• We surely closed our minds by following Descartes’ model of formal thinking rather than Montaigne’s brand of vague and informal (but critical) judgment. Half a millennium later the severely introspecting and insecure Montaigne stands tall as a role model for the modern thinker.

• Outside of textbooks and casinos, probability almost never presents itself as a mathematical problem or a brain teaser. Mother nature does not tell you how many holes there are on the roulette table, nor does she deliver problems in a textbook way (in the real world one has to guess the problem more than the solution).

• Furthermore, the kind of luck in finance is of the kind that nobody understands but most operators think they understand, which provides us a magnification of the biases.

• I have to confess that I never felt really particularly directly of service to anyone being a trader (except myself); it felt elevating and useful being an essayist.

• A few confusions with the message in this book. Just as our brain does not easily make out probabilistic shades (it goes for the over-simplifying “all-or-none”), it was hard to explain that the idea here was that “it is more random than we think” rather than “it is all random.” I had to face the “Taleb, as a skeptic, thinks everything is random and successful people are just lucky.”

• One needs to go out and buy a lottery ticket in order to win. Does it mean that the work involved in the trip to the store caused the winning? Of course skills count, but they do count less in highly random environments than they do in dentistry.

• Assume that good qualities cause success; based on that assumption, even though it seems intuitively correct to think so, the fact that every intelligent, hardworking, persevering person becomes successful does not imply that every successful person is necessarily an intelligent, hardworking, persevering person (it is remarkable how such a primitive logical fallacy—affirming the consequent—can be made by otherwise very intelligent people, a point I discuss in this edition as the “two systems of reasoning” problem).

• That all millionaires were persistent, hardworking people does not make persistent hard workers become millionaires: Plenty of unsuccessful entrepreneurs were persistent, hardworking people.

• logic does not require empirical verification (again there is what I call a “round-trip fallacy”:

• Most journalists do not take things too seriously: After all, this business of journalism is about pure entertainment, not a search for truth, particularly when it comes to radio and television.

• Almost all the book editors who read the draft recommended changes at the sentence level (to make my style “better”) and in the structure of the text (in the organization of chapters); I ignored almost all of them and found out that none of the readers thought them necessary—as a matter of fact, I find that injecting the personality of the author (imperfections included) enlivens the text. Does the book industry suffer from the classical “expert problem” with the buildup of rules of thumb that do not have empirical validity? More than a hundred thousand readers later I am discovering that books are not written for book editors.

• Delivering advice assumes that our cognitive apparatus rather than our emotional machinery exerts some meaningful control over our actions. We will see how modern behavioral science shows this to be completely untrue.

• Croesus, King of Lydia, was considered the richest man of his time. To this day Romance languages use the expression “rich as Croesus” to describe a person of excessive wealth. He was said to be visited by Solon, the Greek legislator known for his dignity, reserve, upright morals, humility, frugality, wisdom, intelligence, and courage.

• it does not matter how frequently something succeeds if failure is too costly to bear.

• He finished writing his thesis in philosophy. But not the Derrida continental style of incomprehensible philosophy (that is, incomprehensible to anyone outside of their ranks, like myself).

• Nero is allergic to the vocabulary of business talk, not just on plain aesthetic grounds. Phrases like “game plan,” “bottom line,” “how to get there from here,” “we provide our clients with solutions,” “our mission,” and other hackneyed expressions that dominate meetings lack both the precision and the coloration that he prefers to hear.

• Every time his risks increase, he conjures up the image of the quiet hallway at the university, the long mornings at his desk spent in revising a paper, kept awake by bad coffee. No, he does not want to have to face the solemn university library where he was bored to tears. “I am shooting for longevity,” he is wont to say.

• Blow up in the lingo has a precise meaning; it does not just mean to lose money; it means to lose more money than one ever expected, to the point of being thrown out of the business (the equivalent of a doctor losing his license to practice or a lawyer being disbarred].

• Today, at thirty-nine, after fourteen years in the business, he can consider himself comfortably settled. His personal portfolio contains several million dollars in medium-maturity Treasury bonds, enough to eliminate any worry about the future. What he likes most about proprietary trading is that it requires considerably less time than other high-paying professions; in other words it is perfectly compatible with his non-middle-class work ethic. Trading forces someone to think hard; those who merely work hard generally lose their focus and intellectual energy.

