Nassim Taleb On XIV: "Why People Who Make Money Are Usually Wrong"

Echoing Mark Spitznagel's insights into how 'naiveté' led to the epic losses experienced by many 'nickel-picker-uppers' this week in the short-vol game, Nassim Taleb takes to YouTube to provide some more color on the fallacy of forecasting and what destroyed XIV traders.

Taleb begins by noting that "many people attempted to profit by forecasting volatility [would drop] and from the fact that  the contract [in this case XIV] was poorly constructed... they were right, until they were destroyed."

Academics cannot get the idea that you don't have to be right about the world to make money.

"Antifragile explains why understanding x is different from f(x) the payoff or exposure from x. Most of the harm/gains come from f(x) being convex or concave, not from understanding x.

Forecasting is off an average, and average is for academics and other morons."
As Valuewalk's Jacob Wolinsky writes, this video illustrates the point with XIV that went bust while being correct about volatility --and why people who make money are usually wrong.

Transcript:

Friends. Let's discuss the problem forecasting one same time explaining the XIV/VIX trade. A bunch of people constructed the contract saying the VIX is overpriced, mis-prices volatility, how over-forecast the variation in the market is; the contract is poorly designed, so let's make money off of that... And they were right but they were destroyed and lost all of this money.

Why?

Because they didn't realize that forecasting has nothing to do with P&L, nothing to do with real-life; what matters is you payoff function.

So these people were right. If you invested say $25 you would have made some money. I think a high of $146 overtime. And in one day they lost everything.

It's now at $5 and probably shopuld be lower.

So what what did they do that was wrong.

What they did is not understand that being right on a random variable X doesn't mean making money out of it. Your payoff f(x) needs to be aligned with what you're forecasting. And in fact the payoff function f(x) is never X; and f(x) can be very complicated. In real-life, most people think you've got to focus on X or academics or other idiots.

f(x) is what you focus on when you make the decision. It's much easier to understand your function of a random variable than the variable itself. That's what I said throughout 'Antifragile', and very few people are getting it.

[00:01:57] Academics cannot get the idea that you don't have to be right about the world. You have to make decisions that are convex, in other words, decisions that make sense and in fact you don't have to be right about the world. And this also explains why paranoia is entirely justified, if you're f(x) is concave.

So your overpricing and underpricing of probabilities is not what matters; what matters is your payoff function.

So let's see what happened here... Let's take your payoff function. Remember you have a payoff function that's a polynomial - you know pretty much everything in life is some nonlinear function that can be expressed through splined polynomials (and of course you can do it a more sophisticated way, but that's pretty much what it is).

This is a way for us to understand first-order non-linearity.

When you plot (1-x^2), you see what happens here (below) and so I build a forecasting function that is the mean of (1-x^2). So what does it do here

[Taleb shows the function's attempts to 'forecast' the 1-x^2 using its historical mean to that point]

[00:03:45] Although you're right on X you're wrong in your payoff function you're going to be harmed big time.

 

Now let's take an extreme case.

This is why I often say, "I've never seen a rich forecaster; good forecasters are always poor because they don't forget that the average forecast is not what matters. What matters is not to be harmed by these concavities."

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Comments

DillyDilly Sun, 02/11/2018 - 15:02 Permalink

What's the definition of "make money"?. Is that, like, having your own money counterfeitting printing machine that DOUBLES as a way for people & governments (which then, layer another tax 'on' the same people) to OWE YOU MONEY, (from thin air)? 'Derivatized' to the "nth"?

GUS100CORRINA translator zero Sun, 02/11/2018 - 16:18 Permalink

Nassim Taleb On XIV: "Why People Who Make Money Are Usually Wrong"

My response: I AGREE COMPLETELY!!!

Below is my favorite BEAR chart of the week (SVXY). Of course, anyone positioned correctly on the short side made a "BLOODY FORTUNE" very quickly (See second chart for TVIX).

SVXY - ProShares Short VIX Short-Term Futures

https://www.finviz.com/quote.ashx?t=SVXY&ty=c&ta=0&p=w

TVIX - VelocityShares Daily 2x VIX ST ETN

https://www.finviz.com/quote.ashx?t=TVIX&ty=c&ta=0&p=d

In reply to by translator zero

A Sentinel GUS100CORRINA Sun, 02/11/2018 - 19:18 Permalink

Taleb is the big celebrity in the subject of swans and [swans are] precisely the focus of the current development of my technology.

