Fooled by Randomness
Fooled by Randomness

Fooled by Randomness

Table of Contents

Past events will always look less random than they were (it is called the hindsight bias). (Location 267)

Tags: hindsight, randomness

Note: past events always look less random than they were at the time

This book is about luck disguised and perceived as nonluck (that is, skills) and, more generally, randomness disguised and perceived as non-randomness (that is, determinism). (Location 435)

Tags: luck

We are still very close to our ancestors who roamed the savannah. The formation of our beliefs is fraught with superstitions—even today (I might say, especially today). Just as one day some primitive tribesman scratched his nose, saw rain falling, and developed an elaborate method of scratching his nose to bring on the much-needed rain, we link economic prosperity to some rate cut by the Federal Reserve Board, or the success of a company with the appointment of the new president “at the helm.” (Location 441)

Tags: pattern, luck

Note: we find explanations for events that fit our view of the world

we underestimate the share of randomness in about everything, (Location 460)

Tags: randomness

Note: .randomness

the ideas of this book fall squarely into the Tragic category: We are faulty and there is no need to bother trying to correct our flaws. We are so defective and so mismatched to our environment that we can just work around these flaws. (Location 537)

Part 1 SOLON’S WARNING Skewness, Asymmetry, Induction

skewness issue; it does not matter how frequently something succeeds if failure is too costly to bear. (Location 583)

Tags: risk, failure, favorite

Note: If the cost of failure is too great, be very wary of taking the risk, even if the chances of failure of low.

his wife had rarely encountered repressed new wealth—the type of people who have felt the sting of indigence at some point in their lives and want to get even by exhibiting their wares. (Location 708)

Note: Regressed new wealth = people who were poor, are now rich and want to show off

Psychologists have shown that most people prefer to make $70,000 when others around them are making $60,000 than to make $80,000 when others around them are making $90,000. (Location 746)

Tags: salary, comparison

Note: .comparison we hate making less than others

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. (Location 778)

Tags: luck

Note: Lucky fools dont know that their success is due to luck

A word on the display of emotions. Almost no one can conceal his emotions. Behavioral scientists believe that one of the main reasons why people become leaders is not from what skills they seem to possess, but rather from what extremely superficial impression they make on others through hardly perceptible physical signals—what we call today “charisma,” (Location 791)

Tags: leadership

Note: .leadership physical characteristics convey leadership


Heroes are heroes because they are heroic in behavior, not because they won or lost. (Location 1013)

Tags: systems, outcomes, heroes

Note: Heroes are heroes, regardless of the outcome

Here I could not help seeing in the person of George Will the representative of so many nightmares in my career; my attempting to prevent someone from playing Russian roulette for $10 million and seeing journalist George Will humiliating me in public by saying that had the person listened to me it would have cost him a considerable fortune. (Location 1033)

As a derivatives trader I noticed that people do not like to insure against something abstract; the risk that merits their attention is always something vivid. (Location 1059)

Tags: insurance

Note:  people insure against something vivid rather than abstract

This sensationalism can divert empathy toward wrong causes: cancer and malnutrition being the ones that suffer the most from the lack of such attention. Malnutrition in Africa and Southeast Asia no longer causes the emotional impact—so it literally dropped out of the picture. In that sense the mental probabilistic map in one’s mind is so geared toward the sensational that one would realize informational gains by dispensing with the news. (Location 1072)

Tags: news

Note: .news the media focus on rare sensational events, reducing attention on legitimate problems such as hunger in Africa


I reckon that I outgrew the desire to generate random runs every time I want to explore an idea—but by dint of playing with a Monte Carlo engine for years I can no longer visualize a realized outcome without reference to the nonrealized ones. I call that “summing under histories,” borrowing the expression from the colorful physicist Richard Feynman who applied such methods to examine the dynamics of subatomic particles. (Location 1242)

