Aug

16

The solemn and ominous sounding bear cultists are bringing out the flaming hydrogen ballons. Several mentions today of the Hindenberg Omen– not talked about on this site since an April 18, 2006 mention (at a time when the market found helium and moved up roughly 20% over the next year). Nattering nabobs of negativism…

The traditional definition of a Hindenburg Omen requires that:

The daily number of NYSE new 52 Week Highs and the daily number of new 52 Week Lows must both be greater than 79. (Source) The daily number of NYSE new 52 Week Highs and the daily number of new 52 Week Lows must both be greater than 2.2 percent of total NYSE issues traded that day. The NYSE 10 Week moving average is rising. The McClellan Oscillator is negative on that same day. New 52 Week Highs cannot be more than twice the new 52 Week Lows (however it is fine for new 52 Week Lows to be more than double new 52 Week Highs). This condition is absolutely mandatory.

Paolo Pezzutti comments:

More about it on this chronically bearish site. To me it looks like a nostradamus prediction more than a pattern. Bears are trying to find new ammunitions…and last week was encouraging.

Victor Niederhoffer comments:

I can't tell if everyone is kidding or not about Hindenberg. But in edspec, I show how a run of 25 in one direction is not inconsistent with randomness, and Birinyi turning points and come up with an infinitely better indicator than Hinden.

Marlowe Cassetti replies:

But The Chair should admit that Hindenberg Omen has such a funereal appeal, an air of foreboding. Rather like the Mayan 2012 Prophesies. 

Russ Sears comments:

But could you come up with a better marketing name? It has great name recognition and implies that they know something that others do not, but will soon after the fact think it should have been obvious. It would seem the splashier the name of this or that indicator in the media, the more desperate their position and need to bring in the masses to offload their positions. May be profitable if one could quantify such an inverse correlation. 

Aug

16

base of giant sequoiaSequoias are often thought of as the monarchs of the Sierra Nevada ecosystem with good reason if you think how tall and old they can grow to be. The main cause of their death is toppling, since they are so resistant to diseases. Sequoia groves adapted to natural processes that must continue if they are to remain healthy.

As a reader of this site, I wonder if there are similitarities between the natural processes that help sequoias remain healthy and markets. These monarchs remind me of big banks and corporations that dominate and have dominated the markets over the past decades.

During a visit to the Sequoia National Park, one of my girls asked me why there were fires in the forest and no one was doing anything to suppress them. I was surprised to find the answer as I was not aware of the importance of fires for sequoias. Fire is actually one of the major processes essential to the health of giant sequoia groves. In markets as well, fires can be important for the health and growth of the financial markets ecosystem. Researchers have determined that low intensity fires swept through the trees approximately every 5 to 15 years. Sequoias rely on fire to release most seeds from their cones, to expose bare mineral soil in which seedlings can take root, to recycle nutrients into the soil, and to open holes in the forest canopy through which sunlight can reach young seedlings. Sequoias also need fire to reduce competition from species such as white fir and Incense cedar, both of which compete with sequoias for water and nutrients. A natural fire cycle thins these competing species, and provides suitable conditions for sequoia growth. That is why forest management policies are aimed at restoring fire to its natural role in Sierran conifer forests. This is accomplished by prescribed fires burning.

Here are a few more reasons why fire is so precious to sequoias and how this could relate to markets:

- Seebed preparation. In a sequoia-mixed-conifer forest, moderate to heavy surface fires provide soft, friable, ashy soil on which the lightweight sequoia seeds fall and in which they are buried. Each crisis is good to prepare the environment for the next trend and expansion. Companies restructure and reorganize, governments improve the framework for investors.

- Nutrient recycling. Fire plays a significant role in returning various mineral nutrients to the soil. The ash deposit increases available phosphorus, potassium, calcium, and magnesium. Entrepreneurs reallocate efficiently capital to increase their returns.

- Impact on succession. Species requiring sunlight, such as pines and sequoia, were favored over shade-tolerant forms such as white fir and incense-cedar; and fire-resistant and fire-dependent species and associations were favored over nonfire-dependent forms. Big banks and corporations are favored in this environment of small and moderate fires because competitors don't manage to upscale their operations enough before the next crisis arrives.

- Formation of a vegetative mosaic. Periodic burning causes development of uneven-aged stands, comprised of even-aged groups of trees of various age classes. Crisis and recessions create a landscape of investors and entrepreneurs which is rich and varied as old farts disappear and new players appear on the scene.

- Faunal relationships. The influence of fire on wildlife is largely related to fire's role in stimulating germination of plants and trees that are useful to animals for food or cover; or making openings in the forest that favor wildlife. Fires create new opportunities and inefficiencies that can be exploited by market players.

- Influence on insect-suscptible trees. Fire apparently has a sanitizing effect by thinning stands or eliminating old stands or old trees before insects and disease have overtaken them. I think here of the role of crisis to get read of scams and market cancers (see for example Madoff or the dotcom situations of Enron and others).

- Influence on fuel and fire hazard. It is believed that the worst enemy of a fire-suppression agency in this regard may be its own efficiency because "the longer forests go without burning, the greater the fuel accumulation and the greater the hazard". Trying to avoid recessions and suppress fires may eventually lead to bigger problems for the ecosystem as a whole. Through fire-suppression programs, the cycle is slowed and it occurs a higher buildup of fire hazard. The 2008 crisis came after a long time where measures were taken to keep the economy going (may be unnaturally?). The crisis was so big that almost burned even the big giants so resistant to fire. Only the government help managed to avoid a profound reshaping of the ecosystem with the "too big to fail" considerations that were made (except for Lehman).

Many other questions could be asked, such as:

- What is the role of regulkators in managing prescribed fires?
- Even after a big fire, the forest grows again. It is just a different forest. With no sequoias. Is it good or bad?

Aug

3

I am quite skeptical that nowadays it is enough to be a good programmer to make money on Wall Street. A very famous trader recently said in this regard that what is and will always be important is understanding human nature. However, it seems that successful programmers want to strike deals that give them the possibility to share profits and retain the ownership of the code they write. The companies they work for make $100K a day when they may be paid $150K a year. It is an intellectual property problem. When competition increases in high frequency trading, margins will decrease and programmers might want to go back to the old "safe" way they were paid. Sometimes I have the doubt that it is enough to have a piece of spyware, which can monitor information from programs that use certain protocols to make big money. A hacker could monitor someone's trades dropping a sniffer and intercepting trading programs. It would be a sort of real-time insider trading. A modern version of an old, and "sure", way of making money.

Read more in this article.

James Lackey comments:

Stick a trading sheet with a programmer's name on it with a 500k daily loss and see if he wants to enlist in the traders training program or go back to his desk. Ha. It's easy to target shoot but it's harder when they are gunning for you.

But Tony C on here years ago thought he discovered Spyware on his quotes from Enron. Drag your mouse cursor over the quote and see if HFT lifts their 100 share penny offer.

 Charles Sorkin writes:

I've often suspected that something like Tony C's situation happens in the options market. For instance, I can't tell you how often I've entered limit orders on an option with limited activity, and I get "pennied," so-to-speak.

For instance, consider a market for an equity call option that is quoted as $2.50 - $2.80, for a few hundred contracts on both sides. I enter a limit order to sell 10 contracts at $2.70, making the market $2.50 - $2.70, hundreds x 10. Hardly a second later, the market updates again, to something like $2.50 -$2.65, hundreds by 10. GRRR!!!!

Somebody/ something steps in front of me, on a contract that potentially has hardly any open interest, and very little activity in the whole series, perhaps with the expectation that I will lose patience and hit the original bid.

Very frustrating. Sometimes I pull my offer, and watch incredulously as the quote reverts to it's original level.

Jul

20

sales of iphone 4Of all the canards, snares, delusions, and misinformation about markets designed to put the investor on the wrong foot, to increase the flow and likelihood of resources from those at the bottom of the web to the top, surely one of the most destructive is the idea that sales are more important than earnings, an idea that seems to have the market in its grip. The reaction of IBM to an increase in earnings above estimate of 8% and sales below estimate by 6%, with the stock dropping 5% is just one horse from that dump heap.

Same thing happened to General Silo when it announced great earnings but sales declined. Must make all these proud CEO's shake their heads in disbelief when they tell their boards that they can't believe that the stock is down when they're doing so well, and their every sale is at a profit and they are only selling profitable products rather than just selling anything they can to get cash.

Indeed, the first item reported now from the traditional income statement announcement is the sales number versus the corresponding quarter, and the surprise factor of sales. Compilations of companies that beat the bogey for sales are now almost as numerous and useless as those for earnings.

Sales are the easiest thing in the world to manipulate. From economics, the buyers have a demand curve for a product, with alternate uses and utilities for it. The marginal utility of each additional unit decreases. At a low price, they will use it and buy it for many uses. For example, the traditional explanation in Heyne where water is used for plants and baths at low prices but only for drinking at a high price.

From a practical standpoint, every business person knows a million ways to increase sales at the expense of profits. you can sell to bad credit risks. You can dump inventory at close to cost. You can offer discounts for bulk orders or pre orders. You can reduce the price and ask your customers to store it for a rainy day or some other use. You can sell to a wholesaler or distributer instead of the ultimate customer, especially for a price. You can justs turn over your product to your customers with a "I'll take 5% on this. Just enough to keep me going". Or you can produce a higher quality product with better terms and tell the customers what a bargain they're getting by taking it out of your hide. Or you can buy a division or company to expand sales, or work off your inventory to change the number.

Indeed there's no item in the expense or revenue side of the income statement that can't be manipulated to increase sales. From a value standpoint, the stockholders desire an increase in wealth, not an increase in sales. What gives them wealth is earnings, not sales.

Okay, where do all these crazy reactions to sales come from? There must be some academic study, doubtless done with retrospective data that shows that sales provides information. And some earnings aggregator sellers must have shown that sales is a important signal with data from one of the retrospective data files that are so misleading and cause so much havoc. Or perhaps there was one period with a turning point where style investing based on sales had some information value.

Of course, companies are very smart, and it's so much easier to manipulate sales than earnings because you don't have to have the complicity of the accountants or move one item on the balance sheet to never never land to change sales. So even if sales were once of reasonable signaling value, now they will be changed in cycles in the typical Baconian way, and of course the public will be behind the form even more than usual.

But in the interim, what a fantastic opportunity to take advantage of this ridiculous malarkey and the reactions of stocks thereto.

The funny thing is what must go on before the release of the income statements these days. The insider and the outside flexions for the big companies must keep the earnings in the hip for a few weeks on a need to know basis only with smug satisfaction that they have beat the guidances they gave out to the analysts and the favored institutions and that they have pulled the wool over the eyes of the accountants to a reasonable degree to pull the earnings into the right territory. Then the horrible realization must come that they forgot to run a sale of buy that division before the quarter occurred and the sales numbers actually show something below the bogey must arise, and their smug satisfaction turns to the agonizing thought that even though business is great, they're going to have to do a lot of explaining to the board as to why the stock is down. 

Paolo Pezzutti comments:

There are also other ways to try and increase sales and earnings at all costs. Apple is in my view the last example of a company which is struggling to keep up growth prospects at all costs. And the bigger the company becomes the more difficult it is. The problem of the antenna of the iPhone indicates that they did not give enough time to their engineers to test and make sure technically it was all fine…because of the hurry to come out with something new as soon as possible. Eventually, however, this approach to customers might painful. Hopefully they understood. 

Ken Drees asks:

Do consumers get conditioned over time that products need fixes and patches and it's just the way it works in tech– so no problem–send me a carrying case and a patch and we love Apple just the same?

Plus, Apple prices their new stuff way high on debut and people can't get enough of it and then they lower prices to get sales goosed–which pisses off the early buyers yet they seem to forgive next time around.

Also, what is your general opinion on dividends? In my market lifetime, dividends were always poo-poohed and shunned as a way to lose capital. Friends in business always reinforced that concept the putting money back into the company was more prudent. However in my father's lifetime dividends were an important investment consideration and if the dividend was solid or not, or if it grew each year and thereby showed business health. High dividend taxation rates affect investor sentiment about holding div paying stocks. The repeal of tax cuts in Jan will hike div tax rates. I wonder how retired people structure their investments to throw off income these days–bonds don't pay much, energy patch only real div sector that comes to mind.

You can't fake a dividend. 

Rocky Humbert comments:

Ken: You are correct in all of your statements about dividends. However, while you cannot "fake" a dividend, you can "cut" a dividend.
The interaction between dividends and taxes, dividends and management stock options, dividends and corporate cash balances/reinvestment are well understood. Also understood is that fact that a substantial portion of total market returns can be attributed to REINVESTED dividends.

Notwithstanding this, whether you cut a pizza into 8 slices or 7 slices doesn't change the size of the pizza. However, if you have eight friends over for dinner, serving 8 slices makes you look like a good host. Whereas serving 7 slices makes you look like a miser. This illustrates nicely the investor preference for dividends from time-to-time. If you don't ever have friends over for dinner, it shouldn't matter….

One thing that is poorly appreciated– and which I encourage you to consider– is the relationship between dividends and the "duration" (to use bond parlance) of an investors' stock portfolio. Here's an example: If you buy the 7-1/4% treasury bond of May 2016 at a price of 129, the duration is 4.9 and the convexity is 0.29. Whereas if you buy the 2.625% of April 2016 at a price of 103, the duration is 5.32 and the convexity is 0.32. So, the lower coupon bond has more duration and convexity even though it's a slightly shorter maturity date and has essentially the same Yield-to-Maturity. I'm sure the quants out there will find fault with this analogy, but I believe there's a similar effect in stock portfolios.

Jim Lackey comments:

No they are not Mr. Vic.. mid quarter updates– TXN or IBM or any of them– say all good, and why stocks gap so much is insider selling and we all know it. It's not all that bad as they raise the full year outlooks and TXN book TI bill ratios fall as a certain handset maker is on the ropes. But the joke is now vs 99 they can contract out manufacturing and ramp up and down production so fast all the old school book to bills or updates are well, perhaps useless. But a few still have their own factories, and if they buy new fabs from Klac LRCX or Nvls… I don't know how it's bearish in the time frame your looking at, but AMAT is all in Solar and that reminds me of used car sales, and one guy on the internet who went to a solar show and he said it reminded him of used car salesman and I thought good! Perhaps some sales will get done.  

Stefan Jovanovich comments:

Samuel Butler scandalized his readers by suggesting that the banking system of Britain had replaced the C of E as the national church. I think he would have been bemused to find that the language of finance has now become completely theological, that wisdom takes expression in the form of discussions about "decent" returns on capital, etc. I know Butler would have laughed out loud at the discovery that in the 3rd millennium mankind had reached the point where money itself could only be discussed in terms of its moral meanings and the words "sinister" and "deflation" could seem perfectly compatible usage in a single sentence.

From Mr. Butler's pen:

"MANKIND has ever been ready to discuss matters in the inverse ratio of their importance, so that the more closely a question is felt to touch the hearts of all of us, the more incumbent it is considered upon prudent people to profess that it does not exist, to frown it down, to tell it to hold its tongue, to maintain that it has long been finally settled, so that there is now no question concerning it."

" I do not mind lying, but I hate inaccuracy."

"Life is the art of drawing sufficient conclusions from insufficient premises."

Those of us who do own companies - not just as thought experiments but as our accursed fate - truly envy Rocky his ability to find answers in the current MBA Book of Common Prayer; what we see on the street in California right now is that the only current action is being handled by the Lackeys and the few other over-traders who have never had the luxury of being able to ignore the current bid. Everything else is talk combined with (1) belief that the "cycle" will somehow continue as the Emperor peddles along on his imported energy-saving machine and (2) a desperate eagerness to get to the next meeting with the representatives of the official church.

Jul

6

A million events coalesced this week to put the market in a highly precipitous state with the expected standard deviation for Tuesday, based on pre holiday lows of 32 being a good twice the normal 15 for any day. Without minimizing the seriousness of a loss of 50 points in a week, perhaps 3 trillion or more in wealth, perhaps one can find some order beneath the random happenings.

First , some quantitative things. Big minima before holidays occurred only 6 times in last 15 years, one on Labor Day 2001, and one 10 calendar days later, two on July 3, 2002 and 2008, and two on Martin Luther King day 2005, and 2009. Changes to the close of -60, -60, 35, 14, -13, and -46 followed those days with a stand deviation of 32.The situation a week later was even more dour, although in an interesting anomaly so typical of markets, the standard deviation of the 5 day change is 28 versus the naive expectation of 70 from the one day change.

On the other hand after big declines in a week, of 5% or so, a event that regrettably has visited us on 1 in 20 weeks that last 10 years, the market is quite bullish with a standard deviation of 35 the next day and a more expected but gargantuan standard deviation of 60 for the following week.

One also notes a string of exactly 5 consecutive losses in the S & P, an event which has occurred on about 1 in 25 days, as compared to its expectation of 1 in 64 days. Fortuitously, the standard deviation the next day is a mere 18, and the expectation is zero.

The situation with the Nasdaq is similar on a weekly basis. With its 120 point decline for the week, the expectations are not much different from random. However, with 11 consecutive days without a rise, that's never happened before. The highest run of consecutive declines was 10 on October 12, 2000, when the adjusted Nasdaq was about twice the current level.

More interesting is the failure of the market to rise a reasonable level in 13 consecutive days, an event that is a true rarity only having transpired on 4 occasions before. That event has again led to an expectation of 0 to negative in the next following days.

Turning to the always fascinating changing web between stocks and bonds, one notes that while the stocks declined 5% this week, the bonds went up about 4 1/2 points from 123 1/2 to 128 1/2, with 5 consecutive rises to Thursday, July 1, close… One would expect contrary to the upside-down sponsor's constant refrain that would lead to some reallocation to the stocks. And indeed to a reasonable extent that is true, albeit the expectation is only 1/10 of its standard deviation going out 1 week in future.

The variability of all these things is so great relative to its expectation that even if the future moves were drawn from the same distributions as the past, nothing here would be of any great regularity.

Thus, we turn to the qualitative. Everyone from the President to the upside down sponsor was on TV talking about the significance of the employment number, all from their own corner of self interest. I like the emphasis now that is placed on private sector jobs, the 63000 increase, a number that is becoming so much less relevant as government jobs gradually become more numerous, more attractive, and crowd out the jobs in the private sector. Along those lines, everything came together with Barton Biggs reporting that he sold his technology holdings. The news came out rite at the close, putting it in the pitching in the pinch category. It was the one thing that determined the market move for the day as just before the market had been up a 1/2 % on the day and the news caused it to decline 1% in the last 10 minutes.

It was the perfect thing as Zeus sat there at 350 deciding which of the Goddeses to favor with his kind attentions over the weekend, with the balance of the market on his scale. And then came the perfect announcement. Biggs is bearish because the intervention and the stimuluses mite stop. And it's particularly newsworthy because he made money in 2009 by being bullish on the stimuluses as if being rite one year has anything to do with being rite the next year. But it's the idea that has the world in its grip. And it provided the perfect backdrop for more interventions coming in the future. And of course the reason that the market is down so much is exactly that the interventions have caused all incentives and all desires to make investments with the increase in service rates of 100 % coming up , totally vanish. Thus, the news followed the price, and led to what is guaranteed to happen, a call for more jobs, more jobs especially for those organized in special groups that can provide votes and funding — but most important of all, a clarion call for taking from the common man to provide a greater need for intervention by those of superior knowledge and tastes.

I believe one gets the picture.

Paolo Pezzutti comments:

I already see those who will benefit for a second round of stimulus counting the big money they will make when borrowing at 0%… A nice and unfair advantage is about to come again for those on the right side. Especially for those whose risk in this "trade" is practically zero! Few, damned and now (!) seems to be logic (although for some it will be another windfall of earnings and bonuses). Politically this is very much convenient and powerful lobbies may already be at work to support similar moves. Someone else will take care of the next generations. We will not be here anyway, so why worry. However, the greedy ones who think that the game will unfold the same way, at least for equities and currencies, this time might be wrong. Mainly because few governments will afford this kind of move. The US could still do it and China. Europe not for sure…Different variables are at play. I was not clever enough last year to understand the magnitude of the implications related to the huge injection of money in the system made by governments. However, my skepticism that this is the right way to solve a problem that is structural in nature increases.

Ken Drees writes:

One item left out of the soup, the China market had a big drop that was partially erased–this drop happened after the recent won float plus labor issues arising. Also hundred year floods are still raging in the southern provinces as well as growth estimates being revised downward. There are some big possible trend changes in place in China right now that are not being looked at for the most part by the west.

I spied some interesting fin tv that was a little bit different from the norm–a la the new paradigm–China catches a sniffle and USA catches a cold. This concept ignored by most financial media and blogs all week. China chart looks likes SPY only a bit tighter.

I think we should look east short term for possible dislocation in the west.

Jul

2

Something significant is happening for sure as market forces came to the conclusion that gold had to be liquidated so fast and the Euro had to be bought so aggressively. Maybe I missed some important development in Europe, but the crisis is still there as it was a month ago. Spain and its debt situation is the next challenge this summer.

The coming slowdown (or it is already here?) will only make things more difficult for European countries. In a few months additional fiscal measures will be required to try and stabilise budgets. So why this rush to buy Euros? At the same time, gold was heavily sold like if all the printing of money in western countries was over. Actually as we go down toward another slow down more easing will be required (for those who are still in the conditions to do it) the printing machines will become hot. May be what we are seeing is just the result of deception and it is a good trading opportunity.

Jun

13

I was in Berlin recently and this opened my eyes to what is Germany today and what the Germans can do.  I visited this city right after 1989. There was a profound wound at that time that needed to heal and the eastern and western sides were so different. They had a lot of work to do on their infrastructure and mindset. 

Berlin is now a new city, completely rebuilt.  From public transportation to government buildings, roads, private corporations headquarters, you can see that everything has been done rationally and neatly. This city works pretty well. There is no traffic, there are excellent services. They restructured old buidings, keeping whatever was left from the old architecture. You can still see bullet holes from machine guns on the walls of some of these buildings. The American Embassy so close to the Brandenburg Gate, the iconic landmark of Berlin, is there to remind you of the past. 

The wonderful Reichstag, the seat of the parliament of the Weimar Republic between 1919 and 1933, was badly damaged during the war. In 1990 it hosted the ceremony of reunification and only in 1999 it became the meeting place of the parliament, the Bundestag. 

You perceive that Germans have a particular relationship with their history. Their past is not presented openly in all its dramatic aspects, but you can feel it in the air. Germany is now in a position of leadership in Europe. It is amazing what they did if you consider the situation of total destruction of this country after the war. They are the biggest economy in Europe. One of the few nations in Europe with a trade surplus. I think the current crisis has blessed Germany as the leader in Europe. In relative terms to other European countries, thanks to the crisis, they are further improving their position. Think of their role during the Greek crisis, and note how badly Great Britain is being hit by the financial meltdown.

They are getting stronger also with regard to the French, who are for sure uncomfortable with a too strong and influential Germany, although their continental ties from a political and industrial standpoint are quite good. 

One of the long term trends I see in Europe is the consolidation of their leadership and an increased role of Germany in all European matters.  This might not be perceived well by those who look at the past history of the country, and also look internally in Germany.   Very recently, the Federal President of Germany Horst Köhler announced his resignation following heavy criticism about comments he made on Germany's military role in the world.  On May 22 upon his return from a trip to Afghanistan he stated that "in emergencies, military intervention is necessary to uphold our interests, like for example free trade routes, for example to prevent regional instabilities which could have a negative impact on our chances in terms of trade, jobs and income."  Some critics said that his comments indicated he would use the military unconstitutionally and for economic reasons. This is an important signal of the sensitivity of discussing certain topics in this country. 

Fiscal measures were decided recently; Berlin will cut the budget deficit by a record 80bn euros by 2014.  Some have been critical of German budget plans. With so many European governments under pressure, German budget cuts do not help the European economy to recover and the risk is that Europe goes back into recession. And I think it will.  Germany is also reluctantly providing the biggest national share of the euro rescue package and the bailout for Greece.

In summary, although Germany is now the recognized leader of Europe, they still are not fulfilling their role comfortably and their population is reluctant more than the political leaders are.

Jun

7

Kissing the Clay in victoryWatching the French Open Womans Final was shocking for any Aussie who had watched Stosur "Demolish", and that she did, three previous number ones on her way to the final. The Italian woman grabbed the opportunity and literally went for broke, and good luck to her, she got the result.

What is interesting is how absent minded Stosur appeared, What happened to her game, her intensity, and the aggressive tennis of the previous few games. Sure Schiavone combatted her well with some mighty deep top spin looping backhands, but there is no doubt bigger questions to be asked, in particularly how one's mind can be prepared for such a proposition.

For both woman it was their first Grand Slam final, and who's to know how they are going to react on the day. Stosur (who had beaten the Italian in their 4 previous meetings), had phone and text messages from all Australian past champions like Evonne Goolagong and Pat Cash, and no doubt many more. (The fact that Italy had no past grand slam champions in tennis ever, may have helped Schiavone).

Should Stosur have turned the phone off and concentrated on routine, discipline and more routine? It appears the case is evident that potentially there is the need for a head doctor, especially with someone totally new, to be brought in for BIG occasions, one off events like this, just to fine tune and set things totally straight.

Samantha StosurIt reminds me of traders who have just made a bundle of cash, p and l looking the best ever…and for some reason everything they have ever been taught or taught themselves goes out the window. They drop the bundle and give back what they made and more in a bout of careless trading.

There was a manager of a prop desk in Singapore who used to buy a book of local cinema tickets every month. If his traders just had their best period for some time, he dished out a ticket, they were off to see a movie. Likewise, if others were under the pump, then they were sent off to see a flick as well. He reckons that book of tickets was the most profitable management decision he ever made. Maybe Stosur could of done with a movie with a slow down of adrenaline, resulting in her accounts having a reval, before stepping on to court.

Paolo Pezzutti comments:

I was quite impressed by Francesca Schiavone's determination and resolution during the French Open Womans Final. Especially during the tie break. No fear to win. Focus on her strengths. Will to dominate the court physically and geometrically. No way for a self-defeated adversary to match the same hunger for victory and glory. Many similarities with trading where self confidence also plays a big role.

Jun

2

Happier timesAn excellent trader once told me that relationships are like trades. "Paolo", he said, "If it does not work, it is time to close it and move to the next one…". It is the concept of stop loss, of having the strength to recognize failure and accept its consequences, of learning from our own mistakes without feeling frustrated and miserable. In two words, it means being mature and responsible.