What he doesn’t say clearly here is that there is a huge disconnect between the algebraic approximation [used for a forecast] and the identification of an event [a point in time in a forecast] as being of a certain type [meaning a swan, or in a wider sense, an inflection.]

What he doesn’t do is give a solution. Here’s a secret: there are ways to bridge the divide, but nothing popularly in use can do it.

An anti-example of a solution is the kind of support-trend-lines you see the Tylers and their advertisers refer to. Why? Because those are 100% REACTIVE or put another way, they tell you about swans only in the past tense, by definition. Frankly, [that goes for] anything the from Mcmc [markov chain Monte Carlo] end to all the box-Jenkins [autorecursive arima or n-manova, etc.] derived approaches that approximate algebra [attempting to describe random walks which are then used as the basis for] forecasts—they are all doomed [when it comes to swans.] I’ve said that for years and the big guy just hinted at it (kinda.)

But I am here to tell you the good news!

Swan forecasting is possible.

 

edit [] are edits for clarity.

In reply to by GUS100CORRINA

TeethVillage88s DillyDilly Sun, 02/11/2018 - 15:55 Permalink

Trump has 'Failed' to Educate Public on Economics, Jobs, Inflation, Trade, Migration, Foreign Policy, you name it.

- Failure of US President is always about revealing "Truth" & Education

Dear President Trump;  Shalom, may Gods peace be upon your house!

- Please figure out how to educate to your Campaign Platform

- Failure to Educated based on you Platform is to lose your legacy, your voters, your history, your credibility

Signed, TeethVillage, Professor of Feudalism, University of Downhill USA

In reply to by DillyDilly

A Sentinel TeethVillage88s Tue, 02/13/2018 - 23:33 Permalink

There’s a mountain of anti-education that needs to be erased before anything like that can begin. 

Just one example: EVEN HERE, on zh, the hip, cool market savvyieat blog anywhere, Malthusian cultists regularly vomit (post) their ABSOLUTELY DISPROVEN blather about population and bullshit finite resource arguments. Goodness gracious! Duh fellows we know that resources are finite. But it doesn’t matter that YOU or I can’t see past that. We know that resources are finite, but BECAUSE WE PAID ATTENTION TO ECONOMICS we know that that only matters when governments WANT famine or catastrophe. Left alone free trade ALWAYS handles it.

-excuse the rant. I’m done.

In reply to by TeethVillage88s

Entertaining1 Anonymous (not verified) Sun, 02/11/2018 - 16:07 Permalink

Paul John Smith,

Finance is not a science.  You are a fucking retard or more likely a plant.  Is this the 2018 version of Million Dollar Bonus--weird non-sequiturs on every article?

Is anybody else a little skeptical the same assholes are commenting on every article with the same foolishness?  Somebody has a lot of time on his hand to read, yet can only create short brainless comments that always go in the same direction.

Cue half a dozen commenters linking to someone's spammy homemade website.  Be sure to upvote each other in your multiple identities.  

Paul, please help us out.   Please tell us, or have another sock puppet tell us, how does an article about a Lebanese Christian educated in Paris become a comment about this other stuff?  Or do you just have a quota of responses per hour to fill?  

I am not buying this.  I am not buying that the people in charge of this site are not in on this.  Too obvious.  

 

 

 

 

In reply to by Anonymous (not verified)

MrSteve Ecclesia Militans Sun, 02/11/2018 - 22:32 Permalink

OK, here's the 4 year-old's explanation:

Go to your local public library, the free one near you with the nice book people. Ask the book people for Taleb's Antifragility. They will help you find the book on the shelves or order it for you from another library. Read this book and your question will be answered. Don't spill drinks on the books! Note that all education is self-taught, no one can learn it for you.

In reply to by Ecclesia Militans

A Sentinel Anonymous (not verified) Tue, 02/13/2018 - 23:38 Permalink

I don’t know ONE Jew who does forecasting* and I know a lot of forecasters and a lot more Jewish bankers who couldn’t forecast for their lives (one Jewish guy, he was back at Meryl when that was a thing) was explaining to me how crucial IRR is for value comparison — and know what? It’s wrong. I was polite, but he must have missed that in whartons intro advanced corporate finance (I think that was actually what they called it.) IRR tells nothing about value, particularly in a comparative sense.