Tags: monte carlo

Note: Consider the non-realized scenarios

In some respects we do not learn from our own history. Several branches of research have been examining our inability to learn from our own reactions to past events: For example, people fail to learn that their emotional reactions to past experiences (positive or negative) were shortlived—yet they continuously retain the bias of thinking that the purchase of an object will bring long-lasting, possibly permanent, happiness or that a setback will cause severe and prolonged distress (when in the past similar setbacks did not affect them for very long and the joy of the purchase was short-lived). (Location 1278)

Tags: happiness, consumerism

Note: People continually forget that purchasing objects will not make them happy

Psychologists call this over-estimation of what one knew at the time of the event due to subsequent information the hindsight bias, the “I knew it all along” effect. (Location 1317)

Tags: hindsight

Now the civil servant called the trades that ended up as losers “gross mistakes,” just like journalists call decisions that end up costing a candidate his election a “mistake.” I will repeat this point until I get hoarse: A mistake is not something to be determined after the fact, but in the light of the information until that point. (Location 1318)

Tags: decisions, favorite, mistakes

Note: A mistake can only be determined based on all the info someone had at the time

People do not realize that the media is paid to get your attention. (Location 1376)

Tags: media, news

Note: .news

Over the very narrow time increment, the observation will reveal close to nothing. Yet the dentist’s heart will not tell him that. Being emotional, he feels a pang with every loss, as it shows in red on his screen. He feels some pleasure when the performance is positive, but not in equivalent amount as the pain experienced when the performance is negative.

At the end of every day the dentist will be emotionally drained. A minute-by-minute examination of his performance means that each day (assuming eight hours per day) he will have 241 pleasurable minutes against 239 unpleasurable ones. These amount to 60,688 and 60,271, respectively, per year. Now realize that if the unpleasurable minute is worse in reverse pleasure than the pleasurable minute is in pleasure terms, then the dentist incurs a large deficit when examining his performance at a high frequency. (Location 1462)

Tags: investing, favorite, losing

Note: We feel loses more acutely than gains. It is not beneficial to frequently review stock market performance.

Regardless of what people claim, a negative pang is not offset by a positive one (some psychologists estimate the negative effect for an average loss to be up to 2.5 the magnitude of a positive one); it will lead to an emotional deficit. (Location 1492)

Tags: loses, emotions

Note: .emotions negative hits are stronger than the positive ones



Board members could not understand why the bank had so much exposure to a government that was not paying its own employees—which, disturbingly, included armed soldiers. This was one of the small points that emerging-market economists around the globe, from talking to each other so much, forgot to take into account. Veteran trader Marty O’Connell calls this the firehouse effect. He had observed that firemen with much downtime who talk to each other for too long come to agree on many things that an outside, impartial observer would find ludicrous (they develop political ideas that are very similar). Psychologists give it a fancier name, but my friend Marty has no training in behavioral sciences. (Location 1712)

Tags: firehouse effect

Note:  people talk with each about a topic so much that they come too believe things that an outiseder would find crazy

Carlos is now out of the market. The possibility that history may prove him right (at some point in the future) has nothing to do with the fact that he is a bad trader. He has all of the traits of a thoughtful gentleman, and would be an ideal son-in-law. But he has most of the attributes of the bad trader. And, at any point in time, the richest traders are often the worst traders. This, I will call the cross-sectional problem: At a given time in the market, the most successful traders are likely to be those that are best fit to the latest cycle. This does not happen too often with dentists or pianists—because these professions are more immune to randomness. (Location 1724)

Tags: success, traders

Note: the most successful traders are those that best meet the current cycle. The are not necessarily good traders

Following the incident, John regarded himself “ruined”; yet his net worth is still close to $1 million, which could be the envy of more than 99.9% of the inhabitants of our planet. Yet there is a difference between a wealth level reached from above and a wealth reached from below. The road from $16 million to $1 million is not as pleasant as the one from 0 to $1 million. In addition, John is full of shame; he still worries about running into old friends on the street. (Location 1783)