As a trader, I tend not to close my losing positions; it is my main problem. I think this is common to many "wanna-be traders". I want to wait for prices to go back where they were, I do not easily accept taking a loss. Most of the times this works well especially in a choppy environment, but if you find yourself in a fast market you can be badly hit.

Similarily, in life I care much about the friendships and relationships I establish. I feel "betrayed" when I lose a friend who is important to me. It happened recently, when a dear friend decided to discontinue any type of contact with me. At the beginning with some justifications. Eventually not even answering phone calls and emails. I know that with every ending there is a new beginning, that maybe I didn't realize what kind of person this was in the first place, that I may have contributed to the situation, that I don't need this person to be happy. However, you are aware there is something of you that has gone away and will not come back. It is complicity what you miss the most. It is the awareness of having wasted emotional energies on a losing investment. "Paolo, it is a closed book. It is time for the next trade" he told me. I know this is right, but I miss this friend.

Chris Tucker advises:

Paolo, You are not a "wanna-be trader" any more than you are a "wanna-be friend". In both endeavors we are all learners all the time. Setbacks will occur in all facets of our lives and they can be painful, sometimes extremely so, but they are not a reason to condemn ourselves or to give up. It's normal to feel frustrated and miserable as long as you don't dwell there for too long. Nor do I believe that you have wasted your emotional energy. Energy that is put into something or someone you care about is never wasted, it's just that sometimes it fails to yield the benefits we expected. So I don't see you as a "wanna-be trader" but as a "trader in training", just like the rest of us, even the spectacular successes. I find that devoting my focus to finding the lessons to be learned from such things not only helps to assuage the pain associated with them, but also prepares me better for similar scenarios in the future. Perhaps you can ask yourself questions like "What can I learn from this?" or "What positive outcome can there be to this?" 

May

12

Recent cycle changes have been instantaneous rather than phasing in over time. The big recent drop changed the stultifying lack of vol and upward crawl which persisted over the last 15 months. Weather wise here in Hawaii we've had drought for 5 months, but since spring arrived, its been raining ever since. Another interesting and instantaneous change in cycles.

A related but different idea is the effect of cataclysmic events which have occurred historically with profound effects on dinosaurs and weather. We are seeing some recently such as Iceland, recent year's and recent weeks market crashes. A cataclysm is an obvious departure from recent norms which seem to kick off changes in cycles or make it clearly recognizable. Perhaps analysis of cataclysm or cycles norms rather than overall norms and means might be a good way to look at data. The dividing line might be tail events.

Paolo Pezzutti writes:

We are all used to changing cycles. In our lives, things go on routinely for months and years, when suddenly an event modifies things dramatically. It can be so disruptive to put into discussion values and relationships that have been quietly developing for years. Unpredictability, ironically, is what counts the most in our life. Most of us live their life striving for stability. We want a family, we want an indefinite contract job, we work to build a pension, we pay expensive health care insurance policies and so forth. Suddenly, a thunderclap, such as a death, a divorce, a new acquaintance or a new job opportunity accelerate the speed of our life. We find surprisingly ourselves making decisions with new parameters that we would have never considered only a few weeks before.

Similarily in markets, cycles changes suddenly, with no possibility to predict when they change. (Or is there any clue that this can happen?) Similarily, investors move from a low volatility environment to wild swings in a matter of days. At first, they are disoriented and react emotionally. Then they get accustomed to it and play according to the new rules of the game.

Also, robots seem to have the same approach– because they are built by humans. They slowly trade crawling up prices, printing higher opens and strong last hours for weeks, and then suddenly go wild selling all they can until the orders book is empty. I am not sure all this can be predicted. If one knew the logic with which robots (and humans) operate, one could try to anticipate… Alternatively, fast adaptation to the new environment is key. What are the parameters and signals that indicate that a cycle has changed? Is it possible to automate this process of monitoring and learning? Is it only a matter of volatility or is there something "less visible"? Visually, it was clear after a couple of weeks how the market was developing the up leg after 8 Feb. Visually, in fact, we noticed how the market changed pace during the past week. In this case, we should try and find quickly the new way of trading this environment post Eurozone sovereign debt bailout announcement. 

May

11

the euroActually I think Europeans are happy to have a weaker Euro. Especially Germans. it will help their exports in times of low inflation.

I am not sure the fund Europe wants to establish will help. Typically, the European reaction to the Greek crisis has been slow and fragmented, with states once again moving based on individual interests rather than a collective European view. In Germany local elections weighed also in how the leadership approached the crisis. The long term issue is that in Europe the imbalances between north and south cannot be reduced without a common European policy. In Italy we know well how difficult it is to reduce gaps between different geographical areas (north and south specifically) even under the action of a centralized government and a more or less homogeneous culture within the country. You can imagine the kind of challenge when the areas involved have different history, culture, economy, social structure.

The problem of this crisis is that Europe should accept the default of Greece. Sorry for the creditors. By the way: who are the creditors? Mainly French and German banks of course, already weakened by the crisis. The PIGS are not the only problem for a risk of contagion. Eastern Europen countries do not have much space on the news these days, but you my recall that they were the first to suffer a lot in 2008 at the beginning of the crisis. Their issues are still there.

It is the social reaction to the fiscal policies around Europe that can produce the biggest changes in the next years, as peoples of Europe will blame capitalism for what happened. The risk is that a bigger role of governments in society and economy will emerge together with some sort of nationalism and protectionism. Not good for growth… Although the US in the long term may have serious issues with their deficits and debt, it is Europe which is going to be weak for several years ahead.

I was in Italy last week and listened to discussions about the state of the economy. People complain that there are no jobs and it is getting worse. Most say that "the government should do something about it"…..

Alston Mabry writes:

The EMU is adopting the drachma. They will print more €'s to pay off the debt and save the banks. The Germans will benefit from a weaker € and better ex-EU export power. And it will be clear that Portugal and Spain can be saved the same way. Gold up! 

Ken Drees writes:

I remember reading an article about the palindrome when I was just learning about speculation, it showed him sitting and playing chess outside. It was after he had broke england out of the currency band and creamed the pound. He said something to the effect that england was going to amass some large number to defend the pound–and he was prepared to sell twice that amount for starters. I think its similar to europe now as they bluster and puff about in hopes of throwing off the currency attackers. They are in a losing position as Paolo points out. Nothing gets the juices flowing like lines in the sand. They have to have a plan for the entire string of piggies–all the way up the ladder or the wolves will chase them all the way to the end. The euro is surrounded by wolves and swinging the torch around in a circle only works so long. Eventually the wolves get more and more agressive and the attacks become more brazen.

So far it looks like their best attempt to date will be their announcement today/tonight. Anything hollow or doubted will be attacked ferociously or anything a little workable may have the wolves waiting and keeping their distance, following along. And if Big Al is correct than gold wins either way–massive QE or massive breakdown–time will tell.

Alan Millhone writes:

I want to see the US Dollar become King and overshadow the Euro et all.

I am bone tired of political correctness.

I build and remodel and rent apartments. Not an easy trade but one I understand. Not for everyone to be sure. Lumber has dramatically increased of late. One learns to not quote jobs too far into the future.

Apr

26

ava gardnerOne is amazed by the similarities between the market and the femme fatale. Especially when you continue to chase the market with expectations of a reversal that never comes.

The more you chase it, the more parabolically it goes up. No matter how you count or look at indicators and candles, it simply goes up. When you finally give up, that is when the market surprises you once more with a sudden reversal and drop of prices.

In same way, you chase the femme fatale and that keeps you hooked and brings you near self destruction and obsession. When you finally give up exhausted and frustrated, she gets back at you once again. Looking for her prey…

Apr

19

Eventually even the strongest, most resistant and adaptable species may disappear as well. Hopefully, the Darwinian selection will allow us to sooner or later get rid of a well known species of greedy predatory birds. However, I am afraid that even if that occurred, they would be replaced in the ecosystem by some other species with similar characteristics.

Apr

18

This reminds of "The Night Of The Long Knives" also called Operation Hummingbird. It is interesting how the market was "prepared" for this event that occurs after an impressive up leg. We will see if the event will be able to trigger more volatility. It will say a lot about this market.

Peter Grieve writes:

You've got to love a keg full of musket balls through the stern windows from the forward port side carronade.

Unless the free market you revere is on the receiving end, of course.

Alston Mabry writes:

With financial regulation reform next on the agenda, it's more like Trafalgar: What better way to start a battle than to cross the T on the enemy's biggest ship and rake them with a full broadside?

Apr

18

I was in Oslo when they started to close the northern Europe air space on Thursday. I decided to take a lift by car from friends to Gothenburg, Sweden at least to get 300 km closer to Milan, Italy. Then I was faced with a dilemma. What is best the best strategy in such an uncertain environment? Wait for flights to go back to normality? Sounds good but how long could it be? Or take a train and travel 24 hours or more? Sounds good as well, but all trains are full now, so the only option is to book a train in some days from now. And what if in the meantime they reopen the airports? Why face a long journey when a plane would be much faster? Or rent a car, provided that they are available, and drive home? That's a long trip, and expensive as well.

It's like being caught in a losing position with limited capital available and having to decide if it is better to close it and accept the loss or hope for the market to go up soon. You cannot wait too long, as you risk losing all your money, but on the other hand it's difficult to sell when you lose.

I have put a stop loss on Tuesday, when I will stop to wait for improvements. Then I will sell and accept the long trip home, provided that it will be feasible. But new (reliable?) forecasts will be provided, and I will change my mind again, as I always do, being unable to fully implement the strategy I decided when I started the trade.

Ken Drees comments:

My father said to me so many times, "he who hesitates is lost". The trading relation lesson is that you first want to doubt the severity of the position going against you. Hoping for the best leads you right into crowd think–things will improve, etc. So here it seems like you at least acted by moving away, but then realized that you are still losing and that losing trades take up capital that can be deployed elsewhere, and losing trades take up time and mental focus and lead to less than perfect mental acuteness. Best to get your arms around the loss and remove it at any cost. 

All these stranded people are like people who have just received pink slips. They just lost their jobs (flights). So should they not take this opportunity to hike the back country, visit that winery, or linger in the cities that they always wished to see, but never had the time to? Some may do so who can afford it, others may not be able to afford to or are not skilled enough to be "re-trained". 

Paolo Pezzutti replies:

I have spent so many days traveling during the past 3 years in so many countries. Most of the times what I have seen is airports, hotels, and conference rooms. Very seldom have I had the opportunity to visit places and understand the culture of the places I have visited. It is like a standardized and artificial reality. For stranded travelers, I think the issue is the lack of choices. You can analyze the options what you want, but practically speaking, in most cases you cannot do anything but wait.

Victor Niederhoffer comments:

Many of us own individual stocks that are stranded, doing nothing while the world spins on its axis. What is appropriate to do in such situations? I would hypothesize that counting would help. Louis L'amour always said that the first moment of a life threatening situation is the best time to act.

Ken Drees replies:

I read once about an older trader, a simple man who simply said that at the end of the day if any one of his trades was "a loser" he would simply "kick it out" of the barn. At first take that seems extreme– or is it? The first time I read that I thought it was too black and white, now it's more of an essential idea for me–the taking of the first loss. Do you like the stock at that price today? Is the stock in a losing position? Would you buy that same stock today–double your position? If the answer is no then its a loser and a candidate for deletion. If every trader on Monday morning got rid of every losing deletion candidate, the force of the positive relief exhaled into the atomsphere would shift the winds over Europe and free the skies for all to get back to work, play, and normalcy. Sell your losers for the tired, the untrainable, the funflighted. 

Apr

14

I am wondering if anyone out there is familiar with a trading opportunity called by some, the Goldman Roll. As it has been explained to me, there is a large numbers of long-only commodity funds. As a given contract that they hold long, say oil is coming due to expire they need to sell that one and then roll into a long position in a further out contract. This creates a very definite trend in the spread that can be exploited. Sell the near one short and buy the next one out. As the roll transactions are executed the Far minus the Near spread has a very predictable and smooth rise. It is claimed that this phenomenon has not be widely recognized and thus remains in existence thus far. Any comments out there on this claim would be appreciated.

Dr. Aronson is author of Evidence-Based Technical Analysis, Wiley, 2006

Nick White comments:

Goldman Roll? More like market roll!

This has been around as long as futures have existed and is nothing sinister. However, as some here were actually around when modern exch. traded futures began, I shall defer to them.

You can maybe get some clue as to roll direction by looking at open interest depending on the contract, but it's not always a good guide. Worth bearing in mind that people hold offsetting positions and much also depends on commercials vs specs etc.Also, if it were that easy to make money, it wouldn't exist…

Michael Cohn writes:

There is index money invested in commodity Indices and a plethora of ETFs. For example, USO or UNG. These commodity ETFs hold futures and there is a need to roll the contracts in a somewhat predictable way although there is now more flexibility as to day. This long exposure always has to sell the near and buy the far contracts. It is fairly easy to see the amounts involved…

David Aronson replies:

Goldman Sachs

Yes, I am on the lookout for all of these creatures. But kidding aside for the moment, are you saying that the claim that such an opportunity exists is on par with sightings of Big Foot? i.e., it's nonsense?

Russ Herrold writes:

It is a safe statement that there are and will always be 'unknowable unknowns' out there in the woods, and that the 'Absence of evidence is not evidence of absence' (but rather sometimes, just a statement that we cannot prove a hypothesis with our current tests and tools)

If I had a Bigfoot in my basement that laid gold bars, I would never reveal that secret, and take great pains to keep that 'trade secret'.

If I had engineered a winning strategy, I would certainly consider sowing disinformation and negative results and disinformation, to lead people seeking to reverse engineer my results, down into blind allies.

I think as a careful investigator, all we can say is: We do not know of a public proof that such exist.

By co-incidence, I am wearing a tee shirt today of a Unicorn, feasting on roast leprechaun, and as she takes knife and fork to her meal, the magic rainbows are let out.

Ken Drees adds:

The idea of taking advantage of a robotic function (mindless ETF doing its monthly maintenance) makes sense; once you notice the ripoff, wouldn't a hunter now wait for the fox?

Tom Printon writes:

I used to fill the GS roll in the coffee pit. Locals typically positioned themselves one to two days ahead of GS. When and if profitable was usually good for few tics, but one had to have size on to be worth while. Off the floor trader's vig would be difficult to overcome.

Paolo Pezzutti adds:

This reminds of "The Night Of The Long Knives" also called Operation Hummingbird. It is interesting how the market was "prepared" for this event that occurs after an impressive up leg. We will see if the event will be able to trigger more volatility. It will say a lot about this market.

Apr

11

It is common sense that the stock market anticipates what will happen in the economy after some time. The invisible hand of the market driven by millions of investors who make decisions according to different quantity and quality of information eventually represent the best way to encapsulate and synthesize the current status and prospects of the world's economy. But is this always true? Or for some reasons markets are resilient to change and slow in timely reading the information available?

If this is the case, what are these reasons and when does this happen? Can markets be manipulated by strong hands or there are simply forces that render decision making viscous and create a breakout friction before markets actually change the course they are following? Like a ship takes some time before reacting after the wheel is turned.

These questions are relevant today as they were before the beginning of the crisis two years ago. As loan underwritings standards deteriorated, the securitized mortgage market developed a bubble in housing prices that continued for quite some time until it finally popped. Even if we now read on several reports that it was clear to many what was about to happen, until the very last moment almost everybody continued to play the same sheet of music. Investors, regulators, government. The markets went on with huge inertia along the tracked lines of unrealistic risk assessments, walking on quants' clouds and careless of gravity. The longer they continue the more violent is the reaction eventually.

It seems to me that currently markets are in a similar situation. After the impressive injection of liquidity in the system (like an adrenalin shot to the heart) aimed to restore confidence and normal functioning of shaken markets, prices of assets have reflated for over a year now. In order to do this, sovereign debt in Europe and the US is increasing to levels that everybody knows are unsustainable. Still, for political reasons nobody wants to take the bitter medicine that would be needed. The show goes on with cheap money poured into assets that go up with a regularity and pace that is almost unprecedented. Regardless of unemployment, housing prices that in some states are going down again, the contracting credit to consumers, some states and cities are very close to bankrupcy, banks continue to be seized by the FDIC, industrial production levels are still 10% lower now than at the pre-recession peak, durable goods orders are almost 20% lower now than they were before the recession began. Finally, equities are up 75% from the lows, but earnings are still almost 40% below their pre-recession levels.

Is this manipulation? When and how is this going to finish? Or actually this time markets are reading correctly what is going on and are simply anticipating a global recovery and the consequent future increase in corporate profits?

Laurel Kenner writes:

The wonder is that the market didn't go up much more, given the trillions of stimulus. Since '07, the market has made short-termers of all of us– at least, of everyone fortunate enough to still possess enough liquidity to trade. We're all dancing in the dark until the tune ends. Meanwhile, the music has changed in the bond market.

Russ Sears writes:

It is my contention that the markets are good at forecasting what is predictable. However, much is not forecastable, like the weather.

I will be presenting a paper Tuesday that Dr. Dorn and I have authored in Chicago Tuesday.

In it we content that faulty risks evaluations can cause neurotic outcomes, in individuals, companies, sectors and even whole economies.

The markets can become, and apparently did become, a mechanism to trade short term gains while coming at the expense of increasing long term risks from over-allocation of resources. The risks of over allocation is often a chaotic system, meaning it is impossible to predict specifically when and how hard it will crash. Statistically, this could be thought of as trying to predict when the correlations will become a self reinforcing mechanism approaching 1 . Or is more practical examples when would over- building of housing in California, Arizona, Nevada etc. lead to deflationary spiral and foreclosures and inability to refinance all across the country and world. Another example would be the over allocation of delta hedging and portfolio insurance in Oct 87.

I am hesitant to make predictions, especially after Bear Stearn then Lehman and AIG and a government run mortgage market in Fannie and Fredie. But I am not as pessimistic as many that this is only a short term bounce. This stems from my belief that while the mortgage markets securities economic value are difficult to predict… the markets are giving at least giving them a more realistic view of their worth given this uncertainty. If this discount for uncertainty is as healthy a discount as I believe; there is still considerable liquidity and value that can return to the markets once these values are realized and known. The markets, at least in my modeling, seems to still give a considerable chance to the deflationary spiral returning.

Mick St. Amour writes:

Paolo, thank you for sharing your thoughts. I like your comments on inertia because that is at work. I see this all the time with retail investors and as of right now that dynamic is at work in that those folks still haven t taken a bullish slant and have been slow to change their minds. most investors are slow to embrace a change in thought when conditions change and they tend to ignore what market prices tell them. They tend to get locked into some ideology and usually only change their belief until after bulk of gains are made. Best trades are made when you can find inertia still at work and market prices begin to shift in different direction opposed to prevailing view. I have found those to be the best low risk trades.

Apr

3

Robert McTeer had an interesting post on StreetTalk. He responded to a TV commentator who claimed the recent BLS employment numbers showed: "Not a single new job has been created." McTeer called the claim misleading because it implied "a stagnant economy dead in the water." McTeer notes that though jobs have been lost on net over the last two years, "The gross jobs numbers behind the negative tell a far different story." Though 8 million jobs were lost in the second quarter of 2009, McTeer notes that "6.4 million were created (674,000 more than in the first quarter)."

A gain of 6.4 million new jobs in a quarter shows a dynamic economy. But I sent an email to Mr. McTeer suggesting there is more to the story. The 8 million jobs lost, I argued, are in some ways as good for the economy as the 6.4 million new jobs.

Eight million people losing jobs means eight million in the market for "better for the economy" jobs, if not at first higher-paying jobs. If these workers were destroying wealth at their old jobs (though no fault of their own), just stopping is good for the economy.

The huge number of union jobs lost in the auto industry is good news for U.S. economy as well as car buyers. Overpaid and badly organized auto industry workers are disruptive for a free society, apart from the problems of high labor costs and uneven auto quality. All these jobs were privilege jobs gained by connections and legal protections. Auto companies could have hired and trained workers at 1/2 or 1/3rd the pay, but were prevented by various labor law interventions from doing so.

The economy has to continue the adjustment out of industries like housing construction and related goods and services, and those resources and workers have to be redeployed into more productive industries and professions. Figuring out and coordinating redeployment to wealth-producing occupations has to be a complex and time-consuming process.

Though a great many job losses could be blamed on taxes and regulations of various kinds, and on uncertainty created by state and federal policies, the lion's share of unemployment was caused by adjusting to new realities after the real estate and financial bubble. What the new realities and opportunities are isn't immediately clear. That is what has to be figured out by millions of entrepreneurial employers and job searchers.

Losing a job creates trade-offs and potential benefits. People for a time lose productivity from established skills and business networks. But as they look for new jobs, the searching process, though labeled unemployment, is actually work collecting information and developing search and self-knowledge skills.

Think how many millions were likely underemployed or by accident in the wrong industries for their personal preferences and skill sets. Most wouldn't leave a secure job, even if they strongly suspected it was somehow not right for them. Though most would prefer underemployment to unemployment, most have probably also been surrounded by employment or entrepreneurship opportunities they lacked adequate incentives to investigate.

If an unemployed worker hired someone else to spend 30-40 hours a week searching for new employment, and to evaluate job-retraining opportunities, that would cost money and likely generate value. Those who lose jobs become self-employed in this informal home-based employment search industry.

Some of the unemployed are not working at job searching (or at "off-the-books" work), so they are taking advantage of opportunities for leisure that a wealthy society like ours affords. This can also have long-term benefits.

Losing my job at the Foundation for Economic Education in 2003 was one part difficult and disorienting, but nine parts a great opportunity to innovate and launch new economic education projects and programs.

Paolo Pezzuti comments:

I agree on the assumption that the economy has to continuously adjust to redeploy workers into more productive industries and professions. Old, low productivity and low added value industries have to be abandoned to move into more remunerative sectors. I do not dispute this because this is the tenet of growing economies and capitalism. This process may be painful for many workers laid off that have to retrain to find better or equal pays in their new jobs, but it brings progress and growth for the individual and the society.

However, I am starting to have doubts that this can be applied to the present situation of western economies, where jobs are simply cancelled to be created somewhere else in the world. This process is negative and is developing in parallel to the healthy process of adjustment I was referring. Jobs are transferred very quickly to areas of the world where labor is less expensive. Our economies cannot adjust adjust timely and fast enough to create enough jobs in the new sectors because the speed at which this transfer of wealth and jobs is occurring is unprecedented. This requires an impressive education system to adapt the professionality and retrain millions of workers very fast. This requires huge investments in high tech and higher value added areas. This takes time, capital, new infrastructures, a government that favors entrepreneurship.

How to manage this transition is the main issues and all elements of the society should be involved in this debate. I am convinced that the governement in the economy is inefficient and should be limited as much as possible. At the same time, without government support, the situation could be disruptive for millions of families while the process of adaptation develops.

Finally our competitors are not looking at us wihout doing anything. They are also moving quickly to acquire the technologies and move their production up the scale toward higher returns industries. They are working to put us out of the market and not be competitive.

Flexible and adaptable economies will be advantaged, but the process is going to be very painful. The transitory will be very long in any case because of unprecedented scale of what is happening. The challenges are huge and success is not ensured even for the most dynamic countries. The outcome, if we are not able to adapt, could be to see our economies and standard of living decline sharply in favor of others. We could simply see unemployment and poverty increase structurally.

Paolo Pezzutti is the author of Trading The U.S. Markets, Harriman House, 2008

Pitt T Maner III adds:

Touring around in Europe in the early 80s you couldn't help noticing the number of young Australians and New Zealanders. Many of them apparently just decided to do a "walkabout" and wait out the bad unemployment situations back home. If you are willing to rough it there are many cheap places to live outside the US. Hanging out for a couple of years in the right "socialist" country with good food, beer, healthcare, law-abiding citizens, low cost education, history and culture would seem to be an option–at least you would get an opportunity to see the pluses and minuses of other systems. No its not the American way. Are citizens of other countries more flexible with respect to moving around the globe to where there are opportunities?

Do today's youthful short-term free riders outside their native country that avoid permanent bumdom become tomorrow's long-term tourists and multilingual global investors?

Russ Sears writes:

While simply based on anecdotal evidence from those I know, I think you will find that "funemployment" is almost exclusively the domain of the youth, still riding on Mom and Dad's pocketbook. It seems to me to be the result of being taught: "you can be any thing you want","you are the star at everything" and most important parents never letting their kids fail– meeting the reality of this job market.
 

Mar

9

High-frequency finance can revolutionize economics and finance by turning accepted assumptions on their head and offering novel solutions to today’s issues. This comes from an interesting article on the topic:

In high-frequency finance:

The first step involves the collecting and scrubbing of data.

The second step is to analyze the data and identify its statistical properties. Due to the masses of data points available for analysis (for many financial instruments one can collect more than 100,000 data points per day), identification of structures is straightforward– either there is a regularity or there is none.

The third step is to formalise observations of specific patterns and seek tentative explanations/ theories to explain them. Fractal theory suggests that we can search for explanations of the big crisis by moving to another time scale — the short term.

On a short-term time scale, we study how regime shifts occur and how human beings react. The large number of occurrences allows for meaningful analysis. We study all facets of a crisis– how traders behave prior to the crisis, how they react to the first onslaught, how they panic, when the going gets hard and finally, how their frame of reference which previously was a kind of anchor and gave them a degree of security breaks down and how later, when the shock has passed, the excitement dies down, there is the aftershock depression and then eventually how gradual recovery to a new state of normality begins. It is possible to build maps of how market participants build up positions and how asset bubbles develop over time.

High-frequency finance opens the way to develop "economic weather maps".

Just as in meteorology where the large scale models rely on the most detailed information of precipitation, air pressure and wind, the same is true for the economic weather map. The development of such a global economic weather map has barely started. The "scale of market quake" is a free service. It is a very interesting experiment. You can read the paper "The scale of market quakes".

I believe these are really exciting developments. More than 15 years ago it was expensive to find end-of-day data and I would update together with my dad the files of the stocks I was interested in using data from the newspaper. Today we have huge online databases available to the average trader. The computer I had at the time and the SW I could afford would allow me to do some technical analysis building indicators and that's it. Today I use Tradestation.  I can program and automate my indicators, studies and strategies. It is a huge advance for average traders like me. High frequency finance is now the new frontier and if you want to be profitable, there you can still find the sort of inefficiencies you need. However, it cannot be accessible to everybody. Once again, you need the data, the computers and the math/statistical expertise. It is getting more and more complex. Moreover, to trade on such a short time frame you need to have very very very low commissions that the average trader cannot obtain. Would you expect something different?