• This free time has allowed him to carry on a variety of personal interests. As Nero reads voraciously and spends considerable time in the gym and museums, he cannot have a lawyer’s or a doctor’s schedule. Nero found the time to go back to the statistics department where he started his doctoral studies and finished the “harder science” doctorate in statistics, by rewriting his thesis in more concise terms.

• Nero believes that risk-conscious hard work and discipline can lead someone to achieve a comfortable life with a very high probability. Beyond that, it is all randomness: either by taking enormous (and unconscious) risks, or by being extraordinarily lucky.

• Mild success can be explainable by skills and labor. Wild success is attributable to variance.

• Arguably, in expectation, a dentist is considerably richer than the rock musician who is driven in a pink Rolls Royce, the speculator who bids up the price of impressionist paintings, or the entrepreneur who collects private jets. For one cannot consider a profession without taking into account the average of the people who enter it, not the sample of those who have succeeded in it. We will examine the point later from the vantage point of the survivorship bias, but here, in Part I, we will look at it with respect to resistance to randomness.

• Consider two neighbors, John Doe A, a janitor who won the New Jersey lottery and moved to a wealthy neighborhood, compared to John Doe B, his next-door neighbor of more modest condition who has been drilling teeth eight hours a day over the past thirty-five years. Clearly one can say that, thanks to the dullness of his career, if John Doe B had to relive his life a few thousand times since graduation from dental school, the range of possible outcomes would be rather narrow (assuming he is properly insured). At the best, he would end up drilling the rich teeth of the New York Park Avenue residents, while the worst would show him drilling those of some semideserted town full of trailers in the Catskills. Furthermore, assuming he graduated from a very prestigious teeth-drilling school, the range of outcomes would be even more compressed. As to John Doe A, if he had to relive his life a million times, almost all of them would see him performing janitorial activities (and spending endless dollars on fruitless lottery tickets), and one in a million would see him winning the New Jersey lottery.

• The idea of taking into account both the observed and unobserved possible outcomes sounds like lunacy. For most people, probability is about what may happen in the future, not events in the observed past; an event that has already taken place has 100% probability, i.e., certainty. I have discussed the point with many people who platitudinously accuse me of confusing myth and reality. Myths, particularly well-aged ones, as we saw with Solon’s warning, can be far more potent (and provide us with more experience) than plain reality.

• Five out of these six histories would lead to enrichment; one would lead to a statistic, that is, an obituary with an embarrassing (but certainly original) cause of death. The problem is that only one of the histories is observed in reality; and the winner of $10 million would elicit the admiration and praise of some fatuous journalist (the very same ones who unconditionally admire the Forbes 500 billionaires). Like almost every executive I have encountered during an eighteen-year career on Wall Street (the role of such executives in my view being no more than a judge of results delivered in a random manner), the public observes the external signs of wealth without even having a glimpse at the source (we call such source the generator). Consider the possibility that the Russian roulette winner would be used as a role model by his family, friends, and neighbors.

• While the remaining five histories are not observable, the wise and thoughtful person could easily make a guess as to their attributes. It requires some thoughtfulness and personal courage. In addition, in time, if the roulette-betting fool keeps playing the game, the bad histories will tend to catch up with him. Thus, if a twenty-five-year-old played Russian roulette, say, once a year, there would be a very slim possibility of his surviving until his fiftieth birthday—but, if there are enough players, say thousands of twenty-five-year-old players, we can expect to see a handful of (extremely rich) survivors (and a very large cemetery).

• We will see that probability is a qualitative subject.

• Note that these ideas of alternative histories have been covered by separate disciplines in intellectual history, worth presenting quickly because they all seem to converge on the same concept of risk and uncertainty (certainty is something that is likely to take place across the highest number of different alternative histories; uncertainty concerns events that should take place in the lowest number of them).

• When I started on Wall Street in the 1980s, trading rooms were populated with people with a “business orientation,” that is, generally devoid of any introspection, flat as a pancake, and likely to be fooled by randomness.

• Some successful scientists had the judgment (and social graces) of a doorknob—but by no means all of them. Many people were capable of the most complex calculations with utmost rigor when it came to equations, but were totally incapable of solving a problem with the smallest connection to reality; it was as if they understood the letter but not the spirit of the math

• Heroes are heroes because they are heroic in behavior, not because they won or lost.

• 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.

• 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.