Tags: wealth

Note: There is a great difference in losing millions to reach 1 million wealth and rising from 0 to 1 million

Both Carlos and John belong to the class of people who benefited from a market cycle. It was not merely because they were involved in the right markets. It was because they had a bent in their style that closely fitted the properties of the rallies experienced in their market during the episode. They were dip buyers. That happened, in hindsight, to be the trait that was the most desirable between 1992 and the summer of 1998 in the specific markets in which the two men specialized. Most of those who happened to have that specific trait, over the course of that segment of history, dominated the market. Their score was higher and they replaced people who, perhaps, were better traders. (Location 1835)

Tags: traders

Note: .traders they strategy was suitable for the cycle, until it wasnt!


How could people miss such a point? Why do they confuse probability and expectation, that is, probability and probability times the payoff? (Location 1910)

Tags: probability

Note: Focus on probability and pay-off

it is not how likely an event is to happen that matters, it is how much is made when it happens that should be the consideration. How frequent the profit is irrelevant; it is the magnitude of the outcome that counts. It is a pure accounting fact that, aside from the commentators, very few people take home a check linked to how often they are right or wrong. What they get is a profit or loss. (Location 1946)

Tags: favorite, traders, probability

Note: the probability is not the only important factor. The magnitude is key

But there is even worse news. In some cases, if the incidence of red balls is itself randomly distributed, we will never get to know the composition of the urn. This is called “the problem of stationarity.” Think of an urn that is hollow at the bottom. As I am sampling from it, and without my being aware of it, some mischievous child is adding balls of one color or another. My inference thus becomes insignificant. I may infer that the red balls represent 50% of the urn while the mischievous child, hearing me, would swiftly replace all the red balls with black ones. This makes much of our knowledge derived through statistics quite shaky. The very same effect takes place in the market. We take past history as a single homogeneous sample and believe that we have considerably increased our knowledge of the future from the observation of the sample of the past. What if vicious children were changing the composition of the urn? In other words, what if things have changed? (Location 2108)


I can use data to disprove a proposition, never to prove one. I can use history to refute a conjecture, never to affirm it. For instance, the statement The market never goes down 20% in a given three-month period can be tested but is completely meaningless if verified. I can quantitatively reject the proposition by finding counterexamples, but it is not possible for me to accept it simply because, in the past, the market never went down 20% in any three-month period (you cannot easily make the logical leap from “has never gone down” to “never goes down”). Samples can be greatly insufficient; markets may change; we may not know much about the market from historical information. (Location 2179)

Note: Just because something has never happened it does not mean that it cant

markets (and life) are not simple win/lose types of situations, as the cost of the losses can be markedly different from that of the wins. Maximizing the probability of winning does not lead to maximizing the expectation from the game when one’s strategy may include skewness, i.e., a small chance of large loss and a large chance of a small win. If you engaged in a Russian roulette–type strategy with a low probability of large loss, one that bankrupts you every several years, you are likely to show up as the winner in almost all samples—except in the year when you are dead. (Location 2210)

Tags: probability

Note: Consider the probability of winning and the expectation from such a win

There are only two types of theories: Theories that are known to be wrong, as they were tested and adequately rejected (he calls them falsified). Theories that have not yet been known to be wrong, not falsified yet, but are exposed to be proved wrong. Why is a theory never right? Because we will never know if all the swans are white (Location 2285)

Tags: theories

Note: .theories theories cant be proven right

Part II MONKEYS ON TYPEWRITERS Survivorship and Other Biases

I do not deny that if someone performed better than the crowd in the past, there is a presumption of his ability to do better in the future. But the presumption might be weak, very weak, to the point of being useless in decision making. Why? Because it all depends on two factors: The randomness content of his profession and the number of monkeys in operation. The initial sample size matters greatly. If there are five monkeys in the game, I would be rather impressed with the Iliad writer, to the point of suspecting him to be a reincarnation of the ancient poet. (Location 2386)

