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Thoughts Inspired by a Magnificent Party, from Victor Niederhoffer
It has been the invariable custom of this site to concentrate on meals for a lifetime rather than meals for a day but even the traditions of the English navy were said to bend when a ship sailed more than 2500 miles from home, and in this context the recent trepidatious seas lead me to break the tradition and perhaps add a foundation that might have immediate as well as ultimate value. In doing this, I am inspired by attending one of the greatest events of my life: the fiftieth wedding anniversary ceremony of my dear friend Larry Leeds and his wife Dahlia. Guests were greeted by 30 violins playing Viennese Waltzes and the Yale Whiffenpoofs singing traditional songs with the 25 piece Jimmy Vali orchestra in the wings and magnificent glass sculpture hanging from a shipshape tent with polished glass floors taking up a city block overlooking the Racquet Club and other venerable sites. The highlight was the celebration of a life and family that these two worthies, "has Larry told you how much he's up this year" and "no one has done more for Israeli-American fraternal relations than Dahlia".
As I left the party at 1 a.m., I had the opportunity to compliment Senator Frank Lautenberg of New Jersey for his heroic activities as head of ADP where he chaired the firm as it set a record of 40 years of consecutive quarterly increases in E.P.S. of at least 10%. His incredible creation of value of $25 billion for shareholders was noted, and the streamlining of the wheels of commerce that the company provides for the payrolls and tax filing of 600,000 businesses was noted, along with the 100 fold increase in the price of the stock under his tenure from a 0.09 adjusted offering in 1961. Regrettably, on his website is just one word about this heroic accomplishment, "businessman", sandwiched among his great feats as a Democratic politician. I will be sending him a copy of the book Masters of Enterprise, which reviews the heroic contributions to civil life of 14 great American businesses, and providing a review of the book on this site in the Senator's honor.
The speculative inspiration to me was the many colleagues of the honored couple on the dance floor dancing with canes. It reminded me that when the Fed first raised the discount rate to the 6% level, the adjusted S&P 500 stood at 11 and the Dow stood at 102. Caneologists who used their canes to buy during periods of grave market declines have had the wind at their back. It also reminded me that those who allow trepidatious world events to engulf them in fear, including the abysmal performance of markets when discount rates have risen to 6% in the past, have not participated in the 10000% forward march per century of the performance of the average randomly selected stock.
In looking at events such as last week's, I have found it much more helpful to develop a foundation from somewhat similar and recurring events than an isolated event like a raise in the discount rate. As my former colleague Prof. Ross Miller points out, the discount rate is purely symbolic because no one has borrowed at the discount window since when the rate rose above the funds rate three years ago. Proceeding from this framework, I note that the three main events of last week were a big decline of a few percent in stocks and the dollar, and a fair sized 1% decline in bonds. Considering any two of the events in combination over the last 10 years, I find that the outcome in the subsequent week is quite bullish, averaging a 1.0 - 1.5% rise by the end of the week, but that such moves are highly variable with a standard deviation of some 5%. Only six of ten such events have been greeted by a rise, and the period of 2000 and 2002, when such events tended to cluster, was very bearish indeed.
Going back to the beginning of cane investing in 1900, as I did in my Preface for Henry Clews's "Fifty Years in Wall Street," I found that such large declines in stocks have been quite profitable on average for Caneologists, except that you would have lost your shirt by following such a path in the early 30s and if you still had it, you would have lost that and much more in October 1987.
I generally eschew qualitative analysis because I respect the wisdom of the market and my own lack of skill in such pursuits, but I do notice the movements in Saudi Arabia. After a 300% rise in the three years ending 2005, the Tadawul index had declined some 50% from its 20000 high in Feb 2006:
Date Tadawul Sun 5 07 11345 Mon 5 08 11376 Tue 5 09 10598 Wed 5 10 10074 Thu 5 11 10046 Fri 5 12 closed Sat 5 13 11036 Sun 5 14 11934
Call it universal gravitation, pilot fish, or the flow of energy, I find such 20% rises on Saturday and Sunday a positive but non-quantifiable augury.
The dismal performance of the market following the announcement of a rise in the Fed discount rate to 6% over all past occasions since the founding of the Fed appears below:
Date SP 1 week later 1 month 3 month 1 year 01/23/1920 10.1 10.4 9.2 9.5 7.5 08/09/1929 28.4 30.2 31.7 19.9 20.4 05/01/1969 103.5 105.1 103.0 93.5 81.4 10/26/1977 92.1 90.7 96.0 88.6 96.0 09/04/1987 316.7 322.0 328.1 223.9 265.6 05/16/2000 1466.0 1373.9 1464.4 1479.8 1284.9 05/10/2006 1322.8
Such an event has happened seven times and on its surface it looks bearish for the 1-year period and neutral for the 1 week, 1 month, and 3 month period. The juxtaposition of five truly disastrous times, following Oct. 1929 and Oct. 1987 and May 2000 and May 1969 crashes and the 1920 Florida land crash, looks worrisome on the surface, but as the index started in the low 20s and ended at 1323, one must place this selective retrospecting of a particular level known to have been associated with bad events that has happened six times in 90 years -- the last three occurring over a 20 year period -- in perspective.
Rudolph Hauser adds:
Five of those times were in recent decades. Three, 1969, 1973 and 1977 were in periods of high and rising inflation. The most recent was in 2000, a time when the market had gone through a very sharp increase that might have discounted an overly optimistic exceptional rosy outlook. Today inflation concerns are far more modest and the market and has not experienced a wild advance. Before 2003 the discount rate was not intended as a penalty rate, as is the case recently when new rules apply. From July 1954 through Dec. 2002, the discount rate averaged 55 basis points less than the Fed funds rate. From February 2003 through April of this year it averaged more than the Fed funds rate by 98 basis points. In some of those earlier incidents, the Fed funds rate was a few points above the discount rate at the time the latter reached 6%. Consequently, a 6% discount rate today cannot be viewed the same as a discount rate in those past times. The market may or may not do well in the next few years, but I would not make the case that this discount rate level insures problems or is a major source of concern.
For the record, the Fed statistics show some minor level of primary discount rate borrowing in every week since the change in the nature of the discount rate. In the week ended May 10 it was $33 million. Two weeks prior to that it was $381 million.
Seven Deadly Sins of Poker, from Nick Marino
The Seven Deadly Sins of Poker are no different from those codified by St. Gregory in the 6th century.
Spassky, from GM Nigel Davies
As if I didn't have enough chess books already, this weekend I bought a half price copy of Boris Spassky's 400 Selected Games by Soloviov, which was reduced because of a scratched cover. It was interesting that nobody else had bought this first as it was far and away the best value on the store. Openings books were selling like hot cakes as usual, showing once again that players in general have no idea what they should be studying.
Perhaps Spassky's most remarkable feature was his adaptability. Having a 'universal' style of play, he could adapt himself to his opponent's weaknesses. So against Korchnoi he tempted his opponent to move his pawns too far whilst against Petrosian he exploited his opponent's inability to play methodical, classical chess.
The other thing I find interesting is his insistence on playing very solid openings, such as playing Black against the Spanish and using the old-fashioned Queen's Gambit Declined. Neither of these are very popular in an era which espouses unbalancing the position, but Spassky has demonstrated that victory can be sought in the middle and endgame rather than just the opening. And if the game is heading towards a draw then so be it as there's more time for tennis.
Steve Leslie comments:
In poker, there is a supporting methodology to Spassky's playing very solid openings and seizing the opportunities at hand in the mid game and the end game.
This is revealed in tournament play:
That is to play very tight in the opening periods of a tournament when the blinds are small. Players tend to be very loose on their calls at this time as it is inexpensive to enter a pot. Therefore, although there is a seduction to play along with the crowd, it is statistically advantageous to play tight or, in other words, play only premium hands and to be sensitive to your position with relationship to the dealer. Players have very little respect for raises at this point since they have very little time invested and much of the "dead money" is still in the tournament. Plus, you are probably playing with people whom you have not played against before and are unaccustomed to their style. You want to see the flop but only if it is inexpensive to do so. Understand that there will be many showdowns and it is important to have the best hand hold up since you may have one or more callers.
Later on, the players will tighten up as the blinds go up and the hours tick by. Now, they have much time invested at that point and are very reluctant to ruin the experience with a bad play. Plus, if you have been observant you will be getting reads on players and better evaluate their styles. There you can loosen up your game a bit and steal blinds and force weaker players out of hands. Ratcheting up play forcing action and making a few bluffs and semi-bluffs become more common. Here is where you attack the weak, and capture their stacks.
Finally, during the end game, it becomes a very aggressive event where there is plenty of all-ins where you are constantly pressuring the remaining players to make a mistake. The end game carries a personality all its own and this is truly the most enjoyable experience of tournaments. Ultimately, you will have many races and the one who wins the critical races will capture the crown.
Various Doctors, by Dr. Kim Zussman
Long ago, while married into a family of self-worshipers, each and every weekend was spent at one or another relatives. The sister, mother, grandparents, grand-sister of half-uncle. No need for friends since there was no time for them.
Such dungeons are crucibles for active minds that want to know, and invention was required. Around the same time some automobiles were available with "heads up display": Patterned after fighter jets, at night speedometer and other gauges project onto the bottom of the driver-side windshield, such that one could see the instruments without taking eyes off the road.
Aha! Relative specs! Eyeglass-wearers forced into relativity could have special glasses with heads-up display (only visible to the wearer), teleprompting reading material along the bottom margin of the scene. All you need is a mini wi-fi receiver, and semi-transparent LCD lenses (tell 'em you're coming down with glaucoma). While grand-aunt smarms the fascinating tale of her cat, you can daven along with feigned interest, all the while scouring the SSRN archives for alpha.
Since gum surgery all day leaves most of the CPU idle, it is not that different from working in a low-wattage Swiss patent office. So one feels pity for colleagues in the psychological arts, who are paid to listen (to those spurned by other listeners) and are duly thwarted from the pursuit of mult-tasking.
Besides psychotherapy practice, such specs might also be useful during billable hours for lawyers listening to tales of woe, or Fed chairs reviewing images of financial anchors.
Letter to a Newborn Son, Part II, by Victor Niederhoffer
You were named after two characters, Jack Aubrey, a very worthy character Patrick O'Brian and C.S. Forester wrote about in their series of books about the adventures of the greatest British naval captain in history, who traveled the world with great skill and overcame great danger to make the world safe for freedom; and Charles Darwin, the greatest biologist, who after a trip around the world discovered the nature of life and change. While both showed extraordinary abilities, mental and physical strength, study, science, and character -- friendship, loyalty, persistence -- in their quests for success, the heroic quality of Jack Aubrey is what inspired your first name.
Heroism is the quality of using great strength to overcome danger toward some noble goal. It is usually associated with the feats of heroes like Hercules and Odysseus and Aeneas who go on great, dangerous adventures around the world to right wrongs and make the world a better place.
Most of these hero stories have some common themes: travels far and wide, romance and peril with a great woman, grave challenges to born, the building of a home, a fight with evil characters and the achievement of great goals and the ultimate uncertainty about their fate and reputation. Indeed, you will learn all of life is a miracle in the sense that out of the millions of possibilities of sperm trying to catch the egg, the chance that any one will capture the prize is highly improbable. For you to be born, you had to overcome not only these normal great odds but the conjunction of many separately unlikely events. And yes, your parents had to perform some heroic acts of their own involving that were not entirely devoid of negative consequences to set the stage for your heroic turn.
Heroes don't have to conquer dragons or live in heavens. They can do everyday things and live in real homes. But they must overcome risk, and they must have lofty goals. Anything good that you achieve in life is going to be fraught with risk and uncertainty. Like Jack Aubrey and other heroes, to achieve greatness in life you are going to have to develop all the aptitudes and abilities that your genes and environment have given you to overcome these risks so you can achieve great things. You will have to realize that the road to achieve them will be as difficult as those that Jack and the other heroes undertook in fighting the French or discovering scientific principles; or, perhaps most important of all, being a wonderful and loyal friend, helping others to achieve greatness whether in his own family, his friends or his loyal shipmates. But at the end, if you approach life in a heroic fashion you'll go a lot further than if you follow the tried-and-true humdrum path that most of us must travel in order to deal with the ordinary challenges of life.
Heroism today is usually associated with the acts of policemen, firemen and soldiers. But the real opportunities for heroic acts come in your everyday life, after you've used everything you've been given to overcome some great danger or achieve a worthy goal. Your father has not been devoid of heroic qualities in his everyday life as a speculator. Nowhere are the dangers greater, the risks more daunting and qualities needed to surmount them more encompassing. Your mother is a hero also, because she has had to overcome a million obstacles that would have killed an ordinary person in order to achieve her noble goals of being a successful writer of thousands of articles, co-author of a book with your father, and mother at the age of 51.
These are just everyday examples of noble goals that can be achieved by everyday people doing everyday things if they have the courage and the heroic spirit and a heroic quest a la Jack Aubrey in mind.
The road to a successful life in many things including specdom which your daddy professes requires heroism. You must travel to all areas of the world of knowledge, including economics, psychology, statistics, physics, . You must experience all aspects of life, gambling, sports, trading, loss, victory, friendship,. You must be of good character to inspire friends , partners, and employees. Most of all you must have courage and inner physical and mental strength to overcome danger. The danger usually comes when there is great or small panic. That's when you have to take out the canes, both physical and mental that you have learned to step into the fray. But at a more general level, the courage you must have is to overcome conventional thinking, the ideas that have the world in their grip at any one time- that are designed to make you a good paying citizen in the entitlement or fixed sum society that the powers that be , whether in the brokerage community, or the market would have you play a proper role in. In the mortal case , which you unfortunately are rather than a God who cant die, the difficulties of heroic acts are even greater because you can die. So you have to make sure like Jack Aubrey that you never risk too much on any one battle so that you are killed in action. Related to this, when you do lose, you should always have the ability to escape, even if it requires like Jack Aubrey did in Post Captain to dress as a bear.
Paolo Pezzutti adds:
Being a hero requires extra qualities. You must possess an inner balance of capabilities, objectives and responsibilities you have. Every time you make a decision you have to weigh risk and reward with regard to the expected benefit and the costs of a loss. Which could be a life, money, honor and so forth. Clear vision of values you have to defend, the burden of the responsibilities you have (your men, your family, you employees, etc.) must provide you guidance whenever you decide to take actions risking something of your own and putting on the destiny's hands also other people's interests and lives. Most of all, I believe, you must be conscious of your capabilities, your value, your ability, your determination to reach the objectives of your actions. You must be ready to bring to sacrifice yourself and those you are responsible for. You must be ready ready to accept a defeat. With honor. And sometimes there is no escape. This is granted only to great men.
Christian Eyerman finds Heroic Passage.From The Autobiography of Andrew Carnegie:
There were two roads by which to return from my uncle's house in the High Street to my home in Moodie Street at the foot of the town, one along the eerie church-yard of the Abbey among the dead, where there was no light; and the other along the lighted streets by way of the May Gate. When it became necessary for me to go home, my uncle, with a wicked pleasure, would ask which way I was going. Thinking what Wallace would do, I always replied I was going by the Abbey. I have the satisfaction of believing that never, not even upon one occasion, did I yield to the temptation to take the other turn and follow the lamps at the junction of the May Gate. I often passed along that churchyard and through the dark arch of the Abbey with my heart in my mouth. Trying to whistle and keep up my courage, I would plod through the darkness, falling back in all emergencies upon the thought of what Wallace would have done if he had met with any foe, natural or supernatural.....
If the source of my stock of that prime article - courage - were studied, I am sure the final analysis would find it founded upon Wallace, the hero of Scotland. It is a tower of strength for a boy to have a hero.
Letter to a Newborn Son, Part III, by Victor Niederhoffer
There is a law that you'll discover called the law of diminishing returns that you're going to have to balance with the noble activities in your life The law is that with a fixed amount of a certain input, as you keep adding other inputs to achieve some ends the returns keep getting smaller The example that's usually used to show it is that if you have a certain amount of land and then you keep adding additional units of machinery or chemicals to produce something like wheat, the additional units of wheat keep getting lower and lower. But this universal law applies to all things that have input.
In your schoolwork, your first efforts at studying or doing homework are going to yield a lot more than your last efforts. The reason for this law is that we all have an unlimited number of things that give us happiness. Because we have unlimited desires and we're only human with a limited amount of resources, be they time, money or mental or physical strength, we have to sacrifice something to achieve any satisfaction.
The things we sacrifice at first to achieve our desires are the ones that are least costly, where the path requires the least effort or the least money. As we go down the road, the path is always a little bit more torturous, and the costs increase.
Because of this law, you're going to have to economize in what you try to accomplish. After something like 10% of your efforts in a particular field, you're going to achieve, say, 90% of the output that's possible. The consequence and the other side of the coin of this law is that the satisfaction you achieve by using your money or time are going to be greatest at the early stages of your spending of time, effort and money than they will be in the later stages.
They call this law the law of diminishing marginal utility, and the first law the law of diminishing marginal return. Both laws are a consequence of the universal law of the path of least resistance.
You will find consequences of these laws in almost everything you do. The number of toys you play with, the number of books you read, the number of girls you share romance with, the number of jobs tat you try, the number of sports you master, the number of jobs you take, the friends you associate with, the employes that give you the most value, the customers who give you the most profits, the times that you make the most money in the market.
Like all good things, there has to be a balance. You see, in order to really achieve greatness in anything, you're going to have to give it that little bit of extra. It's just because of the law of diminishing marginal returns that most people stop at the point where their additional inputs become costly to them. So if you want to achieve greatness, you're going to have to overcome the economical laws of diminishing returns and put in that extra effort -- stuff that's really hard and costly -- so you can differentiate yourself from the herd.
Letter to a Newborn Son, Part IV: The Importance of Books, by Victor Niederhoffer
The importance of books. If there's one thing that is the essence of the Niederhoffer tradition that is key to our being, it's the love of books. Three anecdotes will put this in perspective. I lived in a very small 1,000 square foot apartment. Yet there were more books in that apartment than in the 4 big libraries that I keep today and are written up in the World of Books. The other anecdote is that 5 librarians came to my father's funeral because every week he'd visit the library and take ouT 3 or 4 books and read them and return them with thanks. The third anecdote is that from the day I was born, and you were born my parents read a book to me every night, and I started the same tradition with you.
Books are important for so many reasons but the most important is probably that it can take you anywhere in time or space. It can take you back hundreds of years, or to any place or country or profession, or any situation when you read about what was happening then or there. It can take you to a world of any emotion like humor, suspense, activity, happiness, or pity.
The other reason books are so important is that they contain lots of knowledge. There's an expert on every subject and when they have something really enduring to say, they publish it in a book. They do this usually out of a love of their subject, a calling to communicate with posterity. That's one of the keys to books. They are made to last . They contain what's known about a subject that everyone should know as of the time they're written, and that people should still know in a hard form in a hundred years.
We live in a verbal society where people who can use words well gain power and respect. No better way to learn about verbal power than through books as almost everyone who's good with word eventually writes them. I'm proud to say that my mother and father wrote 6, including one they did together, and I wrote one and your mother and father wrote on together also, continuing the tradition. I am also happy that one of your sisters has already written a very good book, and she has another one coming soon. I hope you will be the third generation to do so.
One thing you should know about books. Take them in many forms. Read them, listen to them in the car or at home, listen to your parents or friends when they read them to you, talk about them in book clubs, ask your friends to tell you a story from books, or try to write some yourself. Each form will develop new levels of knowledge and happiness for you.
One way I have of really enjoying good books is to read best sellers like those of Louis L’Amour or Patrick O’Brian, or Frederick Forsyth, or John le Carre, or Colleen McCullough, or Tom Clancy. They know what things people are interested in, they can construct a plot that keeps you moving forward and ties together beautifully, they know how to get you excited and then release you, and they know how to talk about important things that make you happy. One thing that ties all these authors together is that they write about important things, and they research their subjects so carefully that you walk away from the book with tremendous knowledge of a new field, as well as enjoying your visit to a new world. I can’t conclude this paean to the importance of books without telling you some of my favorite books. Presumably you won’t like all of them now, but I can assure you that they each have been instrumental to the enjoyment and knowledge that I have picked up in my life. The one book that I find that I can read over and over again which people say is the greatest novel ever written is Don Quixote. It's a book about a heroic quest, to right the wrongs of the world, to protect the weak, to uphold romantic values, to make the world safe for women, to enjoy nature, to uphold friendship. And yes, it's a book about books because the thing that inspired it were all the books about chivalry outstanding at that time that were full of holes and mistakes.
I have a recommended list of books on my site that I'm constantly adding to so I'll refer you there for a little review of some of the essentials that will make your life so much better, and on the other side, not to have read them will make your life so much more empty --- Atlas Shrugged, The Patrick O’Brian series about Jack Aubrey, who you were named in honor of, starting with Master and Commander and ending with the Yellow Admiral, (which most people who love Jack and Stephen can never get to read because they're so sad to come to the end, Gone with the Wind by Margaret Mitchell (and be sure to see all the letters I have of hers that show what a great historian and wonderful women she was), Old Home Town by Rose Wilder Lane, Monte Walsh by Jack Schaefer, Moby Dick by Herman Melville, and a few books by Louis L’Amour, any will do but especially Hondo, or My Yondering Years or Son of a Wanted Man, or the Bowdrie Series, Memories of a Superfluous man by Albert J. Nock, Memories of my Life by Francis Galton, and some Shakespeare since he has shaped the western mind, and is Mr. Literature, and some Mark Twain, because everyone should have a little bit of Tom Sawyer, or Huck Finn, or the Connecticut Yankee, or the Traveler up the Equator, in him.
