Allen Gillespie has delivered a shocking rich tapestry of ideas for profit and research that overwhelms the senses. I studied many of these things 50 years ago and wish I had the expertise to follow up on them. The Confederate paper is particularly interesting and brings to mind what one is often told that the price of stocks on the French Stock Exchange during the Guillotine area kept rising apace. Laurel and I had the pleasure of meeting Mr. Gillespie when he was a budding momentum buyer of growth stocks and recognized him as an extraordinary talent. His growth in many areas is most pleasant to memorialize and note as one of the shining memories of a not entirely nondescript career.
Allen Gillespie writes:
For what it is worth, tonight's bond retest of the high looks like a classic rest of a high after a momentum break and in equities, many crashes end when the YTD performance goes negative. People hate giving up their year.
Counterparty Risk was what drove a lot of the de-risking in 2008. Since that time the Fed have made banks hold increasing amounts of capital in "safe" assets (aka government bonds). In announcing that everyone passed the stress test and releasing capital for buybacks and dividends, the bond market has sold off. We already discussed the end of central bank buying but if counterparty risk is deemed to have declined - then the sell-off in safe non-earning assets might have a ways to run.
One believes that the tremendous computers at the high priority broker are not set up to liquidate options positions on spiders or options that don't trade till 9:30. This could create a shocking move. On the 8/24/2015 weekend there was a rally from 4 am to 5 am or so before going limit down when the liquidation at 9:30 started. From there it was straight up until the close.
It's a bit too coincidental how many market moving events occur when the US stock exchanges are closed. With all now being electronic, computer-driven, every market could easily trade 24/7, and I wish they would.
Anatoly Veltman writes:
Gold up 100 is your sure indicator of big reversals coming in this session.
Allen Gillespie writes:
Many futures brokers double the margins, so I would think the moves might equal 2x the size of the doubled margin requirements which for most works out to 8-9k per contract. So a 2sd move on the doubled margins just to knock everyone out.
Victor Niederhoffer replies:
But then the poor public must have maintenance margin of 6000 after the initial move so 80 points is enough to put them well below maintenance.
Allen Gillespie writes:
Event odds? Does anyone have or know where to get the monthly data for the UK? Specifically, I am interested in the 1931 period around the the British Exit from the gold standard. My working thesis is the Brexit is a similar exit, which I know qualitatively was a 24% currency move and close to the equity lows. I also know the UK lead 21 others ot break from gold with the US finally doing so fourteen months later. Yesterday, in gold terms, UK shares moved most of that distance but not fully but I believe UK shares might be leading others but it all needs to be currency adjusted. They led on QE and now they will lead on fiscal policy changes.
Can events be classified into those that have a certain date, but are uncertain in magnitude as opposed to those that come out of blue sky and are uncertain in both magnitude and time? Is there a difference in the market reaction? At a more general level, how many qualitative events such as Brexit have come down the pike to create terrible fear in the market and is this bullish or bearish? And for what time?
Allen Gillespie writes:
This question is near and dear to my research efforts. If any one is interested in discussing further I have been attempting to get DARPA to reconsider the question as they shut down their program after 9/11 [DarpaPAM ] and instead choose to record all information and to what effect? I have attached a few items on the question.
Biotechs would be in the first class of events given the known timing certainty of FDA events and ability to estimate markets for drugs, pricing, distribution, etc. Political events to a degree fall in the second - though there may be some momentum towards the event and ability to contingency plan but the time and magnitude of the event may be unknown and the pressures building. Also, political events and calculus are different than market events in that control is the key independent of price (think old school corners, like the Northern Pacific, or strategic petroleum reserves for the US and CHINA in 2008).
Historically, whether an event is bullish or bearish depends on the positioning in relation to the object in question. For example, it would be a negative squeeze if a key commodity (i.e. wheat prices prior to Arab Spring or Oil in the US prior to recession) one imports rises quickly in price and bullish if it falls quickly in price.
All I known is that defense stocks had momentum before 9/11. Gold has momentum now, however, momentum tends to have a reversal pattern from Mid April thru the third week of august before a re-acceleration. Momentum also tends to turn around calendar points particularly if there are legitimate season patterns or tax effects (for example Jan 1 in the US).
The central banks say you can't recognize bubble but in my experience you can recognize a bubble the following way - when leverage continues to increase and price accelerates despite rising interest rates and future returns are negative - then there is a good chance there is a bubble - I think German Bunds futures reached that point as there are only three reasons to own negative interest rate bonds.
1) You have to [e.g. German life insurance companies]
2) You are so scared as to the future you assume your loss is less than on something else.
3) You believe Central Banks can maintain their corner on the market.
The Euro is Europe's gold standard and has choked many countries. Britain was the first to leave gold in 1931 - so as least some magnitude estimates can be developed as well as an outline of subsequent events. The central planners would hate for Britain to spread freedom once again around the globe and let it be known that markets set prices better than planners.
After 9/11 it took the market about 3 months to reprice stocks like INVN when it correctly opened the stock around $9 from $3 ran it to $50 by year end which was the cash value GE ultimately bought the stock for year later.
The Japanese and Fed broke the bond corner last week.
Stefan Jovanovich writes:
A minor historical correction. Britain left the gold exchange standard in 1931; it left the gold standard in 1914, as did all other countries in Europe, when their citizens and foreigners both lost all rights to convert bank notes into coin. The U.S. took a slightly different path, first shutting out stock and bond holders from any exchange rights by closing the NYSE for 6 months and then by allowing exporters to have the Federal Reserve guarantee their customers' IOUs to be as good as gold. Since all modern academic histories are written with the standard Bernanke assumption that money and its legal tender definitions (and their changes) have no economic effects, nothing written on this subject after 1940 has any relation to reality.
The comment has been made that Moneyball strategies undervalue pitching and defense. As a Braves fan I can most assuredly attest that post-season pitching needs and season pitching needs are different. During the season, a 4 deep pitching rotation almost assures extra wins as the other teams pitching tends not to be as deep (so hence the long runs of divisional wins), however, post season pitching rotations get shortened, so one needs one less pitcher and one more bat (hence all the post-season loses). This is why the Braves had incredible records but only the one World Series during their amazing run.
Stefan Jovanovich writes:
The data suggests something else: they (the GM and Cox) never let John Schmoltz–their one genuine strikeout pitcher–start Game 1. Strikeouts win World Series.
I was cleaning this weekend and came across a 2004 article from the chair in Active Trader on survival stats. It seems appropriated given the equity market decline. Separately, it looks a little like 1998 and the "Asian Contagion." Separately, in thinking about the Chinese market giving up all its YTD gains, that is consistent with 1929 and 1987 but the next day there is a really big rally.
Using the Dow Jones Index, if today's YTD change is less than zero then buy tomorrow, it has 84% odds of being a winner. Bear markets generally start down and go down more. Winners tend to bounce back from bad beats while bearish (loosing years) just fold up and come back and try again next year.
Separately, here is a link to my white paper on surviving this financial no man's land at the zero bound. Momentum breaks are signs of switches.
A White Paper by: Allen R. Gillespie, CFA
Thursday's decline of 40 points was within a few points of the largest declines we've had since 8/10/2011. It's only 2% depreciation following 200% appreciation. Sure, get me out, I've become way too rich compared to the income growth within the economy.
Steve Ellison writes:
I have no idea if this was the key weight, or even if it was important at all, but I had noticed that the DAX last made a new high on June 20. It made a 20-day low on June 26. It made new 20-day lows on July 8, 10, 21, and 28 while the S&P 500 continued making new highs, with the last new high on July 24.
Allen Gillespie writes:
Clearly the taper (smaller negative interest rates) have an increasingly large impact. we v - cf/i. The curve bends take and to the right as one approaches zero. Law of small numbers in the denominator. The no man's land of the zero and then the euphoria of the small positive followed by the small number effect again should be interesting.
There is a passage in Memoirs of a Superflous Man I believe from Turgenev about a lake that appeared so beautiful but was deceptive about the coming terrible storm. Sort of like Caesar trying to calm the senate before becoming dictator. I will try to find that passage which Nock used to describe the calm and deceptive serenity before World War I's outbreak. And angler fish uses it in a form of aggressive mimicry. The movement of crude today at the open, the only market down among 30 on my screen to the constructal number of $5.00, strikes me as such a fish. Amazingly I will not buy it today. What other deceptive calms arise to lure you in before devouring you for the kill?
Update: I found the beautiful passage from Ivan Turgenev's "Clara Militch":
"Evil is coming… and here is the lake, isn't it blue and smooth? And here is a little boat of gold. Will you get into it? It floats of itself."
Now I sound like the bearometer. But I mean it merely for the one market that's down today. What is the performance for example of the 10 worst stocks of the day when the market is way up?
Allen Gillespie writes:
This is my favorite bull to bear passage from one of the best books ever written, Lonesome Dove by Larry McMurtry Chapter 91.
"But a week passed an they saw no Indians. The men relaxed a little. Antelope became more common, and twice they saw small groups of buffalo….The country began to chnage slightly for the better. The grass improved and occasionally there were clumps of trees and bushes along the riverbed…He felt the threat of drought was over…Traveling became comparatively easy…
The next day, as they were trailing along a little stream that branched off Crazy Woman Creek, Dish Boggett's horse suddenly threw up its head and bolted. Dish was surprised and embararassed. It had been a peaceful morning, and he was half asleep when he discovered he was in a runaway headed back for the wagon. He sawed on the reins with all his might but the bit seemed to make no difference to the horse.
The cattle began to turn turn too, all except the Texas bull, who let out a loud bellow.
Call saw the runaway without seeing what caused it at first. He and Augustus were riding along together, discussing how far west they ought to go before angling north again.
"Reckon that horse ate loco weed or what?" Call asked, spurring up to go help hold the cattle. He almost went over the mare's neck, for he leaned forward, expecting her to break into a lope, and the mare stopped dead. It was a shock, for she had been quite obedient lately and had tried no trciks.
