5 Things I Learned From Fooled by Randomness

Nassim Taleb’s Fooled by Randomness is about “luck disguised and perceived as non-luck (that is, skills) and, more generally, randomness disguised and perceived as non-randomness (that is, determinism).”

It’s an enlightening read in its entirety, but here are 5 things that I find worth sharing with you guys from the book.

1. Beware the Hindsight Bias

Things are always obvious after the fact … When you look at the past, the past will always be deterministic, since only one single observation took place. Our mind will interpret most events not with the preceding ones in mind, but the following ones. Imagine taking a test knowing the answer. While we know that history flows forward, it is difficult to realize that we envision it backward. Why is it so?

…here is a possible explanation: Our minds are not quite designed to understand how the world works, but, rather, to get out of trouble rapidly and have progeny. If they were made for us to understand things, then we would have a machine in it that would run the past history as in a VCR, with a correct chronology, and it would slow us down so much that we would have trouble operating. Psychologists call this overestimation of what one knew at the time of the event due to subsequent information the hindsight bias, the “I knew it all along” effect.

The main culprit for our inability to acknowledge randomness is hindsight bias. When we look back at things that have happened, we see them as less random than they were. As they say, the hindsight vision is 20/20. Once we know the outcome of an event, we find it hard to imagine the other possible ways in which things could have happened. And that often causes us grave problems as we start expecting certainties in a highly uncertain world.

2. Luck is not Skill

There is one world in which I believe the habit of mistaking luck for skill is most prevalent – and most conspicuous – and that is the world of markets … we often have the mistaken impression that a strategy is an excellent strategy, or an entrepreneur a person endowed with “vision, ” or a trader a talented trader, only to realize that 99.9% of their past performance is attributable to chance, and chance alone. Ask a profitable investor to explain the reasons for his success; he will offer some deep and convincing interpretation of the results. Frequently, these delusions are intentional and deserve to bear the name “charlatanism.”

A consequence of confusing being skillful for being lucky is that we tend to think it’s easy to be a successful investor. The ultra-successful, even though they are few, have an outsized effect on us. We believe we can succeed because they did.

The world of investing, like most things in life, produces success stories but it also generates as many failures. It’s human nature to wish to emulate success. However, an ironic truth is this: To accept success at face value without acknowledging the role of luck is a strategy for failure.

3. Do Your Work, Then Let Randomness Do Its Own

…risk-conscious hard work and discipline can lead someone to achieve a comfortable life with a very high probability. Beyond that, it is all randomness: either by taking enormous (and unconscious) risks, or by being extraordinarily lucky. Mild success can be explainable by skills and labor. Wild success is attributable to variance.

In general, the world is disorderly and full of random events. But in the field of finance in investing, you find many with the irresistible urge to seek patterns and this can get us into serious trouble. As investors, it’s important to know that we’re dealing with something where randomness and chance can distort the expected outcome in the short term.

Time and again it has been proved that majority of stock price changes are nothing more than random jitters in the system for which no explanation is ever required (Mr. Market’s mood swings) — yet you can find people obsessing over every minuscule movement and explaining them like kids spotting animal shapes in the clouds.

4. Focus on Process over Outcome

Heroes won and lost battles in a manner that was totally independent of their own valor; their fate depended upon totally external forces, generally the explicit agency of the scheming god (not devoid of nepotism). Heroes are heroes because they are heroic in behavior, not because they won or lost.

As investors, we often struggle with judging whether a decision was good or not, even in hindsight, because we often only look at the outcome to judge. We tend to miss out the importance of the process. A good process is something that could help us bring the odds of success in our favour. I believe that with a good process we stand a chance to do well in investing over the long run.

5. Know Thyself

It certainly takes bravery to remain skeptical; it takes inordinate courage to introspect, to confront oneself, to accept one’s limitations – scientists are seeing more and more evidence that we are specifically designed by mother nature to fool ourselves.

One of the most underrated but among the most valuable skills required to succeed in stock market investing is resilience i.e., the ability to properly adapt to stress and adversity.

How easily can you bounce back from a market crash? What would be your reaction to a sharp decline in your stocks’ prices? How many ‘black swan events’ can you withstand in quick succession? How safe is your overall portfolio in the bear market?

We are designed by mother nature to fool ourselves. If you don’t know who you are, the stock market is one expensive place for you to find out.

Fooled by Randomness is a wonderful book. Read it certainly, and slowly.


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