When Genius Failed: The Rise and Collapse of Long-Term Capital Management by Roger Lowenstein
Long-Term Capital Management’s demise comes from a mix of how their perfect models quantify risks in an uncertain world, a sense of infallibility, 30 to 1 leverage, illiquid trades, and basic greed. It is like betting on the outcome of a coin flip and if you lose, keep doubling down on the bet until you make it. Except for the fact that markets are often irrational. Or put it differently, even if something has a 0.1% chance of ruin, do it long enough, the chance of ruin is 100%. By using past trends and volatility to model future risks, LTCM believes they can quantify risk using mathematical formulas and tame the element of chance in life itself. And when you think something is safe, you do more of it until you discover the consequences.
I think there are a few things you can learn from this book. You want to avoid what Neil deGrasse Tyson considered a challenge in life: “Knowing enough to think you are right, but not knowing enough to know that you are wrong.” And “Better to take risks you can measure than measuring the risk you’re taking.”, as Nassim Taleb puts it. We have models that help us to make sense of reality. But they’re imperfect. Therefore, instead of trying to fit reality into our models (measuring risk you’re taking), we should appreciate the imperfection of our models, recognize the limitations of our knowledge, and always be ready to change our minds.
Into Thin Air: A Personal Account of Mount Everest Disaster by Jon Krakauer
A journalist’s personal account on an Everest expedition with a group of climbers that turns into one of the worst Mt. Everest disasters in history. If you can learn one thing from this book, it is to see risk in a new light – risk can come to you from totally unexpected ways. It doesn’t appear when you’re right at the top of the mountain, but in every decision, you made right before the climb. That applies to investing too. Risk is both when all your money is in the market and when all your money is in cash; risk is both when you think you’re right and when you think you’re wrong; risk is action and inaction. And in both climbing and investing, the risk doesn’t come from the activity itself, but the temperament that goes into it.
While The Drunkard’s Walk approaches randomness through maths and science (Leonard Mlodinow is a mathematical physicist), Nassim Taleb looks at it from the eyes of a trader and philosopher. You’ll learn how randomness can fool us; why we’re not wired to think probabilistically; and why the things that didn’t happen: alternate histories, are just as important as what happened. You’ll also understand how news is like french fries; it keeps us satiated while slowly killing us from the inside (but we don’t see it). Required reading for those that say “If I had listened to you, I would have lost money”. This is the same group that believes everything you say when you tell them your past 10 predictions are correct. Fooled by Randomness is a hard book, but packed full of wisdom. Drawing examples from the stock market, medicine to philosophy, and biology to explain what we think we know can be dangerous. It will change your perspective as an investor.
Antifragile: Things that Gain from Disorder by Nassim Taleb
Antifragile explains the more we try to ‘stabilize’ or control something to make it safe, the more unstable, dangerous, or fragile it becomes. If you put out every small, localized fire in a forest, you increase the chance of a large scale firestorm. Similarly, the more a government tries to ‘shore up’ the economy to prevent a market recession, the more fragile the economy becomes and increases the chance of a big scale crisis.
This also means if shielding things from randomness or shock makes them fragile, a certain amount of exposure to randomness improves it. For example, some (but not too much) stress is productive; some physical work is good for the bones; some fasting is good for the immune system etc.
On the information/knowledge level, we can think of constantly exposing our ideas, beliefs, investment thesis to a certain level of contradictory information that makes them less fragile. Since you’re always updating and calibrating your perception with reality, you’re less likely to be ‘caught by surprise’.
Deep Survival: Who Lives, Who Dies, and Why by Lawrence Gonzales
Laurence Gonzales explores the question of why someone survives while others die in a disaster. This book is far relevant to investing than most people thought. Gonzales looks into the psychology of what makes people take risks, the role of hubris, the unpredictability of complex systems, and the importance of self-control. The ingredients of staying alive in a disaster are not that different from surviving in the stock market: a good dose of humility, a prepared mind, knowing what you don’t know, and open-mindedness.
The Black Swan: The Impact of Highly Improbable by Nassim Taleb
The Black Swan is the continuation of Taleb’s work on randomness. The book dives deep into the fat tails of randomness to understand why it is hard to predict rare events that carry extreme impacts. While a black swan is normally associated with rare, global events such as the 1997 Asian crisis or Black Monday of 1987, it is just as applicable to unseen risks that happen on a smaller scale. As an example, an overly concentrated portfolio or leveraged position can both result in large magnitudes of losses. Narrative fallacy, confirmation bias, and silent evidence can all blind us to such risks. This book is more about ‘how not to’ than ‘how to’. While the book can be technical on a few chapters, it is nonetheless filled with interesting and widely applicable ideas that improve thinking.
Risk Savvy: How to Make Good Decisions by Gerd Gigerenzer
Less is more. Gerd Gigerenzer explains why a simple rule of thumb beats complex algorithms when making a decision in an environment that is highly uncertain where information is limited. Gigerenzer then shows us how using a rule of thumb and gut feeling can help us make better decisions in investing, finance, health, and even relationship.
The Most Important Thing: Uncommon Sense for Thoughtful Investor by Howard Marks
Investing is about managing risk first before making money. Howard Marks covers some of the important lessons in investing in market cycles, market fundamentals, risk, and psychology.
The Unthinkable: Who Survives When Disaster Strikes – and Why by Amanda Ripley
The 3 stages of a survival arc are denial, deliberation, and the decisive moment. We first deny that something is wrong, then we choose to find out if the danger is true by finding more information before we accept the situation and decide whether to act or not.
One of the unsurprising findings is that people who are better prepared have a higher chance of surviving. What happens when you’re not prepared? You do stupid things. It is like you “put a kid in a car, take him out on an interstate at 60 mph during a snowstorm and the car goes out of control, his brain is going to totally disintegrate. There is no programming. So what does he do? Freezes. Closes his eyes. Does all the wrong things. Young people can respond in a nanosecond. The problem is, most of the time they do the wrong thing.”
We have disaster preparedness from building evacuation drills, tsunami evacuation training to earthquake drills. Pilots use simulators to program themselves how to react in panic situations. We should have some kind of drills that program ourselves in a market crisis as well.
Ubiquity: Why Catastrophes Happen by Mark Buchanan
Self-organized criticality. Most systems—forest fires, earthquakes, traffic jams, mass extinctions, stock markets, etc—are constantly operating in a critical state between order and disorder. That means it is impossible to predict when a market collapse is going to happen or how big it will be. Despite the unpredictability, there is a regularity of power law that underlies the frequency of these events. Just as a smaller earthquake will happen more frequently than a bigger one, smaller movements in the stock market, say 1% will be more frequent than 5% movement, which itself is more frequent than a 10% move.
The Big Short on the unfolding of the global financial crisis; Midnight in Chernobyl—a well-written book on the Chernobyl nuclear disaster; Capital Returns highlight the risk of jumping into companies that are flushed with capital; The Psychology of Money by Morgan Housel shows the obvious things that we don’t see; What I Learned Losing A Million Dollars is my personal favourite on how we lose money and how to avoid it.