60 pages • 2 hours read
Nassim Nicholas TalebFooled By Randomness: The Hidden Role of Chance in Life and in the Markets
Nonfiction | Book | Adult | Published in 2001A modern alternative to SparkNotes and CliffsNotes, SuperSummary offers high-quality Study Guides with detailed chapter summaries and analysis of major themes, characters, and more.
Themes
The Distinction Between Luck and Skill
The distinction between luck and skill is a central theme in the book, one which Taleb points out has gotten little attention from scientists. The distinction tends to be either overlooked or entirely misunderstood. Among scientists, this is because factoring uncertainty into prediction models is notoriously difficult. However, the distinction is often misconstrued by ordinary people as well, particularly those who experience great success. Taleb explains that “Mild success can be explainable by skills and labor. Wild success is attributable to variance” (44-45). Those who experience these wild successes are not aware of the way luck and randomness exert influence. This is due to the attribution bias, which Taleb describes as the way people tend to attribute failures to bad luck and success to skill.
Mistaking luck for skill has wide-reaching repercussions. Taleb points out that “that which came with the help of luck could be taken away by luck (and often rapidly and unexpectedly at that). The flipside […] is that things that come with little help from luck are more resistant to randomness” (35). The attribution bias blinds successful traders to the fact that their success is thanks to luck as much or more than skill, which makes their failure more likely. Two fictional characters illustrate these two different experiences in the book: John represents the wildly successful but lucky person, and Nero represents the person whose conservative, risk-avoidant strategy steers him away from the influence of luck.
There are nuances to this dichotomy, however. One lucky break can set a person up for significant future success. Taleb discusses Bill Gates’s rise to elite-level wealth in the book. As an entrepreneur, Gates does not quite fit into the Nero/John binary. Taleb acknowledges that Gates worked hard to develop a product that people bought and that still has enormous influence in today’s world. However, Taleb asks the following question of Gates’s wealth and success: “Does he deserve it” (212). At the time of Microsoft’s founding, Gates was not the only one striving to develop a computer product along the lines of Microsoft’s, yet somehow, he was able to rise above the competition. Was this attributable to skill? Taleb says that it is not. Chance enabled Gates to gain a foothold in the market, and once that was established, the product sold itself. Taleb says, “Most people are equipped with his software…because other people are equipped with his software, a purely circular effect” (212). Taleb also discusses scenarios where actors might have the same kind of path. An actor has the good luck to land the lead role in a huge blockbuster, and on the strength of that success, they become a star. Their reputation from that lucky break garners them more and more blockbuster roles. Meanwhile, the “losers,” those who did not land the role even though they may have been just as skilled as actors, remain spinning in anonymity.
Human Perceptions of Cause and Effect
The core flaw in human perceptions of cause and effect for Taleb is that “we underestimate the share of randomness in about everything” (27). Randomness implies uncertainty, undermining the clarity that people desire when they make decisions. Taleb argues that the “randomness in one’s life is an abstract idea, part of its logic counterintuitive, and, to confuse matters, its realizations nonobservable” (60). The random elements in a situation can be difficult to identify or understand, both for individuals and for researchers trying to understand events or systems. Because randomness cannot be definitively or empirically proven, it is often overlooked.
One of the other ways people respond to randomness is by reverting to superstition. Taleb attributes this tendency to human evolution: “We are still very close to our ancestors who roamed the savannah. The formation of our beliefs is fraught with superstitions—even today” (26). He probes this idea further later in the book when he points out his own tendency toward superstition. He begins associating wearing glasses with success in the market, so he takes to wearing glasses more than he needs to. Although he was taught that superstitions are culturally inculcated, Taleb says that his “superstitions needed to be biological—[…] there was nothing cultural about my link between my wearing glasses and a random market outcome” (269). He connects the human drive to apply causal explanations to random events to scientific evidence that human brains are wired for superstition.
According to Taleb, the greater one’s belief in human reason, paradoxically, the more likely one is to have a flawed perception of cause and effect. Those who dismiss the impact of randomness on the nature of cause and effect “believe in reason and rationality […] thinking we can control our nature at will and transform it by mere edict in order to attain, among other things, happiness and rationality” (31). At the core of this outlook is a belief that humans can shape outcomes through their will. By omitting the influence of randomness on cause and effect, people of this sort tend to perceive flaws in the human condition as rectifiable. By contrast, Taleb points out that some adopt the “Tragic Vision” of humankind, and believe “in the existence of inherent limitations and flaws in the way we think and act and requires an acknowledgment of this fact as a basis for any individual and collective action” (31-32). For people of this outlook, the relationship between cause and effect defies easy explanation. Taleb emphasizes his own superstitions and mistakes in causal reasoning to argue that the most responsible way to approach the problem of human perceptions of cause and effect is to accept that our perceptions are fundamentally flawed and try to understand those flaws so that we can compensate for them.
The Limitations of Financial Models and the Unpredictability of the Markets
Taleb takes issue with some of the ways commentators and other analysts attempt to predict the market. He discusses faulty reasoning such as the survivorship bias and data mining. As an example of the latter, Taleb says, “The more I try, the more I am likely, by mere luck, to find a rule that worked on past data” (199). In other words, data mining as described here is unreliable; it is a post hoc exercise whereby a researcher seeks to establish patterns in past data that they think can be used to predict future market activity. Taleb is consistently skeptical of too much data. While it can be used effectively, in Taleb’s view, it can also pose unforeseen problems. He says, “The major problem with inference in general is that those whose profession is to derive conclusions from data often fall into the trap faster and more confidently than others. The more data we have, the more likely we are to drown in it” (171). Too much data ironically imposes a limitation on the accuracy of financial models by making it easier to generate spurious explanations for random events.
Taleb takes a cynical view toward the media in general and is at times contemptuous of financial commentators specifically. Taleb spends time discussing how the media contributes to the noise while drowning out the signal. For example, he says:
[V]olatility seems to be determined […] by the tone of the media. The market movements in the eighteen months after September 11, 2001, were far smaller than the ones that we faced in the eighteen months prior—but somehow in the mind of investors they were very volatile (72).
Taleb suggests that media hype often attempts to impose a kind of predictability on the market, but often it misinterprets the reality of what the market is likely to do. Furthermore, Taleb states, “Such tendency to make and unmake prophets based on the fate of the roulette wheel is symptomatic of our ingrained inability to cope with the complex structure of randomness prevailing in the modern world” (69-70). Commentators and pundits misunderstand the nature of probability models and exclude the effect of randomness, and in so doing, they create models that mislead others.
In response to market unpredictability, corporations have taken to hiring risk managers, “someone who is supposed to monitor the institution and verify that it is not too deeply involved in the business of playing Russian roulette” (74). Taleb argues that this is window dressing. It gives the appearance of the corporation being careful, but again, these risk managers tend to misunderstand randomness. As with the distinction between luck and skill, the core of the problem lies in people believing they have control when they do not.
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By Nassim Nicholas Taleb