"Call, look" Augustus said.
There was a thicket of low trees along the creek, and a large, orangish-brown animal had just come out of the thicket.
"My lord, it's a grizzly," Call said.
Augustus didn't have time to reply, for his horse suddenly began to buck. All the cowhands were having trouble with their mounts. The horses were turning and running as if they meant to run to Texas. Augustus, riding a horse that hadn't bucked in several years, was almost thrown.
Call drew his rifle and tried to urge the Hell Bitch a little closer, but had no luck. She moved, but she moved sideways, always keeping her eyes fixed on the bear, though it was a good hundred and fifty yards away. No matter how he spurred her, the mare sidesteeped, as if there were an invisible line on the prairie that she would not cross.
There was confusion everywhere. The remuda was running south carrying the Spettle boy along with it. Two or three of the men had been thrown and their mounts were fleeing south. The thrown cowhands, expecting to die any minute, though they had no idea what was attacking, crept around with their pistols drawn.
"I expect they'll start shooting one another right off," Augustus said. "They'll mistake one another for outlaws if they ain't stopped."
"Go stop them," Call said. He could do nothing except watch the bear and hold the mare more or less in place. So far, the bear had done nothing except stand on its hind legs and sniff the air. It was a very large bear, though; to Call it looked larger than a buffalo.
"Hell, I don't care if they shoot at one another," Augustus said. "None of them can hit anything. I doubt we will lose many."
He studied the bear for a time. The bear was not making any trouble, but he apparently had no intention of moving either. "I doubt that bear has ever seen a brindle bull before," Augustus said. "He's a mite surprised, and you can't blame him."
"Dern, that's a bit big bear." Call said.
"Yes, and he put the whole outfit to flight just by walking up out of the creek." Augustus said
December 23, 2013 | Leave a Comment
The movie Wall Street was released in 1987, Boiler Room in February 2000, Wall Street: Money Never Sleeps in 2010. Now there's the Wolf of Wall Street coming out.
Are there other movies to be considered and what does it portent?
December 21, 2012 | 2 Comments
A friend will ask you what you think of gold. "It's below the round number," the personage says. "Well, I doubt anything bad could happen near the end of year you say. Christmas et al," you say. The friend buys, wets his or her beak. News of liquidation of big gold bugs hits. Gold has the biggest drop of the year 50 bucks in two days. You don't look like Marilyn Monroe or Paul Newman in the friend's eye as the case may be.
Allen Gillespie writes:
The big leg down in bonds seems to have been the hammer on all things. On nights and days like this, however, one cannot help but think about Profitable Grain Trading by Ainsworth-- his basic system looked to by the lows of the prior month 7-9 months before final expiration and weekly lows once the time to expiration was 3-4 months. I think his explanation of the economics of discounting futures is conceptually sound. One cannot help but notice that the Aug futures low in gold in Nov was 1680.90 and we just traded through that two days ago.
Vince Fulco writes:
Not bad, an 80 year old book which in reprint still runs around $50. Can't say that about the vast majority of trading tomes.
Easan Katir writes:
It was reviewed on Dailyspec a few years ago by Mr. Sogi.
February 22, 2012 | 2 Comments
Do markets learn from each other? For example, is the S&P market this year following a similar path to bonds last year, with every trepidatious move down being requited with a rise? Are such "learnings" graduated to the point of regularities. And is it a domino effect or a path of least resistance or consilience or convergent evolution or what have you? What do you think? Can it be quantified? Should it be quantified?
Allen Gillespie answers:
Yes they do. In the old days that could be because some pits closed before other pits, so you could have individuals walk between pits and trade both. Today it would be the result of correlation trading desk and carry trades. The correlations, however, do change depending on what the Street owns - it is simply a balance sheet effect. There is also the issue of relative levels v. absolute levels. This is important because leveraged and professional traders may act on relative relationships more quickly and at higher price levels, where as, unleveraged traders need both an attractive relative and absolute relationships to act. This is the problem with ZIRP. Discount models become meaningless near zero i.r. as values become highly sensitive to small changes and price changes gain increasing amplitude. It encourages leveraged carry trades regardless of the absolute levels sought by cash buyers. That's the issue now no? Inflation targeting is just the gold standard, and under the gold standard short term interest rates were highly volatile while long term ones were not because there was no long term inflation except for natural growth which caused periodic revaluations of the currency. So, the Fed views long bonds as the same as cash, however, this is because the Chairman does not believe that currency is supposed to serve the function of acting as a store of value. If it cannot serve that function then it truly is worthless.
So, stocks are following bonds because there's 600 bps of carry (relative to the Ten Year last August) or 800 bps of carry (relative to ZIRP) or 500 bps relative to corporates. I call it the old bankers trade (3-6-3), borrow at 3, lend at 6, play golf at 3. Stocks then would give you an additional 280 bps on the 6. The issue now is 0,3,6 (borrow at 0, lend at three, get up at 6 because at $1360 on the S&P the earnings yield is 6.4 and this probably does not adequately reward investors in a world where the currency is worthless and where the value of a $1 perpetuity at 10 bps is $1000 and at 11 bps $909 and at a mere 15 bps back to the deal with the devil $666 that the S&P made in 2009. Another way to consider it is to think you will get that 6.4 two thirds of the time or 4.25% which is still better than a bond, but is it adequate? AA bonds have a 20 year cumulative default probability of 2.71% but an average loss severity of 36.5% or so at anything less than 2.3% they really have used your money for free for 20 years. Didn't our president say something about spreading the wealth around? Well, using money for free would meet my definition of how to do it. So, we are in the ABT market (anything but treasuries) since last August and I truly suspect current bond issues will someday be referred to as those Obamanations like the old not worth a Continental all made possible by Wall Street's deal with the devil at Fed. The rub is the math works both ways.
One way to quantify would be to take all market periods (say one year) and then run a correlation against the second market 1 year forward, with the hypothesis being that would be see consistently high correlation numbers. Thus one would see not just the direction of the relationship but the consistency.
October 26, 2011 | 1 Comment
A Congressional Budget Office report released today shows that from 1979 to 2007, after-tax income grew by 275 percent for the top 1 percent of households, compared with 18 percent for the bottom 20 percent. Bloomberg News.
Great example of the regression fallacy. Ones that happen to be in top 1% in 2007 necessarily grew more in % than typical person, much more than ones in bottom 20%.
Allen Gillespie adds:
And isn't that also true for trees, the top ones pulling nutrition from the bottom ones and growing from the inside out and higher simultaneously. Hence, why utilities as regulated monopolies are the most stable - they have eaten all the competition.
Stephen Stigler writes:
A reaction to the report which says "A Congressional Budget Office report released today shows that from 1979 to 2007, after-tax income grew by 275 for the top 1 percent of households, compared with 18 percent for the bottom 20 percent."
First, it is not clear what they actually did, but you can be pretty sure they did not find what the item says. That would involve following a very large number of people and their individual after-tax income over a 28 year period, and I do not believe such data are available - and even if they were available there would be a serious problem of definition - do they mean top 1% in 1979? Or top 1% in 2007? These were not the same people - in fact, some of the top 1% in 2007 were in the bottom 20% in 1979, including probably Steve Jobs.
So what they probably did was just take the average after-tax income of the top 1% in 1979 and compare to that of the different group of people who were top 1% in 2007. Now, as I say, these were different people by and large, with an unreported overlap to be sure.Some in the 2007 group would be testimony to the opportunities that allowed them to improve from even the bottom 20% in 1979, a change that some might think possibly admirable and certainly non-discriminatory.Other problems are that the bottom 20% includes not just the undeniably poor, but also the young and not yet successful, and the comparison at the top compares the pre-Reagan tax cut era (when there were huge incentives to keep income out of the tax calculation), to the peak boom year when rates were relatively lower and the incentives to hide income much less.
This is not really a regression effect, but a different type of selection fallacy. Had they really taken the top 1% in 2007 and followed them individually back to 1979, similarly with the bottom 20%, that would have produced a regression effect. But I doubt they could do that. Anyway, who cares what Mark Zuckerberg was making in 1979? He was born in 1984!
October 19, 2011 | 1 Comment
How to quantify similarities between such "mountains" [i.e. price charts] ?
1) Decide trailing periods and criteria to be used - YTD performance > X, last 5 year performance > Y, etc
2) Build universe/database of similar companies for each year
3) Build correlation table to confirm
4) Build composite model
5) Look at forward if-then test
In my experience, the bearish case on high momentum names, frankly any name, is best fundamentally analyzed as a move from Blue Oceans to Red Oceans and along with general market trends. Blue oceans situations tend to be P/E unconstrained, consistent growers, etc http://www.blueoceanstrategy.com/ but once we move into the Porter world of Competitive Strategy then P/E becomes constrained which leads to compression. Generally, there are subtle clues - RIMM announced a move into consumer markets where AAPL played- so the business market was saturated - NFLX CFO left when the stock was below $200 on its way to $300. They started focusing on cost strategies, changing the story from new subscriber adds. I haven't followed GMCR that closely - but is there a competitive threat that is changing the marketplace - are they experiencing a strategy change - that's the key question.
Solar existed on subsidies granted by bankrupt governments, so it has to compete with more economic alternatives. Hence, the president's loan issue.
Stocks have to compete with bonds, so stocks crashed in 1929, 1987, 2000, 2008, etc
EK lost to digital photography.
My worst mistake ever came from Able Labs - a generic drug maker - had 26 NDAs pending, huge margins and a new lab in NJ - problem: small reference to litigation in the SEC filings that later turned out to be because they were getting their margins by diluting the drugs - stock went from new high list to opening down something like 86%, where I sold before watching it go to $0 in 30 days. Subtle clues. They are really important if one is making the bearish case.
in reply to Victor Niederhoffer's comment:
Strange similarity between those two [NFLX and GMCR] to a person who looks at it as
two mountains of different heights with similarly looking crests
relative to the peak.
