Copyright: 2004 (2nd Edition)
Publisher: Thomson
ISBN: 1-58799-190-X
I made the mistake of reading the two Taleb books on my list out of order. In fact, had I read Fooled By Randomness first, I could have skipped reading The Black Swan since the bulk of the material is covered in the first book (and covered better in my opinion.) That is not to say that there was no new material in the second book, but rather that the new material was not enough to justify spending the time to read through the re-hash. As far as readability goes, I would recommend Fooled By Randomness over The Black Swan.
Why dont' we just do the successful things?
Part of what I liked about this book was the number of stories that Taleb used to illustrate his points, without belaboring us with his name-dropping references to classical literature etc. I am sure that the reader will be duly impressed with Mr. Taleb's erudition regardless so hopefully he won't be too worried about that (although judging from his writing he IS worried about that.)
One anecdote that Taleb shared was that of a managerial type that analyzed a set of transactions to see if he could reduce the overhead associated with the shear number that were taking place. He found that only 1% of those transactions generated significant profit so he promptly wrote a report detailing how they should simply do more of the winning trades and fewer of the losing trades. Just by doubling the number of winners they could have a significant impact on the organization's bottom line.
Of course the hindsight bias that we see here is not confined to the trading world... it happens in nearly every domain. The real key is why do we have Monday Morning Quarterbacks if we all know they exist (and look silly)? Taleb does an excellent job of explaining that our minds tend to view history in a backwards fashion, in other words that the events that took place were deterministic. Our minds are built to "get out of trouble rapidly" not "understand how the world works". This may be an oversimplification, and is certainly overly dependent on an evolutionary view of the mind, however it clearly illustrates the point.
For instance, look at the decisions you made last week or last month. It is usually easy to see by now which of those decisions were good and which were bad. The problem is that we are qualifying them as "good" or "bad" based on information that we have gained since the decision was made. We are viewing history backwards, but in reality it flows forward. So the decisions we make today are likely to be the right decision, given the information we have right now. Since we cannot possibly have the information that we don't have yet, the decision we make right now is likely the right one and only the subsequent events will invalidate it.
The practical implication of this lies in how we make our decisions. We tend to agonize over whether or not a given decision will be right when we look back on it. In other words, we play "what if" games with our decisions. Now that may or may not be a good thing depending on how you use the information you gain from the "what if" scenario. If you develop a scenario and determine that there is more information needed to make a decision in that case, then you should go get that information. If there is no way to gather more information than you already have, then further agonizing is not likely to result in a better decision.
Likewise, when we look back on "bad decisions" that we made in the past, we need to learn more from them than "guess I won't do THAT again". Instead we should reflect on what information we could have gotten that would have influenced our decision at that point in history. Realizing of course that in hind-sight we can easily see what information we needed but at that moment in time we couldn't see that information we needed.
It hurts more to lose
Psychologically, we know that the pain from any given sized loss outweighs the pleasure from the same amount of gain. So a long series of losses made up with a single gain is less desirable than a long series of wins followed by a single loss. As investors we have been told to "be in it for the long haul" and "don't rethink your strategy every day" which is sound advice given this oddity of our emotions.
Taleb addresses this concept a little bit when he looks at the scalability of randomness with regard to an investment portfolio. He envisions a dentist's portfolio that has a 15% return with a 10% volatility per annum. (Taleb seems to like dentists very much) This gives us a 93% probability of success in any given year which sounds very good to most investors. However if you look at the time scale factor, you realize that at the extreme, in any given second throughout that year, there is only a 50.02% probability of success. On a more realistic scale, an hourly look at the probability of success gives us a 51.3% chance of success for any given hour throughout the year.
Suppose the dentist (or you or I) were to check our portfolio every hour on the hour. Every single loss that we felt would be more powerful than the pleasure of the gains that we realized. Thus, even though we would, on average, be successful throughout the year, we would feel very strongly that we did not have a good year. This is one reason that long term investment advisors recommend not checking your 401k or other long term investment on a daily basis.
New things are always duds (mathematically)
One interesting perspective that I gained from reading this book was that most new things are worthless. Taleb mentions that he doesn't watch the news or read the newspaper, mainly because most of what is found there is noise, there is little information to be had. I kept track this week of my news watching habits and found him to be quite accurate in his assessment.
Typically I come home for lunch every day and turn on one of the cable news channels. Early last year I decided that as soon as any of the news channels had a story dealing with any celebrity, I would immediately turn the channel. What happens to Spears, Hilton et al. is highly irrelevant to my life. Even with this personal rule in place, I found this week that MOST of what passes for news is really worthless. Stories of lost hikers in other states and bad weather in places I don't intend to visit are of little to no use to me. Likewise, stories about the latest insight into the Presidential primary races are largely noise that will (in a few months) be completely forgotten and deemed inconsequential.