While you're at it you should read some of the most important investments books, and again these are reviewed on our site. Triumph of the Optimists, Trading Exchanges by Larry Harris, Horse Tradin’ by Ben Green, The Economic Way of Thinking by Heyne, a good book on valuation by Damodoran, and both of your father's books.
Start a library when you're very young and try to follow in your parents tradition of increasing it to beyond the previous generation and make the ratio of books to space in your house, exceed ours, and let their be a dozen librarians at your funeral. Love, Dad.
Sushil Kedia replies:
This is touching especially. In many ways than one can enumerate and write. Never in my wildest fantasies would I have been able to imagine when I picked up the Education of a Speculator 5 years ago in a book store primarily attracted by the title and its cover that I am getting a chance to interact with someone who is you...in every sense.
The most privileged findings of one's life, the most treasured learnings of one's endeavours is what each would cherish to coach one's younger ones to. Finding a teacher who is passionate about the role of teaching is in itself a life spending pursuit and then to land up before one who is including the privileged inputs most would reserve for their younger ones is clearly a situation that makes one feel genuinely lucky to get in the observing, retraining presence of a giant. Armed with such a sense of being 'special' makes one feel stronger to attack the negatives faced thus far in life.
The importance of fiction could hardly be over-emphasized. Repeating the cliché' that fiction is a mirror of the times one hastens to add that expanding imagination is a primary goal of expanding capabilities. Fiction in the most fascinating shades of imagination too originates from the human mind of fantasizing the possible. As an example all the writings of Jules Verne that may have appeared at their time as fantasies were fore-runners and harbingers of the coming times.
From a wide canvas of the human drama an avid reader of fiction does get trained entertainingly in imagining meaningfully. Hard skills that one obtains from reading and assimilating intelligence is possibly coated well with the soft skills' training coming from fiction helping one graduate to the application of the formal intelligence into diverse circumstances making the reader of fiction armed with more wisdom.
Whenever you find the opportunity to reflect upon the utility of fiction, it would be highly useful to read your views further.
As a related thought may be, last couple of days one has been imagining ways to configure standardizing interpretations of the fiction that corporate managements spew out in the Directors' Report or the Auditors' Reports etc. in the Corporate Annual Reports and other announcements and the embedded fiction in the research reports from sell side analysts and the strategy pieces from other stalwarts of the business including world famous debt fund managers and the significant bureaucrats who control the world's biggest money creation pump. Due to lack of programming skills' resources I am limited, but you might like to evaluate the feasibility and utility of an idea where say a standard dictionary like the Oxford etc. is plugged into a software with each word or the most commonly occurring words in the fiction and literature around Wall Street have been ascribed rankings on two variable scales: Uncertainty (risk) and Outlook (direction of reward). Then each piece of writing of relevance to a money merchant could be run through such a query to quantify the embedded uncertainty (focusing on words like unclear, variable, hazy, uncertain, contingent) or confidence in the text and the positivity or negativity of outcomes. Some pieces have more conviction, others are catering to tasty arguments leaving enough for the imagining of all prospects in the audience. Then a comparison with the conclusions of such a piece of fiction with the underlying quantification of the body of the text would possibly reveal what are the fears, mis-understandings, hidings, deceptions or the coming blitzkrieg behind such outputs.
Several interesting applications could be possible from such a piece of 'software'. For example not only evaluating each new piece of news, views, analysis, speech, report in whether or not it suffers from flaws of centering one could track the changing intentions notwithstanding howsoever cleverly shrouded of a single source across past and current outputs.
May be once created, such a utility could be used to run through works of literature that have survived over a long time to quantify and find what sells most and what actually goes down best with the crowds. Focused on Wall Street, such an analytical arming could also help improve all the written output that goes out of one's firm and desk too.
May be this is already done. May be it is not worthwhile. Just putting up a thought to the maestro..
Book Review of “Match Play and the Spin of the Ball” by Bill Tilden, from Charles Pennington
I discovered Bill Tilden’s 1925 book “Match Play and the Spin of the Ball” while browsing Tennisplayer, which had a nice excerpt from it, with accompanying video footage of Tilden and other legends at play. There are many used copies of it on Amazon, my copy was a 1969 reprint.
Tilden in 1925 was at the top of the tennis world. Wikipedia says that he won the U.S. Championship (precursor of the U.S. Open) in 1920, 1921, 1922, 1923, 1924, 1925, and 1929, and was a finalist in 1918, 1919, and 1927. “During his lifetime.., he was a flamboyant character who was never out of the public eye, acting in both movies and plays as well as playing tennis.” Elsewhere I’ve read that his fame at the time was about equal to that of Babe Ruth.
Tilden’s writing itself is fresh and interesting. There’s a jaunty tone, just a touch pedantic, a little bit Gatsby, a little bit Dale Carnegie, a little bit Phil McDonnell:
Most tennis players look upon that ball as merely something to hit…Let me suggest the ball for a moment as an individual. It is the third party in the match. Will this third party be on your side or against you? It is up to you.
He gives unhedged opinions--
I have heard people with real intelligence, who should have known better, attempt to prove that the best women’s tennis equals the top flight of men’s. Nothing can be more ridiculous.
--and he is on occasion wrong, here on the same topic:
It is my belief, and has been my experience, that the woman does not live who can go the net with success through three sets and stand up under it
Someone should tell Martina Navratilova!
This is a how-to book on how to play better tennis. Tilden's view, from the top of the game, was that tennis in 1925 had been preceded by first an era of mostly defensive baseline play, then an era of more reckless attack, culminating in the synthesis, in 1925, of a game having strong elements of both attack and defense, targeted specifically at the weaknesses of the opponent. This all described his own game, of course:
Let me open this discussion by a sound tennis maxim: ‘Never give your opponent a chance to make a shot he likes.’…I may sound unsporting when I claim that the primary object of tennis is to break up your opponent’s game, but it is my honest belief that no man is defeated until his game is crushed, or at least weakened. Nothing so upsets a man’s mental and physical poise as to be continually led to error.
He presents strategies for playing two stock characters in the tennis world, the pusher, “Old Joe Gettem,” and the slugger, “Pete Swattem”.
..in playing Old Joe you must be patient, steady until an opening comes, and then severe… What is an opening against his defense? Old Joe will give you several…There are the openings of driving Joe way out of the court, to one side, and hitting hard to the other, and the shot which pulls him to the net so you can pass him, for Old Joe Gettem is seldom a good volleyer.
..in playing young Pete you should rely largely on defense, allowing him to pile up the errors off the backstop or in the net…Young Pete Swattem thrives not upon returning the ball. He seems to join Lady Macbethin her famous soliloquy, ‘Out, damned Spot! Out I say!
Tilden laments that there exist good players, neither Old Joe or Young Pete, and there the situation is more difficult. His advice, admittedly difficult to follow, is to hit “sufficiently aggressive to force your opponent into defense, provided first you are certain to put the ball in play”. Tilden emphasizes though that errors, even at the high levels, often determine the match, and he stresses, “Put the ball in play!”.
Not surprisingly, Tilden advocates practice, practice, and more practice. He describes how his continuous work on mastering every shot. He spent a full winter in Providence on an indoor court, trying to develop a strong backhand, and he credits this work for moving him from the top ten to number one.
The book has some very nice illustrations showing the major grips and strokes of the day, and they confirm that “There is nothing new under the sun”. There were players who tried just about everything. There were flat, spin, slice, and American Twist serves, topspin forehand and backhand drives, slices, volleys, overheads. The western grip, which has become the most common over the past decade or two, was in use back in 1925. Tilden himself hit with an eastern grip, but his main rival, “Little Bill” Johnston, hit with the western. Furthermore, Johnston also used the same grip on his backhand--he hit his backhand on the same racquet face as he hit his forehand, without shifting his grip at all. This is exactly what I do, and I thought I was in uncharted territory.
Some probably think Tilden was equal or better to today’s pro’s. I doubt it. Tennisplayer has video footage of Tilden’s strokes, and they’re just not as advanced as today’s. For example, on his backhand drive, his left arm hangs limply by his side. In what other athletic motion would you not move the left arm? Pitchers, skaters, javelin throwers, bowlers…they all use their left arms as counterweights to what’s happening on the right. Furthermore, why should we expect, a priori, that tennis players haven’t improved over the past few generations when we know that athletes in more quantifiable sports, e.g. runners, sprinters, weightlifters, swimmers, etc., have all continually advanced their world records.
Tilden had some well-known fatal flaws that got the best of him, and one reads uneasily the chapter titled “Youth to the Fore” about the upcoming junior stars of the day. Ultimately his is a sad story. Nevertheless this book captures his deep thinking about tennis, written in plain, entertaining prose, when he could and did speak confidently from the top of the game.
"Never Tell Me the Odds" -- Thoughts on Star Wars and the Market, from David Baccile
My children are probably too young at the tender ages of 5 and 4 to be watching the original Star Wars Trilogy, but I let them anyway. (Of course, I also bought them boxing gloves and one of our family bonding moments is when I get on my knees and don the gloves. I mention this so that you can place the rest of what I say in some context.) There are a couple of scenes in which my 5yr old son, Gabriel, will excuse himself from the room because he thinks it too much. My daughter, Mira (4), has no problem with any of it as long as dad sits with her. They both really like the episodes and play with small Star Wars action figures constantly.
The cinematography of the original Star Wars Trilogy is truly amazing. These works by George Lucas and Gary Kurtz were light years (my wife loves my puns) ahead of anything produced at that time and for many years thereafter. It is no wonder that Star Wars will survive the ages. In addition to the beautiful cinematography and special effects, the story of good prevailing over the Goliath of evil is universally popular.
Having watched these movies a couple of times recently, I found myself picking at some of the storyline - and the underlying themes.
Historically, Wall Street has been known for the testosterone based bravado that is supposed to pervade the big (and small) houses on The Street. From at least the late 1970s through the 1990s, the sexy, gunslinger personalities were revered in the media and press. It took a long time for nerdy computer geeks to gain any recognition in the brokerage houses and trading desks. These thoughts came to mind as I listened to Han Solo tell C3PO to "never tell me the odds" as Han plunged the Millennium Falcon into an asteroid shower against the counsel of his droid. And who was more sexy than Han Solo, that Scoundrel! We grew up worshiping that bravado - and it was cool to go against the odds, to rebel.
But rebels don't last long in the markets. The Mistress may encourage those that try to defy the odds. She will look longingly as you throw caution to the wind and as you shout "never tell me the odds!". We rarely hear of the hundreds, no thousands, that have succumbed to Mistress after going against the odds. In fact, most Wall Street failures that gain notoriety seem to be those that at least attempted some science and probability to their the analysis and processes. Long-term Capital Management was a great example in which the "lesson learned" was that no statistical models, no matter how smart or sophisticated, are good enough to succeed in the Market.
As a youngster, I definitely never picked up on the mystic qualities of the Star Wars Trilogy. But now, you can't miss it. In "The Empire Strikes Back", Yoda tells a young Luke Skywalker in training to "feel the energy of the force all around" and that you "must let the force flow through you". George Lucas places far less importance on intelligence and the mind (sorry for getting a little Randy) and, instead, makes the fate of the Rebellion depend on chance and "the Force". The important traits of determination and courage are rightly celebrated. In training, Yoda tells the young Skywalker "Do or do not, there is no "try"." Some of these themes are wonderful lessons for my children but I also think it necessary to point out the weak areas too, for I do not want my children to have to spend time and effort unlearning what I may have unwittingly taught them.
George Zachar notes:
The Star Wars universe provided me with years of useful lessons, parallels, and anecdotes when my children were very young: the nature of good and evil, the need for training/focus, how to adapt tactics to changed circumstances and limited resources, the broad range of personalities and specialties in the world, etc. etc.
Edge Effects and Markets, by Victor Niederhoffer
One of the joys of reading the book (and listening to the accompanying CD) Masters of Enterprise by H. W. Brands, which gives 14 lessons in how the titans of industry shaped the US Economy, is the insights into the key variables that enabled the titans to succeed. There's the lesson that Jacob Astor teaches that it's a mistake to bet against the future of America. "If I could do it over again, I'd buy up every foot of land on the Island of Manhattan". There's the emphasis on standard French fries that Ray Kroc learned that was key to his success involving the accidental discovery that the desert wind made his fries the best, and thus he artificially recreated it in all his restaurants. And then there's the lesson that Sam Walton teaches that the place to open stores is on the edge of towns where property is cheaper and a big parking lot was available and people from all the surrounding areas could drive in.
The edge has traditionally been a place where great changes occur on the boundaries between two different types of environment. We feel it when we enter an air conditioned building after being on a hot street, or riding on a bike on a street into a park or going to work after a night of hot romance with the other. Most traditionally, we see it when forest lands are clear cut. The clear cut ground is now open to the sun, warmer, drier, and more exposed. Some animals like the deer and elk love the edge because they can forage in the clearing and find cover in the forest. Others like the owl avoid edges because they can be pursued more easily.
Edges occur in markets often. There's the edge between the opening and the night session, the time between the end of the month and the beginning of the month, the time between the announcement of the listing on an exchange or index and its actual arrival, the time between an embargoed press release and the actual announcement such as the FOMC or the after-hours earnings report, the time before you are slammed with a big market order on the opposite side when you have a seeming free lunch -- the Minister, Professor Pennington, adds the following: the bullish overnight trades, beginning and end of the month or week trades, companies doing business in coastal or border regions versus companies in heartland regions, early performance of IPOs, companies with low correlations of movement with the market must be on the edge of something.
Another area where the edge comes into play is close to my heart because it's one that I have tried to engender in all our researchers. There is an edge between systematic trading and qualitative trading which is exposed to direct sunlight, change, and danger. That's the edge, however, that we believe has the most potential for staying ahead of the market.
I like to think of edges that occur in markets when there has been a move, but in some sense it is not complete. If there were a way of defining the edge that exists before the final loud and fast notes occur it would be very helpful and illuminating. The problem is that sometimes you wait for that denouement to occur, like Alan Abelson or his altecockers waiting for the last ounce of bullish enthusiasm and excess to be taken out of the market before he calls the market a buy. (Regrettably he and his colleagues have been waiting from 1966 for that one, as even the 1987 Crash to him was just a beginning).
To get a handle on it in a more systematic way, I looked at the occasions when such things as a three-day extreme but not a five-day extreme occurred in various markets for all sorts of combinations of the small extreme and large extreme. This exercise is particularly useful at a time like this when the trendfollowers are having their moment in the sun with a 15% average gain in the last two months according to the S&P investable trendfollowing index. Any knowledge on this subject is doubly useful at a time like this, when prices have been impacted, and substitution effects have been engendered by these large gains. In any case, I found that for 200 3-day minima that were not 5-day minima the average move in the next two days was down one point. But for the 450 3-day minima that were 5-day minima, the average gain the next two days was one point. A similar effect occurs after 3-day maxima that are not 5-day maxima. Such divergences are quite inconsistent with randomness and would almost be useful if the gains were not so small relative to commissions and bid/ask spreads, and the particular small and large extremes had not been selected retrospectively to illustrate a point.
The Professor considered the subject of lying in the middle of the forest versus at the extremes by considering 14,000 company-years from 1998 to 2005 as the trees in the forest. He divided the companies into deciles each year based on their correlation with the S& P over the previous 250 days, and then looked at at their return in the next quarter:
Returns Next Quarter Based on the Previous 250-Day Trailing Correlation with S&P Decile Past Correlation Return 1 0.70 2.8 2 0.65 3.0 3 0.55 4.6 4 0.50 3.5 5 0.47 4.3 6 0.43 5.6 7 0.40 3.1 8 0.35 2.2 9 0.30 3.0 10 0.25 2.9
Thus the returns average around 3% at the four most extreme deciles, and about 4.5% around the middle deciles. The edge is apparently a dangerous place to be for stocks, as well as for butterflies and birds.
And Galton's valuable insight, that we inherit many conformist tendencies from our hedging ancestors, is confirmed. Such are the inspirations that I gain from reading books about enterprise, and I encourage contributions and speculative thoughts on the influence of enterprise, edges, and herds so that we can all improve our knowledge.
Andrew Moe mentions:
My wife is one of the great jewelry shoppers in the world. She is known on a first name basis by both private and public jewelers. When I told her how much gold had increased in price her face paled. But within seconds, she regained her composure and said "It's OK, I'll just by knockoffs until the price comes down." Remote in hand, she paid a quick visit to QVC.
Gary Rogan adds:
When herds of animals graze in the wild, the sharpness of the edge of the herd depends on the prevalence of predators. It is more dangerous for each particular animal to be close to the edge of the herd, but to the extent that there is an edge, in case of predator attacks it should be small and well-defined in order to be easily protected. In the areas free of predators, herds are more widely distributed and the edge is less well defined. This allows each individual animal to have more grazing area to itself and thus obtain more food in less time. Thus, just like in the markets the sharpness of the edge is directly related to the danger that the herd is feeling and the middle of the herd is the safest place to be when danger lurks.
Weekly Commentary from Dick Sears: "Ouch!"
Lifespan Perception, by Dr. Kim Zussman
Last weekend we visited friends for their son's 6th birthday. It was an outdoor affair which we attended last year; only it seemed just a few months ago. Most will be familiar with the sensation of the acceleration of time's passage: You graduate, get married, work a while, kids are born, they go to school, and like a cruel joke now they are graduating.
This relates to investing; since gross annual returns come to you faster each year, there is a sensation of wealth building derived merely from acceleration of the passing of time. A common explanation for time-perception acceleration is that when we are young a year is a big fraction of our experience, but as we age this fraction gets smaller. To the extent that this explains the effect, the passage of each year "feels" like 1/age.
The 1/age effect can be related to life expectancy as the sum of fractional experienced years for the remaining years of life. For example, from social security actuarial life-tables, a 51-yr-old male lives on average another 27 years. Each of the subsequent years passes faster than the prior, according to the 1/age assumption. So the perceived lifespan to 78 from 51 is sum (1/age) for all the remaining 27 years.
The method sum(1/age) for remaining years was calculated for life expectancies of a male for each year 1-85. This is plotted here, and shows the marked decline in "how long remaining life feels" as a function of age and life expectancy. An equation that fits the data reasonably well is:
The regression equation is:
exp per = 3.789 - 0.1709 age + 0.002939 age**2 - 0.000017 age**3 S = 0.197146 R-Sq = 95.8% R-Sq(adj) = 95.6%Here are the data.
Encoding Prices in Binary, from Dr. Philip McDonnell
Claude Shannon's work on information theory demonstrated conclusively that all information could be efficiently represented in binary code. This breakthrough enabled tremendous advances in digital communications. In addition nearly every computer since that time has used some form of binary storage for both numbers and character oriented information.
With recent discussion of information theory it is appropriate to note that price patterns can be conveniently encoded as binary patterns as well. For example if a day was up that would be a 1 (one) bit and if it was down it would be a 0 (zero). Binary representation only has two digits 1 and 0.
Our everyday decimal system is based on powers of 10. Consider the number 123 - one hundred and twenty three. The right most digit 3 is multiplied by 10 to the zero power. Any number to the zero power is equal to 1. So the result is 3 times 1. The 2 is multiplied by 10 and the 1 is multiplied by 10 to the second power or 100. Add it all up and the result is 123.
Now let us convert the number 6 into binary. The powers of two we need are 1, 2, 4, then 8, 16,... To convert we divide the number by the highest power which can divide into it. We divide by 4 and get a remainder of 2. Now divide by 2 and get a remainder of zero - we are finished. The following table shows the powers of two in their places:
8 4 2 1 0 1 1 0 = 6 (decimal)
The order is the same as decimal notation in that the least significant place is the rightmost ones place and the 2 squared, cubed etc going to the left. To convert 6 into binary we only had to divide by 4 and 2 and so those are the only two positions which show a 1 digit in the binary representation of the number 6. The rest are zero.
To use this to construct character codes for price patterns we could take the last 3 days of up down net change and assign 1 if up and 0 if down. The pattern + - + would take on the code 101. Here is a table of the first 8 binary numbers:
decimal binary 0 000 1 001 2 010 3 011 4 100 5 101 6 110 7 111 421 Binary Place Values
So to convert our pattern + - + to binary we add 4 * 1 plus 2 * 0 plus 1 * 1 to get 5 (=4+1). Because we all think in decimal it is fine to use it as the number 5. The important point is that we are talking about bucket or bin number five. So if we are studying what happens the day after a number 5 pattern we put all those results into bin number five. Thus from the bin 5 results we can calculate the average, standard deviation and probability of being up after that pattern is seen. The same principal applies to the other bins.
Another different use for such bins is to calculate the entropy of all the bins for a recent period. In an earlier study I found that increased entropic diversity tended to be followed by better markets than other periods. One simple measure of this would be to take the last 8 non-overlapping periods of 3 days and set up the bins as described above. We now look at how many fell into each of the 8 bins. The maximum diversity is achieved when each bin contains exactly 1 observation. The minimum is when all observations fall into only one bin. So our resulting statistic is a number from 1 through 8 which can be checked for its relationship to subsequent market performance.
A slight refinement of this would be to do a more sophisticated entropy calculation using a summation of the logs of estimated probabilities per Shannon's original formula.
Increased Efficiency Causes a Domino Effect, from Jan-Petter Janssen
Recently I have done some thinking about why (and when) markets sometimes behave seemingly irrational. However I’m not sure if my thoughts offer any originality, as I only know a few theories on the subject. Nevertheless, I find the Grossman-Stiglitz paradox as a good fundament for describing this:
Increased Efficiency causing a Domino Effect away from Efficiency
If the market were efficient there would be no incentives to trade. But if no one traded on the new information the markets would not reflect it and therefore not be efficient. This is the essence of the Grossman-Stiglitz paradox.