Note: The number of people in the field is important


Aside from the misperception of one’s performance, there is a social treadmill effect: You get rich, move to rich neighborhoods, then become poor again. To that add the psychological treadmill effect; you get used to wealth and revert to a set point of satisfaction. This problem of some people never really getting to feel satisfied by wealth (beyond a given point) has been the subject of technical discussions on happiness. (Location 2459)

Tags: hedonic adaptation

Note: .hedonicadaption you get rich, move to a rich area and then feel poor in comparison to your neighbours


Remember that nobody accepts randomness in his own success, only his failure. (Location 2647)

Tags: randomness, success

The most intuitive way to describe the data mining problem to a nonstatistician is through what is called the birthday paradox, though it is not really a paradox, simply a perceptional oddity. If you meet someone randomly, there is a one in 365.25 chance of your sharing their birthday, and a considerably smaller one of having the exact birthday of the same year. So, sharing the same birthday would be a coincidental event that you would discuss at the dinner table. Now let us look at a situation where there are 23 people in a room. What is the chance of there being 2 people with the same birthday? About 50%. For we are not specifying which people need to share a birthday; any pair works. (Location 2684)

Tags: statistics, birthday

Note: .birthday if you have a group of 23 people the odds of 2 of them sharing a birthday are 50/50



when something is in relation to something else, that something else can be manipulated. Psychologists call this effect of comparing to a given reference anchoring. If we take it to its logical limit we would realize that, because of this resetting, wealth itself does not really make one happy (above, of course, some subsistence level); but positive changes in wealth may, especially if they come as “steady” increases. More on that later with my discussion of option blindness. (Location 3168)

Tags: happiness, wealth, anchoring

Neurobiologists also have their side of the story. They believe (roughly) that we have three brains: The very old one, the reptilian brain that dictates heartbeat and that we share with all animals; the limbic brain center of emotions that we share with mammals; and the neocortex, or cognitive brain, that distinguishes primates and humans (note that even institutional investors seem to have a neocortex). (Location 3289)

Tags: brain

Note: .brain three parts

one Harvard lawyer used the specious argument that only 10% of men who brutalize their wives go on to murder them, which is a probability unconditional on the murder (whether the statement was made out of a warped notion of advocacy, pure malice, or ignorance is immaterial). Isn’t the law devoted to the truth? The correct way to look at it is to determine the percentage of murder cases where women were killed by their husbands and had previously been battered by them (that is, 50%)—for we are dealing with what is called conditional probabilities; the probability that OJ. killed his wife conditional on the information of her having been killed, rather than the unconditional probability of O.J. killing his wife. (Location 3328)

Tags: statistics

A test of a disease presents a rate of 5% false positives. The disease strikes 1/1,000 of the population. People are tested at random,  regardless of whether they are suspected of having the disease. A patient’s test is positive. What is the probability of the patient being stricken with the disease? Most doctors answered 95%, simply taking into account the fact that the test has a 95% accuracy rate. The answer is the conditional probability that the patient is sick and the test shows it—close to 2%. Less than one in five professionals got it right. I will simplify the answer (using the frequency approach). Assume no false negatives. Consider that out of 1,000 patients who are administered the test, one will be expected to be afflicted with the disease. Out of a population of the remaining 999 healthy patients, the test will identify about 50 with the disease (it is 95% accurate). The correct answer should be that the probability of being afflicted with the disease for someone selected at random who presented a positive test is the following ratio: here 1 in 51. Think of the number of times you will be given a medication that carries damaging side effects for a given disease you were told you had, when you may only have a 2% probability of being afflicted with it! (Location 3364)

