January 30, 2008

 

Random Swan

I'm positively illiterate by the yardstick of number of books I read. That count is embarrassingly low. But, last year, I managed to read two interesting books by Nassim Taleb - "Fooled by Randomness" and "The Black Swan". The central argument of "Fooled by Randomness" is we underestimate the role of chance (or luck) played in life, in general, and financial markets in particular. "Black Swan" builds on the base of randomness about how some of the rare events go on to make huge impact. "Black Swan" event is defined as "large-impact, hard-to-predict, and rare event beyond the realm of normal expectations." Also, Black Swan event appears less random (or more predictable) after it happens. Some of the examples of Black Swan events are 9/11, rise of Google and sub-prime crisis. Thanks to the recent sub-prime crisis, the term "Black Swan" is selling itself. (And the book is at #1 in Amazon's 2007 non-fiction category.)

Stock market investing is one my hobby, albeit an expensive one. I say it as a hobby as my primary intention is not to make money, though I am very careful about not losing my money. (Money can be made by investing in Mutual Funds, but it is very boring and un-sexy.) My stock picking skills are lousy. And if I somehow manage to pick good stocks, I sell them early and watch them make new highs weeks after weeks. I digress. After reading "Fooled by Randomness," a fresh perspective to my hobby was added. The books tosses many interesting ideas to you. Guess what, now my hobby is far more entertaining.

I will probably write multiple posts about various ideas from these books with some parallels in financial markets. Here is the first one.

While our brain can store lot of (junk) information, retrieving it out of the storage is difficult.You may know lot of "facts" but you will be able to recollect only a few of them. Brain needs a kind-of short cut to get the information out. It needs a story. eg. Miandad pulling a sixer to Chetan Sharma is a good story. With that story one can recollect various facts about the match.

In the financial markets, most of the numbers have a story around it. Everybody - journalists, reporters, experts, stock operators - spins a story around the event so that it is easy for consumption. It will never be "Stock market rose by 2.3%", but "RBI rate cut pushes Sensex up by 2.3%" Even when there is 1% change in the stock prices, which is more of noise than signal, you will find somebody out there will have a reason, a story for that change. Observe it for yourself. You will never see vanilla numbers being reported in the headline. It will always be with a reason. Always.

Let's take another example. Last week when market went into tailspin, some of the reasons offered were sub-prime crisis, US slowdown or recession, global liquidity crunch, rich valuation for Indian stocks, high crude prices, etc. You know what, these problems were there even when Sensex went from 16000 to 21000. So, what changed exactly on one fine Monday morning? But, no, when index fell by 10% a story had to be told. A sound bite had to be provided. And quickly. Never mind that few days later world comes to know that a bank in France was furiously unwinding positions worth $70 Billion by during that time. (This also shows "expert problem," "epistemic arrogance". More on that later.) Now the new reasons provided are Vaastu and bad omen due to removing the sculpture of bull from BSE building. Fascinating!

More on the same. Why IT sector is down? Dollar is falling. Why power stocks are going through the roof? India is a power deficient country and we need power to sustain 9% growth. Complex questions but utterly simple, convincing and deep-sounding, answers. Only problem with such answers is most of the time they are misleading or plain wrong.

Next time, when you read headlines reporting a fact laced with a story embedded in it, smile.

 

I said exactly the same thing.

It's not a regular phenomenon that one-off topic you chose to blog is seen on slashdot after few months. Apologies for such a gratuitous post whose sole purpose is to earn some You-Heard-It-Here-First bragging rights.

My post on 10th October, 2007: "The most expensive data service in India is SMS, especially to the short-code services. To send less than 160 characters to a premium short-code service, you pay Rs 3. That is Rs 19,659 per MB..."

Slashdot Story on 29th January, 2008: "This article does the math and concludes that, for example, sending an amount of data that would cost $1 from your ISP would cost over $61 million if you were to send it over SMS."

So, yeah, telcos are uniformly ripping the consumers across the globe. Thankfully, we are little better-off in India, there is no charge for incoming SMS. Otherwise, services like SMS Gupshup or Vakow would have found it tough to exist.

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