How Wall Street gets Fooled By Randomness Nassim Taleb

And how to avoid being overconfident

Who Is Nassim Nicholas Taleb?

Nassim Nicholas Taleb is one of the world's most influential thinkers today. Taleb has crossed the chasm from financial to mainstream. His beliefs stem from the unpredictability in the financial markets, but by taking these and applying to other fields, he has become well known for unconventional ways for the world run.

He has written several books including Antifragile, Fooled By Randomness, The Black Swan, and Skin In The Game. His work focuses on probability theory, risk management, statistics and economics.

And Fooled by Randomness is based around the financial markets. But many of the biases he mentions plague humans in everyday decisions. Everyone, no matter what walk of life they come from, can learn something about themselves by reading this book.

Today, we'll talk about the most important lessons Taleb tries to impart upon us through this book. 

We often confuse luck with randomness

This sounds a bit depressing when we think about it. But Taleb posits randomness is a common factor in life... And luck plays a bigger role in our lives than we like to give it credit. 

However, it's a common flaw many people posses. When good things happen, we think it is because of our hard work and grit. We deserve to have this good thing happen. Or when we make a successful investment, we "knew" it was bound to succeed. 

And when something goes against us, it's because of "bad luck." It is rarely because we were dumb or didn't try hard enough. 

It's impossible to determine the impact of randomness in our lives... Or our investments. But we should try to not get too cocky.

In my opinion, one of the worst things aspiring traders can do is get too confident in one idea or trading methodology. They rack up a few winning trades and get cocky... Then they level up their trade size much higher than they used before... And of course, that's the time the trade goes against us. And one oversized trade can ruin a string of good trades.

So it's important when making investments or trades that we use appropriate position sizing. That way if something goes against us, we can live to fight another day.

But this leads us to another of his big lessons... One many of us are taught from a young age.

Life isn't fair

Sometimes we don't get what we deserve. And sometimes the best person doesn't win. That's just how life works. 

We must be prepared for these outcomes. At times we must take a chance in life. And sometimes those chances won't pan out. 

I'm sure many of us have applied for a job and saw someone of inferior intelligence get the job. Or many a man has tried to woo a girl only to see her pick the jerk instead. 

Sometimes bad things just happen... And we should be prepared for that. And it never hurts to have a plan B or C ready to go. 

We are inherently poor at understanding the impact of rare events.

The world is full of surprises. Even the most mundane things can turn out differently than you expected. This is especially true when it comes to decisions. You might think that you're making the best choice possible, but sometimes there are hidden factors that influence our choices.

One example is that we often overestimate how likely something will happen. When we see something very unlikely, we tend to assume that it won't happen. But what if we don't understand the odds behind the event? What if we ignore the fact that rare events do happen?

In one study, researchers asked people to estimate the likelihood of three different types of events occurring. They found that participants tended to underestimate the chance of rare events like extreme weather and natural disasters. In another experiment, participants were shown images of rare events and asked to predict whether they'd ever occurred. Again, they underestimated the chances of these events.

This tendency to ignore rare events could lead us down some interesting paths. For instance, if we believe that rare events never happen, we'll probably try to prevent them from happening. If we feel that extreme weather is unlikely, we might build infrastructure to protect ourselves against it. However, ignoring rare events can actually make us less prepared for future events.

These are what Taleb calls "black swan events." These events can be anything to a precipitous drop in a stock's price to a one in a hundred year flood. Both of these can cost us a lot of money (or even our lives) if we are not prepared. 

That's why we buy insurance on our house. We never hope to use it, but if we need it, we're glad to have had it. 

This is also why Taleb buys far out of the money options. He feels that the markets misprice these options because people are bad at predicting rare, black swan events. 

These types of strategies have a very low win rate, but when they pay off, they pay off in a big way... Buying these low probability event options is actually one of the most durable investing strategies over time. 

But to do that you have to ignore your short-term performance... You will bleed money for a time. Until the next big event happens... But that's what we look for here at barbellalpha.com. 

And the last big idea is sort of related, but not completely. 

Block out the Noise... In both the media and the stock market

A majority of news stories are just noise. Most won't matter a week from now... And a vast majority will be forgotten by this time next year. If that's case, why pay attention to it? 

Same goes for many of the hottest shows of the time. Does anyone really remember or care about the Tiger King show that was big early in the pandemic? Not really. 

Wait for news to pass the test of time. I'm continually a month or so behind on my podcast listening. I do that partially on purpose. I want to listen to the best information that will be important in the future.

If I hear someone talk about last month's topic du jour, I skip the podcast and go onto another one. 

Or if I get behind on reading my emails, then find myself deleting a lot of emails from a certain sender, that one is not important and gets unsubscribed from. 

Most of the daily news, especially news in the stock market isn't relevant in the long run, if even today. Wall Street likes to have a narrative for why stocks moved. But in reality, oftentimes the narrative gets tied to the movement in stocks. 

Ignoring these headlines gives me more time to focus on important concepts and learnings. 

I learned that in large part from Taleb.

This is one of many life changing techniques you can take away from reading Taleb's works. We will be covering more of these in greater detail as time goes on. 

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