Consider that I buy the option for $1. What do I expect the value of the option to be one month from now? Most people think 0. That is not true. The option has a high probability, say 90%, of being worth 0 at expiration, but perhaps 10% probability to be worth an average of $10. Thus, selling the option to me for $1 does not provide the seller with free money. If the seller had instead bought the stock himself at $100 and waited the month, he could have sold it for $120. Making $1 now was hardly, therefore, free money. Likewise, buying it is not a wasting asset. Even professionals can be fooled. How? They confuse the expected value and the most likely scenario (here the expected value is $1 and the most likely scenario is for the option to be worth 0). They mentally overweigh the state that is the most likely, namely, that the market does not move at all. The option is simply the weighted average of the possible states the asset can take. (Location 3385)

At birth, your unconditional life expectancy may be seventy-three years. But as you advance in age and do not die, your life expectancy increases along with your life. Why? Because other people, by dying, have taken your spot in the statistics, for expectation means average. So if you are seventy-three and are in good health, you may still have, say, nine years in expectation. But the expectation would change, and at eighty-two, you will have another five years, provided of course you are still alive. Even someone one hundred years old still has a positive conditional life expectation. Such a statement, when one thinks about it, is not too different from the one that says: Our operation has a mortality rate of 1%. So far we have operated on ninety-nine patients with great success; you are our one hundreth, hence you have a 100% probability of dying on the table. (Location 3449)

Tags: favorite, lifeexpectancy, ageing

Note: .ageing .lifeexpectancy

Professionals forget the following reality. It is not the estimate or the forecast that matters so much as the degree of confidence with the opinion. (Location 3507)

Tags: favorite, forecasting

Note: .forecasting giving confidence levels is key in forecasting

Part III WAX IN MY EARS Living with Randomitis


The Greek philosopher Pyrrho, who advocated a life of equanimity and indifference, was criticized for failing to keep his composure during a critical circumstance (he was chased by an ox). His answer was that he found it sometimes difficult to rid himself of his humanity. (Location 3669)

Tags: quote

Note: .quote


You attribute your successes to skills, but your failures to randomness. (Location 3833)

Tags: favorite, success

Note: .success


Repetitiveness is key for the revelation of skills because of what I called ergodicity in Chapter 8—the detection of long-term properties, particularly when these exist. If you bang one million dollars at your next visit to Las Vegas at the roulette table in one single shot, you will not be able to ascertain from this single outcome whether the house has the advantage or if you were particularly out of the gods’ favor. If you slice your gamble into a series of one million bets of one dollar each, the amount you recover will systematically show the casino’s advantage. This is the core of sampling theory, traditionally called the law of large numbers. (Location 3942)

The central banker lowers interest rates, a recovery ensues, but we do not know whether he caused it or if he slowed it down. We can’t even know that he didn’t destabilize the economy by increasing the risk of future inflation. He can always fit a theoretical explanation, but economics is a narrative discipline, and explanations are easy to fit retrospectively. (Location 3978)

We favor the visible, the embedded, the personal, the narrated, and the tangible; we scorn the abstract. (Location 4060)

Tags: visual

Affirming the consequent: The logical fallacy is generally presented as follows. If p then q q Therefore, p (All people in the Smith family are tall; he is tall therefore he belongs to the Smith family). (Location 4086)

The millionaire mind: Stanley (2000). He also figured out (correctly) that the rich were “risk takers” and inferred (incorrectly) that risk taking made one rich. Had he examined the population of failed entrepreneurs he would have also inferred (correctly) that the failed entrepreneurs too were “risk takers.” (Location 4092)

Tags: risk

Note: .risk the rich are risk takers, but so too are many poor and failed entrepreneurs

I can remember struggling with these same theoretical questions as a child, when I tried to pour ketchup on my dinner. Like all children encountering this problem for the first time, I assumed that the solution was linear: That steadily increasing hits on the base of the bottle would yield steadily increasing amounts of ketchup out the other end. Not so, my father said, and he recited a ditty that, for me, remains the most concise statement of the fundamental nonlinearity of everyday life: ‘Tomato ketchup in a bottle—None will come and then the lot’ll.’ (Location 4275)