Archives April 15-30, 2006 Home Write to us at: (not clickable). Please include your full name, and omit attachments.

30-April-2006
Predator-Prey Models, by Henry Carstens

We all know about ever-changing-cycles, what wasn't clear to me until yesterday, was the implied notion of 'continuous improvement' in the cycles.

A model:

Assume a predator - prey model. Assume the market is made up solely of mechanical trading systems. Assume that every day new trading systems are injected into the market and old, failing ones removed. Assume that the majority of the new trading systems are incrementally better than prior population (some are better, some worse but as a whole they are just a bit better)

What happens? At each cycle, some prey are removed from the game At each cycle, some predators become prey. At each cycle, old predators continue, but as a whole w/ reduced edge vs the young predators

Who doesn't survive? The fixed predator as he eventually succumbs to the continuous improvement of the new predator systems

Who does survive? No one. But it's the wrong question.

Who thrives? to be continued...

What does volatility look like under Kurzweil's law of accelerating change? to be continued...

What is so striking about this is the extent to which the model mirrors the circle of life...

John Kuhn responds:

I like this post; very interesting and crisply put. What is in the "cycle of life", though less emphasized in this post, is that in, say, the African plains the prey survive by sheer numbers. In systems' use, perhaps the most beneficial system to the overall market "system" is one in which the predator feeds very slowly and the overall population of prey, of protein availability, continues to expand. That predator seems to be the broker interjected into all trades in the form of the commish/spread vigorish.

The use of individual "trading systems" must be fairly limited (in a vast market they'd employ different feeding styles; one a falcon, another a basking shark, still another a shrimp-the fingertrader or crumb seeker) Setting aside for now the highly sophisticated systems of some of my genius friends, just in the daily financial papers there are so many systems for sale - with many sub menus or systems ala omnitrader or of the betty crocker variety ala Tradestation where you add an even higher percentage of your own ingredients albeit all from off the "supermarket shelf" of technicals, enhancing pleasure and pride of ownership. The more adept or fortunate can escape predation longer perhaps, even prey on others for a time; all the while tugging along the remora of vig which aims to feed but not to kill.

One extremely effective predator avoidance adaptation seems to be to just remain absolutely motionless for a very long period of time. Another dominant technique is the use of other peoples' flesh as bait. If one snares a big one, one takes a % of the win. If not, well.. one hopes one's not used up the last sacrificial goat.

One point you make is particularly intriguing; continuous improvement: The last several years' huge inflows into hedge funds suggests folks who may normally be considered as "prey" are looking at success of the predators and throwing their "protein" at them willingly to vastly expand their class. One thing the system perhaps can't tolerate quite so well would be an unnatural bloom of predators versus the prey population. In a natural cycle, this could entrain a gradual starvation based die-off of the predator classes.

30-Apr-2006
A Lesson from Dr. Philip McDonnell: Robustness of Counting Studies

Suppose we have performed a study of some methodology for the last 1000 days of trading and found that it produces an expected return of r with a standard deviation of s at the 5% significance level. What do we really know and how much confidence can we have in our results?

First, the significance level implies that the result could have arisen through chance only 5% of the time. That means if we did 20 significant studies we would expect that 19 would be valid and one would be the result of a random data aberration. 95% of the time the study will have validity, 5% it will not. So if you want perfect guaranteed returns consider T-bills not statistics. I also hear that Elliot Wave, astrology and Gann work perfectly as well but haven't tried them.

If you've decided that 95% confidence is good enough for you then the next question is how to test your study for robustness. One way is to break the data sample into different time periods. If the study worked in an older period and in a more recent period one can have a higher confidence in it.

By the same token we can look at the variance of two different periods. If the variance is changing then we may have a problem called heteroskedasticity (simply means different variances). An F statistic can be calculated to tell us if the data has a significantly different variance in two different periods.

Markets often exhibit non-stationary variance and that is a fact which must be recognized. However our choice of model can also be the cause of some of the heteroskedasticity. For example with long term data choosing a simple linear model without detrending can result in serious heteroskedasticity due solely to the wrong model. Using a log transform minimizes the problem because it yields a better fit of the long term compounded returns of the market.

Another common syndrome is autocorrelation in the residuals or in the trading results. One can test for this with a simple autocorrelation of the residuals or use a Box Jenkins statistic. If present it usually means there is a missing variable which should be included in the model if you only knew what it was. One can explicitly include a variable for the last residual or alternatively use a Kalman Filter to do the same thing.

Classical non-parametric tests can be used if the underlying distribution is non-normal. Examples include Mann-Whitney, Spearman rank correlation, Chi Squared, ANOVA and simple binomial tests. Robust testing using bootstrap techniques can also give us confidence intervals and p values irrespective of the underlying distribution.

Dr. Kim Zussman responds:

I think there's a question of Epistemology.

If you are interested in predicting what MSFT does after a big jump in volume, you can look at prior examples to see if a significant pattern exists. But what priors to choose? Does what happened with MSFT the company, over the period in which it developed personal computing for everyday people, explain the early stock returns? Is this same revolution happening now, and if not can you extrapolate from the revolutionary period?

One should have the same concerns about entire markets: i.e., how pertinent today is what happened to the SP500 in the 1990s? What about 3/2000-3/2003?

One way to address this is to assume that the recent past is more relevant than distant (ask all the guys who think a 5% drop is the first part of 1929 revisited). This method can also help defeat the effects of data-mining, in looking for patterns which remain significant out of sample. However, assuming recent market behavior should have momentum has at times been a momentous mistake.

On a hike recently I was thinking about how epistemology relates to regression to the mean; and the way that the random scatter of real-life experiences hover around reality. Given how much changes over time, why should statistically significant patterns in markets repeat at all (assuming they are not arbed out yet)? I found an answer in the Chumash cave-paintings I saw recently, which were hundreds or thousands of years old. Regardless of what era we live in, how wealthy the people are, or who is president of Iraq, human nature is essentially immutable because it is written in the genome. And if you can identify those little blips on your monitors, like the telltale signature of an MI on an ECG, you can model the weakness of your lessers and the strength of your betters. More or less.

30-Apr-2006
The Wright Brothers, by Allen Gillespie

I had an opportunity this weekend to visit the Wright Brothers Memorial, and I must say it left me highly inspired and with the impression that a speculator could learn a lot from the brothers.

1. Optimism: It is not really necessary to look too far into the future; we see enough already to be certain it will be magnificent. Only let us hurry and open the roads. — Wilbur Wright
2. Patience: The build up to the 1903 flights were years in the making and involved thousands of glider and lab tests.
3. Observation: The Brothers learned from carefully watching vultures.
4. Testing: The brothers tested many ideas before going with the one that made them famous. Reminds me of the Palindrome's theory on testing.
5. Isolate Variables: The brothers methodically attacked each variable that effects flights.
6. Don't Get too Excited by Success : Or you may loose your airplane in the high winds.

29-Apr-2006
Thoughts on Restructuring and Meetings, by Victor Niederhoffer

It was regrettable to see the use of alliteration in Intel's analyst day talk where CEO Paul Otellini pledged to "restructure, resize, and repurpose Intel for the future". It has been anecdotally noted on this list that alliteration by corporations often is the signal of gilding the lily and fuzziness and decline.

Intel had its biggest percentage rise in five months on analysts days. I would speculate that analysts days in general are bullish as the recent Google one was, as the companies store up their good stuff to unload on analysts day as we all are prone to do when we have big meetings or the attractive "other" is in the audience.

There seems to be a standard way now of getting the stock of big companies up, go to a meeting and announce that they are taking a fine tooth comb and razor to every aspect of costs in the company and firing workers galore. Amazingly, I hold just a handful of individual stocks, and I have been victimized first by falling profits and then given a temporary reprieve by this message in the last year in a high percentage of the stock I've owned, Pfizer, IBM, and Intel among others. Somehow I believe this formula for goosing the stocks is rather ineffectual over a long term basis as it always seems that the cost savings involved are far smaller than the write-offs that are necessary to accomplish it. Someone should investigate this new tool of the CEO systematically and write a Harvard Business Review article on it as an adjunct to their consulting business which it seems is the unstated purpose of most HBR articles.

The whole subject of the performance of companies before and after meetings should be fruitful. Information and reduction of uncertainty is costly and after these meetings there is much more to base an analysts report on. It would stand to reason that there should be a spate of analysts reports after such meetings, and indeed I have noticed about 10 times the relative frequency of same after such meetings than before. Since most analysts reports are still favorable, one would suspect that meetings should be good.

There are some three hundred thousand entries on Google for various permutations of meetings, NYSE, NYSSA (New York Society of Security Analysts), et al. And services such as Bloomberg list hundreds of meetings each week under NI meetings. As far as I know, however, no systematic study of such meetings has been made in recent years, except for this lone effort by a collaborative pair.

One would hope that there would be many meals for a day in the pursuit of this subject.

30-Apr-2006
Applying the "Rules of War" to the Market, from David Baccile

Bevin Alexander's "How Wars Are Won" details 13 rules for waging war. I'm just beginning the book and hope to provide a review when done. If it is anything like the short 10-page introduction, it will be a rewarding read. I will provide some quotes from the introduction and add some of my thoughts on how these rules of war may apply to the markets.

Both countries (France and the U.S.) tried to fight a conventional, or traditional war against the Vietnamese Communist forces, but the Communists insisted on fighting a guerrilla war. That is to say the Vietnamese used different weapons, and with those weapons they were superior. They, like the September 11 terrorists, eluded strength and struck at weakness.

The rule "eluding strength and striking weakness" is an old rule that all great warriors and commanders such as Napoleon have used to gain advantage.

How may such a rule apply to the markets? In the markets we are not matched against one great commander but many, many great commanders. Large Wall Street dealers with unmatched capital and sophisticated hedge funds both attract the brightest minds in the world to employ technology and methodologies to their advantage. In addition to this group, we are up against large money managers with teams of trained analysts and traders.

How do we, as smaller traders / investors, then elude their strengths and strike at weakness? First, we must identify the weaknesses and they - let's identify "them" as the Chair's "Market Mistress" - do not all share the same weaknesses.

