Table Of Content

"[Fooled bRandomness] itsoc onvenWtailSoltn raele t y wisdaopmp roxwihmaaMtta erlLtyui tnh neirn'est y-nine thewseertseot hCea thCohluircc h." - MALCOLGML ADWEaLuL,to hfBoli rnk F )0.LETJ BY R.AlvDOWlvESo- TheHi ddeRno loefC hance - inL ife anidnt hMea rkets NASSNIIMC HOTLAALSE B SECOND EDITION, UPDATED BY THE AUTt OR 1 .s A , PRA/S£ FOR • FOOLED BY RANDOMNESS "Fooled by Randomness ... is to conventional Wall Street wisdom approximately what Martin Luther's ninety-five theses were to the Catholic Church."-Malcolm Gladwell, The New Yorker "The book that rolled down Wall Street like a hand grenade." -Maggie Mahar, author of Bull! A History of the Boom, 1982-1999 "Fascinating ...Ta leb will grab you."-Peter L. Bernstein, author of Against the Gods: The Remarkable Story of Risk "Recalls the best of scientist/essayists like Richard Dawkins ...a nd Stephen Jay Gould."-Michael Schrage, MIT, author of Serious Play "We need a book like this. ...F un to read, refreshingly independent minded."-Robert J. Shiller, author of Irrational Exuberance "If asked to name the five best books written about markets, Fooled by Randomness would be on my list."-Jack D. Schwager, author of Market Wizards "Intelligent, honest, and revealing. There exists a distinct Taleb way of thinking and it is contagious."-Marco Avellaneda, professor of mathematical finance, New York University "Taleb's book is mathematically sound as well as entertaining and informative for the general public, which is quite an achieve ment."-Donald Geman, professor of probability theory, Johns Hop kins University I\ "Ideal for summer reading and graduation gifts. [Taleb] explains how almost everything in the realm of business and finance that looks like 'talent' is really pure luck."-Scott Adams, cre ator of Dilbert "Excellent and thought-provoking ...a n entertaining book." -FinanTciimaels "The perfect antidote to the hundreds of titles that will be pub lished this year promising unbeatable (stock market] strategies. " -L ondon SundTaiym(B eosok of the Week) "This entertaining work ...w ill prompt readers to think carefully about the nature of success and the role of chance."-Barron's "Here's an articulate, wise ...m editation on the nature of success and failure that anyone who wants a little more of the former would do well to consider. Highly recommended.-" Harry C. Edwards, edti or, Amazon.c om "An instant classic. Readable and remarkable at every turn." -Patr i kc L.Yo ung, auth or of ThNee wC apiMtaarlkR eetv olution "The style of the book is informal and funny. ...W e hop from one topic to the next but the author's points come through loud and clear. ... Overall, a warmly recommended book."-slas hdot.org "Using a variety of imaginative examples, Taleb reminds us that we view the world through the lens of surv ivorship bias-we tend to consider only the few winners and not the many losers in a partic ular endeavor. ...I t is important to remember, as Taleb shows in his charming and colorful book, that randomness can fool us." -WilQsuoanr terly "[One of] the best books I've read in years. [Taleb will] stretch your mind, make you smile and give your skepticism a healthy boost."-Paul Sturm in Smart Money "A wise and readable guide to clearer thinking, drawing insights from thinkers ranging from George Soros to Yogi Berra."-Futurist "A blast of common sense.F rom classical to modern philosophers, via cab drivers, businessmen and dentists."-Paul Wilmott, author of Derivatives "[Writing] in an accessible and entertaining manner, Taleb com bines personal trading experiences with details and examples from a multidisciplinary array of topics-ancient history, classical literature, philosophy, mathematics, and science."-Word Trade "Fooled by Randomness is a serious intellectually sophisticated book, well worth reading carefully. ... Great insights."---"-Barton Biggs, major Wall Street investor "Taleb is a true intellectual in a world filled with too many resume builders. He has a better command of the literature than most Harvard professors. Furthermore, it is refreshing that this comes from an almost overriding passion for the subject. Unconstrained by academic rules, he follows his instincts and passions to investi gate and illuminate human nature."-Terry Burnham, Harvard Uni versity, co-author of Mean Genes l=OOLEBDY RANDOMNESS • l=OOLEBDY RANDOMNESS • Thl-lei ddReonlo efC hance ,. inL iafneid tn h Mea rkets SECOND EDITION, UPDATED BY Tl-IE AUTI-IOR NassNiimc hToallaesb 0 RANDOM 1-WUSE TRADE PAPERBACKS NEW YORK Fooled by Randomness is a work of nonfiction, but certain names of nonpublic figures have been changed, and some of the private individuals described are fictionalized or composite portraits. 