Your assertion? As wrong as the Jewish banker telling me about IRR.)

* I know jews in ai and some that are damned good in bi, but I really cannot think of one in actual forecasting.

In reply to by Anonymous (not verified)

MusicIsYou Sun, 02/11/2018 - 15:12 Permalink

People in general are just stupid and most things about the economy and society aren't even needed.  Case in point: all the various nuts and Bolt sizes.  Or something newer recently created at the University of Maryland: wood that is 12 times stronger than regular wood, lighter than metal,  and in some ways tougher than titanium, and neither does it need to be sealed or painted.   So basically some manufacturer can produce 'snap together homes' and we don't need tools anymore and we can say goodbye to Home Depot,  Lowe's,  and Ace Hardware etc and all the manufacturers of various painting compounds since homes can be manufactured in the colors people want. We have a broad unreasonably complex economy for no other reason except just to have it.  People really are dumb animals but they think they're the smartest on the planet. And they're raping,  pillaging,  and killing the earth for no other reason except that they can,  but what comes around goes around and today the planet has begun to target people. 

dhengineer MusicIsYou Sun, 02/11/2018 - 16:22 Permalink

Such materials are fine and good, but the weak link in every structure is the method of connection.  How do you connect various pieces together in ways that do not lead to brittle failure or fatigue?  No, you cannot have snap-together houses because nature is not static.  Wind, seismic events, foundation settlement, temperature changes, and water infiltration always degrade the structure, whether microscopically or overall, leading to leaks, misalignment of doors and windows, air infiltration, and many other problems. 

Structural design is not always about strength.  In most cases, serviceability controls the sizes.  All else being equal, supposedly one could design floor structures with members that are one-twelve the size of standard wood using this new material.  The problem is that the floors would bounce like a trampoline because they would be so flexible.  Walls and roofs would flex significantly in the wind.  There is no advantage to using such strong materials because you still need to provide the necessary stiffness to prevent excess deflections. And that means using a bigger member than is indicated by strength alone.  Complexity is not a bad concept in structures.  In fact, the more complex a framing system (within reason), the more load paths are available.  If a member is damaged during a seismic event, for example, the loads that are normally carried by that member must be redistributed to adjacent intact members or the structure will begin to progressively collapse.  Typical wood structures set up complex load paths using the wall and roof sheathing in diaphragm action to transfer loads in ways that are not always obvious or subject to calculation.

My engineering professors always told us that we cannot control nature.  All we can do is to direct the effects of nature on our designs to minimize future problems.  

In reply to by MusicIsYou

keep the basta… dhengineer Mon, 02/12/2018 - 02:22 Permalink

How about the new material is designed to work? Maybe it suits quick fix domes on a poured base plus a bit of my new fave basalt with its 100 Russian patents. 

Your engineering professors sound like the gp doctor I saw at huge over charge, whose professor was there at huge expense to inform me that prednisone was good for me. 

The new info is coming so so fast now. 

In reply to by dhengineer

keep the basta… dhengineer Mon, 02/12/2018 - 02:22 Permalink

How about the new material is designed to work? Maybe it suits quick fix domes on a poured base plus a bit of my new fave basalt with its 100 Russian patents. 

Your engineering professors sound like the gp doctor I saw at huge over charge, whose professor was there at huge expense to inform me that prednisone was good for me. 

The new info is coming so so fast now. 

In reply to by dhengineer

A Sentinel dhengineer Tue, 02/13/2018 - 23:42 Permalink

Another reply: if each piece is sequentially aligned, you’re right. I believe that Hitler loved to say that a chain was only as strong as it’s weakest link. But what if you don’t rely on sequence. What if you remain aware of trends but don’t use them to forecast?

figure out how to do that and you’re not trapped by trends where losing sight of the fact that history and future are symmetrically uncertain dooms you (as the author says) to confusion between x and f(x) where market behavior is the variable and the profit function is the independent variable. 