Query. How would one quantify similarities between such mountains?
And once quantified, what is best way to see the predictive value of
such similarities. I am reminded of the cotton traders most famous
trade. He noted that 1987 looked similar to 1929. then he knew it was
going to have a crash. The drunk man saw the same similarity and started
out long that Monday, and then sold. Between the two of them, they were
enough to trip the portfolio insurance to sell.
Query. How ridiculous can you get without quantifying the two
questions I asked? I say it wasn't that similar to 1929 as compared to
other years. and also that the ones most similar to a given few years of
bearishness, in the past, the less is the relation between past and
present. i.e. no predictive value to start.
Gibbons Burke comments:
There is another model which incorporates a similar gradual buildup with no appreciable change, then catastrophic breakdown, like the straw breaking the camel's back. A simple model is dropping grains of sand onto a surface. A pile builds up. With each grain the pile gets higher and higher, in an orderly fashion and is stable, until the angle of repose gets to a critical point, at which the next grain of sand sets off an avalache. Similar but subtly different. The concept is known as "self-organized criticality", and I suppose it may have some relevance to how bubbles build up and then collapse:
Christopher Tucker writes:
See also Slope Stability Analysis Methods:
A similar criticality phenomenon is Flashover:
(quoting the wiki - http://en.wikipedia.org/wiki/Flashover )
A flashover is the near simultaneous ignition of all combustible material in an enclosed area. When certain materials are heated they undergo thermal decomposition and release flammable gases. Flashover occurs when the majority of surfaces in a space are heated to the autoignition temperature of the flammable gases (see also flash point). Flashover normally occurs at 500 °C (930 °F) or 1,100 °F for ordinary combustibles, and an incident heat flux at floor level of 1.8 Btu/ft²*s (20 kW/m²).
another is Phase Transition: (from http://en.wikipedia.org/wiki/Phase_transition )
A phase transition is the transformation of a thermodynamic system from one phase or state of matter to another.
see also Crystallization: http://en.wikipedia.org/wiki/Crystallization
Gibbons Burke responds:
I was lucky to be in the right place at the right time to capture a flashover in a fire near my home (in 2006) in New Orleans:
Stefan Jovanovich comments:
The sad fact is that the firefighter community still has no agreement on how to deal with flashover risk. They have not even settled on the question of whether to use a wide fog or straight stream!!!!!
The best teacher I ever had (an instructor at the Navy's Damage Control School in Philadelphia), said that the Navy were the only firefighters who had figured out how to do something besides spray and pray - i.e. use foam to suffocate fires and inert gases to secure the fuel lines - and even so there was a fatal tendency to believe that all you needed to do was get a big enough bucket. He pointed out to the class that the greatest risk of the Forrestal fire turned out to be the water from the firefighting itself, which almost capsized the ship and washed away the retardant foam.
Once again the market has been fast in recovering, and it seems that certain levels cannot be broken to the downside. What are the structural reasons for the US market better performance? One is tempted to say that the bear case has no hope. However.
Allen Gillespie writes:
The bear case is as strong as ever in real terms. There are only 4 ways out of a debt crisis.
1) Inflation = losses to bond holders in real terms
2) Deflation = losses to other claim holders and parasites (austerity)
3) Default/Restructure = shared burden between all claim holders
4) Productivity Gains = actual improvement in debt servicing capabilities
Historically losses in sovereign defaults are estimated to be around 40% over 8 years. Recall the official policies are thus
1) Fiscal = "I want to spread the wealth around" - notice the use of the word wealth not income. Wealth is all accumulated savings of income. And how do you tax wealth - inflation and regulation.
2) Monetary = Inflation targeting at 2%. Inflation targeting is nothing more than a gold standard with a higher base rate. Under the gold standard there was no long term inflation, so short rates tended to be volatile but long rates very steady. Flat yield curves prone to violent inversions like the one we got prior to 2008 (19 months).
I think the government model is the 1940s where government was ramped up during the War and then handed things back off after the war to the private sector. This was a time of 2.5% interest rates and 5.5% inflation because inflation would go from 0 to 10% twice in the decade.
We are close to inflection - the food companies have announced that food inflation will be 7-8% next year.
The saddest part is that the powers that be think only #1,2,3 are possibilities because they have no appreciation or trust in people for #4. Peter Thiel is the best thinker on that issue.
Take energy as an example - are earnings up because of #4 or #1? Obviously, more #1 than #4 but some of both looking at nat gas. However, the Prez wants to determine the winners and losers so that is disadvantaged to other lobbies. It's sad.
Are you shorting in nominal or real terms - important question.
Today we in China had an athletic breakthrough. Since geography appears to be important in college sports, one wonders if geography has a similar effect in markets.
As a point of reference, stocks from Texas did 1% per year better under Bush than non Texas stocks in a quick study we did. If this is so, what are the key geographies? Chicago?– commodities seem to be doing well and if swaps move to the exchange– it will be like manna from heaven for Chicago at NYC expense.
Does the difference between the Bulls and Knicks, Bears and Giants, etc. portend anything?
The problem I have had with the former advertising manager's methodology is that it is not clear to me that any studies show that value outperforms growth, and I am not convinced he used prospective files for his studies, even though the rumor is that the Columbia students he hired to do his research did so, and the results in his books are completely random, as well as the wide diffusion of his seemingly random and regime based studies.
Allen Gillespie writes:
The misapplication comes by using P/B to declare stocks growth or value. The best growth stocks have little in way of book but much (non-book) goodwill (though not always booked goodwill) associated with the product or brand. In fact, some of the best growth stocks show this interesting pattern (high sales and earnings growth) while the value competitor shows on Altman Z-Score screens (think SNDK/EK, NFLX/BBI). One grows by eating the other (monopoly rents) and rebirth. How many stores did Walmart eat? If one looks at the pure style indices (RPG and RPV etfs) v. the old Russell two way classification (IWF and IWD) one will find the excess returns above cash for the growth and value risk premiums are equal and greater than the traditional growth and value classification (where there is a value bias). This makes sense, as the pure style indices are more concentrated into those stocks that actually exhibit the growth/value factors. Particularly regarding growth, imagine the age distribution of a population, it will have more adults than children because more are grown than growing. If you sliced it in half you will have one set with some growth, but highly diluted. This also presents an index problem as by definition young companies are likely not to be included in the indices initially and will be underweighted even when they are. None of this, of course, is to deny that there aren't cycles where the relative spreads between the combinations don't over or under shoot the trend.
Industries, of course, can regenerate by cannabilizing themselves at times (I am watching closely) the combination of high fuel prices and cars– the fuel efficient fleet will ultimately eat the existing stock leading to a long number of years of above average growth into a downsized industry. This is the value players dream situation as the stocks will be priced on the history with the future ahead. 100 years ago horsepower add horses, even on the tracks unfortunately.
Rocky Humbert writes:
(With SAT test season approaching, I humbly request that fellow specs weigh-in with the current usage in my paragraph 2 below. Should the correct form of to-be be "is" or "are"? [….a portfolio of stocks which *is* trading…] If we cannot reach consensus on the proper rules of English usage, there's no hope for other conciliations.)
A problem with the problem is the definition of "value" versus "growth." S&P's methodology is to put stocks with low p-e's (or p/b's) into the value category, and stocks with high p-e's into the growth category. The approach is self-referential, and although convenient, it's arbitrary and silly.
Yet, if one takes the S&P approach ad absurdem, The Chair cannot quarrel with the proposition that a portfolio of financially strong stocks which is trading at 5x earnings (and which is paying out 100% of earnings as dividends) will eventually outperform a portfolio of stocks which are trading at 1,0000000000x earnings. The asymptotic nature of compounding and the laws of economics ensure that this will be eventually true. Once The Chair accepts the irrefutable truth of this observation, the discussion becomes much more nuanced — leading to an analysis of what conditions lead to Value outperforming Growth or visa versa.
Lastly, one must note that, in general, the volatility of stock prices is greater than the volatility of the underlying business performance. This is the essence of "taking out the canes" — and one wonders whether value investing is a second cousin of Mr. Clewes?
Tim Melvin writes:
Let's use Walter Schloss's definition and see if any testers with better databases and math skills than I can compute the results.
True value investing as practiced by Graham, Schloss, Kahn, Whitman et al looks something like this:
price below tangible book value
debt to equity ration below .3
profitable or at least breakeven
closer to lows for the year than highs
a minimum of 10% insider ownership
Using pe or relative value is NOT value investing as best and originally define.
One played a game of checkers with someone likely to be a front runner for president in a few months, and we discussed the importance of Tom Wiswell's proverb "moves that disturb your position the least disturb your opponent the most". In checkers, I think it means not to break up your foundation, not to have too many infiltrator single men far removed from the bulk of your pieces. Not to have too many holes in your position. Not to have too many of your forces divided by big spaces. Maintain your dike which is a solid row of checkers on a diagonal of at least 4 or better 5 or 6. In general, make sure you have near neighbors for all pieces. I got to thinking how this applies to markets. It seems very applicable. Don't put all your chips at one price. Do things on a scale down or up. Don't move into other markets with big positions when you have the bulk in one position. Keep your positions at approx the same size. Don't throw all your chips in at a certain time, but gradualize into positions. Don't get out at close or in at open. Maintain a constant capital stream. Be humble.
What else would you say? How would it apply to life? Don't move into new investments unrelated to what you do without much reflection and gradualization. No staccato in your movements into your second childhood? What else?
Anatoly Veltman writes:
To add: a grandmaster can't use the same sole opening pattern all the time. High level competition will adopt– and they will no longer be disadvantaged. So while it's important to stick with your successful patterns– see if those patterns can be validated for situations arising out of a different opening sequence.
