If you go to the bookstores, they’re full of biographies of successful men and woman presenting their specific explanation on how they hit their own home runs in life. If you ask a profitable investor to explain the reasons for success, he will offer some deep and convincing interpretation on the results . We underestimate the role of randomness in just about everything. We often have the mistaken impression that a strategy is an excellent strategy, or an entrepreneur is a person endowed with unique vision. Or a talented trader, only to realise that 99.9% of past performance is attributed to chance alone.

Nassim Taleb believes that the world is much more random than we think. But in saying that doesn’t mean that everything is random and success is based on luck alone. Hard working people show up on time in a white clean shirt with deodorant and have qualities such as persistence, doggedness and perseverance – all the conventional ingredients that contribute to success. One needs to buy the lottery ticket to actually win. But does that mean the trip to the lottery store is what caused the winning?

Skills count, obviously. But they count much less in highly random environments like trading, than they do in the predictable ones, like dentistry.
Fooled By Randomness shows us how to recognize randomness and luck, which is involved in everything you do. In doing so you can humble yourself, turn down your assumptions about your abilities, and have a more accurate view of how the world IS, not how you think it should be.

Taleb’s Russian Roulette – A New Accounting Paradigm

Let’s imagine that someone offers you $10 million to play Russian Roulette. To play, you need to put a revolver containing one bullet in the six chambers of your head and pull the trigger.

Each realisation would account for one history, for a total of six possible histories of equal probabilities – 5/6 of these lead to enrichment, one would read as a statistic. The problem is, that only ne of the histories is observed in reality.

The 5 people who survived the game got rich. They might even write a new biography and take classes on this new “get rich quick scheme”. They’ve just found a new way to make $10M in less than 2 seconds. Journalists feature them on the front cover of magazines and they will have everyone’s attention at their next family barbeque. But of course, in time, the roulette betting fool keeps playing the game, the bad histories will tend to catch up with them. A 25 year old could play the game once and make out wealthy. But if they played once a year, they stand almost no chance of making it to their 50th birthday…

If you have enough people playing this though, eventually you’ll end up with some serious rich 50 year old’s. Let’s say you start with 1000 players of this game of Russian Roulette, 990 will die but the remaining 10 would’ve collected a quarter of a billion dollars each over their gambling lives.

SO – we should consider this as part of our accounting methods. A $10 million earned through Russian roulette doesn’t have the same value as $10 million earned through the diligent and artful practice of dentistry. The money is the same, can buy the same goods, except that one’s dependence on randomness is greater than the other. To an accountant and your next door neighbour though they are identical.

Unfortunately, reality is far more vicious than Russian Roulette… Firstly, it delivers the fatal bullet infrequently. More like a revolver with hundreds, or thousands of chambers instead of six. You might pull the trigger twenty times and forget that a bullet ever existed. You may be lured into a false sense of security.

In the real world, one could be playing Russian Roulette and start calling it by a low risk name. They see the wealth being generated for the winners and the losers quickly pop out of existence.

Taking into account all of the “observed” and “unobserved” things might sound strange. You should look into things ‘probabilistically’. Just because you got lucky this time, doesn’t mean that the game you’re playing is a good game. You cannot judge the performance by the results, but you must also consider the cost of the alternatives.

Survivorship Bias

If one puts an infinite number of monkeys in front of typewriters and let them slam away, there is a certainty that one of them will come up with ‘Harry Potter and the Philosopher’s Stone’. The probability is obviously ridiculously low. But lets carry the reasoning one step further: now that we have found the hero amongst monkeys, would you invest your life savings that the same monkey would write the ‘Harry Potter and the Chamber of Secrets’ next?

In this thought experiment, the second step is where it gets interesting. In this scenario, how can past performance be relevant for future performance?

According to Taleb, It depends on the number of monkeys.

If someone is performing better than the crowd in the past, it is obviously more likely that they will do better in the future. But the presumption is very weak to the point of useless in decision making. The odds that they’ll do better is dependant on the randomness in the profession and the number of monkeys that were in operation. The initial sample size matters significantly. For example, if there were only 5 monkeys in the game you’d be impressed with the writer of Harry Potter and the Philosopher’s Stone. But if there were 1 billion to the power of 1 billion monkeys, you’d be surprised if you didn’t get some well known piece of work.

Nassim Taleb is also the author of some books we’ve done previous: The Black Swan and Antifragile