• The market movements in the eighteen months after September 11, 2001, were far smaller than the ones that we faced in the eighteen months prior—but somehow in the mind of investors they were very volatile. The discussions in the media of the “terrorist threats” magnified the effect of these market moves in people’s heads. This is one of the many reasons that journalism may be the greatest plague we face today—as the world becomes more and more complicated and our minds are trained for more and more simplification.

• The risk managers’ job feels strange: As we said, the generator of reality is not observable. They are limited in their power to stop profitable traders from taking risks,

• Mathematics is principally a tool to meditate, rather than to compute.

• Stochastic processes refer to the dynamics of events unfolding with the course of time. Stochastic is a fancy Greek name for random. This branch of probability concerns itself with the study of the evolution of successive random events—one could call it the mathematics of history. The key about a process is that it has time in it.

• It is a fact that “true” mathematicians do not like Monte Carlo methods. They believe that they rob us of the finesse and elegance of mathematics. They call it “brute force.” For we can replace a large portion of mathematical knowledge with a Monte Carlo simulator (and other computational tricks). For instance, someone with no formal knowledge of geometry can compute the mysterious, almost mystical Pi. How? By drawing a circle inside of a square, and “shooting” random bullets into the picture (as in an arcade), specifying equal probabilities of hitting any point on the map (something called a uniform distribution). The ratio of bullets inside the circle divided by those inside and outside the circle will deliver a multiple of the mystical Pi, with possibly infinite precision. Clearly, this is not an efficient use of a computer as Pi can be computed analytically, that is, in a mathematical form, but the method can give some users more intuition about the subject matter than lines of equations. Some people’s brains and intuitions are oriented in such a way that they are more capable of getting a point in such a manner (I count myself one of those). The computer might not be natural to our human brain; neither is mathematics.

• Mathematicians are born, never made. Physicists and quants too. I do not care about the “elegance” and “quality” of the mathematics I use so long as I can get the point right. I have recourse to Monte Carlo machines whenever I can. They can get the work done. They are also far more pedagogical, and I will use them in this book for the examples.

• 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.

• Every man believes himself to be quite different, a matter that amplifies the “why me?” shock upon a diagnosis.

• Things are always obvious after the fact. The civil servant was a very intelligent person, and this mistake is much more prevalent than one would think. It has to do with the way our mind handles historical information. When you look at the past, the past will always be deterministic, since only one single observation took place. Our mind will interpret most events not with the preceding ones in mind, but the following ones. Imagine taking a test knowing the answer. While we know that history flows forward, it is difficult to realize that we envision it backward.

• A mistake is not something to be determined after the fact, but in the light of the information until that point.

• A more vicious effect of such hindsight bias is that those who are very good at predicting the past will think of themselves as good at predicting the future, and feel confident about their ability to do so.

• The principal criticism against Shiller came from Robert C. Merton. The attacks were purely on methodological grounds (Shiller’s analysis was extremely rough; for instance, his using dividends in place of earnings was rather weak]. Merton was also defending the official financial theory position that markets needed to be efficient and could not possibly deliver opportunities on a silver plate. Yet the same Robert C. Merton later introduced himself as the “founding partner” of a hedge fund that aimed at taking advantage of market inefficiencies. Setting aside the fact that Merton’s hedge fund blew up rather spectacularly from the black swan problem (with characteristic denial), his “founding” such a hedge fund requires, by implication, that he agrees with Shiller about the inefficiency of the market. The defender of the dogmas of modern finance and efficient markets started a fund that took advantage of market inefficiencies! It is as if the Pope converted to Islam. Things are not getting any better these days. At the time of writing, news

• However, the main theme of the works of Rushdie is not theory, as the dialectic paradigm of reality suggests, but pretheory. The premise of the neosemanticist paradigm of discourse implies that sexual identity, ironically, has significance.     Many narratives concerning the role of the writer as observer may be revealed. It could be said that if cultural narrative holds, we have to choose between the dialectic paradigm of narrative and neoconceptual Marxism. Sartre’s analysis of cultural narrative holds that society, paradoxically, has objective value.     Thus, the premise of the neodialectic paradigm of expression implies that consciousness may be used to reinforce hierarchy, but only if reality is distinct from consciousness; if that is not the case, we can assume that language has intrinsic meaning.

• Accordingly, bullish or bearish are terms used by people who do not engage in practicing uncertainty, like the television commentators, or those who have no experience in handling risk. Alas, investors and businesses are not paid in probabilities; they are paid in dollars. Accordingly, 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.

