Randomness (or luck) plays a huge role in outcomes, and the outcomes of random and non-random events should be treated differently.

Therefore, when judging whether investment results are repeatable, we must consider the impact of randomness on the performance of investment managers and whether their performance is based on skill or simple luck.

$10 million earned playing Russian roulette is not worth the same as $10 million earned through hard work and good dental practice. They are the same amount of money and buy the same things, but the former has a higher random component than the latter. To an accountant, they are exactly the same.

But deep down, I always feel that they are of very different natures.

When examining investment performance, one should consider other possible outcomes - what Taleb calls "untapped history" - history that can happen just as easily as "real history."

Obviously, the way I judge things is probabilistic in nature, based on the idea that anything can happen.

The greatest generals or inventors in history we hear about are those who took great risks (like millions of others) and happened to succeed. They were smart, fearless, noble (sometimes), and the most accomplished people of their time, but millions of others are doomed to become stale footnotes.

Every once in a while, someone comes along who makes a high-stakes bet on an unlikely or uncertain outcome and turns out to look like a genius, but we should recognize that his success was made possible by luck and courage, not skill.

Think of a backgammon player who has a 1 in 36 chance of winning by rolling two sixes at the same time. The player takes the dice, doubles down, and wins his caravan. It may not be a wise gamble, but because he won, everyone thinks he is smart. We should think about the possibility of other situations other than rolling two sixes at the same time to understand how lucky the player was to win. This is enough to show the possibility that the player will win again. In the short term, many investment successes are just because of doing the right thing at the right time. I have always said that the key to success is ambition, timing and skill, and someone who is aggressive enough at the right time does not need much skill.

At any given point in time in the market, the most profitable traders are often the ones best suited to the latest cycle. This rarely happens with dentists or pianists - that's the nature of randomness.

There's a simple way to understand this: During boom times, those who take the highest risks tend to earn the highest returns, but that doesn't mean they are the best investors.

In the appendix to the fourth edition of The Intelligent Investor, Warren Buffett describes a coin-flipping contest in which 225 million Americans each contributed $1 a day. On the first day, the correct guesser won $1 from the incorrect guesser, and the next day, and so on. Ten days later, 220,000 people had guessed correctly 10 times in a row and won $1,000. "They may try to be very modest, but at cocktail parties, in order to attract the attention of the opposite sex, they occasionally brag about their superb coin-flipping skills and genius." After another ten days, the number of people who had guessed correctly 20 times in a row was reduced to 215, and each won $1 million. They will probably write a book called "How I Made $1 Million in 20 Days with $1 by Working 30 Seconds Every Morning" and sell tickets to seminars. Does this sound familiar?

It follows that few people fully appreciate the contribution (or detriment) that randomness can make to investment performance. As a result, the dangers lurking behind all hitherto successful strategies are often underestimated.

It might be a good idea to summarize Taleb’s argument by quoting a table from his book: He lists something in the first column that could easily be mistaken for the second column.

Luck Skill

Randomness Determinism

Possibility Necessity

Idea, hypothesis, knowledge, truth

Theory Reality

Anecdotes, coincidences, cause and effect, laws

Survivorship Bias Market Outperformance

Lucky Fool Professional Investor

This dichotomy is too clever. We all know that when it comes to success, luck looks like skill and coincidence looks like causation. "Lucky fools" look like professional investors. Of course, even knowing the effects of randomness, it is not easy to distinguish between lucky fools and professional investors, but we must try to make the distinction.