I wonder if this can be illustrated by a wave. Let’s first define these letters for use in mathematical formulas:
L – Labor cost P* – The efficient price which includes all information P – The market price ∆P – | P* – P | Q – Quantum, number of shares W – Wealth accumulated n – Number of trades π – Profit (from inefficiency) t – Time T – Period on the wave x – Vulnerability factor
For the informed trader the expected profit should compensate the constant labour costs associated with getting informed.
π = ∆PQ = L
Every time a trade is done the profit is added to the wealth.
W = nπ = n∆PQ
As the traders accumulate more wealth competition will force more efficient markets.
W = PQ = nπ Q = nπ / P
Since π and P are independent from n and Q, Q will grow as n increases. From π = ∆PQ we see that the price inefficiencies diminish.
A wave illustrating the price inefficiencies can be written as:
P = P* + ∆P * sin(2Pi * t / T) = P* + π * sin(2Pi * t / T) / Q = P* + W * sin(2Pi * t / T) / nQ
However, here I have only used the expected profit. P* will most likely change in any direction between the entry and the exit of a trade (T / 4). If the trader can only handle a loss of x∆P, there is no guarantee P* will not change, pushing P as well, while the trader still holds an open position. In such a case the trader who is covering will push the price further away in the wrong direction. If this forces yet another trader to cover, a chain reaction may have started, which can be described as the niche’s x∆P Mass death is the result and only the very strongest ones are left when the cycle starts all over again.
I think this wave can illustrate one specific niche. Mass death in one niche might influence another niche, causing a collapse. The shorter the amplitudes, the more fragile the market is. I believe this also can be used to explain how species die out (genetic variability as the amplitude?), as well as to be used in politics, maybe psychology and also other areas where evolution is present.
Blue line = efficient price P* Green line = market price P Red and dark red dots = the vulnerable price x∆P where the domino effect starts
United 93, from Yossi Ben-Dak
When you enjoy seeing movies, you rarely find the kind of experience that should be digested fully, in order to get a better hold of when and where you live. Mission Impossible 3, better perhaps than all the previous ones, is to me still impossible. The horror movies that do so well in the mass market have a limited titillating function that I can consume only rarely and I still learn more from my regular nightmares. Even more significant is the need to be in touch with factual basis of our life, which need not contradict being entertained, by viewing a few true reality movies, from time to time.
We all know, that is those of us that are somewhat Educated, that "Deception is ubiquitous". We always want to deal effectively with uncertainties. Nevertheless, we often dare not fully comprehend evil when it faces us and is intent on having the upper hand. Mission and fake evil movies may entertain precisely because we know it is not the real smell, color and threat--and most importantly because consequences are truly inconsequential.. Spitting back more questions after we tested hypotheses and confirmed outcomes is mostly useful when real life understanding and forecasting is, thereby, enriched.
However, when so many of my friends keep asking if United 93 is a too soon film or already too late, I do have my reservations regarding both, because I think that for most people this is an experience that includes an opportunity to reexamine our mental and political awareness and muscles in a given situation that has ingredients of future realities. With imagination, it can be extended to a whole plethora of horrible scenarios. It is not too early, because it is not only a movie about a painful disastrous death of crew and passengers of a plane, that we heard so much already about in 2001. It brings home a real time, carefully scripted to be valid, background scenario of unpreparedness in terms of real US government, US armed forces, Air Traffic Control Centers, every present individual's -- and our own -- mindset. Before the threat became very obvious and particularly after, we experience a system that, in parts and in whole, was not ready to accept that others who hate us are just about finished studying us, motivated and capable, and even though they look like us, they are not. These enemies are full of "obscurantist, mass -homicidal, suicidal Islamist fanaticism" as Eclipse magazine puts it. They not only exist, but perpetuate.
This depiction, as chillingly honest as is the flight group (stewardesses, passengers) realization that perfect evil must be battled as effectively and as promptly, with possible self sacrifice in clear sight, is yet to arrive home in our national, local community and individual consciousness. The point is that it is not too early to realize that the varieties of in coordination, miscommunication, over crowdedness in decision spaces allotted for responsible managers, lack of rules of engagement or understanding their dynamic imperatives, mental and info noise that cuts into efficiency and efficacy of critical regular activities, e.g. in air control centers -- so well elucidated in the film, are going to stay with us for a long time. These have nothing to do with theatrical repair motions of the Commissions that were set up to study and countervail terror. The deepest insight in this movie to me, is in exacting the awareness that government cannot defend citizenry from the unending scenarios of terror, because of its complexity, its built in laziness, its bureaucratic and fright incapacity to draw conclusions across events and trends and because, unlike markets, the confusion between sales and wealth for shareholders is never ending, because in democracy, every person and group can effect the political game of values maximized -- a right which is used and abused.
The growing responsibility that falls on the shoulder of the average citizen in facing terror and the imperative of second amendment implications cannot be exaggerated when you see the 33 passengers and seven crew members stand up to the four knife wielding hijackers, once they massacred the two pilots. The fact is that not enough was done and will ever be done to insure that that scenario -- or others that evil will concoct -- will have zero chances before it happened. The only saving grace, which in the movie did not work, depends on collective intent of courageous and aware individuals. It is definitely not too late to realize that we need to train ourselves not to be in the victimized position flight 93 found itself in. My wish is for a preparation of response set that requires no self sacrifice because imagination and planning too their proper function in our lives.
We may know it all, you might say, without having to see the movie. Perhaps -- but here are some more details why the lessons and experience are truly worthy.
I like the moral stand that was taken by the gifted Paul Greengrass, the director and writer of United 93, to get the support of the families of the passengers and crew. He did what so many others ignored in similar projects in the past--the right for a say about the memory of departed loved ones, especially these heroes.
What is of special value to our discussion above is that Greengrass did a momentous groundwork to depict the realities as they actually were. For example, all cell phone records with the passengers are inputs to the script; physical properties and interviews with close relatives of the passengers and terrorists were used in effective casting; actual air control maps and on the go verbal instructions were captured in the movie. [see for comparison, references in PG News, October, 28, 2001).
Aviation and military roles are, to a degree that I have never seen before, played by the actual personnel. Particularly instructive is Ben Sliney and his team at the Virginia Federal Aviation Administration's Command Center that celebrated their first day of collective working relations, on September 11. The validity and courage in showing their colors including gray ones and a few terrible judgments adds the realism missing in many fake movies on air control scenes.
The contextual and time line events are extremely well documented with real time picture and original verbal analyses and hypotheses, as these were developed on the fly. This is how we learn about the other planes hijacking stories and corresponding reality as it sank in ,at various levels of decision making, and the passengers cognition of their world and options. Certain rumors like the one that had an F-16 circling Flight 93 and being in visual range at the time of the crash or other reports about actually shooting down of the United flight are all dealt with forthrightly with evidence, often calling into the screen, the decision makers themselves. [see for comparative reference, "How Did United Flight 93 Crash", on line, last updated August 1, 2003]
This, of course, is not a classical entertainment movie because it poses directly and indirectly very serious questions of individual and collective responsibility and the need to move away from mediocrity in next stage rethinking. Clearly, it provides raw material that is valid and reliable [certain in-flight events had to be imagined without evidence] and needs to be comprehended, before we are ready to do better in life that is full of joy and excitement, yet more responsible for and with future generations.
The Serious Matter of Football, from Stefan Jovanovich
We are now less than 1 week from the UEFA Cup Final - Arsenal v. Barcelona. It is scheduled to be broadcast on ESPN2 at 2:30 PM EDT on May 17th. Even if your idea of football is the Pittsburgh Steelers, this is a contest you have to see.
Quote of the Day, from Dr. Janice Dorn
I found one day in school a boy of medium size ill-treating a smaller boy. I expostulated, but he replied: 'The bigs hit me, so I hit the babies; that's fair.' In these words he epitomized the history of the human race. -- Bertrand Russell, philosopher, mathematician, and author (1872-1970)
Floyd Patterson, from David Lamb
I'm re-reading the novel, "The Power of One" by Bryce Courtenay (I first read it when I was a teenager). It's about a similar story of a boy rising from the pits of despair to becoming a boxing champion and a healer of a nation. This Patterson passing away reminded me of this book. Yes, Courtenay's book is fiction and Patterson is real life, but they both offer great examples of how I should try to be.....selfless and undaunted.
The Sultan of Technical Analysis -- Victor Niederhoffer?, from Peter Nilsson
I am forever grateful to Victor and Laurel for putting their experiences into words and giving us to wonderful books. They have taught me to be a skeptic, to question. I am a technician, and also a writer. I have written three books about trading and technical analysis. When I find Victor opposing technical analysis I am bewildered. Why is that? In my books I have offered a definition of technical analysis:
Technical analysis uses deviations from the efficient market hypothesis to make best guesses about future movements in the financial markets.
Isn't that what you are all about? In my mind you are the Sultan of Technical Analysis.
Ambushes and Signals, by Dr. Kim Zussman
Some Garden Variety Fallacies about Markets, by Victor Niederhoffer
While there are some deep problems with the way the public thinks about markets that always cause them to lose so much more than they have any rite to lose as we have often illuminated; like churning their accounts, trading for ephemeral reasons, selling at the lows and buying at the highs, or investing in treasury bills rather than stocks for long term returns, there are many more garden variety errors that the public makes on a day-to-day basis that when added up can be just as costly in the aggregate as so many of the more profound ones that I have tried to cover before. Here are a few, presented from a stoical standpoint without any blame or hope that they will change, but just for the sake of those who wish to understand the natural order of things and better keep their feet on ground.
Of course, nothing that I say will change the reaction of the public to these recurring garden variety errors, as it is necessary for the public to do what they do to pay the massive overhead of the market. And if they were to change their reactions to many of the ephemeral factors above en masse, a whole bunch of new fallacies and errors would immediately spring up to take their place.
Steve Ellison responds:
The gem of wisdom that made Livermore's book worthwhile for me was his admonition to avoid tips at all costs, with his observation that 90% of the people he encountered on any day were avidly looking for tips and his recounting of the disasters that befell him when he followed tips. I could tell similar tales of woe about early investments in companies favored by a well-known money manager's wife on her mall visits.
Weekly Commentary from Dick Sears: "Cinco de Mayo"
Market as Dialog, by James Sogi
The markets area form of communication in which the prices are debated back and forth, and settled. How much of it is redundant? In conversation it is said that content is highly redundant. Speakers are advised to say what is to be said, say it, and summarize what was said. In phone conversation or casual conversation much air is wasted with pleasantries, warm up, content, repeated content, "like I was saying", and "here's what I heard you say:, etc, etc, etc, yada yada yada. There is redundancy to be sure all parties are clear on what is said, what is meant, and what is understood. The markets, as communication suffer from similar if not worse, redundancy of communication. There are statistical methods for analyzing speech, content, and redundancy. This 1327 point has been made over, and over and today again. OK I get it. Email is good. You say it once: done. No wasted air. There are standard patterns or rhythms of speech that typify modern colloquial intercourse. What similarities might be drawn in similar interchange in the markets?
Dr. Michael Cook responds:
A few years ago I heard that Rena!ssance Techn0logies was hiring computational linguists to develop trading models / systems. To build speech recognition systems you have to have a model of the speaker, of what kind of utterances he/she is likely to make, and then model what they are saying with this background knowledge, and anticipate what they are going to say next. Applying this kind of short term predictive algorithm to the time series that is "market data" (obviously some filtered, massaged subset of this vague concept) might be a way to make money.
If I say: "Something is rotten in the state of ----" and the last word is garbled, most English speakers (well maybe not those coming out of our school system these days) will know what the missing word was. And if I said "something is rotten in the state of Penmark" most people would hear "Denmark".
I have a friend who worked for 20 years at Bell Labs developing the technology that automatically recognizes telephone numbers. This required sophisticated models and algorithms and powerful hardware - a big part of the problem being to recognize different speakers.
To hear what the Mistress is saying, it helps to love her!
Steve Humbert mentions:
I was actually pondering the markets as language over the last few years and recently attempted to put my thoughts on paper. It is small but a start:
"Language of speech and the language of Markets"
Speech for most individuals is an effortless task of everyday life. One does not consider the complexity of speech, only the fact it is needed for communication with others. People will speak slightly different from the next individual in terms of pitch and pronunciation. Even with different backgrounds and variations in language, it remains an easy task to understand and communicate language. When one attempts to breakdown language in how our vocal cords act, the study of phonemes and the problem of invariance there comes an appreciation for the complexity of language. The issue of co-articulation is akin to similarities one will experience in the trading markets.
Co-articulation is the ability of the body parts that produce sound (jaw, tongue, lips) to move rapidly and in perfect co-ordination to produce vowels and consonants in a very smooth process. The listener is able to de-code the information in an effortless manner and thus language is able to bring together individuals in a complicated form of exchange. The amount of influence of one phoneme on another will vary depending on its relation to another phoneme. Other factors that has considerable influence include rate of speech, ability to identify one phoneme from another, and loudness (attention grabbing). Investors will recognize these behaviors in their and others trading patterns as attention to a particular security detail initially got them interested in a particular security.
In particular, the loudness of a stock (just like who speaks the loudest) most often grabs our immediate attention. The similarities between speech and trading activity are remarkable similar, in fact a hedge fund in Stony Brook NY hired most of the IBM speech recognition team onto his hedge fund and has posted an impressive performance for over a decade. Off-course, a hedge fund has other angles that is uses to explore the market for anomalies but language seems to certainly be a part of it.
The actions of a security are related to others in the sector, which in turn is compared to the market as a whole. If stock A is performing well, it will be judged according to its sector. In typical feedback stocks in a sector often move as a group due to common traits they share with the competition. Further, as one sector begins to perform other sectors will enjoy spin off effects and in rapid correlation with the general markets (economy) will all start to propel ahead. From a macro economic perspective if the yield curve is accommodating enough to induce investors to invest in capital goods (plants and equipment) instead of savings, then markets will move higher due to increased demand for services such as plant, construction, raw materials, etc. In short term trading the macro effects are small and company profitability has the most impact when there are surprise earnings (for better or worse).
Inside all of the activity the" market is a weighting machine in the short term" (according to Benjamin Graham), placing stock prices in relation to others and competing for investor attention. The outcome will not always be rational and relationships will change with the reference and context the stock comes to the attention of investors. A simple mention of a company within an industry that is performing well will have a positive effect on the stock price, as will a rising market to quote the famous Wall Street saying "a rising tide lifts all boats".
The measure of loudness is best measured in the amount of media attention a stock is able to garner. To get noticed stock end up on the most active list, biggest winner, biggest loser (no stock wants to be here) and stocks making yearly highs and lows (no stock wants to be on that list). Other ways to get attention is to have a stock price that has been on a gradual rise over the last few months, this will show as a up or down trend on a chart - the equivalent of pattern recognition signs. Pattern recognition may have actual meaning behind it but looking at charts is a one-dimensional world that is devoid of the words to accompany the movements. There is no standard method to qualify market moves, thus opposing logic means that for every buyer there must be a seller - they are both talking different languages and neither has an interest in understanding the other. To the observer the differences at a glance appear to be random and often mean reverting. The language is in the delivery of the words, and in the markets the delivery is often noise.
J. T. Holley adds:
I have often thought that the Mistress was oft Socrates spitting back more questions after I've tested hypothesis and commenced to look at their outcomes. It's like she has a negative way of eliminating our hypothesis's that don't have that extra push for significance and change and shift suddenly in front of our very eyes and ears. Almost as if the Market were another person conversing with us as we are engaged in your stated speech Jim. I swear I haven't learned her language and am an devoted student taking language classes daily. If the Mistress had a voice it would be that of Billie Holiday in my book. I can't have more than a two word conversation with her it seems before I am sucked into her sultry words of capture and loss.
Vinh Tu offers:
In Claude Shannon's information theory, redundancy is the same as predictability. Predictability is, of course, contrary to the efficient market hypothesis. In the real world, predictability is "punished" or preyed upon by traders, hedge funds, etc. As such, there is a cost associated with the back and forth of communication, which would encourage terseness in a way akin to telegrams or long distance in the old days. Yet, sometimes a message warrants redundancy, despite the expense. Delivery of improbable yet important news needs confirmation. Thus, while the message "don't forget to feed the dog" will not require much discussion on an expensive line, the message "I want you in Timbuktu tomorrow" may deserve some redundancy and confirmation.
How does this apply to the markets? Maybe the conversation is like:
We need more oil. Okay, there's lots of oil. No we need more. Are you sure? Yes, you better pour much much more money into equipment and drilling new holes. Are you sure? Yes. Are you sure? No. What? (spiking everywhere) I mean yeah. (rally)
And so on, all the way up to the peak and then down again.
This could be one possible explanation for the Lobagola: a serious change in price level which implies a reallocation of society's priorities would elicit skepticism and a desire for redundancy. I admit the above is a very simplistic view of the "language" of the market. The actual syntax is no doubt far more complex and includes, in addition to price levels, things such as trends, gaps, reversals, etc. As well, the market is a conversation among many parties, each of whom may get the joke quickly or slowly, some of whom merely pay for their pointless banter.
The connection between information theory and gambling is extremely interesting and I'll echo the previously made recommendation of the book "Fortune's Formula" which wonderfully tells the story of the connections between Claude Shannon's information theory and John Kelly's formula for optimal betting.
Some interesting things I am hereby led to ponder:
I plan on reading on E. T. Jayne's book on probability shortly and hope that from this interaction of ideas there will come some illumination.
Baseball as a Business Article Highlighted by Rich Bubb
From the article...
"Baseball metaphors run through business speak as easily as Willie Mays ran down fly balls. But too often, writes consultant and baseball columnist Jeff Angus in Management by Baseball (HarperCollins, May), business fails to live up to the American pastime. Fast Company shared a bleacher with him at a spring-training game of his hometown Seattle Mariners."
Duncan Coker does a quick review:
I thought the post with a baseball article from Fast Company magazine was interesting and applies to trading. This gist of article is that baseball managers make good businessmen. No numbers on the table, but some good things they do:
Use data and make prompt decisions:
"..the amount of data they have to handle while coping with rapid change. Plus, they can't be passive and wait for something to work itself out, a behavior that's endemic in business."
View all contingencies, options and possible outcomes:
"It helps to think like a catcher, which is why so many become good managers. A catcher always has the whole play in front of him and can think critically about what he sees. "
Practice and drill:
"You need to learn what people do in situations where their success or failure is less critical. That's what the minor leagues and spring training are all about. In business, there are plenty of opportunities to get people up to speed before you have to count on them for game-day results."
Adjust every year for new conditions:
"Every off-season, they debrief, reassess, start a new cycle, bring up young players, try people in new positions. Look at the Atlanta Braves teams--and they've all been competitive."
Roger Bastien gives an expert's opinion...
I appreciate the context. The author is obviously a fan of baseball and I am sure a knowledgeable fan. As a thought provoking piece it serves its purpose but for the sake of argument I would say that most ballplayers in leadership positions (shortstops, point guards, quarterbacks et al.) make very good business men by virtue of their leadership skills. I disagree that the catcher has an advantage or special insight by virtue of "seeing the field" as a business man but catchers do have special insight as baseball managers because of their unique relationship with position players as well as pitchers...
Market as Meaning, from James Sogi
The paper, "The Mathematical Theory of Communication," by C.E. Shannon discusses the mathematical underpinning of the idea of the market as communication. The idea is that the various moves spell out letters or words that convey meaning. What is the meaning of the moves, what do they say? How much information do you need to figure this out.
Julian Palardy responds:
In an efficient market, moves are supposed to be meaningless. What has meaning are trades. Entropy is used in financial markets to measure the information content of trades, the speed at which prices integrate information that is diffused by trading, and also to measure asset prices in incomplete markets.
Turning trades into prices is a process through which information is supposed to be separated from noise. In reality, this process is often inefficient (not d-optimal), and sometimes not enough information is integrated into prices because information content of trades is underestimated, or at the opposite, noise leaks into prices because information content of trades is overestimated. Both of those cases are where you can make money.
Sometimes also, a spread between the entropy of trades of two markets is larger than what no-arbitrage theory should allow. That is another case of where you can make money. Hope this helps your idea of how markets sing.
The Halloween Effect, from Paolo Pezzutti
Is it realistic to believe that some industries and sectors have a seasonal effect and perform better during the summer months?
A new study that has just begun circulating. The study, "The Halloween Effect in US Sectors," was written by Ben Jacobsen and Nuttawat Visaltanachoti, from New Zealand's Massey University. The outcome of the study is that all US stock market sectors and industries perform better during winter than during summer in the sample adopted from 1926-2005. US investors can profit from a Halloween effect, documented by Bouman and Jacobsen , based on sector rotation. The authors found that while the effect does not show strongly in the general market index, it is strong in individual sectors (and industries). All US stock market sectors perform better during winter than during summer. In two thirds of all sectors, this difference in summer and winter returns, known as the Halloween effect, is statistically significant, and in half of all sectors risk premia are negative during summer. However, while all sectors show this effect, some sectors show it more strongly than others. The effect is almost absent in sectors related to consumer consumption, especially those sectors of products with short life spans and lower betas and very strong in production sectors, especially when these are related to raw materials. The study illustrates how these differences between sectors might be used to improve the risk return trade off using sector rotation, at least if the past offers any guidance for the future.
Gabe Carbone comments:
I would worry that the multiple comparison problem seasonal studies, discussed extensively on this list at one time (try searching the archives for "almanatarian" or "almanac"), is compounded by using multiple sectors, industry groups etc. (Just think of the all the combinations you can come up with with say a bunch of sectors and 12 months of the year).
For what its worth, "the effect does not show strongly in the general market index" is borne out in SPY monthly returns from Feb. 1993 through April 2006, where the winter months return an average of 0.89% and the other months an average of 0.93%. This seems to be a pretty small difference, at least in an economic sense.
