Fooled by Randomness

Book report 1

Fooled by Randomness

Ruozhu Wang

h702322882

This book talk about when the author Taleb was a rookie-level trader in the stock market, he had succeeded in spying on a stock disaster, and he studied the finance storm for half a year, thought that his escape was not because he is clever than anyone else, it’s full of luck. Luck in the financial market plays an important role. But people are always too low to estimate the random effect. Cannot help to make their own interpretation of things which formed a variety of superstition. So he wrote such a book about luck - randomness.

        Life is random everywhere. Even a professional mathematician, and proficient in the calculation of probability. He may also tend to be arbitrary by tease, Taleb finally suggested: Although we cannot avoid randomness, but we can learn to accept it. This is also a practical book, the stock market is the most typical random phenomenon, ups and downs only occurred in a moment, but learn from Taleb's operation, you will be able to effectively avoid the risk. And make a fortune when the black swan appears. It said that each stock trader should have one this book.

        In the author's view, the future of the world is uncertain, random phenomenon can be seen everywhere. Some of the investment experts get the award only in a suitable environment of him, it is likely that they would be eliminated in unsuitable environment. The biological structure of man is destined to be misunderstood and ignorant for certain probabilities, and there is a blind spot for both samples and deviations. The power of the black swan is everywhere, at the beginning of the book, the trader who is careful, different, trying to avoid the rare event of destroy, after he witnessed his neighbors - the random fool was furiously reported, his career were thriving , but because of disgusting the city traffic congestion for a long time, he drove a helicopter to work, finally died because of machine destroyed.

        The book is divided into three parts:

        The first part is about skewing, accidental events. Also talked about a lot of probability related issues. The second part is to live with the deviation, because we only see the success, and thus formed a distorted view of the opportunity. The third part is about the path dependence, and the choices that people make in the past determine their current and future possible choices.

        The division of the three parts is clear, but many of the author's ideas are repeated and interspersed.

        The author's investment strategy:

        Prudent investment to prevent "blow up". Really good traders do not have to make money in the short term, but have to make themselves alive, be aware of occasional events and rare events. Do not let those rare events ruined their own. When the rare event occurs, it is necessary to make a “U-turn”. Do not be obsessed with some wrong beliefs. These beliefs may come from economics or statistics, but it is terrible. Because economics, statistical summary of the law is based on historical events, some are coincidental. It is not eternal truth.

About the induction question, Taleb also took the famous example of human nature by Hume: we see that the number of white swans, but we cannot infer that all swans are white, but they can overthrow the inference as long as they see a black swan. The asymmetry exists in the foundation of knowledge. We are in a world full of randomness, what can we do? You can use the method of statistics and induction to make a positive bet, but do not use them to manage the risks.

        The author is more often to use reverse investment strategy. In the rare event, it’s more easy to make money, he believes that the rare event’s possibility is small, so the value is often undervalued. Fixed-income bonds tend to have this opportunity to reverse the rare event for traders, they usually may lose money, but when they meet rare event, that they can earn a lot of money. I think it is true that many times and many opportunities will be underestimated, so there has arbitrage space.  

        Through experience, we can determine whether there has arbitrage space, but as more and more people know arbitrage space, arbitrage space will disappear, traders will be revised expectations. But arbitrage space will continue to emerge. in fact, it is not sure that Taleb could make money though arbitrage in long-term. Because some arbitrage space is clear, such as the same commodity have different prices in different market at same time. And most of the arbitrage space only exists in people's expectations, they expected that they  will make money. Take a business example, if it is winter now, I buy a the air conditioning at low prices, and then sold at high price in summer. Taleb's strategy is same as it. 

        Risk management:

        Is risk management useful? Risk management was necessary. Earning money often company with risk, risk control often loses a lot of chances to make money, especially the views afterwards. And a lot of risk, you cannot measure it, just could use experience. The problem is that, everyone's experience is different, how do you know your experience is better than someone else's experience? Of course this is not the biggest problem, the biggest problem is the power and responsibility is not equal. When there are risk problem appeared, how to judge the responsibility is from the trader a risk manager? This is the problem that all the business executives who set up a risk manager would be encountered when they designed the mechanism. Because this problem cannot be solved, so the best way to deal with the risk is traders will make the responsibilities. Of course, the management of risk control cannot be exhaustive, like all the strategies on the capital market cannot be tested many times, after all, it will depend on the market test. 

        We are always “blind”, confused by the false of reality. Survivors said a lot of deviation. For example, we always see the people around are very well, so we think that we are very poor. In fact, there are many people who are not better than us. To see the truth is difficult, in the eyes of skeptics, we cannot see the truth, we think we are not so ignorant, or that we are less ignorant than the past. But from the God's perspective, you will find that man is still ignorant. The author gave an example of a Russian turntable. We often only can see successful people, but the failure to see the people who are inadvertently or deliberately ignored. And if you use the "Russian turntable" to do analogy, these successful people maybe just because they are luck. The same thing repeats over time, the lucky thing will be taken away sooner. And real life is same as the "Russian turntable", it is more complex, you cannot understand the principles of its operation, cannot accurately calculate the probability. In other words, people do not think that their success is brought by luck, or ignores the random occurrence of events in the future.