Fooled by Randomness

[B]ecoming more rational, or not feeling the emotions of social slights, is not part of the human race... not with our current biology. There is no solace to be found from reasoning...

A mistake is not something to be determined after the fact, but in the light of the information until that point.

Many scientists... are... subject to such foolishness... One flagrant example is... global warming... These scientists initially ignored the fact that these [high temperature] spikes, although rare, had the effect of adding disproportionately to the cumulative melting of the ice caps. ...[A]n event, although rare, that brings large consequences cannot be ignored.

[E]conomists are evaluated on how intelligent they sound, not on a scientific measure of their knowledge of reality. (page 85)

Let us use 10,000 fictional investment managers... [O]nce a manager has a single bad year, he is thrown out of the sample. ...[T]oss a coin; heads and the manager will make $10,000 over the year, tails and he will lose $10,000. ...We have, in a fair game, 313 managers who made money five years in a row. ...[I]f we throw one of these ...into the real world we would get ...comments on his remarkable style, his incisive mind... His biographer will dwell on ...a great mind in the making. ...[S]hould he stop performing (...his odds ...have stayed at 50%) they would start ...finding fault with his dissipated lifestyle. They will find something he stopped doing, and attribute his failure... The truth ...he simply ran out of luck.

Maximizing the probability of winning does not lead to maximizing the expectation from the game when one's strategy may include , i.e., a small chance of a large loss and a large chance of a small win. If you engaged in a Russian Roulette-type strategy... you are likely to show up as the winner in almost all samples—except in the year when you are dead.

What is easier to remember, a collection of facts glued together, or a story, something that offers a series of logical links? Causality is easier to commit to memory. ...What is induction exactly? ...It is very handy, as the general takes much less room in onel's memory than a collection of particulars. The effect of such compression is the reduction in the degree of detected randomness.

Optimism, it is said, is predictive of success. ...It can also be predictive of failure. Optimistic people... take more risks as they are overconfident of the about the odds; those who win show up among the rich and famous, others fail and disappear from the analysis.

Probability is not about the odds, but about the belief in the existence of an alternative outcome, cause, or motive.

[In] economics... you can disguise charlatanism under the weight of equations and nobody can catch you since there is no such thing as a controlled experiment. Now the spirit of such methods, called scientism by its detractors, continued into the discipline of finance as a few technicians thought their mathematical knowledge could lead them to understand markets. The practice of financial engineering came along with massive doses of pseudoscience. (page 115)

[W]e like to emit logical and rational ideas but we do not enjoy this execution.

We favor the visible, the embedded, the personal, the narrated, and the tangible; we scorn the abstract.

Wittgenstein's ruler: "Unless you have confidence in the ruler's reliability, if you use a ruler to measure a table you may also be using the table to measure the ruler." (page 224)

[W]e read too much into shallow recent history... but not from history in general [which] teaches us that things that never happened before do happen. ...outside of the narrowly defined time series; the broader the look, the better the lesson.

The major problem with inference... is that those whose profession it is to derive conclusions from data often fall into the trap faster and more confidently... The more data we have, the more likely we are to drown in it. For common wisdom... is to base... decision making on the following principle: It is very unlikely for someone to perform... well in a consistent fashion without doing something right. ...[I]f someone performed better... in the past then there is a great[er] chance of performing better than the crowd in the future... But... [a] small knowledge of probability can lead to worse results than no knowledge at all.

David Hume posed the issue in the following way (as rephrased in the black swan problem by... John Stuart Mill) No amount 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.

[E]conomics is a narrative discipline, and explanations are easy to fit retrospectively. (page 257)

Mild success can be explainable by skills and labor. Wild success is attributable to variance.

I do not dispute that arguments should be simplified to their maximum... but people often confuse complex ideas that cannot be simplified into a media-friendly statement as symptomatic of a confused mind. ...MBAs tend to blow up in financial markets, as they are trained to simplify... beyond... requirement. (...I am myself the unhappy holder of the degree.)

[N]ews... is full of noise and... history is largely stripped of it.

There is a saying that bad traders divorce their spouse sooner than abandon their positions. Loyalty to ideas is not a good thing for traders, scientists - or anyone.

I have two ways of learning from history: from the past, by reading the elders; and from the future, thanks to my Monte Carlo toy.

A trader's mental construction should direct him to do precisely what other people do not do.

It does not matter how frequently something succeeds if failure is too costly to bear.

[T]he epic poet did not judge heroes by the result... their fate depended on totally external forces... Heroes are heroes because they are heroic in behavior, not because they won or lost.

Mixing forecast and prophecy is symptomatic of randomness-foolishness...

Delivering advice assumes that our cognitive apparatus rather than our emotional machinery exerts some meaningful control over our actions.

Lucky fools do not bear the slightest suspicion that they may be lucky fools - by definition, they do not know that they belong to such a category.

There are hordes of thoughtful journalists... [I]t is just that prominent media journalism is a thoughtless process of providing the noise that captures people's attention and there exists no mechanism for separating the two.

Trading forces someone to think hard; those who merely work hard generally lose their focus and intellectual energy. In addition, they end up drowning in randomness; work ethics draw people to focus on noise rather than the signal.

[A]ge is beauty. ...[M]y instinct is to value distilled thought over newer thinking, regardless of its apparent sophistication—another reason to accumulate the hoary volumes by my bedside... For an idea to have survived so many cycles is indicative of its relative fitness. Noise, at least some noise, was filtered out. ...[P]rogress means that some new information is better than past information, not that the average of new information will supplant past information...

A... vicious effect of... is that those that are good at predicting the past... think of themselves as good at predicting the future... [W]e live in a world where important events are not predictable...

I... found a significant advantage in selecting aged traders, using as a selection criterion their cumulative years of experience rather than their absolute success... [O]lder people have been exposed longer to the rare event and can be, convincingly, more resistant to it.

From the standpoint of an institution, the existence of a risk manager has less to do with actual risk reduction than it has to do with the impression of risk reduction.

[T]he mental probabilistic map in one's mind is so geared toward the sensational that one would realize informational gains by dispensing with the news.

Veteran trader Marty O'Connell calls this the firehouse effect. ...[F]iremen ...who talk to each other for too long come to agree on many things that an outside, impartial observer would find ludicrous...

Unlike a well-defined, precise game like Russian roulette, where the risks are visible to anyone capable of multiplying and dividing by six, one does not observe the barrel of reality.