Nigel Davies writes:
I agree with Anatoly. Actually I've often given up opening systems at the height of their success; waiting crocs plus loss of vigilance etc.
Jordan Neuman writes:
There is a similar thought in baseball strategy. In a situation where one's move will lead to countermoves, it is sometimes best to do the opposite of what your opponent wishes you to do given his perception of his own countermove options.
This is all under the general category of putting yourself in someone else's shoes. I find it very easy to see where others have messed up their or their children's lives. I would say my "win percentage" is much higher in those cases, prospectively, than in my own life. Perhaps the Wiswell proverb describes depersonalizing decisions as a way to make them less emotionally difficult.
Henry Gifford comments:
Regarding the above about ruining the lives of one's children, my uncle used to say he ruined the life of his son, who was a heroin addict.
Looking at what he said from the other side, if what my uncle said was completely true, then parents have the power to stop their children from doing drugs or partaking in other ruinous activities, something many parents are frustrated to know is not true.
This perspective can ease the pain in some situations in life, and maybe in trading losses also.
Allen Gillespie writes:
On the violin to play fast one must leave fingers down for the return.
March 22, 2011 | 2 Comments
I conducted a study on this [what would the return on buying one share of every internet related company have been for various beginning and end periods] during 1999 when we were trying to measure the opportunity costs for not participating in investing in internet stocks. I have also used some papers that appeared in the various CFA Journals about the steam engine where it was 13 years between development and commercialization and one on the value to 3 or 4th generation adopters or implementers of new technology. The Nifty 50, etc. The biotechs in my study earned the equivalent of t-note return but with obviously higher volatility for 7 years, then surpassed it. The upside was, however, if you invested after the bust or even waited until the first signs of profitability returns were between 45% and 20% per annum respectfully. My conclusions were successfully to buy Google on its first day of trading and are behind my thoughts how to play china, solar, and cloud computing now.
1) In the mania - long/short (go long profitable ventures and short the unprofitable ones) - but in a more paired fashion (you need the industry and sector and multiple hedges– mismatched books can get difficult (i.e. the MSFT v. cloud issue now). The market when it achieves good clarity will price things on par with "risk free" investments, however, the unprofitable will always collapse at a faster rate than the profitable even within the bubble space. The best thought on this was from John Griffin who suggested shorting those brought public by second tier underwriters. He's logic - if even Goldman, Morgan, Merrill won't IPO it how bad is it. He found 30 internet stocks brought public by Whale Securities.
2) During the bust - redouble positions on profitable names - and pile in on 3 and 4 generation situations. i.e. Google was not the first search engine. AMZN has surpassed its highs just like AMGN and BIIIB of the prior study. EBAY is on the move again. QCOM - the biggest mover of 1999 has moved past its old highs.
3) Develop comps (for Google, we assumed the internet was as important at the PC, so we took Google's EPS divided into MSFT's EPS but assumed a 3x growth rate - on par for ho the PC industry developed). In the case of a NFLX, GOOG, SNDK, etc. look for what existing industry can be cannibalized for valuation purposes. GOOG was about TV ad revenue, NFLX put blockbuster under, and SNDK and the digital camera ate EK. The two way pair test on this would be a company on the Altman Z-Score test like Blockbuster or EK with its opposite on the sales and earnings growth momentum screens.
Current thoughts along these lines - if the Chinese are already the largest player in the physical markets (oil, copper, etc) and they are the mercantilist they seem to be (i.e. BIDU v. GOOG) then won't their financial markets ultimately be the same? If so, they what companies - probably not the ones listed now - who built the interstate? but who has a store on every exist?
SOLAR and alt energies rest on subsidies but if the productivity gains are real there is a cross over but there will be a bust - with only the ones getting to legitimacy surviving.
Cloud computing– another fine area
4) Spin-Offs & cross holding- follow smart company monetization strategies (i.e the Barnes & Noble v. B&N.com effect). Today see LVS, MGM, WYNN, on their Macau holdings. PM v. MO. It is a trend that should be concerning to the country. The companies are showing there is no growth here, so you spin the domestic and load it with debt (aka MO) and price the other for growth. In solar, CY, etc.
I have become fascinated with this site Quibids as a lab in which to study pricing particularly as it relates to psychological and odd pricing and substitute good pricing. Any thoughts and commentary would be appreciated. What are the fractional relationship of goods at various price points and what impact does the prior action have on the subsequent auction. Does a $100 gift certificate for different stores tend toward different average prices. Are these different prices also reflect of perceived value of the store and offer insight in the company's related stock price. Does the average price of a company's gift certificate auction lead moves in its stock price? So many questions this site creates.
How would one interpret a chart like this? In terms of numbers, a certain beginning harmony with DAX above 6200 and SPU lobogaling toward 1100 has been achieved with 6 up days in a row after 11 down in a row. How can chart swings be quantified to advantage and harmonies?
Pitt T. Maner III writes:
Now impresarios, big band leaders, conductors, choreographers, tenors, alto sopranos, glee club members, and assorted cheerleaders lining up in Fellini-esque fashion to lead the choir toward the November subscription drive.
See the song: "We're in the money".
Allen Gillespie comments:
Think of the circle of fifths. If 11 is too high an octave, then divide by 2, yields 5 1/2. And the point drop was nearly 1/2 of the Hz of middle C.
Kenneth Sadofsky comments:
This video seems askance, but it shows a sumo wrestler and a monkey in a game of tug of war. It seems that most of the time isometric strength was used. Then the wrestler stood up, losing his leg strength and ended up on top of the see saw, here losing some contact with the ground and center of gravity compared to the monkey. Then the monkey fed the wrestler rope where the wrestler would fall down and come undone. This probably doesn't answer the question necessarily, but my mind wandered into this area. Of course the monkey could just be stronger , but they were equal for a few seconds.
Here is a biomechanics paper taken without permission that describes force, etc. I stumbled into it while doing a search. Probably not much for those that already know the material, and of negligible value to those like me. It did stir my curiosity.
A friend of mine sent this very interesting link. It's about the work of Didier Sornette.
Victor Niederhoffer comments:
He's an actor always predicting the end of world, reporting one blade of scissors never expectations, like its 30% likely there will be catastrophic decline but never that it's also 40% likely that there will be an extraordinary rise. Similarities and retrospection galore and a doomsdayist.
Allen Gillespie writes:
I can't speak to that, but his book does have an interesting section regarding the implications of a zero interest environments and he references Von Neumann and other who wrote in the late 1930s the last time t-bill went to negative yields. The math is such that both U and -U can be solutions and hence jumps (up or down) like the "flash crash" and 1999 become acceptable solutions. That's the problem with ZIRP and QE because what is the value of a continuous stream of rising dividends at near zero discount rates? And what happens when QE stops like it did March 31, and on the fiscal side where the government reached is max transfer payments on April 15? Where despite rates still being near zero there was a exponential relative tightening of monetary conditions. And where did PG and others print? Why just below the last free market lows in 2009 before QE.
So, in effect, he does mention the possibility of a large rise and decline because both U and -U are solutions in a speculative bubble regime driven by ZIRP, QE, and massive explicit moral hazard. In short, things can trade anywhere and the days around the timing of when the Fed finally removes its ridiculous rates low forever language will be interesting as it will represent a 3rd non-traditional tightening. The issue is the Fed will probably need to run QE2 in the background when the debt roll doubles next year and climbs more in 2012 before falling and stabilizing thereafter by which time FNM and FRE might have run through the max losses.
I am not a quant but just a fundamental guy who also has a decent eye for politics, and I think it is relatively simple– the Fed's said "oh sh_t" after Lehman so they have tried to put Humpty Dumpty back together again by running bonds back to par and stocks back to Lehman levels (1166). Prices above that they will not artificially support, far enough below that they will so long as they are allowed to print $$$. The big risk, which cannot be quantified, is that historically it is a POLITICAL event which removes this support mechanism from the markets and that can happen in a day and stocks must fall a lot to find true cash (not bank convergence trade) buyers - those old men with canes who do exist but are becoming fewer.
Also, for the curious given current events– there was a large rise when the U.S. declared neutrality in the third quarter of 1939 only to fall a year later as this laid the ground work for its friends being run over. Isn't GM supposed to be IPOed then - TM problems real? - AIG insured Goldman? BP - the green energy firm - Yukos for the industry anyone - except we can't create a faux back tax - so we will just grab it with environmental taxes that will be coming. As to gold, its takes tighter money to kill a real bubble as 1999 and 2004-2007 showed and while on a relative basis the Fed has tightened with no QE, Europe has eased and until the U.S. can roll its 3 year average maturity debt with large origination years of 2008 and 2009, I am staying long and I bet other are too.
Peter Grieve writes:
The word "econophysicist" alone should be a danger signal, that someone is hubristically applying a certain analytical discipline outside its sphere.
One might as well say "gamophysicist" for "marriage counselor", or "hippophysicist" for the author of a horse betting pamphlet.
I bow to no man in my love of physics, but it only has power in clear cut situations.
Ralph Vince Concurs:
Gimme a break!
"…bubble markets display the tell signs of the human behavior that drives them. In particular, people tend to follow each other and this result in a kind of herding behavior that causes prices to fluctuate in a periodic fashion."
Really? Who would have guessed that!
Ah, Switzerland! Yodeley hee hoo! These guys are always in Switzerland, aren't they?
Yishen Kuik writes:
Victor may be right– some of Sornette's older (erroneous) predictions which I think appeared on his faculty UCLA website aren't around.
I don't know if someone has consolidated all his predictions to check the batting average, but he certainly may have left out his losers in recent press releases and papers. He seems to have channeled a lot of energy at bringing press attention to his work. I suppose his final objective is the lecture or consulting circuit a la the distinguished expert on derivatives and other professors.