Areas of Weaknesses for the Market Mistress:

1. Tied to a benchmark. Perhaps the second worst concept ever created was that of comparing performance to a benchmark (the first being CAPM). Most money managers are pleased if they can beat a benchmark every year by 100 - 200 basis points every year. They adopt rigid styles to keep them invested in a similar fashion to their chosen benchmark.
2. Short-term orientation. With some notable exceptions, Money managers, hedge funds and dealers focus on short-term success. When this short-term orientation is combined with a rigid style, the result is a flocking, or herding of managers within similar styles into the sectors and stocks that are "working" and out of those that aren't.
3. Success get punished. A money manager or hedge fund that performs well is then "rewarded" with a flood of new money as investors seek to garner their share of any prospective success of this talented manager. The additional funds, reduce the managers ability to capitalize on his advantage and the alpha is diluted. This leads to a fourth weakness.
4. Size matters. Successful money managers typically manage large sums which often limits their universe of potential investments. Liquidity constraints may keep a manager from investing in potentially fruitful areas.

Striking at the Weaknesses of the Market Mistress

Many reports and studies show that contrarian and small-cap strategies out perform in the long run. Both strategies strike at the weaknesses noted above. Contrarian strategies often take time to play out which requires the patience and confidence that many money managers lack - especially those "run by committee". Small and micro-cap stocks have gained popularity in recent years due to their strong performance - look at the Russell 2000 and you'd never know we experienced a major bear market in 2000 - 2002. By focusing on these two strategies, small investors can profitably strike at some of the Mistress's weaknesses.

The commander must evaluate every new situation with great care, and *then*choose the rule or rules he must employ to achieve success. The rules of war relate to solving specific problems as they arise, and are not general rules always to be applied to all situations. In fact, applying a rule in the wrong situation can lead to disaster.

Sound familiar? This passage seems terribly similar to the Chair's concept of ever-changing cycles. Trading strategies must be adapted to shifting market sentiment and the Mistress's ability to punish those that cling blindly to what has been working for them.

The general seeks a quick victory, not lengthy campaigns; extended operations exhaust the treasury and the troops. The commander attacks only when the situation assures him victory. By threatening in many directions, he seeks to disperse the enemy to defend everywhere. If defending everywhere, the enemy is weak everywhere. As water seeks the easiest path to sea, so armies should avoid obstacles and seek avenues of least resistance.

The Mistress works to disperse us, the enemy, by spreading market myths and useless information from global business new outlets. Once weakened, the Mistress attacks and scores victory. Counting is one of the ways to combat this strategy and break-thru the myths and other market noise. Statistical studies and deep financial analysis combined with rationale business sense is probably our best, if not only, defense against this method of attack commonly employed by the Mistress.

Another lesson learned from that quote might include the need to stay within your strength - or build-up new areas of strength before venturing off in different directions. Trading only when the advantage is solidly in our favor will help to ensure ultimate victory.

Steve Ellison responds:

I eagerly look forward to the full review, after such insightful applications of just the introduction. One of the early proponents of contrarianism, Earl Hadady, argued that extremes of sentiment concentrated strength on one side of the market. If, for example, 80% of participants in a futures market were bullish and 20% were bearish, one could infer that:

1. The average short held 4 times as many contracts as the average long
2. The average short therefore had far more financial resources and was better able to withstand an adverse price move than the average long
3. Thinly capitalized weak participants were concentrated on the long side

30-Apr-2006
Dollar/Yuan Rate, from Sushil Kedia

A currency becoming stronger improves the purchasing power and hence may not be seen as economically worse than having a weakening currency where purchasing power actually goes down. In the immediate term this holds. Every example of a currency going real weak has brought in its wake circumstances similar to those in Zimbabwe or Indonesia. Please give one example where a strengthening currency produced a situation anywhere close to this. No, even Russian society went asunder once the artificially maintained high value of the Ruble came to terms with market value, not before.

However, a strengthening currency while raising PP assumes the risk of being witness to a depleting reserve (higher imports lower exports) on the trade account, yet on the capital account more and more investments would flow in. So, like all other optimality problems it's an ongoing discovery and adjustment of the variable values to ensure a balance between improving internal quality of life and maintaining sufficient forex reserves.

Irrespective of whether a nation is a borrower or a lender, a stronger currency helps in retiring external obligations cheaper.

So, why is everyone in the world ever since I have been an adult bothered about ensuring more exports, less imports, weakening their own currencies and strengthening others'? Are all of these mantras not part of a grand-meme?

Until a nation like China while under-cutting every one else on pricing (due to a suppressed Yuan) AND also because of focusing on producing quantity and not even bothering about quality is appearing to be building pressures on the trans-national corporations' competitiveness in selling, who else is really having a problem? Let's make an assumption that Yuan peg will not break for a long time, then what happens? Will it force manufacturers in the rest of the world to be worried about profitability competing against the 5 cent batteries, 10 cent dolls, 15 cent perfume packs churned out from China? If at a lower purchasing power of its currency China starts investing in quality improvement, pollution control, discoveries and inventions it has lower odds of turning a better competitor. Yet at a stronger Yuan it would cost them lesser chips to take on a Mitsubishi or a Caterpillar or a Skoda.

Now, focusing on Mr. Kipnis's question on how does the US break the Yuan peg? Well, in enterprising China as you point out with one of the possibilities and a hundred others, over course of time like water and like markets the Yuan will find its level. Why only the Chinese businessmen, but even all other businesses that are owned from elsewhere but run in China could be exporting through intrepots and havens to the rest of the world. Like water, the Yuan will also find its level.

However, what bothers me most, when markets do find their levels, why bother to encash one's own chips at a discount? Or is it that rather than do such independent thinking, it is better to focus on what was taught in Economics 101 at college?

30-Apr-2006
Misperceptions -- Badminton and Rowing, by Pitt Maner

There is a world of misperception out there. And I am no doubt as guilty (or more so) than others on a variety of issues. But if one checks things out, counts (as this board strongly recommends), gets in the pits, puts one's nose to the grinder, consults with many, does due diligence and employs a hands-on approach, the miasma of misperception tends to recede -- and very quickly -- particularly in the field of sports.

Oh goodness, they say, badminton is such a child's game and so, so, utterly easy. Having played a bit of badminton in a college gym class I can assure you it is one of the most difficult racquet sports you can imagine.

You can't be serious! Well, yes I am. A Pakistani expert player once challenged me to win one point to his 15 or 20 for a case of Heineken -- fortunately I wisely avoided that losing bet. In the hands of a skilled player a feather shuttlecock can be barely dropped over the net (think "drop shot" in tennis) and then driven deep to the end line, over and over again until the novice player is totally exhausted after one point. It is a game of incredible touch punctuated by tremendous smashes. Yes, there is a similar game played in the backyards across this country--it bears little resemblance to pro badminton.

Several years ago a "personal trainer" was giving a tour to a new member of the gym I belonged to and stopped before the rowing ergs and stated something to the extent that these machines really did not provide much exercise and were amongst the easiest of exercise equipment to use. There is a lot of literature on this subject, but I can tell all from first hand experience that rowing is incredibly demanding and a sure way to test your tolerance for painful lactic acid buildup -- and a great way to stay in shape. Yes, you can go easy on your workouts and still get benefits, but the English don't call it a Weapon of mass reduction for nothing.

In my 30s I stupidly bragged to a veteran Navy SEAL while working on the former Roosevelt Roads Naval Air Base in Puerto Rico that I had done 2,000 meters in 7:02 minutes on a rowing erg (during the best shape of my life, age 37), which was a machine the SEALs used for training -- and he seemed impressed. The SEALs to me were and are some of the most impressively conditioned and courageously strong individuals I have ever seen. Watching them run hills all morning for hours with packs on their backs is a sight I will never forget. Incredible mental and physical discipline. Very inspiring to see.

A friend of mine, a former English Jr. Olympic rower who is about 80 pounds lighter, 5-inches shorter, and in his 40s (and just started getting back in "shape" after years of light training) recently mentioned that he is doing a 7:02/2000m now on the rowing erg -- no doubt on his way back to 6:40 min -- 2000 meters times. How bloody irritating! Psssssssssssst the air exits the ego balloon.

Morals of the story--the game is played on a far different level amongst pros -- say several orders of magnitude better. You may be stronger than average in some areas but the pros are stronger across the board and they are training every day starting at 6 AM. Don't foolishly assume something is easy until you try it. Be very humble, because there are a lot of people out there who are as good or much better than you. If you want to approach a pro level you need to do an awful lot of work and respect those who have done the work to get where they are and try to learn from them.

28-Apr-2006
Hunting Easy Water, by Andrew Moe

Each day, we load up our account balance to some degree and head out across the mighty river of the market, hoping to pocket a bit of overplus for safe passage to the other side. From past history, we know the drift and thus can calculate the optimal average path to the other side. But as anyone who has ever tried to ford a river knows, localized conditions can be far from optimal. And when a big steamer plows upstream seeking easy water, even the best equations go out the window. But thinking about drift when you think about market moves is critical and I would suggest looking not only at the overall stats but also at short term 'crossings' before diving in.

"We fixed up a short forked stick to hang the old lantern on; because we must always light the lantern whenever we see a steamboat coming down stream, to keep from getting run over; but we wouldn’t have to light it for upstream boats unless we see we was in what they call a 'crossing'; for the river was pretty high yet, very low banks being still a little under water; so up-bound boats didn’t always run the channel, but hunted easy water." Huck Finn (Mark Twain)

River Crossing Problems:

Minimize the Total Time

Model with Islands in the Middle

Physics Classroom

28-Apr-2006
Squash, from Justin Klosek

Recently, I have expanded my exercise regimen by taking up the fine game of squash. The club here will set up matches at my skill level, which is great: I have played some fellows in my office, guys who could lose 40lbs, a guy who is 5'3", 120lb soaking wet (I'm 6'9", about 240), my futures broker, and a fine gentleman who is probably pushing 70 years old.

Every single one of them kicked my butt!  It hasn't even been close.

While I am improving -- I hope -- this experience has shed some light on markets. Indulge me:

1. Focus. Sometimes I will win a few points in a row (once, even a whole game). This is entirely consistent with randomness. But after 3 points in a row, I start to think I know something, and start to plan the phone calls to my friends ("I won!") -- and sure enough the focus wanes and I lose the game and match. I need to shut that part of my brain off and just play. There is always time to discuss victories years later--provided you actually win!
2. Humility. Sometimes -- again consistent with randomness -- I can put a few good shots together. Wow, I think, I can dig the ball out of the corner/hit a boast/return that serve. And as soon as I think I can, something new happens, and I lose the point/game/match.
3. Deception. Fortunately many of my opponents have been very willing to offer pointers on how to improve my play. On Wednesday I was pretty well schooled by my futures broker. He would be in position, take a full backswing, and see how I reacted. If I guessed hard shot, staying back in the court, he hit it softly. And vice versa. I fell for this over and over again -- but I wasn't in position to stop it.
4. Anticipation. Let's say I actually hit a nice rail into a corner. My opponent's return (at least at this level) will probably not be strong, and will most likely go to the opposite corner on the front. I can move a little forward in the court to anticipate where the ball will hit so I can put him away.
5. The perfect shot isn't necessary. I don't have to hit a low screamer right above the line to put someone away. A softer shot hit a little higher on the wall works just as well, and does not carry the risk-of-ruin inherent in the low screamer.
6. Mentoring. Following the above point, there is much I can learn from those who are willing to teach me. I just have to listen and be open to their suggestions.
7. Off the desk. There is nothing like getting off the desk and away from the blinking prices. Clear the head, get the blood flowing. Sparks the creative juices.