Of course, the real way to figure out whether these monthly patterns exist or not would be for me to start trading them, at which point I'm certain that they would instantly cease to exist.
Dr. Philip McDonnell adds:
Once one trades some pattern, it instantly ceases to exist. That is an interesting concept by any measure. It sounds like a corollary to the Law of Ever-Changing Cycles. Perhaps we could call it the Law of Antagonistic Cycles. Just because one is paranoid does not mean they are not out to get you.
With respect to the Halloween Effect paper it appears to address the issue of multiple comparisons adequately. In particular the Newey-West adjustment was used to compensate for the multiple comparison issue.
The other flaw which often comes up in such studies is the January effect. Because the Halloween through May seasonally strong period includes the month of January it is possible that the effect is merely a rediscovery of the January effect in disguise. However the authors seem to have anticipated that possibility as well. They publish a regression which includes a specific factor for January. The results show a reduced but still significant result for the non-January period.
About the only flaw one can find is that the level of significance was lowered to 90% rather than the usual 95%.
It is worth mentioning that the Chair has often said he changes his trading during the summer months. The Senator recommended in his book The Right Stock at the Right Time that one use his Darlings of the Dow strategy from Halloween through about May. From May through Halloween he recommend utilities which were mentioned in the Halloween Effect paper as well. In my opinion this strategy has some merit, but has been well known in this forum for quite a while.
Population Biology and Markets, by Victor Niederhoffer
Population biology considers such questions as the effects of birth, reproductive, and death rates on the age and sex distribution of populations. Typical topics covered are growth without constraint, growth with limited resources, competition between species, stages of growth and reproduction, interactions with the environment, disease and epidemics, life histories, predator prey, host parasite interactions.
Many of the questions that population biology illuminates have direct analogues in the growth of firms, classified by age, the relation of firms with their competitors, the dependence on resources, the distribution of firms by size and birth, the stages in which a company is a good or bad investment, the parasitical relation with the regulators, the spread of information, the interaction between growth and value.
To get a better foundation in the subject I have been reading 3 excellent books: Alan Hasting Population Biology, Nathan Keyfitz and Hal Caswell Applied Mathematical Demography, Horst Thieme Mathematics in Population Biology.
The Hastings book is accessible to all who enjoy working with simple models and it provides an excellent discussion of the tools to use to understand this subject including an introduction to matrices, nice introduction to genetics, simple review of Taylor series, difference equations for discrete time models, life history methods ( births and deaths at different stages of life), community tables for effect of each species on the other in two species dynamic systems, competition between species, predator prey relations, and diseases. It’s highly recommended.
The Keyfitz book is close to the heart as it's written by a 92 year old scholar that I had the pleasure of knowing strangely at each of the 3 schools I went to in succession, Harvard, Chicago and Berkeley. Strangely, almost all the books in those days had library cards and you could see who read the books before you and John Lintner and Nathan Keyfitz and I read almost all the same books in various orders. Keyfitz collaborated with a biologist to write this third edition of his landmark book and it's a encyclopedic treatment of all the main topics in applied biology. He divides the field into the eight combinations of the three variables fixed or varying rates of growth, one or two sexes, or one or two or more species. He concentrates on the one species, single rate of growth, one sex (female) case but the results are generalizable.
The book starts with a provocative query. What would it be like to consider a population just in terms of its size but not its composition? "To represent a population as a number varying in time and in disregard even of its age composition is like treating the earth as a point in space." He finds many things that you can do with such an approach in the beginning chapters of the book and then extends the methods taking account of life tables, censuses, changing age distributions, effects of others variables such as birth rates and reproductive rates on the dynamics of population. Topics included are kinship, changes and stability in mortality, sex preference, forecasting, sex ratios, migration, demography of organizations, reproductive value of a women, sex ratios.
The Thieme book is the most technical and mathematical of the books and contains sophisticated models for illuminating almost every question considered in the prior two books. Integral and differential equations and convex analysis are used throughout and there is little empirical work or applications. A good discussion of the epidemiology of infectious disease with extensions of the Kermack-McKendrick model is contained.
The applications to markets are endless. Let's start with how the distribution of moves in companies classified by value versus growth, in a given period effects the future growth of the various components. Or consider how companies perform based on their longevity, or size or relation with competitors. How about the influence of birth and death rates on the health of a market? For this subject, I recommend the Wikipedia article demographic transition by Keith Montgomery. Please augment these with your own queries and results as will I.
Kount Like a Korean, by Dr. Kim Zussman
All the old chartings on the tombs They do the sand dance don't you know If they move too slow (oh whey oh) They're falling down like dominos All the bazaar men by the Pit They got their money on a bet Gold crocodiles slip on the crude (oh whey oh) They snap their teeth your margin's hit Foreign types with hookah pipes say Ay oh whey oh, light and sweet ohh Kount like a Korean The blonde mistresses take their tips They spin across the trading floor They've got the moves (oh whey oh) You drop your stake and they take more All the B-school kids are tricked by books Mistaking Paradigm for Pair o' dice When the bell rings (oh whey oh) They kount like Koreans All the kids in the marketplace say Ay oh whey oh, Oy, oy veh-oh Kount like a Korean Slide your position through the $treet and hunch your back Offer just a bit and then you pull it bac Alpha is hard to get you know (you don't say, oh?) So strike a pose with a big finance rag If you want to find all the tops The Wiz is at the donut shop They sing and dance (oh whey oh) Spin the wheel lay on the trade All the Japanese with all their yen The party boys now stiff the Krem-a-lin And the Chinese know just how the wind does blow (oh whey oh) They take the bait just like Koreans All the flops at the quant shop say Delta thet-oh, gamma vegg-oh Kount like a Korean Kount like a Korean
Thoughts on Life and Death, by Victor Niederhoffer
There seems to be something entirely unified about the process of life and death. They represent the only two changes in state. But also, they seem to occur with many of the same hallmarks. Looking at it from the macro level in humans, one notes that a typical process of death seems to start with a loss of voice, the loss of mobility, the loss of a smile, the loss of a hand hold, the loss of the opening of the eyes, the loss of ability to swallow and digest, the loss of the ability to breathe, and then, finally, the inability of the cells to function as directed by the brain. Similarly the new born starts out with the opening of the eyes, the ability to breath on his own, the ability to swallow, the ability to move, the ability finally in the third month to smile. The content of communication of the newborn and the dying being are also so similar. Both are able in the main to communicate happiness, discomfort, hunger and desire for cleanliness and nothing else.
I can't tell whether this is a profound or trivial insight as no references to similarity between life and death appear on Google but there are hundreds of thousands of papers on life and death processes. Certainly the change from being in the uterus and having all functions performed for it by the mother, and the change from being in the living world having to do everything for oneself, (assuming no machines) and having all cellular activity stop has been noted.
In any case it seemed to me that often the beginning and end of a period are often inordinately related in a nonrandom fashion. To make my hypothesis come true, I imagine a reasonable formulation would be that the first period is inordinately similar to the last period. I decided to test this in a number of simple exploratory ways. I started with quarterly moves in the S&P 500.from 1989 year end to 2005 year end.
Let's take the four quarters of 2005 as examples:
Quarter Change 1 -3% 2 +1% 3 +3% 4 +2%
The first quarter was down 3%. The nearest quarter to it in % change was quarter 2 at 4% away, call that rank (1). The second nearest quarter to it was quarter 4 at 5% away, call that rank (2), and the furthest quarter of all away was quarter 3 at 6% away, call than rank (3). If there were no similarity between the beginnings and the ends of the period, then there should be a uniform distribution of ranks away for each quarter. Indeed, I found that quarter 4 was ranked (3) seven times, quarter 4 was ranked (2) four times and quarter 4 was ranked (1) 5 times. The standard deviation of the expected number of times that quarter 4 should receive each rank is 1 assuming drawings from randomly distributed quarterly changes so this set of observations is not sufficient to reject the hypothesis of randomness.
A similar study was made to see if January and December of each year are inordinately related. Within each year, I calculated the rank of monthly percentage change (1 to 12). Then I calculated D = abs(Rank(Jan) - Rank(Dec)) for each year. The unconditional mean of D is about 4.34 and I estimated the standard error using resampled monthly returns since 1951.
The mean D from 1990 to 2005 is 4.25 (see below), indicating a very slight and statistically insignificant tendency for Jan and Dec changes to be similar.
SINCE IMPLIED YR ACTUAL MEAN* STDEV* TSTAT 1951 4.07 4.34 0.36 -0.75 1960 4.30 4.34 0.39 -0.10 1970 4.11 4.34 0.44 -0.52 1980 4.04 4.34 0.52 -0.58 1990 4.25 4.35 0.67 -0.14
* Resampled estimates
Finally, a study was made of the moves of Friday as a function of the moves on Monday. It turns out that over the last 10 years, there is a rather significant tendency of the order of a correlation of -0.10 for the moves on Friday's to be opposite from the moves on Monday's. Of course this relation has been attenuated considerably in recent years.
Still, I remain convinced that there is a general tendency for births and deaths to be intimately related at the macroscopic and microscopic level and one will not be reluctant to augment this thread with further ideas from the world of demography and biology in the future in one never ending quest to improve oneself and one's knowledge.
Dr. Janice Dorn comments:
Near the end of his life, Cicero wrote that "Nature has only a single path and that path is run but once, and to each stage of existence has been allotted its appropriate quality." Across all cultures, epochs, classes and races, the experience of aging is a universal denominator of the human condition. From a biological standpoint, each human life has its own rhythm and beat which consist, at the most elemental level, of alternating cycles of growth and decay. The song: Windmills Of Your Mind says: like a circle in a spiral, like a wheel within a wheel, never ending or beginning on an ever-spinning reel.
For many Native American tribes, life is manifest by "four hills" (childhood, youth, maturity, old age), Each of these hills corresponds to a wind and a season, and possesses its own challenge, climax, and resolution. To the Hindus, it is a journey through four spiritual spaces called ashramas. Pythagoras was among the first western thinkers to interpret life as a cycle of four phases, each roughly twenty years long and each associated with a season: the spring (childhood), the summer (youth), the harvest (midlife) and the winter (old age). This is analogous to the Roman division of the biological cycle into four phases: pueritia (childhood), iuventus (young adulthood), virilitas (maturity) and senectus (old age).
Quaternal seasonality of the human lifecycle has remained a constant in literature, philosophy, and psychology. "Metaphorically, everyone understands the connections between the seasons of the year and the seasons of the human life," writes sociologist Daniel Levinson. "Each has its necessary place and contributes its special character to the whole. It is an organic part of the total cycle, linking past and future and containing both within itself." Carl Jung similarly describes the "arc of life" as "divisible into four parts."
Setting aside all but one aspect of the phases of our lives, i.e., focusing on values, it may look something like this:
Childhood -- acquiring values Young adulthood -- testing values Midlife -- applying values Elderhood -- transferring values
You all know that I am not a counter. I look at technical patterns, and, for many, this is pure heresy. However, for purposes of expanding on the life cycle, please indulge me this simplistic rendering? The stock market is a living organism, and, as such, stocks go through the same stages of life as do human beings.
Childhood: this is the basing period which occurs in the early stages. Reasons for this aside, such basing may occur for months to many years, oscillating within the restraints of so-called support and resistance. It is acquiring value, but this is recognized by few. One day, it overcomes resistance and enters into what is called a break out. This begins the next stage;
Young adulthood: volume increases, growth of the underlying company becomes evident and the stock is bid up by those who see these changes and improving business conditions. It is testing values, and may, at this time run to its 200 period moving average. This is a technical signal for many to either buy the stock or buy call options on it. This is the period of testing its value. based upon those who are willing to invest in it. At some point, the stock becomes overvalued and distribution may begin, sending it into the next stage:
Midlife: here, as in so many of us, there may be a mid-life crisis of sorts when what is referred to as "distribution" takes place. There is usually plenty of time to work through this phase, as it may take a while for the stock to break below its 200 period moving average. The process of distribution can be painful for those "late to the party" and manifest as excess volatility and a confusion regarding the direction of the stock. Values are applied and, in this case, found to be either wanting or in need of readjustment. For human beings who are not well grounded or prepared, this stage of the life cycle can be chaotic. Then, as investors are increasing confused, the stock enters the final phase:
Elderhood: its value is transferred elsewhere, and the stock enters into a period of decline. Those late to the party are confused and may become physically or mentally ill when they realize that the value has been transferred, leaving only a shell of what used to be. The stock is no longer young, or even middle aged. It is decaying and unhealthy. It can then fall to or below the 200 day moving average, and, all the plastic surgery in the world cannot make it young again. A facelift is only skin deep.
The time to find, invest in and nourish a stock is when it is in youth and young adulthood. If you do not do it then, the amount of work, both physical, mental, emotional and spiritual, to bring it to health and desirability is enormous. For some, it is worth it. They scalp or trade it, but don't invest in it. Kind of like a series of one or two night stands. Full of sound and fury, signifying nothing.
We had joy, we had fun. We had seasons in the sun....
Dr. Mark Goulston comments:
On the topic of life and death and the many stages in between, I am reminded of the quote of wonderful teacher and champion of public psychiatry, the late Milton Greenblatt, M.D.:
First we are children to our parents, Then parents to our children, Then parents to our parents, Then children to our children.
Roy Niederhoffer responds:
One thing that occurred to me is that the beginning vs. end of life could work in a "first too little" finally "too much" idea. For example, an infant probably has "too much" oxygen, "too many" undifferentiated cells vs. at the end "too little" oxygen and "too few" undifferentiated cells. The idea is a little like the logistic growth curve where first populations are below equilibrium, then at equilibrium, then exceed equilibrium. External symptoms of "too little" and "too much" in your blood might be the same -- for example, too much calcium vs. too little calcium might affect your behavior similarly (problems with cell membrane transport, maybe?) , but the cause of similar behavior might be entirely different. Maybe people work like stars, where there is a natural path of evolution not that "mortality recapitulates ontogeny" but more like a symphony with an introduction, main part of the movement, then a coda, which may reference the coda but perhaps continue the evolution in the same direction. Here's a link to the way stars evolve... possibly relevant.
Debra Moon adds:
I found your thoughts on life and death very thought provoking. I couldn't help but consider the ideas of volitional vs. non-volitional participation as related to what you wrote. Especially as the ultimate question seems to wonder how patterns effect the market.
For years I was associated with a professional group called Specialists in Group Work. Irwin Yalom, known as the guru of group specialists, identified significant patterns that occur when a group organizes itself over time. The first stage of a group is called "beginning", the birth stage, if you will, followed by the transition stage, the working stage, and finally the termination stage. My observations in teaching and leading group classes for 15 years left me fascinated with the overlaps/similarities of the beginning and final stages of a group. Both were marked by certain features that were inverse but consistent. In fact all of the stages of the group were quite predictable and when mastered allowed the leader to work with the flow of volitional contributions of the members in a way that would allow for ultimate group vitality and productivity or in the hands of a neophyte leader would lead to the group aborting itself. Paying attention over the years increased my fascination for how the volitional nature of groups patterns could be observed in all social interactions if one pays attention. Meetings, dates, even short phone calls have the same beginning, transition, working, and termination stages. I have so much more to say about this in terms of how the stages manifested in the behavioral choices of members but time crunch requires me to save it for another posting (one example: members often inadvertently wore the same color clothes during the weeks of working stage of a group process). Note, the working stage is marked by the highest level of interpersonal intimacy.
Volitional activity seems what makes the market seem chaotic and quite frustrating to interpret. My hunch is that non volitional activities and patterns seems to have less impact than choice in terms of which patterns give the most information for mastering any sequence as well as offering the opportunity to enhance or correct a sequence.
While biological/physical contribution have merit, my hunch is that any patterns in nature or otherwise that are non volitional, if ruled out would expose the pieces of data worth noting. For example, patterns related to conception and suicide seem more relevant than anything cellular or intrinsic. Your brother mentions the patterns of an already written symphony and star formation. Again the non volitional aspect of the finished piece would interest me, but the volitional aspects and stages of symphony writing might offer a far more useful pattern than the characteristics of the finished product. Also performance patterns seem noteworthy by which a piece is rusty at first practice to peak performance to it ultimately growing stale from being overplayed. Examining what else was happening when a new star was formed would seem relevant and more powerful data as opposed to the patterns of star formation.
Taking what might seem like a completely left turn here, I suggest that intimacy/intensity levels as marked by the working stage of any interaction or group process are a huge volitional factor that would lead to understanding market patterns. Heightened intensity marks all volitional intimacy related group/interpersonal activity. Groups, procreation, the choice to die, creativity all somehow eventually demonstrate the intimacy/intensity factor and fosters outcome relevant to the levels of volitional participation. When peak performance is reached intimacy is at its highest. All hypothesis for sure but I thought I'd add my two cents. I just share what I observe and let your experts make the links, if any. Since the market is participatory, since participants create one "huge" group, it might make sense to study patterns of intimacy more closely.
P.S. Emerson said, "what you are shouts so loudly, that I cannot hear what you say." In my field this quote is distilled/simplified as therapeutic folklore into "don't listen to what people say, watch what they do." I love this quote as it creates for my mind a pertinent analogy to volitional vs. non volitional data. Non volitional data is the "say", volitional data the "do". The "say" may be of integrity/truth or red herring quality. Nonetheless, rendering the "say" irrelevant is the first step towards clarity.
Kristian Blom offers:
So much for Google search. Every culture has traditionally seen the loop of Life/Death, and often with a glint in the eye! "We come and we go."
"Where do we come from and where do we go to, and what is it like?" thundered a wandering Dervish. "I don't know," said Nasrudin, "but it must be pretty terrible." A bystander asked him why. '"Observation shows me that when we arrive as babies we are crying, And many of us leave crying and reluctantly, too."
James Sogi remarks:
The ancients viewed dawn as the birth of the day, and night as death. For an early riser, the slow rosy red fingers of dawn spreading across the mountains and sky, the frenetic chirping of thousands of birds greeting the dawn, the sounds of the pond coming to life are part of the birth of the trading day. Various studies have shown a similar market phenomenon occurs where the daily opens and closes tend to be correlated, by higher volume and volatility, and to some degree in return. Philosophically it is good everyday in viewing the birth and death of each day to remember the transience of life and all things human, and to take the time to value and cherish that which is important in this short life.
Russell Sears says:
I am the alpha and omega, the beginning and the end says the Lord, who is, who was and who is to come... Revelations 1:8
For me spring is a spiritual time, after taking daily communion on my runs, throughout dark winter mornings, suddenly there is once again light, vibrant colors, new life and bird's song of love to greet me in the morning.
The Omega of Winter, followed by the Alpha of Spring.
Perhaps the greatest similarity of Birth and Death, is the human reaction to these mysteries. This reaction range for boundless hope to limitless fear. Perhaps it is the basis for religions and the motivation for betterment of the whole. From the most irrational mysticism to the greatest scientific discoveries.
We have all known spent old men that could not make peace with their allotted time and curse the young. Yet most of the loved ones whose death I have witnessed first hand, have had a need for the youth of the new born, to feel the hope that is in a related baby, that their life is eternal. And as my mother died, my internal vow not to let her wisdom part.
All parents know the hope within an expecting birth, that this child is will revolutionize the world with his combination of intelligence, athleticism and leadership. And all parents have had that moment of panic, from a soon to be found save, wondering tot.
Perhaps my God is Hope, as this is the name of my first born daughter. Perhaps my God is Faith in mankind. Yet, we know so little about the beginning and the end. The uncertainty and unknowable in start-ups, IPO's and bankruptcies lead to fear and hopes so fundamental as birth and death.
Nat Stewart adds:
The similarities I see are the simple ones, such as dependence on others for survival. The child starts off completely dependent and goes through a gradual process of becoming independent. The dying go through the opposite process: gradual loss of function, complete dependence, and then death.
In considering a market analogy, this is one factor I would consider. Would beginning or ending periods be times when a specific market would be more inclined to follow other markets? Do markets develop greater independence in the middle periods that would correspond with maturity?
Another commonality between the old/near death and the young can be a certain naivete the willingness to believe or the desire to trust. Children seem to develop a rational facility quickly, but lack experience, acquired knowledge, and context for making decisions. The old/dying can be the opposite: The experience is there, but the ability to recall, reason and function go into a decline. Early on, the market is grappling for footing, context, an equilibrium price as the child struggles to understand and improve, seeking to self correct. Towards the end, it is not a struggle for improvement, but a struggle to exist, the lastly the struggle to exit. Could moves in the market operate on similar principles? Are markets more prone to influence from ephemeral factors at beginning and endings of periods, and could their reaction be different, based on the nature or context of the change (beginning or ending) that is occurring? Secondly, how in the market does the transition occur between the "end" of a period and the "new beginning?" of the next period? Is there a change of tone, readjustment that must occur, perhaps close to open?
The beginning of life, advance into maturity, and death are marked by symbol and ritual. Before birth, at birth, rights off passage into maturity, last rights, funeral, and burial ceremony. Is the pathway between the beginning and end of market periods marked by similar "rights of passage" where character and expectations change? If so, is it discounted? Is behavior in the next "stage" dependent on prior period?
At the beginning of life, one is self focused, the ceremonies one watches and focuses on are primarily ones own with little regard for "out there". Growing older, the ceremonies one focuses on are increasingly those celebrated by others who are at an earlier stage, for example one's children or grandchildren.
Perhaps an analogy is that early in periods, or in the life of a company when growth is strong, the there this same self focus exists its behavioral (innovation, new products) and trading characteristics. Later in the life of the company or period, the factors that influence and lead are external, reacting. On the negative side, the young can be resented, in business legal protections. On the positive side, the old get joy from watching the successes of the young, the young learn from the old. Perhaps suggesting potential relationships in the stock prices between companies with some similarity but different stages in the life cycle? Or something else?