The question I have is whether there are inefficiencies in longer time frames that the big guys do not even bother to consider: the leftovers of their meal. At the 60 minute level or even the daily time frame. I had the privilege to talk with one of the best traders of Wall Street (he trades mainly the emini) about this issue and he believes that this is the only way to stay on the market for the average guy. There is a way to profitable in these time frames. It worked for him. Inefficiencies at micro structure level must be so important that the few big players in the business that can afford that type of game are making a lot of money. In fact, policymakers have started to look into it, but it is very sensitive and interests are huge. With time, competition will increase also in that area and it will become more difficult even for them. But for now, they make billions. As far as I am concerned, I feel like a little fish that lives under the rocks and comes at night out after the sharks have made their dinner and left something back, which was not worth for them wasting time. The search continues.

Paolo Pezzutti is the author of Trading The U.S. Markets, Harriman House, 2008

Sushi Kedia writes:

In the spirit of Daily Speculations, where observations of small fish swimming up predict coming quakes in Japan, investing ideas that can be hypothesized before testing by observing characteristics of oaks etc. etc, one keeps wondering what would qualify from market data points as the proverbial rats, birds and smaller creatures that behave distinctively before coming changes in weather, terrain, storms and big winds. Even if jokingly, when a friend reminded me few days ago that Finance is the art of moving money from hand to hand until it disappears and while I know that fractals make the same ideas appear at every scale making the big and the small equal in their eventual outcomes, one simplifies the notion of fractal finance to the simplest possible that it is the art of moving money from hand to hand across any size, until it disappears. That brings one to a more easily imaginable notion of visualizing the food chains in the markets at action looking at distinctive behaviours of the smaller creatures.

Is retail behavior a richer source of predicting large moves or is the professionals' action a better gauge? Or is it that both used together produce some finer ideas?Does the behaviour of small caps and micro caps provide some extra insights into the markets? Distinct expansion or contraction of range is one obvious thought stemming from Chair's latest post.

So many have been talking about a potential crash coming by, suddenly in the last week or so, one wonders which minnows and sparrows are they watching to get such "feelings".

Are there any distinctive behaviours in volume and open interest too that forebode a coming change in the winds? Has some master of the universe quietly assembled in some corner of this world the mythical all encompassing indicator that captures time, price, volume, open interest? The equivalent of the General Theory of Everything in the markets? How far are the scientists in the markets from the equivalent of an 11-Dimensional M Theory?

Even if this set of simple(ton) queries generates from the specs a list of ideas they have felt over their long years in the marts as precursors to large moves, it would be highly useful to compile them and explore what testable theses can come up from them, for Einstein did say and believe that an ideas should be simplified as much as possible, but not more.

Russ Sears comments:

It would appear to me, that on the anniversary of the turn-around in the markets, it would be wise to review what the Derivative Expert / leading fractal proponent and his teacher/mentor were saying last year at this time.

As I recall, his predictions were that doom was inevitable and that it was just the beginning. The future was clearly going to be worse than the Great Depression. His only hope was, he prayed, every night, and in the morning when he woke up, "he was wrong"…

His teacher was not as sure as him, but thought it was more likely than not, going to be more terrible than imaginable, also.

Yet, I do believe there is considerable turbulence and potential for chaos theory, to occur whenever people allocate resources…However, the markets are the best mechanism for catching those grossly misallocated resources and shuting down those chaotic loops of turbulence that man has devised. While the derivative expert still could be proven right in the long run. One must consider that there are some strong forces of learning from your mistakes built-into the system also. Non-the-less no matter how certain our demise may be, the rebound shows that care must still be taken thinking one way, up or down, is the only direction.

While I will disagree with the Derivative Expert, that the markets are built on a time fractal, a quick look at the human situation shows that herds, large and small, are no protection from irrational thinking. Dr. Dorn and I have been working on a paper, that I will be presenting on April 13 in Chicago at the Enterprise Risk Management Symposium that will discuss this further. It is not directly related to chaos theory or fractals. But one sentence to ponder concerning fractals to whet your appetite: "Individuals, businesses, industries and even whole economies, all, can become victims of mania and panic".
And I will have more to say on how this does more closely tie into fractals and chaos theory in other works, time and receptive audience permitting.

Jeff Rollert comments:

The last 12 months remind me more of the eye of a hurricane.

Mar

5

EinsteinI came across this article on Bloomberg:

"End-of-Life Warning at $618,616 Makes Me Wonder Was It Worth It" by Amanda Bennett

It is the story of a wife who assisted her husband through a long story of pain, hope and money spent to prolong life as much as possible. It is interesting how time has a different value when you realize your life is coming to an end, and when you understand time has become a scarce resource.

Rocky Humbert comments:

Using 2005 data from the March of Dimes, the average pre-term birth costs $51,600 and the first-year medical costs are also about 10x greater for a premature birth versus a full-term birth. This is a lot of money because pre-term babies make up over 12% of American newborns. Amazingly a 2-pound baby now has a 95% probability to live a full and happy life. (Admittedly, some of these babies are permanently impaired and cost fortunes in lifetime medical costs.) Nonetheless, forty years ago, the probability of survival of a 2-pound infant was close to nil.

I bring this up because I like to focus on the positive, and truly amazing advancements in medicine have been achieved over the past decades. Polio, anyone? One of these "expensive" pre-term or in-vitro babies may be the next Einstein, and far be it from me to argue for "pulling the plug" on Einsten at age 0 or Einstein at age 100. Theoretical analysis ignores the infant mortality side of the spectrum. If one can theorize immortality, one should also theorize about the extraordinary efforts and money to reduce infant mortality and increase fertility. Why should one assume that an immortal man does not father hundreds of children? And why cannot elderly women have more children too? Hence rather than reaching the conclusion that the ratio of elderly/young would be unsustainable, one might reach the conclusion that the overall population would grow uncontrollably– perhaps with Malthusian consequences. Which of course argues that we need more Einsteins…

Nick White responds:

One needs only to consider that the march of mankind over the past 6,000 years has been generally forward. Hence if one extrapolates this trend, one is likely to conclude that as human population grows (ceteris paribis), there is more good than evil. A triumph of the optimists…I'm not so sure on this one.

Generally forward? Well, yes. But that neatly sweeps under the carpet vast swathes of humanity who may be net no better off (or possibly worse) than they might have been 6,000 years ago. Certainly, for everyone on this list, life is many orders of magnitude brighter than it was all those generations ago. Yet, overall, I would argue there's quite a bit of skew in the distribution of benefit; largely depends on what region of the world you're in and what ethnic group you hail from.

Is there more good than evil? I think this is another proximate vs. ultimate causes issue. I would argue that rational self interest (ie "greed") provides many collateral benefits– but is that intrinsically "good", and who decides? That depends, inter alia, on one's theology (or lack thereof). Generally speaking I'm short human motives, but long on some of the products of those motives!

Economically speaking, I think the progressive pattern you've identified is perhaps something approximating an unintentional Nash Equilibrium– society at wide has benefited as people have done what was best for themselves in the context of their group….but, on average, I think many people were out for their own end. (nb: of course, your example of Salk etc is duly noted, and there are numerous examples of truly beneficent altruism amongst the pantheon of social contributors) All said and done, I think Gekko sums up my position best, and I think it does capture the evolutionary spirit. It's just the side effects one must pay heed to and much of the colorful debate on this list goes back and forth on that very point; we all agree on capitalism– some of us disagree on appropriate social conscience. 

Jan

31

The partnership between Ostrich and ZebraThe reaction to recent events where something devoutly to be wished actually happened and sadness and disappointment and revulsion occurs is part of a general syndrome related to the dissipation of the sex cells. Time and time again, a company reports good earnings above expectations and a terrible decline ensues. Time and time, an important link in the totality is confirmed a la Bernanke today, and the market drops an immediate 1%. Time and time, a bill that everbody wants, like the stimulus bill, or the Massachusetts election results, occurs, and the market drops an immediate 1% the way it did last Tuesday. What is the reason for this? Is it a variant of 'buy the rumor, sell the news', or is it insiders selling on the news? Or is it related to the general apathy that results when the discharge has occurred? Can it be predicted, and acted upon?

A friend writes in that the ensenble of comovements between bonds and stocks posted on our web site always reminds him of Leo Goodman's classic article "Movements and Comovements between M Dependent Time Series" that Doc Castaldo has kindly sent hundreds of copies out to far sighted researchers in previous glory days. It is good to honor and create a visual model and real life exampe of such important dependcies. And perhaps this will be a prelude to providing statistics on this site that will be at least as informative by half as the average sports statistics contained in such fine publications as The Post or Sporting News under "Stat City". The desire to provide a league standings tabulation is keen.

I am reading several books on animal partnerships and the partnership between the ostrich, which has good eyes, and the zebra, which has good hearing, reminds me of the partnership between many markets. One or the other, whether it's silver or the omniscient one, are there to alert to possible danger. One feels the pain of the CEOs who were at a dinner at the Oval last Wednesday, and learned about the Volcker plan only at 9 pm that night an hour after the dinner and just 12 hours before the 6% decline started. "That's not squash," as my friend from New Zealand used to say when I mixed in a volley or two. Heard at the Olympic Club at 10 pm: "You might want to play an all court game tomorrow, mate."

Of course there is a higher purpose to the recent decline of 6%. First the move must shake out all the weak longs who were buying it based on their hopes for the January baromoter. Next, it has to set all the public behind the form so that they will sell out in disgust at the three-month lows. Finally, it must engender a Dow below 10000 to create the kind of newspaper headlines and fear that will shake out the remaining weak longs before a rally occurs.

Paolo Pezzutti comments:

After you have finished your succulent second plate of spaghetti "all'amatriciana" and you are offered one more, can you eat it? After a long uptrend when earnings have beaten repeatedly expectations for a year, can you really expect more surprises? Some take profits, others go short. It seems that the news release is the trigger to execute actions that were long planned.

I found on CXOAG this post that addresses the issues raised: Earnings Surprises and Future Stock Market Returns. The post reports about the study Aggregate Market Reaction to Earnings Announcements.

The authors investigate the relationship between earnings announcement surprises and market returns on the days surrounding earnings news. The analysis identifies a negative relation between earnings news and market return that persists beyond the immediate announcement period, suggesting that market participants do not immediately fully impound these future market return implications of aggregate earnings news. There may be a considerable degree of inefficiency in the market’s processing of aggregate earnings information. Consistent with this interpretation they find that Treasury bond rates and implied future inflation expectations respond directly to earnings news.

George Parkanyi writes:

Definitely, the same type of news after a few months loses its power to move the market (true for both the down side and the up). At a certain point you stop listening, you’re on auto-pilot. Markets respond to surprises –- the something new, the something different, or the something possible. This is very much a human characteristic.

A related example was the Internet bubble. Everyone was buying the companies that had no earnings – because while they had no earnings the potential for earnings was unlimited. As soon as companies started to report any kind of a profit, they were crushed. For now someone had put a limitation on all that “potential”. I was highly amused at the time how earnings for an Internet company was the kiss of death.

Kim Zussman writes:

If it were as simple as "up on good news", Galleon and others trading on inside information would immediately overtake the solar system –like a hadron-collider black hole. This evidences supernatural laws which prevent even cheating determinists from commandeering supreme mating rights.

Years ago at a Stephen Hawking lecture on time travel, he "discussed" (the lecture spun from his laptop) various paradoxes produced if one could go back in time. For example, if you killed your parents in the past how could you have been born in the future to go back to kill them? One theory was that when you pulled the trigger, the bullet would "diffract"; somehow splitting before hitting it's target — in compliance with rules keeping the universe in logical order. (whose logic?)

Another theory was parallel universes — one in which your parents died, another they lived and you were allowed to develop.

The questioners were kind to Stephen, because of his illness, but after the show he sat helpless in his wheel-chair in a van outside with the dome light shining on his contorted face like an involuntary spot light. A crowd hovered outside to see the great man, like at the zoo.

On a different note, Pfizer's run-up to the Massachusetts Miracle is typical. Removal of near-certain health care reform and promised payoff by pharma met with big decline. Would you have sold knowing the election results before hand? The upside is that if you can be at peace with the way market treats your logic, you will understand how to be a ladies man.

Duncan Coker writes:

I would like to pick up on Messr Parkanyi's comment regarding "the markets respond to surprises, something new, somthing different or the something possible…this is a human characteristic." I agree. Related to this, I attended a showing of the film Poliwood last night where the director Barry Levinson was there for a Q and A session. It is a documentary about the triangle of media, celebrity and politics and how the lines between reality and theater, entertainment and substance, are becoming more and more blurred. Politicians become celebrities and celebrities become politicians. Media fosters celebrity and celebrity feeds the media. Politicians need the media for promotion and the media needs them for content. One of the ways to get high ratings in news television is to present conflict in a dialogue. That is why guests are always at the extremes of a position. It allows for more yelling, arguing and better entertainment for the viewers. Polarization is more interesting television. Informed and moderate discussions is just boring to watch.

I wonder if this carries over into the market. Stagnant markets are boring, wild swings make for better entertainment. Also, who benefits from wilder markets, financial media has something to write about, brokers and exchanges have more commissions and fees, money managers can justify their services. It allows politicians something to regulate, gives floor trades movement to scalp, hedge funds can fire up the algorithms. The causality works in both directions as well. Last week the politicians spiced up the boring upward move of the past 2 weeks. When a fund is rumored to be weak or going under another spike. The media does all it can to create excitement and volatility around the market. When traders over-trade and the line between entertainment and substance can get blurred. Also, like the television example, conflict is more interesting. In the case of the bulls and bears it is most interesting at the extremes, so the market follow this type of cycle.

Ken Drees adds:

This fits here with financial television as of late. The big question or overall theme being is this just another dip for the market or something more? Hopefully capturing viewers by keeping this nail biting question front and center–having two view points and the ensuing debates roll on out.

Off the bottom it was "is this a sucker's rally or a setup for another drop?"; now its "is this just a little dip and the start of a sideways consolidation, or the start of a substantial 5 -10 % correction?"

It seems like these times of opposing question of market direction after extreme linear moves should be watched closely for reversal. I find it interesting that the choice not talked about much off the march low was this: Or is this the start of a nice 50% multi month rally from oversold conditions not witnessed since 2001?

Today the choice missing would be this: Or is this the start of a 50 to 70% drop, retracing most of the gains of 2009?

TV — usually it's what they don't say or its the opposite of what they scream into your face — making great TV but bad advice.

Jan

28

Algorithmic trading developed impressively during the past years. Up to 60% of trading in equity markets is computer-driven. Some say that the increasing dominance of algorithmic trading could cause "tiny price changes to snowball, rolling down the hill at exponentially increasing speed". There is the possibility for a crash to happen also because too many funds are trading in the same style. What is the human control on these machines? How long will it take before a mistake is recognized as such? Is there a way to prevent "algos gone wild"? Can regulation help or would it make it worse? In practice, there is a risk of systemic imbalance. On the other side there are those who believe that high frequency traders deliver a service: liquidity and their systems are the most efficient way to match buyers and sellers.

In the paper "Rise of the Machines: Algorithmic Trading in the Foreign Exchange Market", Alain Chaboud Benjamin Chiquoine Erik Hjalmarsson Clara Vega find that:

- algorithmic trades tend to be correlated, suggesting that the algorithmic strategies used in the market are not as diverse as those used by non-algorithmic traders

- there is no evident causal relationship between algorithmic trading and increased exchange rate volatility

- even though some algorithmic traders appear to restrict their activity in the minute following macroeconomic data releases, algorithmic traders increase their provision of liquidity over the hour following each release

- non-algorithmic order flow accounts for a larger share of the variance in exchange rate returns than does
algorithmic order flow

- there is evidence that supports the recent literature that proposes to depart from the prevalent assumption that liquidity providers in limit order books are passive.

Among the most recent developments in algorithmic trading, some algorithms now automatically read and interpret economic data releases, generating trading orders before economists have begun to read the first line. They allow trading to take place automatically in response to market data and news, deciding when and how much to trade. There are services that allow to react more quickly to breaking news events, providing a quantifiable measure of qualitative information present in news articles. The result is that computers can place orders more strategically than humans.

In the paper, it emerges that there is no positive correlation between algorithmic trading and the level of volatility. The evidence points towards a negative relationship, suggesting that the presence of algorithmic trading reduces volatility. Computer trading provides liquidity in period of stress (after the release of news). From the data analysed, the growth of algorithmic trading has not caused lower market quality.

George Parkanyi writes:

I don't see them being a problem unless everyone is automatically increasing trade size and leverage with the trend. The associated risk-management is fairly sophisticated. That they would do this in a highly-correlated, invisible way is highly unlikely. And high-frequency trading is by definition short-term, so there is constant buying and selling in the market. A lot of these strategies may not hold a position overnight. Markets that are up a lot or down a lot as one-way sure-bet trades are pretty highly publicized. You'll eventually get a sudden reversal, and a lot of haircuts, but these overextensions most savvy players can see coming (though you don't know where or when the turn is going to happen). Wouldn't worry about it - enjoy the liquidity.

Jan

25

skiiersI spent the weekend at Massanutten, located 2.5 hours west of Washington DC, with my family. We had a great time, and the girls were very excited to go skiing for the first time in their life. I decided to sign them up to the ski school program called Slopesliders. They got their buttons with their names on it, and started their first day of lessons. I am a very good skiier, but I wanted them to go the ski school. Why? Because instructors have the right method to teach and because my girls would never listen to me: "Stop it Dad, we always have to do what you say! Let us do it our way….". Instructors were very good, they were teaching about: "pizza wedge" and "french fries", increasing the difficulty step by step and visualizing concepts and ideas. They managed to build up the kids' confidence with their new tools (the skis) and themselves. After only two days it is amazing what these girls could do on the slopes (like any other kid anyway). They managed to replicate movements and develop their own style so quickly. (Actually pizza wedges reminded me, triangles and french fries sideways moves in the market, and the importance of visualizing patterns and trends). Finding good teachers is very important to give you the basics and tools on which you can then build your own style and approach.

Jan

3

spring is nearI found this post on Trading The Odds.

He analyses 3 set-ups on S&P 500 with respect to a holiday: assumed one would’ve bought the S&P 500 on the close two sessions before the Holiday (setup 1), on the close of the session immediately preceding the holiday (setup 2), and on the close of the session immediately following the Holiday (setup 3).

His results:

1. New Year’s Day (celebrated on January 1)

The model will take a long position on close of the first session of a new year.

2. Martin Luther King Jr. Day

The model will not take into account the Martin Luther King Jr. Day exchange holiday.

3. Washington’s Birthday/Presidents’ Day

The model will not take a long position on close of the the session(s) immediately preceding Washington’s Birthday/Presidents’ Day

4. Good Friday

The model will take a long position on the close two sessions before the Good Friday exchange holiday.

5. Memorial Day

The model will not take into account the Memorial Day exchange holiday

6. Independence Day (celebrated on July 4)

The model will not take into account the Independence Day exchange holiday

7. Labor Day (celebrated on the 1st Monday in September)

The model will not take into account the Labor Day exchange holiday

8. Thanksgiving Day (celebrated on the 4th Thursday in November)

The model will take a long position on the close two sessions before and on the close of the session immediately preceding the Thanksgiving Day exchange holiday, and no long position the session immediately following the Thanksgiving Day exchange holiday, at least if not any other criteria are met.

9. Christmas Day (celebrated on December 25)

The model will always take a long position on the close, between two session before until two session after the Christmas Day exchange holiday.

In a previous post :

1. The (calendar) Day of the Month

The model will take a long position on calendar day 30 or day 31, depending on which one represents the last business day/session of a month

2. The Day of the Week

 The model will not take into account the day of the week.

3. FOMC Meetings (scheduled) and FOMC announcement sessions

 The model will take a long position on close of a pre-FOMC announcement session as well as on close of an FOMC announcement session if the index doesn’t close up greater than +0.50%.

4. Government’s Job Report Friday

The model will take a long position on close of a session immediately preceding the Government’s Job Report Friday in the event the index closed up.

5. Option Expiration

The model will not take into account the option expiration.

This is not complete and may not add much to what you do, however, I find it interesting that counting is done by many out there. The problem is: what is the right way to count?

Victor Niederhoffer comments:

There would seem to be many problem of multiple lookback, multiple comparison, Monday morning quarterbacking, selective retrospection, and consistencies with randomness with such an approach. Most important of all, they don't take into account the diference between likelihood (which is very high) and predictability. The seasonarian left our site because of "e" and is not here anymore, but his ghost lives on in this interesting post, designed presumably to elicit this comment.

Dec

7

I was wondering if one could be taken off the street, with no experience, and taught to be a profitable trader. My father says no, with a few added conditions. He believes there's a genetic component combined with many early childhood predictors that indicate a propensity for success in trading. He cites games, sports, competition, and the willingness to accept risk as major predictors of success. He also believes that if one doesn't exhibit these characteristics by adolescence, it would be very improbable that one would become a successful trader later on in life. He also says that mentors are not enough if you don't have a "fire in your belly." My uncle, on the other hand, says he could take a monkey off the street and teach him how to trade successfully within a year. What do you think?

George Parkanyi responds:

I think the question becomes can you teach creative thinking, self-motivation, self-discipline, courage, patience, and self-confidence? If you believe that these can be taught (which I do, but it's not simple or easy), then I believe you could teach someone to successfully speculate. Good ideas and opportunities abound in speculation and are recognizable to many people, and the mechanics of trading are fairly straightforward. But actually implementing them and managing the risks are altogether something else.

Also I think that to be good at anything you just have to do it — warts and all, and make the necessary adjustments as you gain experience. You would never be able to teach the things I mentioned above without a heavy dose of hands-on application.

Paolo Pezzutti writes:

I agree that being good at sports and in particular at sports competitions is an indicator of predisposition to trading. Determination, ability to remain focused, to implement a game plan, to understand weaknesses and strengths, the self-confidence that allows to take reasonable risks with a winning attitude and so forth. However, that there is not only the "fire in your belly" component. I do not think that one can trade only by instinct or intuition. There are also analytical qualities that are more intellectual and less related to the guts. Can technology help somehow? However, if one is a great mind and finds certain market inefficiencies that a computer can exploit, does one need to have the great athlete's qualities? Those who develop successful algorithms need to to have the "fire in their belly"? I am not a trader so I cannot say for sure, but I tend to believe that mechanical trading can be successful. Besides that, if your father believes that he could teach a monkey how to trade in a year, I think I am better than a monkey and if he wants he can try with me!

Craig Mee replies:

No doubt a few of you have heard of Dennis and Eckhardt… these days different rules, different times, maybe if there had been tasty markets for it, before the rules of ever changing cycles kicked in. I believe Richard Dennis has struggled to replicate his results.

Dave Goodboy replies on behalf of Michael Covel: 

M Covel"Whether you agree or disagree with my book The Complete TurtleTrader it is one of the most unique "training" experiments ever conducted on Wall Street. It is the true story of literally taking novice traders off the street, injecting them with trading rules, and then watching millions be made. 25 years later it is also interesting to note which of the originally group thrived and which imploded. As far as the genetic component debate goes there are some great books out now about "talent" (see: "The Talent Code" and "Talent Is Overrated") making a very convincing case that success is far less genetics and much more about deliberate practice –which backs much of my research."

- Michael Covel

Dec

2

T WTiger Woods apologized on his website regretting his "transgressions".

He claims his "right to some simple, human measure of privacy". He continues saying that "the virtue of privacy is one that must be protected in matters that are intimate and within one's own family. Personal sins should not require press releases and problems within a family shouldn't have to mean public confessions".

I have sympathy with his view although the public (often morbid) curiosity and the business generated by these kind of news makes them void statements. What I do not understand personally is why he and other public persons in similar situations have to blame themselves publicly for what they have done recognizing it was a mistake with statements such as: "I have not been true to my values and the behavior my family deserves." "I will strive to be a better person and the husband and father that my family deserves."

It is clear that they are saying this only because their affairs have become publicly known. It should have been probably better to be silent on the repentance issue.

Nov

24

I read an interesting post at The Disciplined Investor on the Natural Gas ETF UNG.

If you bought the “natural gas” fund assuming that it would follow the commodity’s performance you would be wrong. Since last September, in fact, UNG underperformed significantly the spot price of the commodity. This is because it follows the percentage change in the price of the commodity’s front month contract. The problem is the market is in contango. In this situation longer-term contracts are priced higher than near-term contracts and the fund will underperform the underlying commodity. The result is quite impressive and disappointing (for some at least).

I have no idea why the divergence in behavior started in September and why there is such a wide contango in gas. The post proposes two scenarios. One where "UNG will come back in line with the natural gas pricing when (if) there is a the contango spread reduces to historic levels". The second where as the fund is "too big and because futures roll every month, there is no way that this can ever catch up".

Quite interesting example of product "inefficiency".

George Parkanyi writes:

I’ve been trading in Canada a similar ETF called Horizons BetaPro Natural Gas Bull+ ETF (TSX:HNU) – a double-long ETF. That’s also been in an abysmal bear market, having completely imploded after the commodities collapse in the second half of 2008. If you’re buying and holding a double long or short ETF (much worse for the short ones), a long one-way move against pretty-much wipes out the value and you will never recover if you bought at the higher end. However, for an active shorter-term trading strategy, you can still get very good moves out of these. HNU rallied from about $8 to $17 in September and October just recently. That’s a pretty good move if you can catch it. (Although its back down around $9 again now.)

You are right about the contango. As soon as they roll into the front month, it immediately goes down. Keep doing that every month… I have a large gas weighting in my portfolio and that’s my main concern as well.

Nov

12

In pure spirit of "contrarianism", I like this article about global cooling:

Statisticians Reject Global Cooling

In a blind test, the AP gave temperature data to four independent statisticians and asked them to look for trends, without telling them what the numbers represented.

….Global warming skeptics base their claims on an unusually hot year in 1998. Since then, they say, temperatures have dropped — thus, a cooling trend.

….if you analyze the trend during that 10 years, the trend is actually positive

….to find the cooling trend, the 30 years of satellite temperatures must be used.