I have an 11:30AM game today.

Gabe Carbone notes:

I'm a pretty poor squash player (not only by list standards, which are obviously quite high, but also by most other yardsticks).

One thing I can tell you, however, is from the book Taking Chances: Winning with Probability (Paperback) by John Haigh. Given equal skill, the player who has the first serve has a 0.52 chance of winning the match. (This only holds for the standard club rules of playing to nine and having to win serve).

So, next time you have the first serve, be sure to press your advantage!

28-Apr-2006
Cul de Sac, from Victor Niederhoffer

The market today reminds me of what happens when the Mafia captures a victim and puts a bag around him for carrying to the forest. He struggles so hard at first but then eventually he hangs peacefully. The Mafia, according to Puzo, changed their tactics in recent years to handle their murders with much superior force to prevent that initial struggling.

28-Apr-2006
Thoughts on China, from Yishen Kuik

I was at a dinner last night where a Chinese professor from Yale was speaking on the Chinese historical experience with limited liability corporations and the stock market.One anecdote was especially memorable. In the 60s, 70s and 80s, when the great powers in the world were engaged in the Space Race and other feats of technological one-upmanship, the Chinese decided they too needed to prove their prowess in scientific invention and engineering to show to the world they too were a great power.

The thinking then went - to have great progress in science and technology, you needed two things 1) lots of scientists/engineers and 2) lots of capital.

So, China proceeded to push tens of thousands of engineers and scientists through its universities. Since all national savings were centralized through the State, the State had unlimited resources to put at the disposal of these engineers and scientists.But no great science or technology emerged.What was lacking was incentives?

The Chinese stock market was reintroduced in 1990. Hong Kong and its exchange was returned to the mainland in 1997. Today, Chinese entrepreneurs like Robin Li, a youthful multi-millionaire after the IPO of Baidu and others are the poster children of success in China. His storie and others like him are igniting a frenzy among the engineers and scientists, excited by the possibility of IPO riches.

If Chinese companies continue to produce successful IPOs making young men rich, the long awaited results from combining talent and capital may yet take place in China.

28-Apr-2006
Thoughts on Russia, from Dr. Kim Zussman

In my travels and experience with modern Russia:

1. The average Russian is not only religious, but also very superstitious.
2. They are nationalistic in a way different from America. Northern Russians consider themselves a Russian race (i.e., Jews, Azeris, etc are not Russian), and this race identity manifests itself in language, culture, arts.
3. They have trouble living down the great ironic lies; that virtues described in Russian writings and music are the exception in real life, which is replete with dishonesty, graft, corruption, infidelity, alcoholism, etc.
4. MAD (mutually assured destruction) of the post WWII period has lost potency, and the vacuum has been filled with Russian oil money and its influence.
5. Most of the time Russia will take the other side to the US, in part out of competitive envy and in part to pad its influence account.

The fact that Russia sits on huge oil while having military deterrence makes for a formidable opponent.

27-Apr-2006
"Make It An Old-Fashioned, Please" from Victor Niederhoffer

From "Make It Another Old-Fashioned, Please" in Cole Porter's Panama Hattie:

                Make it another old fashioned, please
                Make it another double old-fashioned please
                Make it for one who's due to join the disillusion crew
                Make it for one of love's new refugees
                Once high in my castle I ran to you
                And oh what a castle, built on a heavenly dream
                Then quick as a lightning flash, that castle began to crash
                So make it another old-fashioned, please

Today I woke up to find the S&P 500 down 8 points, its biggest overnight decline since July 7 when it opened down 12 points. I looked at the headlines and sure enough Ben Bernanke was scheduled to testify in Washington. It turned out that he was scheduled to testify before the Joint Economic Committee -- twice a year in April and October without specific dates.  Like the old times I immediately said "darned Humphrey Hawkins Testimony!"

Now, of course, there hasn't been a Humphrey Hawkins testimony since the late 1990s. However, there's a monetary policy report to Congress that's semi-annual in February and July where the Chairman voluntarily tries to walk between the Scylla and Charybdis of economic growth and inflation while advancing the power of the Fed and maintaining a Delphic persona. But it's an old fashioned reaction to think it was Humphrey Hawkins and it was an old fashioned kind of day. The market eventually opened down 5 points at 1304 (an eight-day low) and quickly moved to 1300 to induce liquidations and squeezes. All who follow trends, pivots, and follow the fear factor in general were liquidated and like the old fashioned corners on Wall Street, once the weak holders were out, the wives wouldn't let the old timers reach for their canes. So it was fair game to take it up to within a whisker of the six-year highs at 1321, just 4 points below the 1325 high of last Thursday.

In any case, the move got me thinking of how to tell if you're truly old fashioned so that you will better be able to circumnavigate squeezes like this in the future with a historical and disinterred view of your cane in the grandstands. Here's a list that I came up with to tell if you're old fashioned .

How to tell if you're an old fashioned market persona:

1. You wait for the money supply to come out each Thursday as the key to moves in the fixed income and stock market.
2. You refuse to buy stocks until there's a true selling climax where not one weak long is left in the market and there has been confirmation of a rise.
3. You follow Western Union, AMF, or General Motors or JDS Uniphase as the bellwethers.
4. You still think of IBM as the leading computer manufacturing company.
5. You believe the greatest trader of all time was Gann, Livermore, or the Large Man.
6. You're waiting for Granville, or Prechter, to turn bullish before you get back into the market
7. Your favorite game is checkers and you remember seeing the game room at the Big Board or the Ocean Liner or the barber shop where all the checker boards were set up.
8. You love to be spanked on the bear side by female market technicians with very great legs who may have appeared in a nylons ad.
9. You refer to the phone as "the wire" and a CD as a "tape".
10. You have to have the 20-year-old in the next seat show you how to turn on the airplane media system.
11. You don't own a handheld video game, and you listen to  music and books-on-tape on a cassette recorder instead of an iPod.
12. Your greatest computer proficiency is on a VAX or Wang or Radio Shack TRS-80.
13. You refer to any squeeze engendered by a Fed Chair speaking in Washington as a "Humphrey Hawkins deal".

I am open to other signals of old fashioned thinking so that we can at least know what the characteristics of the disease are, so that we will have less tendency to succumb in the future.

George Zachar notes:

I sometimes still think of a price screen as a "Quotron".

Andrea Ravano adds:

1. You wait for the fixing of European forex cross rates until it's bed time.
2. You believe a certain stock is moving up/down because KIO (Kuwait Investment Office) is moving on it.
3. You wait for central banks interventions to moderate an upward/downward move in the dollar.
4. You call the British Pound "Cable".
5. You offer a lady your seat.
6. You don't find VHS films for your VCR because at your local shop they have only DVDs.
7. You razor still has only two blades.
8. Is Kaufman still at Salomon Brothers?

Duncan Coker offers:

I Couldn't find much on short squeezes, oddly, but I liked this one:

One of the strongest anomalies of speculations is in the facility with which men are induced to take large risks on false information and manufactured "points" . Considering the readiness with which a numerous class of "outside" operators buy or sell on sensational rumors, its is not surprising that the professional operators should keep the market well supplied with decoys: and it is not easy to say which most deserves condemnations-the heedless credulity of the dupes, or the deliberate lies of the canard-makers. -- "Twenty-Eight Years of Wall Street"

Perhaps today and all week with every economic number of strong news pointing to rate increases, then China raising rates today, it contributed to false information and squeezed first, the longs, then the shorts.

Easan Katir adds:

1. Nifty Fifty
2. Hotchkis & Wiley
3. Engraved stock certificates
4. High commissions
5. Expensive data feeds
6. Ticker tape parade
7. What's good for General Motors ...
8. Reading 'paper' newspapers
9. Fortran, Basic
10. Depositing cash at a brokerage office
11. Sam Walton hula'ing on Wall Street
12. Bearer bonds
13. Gold mines ( oh wait,,, that's new-fashioned too )
14. Triple-A credit ratings
15. Suspenders, power ties, horn-rimmed glasses
16. Bankers 3-6-3 rule: borrow at 3%, loan at 6% get to the golf club by 3 pm

Peter C. Earle contributes:

1. You've got a couple thou worth of Prussian bonds in the old safe. After all, you never know...
2. Just how long *is* the hem on the office girl's skirt this quarter?
3. You don't worry about missing the Friday session - after all, the market will be open for an hour or two on Saturday morning.
4. "As goes GM so goes the nation!"
5. Despite having merged with the NYSE, to you, ARCA will always be plucky little TNTO.
6. You remember any of the following OTC acronyms: PENL; SYND; BIDW; OFFW.
7. You know what a dealer saying "out to competition" or "stale" means.
8. You are aware that "program trading" did not, for the first couple of years of its existence, involve actual programs.
9. A *fax* machine? What can that do that your Teletype cant?
10. You could be sure - if just from the commissions you were charged (*ahem*) - that there was a difference between a *held* and a *not held*order.
11. The mile-long lines out the door of the WTC Krispy Kreme. (Alas.)

And, (For Lack) You recall any of the following:

• The "five minute" rule;
• A three-foot-high wall you had to lean over to yell at inputters if you weren't registered;
• 200, 500, and 1000 share "SOES tiers";
• A cottage industry around "backing away" complaints;
• SelectNet broadcast vs. "preference";
• 150K shares per day being inconceivable;
• "All-Tech", "First Westchester", "A.J. Michaels", "Cornerstone", "Heartland", "On-Site"..
• Block and Burke on the cover of Inc Magazine in 1997;

Ah, memories.

27-Apr-2006
A Good Market, by Victor Niederhoffer

The question arises: What makes a good market?

As a preliminary step in this direction, I counted the number of times that various representative non-stock markets are up in conjunction with an S&P 500 rise of 40 full points, in the last 20 days, a mark which it set some 17% of all days in the last 6 1/2 years.

