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Froth and noise debunked by an experienced market practition
on 10 February 2002
If you have ever listened to economists, analysts, or other supposedly intelligent commentators and wondered is it just you or are they really talking complete rubbish, then this book is for you. Taleb has produced a witty, informed, and entertaining book that debunks much of what passes for analysis and success in financial markets.
Taleb has a clear admiration for Physics and adopts a physics approach. He dives right into the heart of the problem, finds the essential truth - that markets are random, the path we observe is only one of many, and that we cannot make proper assessments on trading strategies until a sufficient time-period has elapsed to give a significant sample which includes those rare but headline-making events that occur from time-to-time. He picks out several consequences of this phenomenon. The main one is Survivorship Bias (that those experiencing good fortune at picking the right investments will be elevated to guru status, until one of those rare but extreme events removes them from their pedestals). There are many other useful insights here; how the shorter the time-scale we use to study performance the more noise we see; how journalists comment on the one random outcome we observe and interpret it as significant news; how pseudo-science has spread to all sorts of unsuitable areas; and how groups of traders form collective opinions which defy rational analysis (the so-called "fire-station" effect); how lucky traders become all puffed-up with their own success, and the link to Seretonin levles and evolutionary benefits of being able to identify winners in competitions. This entertaining section gives compelling reasons for sharing Taleb's scepticism about much of the modern financial world.
Physics, however, has difficulty providing a complete explanation for any system more complex than a single particle. Real problems benefit from a more all-round approach, or a more heuristic analysis. Taleb's single parameter analysis of success in financial markets and the behaviour of participants and institutions soon runs into contradictions and problems. He frequently talks about "good traders" and "bad traders", but sees this only in terms of buying low-probability events which he insitst are universally undervalued, and gives pseudo-real case histories of bad traders who blew up buy selling these lo-probability events. Yet he also comes up with a list of distinguishing features of bad traders; so could a bad trader become self-aware and learn to become a good trader, but still sell low-frequency extreme events? Is anyone who buys extreme events a good trader? More analysis is needed here to give a water-tight case.
When discussing bubbles such as the recent tech-stock bubble, Taleb's single variable explanation misses a whole dynamic. Everyone knew it was a bubble that would burst, yet many made money from buying into it, and some who held out against going into it at lost their jobs. The mass-psychology that sucks so many people into bubbles against their better judgement is a fascinating subject. There is much that can usefully be said, and now would be a good time to say it, but it isn't said here.
Elsewhere, Taleb's explanations also fail to enlighten as much as they might. The influence of randomness in medical research and medical practise is mentioned briefly, and the use of statistics in the legal profession gets a mention as well. There are many legal cases where statistical arguments have formed the basis of judgements and mis-judgements, from the Dreyfus case right up to the Sally Clark case in the UK today, yet all we get is a couple of throw away-examples from the O.J. Simpson trial. Perhaps if Taleb had spent less time reading high-society gossip pages and a bit more time researching his arguments he might have produced more significant arguments here.
Taleb has written a useful, readable, and thought-provoking book. Reading it is probably a better use of your commuting time than reading the Wall Street Journal. Yet the book ultimately disappoints because Taleb is neither original enough to fill an entire book with his musings and thoughts, nor diligent enough to give a properly researched presentation of his case.