You hear from people at the beginnings and at the endings. First it is congratulations, then it is condolences or sympathy. people you have not heard from in years, never expected to hear from again, who are completely out of touch but for a moment. Who are the genuine well wishers and phony sympathizers the market hears from at the beginning and ending of market periods, and do "they" have a reaction, mood, or one-two liner that can be predicted?
Dr. Mark Goulston responds:
It's more than thirty years ago and I'm doing EKGs as a medical student in a moonlighting job at a home for the aged in Boston. On the third floor at the far end of a corridor is a man in a wheelchair, who sits there most of the day with no visitors. I asked the nurses what that was all about. They said he was a famous attorney that nobody ever visits. He was as arrogant and condescending as he was brilliant, and even though he had won many cases in his life, he hadn't won many friends.
"Hmm," I thought to myself. Something about that didn't add up.
I then ventured into the room of Mr. Cohen who was alert and so full of energy that he seemed very much out of place in the "holding station" for the next world. I asked him what he was doing there, especially when he seemed so...uh...alive.
He told me: "Two floors below us is my wife. She had a stroke three years ago and on her best days, she smiles a little and I believe she recognizes me, but I can't be sure..."
"That's all very nice," I interrupted, "but you could live on the outside and visit her and still have a life."
"My wife and I escaped from Russia," he interrupted me and took back the conversation, "in 1915 to Europe and then we moved to America. I can't keep track of how many times she saved my life and I saved hers, but it was more than a few."
Young, impatient and "transactional" (I didn't know that word back then) in my mind set, I re-insisted, "Yeah, yeah, I understand, but you still don't have to live in such a depressing (I couldn't fathom living there) place as this."
"Sit down," he insisted, "every day I get up, get my newspaper, go down to my wife's room, change her diaper, bathe her, and braid her long beautiful hair just as it was in the old country. Then I sit next to her and read my newspaper."
"That's very sweet, but..." I started again, but couldn't get my words out when he cut me off.
"Every day," he now spoke firmly, "I get to go down to my wife's room and give her dignity. She would have done the same for me. I enjoy doing that. She was and still is the love of my life."
"Okay," I said in exasperation (still myopic in my youthful arrogance), "you're a very nice man, but I still don't get it."
I packed up the EKG machine and started to leave the room and Mr. Cohen offered me his parting comment: "Maybe some day you will."
And now thirty-five years later, "I get it."
Sushil Kedia comments:
'A matter of life and death' is one phrase that is so oft used with the correct logical operand 'or' displaced with 'and'. No one bothers to seek the logic behind this and here instead of or when actually in the context and is meant as or.
But then, could this be not an expression where the issues, parameters or statistics of import are known in our minds to be the same in either situation?into feasible Boolean operators, one clearly has ease in assigning 0 to death. However, life is one state where there are shades of 0 and 1. It's a very unique Boolean. Goes to the realm of Fuzzy logic then.
In the end we are all dead is a truth that does over-ride all else with certainty. However, despite this certainty the difference is made by how one chooses to spend the opportunity in between life and death. Between the life and death of an investment, trade, business or economy is a struggle to overcome the counter-cyclical forces operating against its life. Acknowledging fully well that so far any expectations of beating death are totally improbable each and every organism, social structure & system indeed endeavors to outsmart death.
Like the ever-prevalent relay race, at the expiration of the doted line a runner hands over the baton to the next one. The circle of life progresses past the doted line of death by handing over batons of coded information through accumulated knowledge of the solved problems and aspirations of the unsolved.
If weekends, month-ends, year-ends, seasonal-ends, pattern-ends, runs-ends, non-run-ends, points-of-inflexions on ever-changing cycles all contain a coded byte of information influencing the behavior of the latest carrier of the baton then it has a possibility of being another extension of the human perceptivity and collective wisdom.
For each, death is a certain reality. There are phases within life that are for some often and for others less frequently uncertain reality. With all the possible advances in estimation technologies of the duration or survival time of life, in the larger domain the certainty of death is as uncertain as life itself.
In the fluctuating pendulum between the perceived certainties of life and death there is however another parameter of a generally certain truth erupting with a far more predictable regularity and much much higher frequency of hunger. The word hunger can evoke pictures of insurmountable suffering, agony and deprivation on one hand while it clearly is the measuring stick of the efficacy of life. Companies that are continuously hungry for cash, whatsoever a size they may reach are in fact the one's that have enough growth opportunities available. On the other hand, the cash spewing machines, the one's with an overplus which they are not comfortable in deploying anywhere in the world (not even in cash itself) are the uneasy giants that have come close to the point of crossing the hill of growth, if not already having done so. So, if death is the only reality that relieves one from facing the daily reality of hunger it adds up with the idea that quality, quantity, frequency of the occurrence of hunger and its resolution is a possible fair way of projecting the curve of life remaining ahead.
Getting back to the idea of points of disconnect in between the regular flow of markets, a longer than usual holiday, weekend, unplanned disruption (pleasant or otherwise) coming by, is there a tendency for the group-think in the herds of markets to unwind? There is a doubting Thomas inside the mind of every man playing at ever-changing frequencies. Self-evaluation, constant monitoring and adapting to the environment are desirables in the affairs of men. Is it not happening that such breaks tend to take the individual to be more an individual than while he was during the preceding week, month, day or year participating in the crowds. The weaker hands, then clearly have a possibility of in sufficiently large numbers wishing to acknowledge their individual mistakes over the break, getting it incorrect yet again to set off in the next baton carrying relay of markets the similar phases and relationships of prices.
Dr. Kim Zussman responds:
The physical changes shortly after birth, and as one approaches death, mirror the cycle of the entire life process. Life is a temporary organization of molecules, themselves once being involved otherwise, which will once again disperse to become part of many other organisms. Imagine just knowing the participatory history of each carbon atom within your body since they first formed in a star. Which rock was it trapped in, until volcanic heat released it into the air? What cities did the wind that carry it through, and which ocean currents did it swim? Which life forms were once made of what you are now?
Thousands of years ago, a tree grows solid structure of cellulose and protein formed of CO2 welded with photosynthesis using energy from the sun. After living a hundred years the tree dies, falls, and rots for another decade, through the action of microbes and water. Bacterial and fungal enzymes break down structural cellulose and smaller molecules are liberated into the soil and the air as CO2. These once again are taken up by new plant life, which might be grazed upon by cattle or formed as carbohydrate-containing fruit which is pureed and fed to young and old people without teeth.
Stars like the sun are composed mostly of fuel hydrogen, and heavier trace elements formed in nearby supernova explosions billions of years ago. The violent death of huge stars seed the cosmos with ingredients for birth of higher complexity.
We are programmed to think of ourselves, our species, race, or families as unique enough to fight to the death to defend, and entitled as winners of competition to consume the flesh of lessers. This battle between relatives is as ubiquitous and eternal as our cells made of atoms once of someone else but destined to become countless others when the temporary collection "me" is over.
Odds and Ends, by Edward Talisse
“The strong data released the past week led the futures market to raise the odds that the Fed will continue to hike rates beyond June.”
We read statements like that all the time in the financial press and in market strategy pieces. It’s total nonsense. The odds of an event's happening have to do with a payoff of an outcome, not the probability that the outcome actually happens. Odds are chosen to reflect the magnitude of betting. For example, if the odds of a horse's winning a race are set at 2:1, it simply means that you get back two units for each unit you bet if your horse wins. The odds are set to ensure that: ∑ W ≥ (Odds of Horse A winning +1)* $ amount waged on Horse A, where W equals the total amount collected by the track. The track can never lose. The odds are always changing to ensure that the total amount collected is greater than the payout on any particular outcome. So odds are set, not based upon the probability of Horse A's winning, but rather on how much was bet on Horse A. Two to one (2:1) odds on any outcome just mean a lot of people have bet on this scenario. It has nothing at all to do with the probability of Horse A's actually winning. It's just a consensus opinion.
So the next time a salesperson tells you that Euroyen, Eurodollars or the Euribor strip reflects the probability or odds of an outcome, tell him to take a hike. It just reflects consensus opinion. Nothing more. By the way, if you like to gamble and you go to casinos, you should only play blackjack or poker. Why? They are the only games casinos offer where the results are conditional on previous events. Most Casino games are a Markov process, meaning that the game is a random walk with no memory beyond the present. In blackjack and poker, your current hand clearly depends on the cards that have already been dealt. That’s your only edge in a casino.
Defend Then Attack, from David Baccile
Defend then attack is one of the 13 rules of war in How Wars Are Won, by Bevin Alexander. The Byzantines used such a strategy against the larger and stronger Goths in the 500s to their advantage. The defend then attack strategy requires a superior weapon and/or tactic. The Byzantines employed a new tactic: placing foot archers on each flank. When the Goths attacked, the flanks were rushed forward such that the attacking Goth army became engulfed with arrows, and by the time the army finally reached the entrenched Byzantines they were severely weakened. In one day, following attack after attack, the Goths lost 6,000 men. The Byzantines then went on the offensive and swept the remaining Goths from Italy.
The Civil War might have ended differently had General Lee followed the counsel of Generals Stonewall Jackson or James Longstreet. Jackson understood the challenge of fighting a much larger Federal army in frontal assaults and he also saw the great advantage of the new Minie ball rifle, a weapon with four times the range of the musket. The Minie ball would make it difficult on attackers because defenders would be able to inflict significant casualties before the attacking army even got off a shot. Jackson continually recommended baiting the Federal army to attack and then, upon successful defense, go on the offensive by moving against the Federal army on an open flank. Every time Jackson made this recommendation, Lee turned it down in favor of a frontal assault -- culminating in the loss of 1/3 of the Confederate army at Gettysburg.
Defend then attack may have limited application to the markets but it would seem to favor reversion to mean and going against the strategy known as trendfollowing. By waiting for the market to make a move -- an assault -- then countering with an opposing move, a trader might find advantage. Again, this strategy requires some superior "weapon". That superior weapon or tactic might come in the form of "counting". Picking a position of defense would be similar to holding some tested hypothesis and waiting for the opportunity to attack against a weakened market, weakened in the sense that much of the assaulting capital has already been deployed. Selecting a strong, defensible position is key. That might include buying stocks with very large base of short sales, insider buying, or ongoing buyback programs. Either of these might provide some additional support during a counter-attack.
Professor Mark McNabb on Bikes, BBQ and Birmingham
I drove to VA from Cincinnati (Cincy) by way of Birmingham AL this weekend for two reasons: bikes and BBQ.
First I was knocked out by the largest and most impressive motorcycle museum in the country (and I guess since the fire in the UK, now the largest in the world at 800+ bikes and 100+ makes). George Barber, who raced as a young man, founded this collection and in less than 20 years has built it into a Mecca of motorcycle history and style open to the public. I have never seen so many perfect bikes. What made it even better, is that the facility has its own race course (home to Porsche Driving Experience). The track was hosting a vintage bike race as I looked on from inside the museum.
Two links: one to museum and one to some snaps I took. I'm partial to Ducatis and Indians and Vincents, but I love the most aptly named bike in the world 'Morbidelli'.
Second I stopped in the community of Decauteur Al to try Big Bob Gibson BBQ, seven time National BBQ champion, to see how their craft stands in the big restaurant. Bob Gibson does pork, chicken, and beef, which is unusual in most places. Excellent smoked meats although I suspect they're boiling the ribs and the brisket in order to speed the cooking process in the restaurant. The flavor was outstanding even if they are cutting the corner a little. So good in fact, that I had the brisket in leftover sandwiches without any sauce the following day in the Barber Museum parking lot. I didn't find their award winning sauces to compare with my homemade for one of our Applewood smoked prime ribs or wahoo, but that's a quibble. Big Bob is also noted for homemade pies and I went for the coconut cream pie, outstanding. Curiosity was rewarded and worth a trip, even if six or seven hours from Cincy.
If seeking comfort food and you're in Chapel Hill, NC, Mama Dips is the place.
IF you have that fried okra and sweet potato pie binge, it's worth a small detour on the way back from Atlanta to Cincy by way of the Chesapeake Bay.
PS. Meanwhile the oil (stocks), gold and emerging markets trade wanders higher but the summer requires more finesse as velocity has its hazards. And, oversold groups like the homebuilders should find a sweet spot as talking heads and weak minds obsess about little B's next rate reflection but do nothing of a fiduciary nature.
Perfectionism and Blackmail, by GM Nigel Davies
Janice's post on perfectionism brought to mind a chess technique that you won't find in the books.
When one player holds an advantage there's a tendency for him to want to be very sure about everything he does; an inner voice is telling him 'not to mess it up'. His opponent, on the other hand, is not burdened with this often overwhelming sense of responsibility. So he can blackmail his opponent with the threat of confusing the position even slightly, and he doesn't need to calculate everything out.
This same phenomena exists in markets; when we have open profits it's very tempting to want to avoid any further risk, even if the position is still favorable. So punches are pulled for the sake of 'safety' and excuses made about the reasons why. But this process brings us ever closer to randomness.
High-Beta Stocks Underperform, by Dr. Philip McDonnell
Dr. Michael Cook said in regards to "outside days":
If by adjusting for risk you mean volatility, I think you probably should take that into account. But the idea of the strategy - which I haven't back-tested - is simply that high beta stocks will be overbought, at the expense of low beta stocks, and so will be bid up, lowering their expected return."
Dr. Cook is quite right. The top decile of high beta stocks do under-perform on a risk adjusted basis. This result was found in the first major paper which did a cross section analysis by beta. However the author dismissed it at the time preferring to believe that the data was wrong. Otherwise there might have been a minor blemish on the Random Walk and CAPM theories.
The results have remained consistent in every study I have seen since that time. Readers may recall a study I did involving some 250,000 regressions which showed a very similar result. The result only holds for the upper tier of beta stocks not for the slightly higher than average beta stocks.
I agree with Dr. Cook's explanation as well. CAPM assumes unconstrained borrowing and lending. However Reg T and the regulations and rules at many funds and pensions prohibit borrowing at higher than a certain level of leverage. Anyone who is trying to time the market may reasonably choose to overbuy the highest beta stocks as a means of increasing leverage where other constraints are operative. That explanation also fits with the fact that only the very highest beta stock seem to be impacted.
Wavelets Part II, from James Sogi
As a surfer, my lifelong pursuit is to ride the waves. The Wavelet analysis mentioned in my last post uses filtering algorithms to capture one cycle, one wave, showing the cycle in an otherwise noisy looking time series. The output seems well suited to identify changing cycles. The results return a multi-resolution analysis with the ability to change scales. The pyramid algorithms are filters that transform the time series into multiple vectors that split the time series into high pass and low pass vectors, and then split those vectors again, and into third and fourth moments and more and the output vectors create a matrix. Each step has a wavelet filter (high pass) and a scaling filter (low pass), corresponding in most cases to a high pass and low pass filters. The LA(8) ("least asymmetric") algorithm seems to be the best smoothing. The schematic of the pyramid algorithm is tree formed. The matrices are plotted as multi resolution analysis (MRA) along different scales to identify the change in cycles by smoothing the times series in a way (zero sum and orthogonal) that helps match the peaks and valleys of the original series without the lags that plague moving averages or other Ehler filters. The zero phase filter lines up with the original time, or in real time for that matter, without lag. The matrices are down sampled by inserting 0's which means taking evens or odds (similar to the down sampling tick data into 1/2 hr bars). Circular filtering allows adjustment to tune the wave to match the underlying. Wavelet analysis can be to be used for financial series to identify critical turning points. Wavelets have boundary and length issues like moving averages with the annoying drop offs, but the cycle wave utilizes a zero phase filter which cures some of the problem with use of overlaps (modwt). This qualitative summary is rendered in mathematical symbols for manipulation and proof. This troglodyte will analyze the jet engine that has fallen out of the sky using applied object oriented computational methods rather than Greek symbols. It sounds all rather complicated, but boils down to pretty simple stuff for the small price of a book. The attached wavelet plot is actual R output example using IBM.
The question is what are wavelet MRA plots used for and are they predictive? In practical use, the stretch away from the smoothing, a technique used with other smoothers, might be profitable, or the trend following methods. The Haar maximum overlap dynamic wave transform (modwt) smoothing based on a zero filter tends to line up with original series with reduced the boundary effect and shows the turning points. Its good to have a bias which acts as a rudder. The wavelets help tell when its time to throw the tiller over on the ship.
Is it predictive? The discreet wave transform can be used with ANOVA. probability density functions, Bayesian analysis, chi-square distributions, autocorrelation and other statistical functions can be applied to the wavelets as a representation of a stochastic process, but a description must await the next installment as the grass is quite tall in here and hard to get through with such a dull blade.
Letter to a Newborn Son, from Victor Niederhoffer
The occasion of a birth is always a good time to take stock of the important things in life that a father would like to share. In your case, it's even more important, because at 62, I am the oldest father that the big Pennsylvania hospital that you were born in had ever discharged, and I am going to have to compress much of my hopes and knowledge and love for you into a few short years. Here are some of the main lessons for you that I hope to set in motion so clearly and firmly by my own example and also with practical direct applications for you while I'm alive that it will become second nature to you, and these guidelines will be useful merely for a review, but it's too late to lock the stable after the horse has been stolen, so here goes.
The Mouse with One Hole
You will soon learn to love the memory of your grandmother Elaine. She gave of herself selflessly so that her family could excel and prosper. Nothing for her three kids and 10 grandchildren and her many good friends was too unimportant for her to attend to. She led an exemplary life, with nary an enemy. Hardly anyone who knew her who didn't love her. One thing she really wanted was to see you before she died. But, regrettably, things don't usually happen the way you hope, and she died one week before you were born. Okay, a tragedy, but at least she had many a smile thinking and hearing about you while she was waning, and you will through her teachings, her books, her progeny, her eulogies, and her bios have many opportunities to learn from her. Nevertheless, let this be a lesson for you.
Your investments, your romances, your aspirations will never be realized the way you planned. There is much uncertainty and risk in the world. Even when the outcomes are known, it's largely chance what's going to occur. Do account for risk and uncertainty in what you do. Never leave yourself with just one exit on any important pursuit. Constantly plan for the contingencies that are not at the peak of your hopes, or most likely outcome. Follow the wisdom of many animals, and the proverbial "the mouse with one hole is quickly cornered".
Listen and Learn
While we're on the subject of your grandparents, you'll soon find out your paternal grandfather was a king among men, whose spirit lives in thousands of others still living. My book Education of a Speculator is a love story about him, and you'll get the main ideas from that. Regrettably, he never thought he was going to die young, so he never wrote down guidelines like these, but he did read me and Diane and Roy a story every night for 18 years, and he drove us to and attended all our 10,000 lessons and tournaments, so we got a good dose of what he would have told his kids. One of his most important mottoes was "Listen and Learn." In its most exact sense it means that you should always be ready to find wisdom in what other people say, and try very hard to absorb it without injecting your own preconditions into the fray. But at a more general level, it means to be humble, to always be wary of your own liability to error, to always give the other person the benefit of the doubt.
When you're investing, there is one super person that you must always listen to, and that's the market. To fight the market without humility is the cause of certain death. You see, all that has to happen is for you to be wrong enough for you to lose all your chips. And it doesn't take long for that to happen, especially if the market or anyone else, senses they can make a killing by doing you in. Regrettably, there are some people who, like the vultures and maggots and hyenas, specialize in waiting for you to be near the death point, and they always can tell when you're near death, so the market usually will take that last move just to suck your life blood away when you're not humble.
Give Others the Benefit of the Doubt
The world is full of great people and small people. You'll find they all think they're well-meaning and good. There is good and bad in everyone, but if you treat everyone as if he's a good person, you'll tend to bring out the good. That will augment your life immensely. Conversely, if you treat people like they're bad, not only will they clash with you but you'll help them to become bad. People never give you more than you expect of them. Artie was a master at giving the other person the benefit of the doubt. There was a joke in our family that we all hated to play ball when Dad was on our side, because every ball we hit was out and every ball they hit was in, according to him. But he taught us the value of sportsmanship. He taught us that if you needed to win so badly that you had to bring out the worst in other people then you'd bring out the worst in yourself also.
When you're doing business with someone, remember that all profits come from recurring relations with the other side. If you're the kind of person who's always trying to get the edge by assuming the other side is trying to put one over one you, no one will want to do business with you twice because it will be so unpleasant for them. Sure, you'll get gypped a few times by giving the other person the benefit of the doubt, but you'll make up for it on the many occasions when someone says, as they sometimes say to me, "You know - you've never asked anything from me and you've brought out the best in me, and here's something meaningful for you." As for the applicability of this to investing, remember that your counterparts, brokers and agents are going to have to benefit from doing business with you, or else they can't continue in business. So you have to give the other person the benefit of the doubt; otherwise, you won't be able to continue.
On another level, giving the person the benefit of the doubt assumes he is very intelligent and knowledgeable. That's part of being humble and preventing yourself from assuming that you know more than others. The importance of humility as a requisite to success in investments cannot be overemphasized. That is why it crops up in many of my points as a corollary or condition to success. You'll learn this best sometimes by falling victim to the contrary. Eventually, you'll see people who are always boasting about their own success and how much smarter they are than everyone else. They're obviously not giving the other person the benefit of the doubt. You'll find a lot of these arrogant blowhards around, but you may overestimate the number doing business at one time, because they're sure to go out of business. So the only ones who are left are the newbies who have not gone under but soon will.
People are Able
The one observation that I can make from my own experience that has the most explanatory power is that almost everyone you meet will have some aptitude, know-how, taste or expertise that's highly effectual and interesting. When you go through life, try to elicit those unique qualities in the people you meet. Assume that the average Joe on the street has much to teach you, and be ready to drink it in. One of the most effective ways that I've found to bring out the these know-hows in people is to sit down with them sometime over lunch or take a walk, and just say, "Tell me a story," or "Teach me something." You'll be surprised at how those simple words open vast vistas of erudition and knowledge that were completely undreamed of.