All independent variables are measured over the same contemporaneous 20-day period that the stock market was up 40 points, i.e., the query is what were the concomitants of a great good market. (Thus in part we are making the same mistake that Sornette and so many others make by concentrating on the likelihoods of an extreme up, not taking into consideration that the same variables that enhance the likelihood of an extreme up might enhance the likelihood of an extreme down.)

The answers were as follows:

Percentage of times that Markets Moved in Conjunction With The S&P 500 up.

   Market               % of co-movements
   bonds up                  53%
   bunds up                  58%
   Gold down                 58%
   Eurodllr down             62%
   Yen down                  60%
   Crude oil up              59%
   Natural gas down          55%

Now assuming perfect knowledge that a move of more than 40 full points has occurred in the S&P 500 over the past 20 days, what is the best quantitative forecast given perfect knowledge of the independent variables.

Here's the best perfect knowledge descriptive equation for the S&P 500: S&P 500 = 45 points + 3 times the move in bunds less 1 times the move in us bonds less 230 times the move in the euro less 1.5 the move in yen per dollar( a fall in yen per dollar means the yen is up and the dollar down). The key variable that describes and accompanies a big move in the S&P 500 is a decline in the dollar and a rise in bunds.

That equation has a r2 of 0.10 which corresponds to a correlation between prediction and actual of 0.3, quite helpful assuming you had perfect knowledge of all the independents and you already knew that the S &P 500 was up over 40 points over the last 20 days. None of the other independents such as gold or crude are significant.

Now, consider an unconditional description of the S&P 500 move over the next 20 days without any knowledge that it went up or down. That descriptive equation is S&P 500 = 3 points + 2 times the move in bunds less 2 times the move in bonds less 264 times the move in euro less 1.5 times the move in yen per dollar less 1 times the move in crude .

That equation has an r2 of just 0.04, thus the squared error in forecasting the S&P 500 over the next 20 days is reduced by just 4% even if you had perfect knowledge of all the other key independent variables during that same 20- day contemporaneous period. (Of course this excludes markets that are part of the US stock market like the Dax or the Nikkei.)

I have seen various other approaches to the philosophy of what makes for a good market including the amount of good news, the state of the p/e, the number of terrorists detained, the amount of positive news about the economy, the number of years into the Presidential cycle.

I prefer the approach based on market co-movements as it's less wishy-washy, but then again I know almost nothing about philosophic questions like this and would appreciate guidance from my friends and readers.

Abe Dunkelheit replies:

I would assume that people as a group tend to be more happy if they have steady and predictable returns over a long time period. Therefore, I'd define a Good Market as 'low' volatility around a 'normal' and 'long-lasting' drift rate.

In analogy to the life of a human being, 'long-lasting' means a long life; 'low' volatility means no exposure to stress or physical disease; a 'normal' drift rate means the right mix of emotional and mental stimulation (not too much nor too little) to have a fulfilled life.

Sushil Kedia comments:

A capital market has as its core function the allocation of capital. So, a good capital market would be one that refrains from repeatedly or regularly getting either into states of manic euphoric bubble conditions or even the severe depressive conditions where it saves the economy and its people from not allocating capital to fly by night fanciful operations or does not hesitate ever in facilitating the formation and dissemination of new capital.Through expansion of investment wisdom, sharing of knowledge and embracing openness to change societies, possibly, are endeavoring in sustaining the primary goals of their capital markets.

A good market is one which would reward the enterprising astute risk taker and one which does not bring about passive investing as the best option. Such a market would also continue to place premium on credibility, prevalence of trust and, ideally, be self-regulated well enough to keep external regulators, the public and the media in harmony with itself.

A long-lasting attribute akin to the human life is for a good market to show its resilience to overcome challenges and difficulties that would be part and parcel of its existence. A good market would foster institutions of disseminating education to its participants, instill proper risk controls for executing fairness of dealing and sustain liquidity to ensure longevity and survive in the face of adversity to come out as a stronger institution. It would be a vehicle for helping achieve and sustain the cherished societal goals of fostering freedom of choice, fair exchange and productive economic contribution.

27-Apr-2006
Lies, from Hany Saad

In today's society, there is a fine line between lying and deception. When one assumes a person is a liar, one dismisses anything this person says. This is where the folkloric expression "with a grain of salt" comes in. However, a generally truthful person can and will lie if subjected to a certain amount of pressure. The distinction between the two, while a fine line can make all the difference between the survival of a society, a relationship, etc, or their demise altogether. This largely depends on the open-mindedness and the forgiving ability of the partner subject to the lie.

I personally hate being lied to. With the exception of violence, it is the worst thing you can do to me. Lying is in essence is stealing. One takes a lie to be true and as a result invests time, or money, or even love and care based on the lie. Everyone agrees that lying is morally wrong even the most astute liars. It's curious how they can be very defensive if accused of lying. Lying creates a short term advantage for the liar (seemingly so), and frequently only in the liar's mind. A liar naturally does not like being lied to; so he/ she is operating from a premise of inequality and possibly intellectual superiority (as no liar is expected to be caught in his lie) with the outside world.

Before I pursue my naive philosophical ramblings any further, I would like to dispose of the idea that, where lying is concerned, a lie is a lie is a lie. No such thing as a white lie, etc. Some people believe lying is more justified in one area than the other. I despise the distinction and would dismiss it altogether as hypocrisy. This may contradict "the pressured to lie" previously mentioned but I am possibly, subconsciously justifying my own lying, albeit infrequent, and the lying of my loved ones or, even worse, intellectually twisting my beliefs to fit my actions.

Once relationships evolve to become partnerships of equals, truthfulness becomes an obligation - a requirement more than anything. Truthfulness comes to the fore, as it does in any kind of partnership. With this expectation in mind, a miniscule lie or an intentional oversight of what one partner may deem a material information can make a partnership crumble or in the case of marriage, even if the two parties decide to overlook it for the sake of children, need (whether emotional or material), or whatever the reason may be, will always leave a bitter taste years and years after the lie occurred. This is providing that the partner subject to the lie was able to find out that he was lied to. Again, this is where the folkloric "what you don't know won't hurt you" nonsense comes in.

Please notice that all the above ramblings are not based on any religious beliefs. So let's not hear any lectures on Christianity, the ten commandments or how Islam is the solution.

The basic reason why you, as an educated and well balanced individual hate and should hate lies is because you wish to navigate carefully through the abundance of choices life has to offer and wish to do so with the availability of what you deem reliable information. The key word here is "reliable" ,in order to make educated choices / bets. Do you see the similarity here with the scientific method? processing "reliable information" to make scientific/educated choices. In markets more than anything else in life we are exposed to lies after lies. The chair uses elegantly the words "propaganda", "deception", etc., but what we are exposed to on a daily basis is lies. Unlike marriage where you would separate from a partner that lies to you constantly, you come back to the markets for more. In fact, you are expecting a lie even before you set foot in the fray.

The web of lying in the market is so complicated and sophisticated that it takes a very curious and sometimes a very suspicious mind to be a good trader. George S0r0s when offered to join a partnership with Vic and Dan at no fee asked "how much exactly is a no fee?"

Vic and his crew put statistics on the table to go against public beliefs (persistent lies). These are just two familiar examples of traders operating from the premise that the mistress is pursuing her nasty habit of lying to the participants. Some example of lies and some unquantified truths.

Lying about intentions: A trader puts an order to sell a thousand contracts while his real intention is to buy or vice versa.

Cliches (persistent lies):

• Never catch a falling knife.
• Losers average losers.
• Always safe to buy new highs/ sell new lows.
• Never answer a margin call.
• The tape never lies.
• The trend is your friend.
• Always watch the volume.

Unquantified and unquestioned truths from credible people and figures of authority:

When the chair asked on this list "why good problem solvers don't make good traders?" everyone in a rush came with a response justifying the statement. Now, is it true that good problem solvers don't make good traders? Did anyone consider that the chair's statement is possibly false?

Did anyone ask the chair for statistics on the table to prove or disprove his statement as he always asks of us?

I don't have the answer to this question and if I do, it is irrelevant to the main premise of this post. It's just an illustration of succumbing to higher authority statements (even unquantified) specially from people with historical credibility, in this case the chair. I am not questioning the statement but the lack of questioning.

James Sogi adds:

The line between truth and lies is even thinner. One person is self-righteously convinced of the truth of his words, the other convinced that those words are lies. Who is right? It is a difficult question in practice between people and there are many shades and circumstances that affect the judgment. In one sense, this is an area in which the markets are simple and 2 dimensional, and for that very reason so great. The transaction has been boiled down in our great markets to simplicity: buy or sell, up or down. No haggling, reneging, breaches. Tell whatever lies you want, just put your money where your mouth is. Oh would that life were so simple! Compared to the questions of life and death doctors deal with daily, or the judgments affecting lives in the legal process, the markets are refreshingly clear cut. There are no algorithms or neat formula to decide life and death.

For those who worry about other's lies, first look inwards and see what lies you tell yourself. Most deny the truth. So we live with lies clothed in the guise of truth, self-righteousness and rationalizations.

27-Apr-2006
Must read books, from Tyler McClellan

I would appreciate in the spirit of sharing, and for my own selfish interests of building a suitable collection of books to read for the summer, if everyone could share the one book, that in hindsight, has challenged or invigorated their mind most substantially. Of course books on trading, markets, et. al are always valued, but others are equally encouraged for hypothesis generation and filling out the mind.

I see Daily Speculations already has an overall List of Book Recommendations and a Spec Reader's List, as well as a substantial Review List.

I would like to see them augmented and will start with my submission. It is the three part series of Immanuel Kant's that followed his ten years without any written work. The Critique of Pure Reason, the Critique of Practical Reason, and The Critique of Judgment.

Nothing has challenged me as deeply, nor rewarded me so fully as this inspiring output.

Steve Leslie suggests:

I will submit Zen and the Art of Poker by Larry Phillips. I always recommend this book to anyone interested in poker. A very easy read. I guarantee a consistent review of the book will yield much at the tables. However, it has far wider applications to trading and life. In it are contained 100 lessons how to improve your general acuity to the game and much more.

From Stefan Jovanovich:

In honor of his birthday today, Memoirs by Ulysses Grant. 75 years after his birth in 1822 -- to the day -- Grant's Tomb was opened in New York.