….It's what happens within the past 10 years or so, not the overall average, that counts

….the 10-year average for the past 10 years is higher than the previous 10 years

….You're going to get a different line depending on which year you choose

….The trend disappears if the analysis starts in 1997. And it trends upward if you begin in 1999

….it's important to look at moving averages of about 10 years

….looking back 31 years, temperatures have gone up

Oceans, which take longer to heat up and longer to cool, greatly influence short-term weather…..the current El Nino is forecast to get stronger, probably pushing global temperatures even higher next year

The quote I liked when I studied statistics at the University (although it could be perceived as politically incorrect nowadays) looks appropriate to me in this case:

Statistics are like bikinis. What they reveal is suggestive, but what they conceal is vital. Aaron Levenstein

These discussions recall those about the stock market. Is it better a 50-days moving average or 13-days? Is the secular up drift over because of the recent downturn or what we are living is just another historical buy opportunity?

It looks like a discussion at a sports bar in Italy about the winner of the next soccer season.

In the meantime, let's take a look at El Niño and its effects on commodities and stock markets. In fact, the pattern of winds and ocean temperatures during an El Niño changes the jet streams steering storms over North and South America. It affects also monsoons carrying away moist air that would produce monsoon rains.

Provided that the forecast is statistically significant.

Paolo Pezzutti writes:

From Bloomberg Beijing's Heaviest Snow in 54 Years Strands Thousands

….the heaviest snowfall in the Chinese capital in at least 54 years blanketed the city for the third day this month. ….The government induced snowfall in the capital on Nov. 10 by seeding clouds with silver iodide, the China Daily newspaper reported yesterday, citing an unidentified official at the Beijing Weather Modification Office. Zhang Qiang, head of the office, said the agency induced snow on Nov. 1 by seeding clouds with 186 doses of silver iodide, according to a separate Xinhua report. The seeding brought an additional 16 million tons of snow, according to the report. Beijing takes every opportunity to induce precipitation as the city is suffering from drought, Xinhua cited Zhang as saying.

Maybe a global cooling could be induced artificially.

Anton Johnson comments:

Though theoretically possible, is induced global cooling really what we want? Looking at the Chinese snow example, what is happening? When seeding clouds, atmospheric super-cooled water completes nucleation and freezes, and then precipitates as snow. At liquid-solid phase change, latent heat is released. The converse occurs at the solid-liquid phase change, thus environmental heat energy nets out. That is, assuming the snow melts.

However, the higher albedo of snow compared to most of the earth’s surfaces causes increased solar energy to be reflected into space. So what happens when this cycle is taken to the extreme, that is, if we get the temperature balance wrong? A net increase in global snow cover will cause a net decrease in total solar energy absorbed globally, causing more precipitation to fall as snow, etc, etc; thus plunging the earth into an ice-age. Good-bye New York, Chicago and London. That is until the oceans cool sufficiently, reducing evaporation and precipitation to an inflection point that reverses the cycle – maybe after 10K-20K years.

Oct

12

In a recent post, The State of Short Term Mean-Reversion, Marketsci blog highlights how mean reversion strategies have not been working lately:

Do I think short-term MR will stage a comeback? Yes. I think the breakdown over the last few months is tied to the strong protracted rally, but that this slow grind up will come to an end and that short-term MR will again be the play du jour once we get to the other side.

I have experienced this deterioration in my systems (all contrarian of course).

Steve Ellison is more pessimistic:

I too lean toward the contrarian side, but am increasingly wondering whether that is just an irrational behavioral bias. If markets were efficient, there would be no mean reversion except by chance. Why should there be an advantage to mean reversion? Who is the dumb money that will buy high and sell low, now that the [daily rebalancing] ETFs are gone?

Oct

6

The type of price action we have seen makes me think of possible thoughts that the public could have had during the past months.

09 March - S&P 676. The typical private investor would say: "It's over. No way I will get my money back from this mess. I knew I had to sell… Moreover, I am losing so much that I do not want to risk anything more than I have already sunk into this black hole"

09 May - S&P 929. They would say: "Come on. It is only a rebound. It is going down again soon. I am not going to put money in here"

31 July - S&P 987. The public: "Unbelievable what I missed. May be this market has really turned around. The recession has a V shape and they will fix the economy… Well, I am even on some of the positions, I reduce my exposure and sell something"

5 October - S&P 1054. "Wow. Something is going on here! They have information we do not have. I am sure the market will continue like this until the Christmas rally. They will drive it higher. How stupid I was not to enter this market last March and to start selling during the summer. I should have known that things could not be so bad! It is true that the economy is recovering. I must buy now!".

Let's see a possible scenario after a few weeks:

Some time in November/December. S&P 900: "Oh no! I messed it up again…"

And by the way, the up gap of this morning [2009/10/05, S&P opened 1043 after closing 1036.40 last night] seems to urge investors and the public to jump on board a fast running train that will not give other opportunities. Do it now or you will have to pay much more to get in!

Good luck to the buyers.

Dr. Pezzutti is a quantitative analyst and speculator who blogs as Short-TermTrading.

Art Cooper comments:

In his book Mass Psychology, James Dines prints a graph annotated with the typical investor's changing thoughts as the price of his investment changes, very similar to those you gave.

Oct

3

There is nothing as bad as losing the money you had and nothing as good as making it back after you lost. Thus, on Wednesday [2009/09/30], the market rose 2% from low and you made it back. The contentment, the joy! And the almanaktarian's favorite day coming up, with a beaten favorite play to boot! But the cronies knew. Disaster. One lost what one had on Thursday [2009/10/01]. You see, we're in crisis mode. Unless the health bill is passed, those jobs will not come back; what we need is to prosecute Secretary Mellon or his modern counterpart the way the magnetic radio person did in the 1930s. On Friday, bonds at a one-year high, and the cronies took profits on the number. Someone has to pay. Let us hope that the seasonalists, almanaktarians, and followers of all stripes will fare better in another world where we will not meet them.

Ronald Weber suggests:

What if markets slowly begin to realize "hey, we have come out of the worst crisis in a 100 year with many scars but we are still on our feet," couldn't it justify a much higher valuation level (lower risk premium) for equity markets?

Paolo Pezzutti analyzes:

Wednesday shows how desperate bulls were to let the market regain the opening level. Their failure and frustration is quite evident during Thursday's action. On Friday they tried to close the down gap of the open, but they were much less aggressive. Maybe they are realizing that the market needs to move to much lower levels before attracting new buyers who are also now concerned with negative news and W, U, square roots shape recession scenarios… If this is true we should sell any rebound next week.

Faisal Danka predicts:

Its not over till it's over. The retail traders who have seen the minor dips since March and have jumped on to the July bandwagon (even if a bit late) would be seeing this as an opportunity to buy on dips. All lagging indicators as well as price is showing break of resistance trendlines and key levels. On the heels of bad to worse news, we still have not seen a correction in above 10% range. This is why I think, a hint of good news and we break above 10k on the Dow. Just when none of the retailer traders will expect, the commercial loan situation will come to fruition coupled with lack of topline growth, and the long-awaited bear run will start.

Sep

15

What is the meaning of this long, long leg, low volatility but directional, with many up consecutive days? Maybe we have to see it as a sign of decreased strength to move to the upside. Maybe it is just a market where bears are still fearful to step in. The down gap of Monday was another lost opportunity for a correction. When will it come, what event will trigger it?

Steve Ellison laughs:

The correction will begin five minutes after you decide you can't stand it any more and buy at market…

George Parkanyi urges caution:

Well, if we muddle into the next earnings reporting quarter in October, the bar was so low last year that we'll probably see more "surprises" to the up-side. I'm not sure you want to be short that. I'm not sure I want to be short that.

Vince Fulco reports:

Sitting at a fancy bar/restaurant I rarely frequent here in the Midwest, have had the chance to listen to ancillary conversations at other tables. Helps to have been on a trading desk with two phones to ears while talking to a third person besides. All the talk is about the dreck stocks– AIG, FNM, BSX, et al. I feel like I am back in 1998 when the 'concept' stocks went gangbusters while liquidity remained too loose. I hate concept stocks like the plague but you know you are getting old(er) when the cycles keep repeating.

Sep

11

What is the explanation (either your own or the "conventional wisdom") for why bonds have been rallying concurrent with a strong stock market and all the talk about recovery?

Bloomberg news reports:

The $12 billion of [long term govt bonds] offered yesterday drew the strongest demand in more than two years. The U.S. Treasury auctioned [a total of] $70 billion of notes and bonds in three sales this week to help finance a record budget deficit. “It was a stellar auction at much lower rates,” said Thomas Tucci, head of U.S. government bond trading at RBC.

Paolo Pezzutti adds:

It seems that all assets are going in the same direction (commodities, bonds, stocks). Is there anything negatively correlated that one could consider to diversify?

Alston Mabry has a one word answer:

USD

Phil McDonnell also replied:

Same day correlations for various assets with respect to stocks (SPY) for the last 105 days:

FXY yen -44%
TLT 20yr -32%

So there are still some things that are negatively correlated with stocks. Same day correlations are not useful for Granger-style prediction [of one time series from another], but they are useful for reducing the risk of a portfolio constructed using the various assets.

It should also be noted that just because price levels have gone up over a certain period of time [i.e. an upward drift in both series] does not mean that the price changes are positively correlated. The preceding correlations were calculated based on daily net changes in order to avoid the spurious correlation problem caused by using price levels.

Dr. McDonnell is the author of Optimal Portfolio Modeling, Wiley, 2008

Vincent Andres answers:

Why have bonds been rallying? In the past, government(s) were putting their hands in the machine only under exceptional/rare occasions. Now they are doing that on a regular basis. Markets (as we used to know them) have never been so oligopolistic and manipulated. The fact that old rules like stocks up/bonds down (and many others) now no longer works is simply one of the signature of all those oligopolistic interventions.

A possible scenario : The stock rally being a completely constructed one, concerning in fact only a restricted number of actors. Those actors aside, the stock markets were not rallying, that is what bond buyers believe and why they buy bonds.

For our stock "markets" (and some others), just a facade subsists.

Aug

14

[The race between Atalanta (l) and Ippomene (r) by Guido Reni, 1618, Museo del Prado de Madrid. She loses the race and wins the boyfriend by picking up the gold "pomo" tossed to her by the Fed.]

After a sagacious relative's Email about POMO, I have been reading as much as I can about it. I found a recent article (August 10, 2009) by CXO Advisory Group particularly interesting.

Jul

23

CycleI may well be wrong, but my belief is that we are at the end of a big cycle. The end of the "easy debt" cycle?

1/ 2008-2009 shows clearly that nothing will be done by borrowers to stop their dependence. Nothing will be even tried. On the contrary. Because of our debt levels, this triggers the question of solvency. At least, this makes the question of solvency exceed a significant psychological level for the lenders. Confidence lenders/borrowers is definitely affected (gone). (Even if little is publicly said about that).

2/ This situation of confidence loss is new. The exhibition of our attitude at such a level is new. The awareness/knowledge/understanding of this situation is new. Presently, neither the lenders, nor the borrowers, have exact plans to deal with this novelty.

3/ … but, under the calm and apparent status quo, they are of course actively searching. At least the lenders. With the intent to do something. (Something will be done, even due to randomness. At least some small domino pieces will fall.)

4/ so my belief is we arrive at a delicate/complex crossroads/nexus/crux/bifurcation point (à la Prigogine). We're now inside a huge, real-life, game theory exercise. Many many things can happen. (But I believe many probable scenarios will share common steps). (I believe even dramatic events are now made possible.) But the status quo seems me rather improbable (even if it would be the case, this would just postpone things).

The above sequence lacks numbers (and may look abstract), incomplete, too coarse and biased with a sort of "pessimism", (but it's not how I feel about it). I'll thank you for any help to remove the flaws/omissions/clumsiness of this reasoning.

Phil McDonnell replies:

Debt is an important part of the big picture.  But I believe that a better perspective on current economics is that private consumer debt will no longer be easy.  In fact current figures show that consumers are 'saving' in greater amounts.  To be sure this savings does not show up in savings accounts or other tangible assets.  Rather it shows up as consumers pay down credit cards and mortgages.

The key thing to understand is that the powers that be do not want a reduction in total debt.  The size of the world economy is directly related to the size of the world money supply and all of its assets.  Given the destruction of wealth in mortgages, real estate, stocks and commodities the only source of money creation to reflate the world balloon is government borrowing.  So in effect the consumer debt is being replaced by increased government debt and conscious efforts to print money out of thin air.

J. Rollert predicts:

The present environment will make people treat debt like our grandparents did… and not trust financial types in particular. This is a social change beyond the cycle.

Paolo Pezzutti recalls:

People will not change behavior and attitude unless they are forced to do it.  When I arrived in the US from Europe two years ago I went to a dealer to buy a car.  There were signs on the cars on sale indicating $400, $350 and so forth that I could not understand at first.  When I started to talk with the guy it became clear to me that the signs were the monthly payments you had to make.  When I buy a car I want to know first how much it costs, not how much I have to pay each month.  But in the US people are apparently either encouraged to buy on debt, or they like to buy on debt, or they must buy on debt because that is the only way they can afford a car.  Only if the behavior of the lenders changes, we will see a different attitude of consumers.  And this is what could happen. Even with 0% interest rates.  Unless lenders find "new" ways to lend "easy" money.

Russ Humbert writes:

It is not just Govt. debt in the traditional sense, that the Govt. is increasing, it is putting more risk on the Govt. balance sheet on the asset side as well.

The Bernanke plan is to keep it coming, from what I can tell, to those that are willing to beg from the government.  Securitization is not dead, for the government quasi guaranteed it… This includes education and housing loans for most people, up to the point of being "rich".  It would seem that those that have no real prospects of paying off the principal, those that won't better themselves will be frozen out. At the other extreme those that better themselves to the point that it's clear Government is impeding personal progress, will not get this "risk free" money.  There won't be another AIG to scoop up all the risks, without any real capital backing it, for a long time.

This may seem momentarily like we are headed back to the sixties, before even credit cards, because of the sharpness of the down turn.  But this still leaves the US with much more debt capability than existed 10 years ago, before things got out of hand.  And money will flow down to consumption, it just won't be direct and if direct not as cheap.

Legacy Daily is skeptical about big changes:

I perceive debt to be the current fuel in the engine of growth. Unless an "alternative energy" is discovered, I believe debt is here to stay. The donut maker got it wrong, "America runs on debt." One reason for the efforts to improve the geopolitical landscapes in emerging economies is to also help raise their asset bases against which further debt can be created to satisfy the unending need for growth that our markets, our 401(k), and our lifestyles require. Since there's nothing new under the sun, just as soon as this cycle of diet and slightly better behavior has run its course, the patient will be right back to the liquor store for more of the same and a new cycle will be born. When and in what shape? That's the really difficult question.

We received a contribution from thin air (or is it Thin Air?):

Let me introduce myself: my name is Thin Air. Yes, THE Thin Air. I've been around for eons upon eons and have enjoyed a fairly tranquil existence. Who or what am I? A Princeton web site defines me thusly: "thin air (nowhere to be found in a giant void) "it vanished into thin air." That's OK with me, I can even live with the example which characterizes me as the passive element in an inexplicable event. Over the centuries millions of people, things, explanations, excuses, villains, heroes, and life savings have "vanished" or "disappeared" into me.

No problem. If you humans lack the will or imagination to discover just whatever it was that was lost, misplaced, filched, or embezzled, that's fine with me. But trust me on this, I don't have any of those people or things….never even was aware they were gone until I looked me up on Google - imagine, almost 3 million references. Rosie O'Donnell's number is just slightly higher, Bill Clinton's is 7 times greater, Barack Obama's 25 times greater, and Michael Jackson's 70 times greater- a telling measure of your society's priorities.

Those individuals weren't chosen capriciously; as a member of the "thin" contingent I chose two thin representatives and, by contrast, two fat ones - although it appears I'm being dissed in relation to other "thins", I love it and want to keep it that way. But Philip McDonnell served as the straw that broke the camel's back when he penned: "So in effect the loss of consumer debt is being replaced by increased government debt and conscious efforts to print money out of thin air."

I'm getting so, so tired of hearing that. You can't get through an hour of CNBC or Bloomberg without hearing that phrase or a riff on it. But those people are pretty lame and I expected Dailyspec contributors to provide a creative twist to a tired theme. Additionally, when phrased as shown above, it appears that I had an active part in the event; that I somehow swooped down and dumped billions and billions of dollars upon a group of bankers. First off, I'm broke; I neither have nor need money (gasp). Secondly, if I did have money, do you really suppose I'd drop it on that group of dummies? Not a chance.

Being a disembodied element and not a human, I can still make value judgments, tell the truth, discriminate, and speak out without fear of being condemned, jailed, boycotted, or shunned. Among those things that are unquestionably bad is excessive debt. It would seem this is self-evident, and Mr. Andres ought to be commended for bringing it to the fore. Similarly, Mr. Conrad (on another thread) reveals that the WEEKLY treasury begging bowl calls for low-interest-loving optimists to pony up almost one quarter of a trillion dollars. If this occurred every week, Treasury's annual issuance would approach the nation's annual GDP.

One can hardly blame debt buyers, though, as it's a given that the system will get better (or as the Sage, a student of Pangloss, stated this a.m. "better than ever") and that American Exceptionalism will prevail where, in similar circumstances, similar efforts failed. On the contrary, we witnessed major adjustments following the Tulip Bulb mania, the South Sea Bubble, Teapot Dome, the Great Depression, the Salad Oil scandal, the S&L fiasco, Russia's Default, LTCM, Y2K and Tech Mania, Enron, and the Real Estate Bubble.

History has demonstrated that none of these came out of Thin Air, nor did their eventual solutions. You can check it.

Thanks for your consideration and

Please leave me alone,

Thin Air

Jun

11

V NSometimes masters can be recognized by how little motion they make in beating you or relieving you of your funds. On this score, note the S&P in a three point range on five consecutive days, and eight of last 10 closing prices have been between 839 and 843. I find that the old mistress has not done this once in the last 15 years with the closest virtuous performance being on October 11, 2006 with the ranges widened to three. Hats off. What does it all mean? What's the sports analogy?

Paolo Pezzutti answers:

I see two boxers studying each other during the first rounds of a fight to find out weaknesses and strengths of their opponent. They test and experiment, trying some punches and techniques, moving around the ring to gauge capacity and time of reaction. They get ready and prepare the assault. When the moment comes, the fight develops furiously and fast with opponents using all their ammunition to try to knock the other out. When this type of match occurs, it is hard to figure out during the first phases who is going to be the winner. Deception to cover one's own weaknesses and strengths makes it quite impossible to bet on the outcome, unless you know values at play. Today's afternoon move could be one of these deceptive moves to be faded.

Thomas Miller adds:

In a most martial arts matches, the superior fighter expends as little energy as possible while letting his opponent expend his energy, become frustrated, lose concentration, and eventually lose the match. A wise fighter who is outclassed and knows it avoids the fight to begin with, waiting for a another day and a better opportunity. A wise trader would do well to avoid tight range markets waiting for another day and better opportunity.

There is tension in this market like a spring winding tighter, waiting to be released.

Henry Gifford comments:

A tiring bicycle rider can be seen many ways, with the most obvious being movement of the shoulders as if there were a second set of pedals connected up there, which of course is not the case, meaning all that movement is wasted.

May

27

Was the Vasa was the greatest warship of her time? By the time Samuel Pepys (great gossip, even greater Gilbert & Sullivan head of the Queen's Navy) became Secretary, the Stuart Navy was successfully challenging the Dutch and the French and offering its protection the Swedish merchant marine ships in their trade in the West Indies.

In his Miscellany Pepys lists the following classes of ship:

Rate          Name        Length     Beam     Draft    Tons  Men  Guns
First          Sovereign      127         46         19     1141  600  100
Second      Fairfax          116         34         17     745    260  52
Third         Worcester      112         32         16     661   180  46
Fourth       Ruby             105         31         15     556   150  40
Fifth          Nightingale      88         25         12     300   90   24
Sixth         Greyhound       60         20        10     120    80  18

A comparison of the Sovereign with the Vasa is dispiriting. The Vasa was roughly the same size - 1200 tons; but it was nearly twice as long - 230 ft. - and its beam was 8 ft narrower (38 ft.). That is a length to beam ratio of 6 to 1.

That was asking for trouble. The rough rule of thumb since people first started sailing and capsizing boats is that a monohull should be three times as long as she is broad. This should not have been news to the Vasa's architects. The Mary Rose (built 90 years before the Vasa) had a ratio of 3 to 1.

There is a reason for the Vasa's builders to have wanted it to be so long. There is even an explanation of why they thought they could build to such an extreme ratio. The longer a boat is, the less beam she needs proportionately. A boat's resistance to being overturned varies as the fourth power of her waterline length, the heeling moment of the wind pressure on the sails or the waves and swells against the hull in an engine powered ship varies as a cube of her length. Length is desirable in itself because the maximum speed of a vessel is - roughly - 1.2 times the square root of its length at the water level.

The Vasa's builders were trying to achieve the same results that American naval architects produced with the Iowa class battleships — the last ones ever built by the U.S. and the last battleships to operate on the high seas. The Iowas had to fit through the Panama canal and be able to keep up with the carriers (which were much lighter and, therefore, faster for the same propulsive power). As a result, they had an extreme beam to length ratio (8 to 1).

Then, why did Iowas survive typhoons while the Vasa sank literally in port? The answer is that the added stability of length can be horribly offset by increases in height. The Vasa had a height of 172 ft. - 75% of its length. For the Iowas to have had the same proportion, their hulls would have had to be 500 ft. high! Adding another 3+ ft. and a great deal more ballast kept the Vasa's sister ship from sinking in the Baltic, but it could never have survived the North Sea. Even using the 3.5 to 1 length-to-beam ratio that the smaller rated ships in Pepys' fleet (the Worcester, for example) would have required the Vasa and its sister to have beams of at least 65 ft; and, in the age of sail, there was no way for them to reduce its height to the dimensions of the Iowas.

The analogy with financial engineering is certainly appropriate. Somewhere in Stockholm in 1630 there must have been some bright young men who looked at the extraordinary success of the ancient Viking long ship designs thought "leverage can only lead to greater glory." But, the little matter of the Viking long boat's limited sail height seems to have be ignored. There are no surviving rigs for the long ships, but the best estimate for a 30 meter boat is that it had a mast height of 12 meters or roughly 40% of its length.

Phil McDonnell writes:

I visited the Vasa Museum. It is a fascinating story of the greatest warship of her time that heeled over and sank within minutes of first setting sail in moderate conditions. In many ways it is the story of man's attempts to master engineering, be it naval or financial. The ship was only raised in the last century with modern engineering and is over 90% preserved due to salinity conditions in the Baltic. The interesting sequel to the Vasa disaster is that her sister ship which was completed two years later was only one meter wider but had significantly improved ballast engineering. The redesigned ship actively served Sweden in the war against the King's cousin, the King of Poland. Highly recommended tour.

Dr. McDonnell is the author of Optimal Portfolio Modeling, Wiley, 2008

Paolo Pezzutti comments:

Maybe the ship was top-heavy.  If the ballast, for example, is not enough, the metacentric height (distance between the center of gravity and the metacenter) is too low, the ship would be unstable.  
 
From the thesaurus:

"metacenter - (shipbuilding) the point of intersection between two vertical lines, one line through the center of buoyancy of the hull of a ship in equilibrium and the other line through the center of buoyancy of the hull when the ship is inclined to one side; the distance of this intersection above the center of gravity is an indication of the stability of the ship".
(The center of buoyancy is the line of action of the resultant of all buoyant forces of the immersed portion of the ship).
(The center of gravity is a function of the distribution of the weights on board the ship and the ships itself).

There could have been different problems. An initial instability because of low metacentric height. Shifting of weights on board the ship may have altered the center of gravity. Or both.

Is how to calculate the metacentric height of a market a silly question?

May

21

The 19th century expansion of trade with America and India (thanks to the British Navy dominance and the imperialist policies of that century) caused the growth of population in cities, the increase of demand of labor and, therefore, wages. High wages associated to the availability of low cost energy (coal) were the main driver of the industrial revolution in Great Britain according to some studies. Basically, the demand for technology was meant to substitute capital and energy for labor. High wages contributed also to increase skills and education. In other parts of Europe and of the world energy costs were higher and labor cheaper making the use of new technology not economical when in Great Britain it already was.

The move from the Industrial Age to the Information Age changed relative values of labor and capital. The value of labor has remained high, but the value of intellectual labor has greatly increased. Western nations (and especially the US) have experienced initially an advantage in exploiting the transition to this age because of the higher level of education relative to other countries. An important characteristic is that less capital is necessary to enter markets in order to develop information related products and distribute them. The Information Age has lowered previously high cost barriers to entry. Geographic barriers as well have been lowered. One can now participate in this sector of the economy from anywhere.

The Information Age has affected the sources of wealth, but it has also altered the balance of economic power. As emerging nations improve their education and skills level, they are able to better compete with traditionally advanced and mature nations because entry barriers to markets are lower. Moreover, these countries have the advantage of low wages. This combination is explosive in the long term.

Not only western countries are moving to emerging countries ever more important parts of the manufacturing sector, but they are moving the higher value added activities typical of the Information Age. Emerging (are they really still "emerging"?) countries are entering these markets with their own companies. At the same time, we see the big innovators and winners of the nineties become gradually mature and slow down their rate of growth (MSFT, YHOO and so forth).

Many believe that renewable energy is the answer. I personally believe this is very important, but it will not provide the solution: solar panels will be made in China! As we will live in the Information Age for some time in the future, we may not see any actually disruptive innovation that will give back to the US the huge technological competitive advantage the country had in the past decades. And it is not a given that the US or Europe will be the leaders in the next innovation era. What will be the drivers? Education and skills again, I think, because, with time, the cost advantage of emerging countries will decrease. The proposed US budget includes $147.6 billion for research and development. After four years of decline in spending on basic and applied research the 2009 spending and the 2010 budget proposal represent a turnaround in federal research investments. This is big money, but I am not sure it is a panacea. May be we should also let the free entrepreneurial spirits at work providing only a sound market and property rights framework as incentives.

May

16

1. My 18 year old Lab regularly wakes up and barks at 5 am, and the coyotes are waiting right outside the door and howl in unison. One wonders if they are waiting for a meal or believing a friend is close. The market often is near death at 5 am and lurches in a spiral, with the Dax plummeting below the round.

2. The last hour on Friday often reminds me of the last two minutes of many basketball playoff games, especially those of the Celtics. The lead changes five times. There are violent moves with three-point shots and running of stops on both sides, and a complete recap of what has happened up to that time. Slow but steady wins the race.