You'll discover that every investor has a different method of applying his trade. That's one of the beauties of an enterprise system like we have in our country. The process of providing a product is divided up into many parts. Because of these many parts, people can pick and choose those they are most interested in or most able at. This is called specialization and niche-building in the animal and plant worlds. The process of finding your own niche, the area that you have the greatest edge, in as well as figuring out what the niches that others specialize in, is a grand goal in life but also a crucial aspect of the process of investing.
The Importance of Small Things
Little strokes fell great oaks. No matter what great goals you have for yourself, and I hope they'll be very high, you have to start somewhere. The best place to start is with something little, something you are accustomed to doing well, maybe from your mastery of games or music. For example, you might want to become the world's greatest trader. To do so you have to start by trading something with someone. Try it with someone in the family, trade a tennis lesson for a piano lesson, or a set of plate blocks, for a penny black. Once you start, you'll find it easier to get to the next step.
The best lessons in doing small things come from music. Every day you have to start by doing some very simple exercises. Then you have to practice over and over again until you can meet anything written in music with great aplomb. Once the technical difficulties are mastered, in music or anything else, you can concentrate on the things that make for greatness, the rhythms, the content of the main themes, what the composer has in mind, the dynamics, and the pedals.
Time and again I've applied the lessons I learned from practicing the piano and violin, which, among other instruments, I'm sure you'll be playing. I found it normal to practice by myself in squash, just by hitting each shot for 10 minutes at a time alone on the court. That's really how I got good, once I received the proper instructions, foundations and guidelines from Jack Barnaby. Amazingly, to this day, hardly anyone else did that, and people used to look at me like I was an oddity for practicing by myself in all my racket sports, and it was much harder in tennis in the old days before they had machines.
When you want to start investing, make a little trade. Wait until there's been a long run without a success in some field like the stock market, and then take the other side with a very small quantity. Do it so small that you can afford to hold for more than a day. Remember the mouse with one hole. If it's up the first day, then get out. If not, wait for two or three days to close out. After that, call it a day. The markets will always be there.
Because of the wide applicability of the value of learning by doing small things, you'll find it applicable to every pursuit. I like to apply it to problem solving. Whenever you have a problem, start by doing the problem as if there were just one or two things or persons involved. Count out the possibilities. Then see how you solved it and apply it to more things. If it worked for one, then did it have to work for two? Not only will you know the way to solve more complex problems that way, but you may have within you a generalized proof by induction.
Actions happen as the result of individuals' making choices about based on a comparison of the benefits and the costs. If you want certain actions to happen, or if you wish to know why they did not happen, compare the benefits that were available to the costs for the individual. When they increase you'll find more of the action and when they decrease there will be less.
The best incentives you'll find are the ones that involve money. That's because people can use money to get more of the things they want and the things that have the most value to them. Sometimes the best way to see the importance of something is to assume you had none of it, or a googol of it. Often when there are no money incentives you see the craziest things. In my day, there was a book about the lack of money incentives in Russia, written by G. Warren Nutter, titled The Strange World of Ivan Ivanov. He said that because they had no incentives in Russia, no one worked hard, and they never produced what people wanted. He and Mises and Hayek predicted that the system would break down, but no one believed him at the time. Indeed, they used to teach at Harvard and all the other good schools that the Russian system was as good for producing goods and grew as fast as ours. But then the truth came out. There was uniform poverty in Russia, except among government officials, and no one was there to take care of the sick cow because there was no benefit from doing so.
Worse yet is what happens to people's character when they don't have incentives. They must constantly fight against their inmost tendencies to improve themselves, which they think about almost every waking minute. If the system doesn't provide for a way to make those incentives to improve themselves easy -- or worse yet, the Russian system made the money incentives to improve yourself illegal, since all economic goods belong to the state and to start a business or trade in Russia was a capital crime -- it makes people crazy and deceptive and suspicious. Almost all the Russians I've met have a strong tinge of dishonesty within them, developed in their communistic upbringing as a prerequisite for survival. The terrible influence of lack of incentives on character is usually present whenever you see people doing consistently bad things.
I hate it when someone who wasn't brought up in an incentive system comes to me. He's always thinking, what can he take from me, what can I give him without a trade. Worse yet is what he thinks about me. He sees me as an enemy, and thinks "What the H am I trying to get?"
I love to buy investments where incentives are changing. Some of the best opportunities arise when governments or associations privatize their activities. All the sudden, the sick cows get milked, people start working long hours, the customer becomes the king rather than a problem. When you were born there was a movement for all the exchanges to become private profit making entities, and the importance of incentives in improving their operations and making them fight harder to get business led to many profit opportunities. Always make sure there are incentives in the people you invest with for them to make money for themselves while they're making money for you. If the incentives are not in balance, then you're going to have big problems unless you or someone else changes them quick.
I've discussed many areas that are crucial to success. How can you keep track of them? There is only one way, and that's to count. Now, counting is best learned by doing. In your family Francis Galton reigns supreme. Your eldest half-sibling Galt was named after him. He is often referred to as the king of counting. Galton kept an index card and pen in his pocket at all times so that he could classify relations between two things into the times they moved together and opposite from each other. This is what the call the process of co-movement and countermovement, or contingency tables, in technical terms. The best way to become a good counter is to do it often. My first memories are of Artie sitting in 90-degree heat at Dodger Stadium and counting the number of hooks and errors in handball. In my mom's book with Artie The Police Family they give a beautiful example of counting, by classifying all the books ever written by police families -- by kind of favorability, style, content, happiness of the characters, and many other variables.
Count often and practice at it, and it will become second nature to you. You'll make many discoveries. Even more important, you'll learn to be skeptical of the kind of things that are going to come down the road that are based on superstition and myth, magic and cult wisdom.
Read good books on counting. I like the classic statistical books on counting like Statistical Methods by Snedecor and Cochran. Also good is Statistics Without Tears by Derek Rowntree. But any book that gets you to take out the pencil and paper and teaches you good examples from many different fields is good. The third aspect of counting nowadays is that it's important for you to develop a tool above and beyond the pencil and paper to do your counting. For that purpose, it's essential to learn a good programming language so that you can count systematically and extensively. The programming languages that I learned on were based on FORTRAN and BASIC. Nowadays, many people find that using the statistical programming environments R and Matlab is an excellent way to round out counting in practice. When you've mastered these three steps to counting, you'll have to gone a long way toward becoming a good speculator. You'll not only have a proper basis for making statements about the relations that matter in markets, but even more important, you'll have a basis for rejecting those that don't. There's a mantra that all the people associated with me follow that has been very helpful in their investments and, indeed, in their lives. When someone suggests a trade or procedure, always ask the question, "Er, have you counted and tested that?"
Aubrey, one of the first jobs that you have is to cry, to let us know what gives you happiness and pain, and to get your body functioning properly. I know this is very important for you but right now it's been keeping your mother and me up for the first two days that you've been alive. And before I tell you the other important lessons, based upon such things as the important of games, the importance of books, or music, the overriding significance of compound interest, the importance of taking a proactive approach, I'm going to have to get some sleep. Then, I'll talk about the importance of having proper mentors, of choosing a path where you have the wind at your back, the lessons about diminishing marginal return, the key significance of trade, and the lessons from examples of heroic men. But, before I tell you about all this, I'm going to have to get a little rest.
Gary Rogan says:
Congratulations on the birth of your son. Talk about a long wait being rewarded...
About incentives in Russia: there aren't any places in the world without incentives unless you are on a rock in the middle of the ocean and are out of resources. Otherwise, some courses of behavior are always more rewarding than others. In Russia they were often not aligned with the common good. When the rules of the game are misaligned the incentives of those playing it, they will violate the rules. The general tendency through the course of history is for the rules to become more beneficial for the common good. The process goes in fits and starts because those in power often benefit from the misalignment or simply from the rules themselves. I'm not sure why you singled out Russia, most of the world is either corrupt or corrupted compared to the US. Let's be thankful we live in a country where the sense of fair play is at the highest stage of development. Rarely do great societies regress, but when they do the whole world suffers enormously.
And I would love to know the story of the squash racket in the picture of you and your son. Mazel tov!
Shui Mitsuda adds, "Things My Grandfather Taught Me":
"I often found it difficult to teach a job to top score graduate because they think they know and they try solve problem only within the knowledge of what they know. A low score graduate on the other hand learn fast because they know they do not know and they don't hesitate to ask if they face problem. It is not a shame that you don't know. What's shameful is you think you know what you don't know. So always stay humble and ask questions until others are fed up with you."
"It is not a question of whether you can get it and cannot get it. Just get it."
"When everyone is dancing around like drunken mad people, the party is close to the disastrous ending " - After selling off his golf membership at $800k in 1990 which is currently traded at $25k as of today.
" No matter who you are, everyone of us encounters a few key moments of opportunities in life if you live long enough. Success or failure all depends on whether you desperately go and grab that few opportunities at right moment of time or you just let it pass by. I see this is the key moment, grab it."
Todd Colbeck notes:
Luck is when preparation meets opportunity. You need to prepare daily to be ready for that window of opportunity when it opens.
Dr. Mark Goulston says, "The Best Advice My Dad Ever Gave Me"
I don't believe in voices from the hereafter. I believe that once you're gone, you're gone... but I did clearly hear the voice of my father speak to me after I kissed his cold, leathery forehead as he lay in his open coffin just before we closed it for his memorial service.
He said: "Don't treat a big thing like a small thing and don't treat a small thing like a big thing. Don't do what I did."
Yossi Ben-Dak offers:
Coming back to civilization after a few weeks of doing my best to stand up to evil people in Darfur and elsewhere, is very redeeming when the first reading you do, back at your computer, is the Daily Speculations.
Physical evil that specializes in the effecting of ugly separation and destruction of loved ones seem to take double pleasure in insuring that children and/or parents suffer the loss fully cognizant of the intense suffering and the concomitant memories that are bound to last ..Disenfranchisement, Pain, Disappointment with the human race, not knowing who is a friend, never having a moment to stop and reflect ---are the only legacies remaining in parts of humanity that seem stuck. Somehow, even those that come to leadership among them seem to expect others to invest in them, for them, to conclude what is right and what is wrong, or alternatively certain leaders react with a selfish, self centered focus on an ideology not founded on anything but a very narrow interest to be pursued--that rarely elevates them to a different stage in life or death. They do know any better and the "caring system" of Humanity is dedicated presently for their paying the worst price for any lesson anybody learns in this inhuman mess.
Civilization to me implies the type of empathy, emotions and reflection shared by Roy and Vic at the loss of their mother --and our friend, Elaine, and the birth of Vic's son, Aubrey.
When you get to appreciate the waning and end of a great personality such as Elaine, you realize that the finality of life always involves prime evil by itself, but when there is that special room and evidence for the 18 years nightly story legacy, planning for uncertainty lessons, the life model to appreciate and mold others -- the pain transfer, in part, --- to enlightened constructive instructions for a choice for others, loved ones in particular, but others as well.
What is uniquely astute in my perception of Vic's letter to his son, is the condensed nature and practicality of this communication predicated on the need to transfer knowledge and insight. One may find it strange that speculation and a dictum of "Er, have you counted and tested that?" seem to be a key perspective in this reflective exercise for a barely born person. However, truth is that such reflections are a communication to ourselves in a constant internal and necessary dialogue of self examination. Only then it is worth the transfer and Vic is, once again, honest, valid and reliable. What makes it very practical is the instruction of one of the first jobs Aubrey has--to cry. At the very least, he will have other jobs to tend to when growing up.
The baby's checklist if crying, in decreasing order:
That pretty much covers it. I wonder if there is a similar checklist for trading?
An Old Debate, from President of Old Speculator's Club
Picking up a thread that went dormant about 2-3 years ago, I still contend it was Jackson who made the Lakers, and that in spite of all the talent they wouldn't have got those rings. The job he did this year with a relative bunch of no-names and Kobe is exhibit C. Exhibits A and B are the Bulls and Lakers, respectively.
The Source, from Dr. Kim Zussman
Recently recalling the late 90's, with all the magazine covers sporting smiling tech CEOs, ads for online brokerages, and overheard waiting-room boasting about positions in Cisco, Amazon, and Broadcom. One scruffy fellow even used the words "due diligence" about his position in MSFT circa 2000; evidently something he read on TV. Which leads to many questions, including whether bubbles only form in liquids.
The recent two years in Southern California have been wetter than usual; last year second highest on record and this one not far behind. During frequent hillside forays, it is easy to see the result at all levels in the ecosystem. Flora is more abundant and lush than what is usual in semi-arid terrain. Heavy growth of sage and other scrub, grasses, and flowering plants impinge the trails, many plants carry odd fruit or berries, with the verdant hills more resembling forests of the deep south.
This lead to an explosion in the insect and helminth population: bees busy at flowers, beetles and flies zipping and darting, worms and caterpillars creeping and chewing. Vegetation and insects feed higher forms, including birds, rodents, and deer, with the short-gestation folk partying most. Rabbits, squirrels, and birds are busy everywhere, while rats and mice proliferate in hiding. The yard has enough food to support a scrub-jay nest near the house, filled with four fat chicks served by programmatically industrious mama and papa.
Reptiles too are booming. Ordinarily hidden snakes are now seen often (three Pacific rattlesnakes and a bull snake within one week). Human encounters with rattlesnakes are usually uncommon, since they hunt in the brush while hidden from the hungry red-tailed hawks circling silently above. But now there are so many serpents bulging onto over grown trails that hikers have to watch their steps more than the scenery.
So the effects of unusually plentiful liquidity has fed growth, and all the various species flourish. Are there historical effects which correlate with prior changes in Fed liquidity? To look at this, historic monthly effective Fed rates were used to calculate QTR/QTR* change in interest back to 1954, and this was taken as a proxy for water. A similar series of QTR stock returns was obtained using SP500 index monthly closes. Then multiple and step-wise regression was done to identify whether any lagged QTR change (i.e., lags of 1, 2, 3 Qtr) in Fed effective rate predicted stock QTR returns.
Turns out only the prior QTR change in Fed interest rate approached significant negative correlation with the subsequent change in stocks (T=-1.87, p=0.063); recently declining interest is slightly bullish for stocks.
* To include recent April showers, series was divided into 3-month periods, "QTR", counting back with April. Thus these are not calendar quarters. Here is the series.
Suggestion for Traders, from GM Nigel Davies
Noting Josef Dorfman's recommendation that chess players take cold showers in the morning 'to build character', plus my own experience of sensing my opponent's next move just before he plays it (other players have reported this too), it was with interest that I saw a documentary in Shintaido yesterday evening. Exponents of this martial art claimed to be able to predict their opponent's next move, and one of their training methods was to stand under a freezing waterfall.
Naturally, I find myself wondering if anything like this has been tried by traders. Clearly there might be a difference between sensing what an individual opponent is about to do as opposed to 'a market', even if the experience of the martial artists and chess players is valid. But it seems like food for thought. An interesting out of bounds exercise for the traders at Manchester!?
George Zachar responds:
Fascinated by Nigel's post on a martial art I'd never heard of before, I immediately Googled the term Shintaido. I shortly found the item below which may be of interest to golfers on the list.
Master Shintaido Instructor H. F. Ito teaches the way of Golf, a series of exercises designed to help golfers: (1) stretch and limber up; (2) relax; (3) focus and concentrate; and (4) enjoy. Using a golf club instead of the traditional six-foot oak staff, Ito demonstrates the proper way to stretch, relax the body, and prepare the mind for a pleasurable round of golf. Mr. Ito also provides focusing exercises for the eyes and mind. Golf do provides insights into the unification of mind and body that produces the best of golf.
Rob Humbert notes:
Shintaido is a development from Shotokai karate and got going in the 60's. The apparently precognitive awareness mentioned by Nigel is referred to as 'Saki' and is featured in other Japanese martial art traditions although it has a stronger emphasis in Shintaido than most. I believe to make sense of 'Saki' as a real phenomenon you have to discard the intuitive notion of consciousness being something like a 'movie reel in the Cartesian Theatre' with near-instantaneous linear linkage to the passage of time in the outside world (as Daniel Dennett critiques in 'Consciousness Explained', 1991) and appreciate your brain as an asynchronous parallel processing computer where your subjective awareness is subject to temporal jumbling and/or editing in the timeframes of the exercises and responses being trained.
Peter Grieve comments:
The mathematical "theory of games" recommends randomizing one's actions, in order to counter this sort of thing. A "mixed strategy" in game theory consists of a number of alternatives, each one of which is assigned a probability. Then the player rolls dice or similar to decide which action is selected. The optimal strategy (in some sense) is the one in which these probabilities are optimally assigned. The opponent may anticipate what *you're* going to do, but I don't think they're going to be anticipating how the dice will come up.
Don't Blame the Speculators, by Henrik Andersson
In the media the speculators are often blamed for the high price of commodities. Let's look at the oil market as an example. As I understand it Crude oil is traded through term contracts, spot market and futures contract. We can define the Speculators as the ones trading in the futures market and let's call the rest Commercials. We know that very few futures contract trading are hold onto physical delivery. Hedge funds and other speculators tend to roll their positions before delivery, so the vast majority of speculators must covers their long or short position continuously over time. The net effect of speculators' influence on the front month price must therefore be close to zero.
The conclusion must be that the price of Crude oil reflects the true economics of supply and demand and that a price bubble can only exit for a very short time. Speculators could increase (or decrease) the volatility but not the absolute level of the price.
It must also follow that the risk of a future peak in production will not and cannot be priced in, in today's prices. One could argue that OPEC would be able to control prices, but since they hardly have any spare capacity left that is questionable. Not all commodities work the same way. Take silver for example, where the funds could corner the market. The new ETF stores the physical. Since I'm a mere student of the markets, I would appreciate any feedback on my line of thinking.
A Gold Mine in the Gold Mines of the Rainbow Nation, from the Senator
The big news in South Africa today is that a gang of 250-300 robbers are living in the gold mines here and stealing some 1.2 billion rand a year in raw gold that is then sold to a European syndicate.
Most the mines are connected, the bad guys actually live in the mines for 30-50 days at a time squirreling gold away and ratting it to the surface. Talk about and underworld!
High prices cause people to act differently, some Austrian fellow said a few years back.
Getting in Tune with the Market, by James Sogi
I play music in a band with some very talented professional level musicians who are much better than I, and when they launch into a tune I don't know I have to figure out the music on the fly in about 2 bars or keep up as they improvise. It requires an "ear" to pick out the chords, progression and 'feel' for the rhythm and the changes in both. This same aesthetic sense and many other measured factors are common to Music and markets and as I try play along with both some thoughts on the structures of music and markets could help.
Tuning a guitar or piano is not done on equal mathematical frequency ratios. Technical discussion of guitar tuning and discussions with a professional piano tuner reveal that the piano must be tuned to the ear rather than strict mathematical frequency ratios. The exact mathematical ratios do not sound good to the ear and may not ring true in their overtone. Each note has overtones in higher and lower registers that also need to match up to sound right. Part of this phenomenon is mechanical in the construction and design of the instruments, but I believe that it is an anomaly of the human ear and the sound waves, and more importantly, as an aesthetic choice. The sound of a vibrating string is caused by elasticity as the inertia of the string causes it to move past its rest position and to deform itself again in the opposite direction of the initial force. The motion from the original position to the maximum deformation in the opposite direction and then back to the original position is another half cycle. This back and forth vibration occurs at a rate that depends on the physical makeup of the object being vibrated. A complete vibration occurs when an object completes two half cycles. The rate of motion of the object is measured in cycles, which is the definition of frequency - the number of cycles per second at which an object is vibrating.
Each string also vibrates simultaneously at many other frequencies other than the fundamental, each progressively higher in pitch and lower in amplitude. These create Harmonics and Overtones. Jimi Hendrix used feedback of the overtones through his amp to make them louder than the fundamental.
Intervals are the distance between the frequencies. There is an aesthetic urge to establish a method of calculating intervals between pitches in the 12 system that is consistent with the "natural" harmonic series. It is the aesthetic urge that ties musical theory to the market. There is some aesthetic feel that the market has as to what is the proper level, and what is the proper range, 12 points per day being the recent average, and what is the proper interval between days, between ranges. Today, the music jumped up an octave when the fat lady sang, but the question is will it stay up in this high octave or return to lower registers and the question whether the Wykoffian rhapsody will alter the melody. The cycle seems to have a daily half cycle and perhaps a weekly cycle. The market wants to satisfy a natural aesthetic and harmonic and will play accordingly. Bad rhythm or melodic dissonance can't be sustained in music, or markets.
In Music, the Interval, or distance, between two pitches is defined as the ratio of the higher to the lower of the two frequencies. It is NOT the numeric difference between the two frequencies. This concept is similar to adjusted futures or the first or second moments of data transforms. In fact, as Phil has suggested for use with market data, Music can also be measured in logarithms which have the property that adding them and then taking the "anti-log" (raising 10 to the resultant power) is exactly the same as taking x and multiplying it by itself by the number of times needed to get to any of the 12 frequencies in the scale, the basic factor used in calculating equal temperament is the log of x. There are a number of musical systems, but the western 12 tone sounds good to our ear.
The market prices oscillate back and forth based on their internal properties in frequencies that can be measured. The intervals can be measured, the pitch and amplitude can be measured. What can't be measured is the aesthetic qualities of the variations and the levels. This aesthetic quality must resonate with the larger concatenation of world and business events or the there is a change of key. Here analysis of the melody and rhythm, in the market and in music can be quantified, analyzed, and learned, and picked up on the fly, hopefully in a bar or two before the song ends.
