Sunday, December 14, 2008

How Not to Make Money on Line

With no intention of upsetting numerous bloggers - some of which I closely follow and benefit - who advise on how to make money on line, Nassim Nicholas Taleb's The Fourth Quadrant: A Map of the Limits of Statistics that was recently published in Edge can be an eye-opener. In his analysis of the latest crisis of the banking system, Taleb says,

When I was a quant-trader in complex derivatives, people mistaking my profession used to ask me for "stock tips" which put me in a state of rage: a charlatan is someone likely (statistically) to give you positive advice, of the "how to" variety.

Go to a bookstore, and look at the business shelves: you will find plenty of books telling you how to make your first million, or your first quarter-billion, etc. You will not be likely to find a book on "how I failed in business and in life"—though the second type of advice is vastly more informational, and typically less charlatanic. Indeed, the only popular such finance book I found that was not quacky in nature—on how someone lost his fortune—was both self-published and out of print. Even in academia, there is little room for promotion by publishing negative results—though these, are vastly informational and less marred with statistical biases of the kind we call data snooping. So all I am saying is "what is it that we don't know", and my advice is what to avoid, no more.

You can live longer if you avoid death, get better if you avoid bankruptcy, and become prosperous if you avoid blowups in the fourth quadrant.
I used to give the same mathematical finance lectures for both graduate students and practitioners before giving up on academic students and grade-seekers. Students cannot understand the value of "this is what we don't know"—they think it is not information, that they are learning nothing. Practitioners on the other hand value it immensely. Likewise with statisticians: I never had a disagreement with statisticians (who build the field)—only with users of statistical methods.

I would like to draw your attention especially to the unpopularity of "publishing negative results" and "the value of what we do not know". Writing about how we failed is equally important as our success stories and it is information.

To give you a taste of the article, let me quote another part:

There are two classes of probability domains—very distinct qualitatively and quantitatively. The first, thin-tailed: Mediocristan, the second, thick tailed Extremistan. Before I get into the details, take the literary distinction as follows:

In Mediocristan, exceptions occur but don't carry large consequences. Add the heaviest person on the planet to a sample of 1000. The total weight would barely change. In Extremistan, exceptions can be everything (they will eventually, in time, represent everything). Add Bill Gates to your sample: the wealth will  jump by a factor of >100,000. So, in Mediocristan, large deviations occur but they are not consequential—unlike Extremistan.

Taleb's essay is a good read for bloggers and economists alike.


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