Dr. Michael Cook offers:

I'm going to recommend a novel by Ken Follett, Pillars of the Earth. I have read little fiction over the years, but I discovered Follett last fall and have read seven of his novels since. "Pillars of the Earth" was the best - it is a historical novel, with great characters, great atmosphere. I will use a cliche that I never expected to use, but which is literally true: I did not want the book to end. It's a historical novel, set in the 11th century in the milieu of the cathedral builders of that time.

Richard Miller recommends:

Joseph H. Ellis recently published Ahead of the Curve. It's one of the better economic forecasting books that I've read. This Goldman Sachs retail analyst (the best in his business for 18 years) brings clarity to the host of economic numbers that we're inundated with daily. Further, it's an easy read, even for the economics challenged.

Consumer spending drives corporate earnings, which in turn drive stock prices. The chain of events makes perfect sense to even non economists: real consumer spending accounts for 70% of GDP, and it's directly related to hourly wage. The first has been an accurate leading indicator for the changing business cycle, the second a leading indicator for the former. Impressive work. Ellis maintains free updates of his charts at this address.

26-Apr-2006
Market Moves: Gold, from Victor Niederhoffer

It is interesting to contemplate the big moves in gold and their impact on markets. Monday, gold was down $12 (and silver down $1.20), one of its 10 largest declines of the last six years. It turns out that contrary to popular belief the move in gold is slightly bearish for future bonds, slightly bearish for gold itself and highly positive for the stock market -- up 80% of the time, an average of about 1%, over the next 3 days with a reasonable t-score. I say this not as a prediction but to try to get a handle on how the current double 10% daily declines in silver shape up vis-a-vis the markets of 1979 and 1980 which are so reminiscent of today vis-a-vis stocks, bonds, gold, and silver.

26-Apr-2006
COT, from Jason Shapiro

I've been trading metals based mostly on my reading of COT data. Important to note: I found out yesterday these data were changed a few months ago such that the long only commodity funds are classified as commercials, not speculators. This to me explains why the commercials have been getting long the last few months and therefore the speculators short. Given this new information it makes the COT data much less valuable and I am now out of all metals positions. What a world of randomness we deal in.

26-Apr-2006
Back To The Future, from George Zachar

For the first time in recent memory, an on-the-run treasury issue is trading with a sub-90 handle (dollar price).

This is the current long bond from Bloomberg:

4 1/2 2/36  89-20 /21  5.18 - 13+

"In the day" of high and volatile rates (circa 1981), most issues traded at substantial discounts to par. More recently, there were spans when "the list" was entirely trading over par.

But a treasury "par bond" trading with an eighty-something handle is something not seen for a very long time. And it is a good bet that many of the folks sitting before screens today have never seen it in their careers. I wonder if there's a round number effect here.

26-Apr-2006
Placebo Forecasting, by Steve Ellison

I am teaching a class for APICS certification and am covering measures of forecast accuracy this week. Sales forecasting techniques are highly relevant to trading, since entering a trade implies that one has a forecast for the market.

The standard measures of forecast accuracy are bias and mean absolute percentage of error. Bias is calculated by summing the deviations of actual sales from forecast and dividing the sum by the number of periods. Bias should ideally be near zero; a bias far from zero indicates that the forecast is consistently too high or too low.

Mean absolute percentage of error is calculated by sum (|A - F|/A), where A is actual sales and F is the forecast for a period. Mean absolute percentage of error provides a measure of the typical magnitude of forecast error, similar to mean average deviation.

I read an excellent article by Michael Gilliland in Supply Chain Management Review called "Is Forecasting a Waste of Time?" Gilliland argues that bias and mean absolute percentage of error measure the results of the forecast, but do not measure whether the process that produced the forecast added any value (in a corporation, the process might include inputs from multiple people and review and adjustment by one or more levels of management).

To remedy this deficiency, Gilliland suggests using a testing method similar to that used by drug companies. Drug companies have a control group that takes placebos in order to compare the efficacy of the drug with the placebo. Applying this concept to forecasting, one would develop an alternate forecast using an extremely simple forecasting method that costs nothing, such as forecasting the next period's sales to be equal to the prior period's actual sales. One would then determine the bias and mean absolute percentage error of both the "placebo forecast" and the real forecast to identify what value, if any, the forecasting process is adding.

25-Apr-2006
An Unending Meme, by Tyler McClellan

The list always looks at instances where the perception of events differs widely from the reality. I am thinking here of our look at the "terrible" dollar or unattractiveness of stocks since 1900 or other such. One that I have increasingly been hearing over the past couple years at all levels, that is at the street, at the undergraduate, at the professorial level, is some variation on a very simple meme.

America is going to be poorer because its economy is not sound in terms of mercantilism. The re-emergence of mercantilist thinking would surprise me were it not now so widespread as to almost be common place. And this is where I ask the list's help. Is it that as a liberal, raised and educated in the tradition of Adam Smith and classical economics, I simply don't understand the nuances of free trade. Is it as Krisrock says, "the numbers on free trade don't add up". Someone tell me once and for all, how is trading United States assets to foreigners for consumption going to make us poorer. Is it just the old argument that we save too little? That is, is it simply a neoclassical argument about savings rates and relative growth of capital stock over time? But what if the capital stock is being used to grow productivity and real wages(?) here in the United States just as much as in the savings powerhouses and if the growth rate of the U.S. in real GDP is greater than the cost of servicing our debt in real interest rate terms. Isn't the spread between real GDP growth and real interest rates in our favor, not theirs, and don't we want them to own the bonds if we get the residual equity and we can cover the nut?

So many thoughts and I ask these questions not in presumption of knowing the answer, but because I want to hear the many more enlightened opinions than my own. Is it me who is failing to get the joke by continuing to think America will prosper?

Sushil Kedia comments:

If China has more savings and more bad loans, while America has negative savings and relatively much lower ratio of bad loans even then the bears would focus only on the negative savings rate of America. Why? Because it suits them.

Since the public is always behind the form, the prevailing 'hammer America' meme exists in abundance for now, and only later the correct answer to the situation will be realized that China is consuming less than it is producing and wasting a good chunk of what it is saving, while America is consuming productively most of what it is producing and wasting little.

For more than a century India has had one of the highest savings rates in the world and, despite being ranked in the top five economies in the world in terms of overall GDP terms, it still remains one of the poorest nations. What is poverty or getting poorer?

Economics being a word derived from Oikos, is a social science of studying the choices made by households at the most rudimentary level. Social progress is what appropriate economic indicators have to be able to measure to be chosen for comparative assessments of poverty or wealth levels between different economies. Numbers like GDP or size of the debt do offer a comparison of the size of aggregates but not a good assessment of the components. So, the search is better focused on per capita ratio numbers between different economies.

Can I thus suggest to re-define the worry in terms of whether on average an American will be able to obtain better quality of housing, sanitation, health-care, social security, education, entertainment etc. over a period of time?

What is mercantilism? If Coke is selling sugared water in 186 countries in the world is the profit from this economic activity accounted on the Balance Sheet of America or of the world? If Nike is selling sports gear in another 180 countries or so, do its profits from that belong to America or to the world?

If consumption goes into hedonistic purchases of trophy towers, wives et al, it is destructive, agreed? However, if consumption gets restricted to the point of tying down the stomachs of a few family members to raise the bank balance, is that productive? The hunger-stricken in the savings powerhouses of the world have been creating an unending cycle of increasingly larger expenses for medical care, delinquency management costs and such other economic leakages. The optimal path is in between. The marginal utility function could very well then be applied even in choosing levels of savings and levels of consumptions. Leverage is never bad so long as it is not getting spent into hedonistic consumption.

If the degree of pessimism prevailing today is ignoring the fundamentals of the competitive advantage of nations, then I can't join an America bear simply because she has some numbers that might appear to suit her hypothesis. The answer is pretty clear as Tyler points out, the real surplus is the excess real GDP growth rate over the real interest rate. Since there is no real good measure of that, the bulls and bears have an undecided contest yet.

Thank you bears, for continually making your case out so compellingly well that it is getting to be so much more rewarding to be an America Bull.

From the President of the Old Speculators' Club:

In the past, when the above argument has been made I've replied that the author (or authors) have obviously been reading materials I'm not familiar with, or watching financial TV unavailable to me. Are there some bears out there? Sure, of course, always have been, always will be. But is it the prevailing sentiment?

Thought I'd never say this but: "Numbers on the table, please."

Stefan Jovanovich comments:

Even in an age of gold, the United States ran "crushing trade deficits". It had to. The "imposts" - i.e. tariffs on imports - were the principal source of Federal revenue, and Americans then as now preferred wherever possible to speculate with OPM. The periodic "panics" of that golden age occurred whenever the chronic savers (principally the Dutch, Scots and English) suddenly decided to curtail purchases of our less than sterling American paper. The Panic of 1907 had a slightly different cast but the same dynamic - an unexpected halt to expected funds transfers. (The difference was that the halt came not from investors but from property and casualty insurers declining to pay the claims from the S.F. earthquake.)

What saved Americans was that, for all our deserved reputations as scamps, we did not (with a notable exception for the poor Germans) exercise the sovereign prerogative of confiscation. You might get sold the Brooklyn Bridge, but the State of New York and the Federal government would not suddenly decide that your title deed was invalid because of your birth certificate. As long as that remains the case, capital will continue flow to the U.S. Foreign savers will need a place to gamble for higher returns with some of their money. As long as our casino remains willing to redeem its chips with no questions asked, we will get the play - even if the visitors usually pick the worst possible time to cash out and go home.

25-Apr-2006
Wavelet Methods for Time Series Analysis, by James Sogi

Wavelet Methods for Time Series Analysis, by Donald B. Percival and Andrew T. Walden, is another wonderful book in the Cambridge Series in Statistical and Probabilistic Mathematics. This series really hits the sweet spot for the spec-listers by discussing the cutting edge subjects from the ground up in a self study format with exercises, (with the solutions provided) and a web site with reference to S-Plus code and computational approaches. The authors carefully cover the underlying basic material on Fourier analysis which is a real bonus in reference to the Minister of Non Predictive Studies Fourier analysis posted on list. This series speaks plain English and S-Plus in addition to the basic statistical and mathematical framework and is accessible to the unwashed with a bit of work.

A wavelet is a small wave set in a limited time that grows and decays, as distinguished from the big wave which is a sine wave that keeps on oscillating up and down. The wavelet analysis is a transform of the data allowing analysis and re-transformation back into the original data form for aid to analysis. The wavelets under the formula are the Haar wavelet which is related to the first derivative of the Gaussian probability density function, and the Mexican Hat wavelet, which is related to the second derivative of the Gaussian probability density function. Wavelets are related to Fourier transform. The changes of the wavelets average amplitude changes over changes in scale allow analysis.