Main thing when playing with a band is to get in tune and play in rhythm. Same with the markets, get in tune with the frequency, and really get the right rhythm. Catch the little internal back beats in addition to the main groove and you'll be singing along with the Mistress in no time. Rhythm is not cerebral. It resides in the foot, oddly enough. You have to tap your foot or bob your head to get in rhythm. Guys that try to count in their head ain't got no rhythm, man. The markets have some sort of gut rhythm too. An overly cerebral approach can sometime jam up that rhythm. You have to go with the band dynamic when playing music, and go with the market flow in the market. This dynamic is not written down on the sheet music, so it takes a great conductor to bring the emotional dynamic out in an orchestra. It happens spontaneously in the markets and in a rock band. Even with complex counting, there is a lower sub cortical, rhythmic, aesthetic approach going on in the market. This is like the deeper emotional aspect to markets, but on a different cortical level.
Addiction to Perfection, Janice Dorn, M.D., Ph.D.
One of the great evils of trading is false exactness...Trading is a fuzzy process and I mean fuzzy in the best sense of the word. That is, as in fuzzy logic, as in the willingness to accept the idea that things aren't exactly quantifiable and to forge ahead anyway" --John Bollinger
Trading is not about perfection. It is about probability and progress. All charts, analyses (fundamental and technical) and trading plans are built on probabilities.
Why then, do so many traders strive for perfection? Why do so many traders miss trades, waiting for exactly the right entry and then beat up on themselves when it doesn't come and the position runs away while they sit there scratching their heads and condemning themselves?
Why are so many traders trying to turn a game of probability into one of 100% certainty?
The answer lies in one of the cardinal sins of trading which is perfectionism.
Perfectionism can be a great help to people in many professions, but can be fatal to a trader. Perfectionists, always trying to find the Holy Grail of trading go from one service to another, from one system to another, looking for a way that they can be right all the time. Yes! Now, I found it. It’s this trading room, or this service, or this indicator! Wait... something is wrong here. Not all of these trades are working and I have draw downs! How can it be that this particular method failed and I actually had to take a loss? Must be something wrong. I will try harder and look for an even better system, a more expensive service, a new and improved guru, some absolutely no-fail software so that I can have only winning trades.
This is perfectionism in action. Not only does this type of irrational behavior and belief undermine and demoralize a trader, but it takes away all the enjoyment and fun of being in the markets. It leads to depression with depletion of psychic and physical energy, and leaves the perfectionist to confront his basic and overriding fear--- fear of failure. In the extreme, it leads to physical and mental illness, including addiction to prescription drugs, alcohol, or illegal substances as well as other addictions. The pain of failure or the haunting fear of failure is simply overwhelming, and one turns to whatever works to medicate the pain.
I want to share something of my personal history with you, as I believe that many of you can identify with and learn from some part of this story.
My parents were seriously ill from the time that I was born. I truly believed that if I was absolutely perfect, scored the highest in school, did the best at music and dancing and elocution and debating that I could make them better. So I did that. I had no life outside of study and learning. I was the perfect little daughter and even became the perfect little doctor for my sick parents, even though I was only 13. Shortly after this, while I was still in my teens, both of my parents died. I was not good enough or perfect enough to make them better. So -- I tried even harder and studied more and more, to the complete exclusion of any personal or social life whatsoever. This time, I was going to be perfect for my dead parents to show them how wonderful I really was and how much they should be proud of me. This reached absolute culmination when, after receiving two doctorate degrees, I still had to continue with more and more exams and more and more training. Can you imagine anything so ridiculous? Even after my parents died, I was still trying to get their approval by showing them how brilliant and talented I was.
Many years later, I suddenly became critically ill, stopped breathing and lapsed into a lengthy coma. This was the culmination of years and years of unrealistic internal demands that I set on myself and which manifested as addiction to perfection. It was only when I awakened from coma that I started on a new road and a new path. I was not superwoman...never was and never could be. Yes, I would continue to work hard and to achieve, but I could never in a bazillion years be perfect. I am not and you are not. So, when I say "Get over yourself" I mean that I had to get over myself. I had to address the demons of perfectionism and move past them. I accepted that I am a flawed human being and acknowledged that I had certain real and wonderful strengths. I chose to concentrate on the strengths and stop beating myself up for the weaknesses.
Life can be lived forwards, but can only be understood backwards --Soren Kierkegaard
What does this have to do with trading?
This is what happens with perfectionists. Perfectionists are made, not born. We are taught from an early age by demanding (and often well-meaning) parents that we have to be the best in order to win their approval and the approval of others. Unfortunately, this is totally upside down. Perfectionists share a belief that perfection is required in order to be accepted by others. The reality is that acceptance cannot be gained through performance or any other external factors. Self-acceptance is the root of happiness and the true beginning of personal evolution.
If you have a perfectionist mentality when trading, you are setting yourself up for failure, because it is a "given" that you will experience losses along the way. You must begin to think of trading as a game of probability. Your losses ( that you hope will return to breakeven) will kill you. If you cannot take a loss when it is small ( because of the need to be perfect), then you will watch that small loss grow into a larger loss and so on into a vicious cycle of more and more pain for the perfectionist. Trading on hope does not work. The markets can remain irrational for a lot longer than you can remain solvent.
The object should be excellence in trading, not perfection. Moreover, it is essential to strive for excellence over a sustained period, as opposed to judging that each trade must be excellent. This is a marathon...not a sprint.
The greatest traders know how to take cut losses and let winning positions run. Perfectionists often do exactly the opposite. They get in at the wrong time, stay in too long and then get out the wrong time. Perfectionists are always striving and never arriving. The market will find the flaw in a perfectionistic trader and exploit it day after day. The market is your greatest teacher and your most demanding critic, so take this wonderful opportunity every day to learn about yourself and make yourself strong.
If you see in yourself this trait of perfectionism rearing its ugly head, it's OK to get angry at it and even yell or curse at it. Do whatever it takes to acknowledge it and then find a way to fix it.
Here are a few suggestions:
If we were always to wait for the most favorable combination of circumstances, no enterprise would ever be undertaken. There can be no end without a beginning--there was never an enterprise in which everything fitted in perfectly, for chance plays a leading part in the affairs of all men. Obedience to rule does not ensure success, but success, on the other hand, furnishes a canon -- a rule of conduct. -- Napoleon Bonaparte.
Dr. Mark Goulston responds:
I do house calls to dying patients. Some years ago, I was seeing an internationally renowned composer/musician who was as known for his foul mood as his music. I said to him: "You were as known for being a nasty sonofabitch as you were for you music for most of your career. What was that all about?" (He very much appreciated my directness, something others withheld from him towards the end).
He said: "I've been famous worldwide for more than 40 years, but in all that time there were only five times when the music in my head matched the music I composed or played. And knowing it was possible, I tried to make it happen every day and every day other than those five times, I fell short."
I looked at him and said: "You blew it! To experience perfection once at the level you know it is more than nearly everyone, to experience it five times is close to godlike. You made an ideal a standard and it made you miserable and miserable to be around. You did just fine so let it go already."
He smiled a slightly embarrassed smile, but did breathe easier.
What I took from that was to: "always aspire to perfection, but find a way to accept that whatever I do now is the best I can do now all factors considered." The corollary is that if I look for ways to not forgive myself I can always find them and if I look for ways to forgive myself I can always find them, too. It all comes down to what I want to look for. As I get older, I'm trying to choose the latter, because sometimes my unforgivingness towards myself can be quite chilling.
Dr. Michael Cook adds:
A few thoughts on Janice's interesting post:
Perfectionism is also reflected in the quest for "optimality". The optimal portfolio concept, which is based on the assumption that your inputs (expected return, volatility, correlation, risk aversion, expected trading costs) are exact.
Herbert Simon coined the term satisfice to describe what humans in fact do, given their bounded rationality and time constraints on decision making - settle for a solution that is "good enough"...
I'm reminded of the incident when a chess playing program was in a tournament, and had a clearly won game, but lost because it used up all its time calculating the best line of play.
Finally, the trend following guru from Lake Tahoe once said "diversification is a more powerful principle than optimization", a remark I find interesting and relevant to the discussion.
The Benefits of Doubting Salesmen, by Dr. Kim Zussman
Ten years with the same eyeglasses, only lenses were updated, correlating with the time series of infirmity. The newer frames were too John Lennon and making statements, and no purveyor had anything close to the ones I liked.
Recently at the local strip mall, wandered in to a dispensing optician (in the spirit of demand, gate-keeping optometrists have been stripped of sole key-ownership). Josh bought the place from a friend who couldn't make a living there; foot traffic was heavy but so was the rent. The new guy showed some frames, and heard me complain that I still liked the ones I had from 10 years ago. He made a photocopy of the specs, and said he would search for similar. Meanwhile, he suggested that if we couldn't find frames I liked, he could refurbish my current ones by changing the temples and nose-pieces, as well as ordering new lenses, and that it would run very little.
His approach stopped me in my tracks. I recalled a different optician who once tried to pressure me into frames I didn't like, which made me resent his self-important self-incentive. Josh, on the other hand, understood the value of listening to what the customer wants.
A few days later the Mrs. and I were shopping nearby, and Josh darted out and called my name (he remembered!). "Have a minute?" he yelled. "Got some frames to show you!". We went in and looked at what he had found, as well as several others in the store. I told him it couldn't change much because the Mrs. might not like it, and that I couldn't afford such risk. She still liked the old me, as it is natural to be fond of the immutable. Josh was ready to schedule the refurbishment, explaining it would only take an hour once the Rx was faxed in. But he paused, and said diplomatically that if he were to be frank, the ones I had were old-fashioned and didn't suit my square head. Josh correctly surmised that his customer was the kind that laughs at it's own head. He showed us a few others, and had me try one that he said made me younger, and the much younger Mrs. agreed with a big smile and the sale was made.
This encounter recalled my late father, a salesman who never finished high school but had an innate understanding of human nature that bought us all higher educations. He sold cars to people who started out distrusting him, but ended up loving him, because that deluxe air-conditioner they demanded was surrendered despite profit reduction from $4500 to $4000. His manager didn't mind, and the customers would always come back for the next car.
All good salesmen, even those who never took algebra, know how to compound and discount the value of sacrifice, no matter how small.
Risk and A Sound Position, from GM Nigel Davies
If you indulge in risky professions like chess or speculation, you cannot have too many mouse holes or systems of defense. A speculative foray should not leave your position bankrupt if it doesn't come off, there should always be another line of defense, a way to start again.
I've seen a lot written on the list about how unlikely 'black swan' events are, and this is no doubt true. But there are so many broad areas in which a 'black swan' can emerge (markets, health, relationships, crime, enforced career change, political upheaval etc), there is a great likelihood that we will all meet one or more of these beasts at some point in our lives.
The odds of surviving the inevitable black swan are much better if your position is intrinsically sound, and that there is no 'point of least resistance'. Lasker, who survived many upheavals both in life and on the chessboard, recommended that one should aim to make all links in the chain equally strong.
Moving on to the question of mortgages: I think it's a great idea to pay off your mortgage as soon as possible, simply because it strengthens your position. And you'll sleep better because your survival instinct knows it's the right thing to do, even if this seems like a less than optimal way to do things according to a mathematical theorem.
Dr. Philip McDonnell mentions:
The Grand Master suggested paying off the mortgage. This is equivalent to buying a 30-year bond. It is also a form of de-leveraging. Buying an annuity is similar but includes a reverse life insurance policy as well - if you die early the company gets to keep your expected annuity payments. If 30-year government bonds are yielding 6% and your mortgage is at 8% then paying it down may be a good choice. If the mortgage is only 5% then it is a demonstrably poor choice to pay it off, rather one could buy a 6% bond and use the coupon to pay the 5% mortgage and reinvest the extra 1%.
GM Nigel responds:
The Grandmaster hastens to point out that away from the drawing board owing a debt and being owed a debt are not the same as being debt free. Far be it from me to suggest that US government bonds are not 100% safe, but I'll take the debt free property if you don't mind. And I'll be keeping a Kalashnikov or two in the basement.. One other factor that's not often mentioned is that servicing debts requires regular income. So if you're debt free and have little in the way of outgoings (e.g. rent), you have far more time plus the choice of what to do with it.
Options on the VIX, from Sushil Kedia
CHICAGO, May 01, 2006 - The Chicago Board Options Exchange (CBOE) announced that reported volume in the recently launched options on the CBOE Volatility Index, "VIX" (options ticker symbol VIX), reached 62,461 contracts (56,569 calls and 5,892 puts) today...
Trying to understand what this might mean:
Expansion of volume on any contract in general connotes increase in the struggle on the prevalent move on the contract. Combining this with Mr. McDonnell's lucid explanation that Options on the VIX are a vehicle to trade Kurtosis.
So, is there an expansion of the struggle between some people who are anticipating a large move/run and others who are not? In general, expansion of struggle or disbelief help propel a meme, a move, a trend further. So, a large move ahead? In what?
Tennis and Trading, by Paolo Pezzutti
I found these similarities between the two.
You know better about yourself:
Control Charts, from Steve Ellison
I have been working with manufacturing control charts recently. The purpose of a control chart is to determine whether a process is in control, i.e., predictable and repeatable, with only random variations. A control chart can show that a process is changing in a non-random way, i.e., going out of control, and is in danger of moving outside specifications. In that case, one must investigate the process to determine the cause of the non-random variation. The "Western Electric rules" provide a good example of the analysis to determine whether a process is out of control:
Rule 1: Any single data point falls beyond 3 standard deviations from
the centerline (i.e., any points fall outside of the upper or lower
Rule 2: Two out of three consecutive points fall beyond 2 standard deviations from the centerline, on the same side of the centerline;
Rule 3: Four out of five consecutive points fall beyond 1 standard deviation, on the same side of the centerline;
Rule 4: Eight consecutive points fall on the same side of the centerline;
Rule 5: Fifteen consecutive points fall within one standard deviation of the centerline.
Below is a control chart of the last 13 S&P 500 futures closes with the center line at 1314. The upper and lower control limits, three standard deviations in each direction from the center line, are at 1324 and 1304, respectively.
Richard Miller adds:
I work in the fiber manufacturing business--among other things as a statistical consultant--and routinely use control charts to maintain process control. In that world, we interpret an out-of-control signal as indicative of a process shift, one that requires adjustment to bring the process back into control. Using just three sigma rules, one would expect an out of control signal to be a rare event in the absence of a process shift (on average, one would expect run lengths of ~370 samples before an out-of-control signal is given in the absence of any process shift). The additional runs rules that you list are used to signal shifts more quickly. One pays for that by getting many more false signals than given by the straight 3-sigma, Shewhart chart. Note too, we enforce the normality assumptions of these charts by dealing with averages, rarely distribution-dependent individuals.
Two other types of control charts are more efficient at detecting small shifts without as many false signals. They are CUSUM and EWMA charts and again widely used in industry.
Having said all that, I don't know what you gain by using these type charts to follow the market. I assume that you would interpret an out-of-control signal as one where the market has moved in response to some event, i.e., in a non random fashion, that you would expect to now require repositioning of the chart factors.
For example, if one gets a data point greater than the +3 sigma limit, does one then assume there's a bullish bias and act accordingly?
Too, the day-to-day price changes in the market, as you know, are not normally distributed so the normality assumption of a Shewhart chart built from daily price fluctuations and their associated probabilities are incorrect. That means that one would expect many more false signals.
Eat Well and Play Well, from Shui Mitsuda
When I was at a British boarding school in England where supposedly students were from affluent family, I used to be called "pig" because of my appetite for food. As a young man and loving exercise, it was natural to have a big appetite for food, but to the high society guys, I suppose, I appeared obsessive or shameful. It seemed for them it was shameful to say that you are hungry or crave food. It was very different culture from the rest of the European continent like, Italy, Yugoslavia or France, as well as other countries like China.
A UCLA professor speculated, "It might be that the nature of an unequal society is affecting everybody." I think the cause may be due to the different cultures in different societies that is affecting everybody. Well, for me, food is a part of the joy of life -- not just surviving fuel like gasoline. So there is no shame about eating. Eat well, exercise well and rest well. The rule seems pretty simple
How Do You Solve a Problem Like Maria? from Andew Moe
From Maria, Sound of Music:
Sophia: When I'm with her I'm confused, out of focus and bemused, and I never know exactly where I am... Agatha: Unpredictable as weather Catherine: She is flightly as a feather Margaretta: She's a darling Berthe: She's a demon Margaretta: She's a lamb Sophia: She'd out pester any pest; drive a hornet from it's nest Agatha: She could throw a whirling dervish out of whirl Margaretta: She is gentle; she is wild Catherine: She's a riddle; she's a child Berthe: She's a headache Margaretta: She's an angel R. Mother: She's a girl... All: How do you solve a problem like Maria How do you catch a cloud and pin it down How do you find the word that means Maria Catherine: A flibbertigibbet Margaretta & Sophia: A willow the wisp Berthe: A clown All: Many a thing you know you'd like to tell her Many a thing she ought to understand R. Mother: But how do you make her stay Berthe: And listen to all you say Margaretta: How do you keep a wave upon the sand All: Oh how do you solve a problem like Maria...
Maria moved the market Monday.
Unenjoyment Day, from George Zachar
The first economic derivatives auction for tomorrow's payroll report was done before the ADP release. It came at 200 +/- 69. The next one came at 200 +/- 67. The one that just closed came at 200 +/- 62, with all the "action" in the last quarter hour as the implicit range narrowed around a relatively fixed point.
One shop noted that the range of Street guesstimates for tomorrow's print is the narrowest on record.
My non-counting takeaway is that the Bartiromo/Bernanke two-step and the ADP print have demoted tomorrow's data in importance, so the next serious macro event will be Wednesday's Fed statement release explaining their stance after a ratchet up to 5%.
Musical Chairs, from J. T. Holley
Fed May Ease Stance on Fannie Regulator, Senator Bennett Says
2006-05-03 13:55 (New York)
My Pa left me with two sayings on his deathbed. One was to "embrace change," he felt that it was the common denominator in life. The second one has been a saving grace to me in my life ever since. It always seems to happen and also relates to speculating and the above headline. It is: "a pat on the back is a few small vertebrae away from a kick in the @ss."
You just know that the above is going to be followed by the lack of ability to do those wonderful 1031 exchanges and also, if you dig further. with the recent Congressional extension of the capital gains and dividend relief, you'll probably see around the corner them doing away with the tax break on mortgage interest.
Now, take away the 1031 exchange and the ability to write off the interest on your mortgage and you'll have the beginning notes of a song that will have a lot of people playin' musical chairs.
Dr. Kim Zussman Reads the Pravda Opinion Page
ADP, by George Zachar
The monthly ADP Employment Report will act as a check on the ability of the cube farmers at Dept. of Labor to b0rk the data.
Assuming for the moment that ADP/Macroecon are Machiavellian, it would make sense strategically for them to kick off the data series with a very plausible, no surprise release, to build the brand/credibility, before embarking on any agenda-driven campaign.
I, naively, will assume they are being honest until I see evidence to the contrary.
Mr. Krisrock adds:
Chateau mon Trichet, from a Bloomberg Columnist
Trichet could have been in a Truffaut movie. Make that Chabrol. Twenty years ago he could have been a Truffaut hero. Do you know that the language of the ECB is English? I went to listen to the press conference and was shocked it wasn't being dubbed. Mr. Chirac would never allow that!
George Zachar replies:
I was similarly surprised the first time I tuned in. I'm not a fan of "Europe" but I give Trichet a lot of credit for his command of English, which isn't his native tongue.
First Fortune 500 CEO With A Blog, from Prof. Gordon Haave
As this becomes a trend, it will be interesting to track the performance of blogging CEOs vs. blogless CEOs.
Romance, Bernanke and Discrete Mathematics, by Victor Niederhoffer
The wild fluctuations in the markets that accompanied the 3 pm announcement on CNBC that Fed Chairman Ben Bernanke had spoken to Maria Bartiromo about the reaction to his testimony at the Joint Economic Committee has unleashed a hornet's nest of questions about the context, purposes, and reactions. A thoughtful set comes in this reaction from reader Paolo Pezzuti:
My first reaction to this is that Dr. Bernanke suffers from a disease that old men are all too prone to -- the temptation to try to impress a pretty reporter. It's so easy to try to appear expansive and profound at an evening off the record session with an attractive reporter. "Why is it always romance?" Horace Rumpole asks at the end of one of his mysteries where he follows the pretty girl to catch an English Professor for a terrible crime? I believe that many of the most powerful people on Wall Street succumb to this character flaw and they should follow the motto that the prettier the reporter, the more careful they should be in their utterances.
However, for those that are subject to the vagaries of markets induced by such lapses, a good dose of counting is in order. If it were possible to quantify the influence of romance on markets it would be a good study. But in its absence, one might wish to do some counting on markets that are way up late in the day, but then end down on the day. A typical counting study shows that the 200 most similar stock market gyrations to yesterday showed a significant tendency for the gyrations at the end of the anomalous (romantic?) day to be reversed by approximately 1/3 during the next day.
The importance of counting to get a better foundation for reactions to romantic moves and other anomalies was underlined to me by the recent change in heart of Stephen Roach from pessimistic to optimistic. Along with Alan Abelson he has probably caused more people to stay out of the stock market and thus lose incalculable wealth than any other wealth destroyer in history. And yet, the former has changed without calculating how accurate his predictions have been, or what the errors in his reasoning were, and the latter has gone on leave without a single apology to his readers for his 40 years of bearishness during which the market has returned some 6400% during his constant bearishness.
