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Six Reasons I am Not Nassim Nicholas Taleb and Neither Are You

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“You find peace by coming to terms with what you don’t know.”
–Nassim Nicholas Taleb

Imagine yourself in a room with 99 other average people. What’s the average weight? If you’re a male, it’s 191 pounds. If you’re a female, it’s 164.3 pounds. What happens to the average weight if you add the world’s heaviest male or female to the room? The heaviest male weighed 1,400 pounds. The heaviest female weighs 643 pounds. For men, the average weight would go up to 203 pounds, a 6.3% increase, and for women, the average weight would go up to 169 pounds, a 2.9% increase.

Now, do the same thing for measuring wealth. The average family net worth is $77,300. Drop Carlos Slim into the room. He’s worth $69 billion. You’ve now increased the average net worth in the room to approximately $683 million, or a roughly 880,000% increase.

This exercise is outlined in the book The Black Swan (#aff) by Nassim Nicholas Taleb. He discusses how we are very good at averaging things out, but terrible at identifying the extreme outliers. Furthermore, we underestimate the actual probability and magnitude of outliers which will positively or negatively impact us.

Think about how the lottery works. The theme of the lottery is “someone has to win, so why not you?” The lottery officials and the media trot out the winners to make them seem like they’re everyday people and that there are lottery winners everywhere. People fall victim to recency bias and go out and buy lottery tickets with the expectation that it’s going to be them. They think that the chances of winning are actually much better than the mathematics reveal them to be. The blind spot of evaluating black swans shows itself.

Taleb ran a hedge fund through his company Empirica Capital seeking to take advantage of the blind spot that we have for black swans. The idea was to make many small bets on outliers where the magnitude of the outlier would be enormous. His firm invested in call and put options where, according to their calculations, impact of outlier * probability of outlier > price of option.

If you read the book, the strategy seems simple. Michael Lewis tells of a story in The Big Short (#aff) where a couple of guys pooled all of their money together, approximately $100,000, made two consecutive options purchases based on similar thinking, and became multi-multi millionaires. Suddenly, the idea is reinforced in your head. Two guys, one phone call, one meeting, and boom! Gulfstream, here I come!

I can also set up the World Coin Flipping Championship, invite 1,024 participants to compete for the grand prize (a two headed quarter, perhaps?), and watch them go. At the end of the competition, there will be a champion. Would you bet anything other than even odds on the winner for the next coin flip?

For every story of a big winner we hear, we never hear the stories of the small (and big) losers. They don’t make for good media stories. The public wants to hear about the extremes. Don’t fall into the trap of thinking that you can be the next lottery winner or that you can predict the next black swan derivatives investment. Here are some reasons why you’re not Nassem Nicholas Taleb.

  • He had the capital to make a lot of small bets. Every day, Taleb would put several hundred thousand dollars into the market in a series of small bets with tremendous upside if they worked. Then he played a waiting game. He only had to win occasionally for the strategy to work, but he also had to have the capital to withstand wrong bet after wrong bet after wrong bet.
  • He had sophisticated math and software to help him identify and make bets. He could screen out millions of different call and put options variations to identify what he thought was a mispriced opportunity.
  • He had the system, and therefore, the discipline to stick to his thesis. As he says, “It’s much harder to be the other guy, the guy losing money three hundred and sixty-four days out of three hundred and sixty-five, because you start questioning yourself. Am I ever going to make it back? Am I really right? What if it takes ten years? Will I even be sane ten years from now?”
  • He had experience in trading in the markets long before he started his hedge fund. He had immersed himself in data and in experience and knew how to build a system which would identify the opportunities for investments.
  • He had the quantity of capital to make a small net gain meaningful. The psychological trauma of watching your fund lose tens to hundreds of thousands of dollars a day while waiting for the fifty million dollar win must be agonizing. So, even if at the end of the year, he’s up 8-10%, it came at the cost of horribly wicked volatility, but he also probably made millions of dollars – life changing money. Could you stomach taking $50,000, doing the same approach in miniature, watch the value go down to, say $2,500, only to be up to $55,000 at the end of the year – a $5,000 gain? If you want or need the extra $5,000 so badly that you’re willing to take that sort of roller coaster ride with your wealth, come up with the ideas which will give you an equivalent pay raise at work or get a second job.
  • You can identify opportunities which will have a higher likelihood of payoff. You can take the same approach as Taleb and try to create your own black swans. If you can spend $1,000 to create a small business which eventually pays you something which resembles your current paycheck, you have created your own personal black swan.