3. The Dollar/Yen and the S&P do a very nice dance together and when you trade one you are really making a forecast of the other. Many times all the people who use the program I invented are waiting for a move to happen predicted by this or that market on this or that day or time, and out of the clear blue sky, someone like Dr. Greenspan will be speaking at a lunch, and will say something that makes the prediction come true. How did it know? And how if it didn't could you keep up with those who don't pay commissions and are always ahead of you on the bid or offer no matter how fast you are?

4. The many and increasing 100 million trading days that the "banks" are realizing these days presumably will help their kids get into certain Ivy League schools or at least get them a good letter of recommendation from former "bigs" there.

5. After a 35% rise, when the market drops 5%, the bearish commentators and the newspapers are not as hopeful of the big decline as they are after declines that follow terrible moves.

6. The Laffer Curve should be generalized to encompass the incentives that people have to buy and pay whenever any purveyor tries to siphon away their margin of benefit.

7. I can never read a Patrick O'Brian book without finding in every chapter insights into how by following the wisdom of Jack or Stephen, I could trade better.

8. I wrote a letter to a little boy telling him that having a strong and long base of operations is a key to success in life and I would be pleased to share it with those who might find it of interest in life or markets.

Alston Mabry writes:

My dogs and I have made a casual but first-hand study of coyote behavior (less casual, perhaps, for my dogs, especially Trevor who lost a dollar-sized chunk of fur and flesh to a coyote bite when he was about three). We call it a "hoot-up" when they howl as a group. In my experience, a hoot-up is a claim on territory. Coyotes coming back into the mountain park here just before dawn, after having spent the night scavenging and hunting cats and ducks in the suburbs, will stop at a familiar waypoint and do a hoot-up: "We're back. This is our territory." Several times, too, when I have been out with the dogs at 3am, and they have found and noisily chased a rabbit through the cactus, the coyotes came along twenty minutes later and did a hoot-up on the spot where we barked and whined, to claim it and try to scare us off. When you have a group of coyotes like that, they are a family, not a pack, with the parents and usually one or two cohorts of siblings not yet struck out on their own.

The end-of-day action reminds me sometimes of a football game, when there are six or eight minutes left in the 4th quarter, and the team that is behind starts throwing long passes and marching down the field. And I wonder, "Why didn't they play like this all game?" But similar to markets, they didn't play like that all game because of risk. When they get to the point where the game is on the line, then everything must be risked or else all is lost.

It's also interesting to throw the Nikkei-S&P correlation into the analysis. Is it time to go long the AUD again?

Is it that we watch the market turn and then interpret contemporaneous news as the cause? And when nothing much is happening, we ignore the news– if the market isn't reacting, then it can't be important. It's good that with both news and market data, there is an uninterrupted supply.

Paolo Pezzutti writes:

Two good friends interact and follow the same path in life. Some time one is leading, some time some the other takes the initiative. Overall they share the same values and enjoy spending time together. Suddenly, for some reason difficult to explain they part and go to different directions and not without pain. Similarly markets correlations emerge and increase to a point where you think there must be really very good reasons for them to work. Then you find out that it was all ephemeral and they were may be brought together inexplicably and randomly. With sadness you look at your friend and do not understand any more, it is simply a different person. And you hope things could go back to the good old days. Sometimes they do, but most of the times they don't.

May

9

There was a time when in my country the barber was quite a personality in villages. The social opportunities and contacts at the barber's or at the bar in the piazza were unique. The barber was a very precious source of information. There you would do your business, get useful information and news about people and things happened, find friendships and establish connections. Much of the talk was about people I must say, and I am afraid that they would not talk about stocks tips and hints because the financial market was not developed at the time. Moreover, it was a place where you could spend some time and relax reading a newspaper with someone taking care of you; it was a weekly routine to be shaved the way only a barber can do. Provided that it was sometimes dangerous… Remember those scenes in old movies where a gangster is shot dead in a barber's chair? By the way, Al Capone's father was a barber. It seems that much has changed today when we consider going to have a haircut a waste of time and money.

May

5

In meteorology, with nowcasting you want to perform short term estimates and prediction of thunderstorms or other events. Typical questions you want to answer are: where is the storm now? Where will the storm be in 60 minutes? What is its path? Is it weakening or strengthening? Are there hazards associated to it (lightnings, flooding, etc)? The problem you want to solve is about spatial location and intensity. It is similar to what we want to know about price: will it be up or down in X hours? How many points? Predictions are performed using algorithms and extrapolating radar echos (based on movement) assuming no growth/decay, which is normally acceptable for 60 minutes forecasts. There are several methods to track objects and estimate motion in real time using filters (e.g. Kalman) and calculate trends. The longer the time considered for the prediction, the higher the uncertainty. Accuracy is strongly depending on the type of model you use. In the stock market, when you try to predict the price of an asset at a certain time in the future you take into account the information you have at the moment you do the forecast. This involves uncertainty, which is also function of the time horizon of your forecast. As time progresses, you are able to include new data and more information in your model to update and refine your forecast. With time, you have more data available and your forecast horizon decreases. As uncertainty decreases, you have a more accurate forecast, but also have lower margin profits. For example, at the close today you forecast the next day's close taking into account the data available up to that moment. As time progresses, you include in your model the overnight action, then the open, the morning action and so forth getting closer to the end of the trading session. Accuracy will depend on how your model smooths data and extrapolates movement.

How can we use this methodology? When you open your trade you expect a certain behavior as time progresses. Nowcasting can be used to check if the path (price) of your asset follows the expected pattern. You have a number of "what if", such as: what happens if it opens higher, what happens if it prints a spike to the upside and so forth. Each time you update your expectations and when the expected path deviates too much from your original forecast it is time to close your trade. Conversely, if, with more data, expectations are reinforced you keep your trade going. It is a matter of thresholds of course and accuracy of your model, that depends much also on the frequency of observations and amount of data available.

Apr

18

The femme fatale seduces her lovers with her beauty and charm, but the sexual allure I think is the characteristic that bonds her victims the most in a deadly and compromising relationship. For some reason, she hypnotizes her victims, sometimes more than one at the same time, attracting them gradually, but inexorably, in a situation they can escape only with extreme actions and outcomes. She builds slowly and scientifically, an asymmetrical relationship where signals of confirmation of her affection alternate with denials. She has a sort of network where victims are monitored and managed to make sure they do not escape. She does all she can not to let them free, including lying. Her lovers enter finally a state of dependence and obsession that she enjoys and of which she drives the dynamics that with time become more and more extreme. The desperation, exhaustion, anxious and obsessive phase of lovers is characterised by an unhealthy and overwhelming attachment that can cause irrational decisions. The final destructive phase involves feelings of self-blame and often anger. The deadly femme fatale has a complex personality, hard to recognize at first. When victims realize the situation, it may be too late. Similarly, the market seduces lovers with charm, beauty and the art of deception. The deadly outcome leaves victims with huge losses.

Marion Dreyfus writes:

Just because the vast preponderance of readers here is male is no reason to excoriate females — the description of f.f. goes way overboard. Most women are aware of their allure (it does not take much to excite randy males, which describes, given the chance, 95% of all the gender), but we do not spin these nets and traps — it is an anachronistic model, based upon the impotence of former females in insurance securities, investments and her own nested income. Absent the need to survive and ensure for her needs, these females melt into the tough, hard-working, capable, no-nonsense female of today. To the extent that women are again (arguable if so) 'femmes fatales,' it is because of the insecurity of the times. That is why skirts rise in lean times: Females are wont to finding and bonding with a future of plenty, not want, and the sexual signal is the come-hither to desirable males.

Indeed, if a woman does behave in this alluring, seductive pattern when a male is about, it compliments his status-quotient. Were he to be adjudged low in value, her interest would not be piqued, and her sexuality would be aimed elsewhere.

We all try to to survive. The devices and tools women have are mimicked in the insect and animal world models–these are meant to procure food and necessities–stop spinning the paradigm as if it were *sui generis* for no reason other than the gratification of the destroyed male.

Scott Brooks replies:

Just like women are often attracted to the rebels…..you know the old saying….good girls are attracted to the bad boys….men are often attracted to femme fatales. I dated a FF for a short time in college. I found myself attracted to her as she was obviously a "bad girl". The attraction didn't last long as I found I was not quite as "adventurous" as she wanted to be.But of course, today, the Mistress has her hooks in me and she's driving me crazy. But I live a well balanced life. My wife is a balance wheel, very well grounded and keeps me on the straight and narrow!

Now our very beautiful, very femine Dr. Dreyfus bemoans the use of the FF phrase…..sweet innocent Marion…..who, I'll bet, has gone hunting, fishing and shot more guns than most of guys on this list…..who did her stint in the IDF. Who has roamed the hostile streets of the middle east and who manages to navigate the often moody straits of the Type A middle aged successful men who inhabit this list……and yet…… does so with flair, feminity and grace.

Fair Marion has probably been in more dangerous situations than many on this list will ever be…..I like to think of her as our groups own private FF……a living character in an adventure novel…..so we get to have all the adventure (but only in our minds) with none of the danger!

Apr

11

When you maneuver a ship, there are controllable forces, such as propeller and rudder effects. There are also uncontrollable forces, such as wind, current, sea conditions. Moreover, each vessel has different characteristics and reacts differently. You have also to take into account the characteristics of your ship that may not be constant and given, such as ship loading and hull conditions. As a result, a captain works in an environment where a ship's behavior is not observed in exactly the same way and each situation is different from another. A maneuver is a dynamic process. You have your plan and when you execute it, you want to have a continuous update to understand the effect that your order has achieved and the next course of action in order to be able to follow your plan. Each time you find yourself in situations where your ship reacts differently due to everchanging combinations of speed, rudder, wind, current, sea state.

You need to be adaptable to the environment. Often, a too frequent assessment of your orders is not good because you need some time to let the ship react to your order because of its inertia. At the same time, if your feedback cycle is too slow, you might not have enough time to correct your action. You might end up not being able to follow your plan any more. In that case, the wisest thing you can do is give up and start again the maneuver from scratch instead of trying improbable corrections.

In markets, you do not have controllable forces, but you have expected crowd behaviors. In this context also each situation is different. A trader establishes a plan and during the trade execution, as new data come in, he/she assesses the market's behavior. The frequency at which this feedback process is done is critical. Traders may overreact and be deceived by the short term noise (you need time for the trade to develop), or they may be too slow to realize that the trade is not going as expected. How much data do you need, how often? How is the behavior different from what is expected is an interesting parameter. What is the threshold that makes you realize the trade went wrong? A ship maneuvering characteristics can be modeled mathematically, but in real life captains have to apply their experience and judgment to work in an observe-evaluate-decide-act cycle, which is very similar to what a trader does in a real time environment. Similarly, the market can be modeled, but most of the times expected outcomes require judgment and interpretation. It is all about the human dimension, where the action-effect cycle is matched against broad assessments of a generic "system" behavior.

Jeremy Smith comments:

“Consider how often a vessel must change its course in leaving a harbor, yet once on the high seas a single heading may bear it to its destination. Only
a major navigational hazard could change it.”

 – Louis Auchincloss, The Embezzler [1966]

J.T. Holley adds:

In the spirit of Patrick O'Brian I would have to disagree or at least add to this quote. Pirates, Enemies and Gov't can cause navigational changes in both the ships directions and destinations as well as in the markets. Seamanship by David Dodge is a excellent book that discusses the navigational patterns as well that the U.S. Navy utilizes. Having served onboard the U.S.S. Stark I can assure you that rarely is "a single heading" utilized to reach a destination. Sure it is the broad direction, but there are other directions that are in between when going from point A to point B.

Pitt T. Maner III writes:

Let me add a nice quote from The New Dictionary of Thoughts (1963). I wish I knew who "Anon" was:

A smooth sea never made a skilful mariner, neither do uninterrupted prosperity and success qualify for usefulness and happiness. The storms of adversity, like those of the ocean, rouse the faculties, and excite the invention, prudence, skill, and fortitude of the voyager. The martyrs of ancient times, in bracing their minds to outward calamities, acquired a loftiness of purpose and a moral heroism worth a lifetime of softness and security. Anon.

The pdf of the book is searchable and many a fine old quote can be found there. 

Jim Sogi adds:

Jeff is right. A sailing ship in particular will sail the best course made good, rather than rhumb line. For example, it will take the best angle to the wind, for the ship best speed, even though off rhumb line, for best course made good. A catamaran, for example, will go faster tacking down wind, zig zagging rather than shortest distance. I think day traders know this instinctively. It's quantified in markets in the absolute volatility numbers, or in Sharpe result numbers.

Another curious effect is when there is a strong current setting the vessel down. The vessel aims at a different point than where it intends to go, and 'crabs' along its course. This is hard for people to understand, as they can't really see the current, but one has to be aware of the motion of the ship in relation to the course, which is a derivative function. I suppose this might be thought of as Sharpe as opposed to gross dollars in trading or percent.

Another odd effect I experienced last weekend up in Alaska skiing was during a white out, a sense of vertigo. There is no visual reference point to balance, and its easy to lose balance in total white out conditions. While standing still, a small avalanche passed by, and though I was standing still, seeing the snow pass by gave the impression of motion, and threw me off balance. Or there is the feeling of standing still, then all of a sudden hit a bump and realize the skier was moving, but couldn't see it. The idea is that sometimes the perception is not correct and some other reference is needed. Pilots know this. This was one of the main points in survival. Loss of a reference point often lead to panic and death. In the markets, it's easy to lose reference. Chair's international numbers, I believe, are an attempt to get some sort of reference point. I had guides skiing up in the wilderness, who have a lifetime of experience and reference. Like markets, if you lose your reference point, you'll be dead in short order. 

Apr

7

Redundancy is one of the keys to digital cell phone transmissions, and packet transmissions for the internet, human speech, credit card numbers, music composition. The list goes on and on, but should include the market. In speech, typically people say the same thing over and over, to guaranty the message gets through. Digital cell phone technology uses some sort of redundant error correction to insure the correct message. Musical composition often has three verses, and repeats the theme to get the message through.

The market does the same. The mechanism is the result of trial and error, to some degree, but also of communication, error correction. A minimum of three is needed to provide some sort of error correction, and to insure transmission of the message. This is why we often see things in threes. It is good to know or expect repetition or redundancy as it gives an edge. For some reason the news and commentators seems to think rather of endless continuation as the normal mode.

Paolo Pezzutti adds:

Redundancy increases reliability of systems, usually in the case of a backup. You can find in many critical-performance systems and applications that some components or modules can be at least doubled. When you have a federated system, for example, you can choose to have a central "intelligent' core and a number of "non-intelligent" sub-systems, or you can have "intelligent" subsystems providing a higher degree of resilience to failures. This is typical of some combat systems on board ships for example. The point is that not only redundancy adds reliability, but it increases also the performance, because intelligence is distributed throughout the system of systems and decentralization is a more efficient and effective solution (there are less bottlenecks and so on).

Redundancy and reliability, however, have a cost. When designing a system you have to weigh costs and benefits to find a balance that meets the user requirements. Markets find dynamically a balance between costs and benefits through the price discovery process. Also in this case, network-enabled players that apply a decentralized approach have an advantage in situational awareness, speed of evaluating the situation and making decisions, and speed of execution have an advantage over bureaucratic, centralized and slow players.

Phil McDonnell comments:

Redundancy can be very good but there are some occasions when it accomplishes less than one might think. For example, most data centers have more than one server. But if they are running on the same electrical power system they are still vulnerable to the loss of that common critical resource.

Another example might be when the sources of failure are not independent. One example using two servers might be if both are plugged into the same wall plug. They are susceptible to common power surges and lightning strikes transmitted over the power lines. Even several computers connected via long network cables can be simultaneously damaged by the EM pulse from a nearby lightning bolt.

Mar

29

What a difference in the complexion of the world markets from last year where at the end almost every market was down 50% with no exceptions. This year as of March month-end the world markets are down a mere 10% and there are exceptions galore, notably Israel up 15% and Russia up 31%. All over, anomalies exist. Norway up 10%. Pakistan and Taiwan up 17%. Indonesia up 10%. All over South America markets up from 10 to 30 % in Peru and Venezuela. Venezuela up 40% from 1999. Recapping the wisdom of Maturin during the French Revolution advising Sophie to buy stocks, a stridency relevant to today shortly.

George Parkanyi writes:

Many a financial network talking head these days pronounces that "buy-and-hold" is dead. Here, or somewhere around here, is the perfect time to initiate a buy-and-hold strategy. This is from where the $3 AMDs and Motorolas of the world go back to $30 or $40 in the next bull market. And what of it if it takes 10 years, not that it's likely to take that long. That's still 100% per year non-compounded. My ex-high-school teacher and stock market mentor Omar Sheriffe Vernon-el-Halawani in the last two decades of his life (he passed away in 2005) did just that for most of his portfolio — buy good companies on the incredible cheap when the opportunities arose, and just put them away. He introduced me to "Reminiscences of a Stock Operator" long long ago, and in his last few years kept admonishing "George, why bother to sell?" (Though he wasn't inflexible either — he did sell Sun Microsystems once it got to $200. A couple of his closer friends rode Nortel back down to nothing.)

Paolo Pezzutti replies:

What if in ten years from now Motorola and AMD do not exist any more because a Chinese or Taiwanese corporation has wiped out these companies in an already mature market of telecoms and semiconductors? Sort of a General Motors and auto industry fate in 2015? In the meantime we have to see if the Western countries will manage to lead the next wave of innovation. It is not a given.

Stefan Jovanovich adds:

Motorola may survive as a defense/government contractor like Studebaker did; but its days as a competitor in the mobile dial-tone device market are long over. It has a legacy business in walkie-talkies, but those devices are now commercial products for — oh, happy day! — the construction and events trades. The "next bull market" will be in businesses that do not need the help or money of the academic/finance/regulatory complex. Some pissed off genius who is dropping out of graduate school right now because he can't stand another day listening to a discussion about hockey sticks will be the guy who creates a viable alternative to the internal combustion engine. The fact that the next Henry Ford did it because his uncle died and left him enough money to allow him to pursue his dream of racing an electric motorcycle will definitely NOT make the history books. Instead, some not-so-bright but perfect resume student of "economic trend analysis" at Berkeley will write a seminal paper explaining how it was all due to the "convexity of the forces of ecological history" (assuming, of course, that CalPERS has not blown all the money and put the University of California into receivership — which may the wildest of all my surmises). On a happier note, the Cal Men won the national swimming championships this week. Go Bears!

Pitt T. Maner III writes:

"Hardened silo" companies, with strong management, that have survived through and handled multiple, steep cycles over the past decades by mothballing equipment as needed, sending seasoned hands "back to the house" when necessary, and which have high barriers to entry (and negative government support) into the particular business would appear value candidates now. High quality drilling and drilling service companies, over the longer term, are appealing at present prices unless solar, windmill, nuclear, and alternate energy supplant the need for hydrocarbons. There are many other groups and companies that probably fit this undervalued, "tough-times survivor" model that odds would favor moving forward.

Jim Sogi adds:

After such a rally, and now when more and more people and pundits are calling a bottom, and I hear news proclaiming a thaw, and I hear talk of people starting to buy, these are the type of things that put my radar up. It's funny that the news media is somewhat stultified in that despite their steady barrage of bad news, the markets are all up. They actually have to change their copy of bit as it's hard to proclaim, markets up 15% on steady barrage of bad news. Obama did make a good call to buy, the day before the low and gave everyone a chance to buy. He knew what was in the govvy cards of course. That was the time to make the big commitment, not now. There should be more chances before they proclaim the next bull market as the market tops.

Legacy Daily writes:

Given things stay roughly the same, I cannot disagree with any of these comments. The challenge right now is that nothing is given.

For people who trade via systems, I have a question.

At which point does one decide to a) modify the system (and to what degree and based on what), b) discard the system (and why), c) continue relying on the system (and for how long); if such a system is producing losing trades more recently but has worked fine for a long time (definition of time scales not relevant)?

Perhaps the answer contains clues regarding our recent government actions (and market reactions) where the scale of the system and the magnitude of its impact is great. The problem is further complicated by control over one's actions but lack of control over [negative] consequences of those actions in a human system.

The second question that does not leave me alone is whether a game of chess (or any other game) can be won if every few moves, the game rules are modified. Does the player quickly adjust and remain focused on winning the game according to the new rules ("queen can only move three squares at a time" for example) or does the focus shift on guessing what the next set of rule changes may be? After a few set of changes and corresponding adjustments, does the player begin to suspect the rule maker in taking one side or the other?
 

Mar

12

I wonder if snow, for example the deluge on Feb 1, 2009, in New York has a negative impact on stocks. It had a positive influence on the ability of youngsters in the 1950s to buy stamps, as school was out and Nassau Street was accessible by train. Now you can't even find kids having snowball fights as they are all inside with Nintendo or Twitter or IM.

Paolo Pezzutti comments:

Last evening I left my girls to spend a few hours at some friends' place. I left them playing with a "Chinese" toy pen with very basic videogames such as bowling or skying in it. When I came back they were still playing with that silly toy. They were hypnotized, although sleepy, but they would not give up. What is the power of these applications — even as simple as this? We can track a parallel with a trading screen and its ability to hypnotize wanna-be traders (and not only them) creating a compulsive attraction and dark force to trade even when it is not the best setup.

I was somewhat nervous about my daughters because they were not stimulated to do something different. It seems that if they are not "educated" and addressed to healthier and outdoor activities kids (and adults too) in most cases prefer spending their time following action on a screen. This is what game companies and stock brokers exploit.

Michele Pezzutti adds:

That's true. This is something I always think about when I reflect on the way kids are growing. I often wonder if the way the kids play today is healthy. I do not want to sound old-fashioned. I do not come from the 18th century. But are fantasy and creativity stimulated the same way by a computer game as they are by Legos, for example? I think that the problem is not in the technology itself but in the use we make of it as in everything else. Too much is poisonous. And I feel relieved when I see that my kids, when they feel like, can still play as only kids can do. From nothing they are still able to create their world and stories. They have plenty of imagination. Then my worries fade away as I can see in them the same kids we used to be. In the end, every new generation must have asked the same question.

Jim Sogi replies:

J SogiWhen my son was younger, we also worried that he also loved computer games and stayed up all night playing. I reasoned, better playing at home than out on the street. He was also an athlete who surfed, snowboarded, skate boarded. But the training he got playing games serves him well now in his new career in the financial markets. Is what we do 24 hours a day glued to a screen any healthier? I say no. It's really the future of work and communication and social structure.

Speaking with my daughter, we compared our contacts with old high school friends and family. She right pointed out that it is easier for her with IM, Twitter, email, sms, and use cell phones to keep in touch. Don't be old fashioned. It's a new world.

Alan Millhone writes:

On the news tonight it was reported on a program in El Paso, Texas schools that has a regular exercise program in the schools that shows that regular exercise in youth produces better test scores, etc.

When I was a youth the neighborhood kids played outside till dark and our parents had to call us in for supper. In the Winter we built snow forts that we defended with snow balls against attackers. In the Summer if a new basement for a house was being excavated when the workers left we had dirt clod battles!

I began collecting stamps at age seven when that Christmas my parents gave me a Coronet stamp album and some stamps from H. E. Harris and Co. of Boston. In my early years they gave me sets of Lionel Trains (still have both sets in the original boxes ). We had no computers, cells, Ataris, etc. to fritter away our time and no TV for several years. We played board games, rode our Huffy bikes with a baseball card held in the rear spoke with a wooden clothespin. Modern technology is good to a point for youngsters. Much though that was good and wholesome has been forever lost. Just like the Checker players that at one time could be found on a daily basis in Central Park under the wooden canopied shelters. Tom Wiswell would not believe the changes there.

Jeff Watson comments:

I just got through watching the excellent movie Surfing For Life. Written and produced by David Brown and narrated by Beau Bridges, it chronicles the lives of people who are still surfing in the twilight of their lives. The movie took a sampling of notable surfers from the ages of 60-93, gave brief bios, and showed them surfing well as seniors. Surfing for Life is much more than a surfing documentary, it's a celebration of man's optimism and the results of living a life of optimism. It showed one particular surfer who visits senior facilities on a volunteer basis, and most of his charges are younger than him. It then cut away to him surfing a nice 6' wave. The central theme of this movie is that living a life with an optimistic bias will ensure personal happiness. My favorite scene is the closing where they show Doc Ball, 93 years old, riding a skateboard. Not only was he riding a skateboard, it was obvious that he was clearly enjoying it like a little kid. I've been told by many that I'm just like a little kid, and take that as a compliment whether they meant it as such or not. Little kids enjoy playing games, are optimistic by nature, and receptive to new experiences and knowledge. I'm of the view that trading is a game, an extension of the games we played as children. It can't be mere coincidence that a plurality of traders I know usually excel at one form of game or sport. Whether it's checkers, chess, poker, the racket sports, or surfing, these games played for a lifetime keep one's mind sharp, and mentally nimble. Game playing also keeps our competitive edge well honed, which serves us well in the markets. Surfing for Life is such a positive, uplifting movie that it should be seen by all, as it exudes optimism. It would be an interesting study to analyze the optimism/pessimism ratio for all market players. I have a hunch that the successful players would fall into the optimistic category. Optimism breeds self confidence.

Russ Sears says:

When I hear tales of the freedom of youth my thoughts often turn me back to my 7th grade year, in Pauls Valley OK, where I delivered the Pauls Valley Daily Democrat door to door on a rusted out Schwinn bike I had spray painted baby blue.

I recently went back and visited the town 33 years later. The drugstore where my brother and I spent our share of the subscription price on comic books, baseball cards and soda fountains chocolate shakes had moved from across the street from the newspaper to the new Wallmart. Parts where still the same, with only a fresh coat of paint, others totally gone.

We had a great time "owning" our part of town. However, I think we were one of the last two kids to deliver papers this way. The only reason they gave me the job, since the Sunday papers weight more than me, was cause they were desperate. Few parents would let their kids do something like this even in small town mid late 70s. And thinking back, there were several times where I think "what were my parents thinking"… As I had a machete to my neck from a high druggie, learned where to drop my collection money off before I went to certain areas, and narrowly escaped a pedophile.

Bottom line is it's not all the kids' fault.

