Fooled by Randomness

Taleb's thesis is that people consistently underestimate the role of chance and see causes where there are none. In markets that means confusing a lucky trader with a skilled one, judging decisions by outcomes, and missing strategies that make small, steady gains until a rare loss wipes them out. He frames the problem through alternative histories, the outcomes that could have happened.

Taleb was a derivatives trader at firms including Credit Suisse First Boston, UBS and Banque Indosuez, and in 1999 founded Empirica Capital, whose strategy bet on rare events. The book, heavily revised since its 2001 debut, is the first of his Incerto series, has been translated into 20 languages and was named by Fortune one of the 75 smartest books of all time.

What sets it apart is the vantage point: it comes from inside a trading room and is written by someone who made his living on other people's underestimation of tail risk. It is also essayistic, digressive and opinionated. Forbes found it playful and self-effacing but at times insufferably arrogant, and Giles Foden, reviewing The Black Swan in The Guardian, found that book's dumbed-down style a step back from this one.

Read it if you hire, rate or allocate to managers, or if you need to explain why last year's top performer is not evidence of skill.

1. Judge decisions by their alternative histories. A profitable bet that carried a one-in-six chance of ruin was a bad decision; consider what could have happened, not only what did.
2. Frequency isn't magnitude. A strategy that wins most months can still lose money overall if its rare losses are large, which is the profile of short-option and carry trades.
3. Survivors distort the sample. The managers you hear about are the ones who lasted; in a large enough field, some will post stellar records by chance alone.
4. Short horizons are mostly noise. Checking results constantly exposes you to randomness and emotional swings rather than information about skill.
5. Use rules where willpower fails. Taleb doesn't claim immunity to bias; he relies on precommitments and fixed rules, as Odysseus did with wax and rope, to protect himself from it.

After a prologue, the book runs in three parts and closes with an epilogue, Solon Told You So, returning to the warning that no one should be called fortunate until his life is over.

1. Solon's warning: skewness, asymmetry and induction. Taleb contrasts Nero and John, introduces alternative histories and the Russian roulette player who gets rich, explains Monte Carlo thinking and why a dentist who checks his portfolio by the minute sees mostly noise, follows traders who thrive in one market regime and then blow up, separates the probability of winning from the size of the payoff, and closes the part with Karl Popper and the problem of induction.
2. Monkeys on typewriters: survivorship and other biases. With enough players, some will compile great records by chance. He covers survivorship bias, data mining, the nonlinear and winner-take-all nature of many outcomes, and the cognitive biases documented by Daniel Kahneman and Amos Tversky.
3. Wax in my ears: living with randomitis. Because knowing about bias doesn't cure it, Taleb recommends tying yourself to rules, as Odysseus did. He writes about superstition in trading, the skeptical philosophy of Carneades and keeping your dignity in the face of bad luck.

Fooled by Randomness is a standalone book in Nassim Nicholas Taleb’s landmark Incerto series, an investigation of opacity, luck, uncertainty, probability, human error, risk, and decision-making in a world we don’t understand. The other books in the series are The Black Swan, Antifragile, Skin in the Game, and The Bed of Procrustes. Fooled by Randomness is the word-of-mouth sensation that will change the way you think about business and the world. Nassim Nicholas Taleb–veteran trader, renowned risk expert, polymathic scholar, erudite raconteur, and New York Times bestselling author of The Black Swan–has written a modern classic that turns on its head what we believe about luck and skill. This book is about luck–or more precisely, about how we perceive and deal with luck in life and business. Set against the backdrop of the most conspicuous forum in which luck is mistaken for skill–the world of trading–Fooled by Randomness provides captivating insight into one of the least understood factors in all our lives. Writing in an entertaining narrative style, the author tackles major intellectual issues related to the underestimation of the influence of happenstance on our lives. The book is populated with an array of characters, some of whom have grasped, in their own way, the significance of chance: the baseball legend Yogi Berra; the philosopher of knowledge Karl Popper; the ancient world’s wisest man, Solon; the modern financier George Soros; and the Greek voyager Odysseus. We also meet the fictional Nero, who seems to understand the role of randomness in his professional life but falls victim to his own superstitious foolishness. However, the most recognizable character of all remains unnamed–the lucky fool who happens to be in the right place at the right time–he embodies the survival of the least fit.” Such individuals attract devoted followers who believe in their guru’s insights and methods. But no one can replicate what is obtained by chance. Are we capable of distinguishing the fortunate charlatan from the genuine visionary? Must we always try to uncover nonexistent messages in random events? It may be impossible to guard ourselves against the vagaries of the goddess Fortuna, but after reading Fooled by Randomness we can be a little better prepared. Named by Fortune One of the Smartest Books of All Time A Financial Times Best Business Book of the Year