If you’re itching to go hunting after black swans, by all means, go for it.

That said, during the COVID-19 pandemic, we took a Taleb-type shot with our at-risk capital by making investments in LEAPS. Time will tell if we were right.

But, generally,, don’t try to do it in the options market. Instead, create your own black swan and capture all the value you can out of it.

Frequently Asked Questions About Nassim Taleb

Where is Nassim Taleb from?

Nassim Taleb was born in Amioun, Lebanon.

How did Nassim Taleb make his money?

He worked as an options market maker, meaning that he participated in the spread between the bid and ask prices. He would later make further money investing in LEAPs.

What books has Nassim Taleb written?

Nassim Taleb is the author of 7 books: The Black SwanAntifragile (#aff), Skin in the Game (#aff), Fooled by Randomness (#aff), Dynamic Hedging (#aff), The Bed of Procrustes (#aff), and The Logic and Statistics of Fat Tails (#aff).

By

Jason Hull, CFP®, was the co-founder of Broadtree Partners, a firm that acquires $1-5MM EBITDA companies. He also was the co-founder of open source search consultancy OpenSource Connections, a premier Solr and ElasticSearch firm. He and his wife FIREd (financial independence retire early) at 46 and 45, respectively. He has a BS from the United States Military Academy at West Point and a MBA from the University of Virginia Darden Graduate School of Business.

You can read more about him in the About Page.

8 replies on “Six Reasons I am Not Nassim Nicholas Taleb and Neither Are You”

That is exactly the problem. Everyone thinks that they are the exception to the general rule. That, yes, they have a better chance of winning the lottery than everybody else. I’ve fallen victim to that as well until I realized that the odds of me having heart attack while buying my lottery ticket is higher than me actually winning it.

I have a similar perspective, but I don’t think I would have been able to write it as eloquently!

I always put safeguards in place when I do anything outside my normal investing strategy. For example, most of my investments are comprised of index funds. But every once and awhile I will buy an individual stock or other investment. It’s always a very small portion of my portfolio (usually 5% or less), and something that won’t hurt me if it goes down (even to zero).

This article reads like you didn’t actually read black swan, or at least not the whole thing. Much of the point of the black swan is that it’s randomness is substantially different from the lottery or the coin flip, these are games where odds are calculable because all of the information is present. This is different than a black swan because it is random precisely because you do not have all of the information required to predict it, not because the odds are incredibly small. This is the ludic fallicy which taleb mentions throughout his book (such that it makes me seriously doubt you have actually read the book). Similarly, you can not make your own black swan. Black swans are random events that are impossible to predict. All that you can do is recognize that such extreme events are possible (such as by switching to power laws instead of gaussian statistics) predict the type of impact such an event might have on you, and try and expose yourself to as many serendipitous black swan events as possible. Taleb calls this process making grey swans.

Not only did I read the book, I’ve also read several of his academic papers. I think that you missed the point of the article: he positioned himself to take advantage of the non-Gaussian nature of market randomness by using large amounts of capital to make a series of small investments at the fringes – the typical tail ends of a Gaussian distribution, where, because of Black-Scholes options pricing, there was mispricing due to fatter tails in reality that were misnamed and priced as “once in 1,000 year” events when they were, in reality, much more common and had a much higher impact. There simply aren’t many people out there who can expend both the capital and the psychological costs necessary to be able to take advantage of the black swan events. Or, you can try to get a couple of large, one-time bets right like the guys described in Michael Lewis’s The Big Short did when buying COF LEAPs (maybe I didn’t read that one either or wasn’t at Capital One during the MOU).

But, I appreciate your comment.

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