This concept is true as well of new inventions and new ideas. We tend to over-value new technology because we look at how "new things" have transformed the world in the past. Flight, the telephone, the automobile and television have all transformed the world and are all relatively new technologies. Yet what is missing is the amount of noise.... those "new technologies" that didn't change the world one iota. If we kept a running record of all the patents that are filed and compared them to the useful inventions that truly change the world, we would realize that probabilistically, virtually all new technologies are duds.
Where is that Tipping Point?
Taleb briefly touches on network theory and mentions Gladwell's book The Tipping Point in the process. He points out that these tipping points... or points where critical mass is reached... are possibly not points at all but rather progressions. While we know that the world does produce clusters, the fact that they exist is the important point since prediction their rise is difficult if not impossible. In other words, knowing that there is a point you must reach to be successful with a software product may be more important than where exactly that point might exist.
What do you expect?
Another important point that Taleb stresses in this book is the notion of expectation with relation to probability calculations. Expectations are when you have two potential outcomes and you compare not just the probabilities but what you can expect from each of those outcomes. So if you have a 50% chance of winning a bet and winning gets you $1000 and losing loses you $1000 then tomorrow night you will have either $2000 (your $1000 plus his) or you will have $0. Your expectation of the bet then is $1000 dollars... you can expect (on average) to have $1000 tomorrow night.
This is a concept that you learn in any introductory statistics class as well as your entry level Finance classes so I am not sure why Taleb seems to think that no one has thought of it before. He does have an interesting take on the idea in the latter part of the book where he points out that most of us cannot "think" in terms of expectations. We tend to either envision winning (and having $2000) or losing (and having $0). We cannot look at the bet from the standpoint of it being "the same as having $1000 tomorrow night."
Satisficing
Herbet Simon did some interesting research into the notion of optimizing our decision making. He had the idea that if we optimized every single decision we make on a daily basis, we would be paralyzed by decision making. The notion of being "boundly rational" comes from this idea that we are rational... we make rational decisions... but only to a point. At some point we substitute some form of heuristic optimizations into our decision making process so that we can "satisfice" (satisfy and suffice) our need for rational thinking.
Anchoring to a Good Month or a Bad Day
Taleb apparently has a fascination with psychology as he brings in some interesting concepts from time to time and explains them in laymen's terms. One such idea is the notion of anchoring. The classic example of anchoring is when you ask someone to estimate a number (preferably one that they truly have to guess at) but first you "suggest another number"... maybe by having them draw a random number from a hat. There will be a correlation between the random number drawn and the estimate that they person gives you because they mentally associated the random number with the estimate they are about to give.
Taleb uses this to illustrate that our notion of our own wealth is anchored to whatever our current status might be. So a person worth $1,000,000 who loses $500,000 is now worth $500,000 but feels poor because of the loss. The man across town who was worth $100 last week and is given $499,900 is now worth the same ($500,000) but he now feels immensely rich because of his good fortune. Thus, what does it mean to be wealthy? Wealth is a relative term, not an absolute term and is only meaningful in relation to the change in status (when it comes to how you feel about your wealth anyway.)
So let's take this one step further. As Taleb asks, what if you have a good month and a bad day? Which one should dominate your thinking? On any given day, if you have a bad day, you are likely to reflect more on how badly your day is going. This is simply because, in relation to the day before, this particular day is going worse. In reality however, your entire month may be going better than all previous months so you should reflect more on how good things are, even on a bad day. This unfortunately is now how we work, but it would be nice if we did!
Can you change your mind and still respect yourself?
Towards the end of the book, Taleb talks about the notion of "path dependence of beliefs". This is where we come to be loyal to our beliefs because we happen to have them or have expressed them at some point. It becomes very difficult for us to change our position or even change our mind because we are expected to "stick to our guns" once we have expressed an opinion.
Taleb values the person who is capable of saying "I used to believe that but now I don't" and in many (if not most) domains I am inclined to agree with him. Within the realm of business decision making, it can be invaluable for a manager or other decision maker to be capable of changing his or her mind in light of new information. As mentioned above, decisions can only be made with the information at hand so sticking to an old decision, even in light of new information, is silly at best and bull-headed and wrong at the worst.
Conclusion
As much as I enjoyed reading Taleb's books, I am still not convinced that I needed to read both of them to gain the information at hand. I felt that Fooled By Randomness was not only a better read, but contained more useful and usable information than The Black Swan. Reading this book will force you to think about some things differently which in my opinion can be a good thing.