Anton Johnson writes in:

In addition to dirt clod fights, we would play king-of-the-hill on construction excavation mounds, resulting in the occasional emergency room visit. During spring-time we played Monkey-in–the–Middle and 500, honing our baseball skills, all the while dodging vehicles and swatting mosquitoes. On moonless sultry summer nights, we played neighborhood wide team hide-in-seek, some of us subtly maneuvering to get close to the object of our affection. Not even brutal winter weather could keep us inside. Often a dozen would-be Bobby Hulls would play ice hockey, taking brutal hits without pads (some of us even wearing figure skates). We shoveled our own rink on the lake, and hauled seemingly endless buckets of water to fill in ice cracks. Almost nothing could deter us, we played whether +40F or -15F degrees, sometimes coming home soaked after falling through the ice or occasionally with a frostbitten appendage. I wonder whether the electronic generation will reflect on their childhood with a similar nostalgia.

Feb

23

Summary From Wikipedia: Haemophagic leeches attach to their hosts and remain there until they become full, at which point they fall off to digest. They all have an anterior (oral) sucker, which releases an anesthetic to prevent the host from feeling the leech. Some species of leech will nurture their young, while providing food, transport, and protection. Not all species can bite; 90% of them solely feed off decomposing bodies and open wounds. Leeches normally carry parasites. However, bacteria, viruses, and parasites from previous blood sources can survive within a leech for months, and may be retransmitted to humans. Bloodletting is the withdrawal of often considerable quantities of blood from a patient in the belief that this would cure or prevent a great many illnesses and disease. It was a popular medical practice from antiquity up to the late 19th century.

Leeches are part of the ecosystem. They have interesting characteristics:

There is only one huge difference:

Feb

17

One evening an old Cherokee told his grandson about a battle that goes on inside all people.

He said, "My son, the battle is between two wolves inside us all.

One is Evil. It is anger, envy, jealousy, sorrow, regret, greed, arrogance, self-pity, guilt, resentment, inferiority, lies, false pride, superiority, and ego.

The other is Good. It is joy, peace, love, hope, serenity, humility, kindness, benevolence, empathy, generosity, truth, generosity, compassion and faith."

The grandson thought about it for a minute and then asked his grandfather, "Which wolf wins?"

The old Cherokee simply replied, "The one you feed."

Michele Pezzutti responds:

This reminds me of The Strange Case of Dr Jekyll and Mr Hyde: I would like to share my experience on how this thinking can make me a better trader.

If I should apply this to my (very, very poor and limited) personal trading experience, I can find Evil everywhere:

 -arrogance, when I trade based on pure instinct and with little/no evidence of trends or data supporting a decision.

- false pride and superiority, for being able 'to beat the market', when I make some profit.

- anger, when I lose too much not being able to put a stop loss.

- lies, when I do not want to admit to yourself that I have acted irrationally.

- regret, when I think 'why did I do that?' And I could go on and on…

Much more difficult is to find examples of the Good wolf. That is, long way to go to become a 'Good' trader.

Paolo Pezzutti writes:

I want to propose a slightly different perspective of the two wolves, the "bad" and the "good" one.

Trading wolves move in packs. They are territorial and wait for their preys to graze standing ready to attack when they are distracted. Wolves can also establish some type of coordination during the hunt. They conceal themselves as they approach the prey, targeting the easiest options available, the weakest animals of the herd. Sick or young animals, even pregnant females. They look for preys they have seen already. They do not take much risk, do not even engage in long chases, and rather wait for their prey to die because of the wounds. Sometimes wolves have to yield to their prey and their killing success rate may be low. But they know that their prey will be there in the same place at the same time the next day. It is only a matter of time, sooner or later the wolves will get it. These traders are deadly, but the current downturn might have killed many of them. They have taken too much risk, too much confidence in their strength. These wolves have become preys themselves in this phase of the market. Those who will survive, however, may become even stronger and be able to adapt their techniques to the new environment.

Single trading wolves can also be found, but less frequently. Lone traders can be old specimens expelled from the pack or young animals in search of new territory. Solitary wolves target smaller animals and many deaths are due to other wolves' attacks. Being alone in the wild can be very dangerous. These traders have to find niches, small inefficiencies left over and disregarded by the wolves packs. They have to be adaptive. They have to learn how to survive. I feel one of the lone wolves. Hopefully I will survive and learn how to be a "good" wolf.

Who knows if any of the wolves will survive this market? After all, species can also disappear.

Feb

11

On February 10th, Treasury Secretary Timothy Geithner presented the details of the Administration's bank rescue plan. The new program includes government spending and private-sector involvement. It provides for buying toxic assets from banks and supporting consumer and small business lending. The aim is to get private investors to buy up the toxic mortgage related assets. Everything looks fine except that the markets plunged almost 5% after the speech in heavy selling. Bank shares lost more than 10%. We know that markets over-react, that the crowd sometimes is not able to make rational decisions, but what we saw today was a real fiasco after the world wide expectations of the first Administration's steps. Hopefully they will be more successful in the next weeks, but today's market reaction was nasty. The plan was deemed by analysts to have lack of transparency and lack of detail. How the plan is going to be implemented was not said and may be investors fear the nationalization of the banks that would wipe out shareholders (shouldn't have it happened already?).

As an agent of change, the new Administration has not offered a striking debut. This is for sure. I think it's important to understand why the strategy was so poor. Was there a lack of details on purpose? If yes, there had to be a good reason and this might be reassuring somehow. One could say they have a good plan and clear ideas, but they have decided not to describe them in detail now. Might this be related to the approval process of the stimulus package? In this case, it was a great buying opportunity. But if the lack of details was there because there are no details yet, well, I think the markets have a good reason to be scared. Everybody now is thinking of what the President said: "The time for talk is over, the time for action is now." And critics are already saying that he won the campaign and now it's time to lead. In this context, the speech given by Geithner today is a false note in the concert of statements received in the past weeks. I do have trust that the Administration will manage to restore trust and confidence, and revive the conomy. The world is looking at the US with great hope (too much?). Hopefully today it was only an episode of failed communication strategy and not the lack of the financial stability strategy.

Victor Niederhoffer comments:

One must always remember the beaten favorite routine with the next time out winning at much more favorable odds by indirection. "Boy, dont work him so hard at 4 to 5 unless he's a clear winner," and also, the bond and stock vigilantes who like to force the forces to do the right thing through going down when they might waver.

Feb

8

During my chess career I learned a lot about the dark side of psychology. One thing that I didn't put into 'Chess for Scoundrels' was how to talk a tournament leader into self destruction.

It goes like this. Let's say that a particular player is leading a tournament and is really 'in the zone'. The way to ruin him is to congratulate him on his magnificent play and then innocently ask what exactly is he doing right? This works in 2 ways, the first part (the flattery) being to cultivate vanity (more preening, less vigilance) and the second (requesting the explanation) fosters the kind of self-consciousness which takes them well and truly out of the zone.

Now I don't use this myself, but I've seen it done many times by, let's say, 'well meaning' fans. They flatter and beg advice, thus unknowingly sowing the seeds of self-destruction in their hero. And of course they promptly move onto a new hero when that one happens to fall.

This is why it's better to only flatter your enemies. And run like the wind when you're the lucky recipient.

Pitt T. Maner III adds:

Gamesmenship is practiced in many sports. And Stephen Potter was one of the masters in a good-hearted way:

All this failure is important, for it never would have occurred to a successful man to devise the four strange books that were the making of Potter's reputation as a comic artist. The idea for these books first arose while Potter was playing tennis with the philosopher C.E.M. Joad as his partner, against two younger and better players. After hitting a ball that was obviously well out of court, Joad called, "Kindly say clearly, please, whether the ball was in or out." By suggesting a slight lapse in etiquette on the part of the younger players, good sportsmen both, it threw them off stride, a stride they never regained, and Potter and Joad went on to win the match. "For me," writes Potter, "it was the birth of gamesmanship." "Gamesmanship" is devoted to "the art of winning games without actually cheating." Actually is the key word here. In tennis, golf, chess, poker, cricket, bridge, hunting and other games, Potter suggests delicate ways of breaking the flow of concentration in your opponent so that he stumbles and falls off his game. A gamesman does what he can to make sure that the best man does not win.

article

George Parkanyi comments:

This would suggest a corollary that insults and criticism would only just strengthen the already confident, i.e. the rise to the challenge gets the creative/competitive juices flowing.

It reminds of a recent football game — I think it was the Super Bowl. For some unknown reason, this huge Pittsburgh player went after this much smaller Cardinal player tossing him around like a rag after the whistle had blown. I remember commenting at the time — "What did he say to that guy?" It certainly was something.

Paolo Pezzutti writes in:

It happened to me after a long streak of winning games during a tennis match. For some reason I was in the game, focused and ready to exploit any weakness of my opponent. But when I would start to rationalize what was happening and why it was happening and building scenarios for the final victory I was finished, and eventually I would lose at least the set. Maybe it's because you take bigger risks: you think you can do even better and change something in your tactics. This makes you out of sync with your physical and mental condition which builds an advantage to your adversary. Similarly in the markets, after a long winning streak, when I try to analyze the what and whys, I end up changing the way I have been trading up to that moment and things get worse.

Nigel Davies adds:

Empty sycophants can be bad news for any teacher, especially teachers who are active participants in their activity and need to maintain great focus and self discipline. I've found in my own mentoring work that the best students can be very difficult, but they can actually help you raise your own game.

Jan

19

The financial crisis has a number of causes including weaknesses and gaps in regulation and supervision. However, the idea of a growing government as a solution to problems created by greedy capitalists and bankers around the world looks too simplistic and has a bit of populism in it. There may be results in the short term, but in the longer term the issues will likely be more than the benefits with an expensive bill for the next generation of taxpayers and citizens. I am not referring specifically to the US, but also to Europe to some extent.

Real change would be first to understand weaknesses and challenges of our industrial, financial and social systems. The world is changing. There are new players in the game. And the relative importance and power of countries is changing with time, and accelerating. We should recognize this fact. This has consequences on our present and future ability to be innovative and competitive, on the possibility to maintain the same lifestyle in the future, the same welfare. This crisis has shown that the US is still vital and fundamental for the good of the world's economy, but it has also dramatically shown the increasing difficulties of the US in maintaining this leadership, which is not only economic, but also intellectual and political. After this crisis we cannot go back to business as usual and our countries will end up with more debt on their shoulders. We cannot solve the crisis just pumping government money in a model that is not working without doing anything to change it. We will only have crisis after crisis if we do not eliminate the roots of the problem. And the problem is that new players in the global economy produce goods cheaper than we do, that they are learning fast how to make high tech products and services, that they sell more than they buy. This is causing a fundamental imbalance in the global system that market forces should solve within a proper framework and set of rules provided by governments. Also we should probably all realize that may be we are living a standard that we cannot afford any more.

From a WSJ article:

One memorable moment in "Atlas" occurs near the very end, when the economy has been rendered comatose by all the great economic minds in Washington. Finally, and out of desperation, the politicians come to the heroic businessman John Galt (who has resisted their assault on capitalism) and beg him to help them get the economy back on track. The discussion sounds much like what would happen today: Galt: "You want me to be Economic Dictator?" Mr. Thompson: "Yes!" "And you'll obey any order I give?" "Implicitly!" "Then start by abolishing all income taxes." "Oh no!" screamed Mr. Thompson, leaping to his feet. "We couldn't do that . . . How would we pay government employees?" "Fire your government employees." "Oh, no!" Abolishing the income tax. Now that really would be a genuine economic stimulus. But Mr. Obama and the Democrats in Washington want to do the opposite: to raise the income tax "for purposes of fairness" as Barack Obama puts it.

Riz Din writes:

Not so long ago, I heard a pundit commenting on recent economic policy responses saying something along the lines of when the fires are raging, the first priority is to put them out, and to deal with the longer term implications later. Personally, I think it is better to sometimes let things burn and let nature take its course.

I agree that we are living a standard we cannot afford any more, but only in the sense that we may have 'brought forward' living standards by a few years and that we may have to contend with tougher times before the wheels of progress start spinning again. Indeed, while a part of me worries that all this policy meddling risks damaging the natural checks and balances of a free system, I am reminded of the old adage 'necessity is the mother of invention', and look forward to new discoveries being born from a period of relative hardship.

Duncan Coker adds:

Looking to history, in the 1930s all the programs rolled out by FDR did little to solve the Depression. There was even a mini Roosevelt depression within a Depression in 1937-38, four years after all the government action. What did get people back to work was arming for potential conflict, which added three million jobs in 1939-40 and continued through the horrible conflict to follow. All the FDR structural reforms played a bigger role a decade later, after the war, when security and arguably a more transparent system allowed for exponential growth for middle class incomes, housing and standards of living. I believe it will be the small businessman and entrepreneur that paves the way this time, really the only ones that can "create" jobs.

Jan

9

The biggest love delusion is illusion. When you feel the irresistible attraction of the first dates, you think she has something special, unique that you cannot miss even for a minute. But with time inevitably daydreams vanish. And you discover a different person. That you don't understand. That you don't know. That you don't like anymore. You remain with the bitter feeling of failure. Once again.

It is similar when you apply a market model that works for some time. All parameters perfectly synchronized with the price action, you are mesmerized by such perfection and beauty. Price swings follow the rhythm that you have perceived and coded. Invariably cycles change and the same parameters and logic applied appear so inadequate and awkward you feel almost ashamed to have considered them in the first place. You remain with the bitter feeling of failure. But for some time, the illusion to have found your meal for a life time remains. The illusion to have found the woman of your life.

Jan

4

The most powerful kind of love is the love that is not self centered, but goes outward. This kind of love can take many forms such as the love of knowledge, compassion and empathy towards others, the love of nature, love of one's profession and work, or the love of art. In some respects one can love the market as a love of knowledge.

I disagree with the oft used characterization of the market as 'mistress'. That definition embodies and emphasizes more tawdry, baser instincts in the relationship. It is an erroneous anthropomorphication and an unhealthy relationship. Empathy is one of the elements of love. Empathy can be used to understand the herd's motivation to profit in the market. Love enables late nights, long hours and tedious computations. Love is power. Love creates power and that is why it is the greatest of all.

Jeff Watson adds:

I'm so glad that the holiday season has passed, as all of the commercialized sentimentality tends to give me a case of a sour stomach and the need for a strong bromide. Holiday cheer is supposed to allow one to demonstrate love for his fellow man, and a person is supposed to show this love by purchasing as much swag as possible to keep the holiday numbers strong. To all of this, I have to agree with Dickens and say, "Bah Humbug." Not to say that I have anything against love, but love has some psychological components that should be examined. Love has been shown to be a mammalian trait, much like hunger or thirst. Psychologists state that there are different stages of love in an interpersonal basis that include lust, attraction, and attachment. These stages can be overlapping and all involve the chemistry of neurotransmitters in the brain and other endocrine glands. Some theories about this misunderstood phenomenon also state that love is composed of three components that are intimacy, commitment, and passion.

While it is all good that psychologists have done exhaustive studies of love, it is my contention that self delusion is a major component of what we call love. When there is that initial attraction between two people, only the good sides are shown, and one only sees an incomplete picture of what the other person is all about. The mind makes up an idealized model of the other person, ignoring all of the other characteristics that could cause one to change one's mind.

Love happens to be a very irrational concept, although it's  worked since time began. Love has been the subject of writers from Shakespeare and Ovid, to Danielle Steele and a hundred other cheap romance writers. Love happens to be big business, in fact it's a multibillion dollar business. It would be a tough calculation to determine the amount of our GDP, that is a derivative of love.

Love happens to be a very bad thing for speculators or any traders for that matter. When one falls in love with a position, irrationality takes over, and one only sees the idealized position, not the real one. When one loves one side of the market, whether it be bullish or bearish, all other rational arguments fall upon deaf ears. When one loves a particular method of trading… a style, one might not see that the method has become unprofitable before it's too late. Love will keep one going back to the same mistakes, all irrational of course, but that's what happens sometimes. One might fall in love with the Mistress of the Markets, and feel a strong desire to be at her side 24/7, and always have a position on. Spending all of one's time in the market courting the Mistress, carrying a position, can spell financial doom. I'm sure that a hundred different analogies about the detrimental effects of love regarding trading could be listed, and this short list is by no means complete. I will admit that I feel a lot of love in my heart for friends, family, and my country. I will also admit that I've felt love in the markets before and paid very dearly for that love. Since I've gotten older, the best trading lesson I've finally gotten after all these years is the lesson of a dispassionate attitude, not love.

Kim Zussman writes:

A man walks into the market, and asks, "What kinda Gin ya got?"

She replies, "Oxygen, Nitrogen, and Estrogen"

It seems no accident to refer to the market's alluring, seductive, narcotizing, hypnotic, deceptive, convoluted, torturous, capricious, punitive, empty, destructive path as "mistress". Not just any mistress; but that just ripe girl with a perfect body, blemish-less skin, and crystal eyes that smile with love just for you. Until you grow to need it.

How do you dally with her without falling in love? As Jeff says, love is the point beyond which ruin no longer matters. If you can be intent enough to see it coming, can you be strong enough to resist the temptation of heroic sacrifice?

Maybe it takes a good lady's man. Presumably the guy who can take it right to the edge, make her believe, but hold back enough of himself to walk away unscathed at any moment. See Casanova.

Dr. Janice Dorn observes:

J DornIn my experience, one approaches the study of the markets, the long hours, the tedious computations with a sense of passion. People truly fall in love with the study of the markets and the attempt to make sense of them. Perhaps it is the challenge of attempting to understand or explain that which can possibly be understood or explained after the fact — not before.

First Corinthians 13: 1-13 says that — of faith, hope and love — the greatest of these is love.

In the actual trading of the markets, there is no place for faith, hope or love. Markets are not entirely rational and not entirely random. They hold out hope and dash it. They hold out faith and dash it. One can fall in love with the idea of trading until your real money in on the line. Then, the mean markets show themselves and love turns to fear and loathing. Certainly, one can use the concept of empathy to understand the motivation of the herd to profit in the markets. The herd needs empathy because, for the most part, the herd loses.

The markets are neither friendly nor loving. This is a game where some 60 million people compete everyday to take your money before you take theirs. If love is truly a battlefield, there is no better place to find the battle than in the markets.

The markets demand humility, they demand gratitude, they demand that one approaches each day as a loser.

I challenge anyone who actively trades these markets every day to tell me that they are not a demanding mistress, that they are not there to take as much money from as many people as possible or that they are loving and kind. 

Paolo Pezzutti adds:

The relationship between love and passion is interesting. A sane passion helps you reach significant results and objectives. You do not have great objectives if you are not a dreamer, and somehow an irrational component in these endeavors is always involved. Markets are not loving and caring, but you can actually love the way they are structured and twork, and how they surprise investors with sudden and unexpected moves which systematically trap the herd on the wrong side.

You can love the long and patient endeavor to discover hidden inefficiencies and short term behaviors due to specific and repetitive moves of certain participants in the markets. However, love must not be confused with obsession. In this regard, the initial phase of a relationship is characterized by an instantaneous attraction. This phase can be replaced by an anxious and obsessive phase, characterised by an unhealthy attachment possibly overwhelming your life. The final destructive phase may involve extreme feelings of self-blame, anger, and desire to seek revenge. Markets are a fascinating expression of social behavior. The emotional behavior and the ever-changing characteristics and number of participants makes them so complex and quite unpredictable. But the feelings that participants in the markets can have are quite similar to those in a relationship. The post Lady in Sorrento I wrote back in November is about this.

Jan

1

1. They say a good symphony ends on the same motif that it starts on in many respects. Would you hypothesize that the market will do the same with respect to its beginning and end?

2. Aside from the admonition of the British Navy that politics and religion not be discussed at dinner, and that no one speak before the captain, and that articles of war are to be read every Sunday, and that no one argue with an officer publicly (a capital offense), and that all invitations from the captain be accepted, what are the major customs of the British Navy that made them the source of so much peace and prosperity and victory for 200 years, in a field where, like ours, just one plank separates you from life or death, and the only certainty is that you always have to be on your guard, with two lookouts always on duty?

3. What are the requirements for a market move to replicate and exponentiate? After a very quiet five up days in a row, what does the market have in store for us, especially considering the unchanged day in Japan, and the fantastic 1 1/2 % moves in 10 minutes at the early stealth close in the Europeans?

Paolo Pezzutti comments:

The following are customs and traditions of the Royal Navy that I find significant in this regard:

- Until 1825 some pay was held back as a guarantee against desertion
- Capt. Cook was determined to avoid deaths from scurvy. His success was an important step in the creation of the British Empire. Other diseases were avoided through keeping the ship, the crew and their clothes clean.
- Organization. Each man's role on board was efficiently defined.
- Discipline was important. Punishment also reinforced organization. Men were punished if they failed to do their duty and put the ship in danger.
- Training made the difference. British ships handled sails and fired guns more quickly than others.
- Navigational skills. They were by far superior.
- Promotion to Commander and then Captain was through merit or bravery. Incentives are key to success of an organization.
- The best officers through patronage could pick their followers. This would create cohesive, ambitious teams willing to pursue victories and prizes.

I would add also:
- Wardroom drinking (which must be social and not solitary), and the toast of the day
- Men remove their caps entering a mess
- The rule about not to call anyone a liar in the wardroom 
- Using the ship's bell to mark the passage of time
- Seniors board last and leave first.

My view is that you do not build a Navy like that only with money. You need to have an organization which attracts brilliant minds, able to understand the strategic context, conceive and implement successful visions, capable of commanding men. On the other hand, you need people who can develop the best operational concepts, understand the operational requirements, design ships and weapons better than others, an industry base able to support adequately the fleet. You need to have good sailors and fighters to achieve the command of the sea and it is not only a matter of money. They need to be professionally skilled, motivated and share common values and objectives.

Nigel Davies adds:

There's also a question of motivation. Britain, being an island, would be able to defend itself by commanding the waves. And being good at seafaring was also essential from a trade point of view. You can still see the influence of these times in today's UK with our preference for preserved foods such as marmalade and port.

GM Davies is the author of Play 1 e4 e5: A Complete Repertoire for Black, Everyman, 2005

Dec

31

I believe that Treasuries should not be even considered at these prices. I see a better opportunity with corporate bonds as investors will switch from low-yielding Treasury bonds to high-grade corporate debt. It’s early to say that credit is finally back, but the LIBOR (London Interbank Offered Rate) went considerably down from recent highs. In September, investment grade bonds plunged after the collapse of Lehman Brothers. Now they have recovered a lot from their lows but the yield spread with Treasuries is still very big. As credit markets normalize, the economy starts to recover and risk taking is resumed this spread will be reduced. Partially because of the huge amount of government bonds that will be issued to finance debt that will finally bring interest rates higher. But also because investment grade bonds will represent a good investment opportunity as general conditions improve at the expense of low yielding Treasury bonds.

Jeff Rollert responds:

We were +95% in treasuries for much of the year.

A more important question is are the events of Q4 are likely to continue in the near future? That is something money can be made from.

My wife an I went to see the movie Australia recently. In it, a boy stands in front of a stampede and looks the lead bull in the eye in an attempt to keep the heard from going off the cliff. Right now, there are many alpha males charging towards multiple cliffs. I sure hope there is a brave one, and they see the boy in real life.

Dec

23

When you are in love with someone, you refuse to see certain aspects of his/her personality and behavior. You find always a way and a reason to justify them. Although you are humiliated and hurt, you do not manage to free yourself from the situation. You are willing to accept any condition provided that the link with the loved one remains established. At any price and any cost. It is impossible to think of a different relationship or even life without that person. When you finally manage to leave this blurred perception of the reality, you may have damaged yourself seriously. Similarly, there are investors who are in love with a specific stock they have been following for years. They look at the ups and downs of prices with the idea that eventually their loved one will reward their patience and trust. When prices go down, they continue to find justifications about the good fundamentals, the strong cash flow, the new products the company is about to launch, the improved market share and so forth. Or even the charisma of the leadership. They average down their positions as prices plunge, but they do not even think of buying something else which could perform better.

Falling in love implies a "fall" into a new state of mind, a dramatic, uncontrollable and sudden emotional change. A state of vulnerability for the investor, but also of irrational excitement to start a new life. During the dotcom bubble these situations were quite common. This is typical of some companies such as Google or Apple. For their fans, it is difficult today to justify why the stocks have lost more than 50% in one year. Actually, I would refer to infatuation more than love at this point. Love is a mutual condition and in this case there is no reciprocity. But we'll see what happens to these emotional relationships and their investors' portfolios in the next months.

Nigel Davies adds:

This is one of the great truths of very many activities. I sometimes think that it's especially dangerous for counters because we can find new numbers on the fly and convince ourselves we're being scientific. I've become convinced that the proper approach is to adopt the same rigor as some of our TA cousins and have trades worked out beforehand and have them written down trading plan. This should of course include escape routes.

By the way, I understand that some hard-nosed American women conduct early dates like a kind of interview, which would be the, er, 'romantic' equivalent. Once their potential beau meets the appropriate criteria (shoes, manners, absence of hair in ears etc) they allow themselves to 'fall in love.' In many respects this actually seems very sensible though I wonder how well it has been tested. If any successful trades had actually been made, presumably they wouldn't still be looking. So the criteria must therefore be arbitrary.

Dec

5

Many years ago I wanted to date a friend of mine. When I called her, sometimes she was nice and would talk. This gave me hope. The same hope you have when markets rebound after a sell off for a few sessions even with light volume. Sometimes she would tell me: "Call me back in five minutes. I am doing something very important." When I called back after five minutes, she would not pick up the phone. Or if she finally did, she would say: "Sorry. I am leaving now. Can you call me this evening?" When I called her later, I wouldn't simply find her at home, she would be busy brushing her teeth or shampooing her hair. Eventually I didn't succeed in my efforts and I gave up. Low after low, rebound after rebound, you refuse to accept that you are in a bear market. You keep on insisting as stubborn as ever. And your losses mount. You refuse to see signals that are very clear to those not emotionally involved in the situation. And you average your positions as prices go down, with horrible outcomes. As if, in the case of my girlfriend's story, hope resulted in a mortal disease.

At the same time, I like to remember the epic fight between Rocky Balboa and Lang. Rocky was feeling the pain of his opponent's tough punches. Lang said: "I'm gonna torture him. I'm gonna crucify him. Real bad." Rocky replied: "You ain't so bad, you ain't so bad, you ain't nothin'. C'mon, champ, hit me in the face! My mom hits harder than you!". Lang expended his energy trying to knock Rocky out. Rocky eventually retaliated and knocked the confused Lang out with an impressive counter-attack. The 9% plunge few days ago hurt me much less than the downtrend did back in October. Eventually you get used to these plunges. You get prepared to expect very negative events. Hopefully bears will get exhausted like Lang did and we will eventually see higher prices and a trend reversal. The selling pressure at a certain point will ease and the bulls will prevail with a fast and sudden counter trend as Rocky came back and surprised his opponent.

