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Posted by Inya Ivkovic Mar 15, 2008 |
In Chapter Six of Fooled by Randomness, Taleb talks extensively about skewness and asymmetry. He starts the section subtitled ‘Rare Events’ with the statement, “The best description of my lifelong business in the market is ‘skewed bets,’ that is, I try to benefit from rare events, events that do not tend to repeat themselves frequently, but, accordingly, present a large payoff when they occur.”
Taleb proclaims himself not to be greedy. He is more interested in hauling in piles of money infrequently, when a rare event occurs, “simply because I believe that rare events are not fairly valued, and that the rarer the event, the more undervalued it will be in price.” Taleb also believes in taking counterintuitive approach to trading, even though most traders are generally not wired in such a manner.
According to Taleb, rare events are usually incorrectly evaluated for a number of reasons, the predominant one being the psychological bias induced by the herd mentality. If something is said in the Wall Street Journal, it must be true. If a famed financial guru, such as Jim Rogers, says that “Buying options is another way to go to the poorhouse,” well, heck, that has got to be true. Oddly enough, for a while, Jim Rogers partnered with George Soros, who Taleb describes as, “…a complex man who thrived on rare events.”
Finally, Taleb mentions an often quoted statistics that 90% of all option trades lose money, which is also the reason why Rogers stays away from them. But Taleb approaches this statistics introducing the variable of frequency. The secret is not in the 90% of losing options, but in the 10% of the winning ones, which, granted, occur infrequently, but when they do, they are potentially extremely profitable.