Random theory, finance and their entrepreneurial implications

If you’ve ever read any books on random theory by itself or with respect to finance as Nassim Taleb so eloquently writes, skip the next paragraph.

The basic premise is that humans are amazing at picking out patterns in data sets. We are animals that gain via pattern recognition but we very often err on the side of thinking we’re identifying a pattern when it’s really just random. The financial side of this is often explained by a wonderful example of monkeys throwing darts at dart boards. If you take all the traders in NYC who have just had an awesome year, their previous year’s amazing results will not predict their next years earnings in any statistically significant fashion. It’s like you took a thousand monkeys and made them throw darts at a dart board; many of them, simply by random chance, will score MUCH better than others and even after a few years there might be a few monkeys who have, by random chance, scored well in all the years running. Welcome to the financial industry. With everyone taking all the available information so well into account, the returns have been whittled down to monkeys throwing darts.

If markets are liquid and all information is taken into account in the price of assets as traditional financial theory maintains, than the only way to consistently make money is by having an unfair informational advantage. Otherwise you’re just a monkey playing the roulette wheel. Well the same goes for entrepreneurial ventures. A business idea and its inherent risk shares many of the same characteristics as assets priced in the market place. You CAN’T know which will prevail and which won’t. If that information were obvious, someone would have capitalized on the asset or idea already (this is done by buying the asset until the price increases to more adequately reflects it’s true value or by starting the business if it’s an idea).

So what do you do about this as an entrepreneur. Well it means you need to have the most swings at the ball as possible. Though you do need to ACT like you believe your idea is 100% the next big thing to get buy-in and inspire your followers, you need to set up your finances and life in a very different manner. You need to set up your life so you can have the most chances to knock one out of the park. Not because you’re stupid and have bad ideas, but because if an idea was obviously perfectly good, someone would have tried it already. You can’t know a-priori if your idea will win. It’s inherently risky.


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