Kim Zussman comments:

It's hard to imagine that most traders can discern random from non-random, not to mention that even scientists have trouble with the subtleties (pertinent variables, sample size, learning set selection, multiple hypotheses, causation vs. association, etc.).

Another way to assess this is whether statistically astute traders do better (under all market conditions) than innumerates.

Dan Grossman remarks:

Regarding the girlfriend story, it is a principle of behavioral psychology, and gambling, that random reinforcement is highly addictive. 

Victor Niederhoffer replies:

One should carefully consider whether there is any evidence that random reinforcement is better than systematic reinforcement or punishment in inducing behavior. The evidence is very mixed and inconclusive last time I studied it.

Gibbons Burke writes:

The wikipedia article on Operant Conditioning in a sub-article titled Reinforcement provides a decent trailhead to further references, as well as criticisms:

Effects of different types of simple schedules

• Ratio schedules produce higher rates of responding than interval schedules, when the rates of reinforcement are otherwise similar.

• Variable schedules produce higher rates and greater resistance to extinction than most fixed schedules. This is also known as the Partial Reinforcement Extinction Effect (PREE)

• The variable ratio schedule produces both the highest rate of responding and the greatest resistance to extinction (an example would be the behavior of gamblers at slot machines)

• Fixed schedules produce 'post-reinforcement pauses' (PRP), where responses will briefly cease immediately following reinforcement, though the pause is a function of the upcoming response requirement rather than the prior reinforcement. • The PRP of a fixed interval schedule is frequently followed by an accelerating rate of response which is "scallop shaped," while those of fixed ratio schedules are more angular.

• Organisms whose schedules of reinforcement are 'thinned' (that is, requiring more responses or a greater wait before reinforcement) may experience 'ratio strain' if thinned too quickly. This produces behavior similar to that seen during extinction.

• Partial reinforcement schedules are more resistant to extinction than continuous reinforcement schedules. • Ratio schedules are more resistant than interval schedules and variable schedules more resistant than fixed ones.

Nov

30

I was driving on the motorway I-95 last Saturday, the day after Thanksgiving, to come back home from Washington DC after visiting some friends. There was traffic, but it was acceptable and with a kind of "stop and go pattern." Patterns change all the time, but my wife came up with the usual comment: "You are always on the wrong lane!". For an Italian driver this is quite an outrageous comment, I have to say. In these situations I normally do not change lanes often, I tend to stick to one lane. After all, the distribution of cars in the three lanes should be efficient with cars moving from one lane to the other until drivers see a benefit in changing. With my portfolio of stocks I tend to do the same. When I start chasing sectors and stocks, I do worse than following a buy and hold strategy. The timing is difficult, I end up overtrading and paying a lot of commissions. For some time I noticed that on the left lane there were more cars than on the other lanes because that lane was faster. However, when cars came to a stop, the left and center lanes were much better because they had less cars. You could see drivers shifting away from the left lane in that situation. As the traffic conditions improved, this pattern disappeared. My mind went to the markets and their ever changing nature. Those investors fast enough to notice a new pattern can benefit from the temporary market inefficiencies and I came to the conclusion that I could also ask my wife to help me manage my portfolio. Then, after almost two hours driving, I happened to see the same truck on the center lane that overtook me during the "stop and go" pattern. He remained very likely on the same lane all the time, while I was wasting time and energy.

Scott Brooks adds:

S BI've written about this before, but when I used to have to fight rush hour (I've completely arranged my life to avoid rush hour and I'm successful about 95% of the time), I noticed a few patterns.

Based on a a 8 - 12 lane highway (4 - 6 lanes in each direction), the best lane to be in was the second to last lane (the 3rd lane if there were 4 lanes or the 5th lane of there were 6 lanes.)

The right two lanes had to deal with traffic merging and exiting so they were slower. The furthest left lane was where most people went to "go fast" (as it is known as the "fast lane" or "passing lane"). However, it was my experience that so many people went for this lane, that it got crowded. It had spurts and burst, that were followed by busts.

So people in the "fast lane" would have periods where they got ahead and things went fast. When that happened people in the second to last lane would immediately jump into the left lane to take advantage of the current "trend" of moving fast. That would clear out the second to last lane and "off we'd go in that lane". People in the second to last lane would also be dropping into the right two lanes to exit. The further I drove, the less traffic would get (because as we moved away from the city centers to the outskirts, traffic merging in decreased and traffic exiting increased) and more and more people would exit.

The fast lane people would usually stay in that lane because they liked the big burst of speed that that lane would provide (at least that's my hypothesis) and would fear that they'd miss out on "the next big run" more than they feared getting stuck in motionless traffic.

My theory didn't hold up everyday. Sometimes the left lane would be faster. Sometimes a traffic jam or a "Sunday Driver" would screw things up. But at the margin, the second to last lane was the best lane to be in to make the best overall time when traveling in heavier traffic.

Nov

8

As you may be aware, shock and awe is a military doctrine based on the use of overwhelming power and "spectacular displays of force to paralyze an adversary's perception of the battlefield and destroy its will to fight". After the second consecutive day plunge in the markets with more than 10% lost, this was the feeling I had yesterday looking at the closing prices: shock and awe.  Your perception is paralyzed, you are not able to fully understand the context in which you are operating and therefore to make rational and informed decisions. Your will to fight is destroyed and you are simply brought to turn away your account statements in disgust.

Is this the result of a campaign built to shake weak hands (and minds)?   Most of us are vaccinated by many other bear markets and crashes, such as 1987 and 2001-2002.  Something really spectacular was needed this time to shake the resolve not to give away stocks at these ridiculous prices.  Well, "they" are doing it.  The public is shaken, hit by bad news on all sides and sudden panics in the markets. The public is selling at any price, stocks, mutual funds, bonds. The average investor cannot see the big picture, overwhelmed by negative information campaigns and catastrophic predictions.

It is difficult to resist, but I will try not to fall victim of this "shock and awe" campaign.  I will not put my stocks "for sale" at these levels.  On the contrary, I will buy new dips. Markets forces are already at work to adapt to the new situation, economies will find eventually a way to deal with the recession. It will be painful, but it will not be the end of the world and capitalism.  We will continue on the secular path of growth. On a different note, I hope that the governments' intervention to deal with dysfunctional markets and the collapse experienced in the past weeks will not kill the patient instead of curing it.   

Vincent Andres asks:

You wrote "the public is shaken". I'm wondering how much of the market is actually in "public" hands ?

If I compare what people (the public) save on their own willingly, and what the public must save in pension funds in mandatory way, I guess the public's direct participation in the markets is much lower than e.g. pension funds. So, I doubt public is now shaken, public has probably gotten out since already several weeks. Of course, this may vary from country to country.

Riz Din notes:

One public, on the other side of the world, seem to be buying with abandon as prices flirt with their lowest levels in a couple of decades. From Bloomberg .

'Nov. 7 (Bloomberg) — Japan's individual investors, armed with more than $7 trillion in cash, piled into shares trading at their cheapest valuations ever last month, even as the global credit crisis prompted overseas fund managers to sell out.'

I'm not sure about the choice of quotes in the article though:

'Individuals are the most clever out of any investor group, in my opinion'

'…they're not the kind of investors who get carried away with optimism and keep buying'
 

Nov

1

There was a lady in Sorrento wearing a pink dress at a party that night. She asked the man in front of her: "Do you think that someone who has been married to a woman for 25 years could decide to leave her for me?" She was beautiful. She was staring at him now. How could it ever be possible for someone to resist her? He saw his own life passing by. The relationship with his wife had become difficult, and his job was keeping him very busy but unhappy. In his mid forties, he was seeing his life progressing on a declining trend. He knew he had to do something about it. He answered the lady: "He is a lucky man, but it is not so easy. There are people who do not accept taking a loss," he continued. "You manage your life the same way you manage your portfolio of stocks."

The bear market had started a year earlier. At the time, it was difficult if not impossible to see what was coming. In the same way, at a certain point his relationship had started to get worse. When prices printed the first leg to the downside he hoped it was only a correction. But prices moved again down to lower lows month after month. He could see his losses accumulate and still he could not act. His relationship was exactly the same, low after low with some rebounds from time to time. The trend was clear, but he could not make a decision. Hope, fear, a sense of guilt, it was difficult to take responsibility for a failure.

He said: "People do not want to sell at a loss. They keep their positions hoping that things will improve. It is human nature. Eventually, when they are desperate and get their margin calls because markets capitulate, they finally liquidate and take huge losses. Similarly, most people will not close their relationship until there is really no other alternative and things have become unmanageable and nasty."

She asked: "So what is going to happen?"

"It depends what kind of guy he is. Ask the lucky man if he uses stop losses in the markets and you will know if he will leave his wife soon. If he does not, then you have to hope for extreme events to come that will overwhelm him and force him to decide." He could see the path he was personally following. He was hoping for her that the lucky man was different. "I wish you good luck. Let me know how it goes," he said and left. After six months, he was reading a newspaper at the airport in Washington D.C. when he recalled that conversation with that lady in Sorrento . Markets were plunging to multi-year lows in a wave of panic. He was at a critical point with his wife. He asked himself: "Can my relationship survive this phase? What has happened to the lucky man?" After all, when you have a sell-off a new trend will eventually emerge… He did not know at the time that he would meet her again.

Oct

26

In a recent Bloomberg interview, Roubini says that markets are dysfunctional, there are no natural buyers, markets are in a situation of deleveraging, capitulation and total panic. He says to stay away from the US dollar, which appreciated too much. Stock prices will plunge another 20-30%. Relative economic, political, geostrategic power of the US over time will be eroded and reduced. It is likely we will experience a L shaped recession with long term economic stagnation. Not really an optimistic view I must say. Sen. Obama has a clearer idea of how to solve the crisis. He said a laissez-faire approach at this time cannot work. I was skeptical when I heard him speak at the beginning of this year and then the economy and markets spiraled down as he predicted.

I do not have enough information or the crystal ball to assess whether he is right or not, however, his "predictions" are quite scary. But are we really able to predict how this crisis is going to evolve? Being optimistic may sound silly at this point. The crisis is spreading to East Europe, smaller governments may default, there may be a currency crisis. The speed of this meltdown in the past weeks has been impressive. Are there any positive points? For the moment I do not see many, unless you believe that market forces will start again to price assets orderly and investors will see good value for money at these prices sooner or later. I believe, however, that we may see even a long rebound, but this crisis will have a long term effect. If you look at the charts, e.g. the Nasdaq, you can see that the bear market has actually started in 2000. The uptrend between 2002 and 2007 was only a long rebound. The long term bear trend has now resumed to print a C Elliot wave for the "secular" optimists or a wave 3 for the chronic bears.

Has the ability of creating wealth in our societies become a problem? If technology and innovation are not creating value in our economies, it may the bad sign of the shifting of geostrategic power to other powers of the world. The challenge is intellectual. We need to rethink if we want to tackle this challenge, and how our societies can re-organize and re-assess their life-style, their education, financial and industrial system.

Nigel Davies responds: 

Quite a few people have predicted something like this, though they tend to differ on how it will play out. The big unknown is how we react to this crisis, for example it's a moot point about whether we should have tried to prop the thing up at all.

One very interesting feature to emerge from this is that the World's nations have come to a very sudden understanding that we're all linked economically. So hostile acts vis a vis oil, for example, end up rebounding. I wonder if this will be the great good that emerges from this crisis, an awareness of our shared predicament.

GM Davies is the author of Play 1 e4 e5: A Complete Repertoire for Black, Everyman, 2005

Oct

12

V N1. Of the 100 biggest markets around the world, almost all are down 40- 60% in dollar terms with the exceptions' being Tunisia and Botswana. The impact of the decline this week, unless rapidly reversed, is going to be very severe on purchases. The previous 20% caused great angst; imagine what this decline will do to those who rely on retirements. The positive feedback of the decline in a negative direction also impacts the election results with every market decline making it more likely the Republicans will be blamed for the situation.

2. The worst aspect of the decline this week from a health point of view was that fixed income around the world cratered, thereby reducing world wealth by a good 15% as opposed to the normal situation where the equities go down 10% and the fixed incomes go up 8% leaving total wealth down only a little. And the people that talked about how bearish it was for stocks because commodities were up would never say that it's bullish now because commodities are down 40% over the past four months.

3. A new word should enter the market vocabulary, a waterboarding decline, being a decline that seems to have a breath of life at the open before going into a death spiral.

4. Because of the decline in all sectors, the wealth/price ratio has stayed relatively constant with corn, copper, soybeans, wheat and oil down 40- 50% since June 30, thereby keeping the number of bushels and barrels we can buy with one DJIA relatively constant, making the number of ounces of gold you can buy with the Dow less than 10 for the first time in a googol, and looking like a bargain for the Dow.

Paolo Pezzutti writes:

In other crises you could see the flow of money from bear markets to more promising assets. From equities to bonds, from equities to housing, from technology to defensive, and so forth. You could see investors moving away from the "bad" returns toward the "new" vein of expected future returns. This time it is a simultaneous meltdown and loss of money everywhere. Only cash has been a safe haven in each country. At least until some of the currencies initiate a fast devaluation path on lack of trust not only of the banking system but also of a country's ability to navigate these stormy waters. Only a few months ago I was confident to see the financial system, at least in the US, finding a good base and start recovering. After all the financial system of the US could not simply collapse! I was not expecting this could go so far. There were many predicting a financial armageddon but I did not pay too much attention. Catastrophists have always been around. The fact that money is simply being burned actually makes it quite difficult to have a complete recovery. I am afraid it will take many years. Because in this case, simply, the flow of investments cannot return to equities. This time there is not enough money to move away from some other asset. What I am really afraid of, and I go back to a previous post I wrote about the end of the US dominance era, is the following: this crisis signals the transition to a new balance of power in the world. I learned at my expense that systems and large organizations continue to act ignoring that they are moving at the edge of an abyss. Factors for a change of balance accumulate but they are ignored. Suddenly they ignite rapid and impressive changes with an avalanche effect (black swans?). It seems that these transitions cannot occur smoothly or gradually. Awareness does not grow gradually. People live in a dream until they are brought abruptly to reality. The reality is that the US and Europe have lived a number of years spending and consuming more than they could afford. Continuously growing current account deficit and immense flows of money out of our countries did not ring the bell. Now, whatever the specific cause that started the crisis we are brought to reality. More regulations vs less regulations, more government vs less government are the discussions we hear in order to try and find a solution. The problem lies in the fact that our societies consume and spend more than they earn accumulating debts that eventually nobody will be able to pay. This has to be changed somehow. And hopefully not through increased presence of the governments in the economy or, even worse, through protectionism. Of course emerging markets are suffering a lot in this crisis. We are the main source of income for them and we finance their surpluses. Moreover, we will not be able to go back soon to previous levels of demand. However, the relative weight of some of these countries will increase as their internal demand will pick up to fuel their growth while we lick our wounds. And demography explains the dynamics of aging western societies. We need to be aware that this historical shift is developing and accelerating. I do not think we will be able to go back to "business as usual". This will have effects in the long term, in my opinion, also in the strategic posture of the US and Europe and in their role in the world governance. There are already signs of increased weakness from the military and political perspective. More in general, we need to understand the possible answers to this crisis. And the implications. This phase, however, if my analysis is correct, could be an opportunity to invest in those emerging markets that will grow faster than we will be able to do (provided that one still has the liquidity to do it).

Steve Leslie remarks:

If it were not enough for ACORN to help destroy the housing market in Florida by being the pointpersons for loans to unqualified buyers, now it seems they wish to start another stain on the Sunshine State with voter fraud. It seems that Mickey Mouse tried to register to vote in the state of Florida at the behest of the political action group. They are currently under investingation in 13 states for voter fraud. My one question would be how in the world did Mickey fill out the application and sign it with those huge hands? And if Mickey Mouse is registered will the other Disney characters soon follow?

Sep

19

Springbok HerdAs animals grazing peacefully hear gun shots and start running without at first understanding the right direction to go, the herd begins to form.  The animals regroup and appear to move together, although their behavior is not coordinated.  Each animal moves, seeking safety for himself by staying closer to others.  Gun shots come now from the opposite side and the herd changes swiftly direction. Again. And again. They run as fast as they can. Many fall, hit by hunters, and others follow, stumbling against fallen animals.  Dust is everywhere, noise is loud.  The animals cannot see clearly where they go, their senses confused.  They are exhausted, many are wounded and fear is driving them away from the gun shots that arrive from different directions, continuing to make them run in any direction.  Unfortunately often the wrong one and right toward the hunters, and many die.  Suddenly there is silence, but the herd continue to run for some time, still grouped.  Then it starts to disperse.  Still scared, any noise can make the animals regroup and run again, although the hunters have ceased their chase and are not around any more.  The herd slows down now and it disperses again. The animals that survived start grazing again.

Aug

6

You can read a lot lately about the end of the US dominance era. Many dare to compare the Roman empire with the United States. Examples can be demographics issues with "barbarians" entering the empire as workforce (as opposed to invaders) while the average "citizens" age increases, high military expenses to maintain presence along the borders, big trade deficit as rich consumers help grow poorer neighbors that produce at lower costs. Environment, food, climate change, and energy are additional problems, which are not exclusively "American", but require a global response. Let's leave aside the parallels between Romans and Americans. There are multiple futures ahead with profound implications from the U.S. perspective. The main drivers are related to:

- energy: peak oil and dependence from foreign sources;

- technology: what happens if the technology gap narrows in favor of competitors?;

- demography: older population and immigration issues;

- climate change;

- global governance and geopolitics: failing states and emergence of areas of regional/global power (Asia/resurgence of Russia).

There could be many other drivers, but, in my opinion, the analysis of the implications of the different future scenarios should start from the present situation.

Twenty years after the end of the cold war the US remains the only global power, however, I think that being global in the years past has shown itself to be too expensive for the benefits it gives. The efforts required to maintain a constant (or even increasing) high level of global presence are too high. The main point is that marginal costs are higher than marginal benefits. In summary, if this trend continues, the country could enter a long decline era, where vital resources are wasted to "guard the outposts of the empire" instead of being used to sustain the country's capitalistic and entrepreneurial spirit. Maybe a global strategy should be set aside in favor of a reduced and more focused intervention in specific critical areas and issues. At the same time, concerns about US "strategic competitors", should not be excessive. No country, from China to Russia and each for different reasons, can cultivate the ambition to become a global player for decades to come. The US should manage the comparative advantage in technology, military, innovation potential, financial markets, social development, property rights, education, and so forth, making a better use of its huge resources. The current trend of deficits and debt is not going in this direction. Many consider this trend acceptable and manageable. Actually, my personal opinion is that a continuously weaker currency, higher inflation, increasing private and public debt, a fragile credit system display that the current strategy (with the related cost and budget implications) cannot be sustained much longer. If we look at the stock market, which represents the economy, in the past ten years it has not grown that much. And, if we take into account exchange rates, the situation looks even less satisfactory. The wave of innovation (and source of huge profits) brought by the advent of the information age in the nineties was initiated and "owned" by US technology and US companies. Microsoft, Intel, Oracle, Cisco, Yahoo! and so forth are some examples. The last wave, still ongoing, but limited in its effects, is now represented by Google and Apple. This sector is getting mature and growth appears to be slower with time. In general, the stock market performance reflects a mature economy where growth can be sustained only at the cost of higher inflation. The US needs badly a new wave of innovation. Where is the next wave coming from? Will US companies once again be protagonists? This is what is really crucial in the next decade. Energy dependence is one important aspect, also from the national security perspective, to take into account in this scenario. Is alternative energy going to drive the new technological developments and the needed growth? Biotech? Nanotechnologies? Very difficult to say. Very important, however, is that resources be allocated properly to maintain the intellectual and cultural leadership in the various fields of human and economic interest and not dispersed to support global strategic efforts, which could reveal themselves as unsustainable in the long term.

Jul

8

PoltavaToday is the 299th anniversary of the Battle of Poltava. In a single afternoon Charles XII of Sweden lost his empire and the political map of Europe was permanently redrawn. Until then (June 27th 1709 under the Old Style calendar, July 8th under the New) Sweden had controlled the Baltic and much of northern Germany, and the Swedish Army had been respected and feared for 3/4ths of a century as the preeminent military force on the continent, in the same way the Wehrmacht was from the Franco-Prussian war to the end of WW II. Then everything changed - in an event that was as important for European and world history as Stalingrad. The Swedish army was routed, Charles fled to the Ottoman Empire for refuge (he stayed five years!), and the Russians became the dominant power in Eastern and Northern Europe. For the next 280+ years the Russians were feared, scorned and courted but never ignored. Perhaps the Russians think that $150 oil is an adequate replacement for the Red Army (the Washington Post certainly does), but I doubt it. What, if anything, they can do to recover their lost glory is problematic - as the Swedes found out (look up Hats' Russian War and Gustav III's Russian War if you want to read the sad and stupid end of the story).

Paolo Pezzutti adds:

On a recent trip to Stockholm I visited the Vasa Museum. The Vasa was a ship built for King Gustavus Adolphus of Sweden from 1626 to 1628. At the time Sweden was fighting the thirty Years' war and the king was impatient to see the ship contributing to the war efforts after unfortunate and multiple ships losses due to storms and lost battles.  The ship had to support the expansionism of the Swedish kingdom and it was supposed to be a powerful and feared ship.  But her destiny was not glorious and the ship sank during her maiden voyage in august 1628.  It was left laying under the sea for centuries when finally in 1959, after being located, it was raised to be displayed in a museum only in 1990 in all her beauty and perfection (but not from the engineering perspective though).

There are several reasons why the ship sank that were investigated. The ship had not enough ballast.  The project was changed to accomodate the king's requests. A line of guns was added contributing to instability.  What is interesting is that it seems that a stability trial was held with little or no success, but that no action was taken at that point.  Several lessons learned in my mind:

- As usual in these sort of projects, changes to the original requirements and specifications during the development may have a bad impact on timelines, costs and performance of the ship.

- Changes came from the top level. Most of the times, the less competent technically, but the most influential politically.  No one dared to stop this.

- After the stability trials, no one wanted to face the king to say that the project was failed. The staff followed blindly instructions without willing to be accountable for the technical choices made.

- There were also financial implications of the failed project development that nobody probably wanted to cope with and responsibility was left to the top management.

Eventually, there was an investigation and nobody was found responsible for the disaster in which 30 to 50 people died.  The sinking was explained as an act of God.  Nice and modern story of power, bureaucracy, economic interests, accountability and motivation versus fighting capabilities, technical competencies, professional expertise, and life of men and women at stake.

Jun

21

During the past week the public has been hit by bad news about the economy and the geopolitical situation. I could not find a single positive event in the news. Even potentially good things have been presented from the negative side. Some examples: 1) The Saudis announced an increase in oil production; 2) US considers starting to exploit their resources more fully (apart from environmental considerations); 3) China increased the price of gasoline. Eventually they were presented as bad news: 1) The Saudis have declared this many times and moreover we really do not know how much oil they have left in their reserves. 2) Oil from Alaska could contribute very little to reduce US import dependence. I even heard that 3) in China this measure could increase demand; and in any case Chinese consumer behavior takes a long time to adapt to new situations. On the other hand other, potentially more negative,  news had an impact on oil prices. Israelis a month ago exercised to bomb Iran facilities. The problems in Nigeria could disrupt extraction. Alternative energies are still a long way ahead. Then we are hit by news about the credit crisis, mortgages, frauds, a plunging housing market, growing deficits.  Skyrocketing inflation is putting at risk emerging markets growth. Food prices and climate change are going to bring instability and famine in many areas of the world. The free trade era may be nearing an end amid food and growth concerns.

The stock market is going to retest last January lows. Earnings forecasts are negative. Recession is behind the corner. Consumer sentiment is at its lows. Terrorism is a threat and the situation in Afghanistan can only get worse and at best it will take a decade to be solved. Similar comments for the operations in Iraq. I find all this quite discomforting. In this climate, it is impossible for the public to build their own map of opportunities and risks if news is so unbalanced to the negative side.

Sometimes I really wonder if it is possible for someone or a group of people/interests to design and implement these information campaigns. Military info ops are nothing compared to what we see on TV and read on newspaper and the internet these days!

I have seen more than one recession in my life. It is always the same pattern.

On the other hand, I remember during the dot.com bubble, every company announcement was the demonstration that a new era had begun. Every bad news was interpreted as uninfluential in the powerful flow of innovation and creativity of the internet revolution. Of course it was not like this.

Now we confront our decision making process with the oil bubble, the weak dollar, the unsold inventory of houses, inflation and so on. I do not want to be positive at all costs. The long process of growth started after WWII brought improvements in many parts of the world. I understand that new elements could arise at a certain point to undermine what for us is now given for granted: a continuous seamless improvement of our conditions. But I really do not think this is the case now.

Between the lines we need to able and read the key drivers for continued growth and development in the next years. "They" are simply making it difficult for the public to see them and make sound investment decisions.

Vince Fulco reviews the events of Friday:

The bears could not have scripted a better one for quad witching if they had hired Hollywood writers for the purpose.  It all revolved around six negative words in the headlines, though the reality was more nuanced:

1) DOWNGRADE- of the monolines the prior night which has been discussed ad nauseam by fixed income and equity analysts alike for months (whoops 5 notches). What happened to efficient markets and discounting of information?

2) WAR- Israeli war games over 3 weeks old, in plain view of most neighboring countries. Comes on the heels two weeks ago of politically motivated utterances by a minister re: war's inevitability which caused selloff and recovery in numerous instruments.

3) PRE-RELEASE- Newswire "reports" unsubstantiated rumours that Mother MER will pre-release. This is after days of repeated number trims and caution by early/late street analysts to the bulge brackets' plight.

4) CREDIT WATCH NEGATIVE- Rating agencies NOW waking up to the reality of >$4 gas and fleets that are inefficient and unsound. Not to mention finance arms run amuck.

5) QUAD WITCH- Primary TV program reporting OT1H "look out for increased vol today" and OTOH "the day isn't as important as years past due to traders spacing out their portfolio changes".

6) OFFERINGS- After weeks of endless capital raises among the big boys, the regionals start to hit the accelerator shortly after being "outed" or "goaded" by GS and (in repeated attempts) by Fed and Treasury.

Tailor made IMHO and a sight to behold given SPUs were only down 4-5 points at 5:00 am. Although it involved numerous random events, sure has a deus ex machina feel to it.