2005 Random House Trade Paperback Edition Copyright © 2004 by N assim Nicholas Taleb All rights reserved. Published in the United States by Random House Trade Paperbacks, an imprint of The Random House Publishing Group, a division of Random House, Inc., New York. RANDOM HOUSE TRADE PAPERBACKS and colophon are trademarks of Random House, Inc. This work was originally published in 2004 by TEXERE, part of the Thomson Corporation, in hardcover. This edition published by arrangement with the author. Library of Congress Cataloging-in-Publication Data Taleb, Nassim. Fooled by randomness: the hidden role of chance in life and in the markets/ Nassim Nicholas Taleb. p. cm. Originally published: New York: Thomson/Texere, 2004. Includes bibliographical references and index. ISBN 0-8129-7521-9 1. Investments. 2. Chance. 3. Random variables. I. Title. HG4521.T285 2005 123 '.3-dc22 2005049005 Printed in the United States of America www.atrandom.com 68 9 7 Book design by Chris Welch To my mother, Minerva Ghosn Taleb PREFACE TAKING KNOWLEDGE LESS SERIOUSLY his book is the synthesis of, on one hand, the no-nonsense prac titioner of uncertainty who spent his professional life trying to resist being fooled by randomness and trick the emotions as- sociated with probabilistic outcomes and, on the other, the aestheti cally obsessed, literature-loving human being willing to be fooled by any form of nonsense that is polished, refined, original, and tasteful.I am not capable of avoiding being the fool of randomness;what I can do is confine it to where it brings some aesthetic gratification. This comes straight from the gut; it is a personal essay primarily discussing its author's thoughts, struggles, and observations con nected to the practice of risk taking, not exactly a treatise, and cer tainly, god forbid, not a piece of scientific reporting.I t was written for fun and it aims to be read (principally) for, and with, pleasure. Much has been written about our biases (acquired or genetic) in dealing with randomness over the past decade. The rules while writing the first edition of this book had been to avoid discussing (a) anything that I did not either personally witness on the topic or develop independently, and (b) anything that I have not dis tilled well enough to be able to write on the subject with only the slightest effort. Everything that remotely felt like work was out.I had to purge from the text passages that seemed to come from a viii PREJ:ACE visit to the library, including the scientific name dropping. I tried to use no quote that did not naturally spring from my memory and did not come from a writer whom I had intimately frequented over the years (I detest the practice of random use of borrowed wisdom-much on that later).A ut tace aut loquere meliora silencio ( only when the words outperform silence). These rules remain intact. But sometimes life requires compro mises: Under pressure from friends and readers I have added to the present edition a series of nonintrusive endnotes referring to the related literature. I have also added new material to most chapters, most notably in Chapter 11, which altogether has re sulted in an expansion of the book by more than a third. Additnotg hW ei nner I hope to make this book organic-by, to use traders' lingo, "adding to the winner"-and let it reflect my personal evolution instead of holding on to these new ideas and putting them into a new book altogether. Strangely, I gave considerably more thought to some sections of this book after the publication than I had before, par ticularly in two separate areas: (a) the mechanisms by which our brain sees the world as less, far less, random that it actually is, and (b) the "fat tails," that wild brand of uncertainty that causes large deviations (rare events explain more and more of the world we live in, but at the same time remain as counterintuitive to us as they were to our ancestors). The second version of this book re flects this author's drift into becoming a little less of a student of uncertainty (we can learn so little about randomness) and more of a researcher into how people are fooled by it. Another phenomenon: the transformation of the author by his own book.A s I increasingly started living this book after the initial composition, I found luck in the most unexpected of places. It is as if there were two planets: the one in which we actually live and the one, considerably more deterministic, on which people are