Why All Eyes Were Fixed On Nassim Nicholas Taleb
The air of the large ballroom was filled with the
loud
clanging of knives and forks as several hundred traders were busy with their
lunches at TradingMarkets 2001.
But it was not very long after Nassim Nicholas
Taleb arrived to speak that the room became dead silent with all eyes fixed
upon him.
Nassim, founder and head trader of a hedge fund
known as Empirica Capital LLC, is a Fellow of Mathematics in Finance and Adjunct
Professor at the Courant Institute of New York University. Recently he was
inducted into the Derivatives Hall of Fame.
He spoke to TM2001 attendees about the role that
randomness can play in making a trader believe that he has a viable trading
approach, when in reality, he is setting himself up for disaster. Most importantly, he talked about how to
overcome the threat of randomness.
| |
 Trading
Outside The Box With Nassim Nicholas Taleb
Fooled
By Randomness |
| |
Here is what Nassim calls the
Black Swan problem:
"$10 million
earned through Russian roulette does not have the same value as $10 million
earned through the diligent and artful practice of dentistry.
They are the same, can buy the same goods, except
that one's dependence on randomness is greater than the other."
"Reality is far more vicious than Russian
roulette. First, it delivers the fatal bullet rather infrequently, like a
revolver that would have hundreds, even thousands of chambers, instead of six.
After a few dozen tries, one forgets about the existence of a bullet, under a
numbing false sense of security. The point is dubbed...the Black Swan
problem."
From "Fooled
By Randomness The
Hidden Role of Chance in the Markets and in Life," by Nassim Nicholas Taleb |
The point hedge fund manager Nassim Nicholas Taleb is making is very relevant to the predicament
faced by daytraders. Empirical observation can lead you astray.
John Stuart Mill put it this way:
"No amount of observations of white swans
can allow the inference that all swans are white, but the observation of a
single black swan is sufficient to refute that conclusion."
By this reasoning, you cannot conclude that a system
that has been profitable for six years will continue to be so in the future.
Put in general terms...
- you cannot judge the viability of any trading
system or strategy on the basis of track record alone
- whatever methodology you use to trade, seek to
understand why and how it works
- make sure that you have walked through every
"what if" scenario, so that the possibility of a catastrophe is
eliminated
The thing to keep in mind as we move forward is
to not merely rely upon a track record or string of results to judge the
viability of a strategy. Traders are accustomed to evaluating a methodology
on the basis of its performance over the course of several years. Even if a
system is a black box, a multi-year track record is deemed sufficient.
However, according to Nassim, any system or strategy can have a hidden fatal
flaw that might be revealed in an unpleasant way when a market environment
changes. That is what happened to many daytraders when the market changed its
character in the transition between bull and bear market. It is possible for a methodology to work extremely well
for three, four, five years, and then suddenly blow up.
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