Report on:

Fooled By Randomness
The Hidden Role of Chance in Life and in the Market

By: Nassim Nicholas Talab

Submitted as part of the curriculum of the course

Knowledge Seminar

Submitted To:

Prof. Malathi Sriram

SDM IMD, Mysore.

Submitted By:

Nikunj Patel (10029)

Piyush Kakkar (10030)

SDM IMD, Mysore

E-mail: nikunj02patel@gmail.com
 Knowledge Seminar (2010-12)

PART:-A

Objectives:

Fooled by Randomness- The Hidden Role of Chance in the Markets and in Life, by Nassim
Nicholas Taleb- an unconventional mathematics professor, is about disguised luck and how we
often mistake it for something else (eg. skill). While it is proposed this happens in all facets of
life (eg. politics, business), it is very prevalent in investment and speculative trading.

This book is thought provoking. Author plays with the topics including philosophy,
mathematics, human behaviour and history apart from Investment and stock market
uncertainties with interesting anecdotes and real observations of the author which make this
book very interesting to read.

Some of the objectives of this book:

 To explain randomness present in surrounding environment and its impact

 To revel many perceptions and misconceptions about luck and chance

 To explain the theory of randomness in light of the theory of determinism

 To explain the impact of Black Swan events (rare/Unpredictable events) and reactions
after its happening

 To explain the fact that what we don’t know is more important that what we know

 To introduce a new facet of normal distribution curve with all dimensions of skewness

Author satisfies his objectives by explaining these points by using various true and hypothetical
examples in form of small anecdotes.

Central Idea of the book:

If we watch a steam engine, we may not know how it works but we can soon get a fairly good
idea of its behaviour, and we can predict its future behaviour accurately. Even though we don't
understand its workings, we can see it's a pretty simple machine, so we can trust it to behave in
a simple way: we have confidence in our predictions based on a short sample of its behaviour.

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Most things in life are not like steam engines, but people treat them as if they were. Life and
markets, involves large number of random factors, and regularly give surprises. Their behaviour
over short time spans may have so little significance and that can be nothing but noise.
Extrapolation of it is impossible or meaningless. Then also we continue to see patterns where
none exist, misunderstand the role of randomness, seek explanations for chance phenomena,
and believe that we know more about the future than we do and that is the core/point of this
book.

The best way to summarize the central idea of this book is that it addresses situations where
the left column is mistaken for the right one

Table of Confusion:

General
Luck Skills
Randomness Determinism
Probability Certainty
Belief, conjecture Knowledge, certitude
Theory Reality
Anecdote, coincidence Causality, law
Forecast Prophecy
Market Performance
Lucky idiot Skilled investor
Survivorship bias Market outperformance
Finance
Volatility Return
Stochastic (random)variable Deterministic variable
Physics & Engineering
Noice Signal
Literary Criticism
None (literary critics do not
seem to have a name for things Symbol
they do not understand)
Philosophy of Science
Epistemic probability Physical Probability
Induction Deduction
Synthetic proposition Analytic proposition
General Philosophy
Certain
Contingent Necessary(in the Kripke sense)
True in all possible worlds
(Reproduced from the book)

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Taleb explains why the more often we look at some fluctuating quantity (the value of your
share portfolio, for example), the less meaning our observations have. Yet he sees traders who
watch prices move up and down in real time on screen − the changes are so small as to be
completely random − and think they are learning something.

Other important ideas in this book are:

1. The Black Swan: A large-impact, hard-to-predict, and rare event beyond the normal
expectations. He gives the rise of the Internet, the personal computer, World War I, as
well as the September 11, 2001 attacks as examples of Black Swan events.
2. Survivorship bias: We see the winners and "learn" from them, while forgetting the huge
unseen cemetery of losers.
3. Skewed distributions: Many real life phenomena are not 50:50 bets like tossing a coin,
but have various unusual and counter-intuitive distributions. Example: a 99:1 bet where
you almost always win, but when you lose you lose all your savings.
4. Taleb Distribution: This is a term applied to situations in which there is a high
probability of a small gain, and a small probability of a very large loss. In these situations
the expected value is (very much) less than zero, but this fact is camouflaged by the
appearance of low risk and steady returns. The term is therefore increasingly used in the
financial markets to describe a situation of moral hazard on the part of hedge fund
managers and bankers.

