors with very different trading strategies. These characters form a basis for reference throughout the book.

The second part looks at our bias towards randomness in particular survivorship bias. In short survivorship bias occurs, as we only tend to see the winners, this in turn leads to a distorted view of the odds. This is brilliantly exemplified with the creation of fictional investment advisors in a Monte Carlo simulation. Cognitive processing and the famous Kahneman and Tversky are also investigated.

Part three is far shorter then the other two parts but no less important. In the final three chapters Taleb highlights with specific examples how we wrongly associate noise and meaning. Path dependence is briefly discussed and the LTCM collapse is briefly discussed.

Conclusion
This is an extremely easy to read yet complete book. I personally found it very thought provoking, in particular it greatly increased my knowledge on the concept of survivorship bias. It also provides a basis for further reading. It definitely highlighted the fact that a basic understanding of probability is not enough to be a truly successful trader. It is a bit depressing to think that ones success in life is for the most part random and luck is most frequently the reason for “extreme success”. The epilogue truly rounds out the concepts of the book. This book is a must read for everyone not just traders.

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

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