“In economic life and history more generally, just about everything of consequence comes from black swans; ordinary events have paltry effects in the long term.”

-Nassim Nicholas Taleb


Nassim Taleb’s contribution to the world of finance are two fascinating concepts — essays really — subsequently expanded into book length. The first is Fooled By Randomness: The Hidden Role of Chance in Life and in the Markets, which describes the tendency of investors to find patterns where none exist, and to attribute to skill that which might be better credited to luck.

His second book is a corollary of sorts, almost the inverse to Fooled by Randomness: The Black Swan: Second Edition: The Impact of the Highly Improbable. The key takeaway being that we dramatically underestimate the probabilities of improbable events, as well as their outsized impacts.

Over the weekend, Taleb had a worthwhile essay in the WSJ: Learning to Love Volatility. I can sum it up in Taleb’s 5 rules:

Rule 1: Think of the economy as being more like a cat than a washing machine.

Rule 2: Favor businesses that benefit from their own mistakes, not those whose mistakes percolate into the system.

Rule 3: Small is beautiful, but it is also efficient.

Rule 4: Trial and error beats academic knowledge.

Rule 5: Decision makers must have skin in the game.

Its worth reading the entire thing.

Over the years, I’ve found that Taleb’s essays are the best way to digest his thinking. This one is no different.



Learning to Love Volatility
Nassim Nicholas Taleb
WSJ, November 16, 2012


Category: Books, Psychology, Trading

Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

18 Responses to “Taleb: Learn to Love Volatility”

  1. wrongtrade says:

    absolutely love Taleb and I have learned form him. If I had followed his investing advice based on his principles laid out in The Black Swan, then I would have chosen a different username (see above).
    I do have a problem with a point he makes on rule 3, however. The reason there are more mice than elephants has nothing to do with the smaller size of mice giving them physical properties that make them more antifragile than elephants. The reason big, fierce animals are rare has to do with inefficiencies in turning fundamental building blocks for energy found at the bottom of the food chain into biomass due to heat loss in subsequent steps of metabolism. That one sentence should be edited out. He is still a genius and I’m not- but I do know biology.

  2. albnyc says:

    Sense and sensibility. If only…

  3. RW says:

    WRT point number 5 — decisions makers need to have some skin in the game — it’s pretty easy to imagine how quickly and equitably the social safety net* that the majority of citizens needs would be reformed if elites were forced to depend on it too.

    *it rankles every time I hear the term “entitlement reform” used as a lazy conceptual blanket to cover four government trusts with individual problem areas that are paid for separately through a regressive tax system solely on labor income (wages), separate from the general federal budget (not part of the federal deficit) and to a significant degree separate from each other.

  4. Detroit Dan says:

    Here’s my favorite from Taleb:

    February 5, 2012: Nassim Taleb: “Every single human should short U.S. Treasury bonds”

    Of course, that was the worst advice ever given, as Treasuries have gone up sharply since then…

  5. ToNYC says:

    This ‘black swan’ meme has morphed into irrelevance. The mathematical probability of the expression of a recessive gene is science is one thing, but conflation to faith-based economic theory is a recipe for more rules to forget. Isn’t a bank like a cat in a washing machine?

  6. The Window Washer says:

    Need to get an Amazon link up to the book.
    I just read the link then went and ordered the book. Taleb is a must read.

  7. The Window Washer says:

    Detroit Dan,
    Didn’t give a time frame. Rememeber the pundit rule.

  8. Uchicagoman says:

    Let me sum up Taleb’s incredible, mind expanding philosophy: “Shit Happens”

  9. Conan says:

    interesting video if you like this subject:


    I also found it interesting how he discusses the Dot Com bust in 2000 as an equity bust and the Housing bauble as a debt bust and the difference between the two.

  10. drewburn says:

    I like this a great deal. It is off center thinking, almost anti-intellectual. Cat vs. Washing Machine is great: I don’t like dealing with either, but the Washer requires a more simple analysis to fix, the cats not so much…. My wife is the cat lover; I’m just a cat liker! If you’re not familiar with cats, the expression “herding cats” is a concept about organizing the un-organizable……..

  11. rd says:

    Or you could be New Jersey Transit, ignore forecasters, and destroy much of your newest rolling stock because the site didn’t flood in the past 30 years:


    We are seeing way too much recency bias and lack of understanding of the impact of rare events from The Powers That Be. In the past 7 years we have lost much of two major metropolitan areas to flooding from predictable events as well as a major financial crisis due to removal of effective regulation.

