Fooled by Randomness, by Nassim Nicholas Taleb, is a disturbing book. It asks questions we don’t want asked and hear answers we don’t want to hear.
Mr Taleb is an investor, par excellence, but an investor with a twist. He despises risk and takes every caution to avoid it. But, wait a minute; is this a book about investing? Yes and no. Part of the book uses examples from the world of stocks and bonds, but much of it does not, and every bit of it applies to your life and mine.
How about this question: Does your boss talk utter nonsense? Your favorite politician? Let’s separate meaningful sentences into two categories, deductive and inductive. Deductive would be something like: Two plus two equals four. From the inputs flows the answer. In the case of inductive sentences, there is more room for discussion. It rains in Spain. Really? A lot or a little? All over Spain? How do you know it rains in Spain? Taleb examines the inductive side with something called the Dada Engine, which can be used to generate grammatically sound sentences that are meaningless. How can you tell the difference, if the statement is inductive? Taleb goes into some detail about how random bits can be strung together to mean nothing, but sound elegant. He didn’t need to use the engine. We get random gibberish everyday, from multiple sources, most of whom are in positions of authority.
Now, to steer toward investing. We’ve all received a letter from an “expert” claiming to have the final word on making money. But, do these experts have true expertise, or are they also random riders on the train to success. Taleb takes a stab at the answer this way. Given X number of investors, and the randomness of the stock market, invariably Y number of investors will make money and Z number will lose money. X, Y, and Z will change as the market swings and investors join in or drop out. Making or losing money becomes a probability, much like rolling the dice. No matter what you do, a certain number of times, you will roll boxcars and a certain number snakeyes. But, what about the guy who rolls six boxcars in a row? He is now an expert, yet the probability of his rolling another pair of sixes is exactly the same the seventh time as it was the first. But, savvy investors make money all the time. Not so fast, ace. As an unnamed investor said of another, “He has successfully predicted five of the last two recessions.”
But, you say, “This guy has a great record of predicting which stocks to buy. He predicted the stock of X, Y, and Z companies would go up. They all did!” Taleb easily explains this and the answer will stupefy you.
Taleb doesn’t stop there. He brings probability to the real world, such as the O.J. Simpson trial and life expectancy. Taleb doesn’t read the newspapers anymore, or watch the news on TV. Why? Too much trivia, misinformation, and downright ignorance of probability. Newspapers and TV upset him.
As humans, there are a couple of things we can’t do, rule out emotions, and consider all the possibilities. When we experience bad luck, which Taleb might call the probability of failure, we only consider that we could have had good luck, or better luck, not that what happened to us was on the upper scale of all the bad that could have happened. And, how can we control our emotions? Truth is, we can’t really. But, we can mollify the effects our emotions have on us. Don't watch the news. Don’t check stock prices everyday.
Read this book. It makes you think and it’s good for investments, but it’s better for the soul.