Fooled By Randomness

Fooled By Randomness is a book I'm reading now. To be honest it is a very very difficult read, and I'm on the verge of giving up. But here is what I've learned from the book so far: Randomness is everywhere in our lives but people don't realize it and stupidly try to make sense out of it. Very often fools that got lucky are applauded as geniuses and mightily successful people.

You see, take 10000 total new traders and let them trade for one month, a few of them are bound to end up with outstanding results. Why so? Are they really prodigies and geniuses? NO!!! It is simply a result of statistics and randomness!!! Lets take it further... Lets gather 10000 monkeys and place two pieces of paper for them to draw for every trade over a month. One piece to go long and the other to go short. Again some monkeys will produce outstanding results simply because of randomness!! See what I'm getting at?

So why am I talking about this? Well, if one is able to grasp the concept of randomness, he is a level above most people and in fact is able to live life without the naivety that plagues most of us. Back to my example above... Do you realize this is how CNBC gurus and several "top" traders are created? The 2-3 traders who managed to perform outstandingly as a result of randomness are elevated to media publicity and lauded as gurus. But are they? Trader A managed to call the top and bottom of the S&P 5 times in a row, CNBC pounces on this and splashes his articles on their site, promoting him as an uncanny forecaster. Well, give me 10000 monkeys and I bet at least one of them will be able to call the same tops and bottoms.

People have an insatiable need to justify everything. A figure of a horse appears in the sky and some tribe will take it as a sign from the heavenlies and start worshiping horses. A man who finally manages to ace an interview after 10 tries realizes that he was wearing a different tie and starts believing it is a lucky tie. George Soros who took a big bet and became a legend overnight because he broke the Bank Of England.

Alright I'm not saying Soros isn't an expert in his field, I've no doubt about that, I just needed an example to illustrate my point :P Was he a 100% sure when he made that bet? Is anyone ever a 100% sure when it comes to the markets? Lets assign a probability to his being right, lets say there was a 90% chance that he'll be right. Now lets assume there are parallel universes where 10 different Soros made the same bet. Well, the result is that Soros will become a legend in 9 of them and a darn fool who broke his fund in the remaining one. Of course, I'm totally speculating and perhaps he did practice risk management which would have left his firm intact.

The same logic goes for traders who draw trend lines all over the chart, connecting multiple points across multiple years. They don't realize that a trend line drawn from two points and projected is very likely to hit another swing point somewhere in the future due to randomness! So we have traders who swear by trend lines and draw dozens of them all over the chart with every permutation of lines across the various swing points. Again I'm not saying trend lines do not work, but you have to identify the really obvious ones which can only be drawn in one way, not those that happen to connect two points 10 years ago and have been ignored since then. And yes I have seen such ridiculous charts before.

The concept of randomness has changed the way I view a lot of things, I'm determined not to be a naive person who chases after lucky fools. I'll smile when I come across heavily leveraged traders who boast about their portfolio multiplication and insane ability to call the markets, knowing that without risk management they'll be reduced to obscure fools sooner or later.