Average values of signals over various scales are used in the physical sciences such as 1)1 second averages of temperature and vertical velocity over a forest, 2) ten minute and hourly rainfall rate in a severe storm, 3) monthly mean sea temperatures on the equatorial Pacific, 4)thirty minute average vertical wind velocity profiles, 5) Yearly average temperatures over England. In physical sciences often it is the changes in the averages that are of interest rather than the absolute values, which of course is of interest to the speculator, the changes, rather than absolute numbers. The analysis looks at non-overlapping discrete intervals. The analysis allows study of time series that have scale based characteristics that are not homogeneous over time...in other words, market time with ever changing cycles,. Statistical analysis is performed on the wavelets. The underlying series can be then recovered. I am quite excited about applying wavelet analysis to the markets with their ability to express an autocorrelated time series in a combination of uncorrelated variables. The variables depend on a limited portion of time series leading to the ability to dealing with time series whose statistical characteristics evolve over time.

An example, by way of illustration rather than prediction, of possible use of wavelets is the moon problem discussed on the List. Fourier analysis did not detect a regular sine wave over the years that coincided with the moon phase, however, the discrete period analysis might show some movement within certain windows that evolve, say over the seasons, that might otherwise throw a sine wave function off. A lunar effect would presumably carry an evolving seasonal component as well frustrating Fourier analysis.

The wavelets can detect signal hidden by noise in a time series. The Professor should have a field day with these ideas and hope we hear from others on the list who have the technical skills to understand these matters better than a mere surfer. Often in these esoteric tomes lay hidden a few gems with code that can be used by specs and it is well worth wading through the tall grass to find them. Finding one could make a career or a meal for life.

24-Apr-2006
The Fallacy of Perfect Knowledge, by Victor Niederhoffer

Perfect Knowledge of the state of the market is not possible. While no great departure from the actual facts of life is involved in assuming this knowledge on the part of dealers when we are considering the course of business in Lombard street, or in a wholesale Produce Market, it would be an altogether unreasonable assumption to make when we are examining the causes that govern the supply of labour in any of the lower grades of industry. ... There may be a good deal of wayward and impulsive actions, sordid and noble motives may mingle their threads together. -- Alfred Marshall, Principles of Economics

One of the more common fallacies in performing market calculations or any others is the assumption of perfect knowledge. Here are some examples of where it comes up.

The bearish Fed signal. Naive commentators with an axe like those who write the Heard in the Street column are often guilty of this. "Okay, we know that the Fed is about to stop increasing the Funds Rate. What's the move in the stock market between the time that they last increased a Federal Funds rate, and the time that they reduced the rate. Well, I calculated it, and ha , ha, the stock market actually declines during that time. So if you're waiting for the Fed to decrease that rate, then don't. Ha, ha. I'm bearish."

The problem is of course that we don't have perfect knowledge of when they're going to end. Indeed there's an extraordinarily active Federal Funds market where depending on the slightest twist of a Governor's attempt to advance his political career, or use us as Guinea Pigs, billions are made and lost, and the implied probability of a rise at a given meeting is calculated to the fourth degree. Also, relevant is that the Fed generally reduces a rate after a stock market decrease. So if you assume perfect knowledge of what the Fed does you're also assuming perfect knowledge of what the stock market did during that period. Also, of course wrong, is the assumption that you can get the exact proper dating vis a vis time "just" before the announcement or time "just" after the announcement. With any event that has a macroscopic momentum like Fed tightenings and easings, there are only going to be a very small number of changes in direction and the variability is going to be so great that you'll always be able to come up with something bearish or bullish depending on how you choose the survival dates, like from the time of the fourth increase to the 10th, or what have you. (The problem of small numbers and the difficulty of predicting when death will occur is one of the reasons survival statistics are so good for studying markets, and why the hazard rate is so difficult to estimate in the game of life and markets.)

"Okay, we know that company x is going to report down earnings next year. How much can we make by shorting it with this perfect knowledge. And, ha, ha, the economy or company x has already announced a shortfall." Or "We've had a bull market now for three years without any 6% decline from a previous top to a bottom within a three-month period. What is the expected market move the next time that there is such a decrease. Ha ha, it's bearish."

We'll have to leave this version of the fallacy and a hundred others now to do some play and kid work but I refer you to An Introduction to Austrian Economics for a nice discussion of the philosophical problems of assuming perfect knowledge in a landscape filled with uncertainty. "Vast numbers of interacting individuals try to make the best use of all available means of want satisfaction... "

Russell Sears adds:

Prof. Gordon Haave said: "Yes... it is not specifics that lead to ruin, but a mixture of arrogance and ignorance."

It takes a lot of confidence to develop a talent, to become a champion. This is on display everyday in sports and art. But it is in the mettle of business, investing and life were we find out if the prefix is "over" or "self" confidence. There is a fine line between arrogance and the courage to try in the face of the unknown. One assumes you are greater than any risk you might face, the other knows you are not, but hopes to learn by trying anyway.

Dr. Michael Cook says:

This is a very important topic, and the Mises's link is one of the best resources on the web. If there was perfect knowledge, there would be no risk. There is no one who will admit that they think they have perfect knowledge, but we all act like we do, sometimes. There seems to be a universal human bias towards "overconfidence", a tendency to think that our interpretation of the limited set of facts we are considering is reality.

There is paradox here - it is hard to focus on what's in the periphery of our consciousness; to know what we don't know; to see what we are not seeing.

The investment implications? The need for humility, and risk controls, and a commitment to these as a policy.

Oedipus Rex is one of the most perfect plays ever written, and addresses these issues in an amazing way. Recall that Oedipus was made King of Thebes because he Solved a Problem! -- the riddle of the Sphinx. When the play opens he needs to solve another problem -- who killed the previous king, Laius? Oedipus sends for the blind seer Tiresias, who says that Oedipus is the criminal. In the end, Oedipus sees the truth, and blinds himself in horror.

Oedipus was guilty of hubris - he thought he knew. But as the old saw goes: "It ain't what you don't know that kills you, it's what you know that just ain't so".

Oedipus didn't have good risk controls. Given the prophecy that he would kill his father and marry his mother he could have instituted a policy of:

1. Not killing an older man
2. Not marrying an older woman.

His hubris was not acknowledging that there was a risk that his "knowledge" was false.

24-Apr-2006
A Book Review from Duncan Coker

I just finished Chalmers Johnson's book The Sorrows of Empire. The book is written by an author with a Libertarian perspective, which I happen to agree with so there may be some bias there. But the facts and research are thorough as some 50 pages of footnotes will attest. As a spec always looking for a way to make predictions based on the facts at present, I take some liberties at the end to maybe make a profit.

Most of the book is spent going in to great detail about the infrastructure of US military bases overseas, the history, the costs to build maintain and service (largely private) and the market place for arms and war type training. Much of this I did not know before other than generalities. For example Western Europe is still by far the largest area for troops and bases. After this Japan, Latin America, the rest of Asia then Middle East. The highest growth rate for bases is in Central Asia, Afghan region. The development of bases follows a general pattern of US warfare through out history where we occupy an area during war, then just stay. This started with Spanish American War where we picked up many of Latin American bases and oddly the Philippines (Spanish colony) which up to recently was a huge US base. The Guantanamo Bay base was acquired during this time from Cuban in their liberation from Spain and amazingly we held it through the Castro revolution and obviously still do. WWII was the next big push in bases including those in Western Europe (mainly Germany), and the entire island of Okinawa in Japan. In global total there are 750 bases, with about 500k individuals including families stationed full time. The larger bases can have value over $1 billion like the Prince Sultan base in Saudi Arabia, important prior to the second Gulf war. On average each base has a replacement value (the way the Pentagon values them) ranging from several million to over a billion dollars. The total value for all the base is around $200 billion in overseas real estate. Not a bad portfolio.

The second part of the book deals with the business side of running this not so small overseas business network of bases. Much of the cost to maintain and support these bases is subbed out to private contractors one of the biggest being Kellogg, Brown and Root, which is owned by Halliburton, They take in roughly $500m a year in defense dept contracts. Cheney doubled their sales to DoD during his time at Halliburton. The defense department gets a nice budget every year which has grown steadily through war and peace years. Cold war years saw budgets of around $280 billion. We are now spending $400 billion (all in adjusted 2002 dollars). This is only surpassed by WWII years where we exceeded $500 billion. To help support all of this is of course tax dollars. In addition, there is another lucrative source of income which is the global arms business. The US is the leader in the market accounting for 50% of the global transactions. We buy from companies like Lockheed Martin, recently award a $200 billion multi-year contact, and we also sell, exporting $15 billion a year in arms and training. This is largely coordinated by the DoD who take a commission or sells direct. Since these are issues of national security most of these transactions are classified. Our main customers include many of our allies like Japan, Israel and Western Europe.

The overall gist of the book is that the US via its foreign military empire has entered a period of (M) militarism. That is growth in the power of the military for its own sake and interests. The military has a large voice, 20 times the size of the state department in budget dollars. Characteristics of militarism include an ever increasing number of bases, a self-perpetuating business between DoD suppliers and spenders, a desire for greater resources, and the use of greater power in dictating foreign policy. Further the author makes four specific predictions for the future which are quite dire. He predicts:

1. a state of perpetual war
2. loss of democracy and constitutional rights
3. propaganda, disinformation and glorification of war
4. bankruptcy for the US

I will make my own predictions. I think 1-3 have and are occurring. The pendulum between security and civil liberties is swinging to the right. I find the size and entrenchment of US bases overseas concerning. I doubt many realize the scope. Not many foreign base here though. I am optimistic the pendulum will swing back the other way but this will take years and more hard lessons to come. Number 4, I think is alarmist and it will not happen. One of the odd comforts I have regarding trade deficits, government debt, social security deficits, bankruptcy, is the Treasury bond market. The 10 and 30 year bond is a real time consensus of global opinion on the long term state of the country. The world is predicting we will sort through these issues and work them out, and I agree.

Regarding how can I predict and profit from reading this book I have several ideas. HAL(Halliburton) and LMT(Lockheed Martin) are already at record highs, so the market is way ahead of me as usual. Is there a niche for getting into the arms trading business for me? It appears that this market is pretty closed off and opaque. This is the exact opposite of markets I like to trade. Transactions are not reported and no bids or offers are listed on any exchanges I know of. Possibly, I could create an electronic market for arms, or for derivative futures/options products. But it would be difficult taking delivery of most products if I get caught long, and hard to value as well; what is the value of a call option on an F-15k fighter, delivery point S. Korea.