• We can look at other aspects of the problem; think of someone involved in scientific research. Day after day, he will engage in dissecting mice in his laboratory, away from the rest of the world. He could try and try for years and years without anything to show for it. His significant other might lose patience with the loser who comes home every night smelling of mice urine. Until bingo, one day he comes up with a result. Someone observing the time series of his occupation would see absolutely no gain, while every day would bring him closer in probability to the end result.

• In the markets, there is a category of traders who have inverse rare events, for whom volatility is often a bearer of good news. These traders lose money frequently, but in small amounts, and make money rarely, but in large amounts. I call them crisis hunters. I am happy to be one of them.

• I have no large desire to sacrifice much of my personal habits, intellectual pleasures, and personal standards in order to become a billionaire like Warren Buffett, and I certainly do not see the point of becoming one if I were to adopt Spartan (even miserly) habits and live in my starter house.

• The second counterintuitive point is that the expectation of the maximum of track records, with which we are concerned, depends more on the size of the initial sample than on the individual odds per manager. In other words, the number of managers with great track records in a given market depends far more on the number of people who started in the investment business (in place of going to dental school), rather than on their ability to produce profits. It also depends on the volatility. Why do I use the notion of expectation of the maximum? Because I am not concerned at all with the average track record. I will get to see only the best of the managers, not all of the managers. This means that we would see more “excellent managers” in 2006 than in 1998, provided the cohort of beginners was greater in 2001 than it was in 1993—I can safely say that it was.

• The same mechanism is behind the formation of conspiracy theories. Like The Bible Code they can seem perfect in their logic and can cause otherwise intelligent people to fall for them. I can create a conspiracy theory by downloading hundreds of paintings from an artist or group of artists and finding a constant among all those paintings (among the hundreds of thousand of traits). I would then concoct a conspiratorial theory around a secret message shared by these paintings. This is seemingly what the author of the bestselling The Da Vinci Code did.

• Linus Pauling, a Nobel Prize winner in chemistry, was said to believe in vitamin C’s medicinal properties, himself ingesting massive daily doses. With his bully pulpit, he contributed to the common belief in vitamin C’s curative properties. Many medical studies, unable to replicate Pauling’s claims, fell on deaf ears as it was difficult to undo the testimonial by a “Nobel Prize winner,” even if he was not qualified to discuss matters related to medicine.

• place. As Sherlock Holmes noted in the Silver Blaze case—the curious thing was that the dog did not bark. More problematic, there are plenty of scientific results that are left out of publications because they are not statistically significant, but nevertheless provide information.

• Popular wisdom has integrated many such phenomena, as witnessed by such expressions as “the straw that broke the camel’s back” or “the drop that caused the water to spill.” These nonlinear dynamics have a bookstore name, “chaos theory,” which is a misnomer because it has nothing to do with chaos. Chaos theory concerns itself primarily with functions in which a small input can lead to a disproportionate response. Population models, for instance, can lead to a path of explosive growth, or extinction of a species, depending on a very small difference in the population at a starting point in time. Another popular scientific analogy is the weather, where it has been shown that a simple butterfly fluttering its wings in India can cause a hurricane in New York.

• It is an interesting attribute of fame that it has its own dynamics. An actor becomes known by some parts of the public because he is known by other parts of the public. The dynamics of such fame follow a rotating helix, which may have started at the audition, as the selection could have been caused by some silly detail that fitted the mood of the examiner on that day. Had the examiner not fallen in love the previous day with a person with a similar-sounding last name, then our selected actor from that particular sample history would be serving caffe latte in the intervening sample history.

• Therefore, as we started building better typewriters and computerized word processors, several attempts were made to rationalize the computer keyboard, to no avail. People were trained on a QWERTY keyboard and their habits were too sticky for change. Just like the helical propulsion of an actor into stardom, people patronize what other people like to do. Forcing rational dynamics on the process would be superfluous, nay, impossible. This is called a path dependent outcome, and has thwarted many mathematical attempts at modeling behavior.

• Imagine yourself practicing the piano every day for a long time, barely being able to perform “Chopsticks,” then suddenly finding yourself capable of playing Rachmaninov. Owing to this nonlinearity, people cannot comprehend the nature of the rare event. This summarizes why there are routes to success that are nonrandom, but few, very few, people have the mental stamina to follow them. Those who go the extra mile are rewarded. In my profession one may own a security that benefits from lower market prices, but may not react at all until some critical point. Most people give up before the rewards.

