Taleb and his book Fooled by Randomness

Nassim Taleb as I have mentioned earlier is one of the smartest human beings in the world right now. His book 'Fooled by Randomness' is probably going to be one of the few books which people will read after 200 years, like Adam Smith's 'Wealth of Nations' or Darwins "The Origin of Species". In showing us how we often mistake coincidence for causality, he is not the first-but his main contribution is to use this idea to make our lives better in a real way, with practical uses and examples. When he says casually "There's no such thing as Alternative Medicine" it sounds like a casual offhand remark-but it is so very significant and useful. You can dump all those alternative medicine doctors safely-Modern Medicine is originally derived from Alternative Medicine and you can safely trust the Scientists at Pfizer and Merck and Ranbaxy to bring you the best of the alternative world medicines-these guys are constantly looking for new ideas and chemicals...

I find so many examples where Taleb's central idea-that we keep getting fooled by randomness, thinking that there's some causality, some pattern out there in our experiences with the world, when there isn't any. Check yourself when you think Sunday is a good day for shopping, or you are a lucky guy always in restaurants to find empty tables-reality is far more brutal, and doesn't care that much about you.

Together with Adam Smith and Darwin, I find Taleb one of the most wonderful and intelligent humans to walk this planet. As often is the case with great minds, they get really famous after their death-and I hope that with Taleb, at least some of the credit he deserves for showing us the difference between anti-knowledge and knowledge he will reap the rewards of in this present life...(a Nobel Prize in Economics by the Swedish Bankers...nah!).

Sanjay

Empiricism and how far we are from it---markets and weight loss

I continue to get more and more empirical in life-trying to lose the bad things we have learned from our ancestors (hidden sometimes in words like "culture"). Continue to believe that one of the biggest authors of our times, probably the only one even, is Taleb. His site here.
He opened my eyes to brute empiricism, and I have taken it further to many walks of life, not just financial markets.

On financial markets-stock market is nothing but a game between humans. The numbers called stock prices keep going up and down; and other humans want to take your money. It hasn't got much to do with the economy---as much as they would like you to believe it. Maybe in the long term it is-but what is long term? If 25 years is long term-I dont want to "invest"--I am happy getting in and out at different times from the market-trying to be a trader catching the market's moves. It is only sometimes that I can see clearly where the game prices (stock market prices) are headed-and that's when I bet. Bet big, sometimes; that's been my general mantra for success. Probably 10% of my trades account form 90% of my profits over the last decade or so that I have been involved in the financial markets.

Now to weight loss. Here's some interesting empirical observations on it.
People will go on diets, start doing exercise, etc. etc. but I have found that they always revert back to their normal weight. From empirical observations-I can say with good confidence that the weight of a human being can't be changed by "conscious" behavior; it is probably determined by their genome.

For one human being-let's say a male-his weight is an increasing function of age. As he gets older; he will get weightier. The individual's weight will vary only maybe +-3-5% from this function-which is determined by their genes. They can't control it-it is the same as trying to control your temperature or your heart beat. For short periods of time they might lose or gain lots of weight (short period would be a few weeks) but then they will revert back to their natural weight, +-5%. Dieting, exercising etc. dont help-I know plenty of cases where they have failed to say that you can't lose weight by doing that. I also have plenty of cases where slim individuals I know take no special diets or do special exercises.

Another important observation is that just as you can't lose weight beyond maybe 3%, u can't raise it more than 3% either by conscious behavior (dieting, exercising). Their is a natural upper limit---regardless of the tasty food you have at hand.

Liposuction is probably a solution. But it is temporary-u will pick it back up.

These are some empirical observations on weight. Dont try to lose weight-u will lose that battle.

And don't believe in buy and hold; it's a game, stupid.

Sanjay

Financial sector earnings as options (volatility) selling

If you have followed the financial sector at all in your life-u see a recurring theme. Banks, brokers, insurance companies make good money quarter after quarter, and then in one or two quarters lose very large amounts of money-sometimes losing all they made in many years! Some of them gone under in one quarter alone. This is was explained very clearly by Taleb in his book-Fooled by randomness.

The crisis in financial markets since last summer has shows this so nicely, AGAIN. Socgen, Wall Street brokers, Citibank, UBS, CFC---u name it, each has contributed it's massive fat share to the financial sector losses in the world. Banks seemingly disconnected to subprime crisis in the US--banks in Japan, China, and India-have lost money on a financial crisis supposedly started by dislocations in the US subprime market.

That is a good/logical explanation, but I dont think that it is the right explanation.

Anytime you see a steady payoff period after period, and then a big loss in one period-it reminds you of the profit/loss profile of an options seller. The options seller is short volatility---makes small amounts of money for long periods of time, and then has big losses sometimes. Financial sector earnings are the same.

What happens is that markets become used to low volatility-smaller and smaller swings in asset prices. To get the same returns then, if you are a market maker at a bank or a broker-you have to leverage more. Or you take more liquidity risk, credit risk, etc-which deceptively looks cheaper to take! The classic Taleb's turkey-the turkey gets more and more confident as it is fed more and more-and it's confidence is at it's highest just before Thanksgiving day.

Lower volatility is the norm-but one wants to be prepared for the black swan of high volatility out there! The only way to do this is to control leverage-a fixed percent of equity-and be very mindful of other risks-liquidity risk, and credit/default risk the two important ones.

The subprime crisis is just an excuse for a period of high volatility. It is hard to prove that it is THE REASON for higher volatility. Any asset price going down can be attributed to high volatility (bursting the internet bubble, russian default, mexican peso crisis)-but if you have an options seller's profile in your overall portfolio-you will lose big when volatility suddenly spikes. The reason is not known, not is it important. The risk demons you have in your portfolio-of liquidity risk and credit risk-come to bite you hard when volatility shoots up. Bids disappear, bid/ask spreads widen, it becomes impossible to sell or buy in size.

In a few years when all this "crisis" wouldve passed-the press will find another reason for the next crisis. Surely it will happen after a period of low volatility, goldilocks scenario-as we saw in the beginning of 2006.

It is very insightful of Taleb to write about this-he reminds us of banks and brokers losing everything they make in many years in a bad quarter, and this seems to happen with remarkable periodicity! Jim Rogers was also shorting financials in 2006---what a great call by these guys!

Will such a massive collapse in the financials finally wake up people to realize that the financial sector in the US is an overpaid lot---the salaries of many of these funky managers need to come down quite a bit? Will the returns going forward in the financial sector lag the market? Only time will tell. But at least this should serve as a big wake up call to all investors in the financial sector.

Sanjay