Author’s intent of writing book:

Author makes his intention clear in this book by advising readers to,

 Be careful and not to attribute all success to skill, and failure only to bad luck
 He warns about black swan events and says that no amount of observations of white
swans can discount the possibility of a black swan (later discovered with the discovery of
Australia)
Eg. Something did not happen in the last 10 years does not mean that it will never
happen in future.
 Learn from history, even though it is unnatural.
Eg: Funds that crashed in 1987, 1990 (Japan), 1994 (bonds), 1998 (Russia), 2000
(NASDAQ) all offered well constructed arguments why times were different, Children
only learn not to touch the stove until being themselves burned
 Differentiate between noise and Information
Eg. Don’t review short-term performance, avoid daily market commentary. Employ
reason, not emotion or superstition, when making a decision. For this author says he

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doesn’t read news paper and make himself away from daily or rather minute based
market updates.

 Is it significant to pay attention on it??

Eg. At the end of the day journalist will explain how & Why market went up or down by
100 points today and we will accept the reasons but before concluding something we
need to check where it is a significant change or just a noice? Because 100 point change
in BSE SENSEX is just 0.05%.
 Be willing to change your mind in the event of new contradictory information.

Structure followed by the author in the book:

Taleb’s style of narration is such that it takes some time to get a grip on the book. However, his
book is full not only of infuriating meanderings and off-putting self-importance but also of
extreme brilliance, and that is what makes the reading entirely satisfactory. Nevertheless, once
we are on it, it is one interesting drive/ride which will change the way we look at business
forever. His idiosyncratic literary approach to the book consists of providing a modern-day
philosophical tale by mixing narrative fiction, often semi-autobiographical, with scholarly and
scientific commentary. Taleb opens packet after packet of insights in front of us and we feel like
Alice down the rabbit hole.

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PART:-B
Dilemmas presented by the author and options for appropriate actions:

Some of the dilemmas present in the book and we find interesting and important are as ..

 Is it luck or skill?
When we succeed in life we should think, is it really a fruit of my hard work or skill? or it
happened just like that and luck played major role in it. One can differentiate between
the role of luck or skill in the success by observing consistent performance as over the
period of time role of luck will be negligible.

 Should we predict the future performance based on one’s past performance?

Author gives an example, if one puts an infinite number of monkeys in front of a
typewriter, there is certainty that one of them would come out with an exact version of
the “Iliad”. Would anyone bet their life savings that the same monkey would write the
Odyssey next?
He says he does not deny that if someone performed better than the crowd in the past,
there is a presumption of this ability to do better in the future. But the presumption
may be very weak.

 Is it noise or Information?
We observe 0.7 parts noise for every one part performance over one year, 2.32 parts
noise every month, 30 parts noise every hour and 1796 parts noise every second. It is
very difficult to differentiate between noise and information in real life so better keep
ourselves away from watching updates from live screen.

 Should we depend on theory or reality?

Here author gives example of Dr. John (Statistician) & Fat Tony (layman). If we toss a fair
coin for 99 times and suppose we get heads for all the times then what is the probability
that on 100th time we will get a heads? If we ask Dr. John, he will say it is 0.5 (50%) but if
we ask to Tony he will say it is 100% because we got it for 99 times so this coin is not
actually fair. Dr.John’s answer is mathematically right but it is only based on theory not
what he has seen for past 99 times. So the moral is sometimes we need to look beyond
the theories because mathematical model may crash when applied to real life situation.

 Is it significant to worry about?

Author says that he got Bloomberg software on his desktop. It shows some of the
headlines related to stock market performance. He gives an example of “Dow is up 1.03
on lower interest rates”, “Dollar down 0.12 yen on higher Japanese surplus”. The change
of 1.03 against 11,000 is just a 0.01% and it is a perfect noise and not a significant at all,
no need to justify it by saying it is because of lower interest rates or so on. The moral

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from this is before justifying something find out is it significant change? then go on
justifying it.