• Nonlinearity in random outcomes is sometimes used as a tool to break stalemates. Consider the problem of the nonlinear nudge. Imagine a donkey equally hungry and thirsty placed at exactly equal distance from sources of food and water. In such a framework, he would die of both thirst and hunger as he would be unable to decide which one to get to first. Now inject some randomness in the picture, by randomly nudging the donkey, causing him to get closer to one source, no matter which, and accordingly away from the other. The impasse would be instantly broken and our happy donkey will be either in turn well fed then well hydrated, or well hydrated then well fed. The reader no doubt has played a version of Buridan’s donkey, by “flipping a coin” to break some of the minor stalemates in life where one lets randomness help with the decision process. Let Lady Fortuna make the decision and gladly submit. I often use Buridan’s donkey (under its mathematical name) when my computer goes into a freeze between two possibilities (to be technical, these “randomizations” are frequently done during optimization problems, when one needs to perturbate a function). Note that Buridan’s donkey was named after the fourteenth-century philosopher Jean Buridan. Buridan had an interesting death (he was thrown in the Seine tied in a bag and died drowning). This tale was considered an example of sophistry by his contemporaries who missed the import of randomization—Buridan was clearly ahead of his time.

• The opposite is a positive science, which is based on how people actually are observed to behave. In spite of economists’ envy of physicists, physics is an inherently positive science while economics, particularly microeconomics and financial economics, is predominantly a normative one. Normative economics is like religion without the aesthetics.

• You add a law here and there and the situation is too complicated as there is no central system that is consulted every time to ensure compatibility of all the parts together. Napoleon faced a similar situation in France and remedied it by setting up a top-down code of law that aimed to dictate a full logical consistency. The problem with us humans is not so much that no Napoleon has showed up so far to dynamite the old structure then reengineer our minds like a big central program; it is that our minds are far more complicated than just a system of laws, and the requirement for efficiency is far greater.

• 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). While that theory of the Triune brain shows some oversimplification (particularly when handled by journalists), it seems to provide a framework for the analysis of brain functions.

• To probe the point further, we need to look at such formations of causal associations in the lower forms of life. The famous Harvard psychologist B. F. Skinner constructed a box for rats and pigeons, equipped with a switch that the pigeon can operate by pecking. In addition, an electrical mechanism delivers food into the box. Skinner designed the box in order to study more general properties of the behavior of a collection of nonhumans, but it was in 1948 that he had the brilliant idea of ignoring the lever and focusing on the food delivery. He programmed it to deliver food at random to the famished birds.

• One of the most irritating conversations I’ve had is with people who lecture me on how I should behave. Most of us know pretty much how we should behave. It is the execution that is the problem, not the absence of knowledge. I am tired of the moralizing slow-thinkers who pound me with platitudes like I should floss daily, eat my regular apple, and visit the gym outside of the New Year’s resolution.

• Dress at your best on your execution day (shave carefully); try to leave a good impression on the death squad by standing erect and proud. Try not to play victim when diagnosed with cancer (hide it from others and only share the information with the doctor—it will avert the platitudes and nobody will treat you like a victim worthy of their pity; in addition, the dignified attitude will make both defeat and victory feel equally heroic). Be extremely courteous to your assistant when you lose money (instead of taking it out on him as many of the traders whom I scorn routinely do). Try not to blame others for your fate, even if they deserve blame. Never exhibit any self-pity, even if your significant other bolts with the handsome ski instructor or the younger aspiring model. Do not complain. If you suffer from a benign version of the “attitude problem,” like one of my childhood friends, do not start playing nice guy if your business dries up (he sent a heroic e-mail to his colleagues informing them “less business, but same attitude”). The only article Lady Fortuna has no control over is your behavior. Good luck.

• This point has applications in evolutionary biology, evolutionary game theory, and conflict situations. A mild degree of unpredictability in your behavior can help you to protect yourself in situations of conflict. Say you always have the same threshold of reactions. You take a set level of abuse, say seventeen insulting remarks per week, before getting into a rage and punching the eighteenth offender in the nose. Such predictability will allow people to take advantage of you up to that well-known trigger point and stop there. But if you randomize your trigger point, sometimes overreacting at the slightest joke, people will not know in advance how far they can push you. The same applies to governments in conflicts: They need to convince their adversaries that they are crazy enough to sometimes overreact to a small peccadillo. Even the magnitude of their reaction should be hard to foretell. Unpredictability is a strong deterrent.