James Lackey writes:

1. Keep in mind it is an election year. 91 saw similar doom and gloom. After the fact Clinton inherited a booming economy and could raise taxes.

2. Dem Sweet is a lock. Taxes are going up without a vote. Best way to have taxes lowered on the rich would be a wicked recession.

3. Global warming green meme is a rise in taxes, a whole new regime of taxes and carbon credits. The quick way around this is to Jam up all energy prices as high as they can get them. No politician can raise energy taxes when even electricity bills go limit up.

The counter argument is now being formed. At the barber shop this am Newsweek or one of the rags had "Global warming is a Hoax". Yet on Fox News on the TV next to the news rack they had Dow at 3 month lows, Energy at highs, stagflation. Ill be looking for a new barber shop without the TV.

Apr

1

African DancersAfrica will start playing a role in global strategic relationships and in the global economy in the next decade. Addressing poverty, terrorism, failing or weak states, and health issues is important for global security. The need to diversify sources of energy and materials in the competition for natural resources and secure access to the global market make Africa an important actor.

Assets move globally in search of low costs of labor and production. Emerging markets in African countries will become with time more and more representative.

In Africa we will see the US, China and the EU compete. Security, stability, respect of human rights are the basis for economic and social development within the respect of the local culture. The way is quite long and difficult but with ups and downs, at times and in some countries even dramatic, the conditions exist for a path of improvement and development.

Clive Burlin adds:

If a country like Mozambique can start making a comeback, the future for Zimbabwe looks ultra bright.

Mar

29

Categorizing market action can be done in several different ways. A simple dimension is associated with concepts such as range and volatility. Another dimension is related to directionality. Using the various combinations you can build a bi-dimensional matrix of market behavior. (I am not sure whether they are the only two dimensions to take into account. You could have multi-dimensional environments more complex to categorize and study.) Considering a bi-dimensional matrix, market conditions are:

1. volatile - directional

2. non-volatile - non-directional

3. volatile - non-directional

4. non volatile - directional

The problem is how to efficiently and with limited lag identify the state the marketplace is currently in. An appropriate trading system would be chosen accordingly. In a non-volatile directional environment you could be quite profitable implementing a trend following system, which would not suffer so much from false signals. In a volatile non-directional environment you could implement a contrarian system which would profit from the high number of false breakouts. And so forth.

Many indicators can be used to define the areas, although borders/lines of contact between areas remain a problem together with the lag you would face during transition phases from one environment to the next. Overall, however, gray areas and lag could impact significantly on your performance.

Building a family of robust systems to cover the whole spectrum of situations is one solution to the problem. For example, you could have a system working well in low volatility conditions (directional or non directional) together with a system working well in high directional situations (volatile or non-volatile) and a system optimized to work in volatile non-directional environments. Combinations of systems could obviously be very different depending on systems' characteristics. Generally speaking, lag would not be an issue because as soon as market conditions change one of the system would overperform others. Definitions of market conditions through various indicators would be simplified as well as optimization of parameters which would lead otherwise to overoptimization. Robustness of systems during sub-optimal phases for their performance is the key to profitability.

Systems not fully satisfactory when traded alone could become interesting when traded in parallel with other systems as the equity lines would be smoother and risk would be reduced although at the expense of the overall profitability.

Mar

5

50% OffWhen I moved from Italy to the US last year I asked for advice about the opportunity to buy a house during my three-year tour in this beautiful country. Most of the responses were against buying and I am glad that I followed this advice. At the time, the exchange rate between Euro and US dollar was 1.28 vs the current 1.52 (almost a 19% difference). There was a house for sale in the neighborhood for 450K$. After one year, the house is still for sale, but this time at 380K$. Moreover, you have to subtract the 19% due to the more favorable exchange rate. For the equivalent of a small two-bedroom apartment in the suburbs of Rome, you can now buy a four-bedroom house here and still have 350K$ cash. This situation is not related only to the housing market, but the economy in general. The difference in price between goods and assets in the US and Europe during the past year has become impressive. Whenever I happen to fly to Europe I have some relative or friend asking me to buy and bring a new computer, telephone, videogame, golf club, article of clothing, etc. The same is true for the price of cars. But of course importing a car from the US is not so easy! The same applies to the stock market. For Europeans and for others the US has a big sale sign on the country! Sooner or later these imbalances will be resolved and markets will start working in this direction as investors will find opportunities in this new situation.

Jim Sogi adds:

Same in Hawaii, the Europeans are snapping up land like crazy. What a good deal, they say. I remember the Japanese doing the same 20 years ago. What a good deal, they said. Many of them bailed out in flames from their excesses.

Stefan Jovanovich remarks:

This is not the first time. One of the least appreciated of President Grant's many virtues was his insistence that the U.S. capital markets become completely open to foreign investment. That was his primary reason for reestablishing the gold standard for the dollar after the Civil War. During the same period J.P. Morgan & Son established its reputation as our country's preeminent investment bank by urging its European customers to exchange their francs and pounds for dollars after the Panic of 1873. When those investments proved to be stunning successes, Morgan's word became literally as good as gold as far as the bankers in Paris and London were concerned. What is truly sad is that, this time, it is the wise visitors like Paolo, not Americans themselves, who see the historic opportunity.

Bruno Ombreux adds:

Because of dollar depreciation, visitors have the purchasing power. Even if American see the buying opportunity, they don't have the purchasing power. Also it seems they are in debt, which makes it difficult to add more debt to take advantage of purchasing opportunities.

I see the purchasing opportunities also. I think I'll buy assets in the States in a couple years. It is cheap. And in the long-term, the USA will be better off than Europe.The US has a better demographic pyramid. It has a lower population density. It has the best universities in the world. Taxes are confiscatory but less than in most European countries.

It is cheaper than Europe and has a better and brighter future. This is a buy.And you are right, this is a historic opportunity. I am trying to micro-manage to time the purchase by waiting a couple years, but maybe I am too greedy.

Stefan Jovanovich replies:

American non-financial corporations certainly have the ability. They have become self-funding, even for capital expansions. They have less dependence on debt markets and banks than they have had in a generation. But their managements seem to be taking their inspiration from Sewell Avery instead of Sam Walton in terms of their confidence about the country's future prospects.

Bruno Ombreux explains:

The US and Europe have different perceptions of history. In the US, the traumatic experience was the Great Depression. In Europe, it was the Weimar hyperinflation which led to the rise of Hitler which led to the horror of WW2. The purpose of the EU is to avoid another WW2. That was the founding principle of its predecessor the EEC. The purpose of the ECB is to avoid another Weimar. European are ready to take it on the chin and suffer a lot to avoid any repeat of Weimar or WW2. In the 1990s the French experienced two recessions for the sake of Europe. First they absorbed part of the cost of German reunification through imported deflation. Then they cut spending to meet the Maastricht treaty obligations, while due to low growth they should have run an expansionary fiscal policy. They'll do it again. The German will do it too. Everybody will do it. The rest is posturing in the context of negotiations between goverments, as well as trying to influence the ECB. The ECB is not like the Fed. The ECB has only one mandate. It is price stability. It is very precise: CPI right below 2%. The Fed has two mandates, price stability and economic growth. I never understood why, because there is a macroenomic theorem that you need to have as many policy tools as economic targets. If you you want to control inflation for instance, you need only one tool, that is either monetary or fiscal policy. If you you want to control inflation and growth, you need two tools, that is monetary and fiscal policy. That is the case if the Fed and the government are coordinating actions as they seem to be doing. But then it means the Fed is not independent. You can't control inflation and growth and the currency. Something has to give. The job of the ECB is much easier.

Paolo Pezzutti extends:

The risk in investing in US assets is not related to the value of the assets in US dollars. For example, buying the depressed and daily hit by bad news financials in the long term is something that will work out to be profitable. The financial system is the engine of the US economy. It simply cannot fail and eventually will recover from its excesses. The question mark lies with the exchange rate between euro and US dollar, which could really impact overall performance as it has done in the past years. However, we are at a point of excessive difference in the purchasing power. For example, if you check on Amazon for book prices or on other sites for electronics, such as iPods or Nintendo, you will notice that they sell an item for 100 Euro on one of the Atlantic and for 100$ in the US, which is quite impressive.

Kim Zussman replies:

What happened to no-arbitrage theory? A 40 year old student converts his Euros to dollars, buys iPods in the US, and sells them for Euros back home. Same with real estate. Sells his Amsterdam flat, converts to dollars, and buys a beach house in Venice, California. True, ganja is only legal in CA by prescription — but a 50 Euro visit to Dr Pheelgut fixes that.

Feb

21

The round number is never a penumbra.

Jeff Watson adds:

The umbra I noticed in South Florida was an oval shape, and considerably darkened the full moon surface. I attribute the oval shape to my different point of view, being thousands of miles from the area where the total eclipse would be complete. However, I was blessed with the clearest, most detailed view of the moon's surface I've ever seen with my little Newtonian. Although I saw the same event as the rest of the people on this continent, I got a whole different observation, and a different set of data from other observers 1000 miles away. Applying this to markets, One can look at a market from one perspective and arrive at a quite different conclusion from someone viewing the exact same event elsewhere. It's up to the speculators to bring the different pictures together to form a composite that is acceptable to all.

Scott Brooks recalls:

During the eclipse, a friend from Anchorage called me. He's getting ready to ship out to Iraq. We talked about the eclipse and what I was seeing. It was just after 9 pm cst. It was only a bit past 6 in Anchorage and not yet fully dark. So they didn't get a good view of the eclipse at all.

The kids and I did enjoy it very much. Since it was too cold to stand outside for very long, we went inside to get a break from the cold and I gave them a demonstration of how the eclipse worked using a ceiling light (the sun), a basketball (the earth), and a white jar of handcreme (the moon).

I moved the handcreme back and forth under the basketball…..and it gave a great visual representation of the the eclipse looked like as you could really see the shadow of the earth (the basketball) move over the moon (the handcreme). I actually did this from several angles with the kids to show them the difference between a full and partial eclipse. It was actually pretty cool to see the expressions on their face as they "got it" (although I'm not sure my 6 year old daughter completely grasped it).

We then went out and looked at the moon again and they saw it differently than they had before. David and Hunter even decided to try and figure out where the sun was in relation to us at that time. They figured that if they pointed to the moon with their right arm, then angled their bodies so that their right arm was at a 90 degree angle with their body and then pointed with their left arm, in the exact opposite direction such that their left arm was also at a 90 degree angle, they were pointing at the sun.

I think David (13) got it and understood that the sun was "in that direction. But Hunter (9), walked over to the spot on the ground where he had just pointed and stood there and asked "so the suns here?" (thinking it was directly below where he was standing. I'll give David credit for trying to explain to Hunter and Abbey (11) too that the "line" they were creating to point at the sun continued thru the earth and didn't just stop at that spot on the ground. I'm not sure if they got it, but it was fun watching David trying to explain it to them.

So Lydia (6) went and stood on the spot on our deck where Hunter had pointed to "where the sun was". She announced that it was just as cold "where the sun was"…….thats when I noticed that she was standing outside barefoot. That was the catalyst send us back inside.

We went back to our bedroom and tried to use the ceiling light/basketball/handcreme combo to explain what David was trying to explain. I don't think it worked.

By now it was bed time. We got the kids tucked in and Gwen and I got ready for bed ourselves. A few minutes later, I went out to see what was going on with the eclipse and noticed that there was a beautiful crescent shadow from the earth covering a portion of the moon. It looked pretty cool, so I ran upstairs to get the girls and downstairs to get the boys and took them all outside (barefoot and in jammies/skivvies) to see the eclipse.

They all thought it was pretty cool…..pretty cool that they got to get out of bed. They acted facinated by the eclipse, but I sense it was a ruse on their part to get to stay up for a while longer.

After a few minutes out in the cold (kids will tolerate a lot to be able to stay up), I dispatched them back to bed.

It was a good evening at the Brooks household!

Paolo Pezzutti writes:

Spin-orbit period coupling concerns other pairs satellite/planet in our solar system.

I wonder what market spin orbit coupling in addition to Nikkei/SP there might be in the market universe. How about various micro relationships spinning about price change?

Russ Sears discovers:

Daily Google close, modulo 100:GOOG

Makes a nice orbit if you graph, flipping it back at 49.99…

Jan

25

Jim SogiI remember the 1960s through the 1970s (Chart). There were 50% price swings. Though I cannot test it, I hypothesize the recent 20 year sample won't be predictive in that 1960s out sample. In the 1970s and early 1980s apparently simple trend following strategies worked, but in the last several years such tactics have not worked. Successful trend followers became extinct. But today we are seeing 20% trend moves which might be defined as multiple 100 point moves without an equal bounce. Bollinger wondered whether old things might have their comeback. I do too. To quantify this, we have had a 200 points down with no 100 point bounce. In 2001-2002 there were several 300 point down moves without a bounce.

In 2000 and 2001 mechanical day trading tactics worked. Strategies such as trailing stops, breakout/down buy/sell stops, buy prior x bar high breakouts, pyramiding etc. These have not worked well the last five years. Also note that ranges, gaps, absolute volatility are all non-significant for 15 years data. Today entries and exits almost had to have been at market to get in or out in time. There were no retracements on the runs up or or down runs. Today's 68 point bounce was the biggest up move open to close since 1994.

Referring back to our discussion of stop/no stop/leverage tactics, the no-stop method does not work well in a trending situation and one trend, whether random or not can hurt a no-stop leveraged account. Larry Williams is right on this. No stops may have been right before, but things have changed, again.

StegosaurusThe non-significance of current moves indicates climatic changes. Only adaptability will prevent extinction. In evolution theory, fixed or slow moving characteristics or non-adapters were wiped out when climates or conditions changed rapidly. Even the mighty dinosaurs disappeared after ruling the earth for hundreds of millions of years. The question is, are the data becoming stale? Hurricanes build when energy is released. All this stimulus is going to keep these storms going strong. What about a 50% trading range like the 1960s-1980s? There were weird government maneuvers going on then too, price controls, the dollar off the gold standard, Vietnam, Savings and Loans, inflation pre-Volcker, assassination of presidents, impeachment, war, race riots. All very weird. I remember getting out of investments in October 2001 after some stiff losses thinking, things are changing. Glad I did. It saved me.

Paolo Pezzutti adds: 

The market will come back eventually.

What is amazing is how quickly you can give back your hard gained money. Especially, what happens to small traders is that even if you do recognize situations like this one as buying opportunities you are under capitalized to enter the market. You are caught by surprise, when you consider selling it is too late, your gains have already gone, you decide to hold because it will go back up, but you are unable to profit from the "On Sale!" prices. You cannot participate in the party and you get only the crumbs. End of story.

When trading short-term you do not have these problems, you are in and out often, but the small trader, part time trader is not consistent, does not have time, has high commissions, may have a not-perfectly-tuned strategy and the results most of the times are at best underperforming.

In all these years, I have learned that when volatility is above a certain level, I have to stay out. One loss can be so big as to eat all the profits I made in two months. Normally volatility does not increase so abruptly that you cannot tell that  the environment has changed.

Dec

27

Lion KingKnowledge in the past was passed by the senior members of communities to the younger generations in a slow and steady flow of traditions, experience, culture.

This role is less and less evident in the Western world today. Parents and grandparents tend to lead their life getting the most out of it for their own pleasure and satisfaction. I sense less dedication and commitment to transmit the famil'sy and the society's values to the next generations. I do not intend to be negative. It is a change, however, that is impacting our lifestyle and it is caused (at the same time) by our life style. Both parents go to work to make ends meet and/or to fulfill their expectations. They may not have enough time to dedicate. Children and teenagers have started to make use of the network to find answers to questions. Usable knowledge may comes from a virtual (but real) mass of humans who interact and share information through chats and blogs. Some blog the most private details of their youth writing very personal diaries to get some type of support from unknown readers. Also children have started to live their virtual life in the network. Virtual characters websites are an example.

Values proposed as the basis of the interaction are those of the website developer. Values are also broadcast by the latest TV series on the fanciest TV channel. Media are powerful vehicles to develop knowledge through sharing of information, but the direction in which knowledge and education is developed has to be based on values, that cannot be provided by the network or a TV channel. It has to be based on something more individual than global, more private than public. Family members cannot and must not be replaced in this role. The family must fulfill a role that is given by given by mother nature. As a father, I wish I were able to transfer to my girls the best part of myself, as a man.

I wish to transmit the story of our family, what my dreams were when I was a child and what has become of them now.

I wish to let them understand my mistakes and how we can learn from them. I wish to share with them my hopes and future endeavors.

I wish to discuss with them what I see right for their future.

I wish to observe them and help them exploit their talent.

I wish to help them be happy about their life and positive.

I wish to learn and understand their personality and to respect them.

I wish to invest my time in their future.

I wish to try and answer their questions. As they grow up, I expect these questions to become more and more difficult.

It needs preparation, it needs commitment, it needs love.

This is what I wish for next year.

Sam Humbert extends:

Old Grand-dadI got to thinking about Dr. Pezzutti's wise words yesterday, on my daily constitutional, in this case through a 200ish acre woodland park a few miles from my house (Vic and Laurel have written often of the benefits of a quiet walk-in-the-woods, and I've taken their sage advice).

Since I'm in the woods often, I've discovered all the local teenage drinking/smoking hideaways. Yesterday I noticed with dismay, at one of these gathering-spots, a bottle of Bacardi Razz — a fruit-flavored rum-based product that tastes like flavored cough-syrup. I can't imagine voluntarily drinking this stuff.

For how many generations past, in affluent Fairfield County, have the underaged sneaked off with a bottle of Early Times or Old Grand-dad (or other dignified, respectable drink) to indulge in the timeless ritual? And where are their parents now, to educate them about what is meet and right?

Frank Corberts advises:

Sam, I can only conclude by your narrative that you, in fact, tasted from the bottle of Bacardi Razz that you found at said party spot. Are you in the habit of sampling random liquors found in the wilderness? If so, I believe that some bars may offer the dreck of unfinished beverages for a man of your distinction. You may wish to thank your stars that the teens had not substituted some more nefarious mixture in the bottle — say, Green Dragon.

Dec

22

I am fascinated by the concept of market inefficiency. From my perspective, the concept is related to the price formation mechanism. But more educated. An inefficiency can be exploited from a trader's perspective only if it is significant enough to overcome the transaction costs. Spread, commissions, etc. can make it not tradeable. This is true especially if the inefficiency occurs in very short time frames at the intraday level.

From a speculator's perspective, a methodology should be in place:

- to identify whether a new inefficiency is created. This should allow, while monitoring the market, to spot a new inefficiency with a very low delay.

- to determine the end of an ongoing inefficiency with a minimum delay, in order to limit losses that come from continuing to trade it.

One issue I see is related to the amount of data necessary to assess and validate a candidate inefficiency. 10, 100, 1000 bars/days? This choice affects directly the delay with which a speculator spots a change in the pattern. But the length of data influences also the probability of mistakes and false assessments. The methodology to follow to identify an inefficiency should follow a scientific approach.

The market presents a behavior which is the (weighted) sum of the behaviors of all market participants. A change in behavior of one or more participants can modify the market characteristics of a specific product. This is very likely what happened since last summer after the financial crisis developed. Why the big ranges? What has changed? or better: who has changed what? I am not able obviously to answer these questions, but the change has been evident to everyone. What is the impact on existing inefficiencies? Is the new environment creating new opportunities? If yes, how to spot them? In this case the length of data to use may be easier to identify as the break with past low-range days was very clear. In other cases, it is not. The parameters to be monitored to categorize market behavior are important. I could find several great ideas on the this web site, but theoretically I lack a comprehensive and systematic view of the approach to take.

Once a pattern is identified, it is important to assess whether it is tradeable. Under specific conditions may the market behave inefficiently. One aspect is related to the validation process. How and how much does the behavior need to be "different"?

The other aspect is that this observation has to become a strategy, with proper entry and exit rules. Which makes things difficult especially when you have to find adequate exit rules in case the pattern does not work out as expected, heavily impacting returns in some cases.

Dec

14

The usual way to quantify intraday range is some comparison of high to low. But this misses another dimension - the length of the path traveled by price, which is related to speed of the market (since o-c time is constant, for the entire session  market speed = path length). For example there could be two days, between 930-415 ET (405 min), both with H-L = 20pt (ES). One goes steadily from low at open to high at close, a path length of 20 pt and rate 20pt/405m = 0.05pt/min. The other is a wild day, with a 20 pt gain followed by a 20 pt loss (net unchanged). The wild day path length is (simplifying) 40 pt, which is a rate of [20 + 20]/405 = 0.1pt/min.

Considering just the constant open-close daily period, market speed = path length (a potentially potent area of study is the reaction to market speed in short time intervals, but I will leave that for later). Exact path length would require summing tick data for each day, but for a reasonable estimate here I use 5 minute closing prices and estimate path length as sum { abs(5min moves) } for each day from 930-415. Here are the largest o-c path lengths since 1/07, along with the o-c return (ES points):

date     sum_abs oc
08/16/07 233.25  24.75
08/10/07 212.50    5
11/08/07 185.25  -7.75
08/01/07 185.25  12.25
11/20/07 176.50    9.5
07/26/07 175.75 -20.75
08/09/07 173.25 -20.75
11/02/07 161.50   -2.5
07/27/07 154.50  -31.5
08/17/07 151.00     -7
10/24/07 150.25   2.75
11/09/07 148.75  -3.25
08/15/07 148.25 -15.25
12/12/07 146.00    -22

Notice the big move yesterday is only 14th longest path length YTD. Since that path length is a form of volatility, I compared o-c return with contemporaneous path length and found the usual negative correlation:

Regression Analysis: oc versus sum abs

The regression equation is
oc = 4.49 - 0.0648 sum abs

Predictor      Coef  SE Coef   T      P
Constant     4.490   1.636   2.74  0.007
sum abs    -0.0648  0.019  -3.27  0.001

S = 11.7078   R-Sq = 4.3%   R-Sq(adj) = 3.9%

Gibbons Burke asks:

Do you consider in this calculation the distance from the previous day's close to the current period's open? If not, then a gap day's net price path sum won't include the overnight move in the path.

Larry Williams adds:

It is not just the range and such but which side is moving the market on that path. It is clear to me the gap from last night's close to today's opening is public activity, the path from today's open to the close much more professional activity; that's the key to the numbers as I see it.

Jim Sogi remarks:

I agree with Larry, but for different reasons.  Rather than just pro/public, the night session is related to the global situation and large gaps seem to be a whole new area recently developing. Yet another new different unseen cycle. 

Paolo Pezzutti suggests:

There are at least two dimensions in play: one is speed, which is somehow associated with concepts such as range and volatility. Another is related to directionality. According to different combinations of these two dimensions you could build a matrix of market behavior. The areas would be:

1. volatile; directional
2. non-volatile; non-directional
3. volatile; non-directional
4. non volatile; directional

The problem is related to indicators to be used to efficiently define these areas. How you identify the borders/lines of contact between areas? This classification can be useful when trying to identify the proper tools and techniques to use in each area. What kind of indicator could one use to take into account speed? What can we use to identify directionality?

Steve Ellison responds: 

In his book "Trading and Exchanges", Larry Harris identifies two types of volatility. Fundamental volatility results from changes in fundamentals. Transitory volatility results from excesses of uninformed traders who move prices away from fundamental values. Price moves caused by transitory volatility are likely to reverse as informed traders take advantage of bargain prices to buy or rich prices to sell. Price moves caused by fundamental volatility are much less likely to reverse.

A hazard for a contrarian trader is falsely assuming volatility is transitory when it is in fact fundamental. Dealers and market makers protect themselves from this risk by widening spreads when the order book is one-sided.

I propose a 2×2 matrix of the actual type of volatility and the market's perception of the type of volatility: 

.                     How most market participants
.                     perceive volatility
.                     Fundamental          Transitory
Actual
type of
volatility:
.                     Price quickly        Price trends
Fundamental           establishes a        as disbelievers
.                     new equilibrium      change their
.                                          minds one by
.                                          one
.
.                     Market reverses      Price quickly
Transitory            dramatically         reverts to
.                                          previous levels

For years, the trading literature was very heavily slanted toward trend following as the road to riches, which biased many traders toward assuming any volatility was fundamental. However, with much money having been yanked from trend following funds this year, the upper right quadrant is occurring with more frequency.

Oct

21

Suppose you bought any Friday where the stochastic indicator was oversold at the close. What is the percentage of winning trades, placing a sell limit order of c+x points for Monday? I checked in the past 10 years all the situations. If the order is not filled, you exit at Monday's close.

 3 points 96%
 5 points 86%
 7 points 80%
 9 points 70%
11 points 65%
15 points 63%

Larry Williams explains:

the problem is  such an approach has massive equity drawdowns and small average profits per trade. The losses, when they come, are much bigger than the gains. Accuracy alone does not make for a good system or trader. Risk/reward trumps accuracy every time. Eventually large losses devour strings of wining trades.
 
To evaluate such an approach, look at the equity curve; not just the numbers.

Jim Sogi adds:

The equity curve Larry talks about is a thing of beauty. We all know what happened after 1987 as well. The survivors prospered. If you want to argue sample, only time will tell. History unfolds in mysterious ways and you can never know the future. If you always look at 1987, you'll never trade. One way to avoid annihilation in addition to money management is to stay nimble in addition to having deep pockets. Wall Street has deeper pockets than you.

Phil McDonnell writes:

Phil McDonnellAs an augmentation, the following discussion of the features of a normally distribued random walk with absorbing upside barriers should prove helpful.  Naturally as traders this simply means using the theoretical distribution with an upside profit target.

Using a profit target will:
1.  Double the probability of being at or above that target at the end of a fixed period of time.
2.  Have no impact on your expected gain or loss.
3.  Reduce your variance and standard deviation
4.  Result in larger losses than gains

This result derives from the fact that the normal distribution is symmetric and self-similar.  Thus it obeys a property called the Reflection Principle. Each price path has an equal and opposite mirror image.  Each price point reached has a distribution of points past it and an equal and opposite distribution of points which were 'reflected back'.   Elementery proofs for the analogous case of stops, using nothing more than high school algebra, are given in my book Optimal Portfolio Modeling.

It should be emphasized that this is the theoretical model.  To the extent that one can find empirical evidence that the market does not conform to this, there may be something tradeable.  But just because you can manipulate your distribution to double the probability of a winning trade does not mean that the average winnings will be any better My Motto: You need an edge — never let your money leave home without it.

— keep looking »

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