Lacking that, I will have to settle for a global macro play. I am long the DoD for the war time years, which could go on for a while. How do you end a war on terror, or a war on drugs, or a war on "insert ideology". So, the Central Asian countries with names I can't pronounce like Turkmenistan, Uzbekistan, Kazakhstan and Kyrgyzstan are good bets. Time to set up a shop, like the merchants who sold supplies to the miners during the California gold rush. Or if they have an exchange or ETF, I'm buying. The boom is on.

24-Apr-2006
The Perfect Storm, by Steve Leslie

Does any man know where the love of God goes when the waves turn the minutes to hours?

I was reminded of these emotional lyrics written and performed by the Canadian songwriter and balladeer while watching "The Perfect Storm" on television last evening.

The movie was based on the 1997 novel by Sebastian Junger which was an uncompromisingly factual account of a brutal storm that attacked the eastern U.S. in October of 1991.

It was created like a type of a Frankensteins monster storm from a confluence of 3 individual storms fronts converging and thus forming what some called the Nor'easter Halloween storm of 1991 and others merely depicted as The Perfect Storm.

What gave the book instant credibility was that the author Mr. Junger neither speculated on things that no living man had seen nor invented dialogue. He developed a very detailed and descriptive account of the events surrounding the storm. He also gave insights into meteorology, the fishing industry, Coast Guard rescue operations, and how dozens of individuals were affected by the storm.

"The Perfect Storm" the movie is a well-crafted example of a film of pure sensation. It is about ships tossed by a violent storm. The film doesn't have complex and evolving characters, although a competent cast including George Clooney as the Captain of the ship Andrea Gail and Mark Walhberg as his able-bodied first mate has been put together. Both give very credible performances. In fact, one senses a particular strong bond between the two in a very paternal way. Other fine action performances are delivered by the crew which includes John C. Reilly and William Fichtner, two brutish mates who constantly war against each other. This feud has evidently developed over time and over the love of a fair maiden.

But these are not needed. It doesn't tell a sophisticated story and doesn't need to; the main events are known to most of the audience before the movie begins.

The film's best scenes are more or less without dialogue, except for desperately shouted words. They are about men trapped in a maelstrom of overpowering forces and most of the second half of the movie is filmed aboard the Andrea Gail.. The captain and the crew respond heroically, because they must, but they are not heroes; their motivation is need.

We know intellectually that we're viewing special effects. Tanks and wind machines are involved as are computer graphics and mock up models, but it is the impetus of the story which drives us forward, and by the end of the film I was drenched. One can criticize the sketchy character development in the film, but this would be pointless. The movie is about the appalling experience of fighting for your life in a small boat in a big storm. If that is what you want to see, you will see it done here about as well as it can be done.

Weekly Commentary from Dick Sears: "Tasty Pudding "

24-Apr-2006
Tim Melvin Challenges the Kentucky Ladies' Arm-Wrestling Champion

24-Apr-2006
Irrational Love, from Andrea Ravano

Can you fall in love with a stone? Hardly so, would argue any rational mind. One could raise the question of defining rationality, but than again the discussion would enter the realm of the really great ones, ancient Greek philosophers. To short circuit such a lengthy discussion I will assume that a rational human being will, on average, fall in love with another animated being. There have been some exceptions to this well known fact. The guard of the Mona Lisa room who ran off with the painting and kept it under his bed just because he didn't want anybody else to look at "his" Gioconda. Some racing cyclists fall in love with specific races. Lance Armstrong with Tour de France, Michele Bartoli with Paris Roubaix. Some traders have a "special feeling" with a certain financial instrument, some of us can trade the cash market better than the futures even though there is no difference, a part from leverage. I would have never thought something of such an irrational nature would have happened to me, but it did. I fell in love with a mountain, specifically Mont Ventoux.

For an amateur cyclist pedaling on this rock that emerges from the plains of Provence is breath taking. The mountain is some 6,000 feet. At the bottom you start with olive trees and finish in the snow. Everything is exaggerated, the harshness of the slope which is an impressive 7.5 pct average on the easy side (north), but in the end is above 10 pct. But most of all, each stone at every corner, tells you a piece of the epic of the greatest race on earth. There is the memorial stone in honor of Tom Simpson who died on the 13th stage, July 13, 1967 (speak of recurring numbers!) while climbing on the rocky side of the mountain. On that day, eyewitnesses recall, the heat was approximately 50 degrees Celsius, and the Briton was on a shot of amphetamines which proved to be too much for his heart. After each curve of the 21 km uphill your eyes move to the top in the hope of seeing the end to your pain. Because it's pain that you feel when your thighs push your shortest crank. And pain you feel as the sun starts beating on your head and shoulders. Yet when you are close to the top and you see the "observatory" you know you have accomplished a remarkable task. From the top the sight is breathtaking. Your eyes wonder to the extreme limits of the Mediterranean Alps to the north and the sea to the south, while in distance Avignon and Carpentras lie in the plain to the west. I guess less emotional folks wouldn't move an eyelid, but to this old "rouleur" the experience was enough to have him promise "I will return".

24-Apr-2006
The Merrie Monarch Hula Festival: Myth and Legends, from James Sogi

The Merrie Monarch Hula Festival is the world championship hula competition among Hula groups from around the country held in Hilo Hawaii. Hula is performed by singly and groups of beautiful women and handsome men set to ancient beats known as Kahiko, or modern songs known as "Auana". Hula is a dance which tells stories in an ancient and almost forgotten language about legends, myths, tales of bravery, love, wind, weather, romance, revenge, jealousy, humor and deception. Each hand movement and motion carries a meaning, and a story is told. Years of study is required to perform, but also to understand the meaning of various gestures and moves, which together with the enchanting rhythms and songs weave an intricate and compelling tapestry cloaked in majestic costume and choreography. legend of King Kamehameha's battle on the Alinuihaha Channel in war canoes, the revenge of Madam Pele, Goddess of Fire, at her sister Hiaka, who invented the hula according to legend, for her perfidy and the epic battles of the elements that raged.

While enjoying the pageantry, my thoughts (as usual) drifted to the markets. Like Hula, the Mistress of the Market weaves an epic tale in her movements. The moves of the market describe to those who understand legends of the rise and fall of Empires, such as the collapse of Soviet Union and the effects on bond spreads, the legend of the World's richest man, Bill Gates and his historic rise to fortune with Microsoft, the epic battles such as the battle of Baghdad beginning in March 23, 2003, or the story of the Hurricane Katrina in October of 2005. As in Hula, the market reveals her story and charms through her movements, with each movement a meaning. Study of hula and the market reveals meaning within specific movements evoking emotional responses or telling a tale heard before for which the ending may be legendary if you know the story and the rhythm. The Greeks, the originators of rational thought and science, rely on a rich history of mythology and legend. They, like the ancient Hawaiians, sought is to portray the unknowable, the matters of the human heart that science cannot solve, that logic, problem solving and reason are powerless to overcome. This is not to say that years of careful study cannot yield wisdom and knowledge as the myths and legend embody basic human reactions to events that will occur again and again and follow predictable story lines. Here the study of the ancient and modern texts about the legends of the market like Cornelius Vanderbilt, Daniel Drew, J. P. Morgan, and Victor Niederhoffer have timeless lessons to teach us all. The lessons are about the basic human reactions and emotions of hubris, pride, greed, revenge. The lessons are some of the most important to be studied by the speculator to avoid the tragedy that may befall and awaits the unwary.

24-Apr-2006
Counting Nadal vs. Federer, from Peter Gardiner

Here are some numbers from Rafael Nadal's recent victory over Roger Federer at the Monte Carlo Masters:

Total Time: 3 hours, 49 minutes

Score: 6-2, 6-7, 6-3, 7-6

                            Federer               Nadal

Total pts won                140                    155
First Serve %                 61                     70
Aces                           3                      1
Double faults                  3                      4
Unforced Errors               78                     39
Winners                       68                     44
Winner - UE                  -10                     +5
Break Pts Won/ Break pts     4/18                   7/14

Note: Match won by 15 points. Spread of unforced errors between Nadal and Federer: 78-39 = 39 pts. Even at the top it is still a game of errors.

Query: What kind of play in the point (t -1) is likely to produce an unforced error on point ( t ) ?

24-Apr-2006
Winning Points and Winning Matches in Tennis, by Prof. Charles Pennington

Here's a tennis simulation.

Suppose that over the long run, you win 55% of your points against your opponent. What is the probability, then, that you'll win a match against him? The answer's about 90%. A table is given below.

Each simulation simulates 20,000 points, 3278 games, 2795 sets, and 930 matches.

There's some obvious statistical error, and I haven't bothered to analyze it. For example, the table says that if you win 40% of your points, you should win 26% of your games. But it says that if you win 60% of your points, then it says you'll win 72% of your games. Those two numbers should be symmetric around 50%, but they're not quite.

The main point is that a fairly small edge in point-winning gives you a big edge in match-winning. Take that overhead, that aggressive shot, if you think you can put it away successfully 55% of the time.

column 1: probability of winning any given point
column 2: probability of winning any given game (given column 1)
column 3: probability of winning any given set
column 4: probability of winning any given match

          20.0%    2.2%    0.0%    0.0%
          30.0%   10.3%    0.0%    0.0%
          35.0%   17.0%    0.5%    0.0%
          40.0%   25.9%    2.8%    0.2%
          43.0%   32.7%    9.5%    2.5%
          45.0%   37.0%   16.3%    7.1%
          48.0%   44.5%   35.5%   28.8%
          50.0%   50.0%   50.0%   50.0%
          53.0%   57.0%   69.0%   77.0%
          55.0%   61.0%   79.0%   89.0%
          57.0%   66.0%   88.0%   96.0%
          60.0%   72.0%   96.0%   99.5%
          65.0%   82.5%   99.6%  100.0%
          70.0%   90.7%  100.0%  100.0%
          80.0%   97.5%  100.0%  100.0%

Dr. Kim Zussman adds:

1. You can't win if you don't play.
2. You should not play if you have no edge or no hope of maintaining one (see the 50% row).
3. The point/game/match edge is the same as for short/med/long term stock returns.