March 17, 2010 | 1 Comment
VIX Doesn’t Work as Signal for U.S. Stock Returns, Birinyi Says
March 17 (Bloomberg) — Investors looking for clues about the U.S. stock market should probably ignore the Chicago Board Options Exchange Volatility Index, according to a study of the VIX by Birinyi Associates Inc.
Speculation that equity returns will be positive after the volatility gauge decreases and negative when it climbs has little basis in fact, Birinyi said. "The VIX is alleged to be an indicative indicator and has become a staple of analysts and journalists alike," Laszlo Birinyi and analyst Kevin Pleines wrote in a report to clients.
The following is a table of the S&P 500's average gain or loss during periods after implied volatility climbed above or fell below the 50-day average: (since September 2003)
1 Month 2 Months 3 Months 6 Months
VIX 20% Below 0.09% -0.49% 3.33% 5.84%
VIX 20% Above 1.25% 0.50% 0.95% -4.51%
Source: Birinyi Associates
Larry Williams writes:
As I have always postulated, the VIX is just the Dow/S&P upside down. It's hard to predict A with A.
Jason Goepfert comments:
I'm not a VIX fanboy by any means, but that article was ridiculous. It only looked at returns since September 2003. And it only tested a strategy of crossing 20% above or below the 50-day average. Why 20%? Why the 50-day average? Why just since September 2003? Did they test anything else? Or is that the one they found that supports their (so far very correct) bullish view?
The ridiculous part is taking such a weak study and then proclaiming "the VIX doesn't work."
Allen Gillespie adds:
He doesn't have enough bins — bins of 5 show something different.
Kim Zussman writes:
- Volatility was extinguished by fiat liquidity
- The only double-dippers left are Jibao, Roubini, and Michael Moore
- Nothing to fear above moving averages
Marlowe Cassetti responds:
I have always doubted the assertion that VIX is a measure of market fear and greed. Years ago I read Whaley's academic paper and I was not satisfied with the author's fear/greed connection. To me VIX is simply the volatility number you plug in to make the Black-Scholes option equation work.
Bud Conrad answers:
My detailed review of VIX concluded that the VIX followed stocks (inversely) a day later. It was not predictive. Longer term charts seemed to indicate opposite movements, but the data could not be used as expected.
I should write something about baseball and markets. I've written about the wisdom of Ted Williams for markets, and Larry Ritter, 100 market related things about baseball dare that was included in PracSpec with collab, and I've written about the hidden signs of baseball with all the thievery and spies of signs etc., and I've suggested some insights of Bill James, but the problem is I don't know anything about baseball, and I hate to write about something I don't know about like the chapter on poker in EdSpec which I wish i had never written since it was derivative and worthless. So if anyone can help me appreciate what baseball can teach about markets, I'd appreciate it. I'm particularly interested in the hidden rules, and I think I have a market system based on not running up the score, etc.
Allen Gillespie comments:
UK came back from a large deficit to tie UT with 2:13 left before loosing the game. Does the market do the same? One notes that the S&P regained its positive footing yesterday after being down for most of the year.
Also, one hidden rule is don't talk to a pitcher that is throwing a no hitter after 7 innings and give extra effort on defense. A market equivalent might be what happens over the next X batters after the first gets a hit if the market is down over the previous 21.
Jordan Neuman comments:
Baseball traditionalists love the idea of the bunt, the stolen base, and assorted "small ball" strategies. These are basically one-run strategies. And as Earl Weaver and Bill James have written, baseball people who actually do the counting, when you play for one run that is all you get. And you might not even get that.
The market equivalent has got to be all those maxims and strategies that emanate from the brokerages and the talking heads that are consistent money/opportunity losers. What is appealing in theory is more difficult in practice. I place covered calls in this category.
Stefan Jovanovich writes:
Any pitch above the shoulders is life threatening; you can die from being hit in the neck more easily than from the top side of the skull. Even so, throwing above the shoulders was within the Code even in the days before helmets had ear flaps. Sal Maglie did not get the nickname of "the Barber" because of his artful use of the straight razor. Drysdale and Early Wynn were notorious headhunters. The rule was and is a good deal more subtle. You can't throw at a batter's head if you also throw a curve ball that breaks away from him. You can't play even high level minor league ball without standing in against a pitch that is coming at your head because, if the guy is any good, that ball is going to break down and away for a strike.
Drysdale and Winn were fastball, change-up pitchers so their aggressiveness was tolerated; it was part of their game. Walter Johnson and Bob Feller are always written about as being "gentlemen" because they never threw at batters; they didn't because with their stuff (fast balls and right-handed down and in curve balls) it would have been attempted manslaughter. Sammy Sosa was "beloved" because he was a cripples hitter; he killed mistakes and ate up mediocre pitchers, but he was never feared by anyone who had stuff and knew how to use it. Barry Bonds was "disliked" because he ruined everybody and because he had the guts to wear protection for the batter's most vulnerable body part - his leading elbow and forearm - and not give a damn what the league or opponents thought about it. He also mastered what remains the hardest thing to do in hitting: swinging late and still getting around on the inside pitch. In that he was a throwback to the golden age when even someone with arms as long as Ted Williams would have his wrists pass over the inside of the plate. Modern hitters with their longer, lighter bats don't go there any more– which is why the Atlanta Braves during their glory years were always coached to pitch outside: "Having Leo Mazzone as a pitching coach lowered a pitcher's ERA by a little more than half a run."
The respect thing is wildly exaggerated. Players appreciate each other's skills but they get paid for winning and numbers, not for obeisance. Chuck Hiller, who was a wonderful catcher for the Giants, once said that if the league learned that a player had leukemia, they would be sad but, if the guy still had his stuff, the dugouts would be calling him "Luke" by the 3rd inning. Bang the Drum Slowly gets that right; everybody is sad for Robert De Nero who is dying but nobody on the team comes to the funeral except for Michael Moriarty.
Rodger Bastien comments:
A pitcher is expected to throw a brush-back pitch in the next half-inning if his teammate has been hit with a pitch, but it's taboo to throw that pitch above the batter's shoulders or behind the hitter ( a batter's instinct is to hit the dirt therefore he could be beaned that way). Good hard slides are a part of baseball but sliding "spikes high" is a no-no. Along with not stealing with a big lead you should not stretch singles to doubles or doubles to triples with a very large lead. If a batter leans over the plate, a pitcher is expected to throw inside to regain that part of the plate; a hitter with such a stance should expect a fair amount of inside pitches and should take his base without protest when hit by a pitch. When an umpire takes a nasty foul off of his unprotected areas or is shaken with a foul off of his mask, the catcher should go to the mound to give the umpire time to shake it off. And middle infielders protect themselves by throwing the ball to first during a double play right between the oncoming runner's eyes; its his responsibility to get down to avoid getting hit.
I could not make the game tonight so I was looking to sell my tickets. It will be a sell-out crowd.
1) First, I got some inquiries from insiders (neighbors, friends, etc.) if I was going to use my tickets. I would never accept an offer above face from a friend due to social reasons, so fortunately I delayed and they made other plans.
Trader Lesson: Insiders always call early and expect a great bargain. In fact, the final difference was about a 1/3. If selling to an insider wait, if buying buy along with them. Just like when the market fell hard insiders bought with great abandon. After all, if you are on the board of the New York Fed it would be impolite not to buy Goldman when the shares were in the 70s from over 200. After all you are friends. Do not befriend your brokerage firm.
2) The opening offers were on average extreme. Bargain hunters.
Trader Lessons: Patience can pay. Follow the Senator's advice and look for an early extreme.
3) After a couple of hours prices settled into a tight range, with a couple of extremes, but these bids were false as they found other tickets.
Trader Lesson: Be quick and skeptical of those good offers — they are just running stops.
4) On average prices were lower the more convenient the geographic distance between buyer and seller. Watch out when too much foreign money piles into a market.
Trader Lesson: Look at markets using various base currencies.
5) Finally, on a rainy day, watch the game from the comfort of your own home as only the young need to stay up late when tip-off is 9pm and the game is on ESPN.
One wonders if 1200 is a price of reflection in gold.
Allen Gillespie replies:
Bernanke is a Depression scholar hence he must believe the key to ending the Depression was the end of the gold standard which raised the price to $35 per ounce from $20.67, a full 69%. The decision was made on or around 3/6/09 when he made a deal with the devil at 666 on the S&P and Citigroup reported things were improving. A 69% change in the price level from that date would be 1125 on the S&P, 11200 or so on the Dow and just above 1550 on gold and a level equal to the old S&P high.
A Quant Asset Allocation Spec writes in:
I contemplated the matter and decided Tuesday that enough was enough, and to not further engage in hog-like behavior; although without enough conviction to lean against the powerful move. My greatest concern now is in which asset(s) to establish a new position. Is the re-flation trade nearing an end? Paramount to me is reducing excessive intra-portfolio correlation risk without getting run-over. Is building a larger cash position appropriate, and if it is, in which currency?
One year ago found the S&P index at 1005.75. When the big government party won, a large sell-off resulted. Now, one year later, the S&P sits at 1042.88 (giving a T-bond rate of return for the year), but the political sites expect the big government party to get thumped today.
Most sports games are fought to win early and decisively, given a choice. This painfully obvious comment alludes to the fact that the middle game and end game can thereby be played with less risk for the winning side. However, this must be measured against the opening winners desire to play all out throughout, just with less overextension, not merely maintaining the advantage. Don't let up on your capacity or talent. Some games and teams will require a full force stance, depending on the point lead and in order to play well. What I suggest is not to rest on a gain. I only suggest to reconfigure the risk/reward ratio. Otherwise, playing a completely defensive strategy will destroy the advantage. Further, risk/reward can allow a highly aggressive stance and be defensive by inducing your opponent to expend more than usual amounts of energy and exasperation trying to defend offputting attacks. Inducing is aggressive. These attacks will accompany random, not constant defensive moves on the aggressor's part, allowing just enough of a hedge and freeing up energy from an overly or hardened defensive posture to a game of overall nimbleness, less probabilistic and freeing up energy to explode at will. Thus, the risk/reward ratio is not all about chasing points, but allows for a game whereby opposing points can be thwarted. This alleviates the need and obvious static (stasis?) energy of a defense only strategy, thereby giving the opponent one's game plan.