Complexity is a part of the answer but simplicity defines elegance. There are tremendously elegant ideas that solve complex problems, even if there’s underlying complexity in them. Limits are an example. Int x (a,b) is a great illustration. It’s not the best example but it shows the point: it’s actually really simple, but underneath the dirt simply process, there are *literally* infinite calculations. Simplicity and complexity are not mutually exclusive.

In reply to by dhengineer

keep the basta… amadeus39 Mon, 02/12/2018 - 02:29 Permalink

Alive is a matter of definition, at the simplest yes, the earth is alive, mars is not. The earth has a core of rotating plasma, this gives the north and south poles and magnetic effects, and it grows as cosmic rays from the sun feed into it and the earth gets bigger, hence the Atlantic ridge as it grows and the seaparation of contentinents, plus quakes and volcanoes during solar minima as more cosmic rays feed in. Cosmic rays just go thru mars, zero happens.

if you are equating live with sentient it gets tricky, maybe you do your work there and go to Russian research.

what do you mean "by what scientific method" there is only one scientific method. Observation, inference, prediction etc... 

In reply to by amadeus39

keep the basta… SunRise Mon, 02/12/2018 - 02:40 Permalink

I agree with music. His abstract observation works for me after a dozen owner builds and living thru them as a child.

sunrise you are free to choose what you need, that's musics wish really.

seems you expect to be told what to do.

and if you want to follow the exploitive domestic building system and get bankstered to death in a mouldy brick venereal that's your choice. As is to get a whip and mirror.

 Music is giving you that blessing. I would rather better building was there for me.easily.

In reply to by SunRise

keep the basta… MusicIsYou Mon, 02/12/2018 - 01:47 Permalink

Yes I agree it's its interesting. Seems any scrap timber can be boiled with simple caustic plus as I recall, then pressed at 100 degrees for 7!hours and with 45 percent lignin holding it together can be thin, many times stronger than metal... non conductive too.

aus will run out of loggable timbers by 2030. Just look at what Aus boutique scumbag architects do to waste it.

read German engineers that in ww2 thin concrete domes withstood bomb blasts in the vicinity...i am looking to yet another build, maybe my last, and needs to withstand 6" hailstones, lightening, snow, gale force winds, heat and cold plus emf. Plus potable rainwater to tank.

clearly this pressed timber material should be cheap as, to build and to make fast domes for shelter is a huge step forward. Of course it's being looked at for planes.

i agree re the legislated down to council level in Aus, the horrendous exploitive building codes for domestic dwellings the obscenity of architects and their training since 1970  and the insane barBasic stupidity of domestic dwelling construction and town planning. The inbuilt requirement for mortgage inflating detail to replace good design. 

Given at age 17 I wanted desperately to correct the obscenity in Aus dwellings and combined bank govt trades manufacturers exploitation and to study architecture... no fkn way no money to support me from the child beating sibling rapist female belittling less intelligent psychopath father who belted me for intelligence and so I have been serially working on homes. As a kindness normal people might learn about genetic psychopathy, and know that the answer is to run far away.

I like hempcrete and looking at basalt fibre and euro shield roof providing run off is potable.   And fk architect training and idiot parasitic architects in Aus for the last decades and fk engineers re domestic dwellings.

In reply to by MusicIsYou

jmack CasualKat Sun, 02/11/2018 - 20:44 Permalink

you are looking for fat tails, outsized moves.  If you are right the vast majority of the time and making .1 your risk, or .5, or even 2x your risk, but every once in a while you ramp up your risk, or you are trading a vehicle that has down time, and you hold thru that, overnight for options, over the weekend for futures, or you hold into a panic sell situation, where you cant get filled until you are slipped 30 to 80 points.  all your small wins go poof, very quickly.  The payoff function.

In reply to by CasualKat

bh2 Sun, 02/11/2018 - 15:27 Permalink

Taleb's comment is right on that only academics and other morons make decisions based on averages. Because, on average, they will be led to make very poor ones.

MusicIsYou Sun, 02/11/2018 - 15:39 Permalink

Smart phones and social sites are actually making people more dumb.  Nature isn't stupid by any means so you have to ask yourself: are smart phones really possibly the planet defending itself? To make it far easier to exterminate large populations of people. A truly intelligent person realizes they came from nature so that means nature is unequivocally intelligent.