24-Apr-2006
Trial by Enron Part III: Opinions, by Prof. Ross Miller

24-Apr-2006
Earnings, by Victor Niederhoffer

You can always hit the earnings target, just sell more of the business. It's not something you can say, 'I can't do that'. That's a management decision of whether you want to do that. -- Jeffrey Skilling in his Enron testimony reported by Fortune .

The earnings numbers in the first quarter are always a full-of-information contest since it's the first report for the year, spending and pricing is sticky, and many aspects of financial life are on a budget. So far of the169 S&P 500 companies reported: 119 were positive surprises, 34 were on the mark or no surprises, and just 16 companies reported negative surprises. In terms of percentage surprise, the median positive surprise for the 119 that were positive was 7%, and the median negative surprise was -5% for the 16 that had a negative surprise.

Turning to the reported earnings versus last year's corresponding quarter, the average earning's increase was up 14% to 22% depending on the weighting. And of the 169 reported earnings: 139 were increases, 3 were unchanged , and 27 were below last year's figures. There are many aspects of the earnings reports that interest me, but I would like to focus on the companies that just missed or just beat the estimate. Given there are numerous ways that a company can adjust its earnings up or down, it takes a very honest company to report a one cent decrease relative to estimates. And the vast preponderance of companies that report an earnings increase of a penny or two, must be stretching on average. I hypothesize that the companies that beat by a penny or two are less trustworthy than those that missed by a penny or two. It is good to do this contemporaneously because there are too many adjustments and retrospections involved in looking back at what the estimates were at a given time and how they actually came out.

Here is a list of the positive surprises of two cents (18) and one cent ( 22): Two cent positive surprises: IMS Health, Broadcom, Leggett and Platt, Robert Half, Equifax, Gilead, Baxter, Costco, Regions Financial, Bed Bath, Danaher, Darden, National City, Lilly, Amgen, PNC Financial, Sensient and UnionBanCal. One cent positive surprises: NY Times, Oracle, Schwab, Texas Instruments, Qualcomm, Huntington, North Fork, Coca Cola, Stryker, Am South Banc, Bellsouth, Bank of New York, US Bancorp, Fifth Third, Marshall & Ilsley, Compass Banc, United Parcel, Johnson & Johnson, Torchmark, Auto Zone, North Fork Bank, and Parkvale Fin.

Here's a list of companies that missed their estimate by one cent: Dow Jones, Ford Motor, Motorola, Paychex, Hershey, Walgreen, Supervalu, United Health, Zions Bancorp, Concurrent Computer, Pacific State Bank.

Here's an approximate distribution of surprises:

Positive Surprises thru 4/21/06 of S&P 500 companies:

    Surprise            Number of Surprises
      50 and up           05
      25-49               04
      10-24               12
      05-9                31
      04                  10
      03                  16
      02                  18
      01                  22
       0                  05
      negative 1          09
      negative 2           0
      neg      3          01
      neg      4          02
      neg      5 to 9     03
      neg  10 or more     01

What can we say about a distribution like that. There seems to be many too many one cent and two cent positive surprises (39) relative to one and two cent negative surprises (9). Particularly striking is that there were not one two cent negative surprises, but 18 positive two cent surprises.

Most striking of all, is the accuracy of the Thomson earning's estimates that were used: 79 of 169 were within 4 cents of actual and 69 were within 3 cents of actual. (Differences in totals and enumerations occur because of the unchanged being fuzzy as to positive or negative surprises in various compilations) (These figures are based on pencil and envelope calculations based on Bloomberg reports) (Comparable figures for the % of companies reporting improved sales relative to the corresponding quarter last year and relative to estimate also show this 10 to 1 favorability ratio) ( A much better metric to measure all these numbers is the earnings change or the surprise in cents per share per dollar of price, or equivalently the total earnings change or total earnings surprise per dollar of price. However, as I must play as well as count, that will be left as an exercise for those who want to go beyond the norm.)

There are many interesting queries that strike one as one performs these tabulations. The most important question is what are the predictive qualities of these first quarter results relative to last year's actuals and this year's estimate, subsumed in these numbers. How has that relation changed over time, especially in the post Sarbanes Oxley era. What are the quantum numbers vis-a-vis surprise and actual versus last year that are good and bad for future performance? Are the reversals in actual or surprises a special class in themselves? What other special classes exist?

An Original Perspective from George Zachar

I've always thought of public company financial data first and foremost as highly nuanced signaling devices -- sometimes intentional, sometimes inadvertent.

The classic case, of course, is the company that always "beats the Street" by a penny, showing that it's "playing the game" [nod/wink]. This class of enterprise's financials must be read as one would peruse a simple press release composed by in-house touts. The silo company comes to mind.

Another category would be the precocious adolescent firm unwittingly showing its immaturity. An eponymous search firm and its odd tax burden miss come to mind.

Still another case would be firms with very well-publicized rot [GM, NYT]. Here, the company can be thought of as answering an interrogative, to wit, "How are you coping with that anvil on your toes?"

At the individual company level, there is much to be gained from parsing financials "in context", much as [cough] Fed watchers read the central bank's statements and analyze economic data.

I confess to being at a loss for a way to translate this analysis directly into a countable, predictive technique. I merely offer the above as a philosophic framework for approaching the question.

How to Explain Skewed Distributions Then? asks Prof. Gordon Haave

If we were to expect that the distribution of surprises would be roughly normal, then how does one explain the skewed distribution that the chair describes above? First, as we all know, companies have the ability to skew their reported earnings. So which direction do they skew them, and by how much? Let's make the assumption that any earnings skewing needs to be "made up for" later on. Therefore, one does not want to skew too high because it will not only need to be made up for later, but might also have the problem of increasing expectations as well.

One does, however, want to have positive surprise. The reason is simple. Every day I get a call or meet with a large cap growth manager. Almost every one of them has in their initial screen the necessity that a company have a string of positive earnings surprises. Many of them have in their sell discipline that if a company doesn't surprise, it's run is over and the stock needs to be sold.

Therefore, there is a great incentive to create a positive surprise, and $.01 or $.02 of positive surprise is enough to "have positively surprised" to meet the large cap growth screen.

Over time, however, consistently phony positive surprises need to be made up for. What all this means is that there is absolutely no reason to miss by a tiny bit on the downside. Instead, if you are going to miss on the downside, you make it a doozy of a miss. You frontload all sorts of costs, what that gives you is a multi-year silo to pull an extra penny out of every quarter to create that $.01 positive surprise so that you can get back into that large cap growth game.

Thus, a distribution of lots of small surprises, and very few small misses over big misses compared to small positives over big positives.

Charles Sorkin Reminds Us to Not Forget the Buybacks...

I suppose that it is also possible that the current strong pace of stock buybacks has been underestimated by the sell-side. We are still in the hundred-billion dollar range of open-market share repurchases, and even if an analyst got the gross earnings correct, the shares outstanding is a moving target.

24-Apr-2006
Speed Reading, from Sushil Kedia

Just picked up Tony Buzan's Speed Reading Book this evening with a promise it is the last book purchase for the time being. This had to be after, getting an ultimatum from my better half that any new book purchases adding to the tome of unread and unused books would draw severe penalties.

It appears to be helpful in solving several issues, other than being the perfectly convincing last crime right under the nose of my wife. Those not averse to eDonkey would find therein many of Buzan's other equally interesting material also. Recommend already despite being only on page 27. It's a do-it-yourself course loaded with creativity along with the usual explanations of reading speed logistics.

24-Apr-2006
Why Do Good Problem Solvers Not Make Good Money Makers? from Dr. Michael Cook

Victor asked this question recently, and it's been kicking around my subconscious. Here's an answer that occurs to me.

Gabriel Marcel said that "Life is not a problem to be solved but a mystery to be lived." There's something existential about trading which involves the whole person and is more than solving a problem. Decision making under uncertainty does not come up in problem solving the same way it does in trading. If you explore a possible solution, uncertain as to whether it will be right or not, you can always backtrack. Putting on a trade represents an irrevocable commitment of money - there is no backtracking. You can terminate the trade of course, but you bear the consequences of your decision.

You don't make money by solving problems but by making decisions. Therefore there's no reason why being a good problem solver would be a predictor of being a good trader.

J. T. Holley adds:

This one to has been bouncing around in my noggin as well. One thing that might shed light upon the dilemma is Nietzsche's words in "The Birth of Tragedy" where he discussed the Greek characters of Apollo and Dionysus. That being form, individualism, rationalism of Apollo and charisma, enthusiasm and ecstasy for Dionysus.

The problem solver obviously falls into the Apollo corner, but we can't be good solvers unless we can go outside the forms to find new revealing things to solve the problems that are created in speculation dealing with the ever-changing.

My conclusion is that you have to be both a good problem solver and at the same time not rational but spontaneous and ecstatic in pursuit of profits. The successful speculator would seem to be one that is both Apollonian and Dionsyian. As Vic talks about not just having a good end game but a good Beginning, Middle, and End game. Look at the examples of S0r0s, to me both Greek characters seem present?

Makes me wonder?

Sushil Kedia comments:

Most people say that is it is the intellect which makes a great scientist. They are wrong: it is character. -- Albert Einstein

Fortunately / unfortunately though character remains an uncountable attribute its capability to differentiate two individuals of the same 'level' of intelligence through a measure of their outputs is still clearly possible. In the context of recent discussions on traders vs problem solvers could we substitute the word trader for scientist in this thought from an all time champion problem-solver?

The character of a problem solver is finding answers to what he does not know, while that of a trader is surviving the unknown with what he already knows. A problem solver is working at finding edges, a trader works at living the edges.

It might appear that patience of being in there is a virtue for a problem solver, while for a trader patience is only a virtue before he gets in there. It's more effective to classify trading as a special class of problem solving that is time-bound. There is always a rate (ever-changing that too) which makes or breaks a trader, while the broader class of problem solving may still be beyond the bounds of time.

A long list could be built indeed. But would it be appropriate to treat traders as a mutually exclusive set from problem solvers? I contend that traders be seen as problem solvers who have identified and continue to improve upon the unique attributes of the trading related problem solving universe.

If indeed the market is seen as a perpetual machine then the problem solvers are not going to solve the problem of trading well. That makes an existence in the markets goal-less with ever changing dreams (and possibly nightmares). But, the moment a trader acknowledges the perpetual machine is reconfigured at each next moment of observation problem-solving trader could continue to solve problems of trading.

Undoubtedly, goals are dreams with deadlines. So, the subset of problem solvers who are engaging in trading have goals. If those traders who end up flowing with the intellectual freedom of the broader problem solving class into dreaming, obvious problems arise for them. The argument that wealth is built by investing (long te