Entice your opponent to play your game: To play drunken martial arts, which requires enticing your opponent to engage on your terms, running out the clock, angering your opponent, retreating or advancing to entice your opponent to your strengths, or limiting your opponent's moves, , while maintaining full force and adaptability in maintaining a defensive posture also come to mind. (Ali trained to take many a pounding to train for an otherwise superior Foreman in '74 or whatever). One's tactics are freed from having to score. Let the opponent, out of sorts and off their game score for you, in which you make easier points, thus conserving one's energy. The corollary, making one's opponent pay big to even get a point or taking a hit is very offensive. But these are only for the very proficient. These tactics under an overall strategy require or expect the deemed defense having to move, not always true in stocks. (Though Buffet said one can swing when one wants; 4 balls will not get you to first in the stockmarket). An exceptional opponent will not take the bait, but circumstances can force their hand. These thoughts touch on defense as offense. We all know the opposite axiom. As one aside, I'd like to see the drunken martial opponent, and this takes on many variations, in boxing, fencing, racing and war, in which the opponent is enticed to overexthend themselves to the winner's advantage, not move in such a fashion into the opponent's traps. Others may have specific games in mind. I am having the problem of analogizing a specific game; a discrete event compared to the market moves over a term. However, the market moves comprise many a game.
Some of what I consider the more continuous sports are soccer, lacrosse, basketball, hockey, fencing, boxing and tennis, in which one can morph from an aggressive stance, to a defensive one on the fly. Of course, this applies to all sports on a limited degree, like baseball and football where a meeting is called prior to a play. I like the former because the action is more often in play than other games, and therefore the strategy and tactics can be applied with more facilty in real time, of course given prior strategizing. Maybe it's like a free form jazz requiring excellent individual talent that understands the other players, compared to an orchestra with a conductor playing 30 second songs cumulatively. Both comprise professionals. We know the market does both as well.
This writing has suggested employing defensive offense, for example keeping the accent on making high percentage shots that tire your opponent mentally and physically. Do not take undue risks in shooting (offense)and upgrade one's focus on preventing the rival from scoring (defense), rather than setting up your next shot. An advantage within or from a game is anticipating further moves or a later game. This allows for other strategies/tactics to surprise, accumulate to disorient, and induce the opponent to weaken lines in order to defend against all possible attacks. Continuing the earlier discrete game, the early winner can devote more resources to defending the perceived advantage with the above considerations in mind. In fact, the simplistic notion of games is not to take undue risks (this assumes a lifetime of understanding) once victory is achieved, while of course playing all out under revised risk/reward calculations. To confuse things, a good winner will continue to play all out, as that is their best game for cadence and alertness. As a warning, many have lost sitting on a win, confusing defense with merely running out the clock. Resting can beckon atrophy, thereby inviting ineptness.
Another is offensive defense. A penny saved is a penny earned. I would submit that a penny saved costs less than a penny earned oftentimes. Drive to the utmost, but how many feet or seconds does another pit stop cost? Can it be skipped with good preparation and execution being the same car, or is it better to plan for a stop in order to have your best car on the track? A lot of movement in life, like mechanics, etc., has exponential costs, like a rocket liftoff compared to cruising, and the same for other bursts requiring torque, like moving onto the beltway. Make your opponent use torque that require more energy and force pit stops that cost time.
Unlike the stock market, in discrete games, a 2 point win is equivalent to a 50 point win. Can we say that if the 2 point wins accumulate, they will become 50 points and be, just a little little bit easier, to come by?
Defensive offense and offensive defense: do they exits, does it matter, is it semantics? It was just a way to make a point and hint that things occur simultaneously.
In sum, winning big early, frees up an added dimension of facileness, controlling time and moves of your opponent, while increasing one's own efforts to thrive and grow toward an increasing advantage. Maybe all games should be played this way throughout, but an early advantage seems to change the risk/reward analysis. The predators are able to employ this. A good follow up would be to depict what the purported prey would do to become the eventual winner. —Maybe the same? but they seem to have less reward in creating a win from behind by just maintaining the stasis. Advisors often suggest that increased risk is not the answer, until Hail Mary time - at least in a discrete game.
Allan Millhone looks at it from the Checkers perspective:
I am packing and getting ready to head to Grove City, Pa. for a yearly tournament there. There will be plenty of stiff competition with our Three-Move Restriction World's Champion and other top Masters. In tournaments my eyes scan the board akin to surfing and try to find a safe line of play. Like a good wave to ride safely to the King row (water's edge at the beach) . The surface of the Checker board at times can be very smooth as you coast towards an easy draw . Other times the ride is bumpy and can be quite turbulent as your opponent( like the waves) can force you off into uncharted waters. The Market trader needs to be wary and look ahead at all times for ever changing Market conditions much like the waves for the Surfer endlessly shift back and forth. The Checker board starts out even for both sides with twelve pieces each, but soon after the calm subsides and the waters of the board begin to swell . The Surfer tries to Master the wave as the Market trader tries to tame the Market Mistress and gain the upper hand.
Tommy Wiswell said: "Look twice before you move."
Steve Ellison writes:
In many competitive endeavors, simply making fewer mistakes wins many games. Mistakes I have made in the markets include:
- Failing to be aware of changes in trading hours
- Using a limit order to try to save a few dollars when I really did want to enter the trade regardless
- Failing to be fully prepared (with orders placed in advance when feasible) for any events that might set up a favorable trading opportunity
- Entering a trade without knowing exactly what I would do if price moved up, down, or sideways
- Deviating from my trading plan
- Using too much leverage
Roy Longstreet wrote in 1967 in Viewpoints of a Commodity Trader:
Did you watch the Packers whip Kansas City in the Super Bowl? I did and was much impressed by the professional way in which they performed. They did not beat themselves by making mistakes.
A professional makes fewer mistakes than others. That is why he is a professional. He may not have more ability than another but he is superior because he has trained himself not to make mistakes.
I was particularly impressed in watching the Packers throughout the season as they seldom were penalized for infraction of the rules.
On Mr. Longstreet's last point, the Detroit Red Wings have similarly avoided penalties in the Stanley Cup finals. Conversely, the Pittsburgh Penguins, who have probably by now surpassed the aging Red Wings in talent, took a string of penalties in the fifth game after the Red Wings took an early lead. As a result, the Red Wings scored three power play goals and put the game out of reach.
Allen Gillespie adds:
Hawks v Supersonics game I went to years ago - 67-66 after three with only Peyton hustling - Steve Smith scores 33 in the 4th running around like a maniac. Also, in soccer, most goals are scored very early or very late in a half.
Nigel Davies comments:
Here's another view from a mistake specialist (both my own and other peoples'):
The mistakes we make tend to crystallise around different deeply rooted thinking patterns and attitudes but then change their form when people notice them and try to something about them.
An example might be that of a trader 'taking profits too early', vowing to do something about this and then taking them 'too late'. He could be 'correcting his mistake' but failing to address the real issue of making arbitrary decisions rather than operating according to a tested plan.
Normally you have to go very deep to ferret out the cause of error and then, assuming someone is willing to go there, it's unlikely they'll actually be able to do something about it. But success can come when the number of good moves outweigh the bad, so for those with an innate 49-51 split have hope…
George Parkanyi says:
Making mistakes is not one you can generalize like that. Mistakes are how we learn. If you are not making mistakes you are probably aren't stretching yourself enough. Mistakes also come in all shapes and sizes — some are disastrous, some are benign.
Recovering from, or leveraging mistakes — now there's something.
I should mention the idiots savants that baseball attracts. The Collab and I saw a few at Cooperstown. They knew the averages of every player that ever played the game. Same thing for markets. So many people can describe what it was like before the cycles changed and they have charts to show their point of view.
Allen Gillespie comments:
Last night BC and Texas set the record for the longest NCAA baseball game at 25 innings. Appropriate that it came at the same time as one of the longest runs in stocks. The rub — it was a pitchers dual with the final a mere 3-2.
April 24, 2008 | 6 Comments
How many things are there in baseball, the swings, the runs, the cycles, the signals, the deception, the consistencies, the standings, the All Stars, et. al., that are directly relevant to trading and could make us better?
Allen Gillespie replies:
I grew up a Braves fan and unfortunately after watching them win many pennants but only one World Series over a decade of dominance I can say this: there is a significant difference between championship teams and good regular season teams.
This is andedotal, but their one champion team I think won close to 30 games in the 9th innings. Spec lesson: never give up, keep it tight, and focus in the clutch. 2) The Braves have always had deep pitching — which helps in the regular season, but in the playoffs things change as teams shorten rotations, and so the Braves were always a bat or two short in the playoffs. Spec lesson: play the late months (Nov, Dec) — more offensively than the long season months. 3) Champions, even when they loose during the season, rarely get blown out because there is too much pride. While I have never been a Yankees fan, Derek Jeater did earn my appreciation when I saw him in some meaningless game during the season hustle to catach a fly while crashing into the stands on the 3rd base line and busting up his face a little to make an out.
Tim Melvin expatiates:
First, it is a long season. Although you have to play to win every day, no team ever has. Winning 100 out of 162 is considered a mark of greatness. A trader who wins 60% of the time day in and day out will probably also reach greatness. There will be losing days in the market as well. Shrug them off and learn from them. There is another game tomorrow.
Swing for the hits. the home runs will happen on their own. Sluggers who routinely swing for the fences every at bat may hot a lot of home runs. they will strike out a lot as well. Good hitters look to make solid contact knowing that the home runs will come when the conditions are right. a fastball inside or a curve hanging out over the plate. The major concern is to put the ball in play and advance the runners. In trading the objective should be to make good trades. the home runs will happen on their own when the conditions are right.
