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Review of The Black Swan by Nassim Nicholas Taleb

By on November 6, 2008

The Black Swan – The Impact of the Highly Improbable

Could there be a better time to read The Black Swan, Nassim Nicholas Taleb‘s enjoyable discourse on probability and humanity’s blindness to it?

It’s a book that teaches you how to avoid – or even better, to profit from – once-in-a-generation events. Like the credit crunch, the meltdown of the global financial system, toxic assets and US Secretary of State from Wall Street letting a bank that is “too big to fail” go to the wall.

Fooled by randomness

The majority of this great book is devoted to explaining the source of blindness. Taleb argues that we are pre-programmed to see causal links where none exist because it was an evolutionary advantage. In our evolutionary past, we would confuse the two statements most killers are wild animals and most wild animals are killers, because, if we stopped to think to think about it, we would have been eaten by a lion. Evolutionary success means that snap judgements, faulty logic and “tunnelling” on sources of uncertainty and risk has been bred into all of us.

Unfortunately, the world has evolved faster than us, into a globalised, interconnected community where hugely improbabe events can have far-reaching consequences. These events are what Taleb christens Black Swans.

The world is full of Black Swans

A Black Swan is an event which is highly improbable (i.e. very rare), has an extreme impact and given our need for narrative causality, has retrospective (not prospective) causality. Taleb notes that a Black Swan’s very unpredictably makes it paradoxically more likely. For example, if 9/11 had been predicted, society would have taken precautions (such as fitting locks on cockpit doors) that might have prevented the attacks. This is not to say all Black Swans can be prevented. If 9/11 had been averted, “something else may have been taken place. What? I don’t know.”

This is the heart of Taleb’s thesis. That the great human need for causality, narrative and meaning has led us to frame the world as a controllable, malleable model. Targets of his opprobrium include historians, “experts” (particularly in risk management) and particularly what he calls the “Great Intellectual Fraud”, the Gaussian distribution or Bell Curve.

The Bell Curve is singled out because it fools us into believing that as an event or occurrence deviates further from the mean, the lower the likelihood of such an event or occurrence and the lower its impact. This is true for, for example, human heights, where a single Robert Wadlow measuring 8’11” does not appreciably change the mean, but not in human wealth, where the presence of a Bill Gates or Roman Abramovich changes the average substantially. Taleb argues that because humans like narrative and scientific methods and predictability, the Bell Curve blinds us to reality: it not only denies the significance of improbable events, if fools us into a false sense of security where we believe that they can, to all intents and purposes, be disregarded.

The Black Swan was named from the observation that Old World naturalists were convinced that all swans were white following millions of observations of white swans; it took just one sighting of a black swan in Australia to convince them that they were wrong. One of Taleb’s most useful and illuminating recommendations is that if you have a theory (about anything), once you have made a handful of confirmatory observations, you should stop look for confirmation and start looking for disconfirmation instead. The logic being that observing another white swan after the first half dozen merely proves that some swans are white: you should instead be looking for a different colour swan to disprove your theory that all swans are white. Taleb convincingly shows that this trait of seeking evidence of what we already believe, rather than seeking counter-arguments, is a key culprit in the blinkered and restrictive vision that stops us from seeing risks and probabilities as they really are.

The narrative fallacy

Taleb also argues that the narrative fallacy, “our vulnerability to overinterpretation and our predilection for compact stories over raw truths”, contributes to our blindness. For example, consider the following two sentences and determine which you think is more likely:

Joey seemed happily married. He killed his wife.
Joey seemed happily married. He killed his wife to get her inheritance.

To most people, the second sentence seems to be more likely, to make more sense. And yet there have been many reasons why Joey killed his wife. By restricting the cause to only one, we have reduced the likelihood of it being true, while increasing our own perception of the likelihood. This narrative fallacy leads us to underestimate the likelihood of extremely unlikely events that do not have an obvious causal chain or fit our current view of the world.

Historians are singled out because of their need to look for causality. Taleb does not write off the study of history, nor does he deny the value of it in understanding human civilization. But he argues strongly that history unfolded as it did because, well, it just did. A series of random events (wars, plagues, natural disasters or merely the failure of two people to meet in the street) interacted in a series of random ways. There is a causal chain, but only because we are here at the end of it. For Taleb, historians could argue endlessly over why the world was not destroyed in a thermonuclear war in the 1980s; he would argue that if the world had been destroyed, we wouldn’t have been here to seek the causal chain, and that is probably due to a series of lucky happenstances.

How to benefit from the Black Swan

Having broadly set out why everything we think about probability is wrong and having argued that modern financial risk management, being Gaussian (i.e. based on the bell curve), is utterly unsuited for the realities of a world where the unpredictable happens every decade or so, the recent financial crisis being a case in point, Taleb sets out his strategy for benefiting from the Black Swan. He starts by pointing out that not all Black Swans are negative: penicillin, the Internet, the Harry Potter books. These are all Black Swans. So Taleb seeks to maximise his exposure to positive Black Swans while minimising extreme negative risks.

The clearest example of what Taleb would seek to avoid is being a lending bank: exposed on the upside only to a few percentage points of interest, but on the downside to the Black Swan of a global meltdown. This is the misnamed low or medium risk, because it is only low risk if you assume that Black Swans don’t exist. But they do; it’s just impossible to model or predict them.

Instead, he would put 80-85% of his investments (time or money) into the safest place possible, such as Government Bonds. The remainder would be put in the riskiest ventures possible: venture start-ups, biotech, mining stocks. Or for a writer, into maximising the chances of success, by networking, writing lots of books, putting proposals in for screenplays, plays, novels or whatever, because, as legendary screenwriter William Golding put it “nobody knows anything” about why a piece of popular entertainment becomes a hit.

In other words, avoid the Bell Curve fraud of thinking that you are limiting risk by being in the middle of the road. Here you are maximising your exposure to negative Black Swans with limited upside. Instead, absolutely avoid risk wherever possible unless it carries the potential for a positive Black Swan. And be prepared to lose everything that you invest in pursuit of these positive outcomes. Which is why you should put the majority of your net worth into government bonds.

There is one element throughout the book that grates, and grates hard. Taleb is smug to the point of wanting to biff him on the nose about having been a “practitioner”, not an academic. He was not a practitioner, he was a trader. He put his theories into practice alright, but in the rarefied atmosphere of hedge fund speculation and proprietary trading. He is dismissive of people who run successful businesses as being generally “lucky”. Having worked in the City and in real businesses myself (admittedly Internet start-ups, which are still not exactly “real businesses”), I would argue that running a business is being a practitioner, whereas taking big bets on the basis of your probability theories is more ballsy than being a theorising academic but it is, at the end of the day, still closer to academia than reality. And to be fair to Taleb, his greatest praise for practitioners of uncertainty is reserved for the military, a class of thinkers that is rarely lauded by philosophers and yet seem to be the most comfortable with the idea that since so much of the world is unknowable, our job is to work out how to operate in a random world, not frame it in conceptual and inevitably flawed models.

This is a timely book that explains why this unprecedented crisis was inevitable (it was just the where, when and what that could not be predicted). Black Swan is not only supremely relevant, if offers a new and practical way of looking at the world.

About Nicholas Lovell

Nicholas is the founder of Gamesbrief, a blog dedicated to the business of games. It aims to be informative, authoritative and above all helpful to developers grappling with business strategy. He is the author of a growing list of books about making money in the games industry and other digital media, including How to Publish a Game and Design Rules for Free-to-Play Games, and Penguin-published title The Curve: