Four hundred years ago, Francis Bacon warned that our minds are wired to deceive us. "Beware the fallacies into which undisciplined thinkers most easily fall--they are the real distorting prisms of human nature." Chief among them: "Assuming more order than exists in chaotic nature." Now consider the typical stock market report: "Today investors bid shares down out of concern over Iranian oil production." Sigh. We're still doing it.Our brains are wired for narrative, not statistical uncertainty. And so we tell ourselves simple stories to explain complex thing we don't--and, most importantly, can't--know. The truth is that we have no idea why stock markets go up or down on any given day, and whatever reason we give is sure to be grossly simplified, if not flat out wrong.Nassim Nicholas Taleb first made this argument in Fooled by Randomness, an engaging look at the history and reasons for our predilection for self-deception when it comes to statistics. Now, in The Black Swan: the Impact of the Highly Improbable, he focuses on that most dismal of sciences, predicting the future. Forecasting is not just at the heart of Wall Street, but it’s something each of us does every time we make an insurance payment or strap on a seat belt.
The Black Swan is a very unusual book. A couple of days after finishing it I still feel like I'm struggling to integrate its message with life. It reminds me a little of Richard Dawkins' Selfish Gene in that respect: its central thesis, which appears to be unassailably argued, indicates that the standard view of the world is wrong. In Dawkins' case, the primacy of the individual (as opposed to the gene) and in Taleb's case, the view that the world is essentially driven by normal, day-to-day events. The subtitle of Taleb's book tells you what it is about: The Impact of the Highly Improbable. According to Taleb, high-impact rare events ('Black Swans') are not anything like as rare as we think they are and their effect is so disproportionately large that they effectively drive events in the world. This may not sound all that provocative, but Taleb's argument is that virtually everybody's view of the world as essentially linear and step-by-step is just an illusion that protects us from understanding that our progress through life is much more random and fragile than we think. Taleb's outstanding first book, Fooled by Randomness, is about the much greater role of luck in life than is commonly understood. The Black Swan develops this thesis further and shows that rare and unexpected events (what you might think of as a subdivision of luck) drive much of the results in the world. Since reading Richard Koch's The 80/20 Principle eight or so years ago - after which I began to look at the world through the lens of unequal cause and effect - I have been coming gradually around to Taleb's views. Even so, The Black Swan is difficult to assimilate - and it must seem extremely odd (and itself most improbable) to those who have not had some preparation. One can see this difficulty in the absolute refusal of modern academic finance to give up theories of how the world works (the bell curve or pattern of 'normal' distribution) that allow them to use complicated mathematics and which are just plain wrong. Taleb thought the Long Term Capital Management debacle in 1998 - in which various Nobel-winning economists proved their (Nobel-winning) ideas did not apply in the real world - would be the end of these dangerously wrong beliefs. However, it was Taleb who was wrong about that: a whole gang of academics who have invested a good chunk of their lives in an idea that turns out to be worthless (actually significantly negative) won't give it up easily (and perhaps not until they are all dead). The sub-prime mess, with accompanying cries of surprise and of '25-standard deviation events' from various hog-greedy financiers and hedge fund managers, shows the continued prevalence of these appalling ideas. After the success of Fooled by Randomness, it would appear that Taleb had more freedom to write (and be published) however he wanted. It makes The Black Swan more idiosyncratic and aggressive than Fooled by Randomness. I imagine this will act as a polariser and some people who would otherwise appreciate the content may not like the delivery. Personally, though, I loved it. As someone who has tried working in various jobs in the City of London (the UK equivalent of Wall Street) I feel in some ways that Taleb is a kindred spirit: I can't stand arrogant, ignorant 'empty suits' either. I thought his "Get Another Job" section (p. 163) was perfect: "There are those people who produce forecasts uncritically. When asked why they forecast, they answer, "Well, that's what we're paid to do here." My suggestion: get another job. This suggestion is not too demanding: unless you are a slave, I assume you have some amount of control over your job selection. Otherwise this becomes a problem of ethics, and a grave one at that. People who are trapped in their jobs who forecast simply because "that's my job," knowing pretty well that their forecast is ineffectual, are not what I would call ethical. What they do is no different from repeating lies simply because "it's my job."" Taleb's very severe and aggressive criticism of risk measurement techniques in modern finance could be interpreted as an intemperate rant. I don't subscribe to this view and suspect Taleb chose this approach deliberately in order to make it clear that the prevalent financial risk management techniques and his ideas cannot in any way coexist: they are absolutely and totally mutually exclusive. (Taleb mentions that after finding it impossible to refute his ideas some people then try to combine them with their old ways of operating.) I also liked the way Taleb approached and structured his book: he uses stories to get ideas across (as with Nero Tulip in Fooled by Randomness) and has separated his book into sections that allow one to understand his ideas with or without the scientific underlay (I think this is a great idea). Some people (whether wilfully or not) confused the central theme of Fooled by Randomness, that much of life is driven by luck, with the superficially similar but totally different 'all of life is driven by luck'. In a similar way, I believe some people think that Taleb's message in The Black Swan is unremittingly negative: that we are all permanently exposed to large unexpected events that can wreck all our plans in an instant, and which we can do nothing about. Taleb's point is rather that most specific forecasting is pointless, as large, rare and unexpected events (which by definition could not have been included in the forecast) will render the forecast useless. However, as Black Swans can be both negative and positive, we can try to structure our lives in order to minimise the effect of the negative Black Swans and maximise the impact of the positive ones. I think this is excellent advice on how to live one's life and seems to be equivalent, for example, to the focus on downside protection (rather than upside potential) that has led to the success of the 'value' approach to investing.
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