Focus when the play starts. Baseball players seem to stand idly around between pitches. But watch how they focus once the pitcher steps on the rubber. Once you hit they key to enter the order, it is time to pay attention.
Situation matters. It is okay to steal second in the third with no outs and no score. In the 8th with the game tied and two outs it is usually not such a great idea to waste the potential winning run. A bunt early in the game with the bases empty and a three run lead does not make a lot of sense either. But in the ninth with a runner on first, no out, a tie and the top of the order coming up, its time to lay one down. If the markets is making new lows several days in a row, it might make sense to buy big on the long side. if it has been making new highs, maybe not so much.
Sometimes you just don't want to pitch to the guy. If a power hitter is up, a base is open and the game is on the line, it might make sense to just walk home and face a less powerful hitter. Sometimes, the small loss is the best one if it appears powerful forces could cause your trade to go strongly against you.
The game is not over until the last out. Keep playing. baseball is riff with stories of 5 run comebacks in the ninth. So is trading. Stay focused and look for the chance to rally.
Defense matters. Ask the Texas rangers. You can play powerful offense but if your pitching and defense callow the opponents cheap runs, it is hard to be a winner. If you have large winners combined with large losses all the time, it is tough to win over time.Not every team will win the World Series. Only one will. But a winning record and playoff appearances fill the seats with fans. Not everyone can be the best trader at every time, but you can be a winning trader.
If you can steal the other teams signals, or just figure them out, you have an advantage. In the market you can gain one by being aware of what large successful traders and investors are doing. Thanks to COT reports and sec filings, it is easier for investors than ballplayers!
What position are you playing and what is your role? Pitchers and catchers are involved on each and every play. Fielders have to watch every play but are only involved when the ball is hit their way. The designated Hitter is only involved three to five times a game at most. Short term day traders are in every minute of every day. Macro oriented traders only when the markets move towards their entry points. Longer term investors only when conditions are exactly correct for entry. Knowing what you are trying to achieve and what style fits your strengths can be critical to your success.
It takes more than one person. Ask Barry Bonds or Nolan Ryan. you can be the best ever at your position but if the team around stinks it will be hard to succeed. in trading I think this goes beyond just the coworkers and analysts you might work with and take advice form. our team is those people we surround us with, bounce ideas off of, celebrate wins and suffer losses with at the end of the day. Our team is our family, friends and confidants. I do not think anyone can be successful without having the strong network of friends with them along the way. It is like being a pitcher with no team. you cannot just be good, you have to perfect as any ball put in play is a run. Pretty damn lonely even if such a perfect person were to exist.
Be ready when called on. Recently jay payton of the baltimore orioles went 5 for 5 as a late inning pinch hitter. it is a big reason the Birds are winning right now. Same with the bullpen. Even when market conditions are not right for your type of trading, stay sharp and focused. You never know when a late inning rally puts you in a position to come off the bench and drive in the game winner. Markets and games can change in the blink of a surprise fed announcement or a three run homer. be ready.
There is more to life than baseball. You must practice your skills, study your opponents and work hard. But it helps to be able to relax away from the game and enjoy other endeavors as well. Same with the markets. Study learn, anticipate, but take the timeout for books, music, friends, family and all the other things that actually make life so damn good. Maybe even take in a baseball game once in awhile…
Dean David adds:
In hitting it is important to let the pitch thrown determine what type of swing you offer. As an example, Rudy Jaramillo teaches hitters to try to hit outside pitches to the "opposite" field. Frequently this approach results in a firmly struck single, where attempting to "pull" an outside pitch will result in a weak grounder the opposite way or a "pop up". It appears that this is lost art early in the season as many hitters look to bolster power numbers by pulling every pitch without regard to its location. Strategy for the pitching coach would be to pitch away to hitters that have yet to demonstrate a willingness to "go with the pitch". This is an addendum to Mr. Melvin's comments about the importance of singles.
Jeff Watson comments:
In baseball, one must always be on the lookout for a pitcher who throws a spitball, a 3rd base coach who steals signals, and a batter who uses a corked bat. In trading, one must look for the same type of behavior.
Alston Mabry notices:
Some similarities between baseball and markets:
Random events are interpreted as meaningful: "Have you noticed how many times you see the guy who made the last out on defense be the next guy up at the plate?"
Talking heads use meaningless stats to produce commentary: "Rodriguez is hitting .243 for the season, but on the road against left-handed pitching, he's only .218."
Lots of fresh data produced every day.
Quants taking innovative approaches see some success, e.g., Boston.
People will, in fact, cheat to get ahead.
The public gets tapped to support the infrastructure.
In the long run, the better teams steadily increase their lead over the poorer teams. In the short run, e.g., the playoffs, "anything can happen."
Phil McDonnell writes:
Some years ago I coached my son and daughter' teams in baseball and softball respectively. In particular one phenomenon noted was that there was a king of the hill effect. We recall that king of the hill is the game where one kid stands on the top of the hill and all the others gang up to bring him down. Then a new king emerges and the gang has a new target. Needless to say no one ever remains king for long.
In my Little League days the effect was the same. Aware of the king effect our team somehow managed to lose every single pre-season game in every year I coached. Naturally one took the opportunity to mention it to every other coach in the League.
On opening day we made slight adjustments to the line-up. Somehow we managed to win 7 out of the first 8 games - yes, every single year. We played about 16 to 18 games each year so that was about the mid point of the season. Usually about then people started to try to figure out the standings. At that point the season got a lot tougher. Coaches would know that we were on top and invariably we would only see the best pitcher on each team. The only advantage that our team had in the latter part of the season was that my batting order simulation model was getting smarter because it had more statistics on our players as the season went on. My estimate was that the model gave us about a 1 to 2 run edge in every game and the average number of runs was about 6 so this was considerable. Still somehow we managed to come in first or second every year, but the headwind from the king of the hill effect made it much more difficult.
The parallels with the top trader or money manager each year are profound. When a manger is on top two things happen. First his style or technique becomes reverse engineered and his trading space become more crowded. Secondly the king of the hill effect is at least as strong in trading as in baseball. If one was number one last year then literally everyone else is out to get you. Literally the other managers and traders cannot afford to let anyone stay at number one too long. They would lose all of their accounts to the top trade. So they have no choice but to gang up to survive.
In the March 3 edition of Barron's there was an article by A. Bary entitled "Risky Bets". The author cites a number of stocks that are down 40% or more from their highs; he believes investing in these companies could be very profitable if the credit markets begin to normalize and the economy recovers.
There are a number of companies other than those he cites that are down 40-50% or more that may be two or three baggers when the stock market comes back. The question is, "Are they reliable companies or future bankrupts"? I've been using Value Line and Morningstar to determine the financial risk of some of these beaten down companies.
However, I'm also aware of a formula called Altman's Z-Score that predicts future bankrupts with 85% accuracy among stocks with a low Price to Book Value. A Google search yields a number of articles describing the approach and financial data to use.
The data to use are:
1) Earnings Before Interest and Taxes (EBIT)
2) Total Assets
3) Net Sales
4) Market Value of Equity
5) Total Liabilities
6) Current Assets
7) Current Liabilities
8) Retained Earnings
I have, with varying degrees of success found these data in the Yahoo, CNBC-MSNBC, and Morningstar Financial Pages. But the data are 6 or more months old or incomplete. Value Line was a big disappointment.
1) Is anyone aware of where more up-to-date and complete financial data may be found on the web?
2) Or is there a web page that lists companies along with their Z-Scores ?
Gordon Haave replies:
For those of you with Bloomberg (the system, not the mayor), there is a Z-Score function built in.
Larry Williams suggests:
Allen Gillespie cautions:
Altman Z-Scores is designed to work for certain industries. You might have to use several different scoring methods to cover all industries.
Eric Falkenstein offers:
I just created a website with free default probabilities for public companies, US and worldwide. Better than anything else I've seen, and I've seen 'em all.
The importance of practice in music can't be overstated. There are hardly any musicians of great competence who took up their study after the teens, and most have been practicing intensively since the age of seven. The problem is that most people hate practice, stop at an early stage, and waste their time when they do this. Michelle Siteman in her magnificent book, "The Pleasure and Perils of Raising Young Musicians " has a chapter "Practice Makes Perfect " in which she gives 10 techniques for improving the quality and quantity of such practice.I have received completely positive feedback from musicians who have read this book that the techniques she suggests are ingenious and useful. I believe the have universal value, and I will try to apply the lessons from Ms. Siteman's chapter to improve the practice of trading with a few of my own practice techniques from racket sports thrown in. This is a subject that has received much too little attention as practice makes more perfect in every field including our own, And this would apply to any trader despite his natural proclivities and abilities. It is common to think that a quality for greatness in a field is to love to practice it. But Vladimir Horowitz, Glen Gould and many other musicians, including Beethoven, hated practice when they were young, but they were able to conquer their aversion, usually with the aid of a firm parent who applied some of these techniques. Presumably the head of a trading team should insist on practice regardless of the qualms or machismo of some of those whose recent track record is good, or believe they were to the manor born. Emulate Pablo Casals and Yehudi Menuhin, who practiced eight hours a day, every day of their lives.
It's not enough to say: practice trading. Most people don't know how to do it. And most are bored while practicing so there has to be something that makes it interesting. Musicians handle this by mixing in some easy beautiful pieces with the scales, finger exercises and and arpeggios.
1. Group activity. One universal technique for making practice more interesting is to make it part of a group activity. Somehow those who play instruments in orchestras stick with their instruments to a much greater extent than piano, and this is why many impartial observers suggest that orchestral instruments are better for a child to play than piano, because they stick with it. Practice sessions for traders should be in groups.
