Episode 10: Fooled by Randomness
Hello and welcome to Episode 10 of Metamorphosis, featuring the book, Fooled by Randomness: The Hidden Role of Chance in Life and in the Markets, by Nassim Nicholas Taleb, a Lebanese-American essayist, mathematical statistician and trader.
The book is an unequivocal essay, on our inability of avoiding being the fool of randomness. Presenting a plethora of heuristics, however, blind to reasoning but revealing that humans are innately biased. At the heart of the text is a cogent argument questioning whether our success is attributable to skill or randomness? and that do we get the slightest suspicion that we might just be lucky fools or does that only factor in when we hit a downward spiral?
Through the laboratory of financial markets and lens of economics, (the area most appropriate to understand differences caused by the pernicious habit of mistaking luck with skill and where the amount of human confusion is most prevalent), Nassim goes against the grain by applying scepticism via probability as a qualitative subject, in a different vein, than a traditional quantitative discipline that statistics 101 classes hold. He deconstructs, “For starters, we are not wired in a way to understand probability … we perceive risk not from the ‘thinking’ part of the brain but largely from the emotional one, implying that rational thinking has very little, to do with risk avoidance. We tend to overvalue that which triggers an emotional response, tipping the scale off from things that aren’t as emotional. We tend to forget the many who fail, remember the few who succeed, and then create reasons and patterns for their success even though it was largely random.” As humans we think in binaries, necessarily ticking the calculative accountant in us, and we certainly don’t need a rational and scientific model when it comes to the details of our daily life.
My first takeaway is drawn from the concept of alternative histories. I found it rather fascinating if you could relive your life, (the set of events that have happened in the past, brought up to this point) 1000 times and observe how varied the outcomes could be?
As he illustrates in the book: Imagine a tycoon offering you $10 million to play Russian roulette, to put a revolver containing one bullet in the six available and pulling the trigger. Each realisation would count as one history, for a total of six possible histories of equal probabilities. Five out of these six histories would lead to enrichment; one would lead to a statistic, an obituary with an embarrassing (but original) cause of death.
The caveat here is regarding the notion of alternative accounting: $10 million earned through Russian roulette does not have the same value as the $10 million earned through the diligent and artful practice of your craft. This has an interesting intellectual extension that leads to the Mathematical formulation of the Monte Carlo engine. Invisible histories/alternative sample paths, from the field of stochastic processes, examine a sequence of scenarios along the course of time. One isn’t concerned with the investor’s worth in a year, but rather the turbulent rides he may experience during that period. Monte Carlo simulations use such concepts to create artificial histories, in today’s day and age through powerful computing such generations of sample paths can help us study dynamic events unfolding with the course of time.
So overall, if that was possible to implement and learn from in our life, we would become certain of traits and characteristics, as our long-term properties, since certainty would be something that takes place across the highest number of alternative histories.
My next takeaway is from understanding that you can never affirm a statement, only confirm its rejection. A method used in mathematics to prove via contradiction. This is to say that we never know things for sure, only with degrees of varying certainty. Illustrated by the statement, “No number of observations of white swans can allow the inference that all swans are white, but the observation of a single black swan is sufficient to refute that conclusion.” In other words, “it isn’t over until it’s over, as simple as that!”
(In some sense, the book sends across this message that we should avoid naïve empiricism, and employ moderate scepticism, however, finding the balance is beyond our reach.)
My final takeaway is that nobody accepts randomness in his own success, only his failure. “When things go our way, we reject the lack of certainty.” We act as if we deserve the success and the strings of successes that follow. The confidence one expresses, increases credibility and deservingness, until randomness kicks in and induces plight. Soon it catches our attention, followed by blame.
As Nassim writes, “Mild success can be explainable by skills and labour. Wild success is attributable to variance.”
It clears the fact that our mind is so much different from the rationality imposed on it in most situations. Tracing it back to the previous point of thinking in binaries, the author gives the famous example, of using randomness to break an impasse: A donkey, equally hungry and thirsty placed at exactly equal distance from sources of food and water. In such a framework, he would die of both thirst and hunger as he would be unable to decide which one to get to first. Now inject some randomness in the picture, by randomly nudging the donkey, causing him to get closer to one source, no matter which, and accordingly away from the other. Herein it exposes the fact that our brain can handle only one state at once. It can’t think in a linear combination of 40% at work and 60% at the beach for holidays at a single point in time. Regardless of how hard we think, we cannot utilize all of that information in order to make useful decisions…
And with that, we segue to the words to live by:
“It does not matter how frequently something succeeds if failure is too costly to bear.”
Thank you for going through this episode of Metamorphosis!