The best antidote I have found to wishy-washy reasoning of this kind is to constantly read books on finite math. All such books start with a chapter on counting, showing how permutations and combinations should be enumerated, and extending basic principles of counting to every variety of problem. The two I am reading now are the highly recommended Kenneth Rosen's Discrete Mathematics and its Applications and the mind-blowing and path-breaking book, A Logical Approach to Discrete Math by David Gries and Fred Schneider.
The Rosen book has chapters on counting, relations, graphs, trees, recurrence relations, Boolean Algebra, and computations. It's excellent on applications and models in all the physical and social sciences. The chapters are self contained and accessible to anyone who's willing to learn and has a pencil and paper handy. He summarizes what he wishes to accomplish as "Discrete structures are the abstract mathematical structures used to represent discrete objects and relationships between these objects. These discrete subjects include sets, permutations, relations, graphs, trees, and finite state machines."
The book by Gries and Schneider is revolutionary in that it teaches you how to work with the syntactical structure of language and how to manipulate it logically. It then takes these syntactical rules, mainly based on logical relations of the kind that we study in truth tables, and develops all the usual topics of finite mathematics such as those enumerated in the Rosen book as well as Propositional Calculus, Hilbert Style Proofs, Predicate Calculus, Programming, Mathematical induction, sequences, integer theory, and infinite sets. This book is a hard read, with many unusual special notations that require gaining good familiarity with before the book becomes readily accessible. It's the kind that's probably much easier to take in a class than as self study. However, because its applications are so deep, and extensive, it will change the way you look at math and life, and certainly will help to prevent you from getting whip lashed by Bernanke/Bartiromo type relations in the future.
The whole subject of discrete math is one that is particularly applicable to the study of markets. All information is disseminated between individuals. All markets have leads and lags with others. The prices themselves are discrete results of buying and selling decisions by different actors in the market panorama. The best way of understanding such activities is to build up the results of their decisions starting from what happens before all other decisions have been made, what G and S call "Starting with Zero".
George Zachar asks:
The Fed chair giving a weekend exclusive to an infobabe? An unforced error.
Did Bernanke say his answer was off-the-record?
Did Bernanke rely on the decades-old, actually enforced tradition, that chatter at this annual dinner by definition is off-the-record?
Did Maria knowingly sandbag rookie Washingtonian Bernanke?
Did Maria not know everything at the bash was off-the-record?
Does Maria, perchance, have her contract up for renewal?
The best outcome would be for the new Fed chair to learn to keep his mouth shut in such environments.
The worst outcome would be for him to use such communication channels in the future, as a means of keeping markets off-balance.
Steve Leslie states:
I doubt that Mr. Bernanke would be seduced by a woman such as Ms. Bartiromo, regardless of her pulchritude. Beauty did not kill the beast, this time it was something far sinister.
No he made the unfortunate and irretrievable error in assuming that comments can still be made off-the-record to the media and that they can be trusted.
Gone forever are the days when the media will protect a politician, public figure or celebrity and everyone is fair game. We all knew Mickey Mantle drank heavily and John F. Kennedy was a philanderer, but that generation understood that not everything was newsworthy and the publics right to know did not supersede that.
The landscape is littering and littered with those who have gone before Ben. From Howard Cosell referring to Art Monk as "that little monkey" to Marge Schott being run out of baseball for getting drunk and allowing the press to sit near her when she called the black players on The Cincinnati Reds as her million dollar n******. Lest we not forget Fuzzy Zoeller's public persona and marketability was forever destroyed when he stumbled around Augusta National after the 1997 Masters celebrating Tiger Woods first Masters Championship and commenting that next year for the champions dinner they will probably serve fried chicken and watermelon.
No these are not your fathers' journalists. There is not a Rukeyser, Murrow, or Jack Anderson in the whole lot of them. This is a far inferior kind. A collection of misfits. Now we are left with a group of sorry impostors, poseurs, photo-op types who cloak themselves inside the First Amendment and make some vain and sordid claim of sanctuary within.
They espouse no integrity, no responsibility nor humbleness. They promulgate their own new rules and standards and in the end arrogantly declare:
If he dies he dies. -- Ivan Drago in Rocky IV
A Perspicacious Spec adds a haiku:
Bernanke now shares
Marion Barry's lament:
"The b!tch set me up!"
Art Cooper remarks:
Maria Bartiromo bears an uncanny resemblance to Sargent's Portrait of Madame X that caused such a scandal in Paris in the 1880s.
Sunrise, Sunset, from GM Nigel Davies
Had an interesting discussion with GM Mark Hebden this last weekend about the trouble older chess players have in battling younger colleagues. The following insights emerged:
Linear Filters, by Dr. Kim Zussman
If I had a Wiener I'd filter in the morning I'd filter in the evening All over this land I'd filter out zygotes I'd filter out virons I'd filter out love between the brothers and brothers All over San Francisco If I had a bell I'd ring it at the Nasdaq I'd ring it at the NYSE All over this land I'd wring out declines I'd ring out vol spikes I'd ring out love between my brokers and my traders All over this land If I were short I'd sell it in the morning I'd sell it in the evening All over this land I'd sell out danger I'd sell global warming I'd sell out love between Bernanke and Maria All over C-SPAN
The Guys by Rodger Bastien
For most people I know, four hours is a pretty big slice of time, reserved most days for hot pursuit of the almighty dollar. On most days I am like most people. But on those days when work is done, sunshine peeks through my blinds and a good buddy requests my presence to fill out a foursome, I have less will power than Liz Taylor at the Old Country Buffet.
“If you want an argument, pick a different subject,” the Bald Eagle says, deftly flipping my golf ball back at me with the back of his putter. I should know better than attempt a self effacing “I stink” after yet another missed four footer. Not today, not in this group. The rule of the day is to dish more than you receive or at least dish early and often. Not only had I been badly pre-empted, but this time by my own partner.
“Old Paint, we never have been able to see eye to eye,” I offer, repeating my best but oldest comeback, highlighting both his advancing years but also his google-eyed countenance as a result of the loss of one eye in a childhood accident. I toss the ball back at him, which of course he drops. “I’ve seen better hands on a clock,” I mutter and walk away, satisfied I had at least drawn even in this exchange.
Bob Rotella, psychologist of a bevy of golf professionals, wrote a book titled Golf is Not a Game of Perfect. Praise the Lord. In my eclectic group of hackers, perfection would not be tolerated, any more than improving your lie or using the proverbial foot wedge. Once we don our spikes and gaudy colored shirts, we are transformed from business owners, doctors, dentists, lawyers and brokers to Archini, Hullpup, John-dog, Rooter, Gray-man, Ben-Jammin‘ and others of that ilk. Nestled in the lack of pretence is the casual warmth of being who you really are for an afternoon on the pristine grounds of your favorite 18 holes. There’s but one rule of decorum and that is that there are no rules. Check your ego at the door lest have it summarily trampled.
“Hey Rooter, are you feeling better,?” asks Arch as he bends over to peg one up. “I heard you had Dunlop’s Disease.”
Cautiously, he takes the bait. “Dunlop’s disease?”
“Yeah, Dunlop’s Disease...,” Arch dead-pans. “You know, where your gut done lops over your belt!”
Across town, my secretary diligently holds my business together. She receives a call from a very important client who insists on speaking to me and inquires as to when I would be returning to the office.
“I don’t think he will be back in today," she begins. “He said he had a very important meeting…with the Greens, I believe.”
A Perspicacious Spec Reads the Tape
11:47 *H@RVARD'S EL-ERIAN SAYS BEST STOCK INVESTMENTS IN ASIA
11:47 *EL-ERIAN SAYS BALANCE OF RISK SHIFTING TO 'OVERTIGHTENING'
11:47 *EL-ERIAN SAYS FED PROBABLY TO RAISE RATES TO 5%, THEN PAUSE
11:47 *EL-ERIAN SAYS 'OIL ECONOMIES' ALSO OFFER TOP STOCK PICKS
Why does H@rvard let him spout off like this?
I guess he wants everyone on this side of the continent to know how smart he is. At Dow5000's shop, he probably qualified as a shrinking violet.
Live Cattle - Beef Ban, from Shui Mitsuda
Since Jan. 2006, the price of live cattle is in a down trend. Jan. 2006, was when Japan stopped importing beef from the US due to having backbone been mixed in the previous shipment (which I think is a stupid reason for Japan not to import). Japan's US beef importation volume is not a negligible amount -- annual importation of 8 to 9 billion US$.
Hence the US government will not accept the current ban situation and there is market speculation that US beef ban will soon be raised sometime around June when PM Koizumi visits the US. As a result, stocks like Japanese Beef rice bowl restaurant chain Yoshino-Ya N9861 is already up, creating a nice spread with live cattle price which "usually" move along with each other.
Japan's consumers are waiting for US beef. We miss US beef yakiniku (Korean BBQ). Once the ban is lifted, there will be huge flow of US beef rushing into Japan creating a perfect vacuum in the market for price hikes. As usual smart US producers have already taken the biggest long position in the recent history. Let's see what happens.
Happy trading & happy yakiniku.
A Story of Music and Business, Highlighted by Rorianne Schrade
In the fall of 1923, Russian aviation pioneer and designer Igor Sikorsky was facing economic disaster. His newly established Long Island company, Sikorsky Aero Engineering Corporation, had nearly run through its meager resources.
Sikorsky, who was virtually unknown in the United States, was working on the S-29A (“A” for America), a twin-engine, closed-cabin, 14-passenger transport. At that time, his “factory” was set up on a chicken farm owned by his friend Victor Utgoff, a former lieutenant in the Russian navy. The obstacles faced by the company seemed insurmountable. Aside from the money problem, the work had to be done by hand, since the farm did not have appropriate machinery. Sikorsky and his workers, mostly Russian immigrants, were raiding junkyards for parts for the airplane, which had to be constantly redesigned depending on the equipment and materials they found. The main structure of the fuselage was built with angle irons from discarded bedsteads. Turnbuckles, which were used to adjust wire tension, were found in a Woolworth’s five-and-dime. The landing gear was installed with the help of Sikorsky’s nephew, Dmitry (Jimmy) Viner, who was a ditch digger. “Since there was no jack to raise the fuselage,” Frank Delear wrote in Igor Sikorsky: His Three Careers in Aviation, “Jimmy dug under it to make space for the wheels and landing struts. With the gear installed, the plane was then pulled out of the ditch.”
Since the work was done outside, cold weather brought it to a standstill. The enthusiasm of Sikorsky’s men, who had worked for weeks without pay, was at its lowest, and the workforce dropped to a mere handful. The few dollars that could be raised by selling stock in the company were spent mostly on food.
The rest of this inspiring story of perseverance...
A Perspicacious Spec Reads the Tape and Waxes Poetic
May 1 (Bloomberg) -- Morgan Stanley chief global economist Stephen R0ach, after years of warning of impending world economic disaster, is turning more optimistic. R0ach cites a number of factors that may help gradually redress lopsided global trade and investment flows, including a weaker dollar, a slowing U.S. housing market and stronger domestic demand in Asia. The biggest reason for his newfound optimism: The International Monetary Fund and the Group of Seven are finally realizing there's a problem, he said. ``If there's one thing that really pushed me over, it's that these stewards of the global economy are coming to grips with these really potentially damaging consequences of ongoing global imbalances,'' R0ach said in an interview.
R0ach needs Bible study
"Put not your trust in princes"
Psalm One Forty Six
Scott Brooks replies:
Something that might be interesting to note is what it means to have a permabear change from bearish to bullish. I have heard it said that bullishness of advisors is usually a bearish sign and vice versa. I wonder what it means to have a permabear come out of mental hibernation and notice that even though it was winter when they hibernated (closed off their minds to positive opportunities) that its now spring and opportunities abound! Of course, most permabears don't notice the beauty of life renewal associated with spring, they'd only see the ticks, chiggars, thorns, poison ivy and mosquitoes. Permabears, or negative people in general, don't notice the beauty or opportunity that abounds around them. They see the thorns and not the rose. They're very much like the biased media and only see those things that support their point of view. If a permabear comes out of his frosty hibernation, is that inherently bearish of bullish? I doubt there is any data on this because a permabear changing his position is probably a rare occurrence.
George Zachar adds:
In addition to erasing his long-lived "sell" recommendation on US assets, Roach also reversed field on volatility:
I now believe that the odds are shifting away from a disruptive global rebalancing. That tempers my long-standing concerns over the possibility of a sharp decline in the US dollar and a major back-up in real long-term US interest rates that such a currency crisis might have triggered. Adjustments on both counts are now likely to be more gradual, or measured.
The man is consistent. As many US asset prices graze all time highs, he withdraws his bear claws. And as vols nick multi-year lows, he looks for "gradual, or measured" adjustments.
If I were a novelist, I'd be reluctant to create such a character, for fear my editor would blue-pencil someone so consistently foolish
Some Lessons from a Harness Outing, by Victor Niederhoffer
'I might miss the big one'
My daughter Kira is 14 years old now, and I confess that Saturday, April 20 was the first time that I have taken her to a Harness Meet at the Meadowlands. For someone in my profession it's important to teach all the kids at an early age that gamblers die broke, so there was not a moment to lose. We went by bus to get the flavor of the persona and talk of the dead beats and compulsive gamblers down on their luck that use such transportation and at first I was surprised because many of the passengers were well dressed Asians and affluent yuppies but we soon learned that these ladies and gents were going to the adjacent Ice Show and that the remaining passengers, who were involved in a screaming battle with the bus operator over possible delay in getting to the track on time were more typical. This remnant certainly suffered from the tendency of all gamblers to completely lose their sense of balance and priorities in a desperate attempt not to miss even one chance to get even. I once had a client from the Mediterranean who insisted on selling the stock market futures short whenever it set a five-day low. He lost about 20 times in a row after 1987 and I advised him to take a break. "I can't. The big crash might come while I was away." he said. I remember Artie's telling me that one of his best friends missed his wedding and never married because he got into a card game on a train going to his own wedding with a wonderful girl.
Lawton not there
When we got to the track I immediately wanted to buy a tout sheet so that I could compute past handicapping performance but the newspaper stand only carried a single 5 by 8 sheet from Bailey's. "Yes he's the best" the attendant said. "And he better be because all the others have gone out of business. Yes. Even Clocker Lawton and Jersey Jim. There's just no demand for them at the track anymore." Fortunately the Harness Eye newspaper remedied that omission by giving the selections of Trackman, Rick Weiner, and Rocky Derosa, (any relation to the great Paul?), as well as Staff Spot Plays from Derick Giwner and Matt Rose. Derick's record appears to be better than most of the advisers in my field, and there's no monkey business about its documentation as he's hit 23 of 83 this meet for a total payoff of $163.20. Regrettably, I cant tell if that's the return from a $1 bet or a $2. But as Artie told me, he once was asked to go into business with the best tout in the land and when Artie asked him "How come you need me to back you, a mere policeman if you're so good?" the tout answered that people are willing to pay him thousands of dollars if he can just keep the losses down to three hundred or a thousand dollars a year. I explained to Kira that most advisers can't make money with their own speculations and that's why they gravitate to giving others advice.
The problem is that if you don't speculate on your own advice then you lose touch with the factors that enter into the nitty-gritty of the trade such as execution costs, and uncertainties and potential for grave risk, but if you do trade on your own advice then the receivers of the advice are much disadvantaged because you would not be able to let them come in before you if you had a big following, because the money you lost from bad fills would be so much more unfavorable than the money or gratitude you got from giving the advice. I also explained that I stopped giving advice to others when I realized that I had a tendency to remember my past winners much more than my past losers, and that I wasn't able to explain to my advisees what the full gamut of reasons that made me want to do a certain trade, so that they were always in much greater uncertainty than I and that if I told them when to enter a trade, and they did follow me, I was up to creek because then I'd have to tell them when to get out of the trade, and their actions would hurt the price that I received by much more than I could make in gratitude or payment for any advice that I had given them. I always tell people I'm fond of to beware of even free advice for these reasons. You see, often the people that give the free advice have an ulterior motive, for example to get feedback on the state of your thinking about a certain trade, or to move their own positions along, or even to get you committed so that they can squeeze you on the other side. For this reason I am even very reluctant myself to give advice on specific trades even to the people that work for me as I suffer from the same human frailties and qualities that the next guy is likely to have also.
A richer palette
I have always felt that the level of systematics and number of variables considered is much greater in sports betting and race betting than in the markets that I trade and the Computerized Past Performance contained in Harness Eye did not disappoint me. Here are some of the factors they reported for the horse in each of the 13 races:
There are so many obvious applications to market handicapping someone could spend a lifetime with many meals for a day just by applying a handful of them. I like to think of the race during the day for a given market or horse as being divided into four quarters and a stretch the same way horses times are classified. I also like to think of the race as between different market moves during the same day like gold racing against bonds, stocks, et al.
The clinical versus the subjective.
As an example of the care and thoughtfulness with which the average harness handicapper expects from his sources consider this from Harness Eye. "This list (of speed ratings) has been compiled using data acquired from different tracks. Unlike other so-called "official " speed ratings, Harness Eye's has been established after three years of analysis using the minds of some of the sport's top professional handicappers. Others have attempted to develop accurate speed comparisons by strictly using final times form track to track. We believe in most cases using mathematical studies exclusively can omit key variables necessary for rating a tracks true level of speed." Even the Clocker himself couldn't have said it better, nor could I in issuing a similar injunction to colleagues in my field.
Well, I will have to leave the lessons learned from the "all horses have participated in a pre race stakes barn since 1100 PM Friday" for next time as I don't know if this is to protect the horses from drugs or from outsiders but I would recommend that all officials who are connected with the gathering of economic reports be similarly sequestered regardless. I will also have to refrain from commenting on what the taxi driver going back told us in that the driver he had a fight with for our fare would have taken us quickly to our destination and then used our fare to rush back to the track to bet on one more race in a desperate hope to get even after 20 years on the job, as this is an example of the kind of compulsive behavior that gambling can lead to. Remember what Artie told me many years ago, "All gamblers die broke" and never marry a gambler.
Jared Albert responds:
When I started trading and was down big after a succession of days, I used to get my brother to duct tape the phones down before he left for work. But the anxiety of watching the market rebound and being unable trade was unbearable and eventually he'd have to take the phones to work with him after a losing streak. Luckily I wiped out 3 times in 6 years and discovered that the pain of having no steak is worse than the pain of missed opportunities. But I wonder if the lessons will stick after an extended period of losses--which is bound to happen at some point.
When I traded on a 'desk' we had a guy who after hitting his daily limit would proclaim that 'losses made him giddy'.
I live in blue collar Queens, NY and the OTB is just down the avenue. The guys who hang out there remind me so much of the day-trading shops I used to trade at. It's the same guys (though not as well dressed) going for a smoke outside to commiserate on losses or shoulda' woulda' coulda' and hope things had gotten better. The same shocked look after a horrendous day of losses. How can a guy who in his working life saved a couple of hundred thousand over 30 yrs go to all tech and drop 30k in an afternoon in a name he know nothing about--amazing!
Because In my real life, I'm as undisciplined as the next guy, I've had to hard wire some trading rules to keep food in the fridge. I'd love to hear other people's thoughts:
The issue of compulsive trading or trading for excitement are clearly among the most dangerous. From my limited experience, it seems that successful traders have an edge that they exploit in a routine manner the way most people do interesting work. The unknown doesn't thrill these guys.
Weekly Commentary from Dick Sears: "Haste Makes Waste"
The Second Rule of Poker, by Steve Leslie
It's a pleasure to meet someone who understands that to the true gambler, money is never an end in itself, it's simply a tool, as a language is to thought. - Edward G. Robinson as Lancey Howard in The Cincinnati Kid.
The second rule of poker:
In hold-em poker, position at the table is the second most important consideration in playing the game. Position means your relationship to that of the dealer. Since the button moves in a clockwise fashion after every hand, each player gets to be the dealer at some time. Therefore if there are 10 players at a table then it will take ten hands to make one round. As a result, you will be forced to make one small blind bet and one big blind bet every round. This is an important consideration for several reasons.
The first point is that if the blinds are $10-$20 then after the first round you will have committed $30 to the game. Also in tournament poker after a certain time limit the blinds will be raised. This will eat into your bankroll so eventually you will be "blinded out". You will have to play and win some pots to avoid this possibility.
The second point is if you are in early position you will have to act ahead of all the others throughout the hand either to check or bet. Therefore everyone behind you will have advanced knowledge of what they are facing and can adjust their strategy accordingly. Conversely, the later position you are in the more implied power you may have. Naturally the person on the button has the best position. When I sit at the table, I always like to know who is left to act behind me and especially what type of player they are. Whether they are loose, tight, gunners, calling stations, or rocks. This has a major impact as to my decision on the hand.
There is a maxim that says "tight in front, loose in the back". This means that if you are in early position, the quality of the starting hand must generally be higher than hands that you might play when you are in late position or on the button. Should you decide to play a hand it will have to be able to withstand a potential raise from those who will be acting behind you. And a potential all-in bet from a player. Naturally their actions will then affect your subsequent actions.
You will notice that poker players are constantly rubbernecking looking around the table. They are reviewing their position and also the size of the stacks that are behind them. This all gets incorporated into the decision of how they are going to play the hand. In Summary always be aware of your position at the poker table and how many players are left to act behind you. Be very aware of your starting hands and be careful not to play them out of position.
Money moves in a clockwise motion around the table. It takes a stronger hand to call a bet than it does to raise. If after 30 minutes you can't figure out who the pigeon is at the table it is probably you. And ultimately ask your self why you were invited to play in the game in the first place.
April 2006 Letter and Contribution Awards!
Daily Speculations is a benevolent forum to encourage good thinking about the market. Material is provided free by us and our readers. Because incentives work, and to augment the mutual benefits of participating in the forum, we offer awards each month for top contributions or letters to the editor. Below are the winners among many splendid posts offered in April:
All winners received $500.