Saturday, October 07, 2006

$6 billion gone ... Fooled by Randomness

A hotshot trader loses over $6 billion in a matter of a week. How can that happen? To understand how such loses can occur to both a successful trader and hedge fund, read Fooled by Randomness by Nassim Nicholas Taleb. This insightful book details how randomness is disguised as seemingly ordered events, leading to incorrect conclusions and decisions, as well as horrific loses.

Brian Hunter, the hedge fund's 32-year-old chief energy trader, was recently hailed as a rising star. What many thought was an innate ability to understand the market was simply a lucky run at the gambling table. The point is that we tend not to look for randomness in events, especially the statistical descriptions of those events.

By assuming that statistics, the tool of the positivist and empiricist, reveals absolute truths, we end up traveling down a path that leads to trouble.

Oh, there certainly is a place for statistics in describing past events, but predicting the future based on a statistical analysis can easily result in the $6 billion loss. As the sage words from the TV show Hill Street Blues reminds us, "Hey, let's be careful out there."

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