 It has not happened till date; does it mean that it will not happen in future?
This is typically called as black swan event or unpredictable events. We always try to co-
relate future with the past events and take decisions and forget about the unusual
nature of the market. Doing this we end up being fooled by randomness and could not
predict the future losses by such events.

Our own conflicts with the thoughts presented in the book.

Author uses true anecdotes which he observed in the market and life. Apart from these he also
uses some hypothetical situations to make us understand the concept in better way.
After getting this book for the first time, we read the views expressed by the experts given at
the back of the book. We found that this book is all about luck and how it affected our life and
business decisions and so on.
• Author says that luck has considerable role to play in our success. Though author clarifies
his view on role of luck, we are still not sure about even if person performs consistently well
for considerably long period how can we neglect the role of luck? (We believe that for some
people luck can be a major source of success for long time)
• Secondarily, as a management graduate we learn to back our point/s with statistics, if not
all but most of the times. And book contradicts this point, so how to deal with the situation
after being as a rational manager.
• In the book Author says that before taking any decision we need to look in to reality
(beyond theory). But in this two year PGDM curriculum we will learn lots of theories (from
each subject) and we had/ will have very less exposure to the reality (just for two months
during our SIP). So we need to ask ourselves that are we really going to be good managers
who deal with the real time situations every day.

How has the book affected our thinking?

After reading author’s dilemma presented in the book and working on our own dilemmas
created from author’s thoughts one thing we learnt is never fully be dependent on the numbers
or theories, do consider reality before taking any decision but same time we should know and
learn them as well.
• As a future managers/ leaders our decision should be rational and mature enough and that
will only come after taking all the outcomes into consideration.

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• As a management graduate we should be different in our decision making process and that
is why while taking decisions we should account the things that we don’t know in addition
to the things we really know.

Book in relation to the other aspects:

This book is classified under management/finance/Investment. But if we think in the broader

perspective this book talks about decision making and how random factors effects our
decisions.

In that context, we can apply this in our daily life decision making. We believe that our decision
should be for long term gain instead of short term gain because while concentrating on short
term goals/ gains we might end up in big trouble in long run.

It is not that we can use this book only for investment management but tomorrow we became
a marketing executive of the company and we need to take a decision on entering a particular
market we can co-relate some of the concepts like… don’t fully depend on statistics or Market
research reports, we need to observe and feel how market really works and behaves?, etc.

In short, we need to create some short of resonance between our theoretical world (MBA
study) and practical world (real world) while taking the final decision.

How do we relate this book to ourselves?

We learnt so many important points from this book as mentioned in the central idea of the
book. Author says that MBAs are not that much good at trading or investment decisions (but
author himself is an MBA graduate). But after reading this book we can implement the concepts
or knowledge gained from this book to our investment decision. It is not that only if we became
portfolio manager, we can apply this, but we can apply these concepts in our own investment
portfolio management as well.

As mentioned just above we need to create a resonance and that will add value to our decision
making process and ultimately to our career. By this we can get success even in the uncertain
market. (Where it is certain that future is uncertain and completely unpredictable).

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Future reading

Nassim Nicholas taleb has published Fooled by Randomness in 2001 after this book he
published two other books i.e. “Black Swan” in 2007 and “The Bed of Procrustes- Philosophical
and Practical Aphorisms”in Dec-2010.
In his book “Black Swan” he talks about rare event and damage caused by this rare events and
also predicts the down fall of the market of 2008-09.
In book “The Bed of Procrustes- Philosophical and Practical Aphorisms”. He says we humans,
facing limits of knowledge and things we do not observe, the unseen and the unknown, resolve
the tension by squeezing life and the world into crisp commoditized ideas.

References

1. N.N. Taleb, fooled by Randomness-The Hidden Role of Chance in Life and in the
Markets,Panguin Books, second edition,2004
2. www.fooledbyrandomness.com
3. www.wikipedia.com
4. Apart from these we used some of the Book reviews by other and experts of the fields.

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