    These events, while blamed on new and unpredictable forces, are actually just events that have occurred in the past if somebody looks at records that go back 50 years or more. They are made worse by the moral hazard of a lot of decision-making (such as land use and building codes) occuring at the local level while they look to be covered for the rare events at the state and federal level. We are seeing that now with the declarations of “We will rebuild!” while Andrew Cuomo prepares requests for $30 billion of federal aid.

  12. Detroit Dan says:

    Thanks Window Washer.

    Actually, I had a typo in my quote. Taleb’s horrible advice on U.S. Treasury bonds was given on 2/5/2010 (not 2/5/2012). Sorry about that.

    So he’s been wrong for close to 3 years now, so shorters would have lost their shirts by following his advice and he is a “hedge fund adviser and financial author”.

    I actually invested in Treasuries before he gave that prediction/advice, and noted to myself that this would be a good test of my understanding of the economy based upon MMT. The results are in: +1 MMT, -1 Taleb…

  13. HowardA says:

    Coincidently, I have been doing a lot of thinking about volatility lately. I am an amateur Forex trader. I have developed a system that in some months makes fantastic returns, but in other months it is a dud. I was stumped as to why until I recently noticed a correlation. My system works well when the VIX is > 17.5, but is a loser when it is below that level. So I agree with Taleb that volatility is a great, and necessary, thing for trading. I’m sure this association can be refined further, but I do not plan to trade currencies if the VIX is < 17.5. By the way from Aug 3 to Oct 23 the VIX was almost always below 17.5, but since then it has for the most part exceeded 17.5, and there have been some tradeable forex trends, particularly with the Yen crosses.

  14. Jim67545 says:

    Several above commented that we’ve done a poor job with black swan events – like Sandy. I was talking with a friend today who complained that the banking ills that brought the financial collapse had not been corrected. My response was that the problem was with perception of risk by the bankers. Each lender evaluates risk individually but they had little information and no sensitivity to the aggregate risk to the industry – the risk that would occur if the entire class of asset became mistrusted. Of course that goes as well for the risks associated with secondary and tertiary impacts in the form of credit contraction, unemployment, and insolvency of consumer borrowers, related businesses (such as real estate developers) and non-related businesses, etc., etc.

    Further I pointed out that asking that individual banks have greater reserves continues the regulators’ silo approach to the matter. It is like the CDC recognizing individuals that have fallen ill from something without considering the aggregate impact/prevalence or how contageous the disease may be. In other words, a black swan not addressed.

  15. Bruman says:

    “To see how large things can be fragile, consider the difference between an elephant and a mouse: The former breaks a leg at the slightest fall, while the latter is unharmed by a drop several multiples of its height. This explains why we have so many more mice than elephants.”

    WTF???, I figured that mice outnumber elephants because 1) the same quantity of ecosystem food can support many many more 20-30 gram animals than 4-7 ton animals, and 2) a gestation period of 20 days with a typical litter of 6-8 will compound far faster than a gestation period of 18-23 months with a litter size of 1. Does Taleb know about compound growth? He’s supposed to.

    But I’m just using academic knowledge, while he’s using trial-and-error logic (throw arguments at the wall, and claim that whatever sticks is his own brilliance), so what the heck do I know.

    Here’s another beauty: “Take the coffee cup on your desk: It wants peace and quiet because it incurs more harm than benefit from random events.” What? My coffee cup wants something? My coffee cup gets harmed by random events? How does Taleb know what my coffee cup is and what it wants??

    I just don’t think Taleb makes any stunningly profound points. Yes, people overestimate their ability to predict things, and it leads to enormous mistakes.. Is this really news? Perhaps economists couldn’t have predicted that, because they assume everyone is rational and (often) well informed, but sociologists and psychologists and historians all know this. The only real problem is that Wall Street seems to think that economists (and now, financial engineers) are the only academically trained minds who matter, because they use math.

    No one is very good at figuring out how messed up things can get, because that requires us to understand multiple nonlinear feedback loops over long time frames, and often we don’t even know the right processes to think about, but we also have to wake up and do something on monday morning, rather than huddle indoors and wait for the end of the world.

    Sure, antifragile institutions sound better than fragile ones, particularly if unexpected events are expected to crash in every few years, but if we don’t even know what kinds of events to expect (other than that we can’t predict them), how can we know if our institutions are antifragile or not?

    The points he makes are relevant, but I don’t think they are brilliant in any way. It’s really just a florid way of saying “Eventually, something very bad (or possibly very good) is going to happen. I don’t know what it is, but I’m going to say ‘I told you so, you should have had something antifragile,’ afterwards.”

  16. [...] Taleb: Learn to Love Volatility (ritholtz.com) [...]