2. Money rewards. And what follows from this is that monetary rewards are a great motivator for musicians to practice. Some parents make their kids pay part of their lessons with their allowance money. This has a very salubrious impact on the efficacy of practice. Group trading practice should have monetary rewards. It's amazing how many of us will stoop down to pick up a $5 bill.
3. Record keeping. Record keeping is an important part of a good practice session. A systematic account of what has been learned and what the goals are is always helpful as a foundation. It's also helpful to be able to review the mistakes and winning forays that went into a successful trade.
4. Parental presence. All musicians find it boring to practice alone. Having a parent around to observe reduces boredom. If it's important enough for the parent to insist the child do it, then it's also important enough for a parent to take an interest. The same would apply to a trading manager, who all too often leaves the trading practice to the subordinates without taking an interest in it.
5. Proper logistics. Practice should be at a certain time, and a certain place and there should be good lighting. That way there's no chance that a session can be missed because of a conflict in schedule that arose because the child or trader didnt know that it was scheduled for that day and time. A proper environment without sibling or other traders squawking that they are hungry also improves results.
6. Consistency. Practice every day is essential. The markets are always changing, and after a day or two all the skills begin to detiorate. I once practiced squash every day, 365 days a year, for 10 years. A trader should practice trading each day, or if a hiatus ensues, should practice steadily for a number of days before entering into the fray.
7. Read books about the techniques that other great musicians used to improve their techniques. What worked for them probably would put you on a path that has at least been tested. Eschew the techniques of traders that were not successful, for example the boy trader.
I would be interested in ideas readers have on improving the training and practice of traders.
Larry Williams adds:
I have always thought mastery is a largely the function of repetition.
Obviously you have to repeat the right things. Today's great home run hitters all have instant access in the dugout to videos of their last time at bat to review and repeat the right techniques and stop the wrong. Many scoff at paper trading — sure, it is not as emotional, but still provides valuable lessons.
Chris Ledoux won the world bareback riding championship with very few rides in actual rodeos. He was so banged up he practised on a bucking machine (also wrote a good song about it) to prevent further injury and shocked all the bettors who had never heard of him as he accomplished his gold belt-buckle dreams.
Jim Sogi suggests:
My Karate teacher said, "What is the best practice and training for fighting? Fighting. You can run all day, you can do 1000 sit ups, 1000 push ups, 1000 sprints, and 1000 punches. But the best practice is fighting with an opponent. "My father once said, " The only difference between a small case and a large case is the number of zeros behind the 1."
You can read 1000 books about trading, study data for hours, but the best practice for trading is trading. Even if you do small size, which is best for practice, it keeps your wits sharp and emotions tough and keeps you in the game.
Keep a place set aside for only trading, always ready to go, 24 hours a day without having to clean up, scoot others away. Same with music practice. Have a set aside place or room for music with all the instruments just ready to walk in and pick up and play, even for 10 minutes before dinner. Pretty soon it becomes a habit.
Allen Gillespie takes it further:
Scales and etudes and pieces played with different bowings, speed, rhythm, etc. Breaking down a passage into shorter component parts. For example, if there is a long passage of quickly played 16th notes, first practice with separate bows for each note, then two on a bow, then three, etc. then change the rhythms from just 16ths notes, then just play the key notes from the scale so the ear hears where the passage is headed as many of the notes are fillers, understand and anticipate the pattern. Learn to play by ear. Finally, Always Play/Practice Musically (i.e. even when practicing the notes do not forget to include the crescendos, etc.)
For the trader,
1) Imagine as many scenarios as possible.
2) The distance between lows or highs or between lows and highs might give an indication as to the key
3) Some notes/days are more important than others
4) Trade smaller during times of practice
5) Test different combinations of variables - first separately then two, etc.
6) Despite all the practice, sometimes the best performances are not straight from the page
7) Finally, trading is an emotional game, so play with passion and remember there is always a low note and a high note and many notes in between.
Sam Marx reminisces:
Practice is important and in my sport in high school I practiced quite a bit but always felt that I had a limit because of physical limitations. I was 6 ft. tall but my hands were below average for my size. I couldn't get a good grip on a football or palm a basketball.
Once I was seated at a dinner table next to Bart Starr, former Green Bay QB. That man had huge hands. I have no doubt that enabled him to better control the football and made him a star. Another time I was in close proximity to Gil Hodges and I noticed that he also had huge hands. I believe he was a first baseman. I could just picture him with an oversize glove catching balls or scooping up grounders that would be missed by the average infielder.
A friend of mine was an excellent boxer. His arms were extremely long, also, his head was smaller than it should be for his size. He could just move around his opponent and jab him silly while keeping his head tucked behind his shoulders. Standing up with his arms dangling on his side I thought he looked like a chimpanzee. He had no desire to become a professional boxer but I've seen professionals in the ring with those characteristics. Kid Gavilan comes to mind.
On the options trading floor I noticed that some traders could hear trades from across the pit. Their hearing was acute.
Practice is important, but don't dismiss physical and mental ability, especially abilities in the 3 plus sigma range.
Don't tell your kid that he can accomplish anything if he practices enough. Offer this advice only when justified. Tell him he can greatly improve with practice but don't offer false hope of attaining the impossible. It can be frustrating if you're not in the 3 plus sigma range in the field you're practicing in.
Nigel Davies recalls:
David Bronstein once advised me to prepare for tournaments by studying chess at the exact times the games were scheduled. And I understand that Vladimir Kramnik took this concept one stage further by solving endgame studies (particularly demanding work) during the last hour of such studies. The last hour of a playing session is known to be the most critical, with most games being won or lost at this time. And it does seem that he got the better of Veselin Topalov at this point in the games.
Easan Katir mentions:
I spent one recent Saturday evening at the Hat and Hare Pub in the basement of the Magic Castle, with two accomplished card men, Aaron Fisher and Tony Picasso, discussing their art. Aaron instructed, "to improve, perform at any opportunity, for anyone." The club was full. He said, "C'mon, let's find you some people." So he rounded up a spontaneous audience comprised of three giggly young things, and gave this amateur the opportunity to perform modestly baffling illusions.
Live performing, live trading. No solo practice or paper trading like it. Mind sharp. Managing audience expectations, unexpected reactions and distractions. The joy of good execution. The thrill of conquest. The glow of accomplishment.
Much theoretical study, counting and practicing correctly precedes such moments. For trading I suppose the advice "perform at any opportunity" could be ambiguous enough to become a way to diminish one's capital, unless one adheres to tested guidelines for what constitutes an 'opportunity'. It works for me to transfer these skills to trading.
Evan McKeown writes:
Practice is such an important topic. I have always believed that if you do what you love, and love what you do, then success will eventually come your way. Success itself means different things to different people.
I am a 5.0 tennis player, and love playing tennis. No matter how much I played, or practiced, I never was able to reach a level much higher. Notwithstanding my dedication or love for the game, I have enjoyed other success by meeting wonderful people that share my enthusiasm and we enjoy our weekly matches. John McEnroe once said he hated to practice, so, instead, he played in doubles tournaments. John had one of the best net games in tennis which is unusual today thanks to his devotion to being a doubles player as a substitute for practice.
I am a trader. Once again, I love what I do. Trading is not a job, it is a way of life, my passion. I trade every day, and practice every day. Practice for me, comes in many different forms. Just as in tennis, there is on the court, and off the court practice time. Off the court (or ticker screen) I stimulate my mind with financial literature. The best book I ever read, and the only book I ever read for a second time, is "The Education of a Speculator." This work of art should be required reading for any college finance class. Long before this book made me any money, it first saved me thousands. Years ago, when a perfect storm of events had collapsed my portfolio and nearly had me on the verge of ruin, I sent an email to Vic and Laurel for some word of encouragement after the market had crashed through a 200 day moving average, financial condition in the market that is not unlike the one we see today.
To my amazement, Vic and Laurel wrote me back with a few simple words that inspired confidence. Not so much advice, as it was knowledge on how to handle adversity. I not only made back the 50% that my portfolio had declined, I ended the year with a 27% gain. That email changed my life forever. Instead of placing a sell order and taking a loss of half my assets, I took the pearls of wisdom and made the most of the opportunity.
Thank you Vic and Laurel, for sharing your knowledge and experience of the markets, for being an inspiration for common everyday traders such as myself, and for taking a few moments and write such an inspiring email that changed my life forever!
Pitt Maner III says:
Many years ago I went for 3 days of tennis lessons at Nick Bollettieri's in Brandenton, Florida. An evaluation was done of each player's ability and then we were separated into groups and sent out to practice for about 5 hours each day (with a lunch break at mid-day to watch films of Agassi playing). Thank God it was not in the dead of summer, but at 80 or so degrees it was still quite brutal for moderately trained weekend warriors.
One of my teachers was a former Rhodesian paratrooper named Ian who picked up very quickly on my poor footwork (even for a 3.5 or 4.0 player) and tendency to "float" or not properly set my right foot when hitting a backhand. The school also emphasized the need to follow through on strokes and to keep hitting the ball deep and allowing for sufficient height of trajectory over the net. In other words give yourself a margin of error and don't try to hit winners all the time from the baseline–play it a bit safe and wear your opponent down.
The tendency of beginning tennis players love to hit winners even at the expense of hitting several poor shots and losing games was discussed. Players were taught to recognize the importance of swing points (ie. 40-30 or deuce or 30 all) and to be more aggressive at 40-0 or 40-15. At the pro level students were shown film of Agassi running Lendl and not finishing off points right away if Andre could get Lendl to "lunge" one more time and thus exert more energy. Tennis warfare by attrition.
Tennis at the highest levels was indeed a different game then what I imagined or had gathered from watching Borg and Conners on TV or reading about in Tennis magazine.
On the adjacent court one could watch the 10 year old Anna Kournikova practice with her coaches under the vigilant eyes of her Russian mother. The tennis school had a quite rigorous schedule for the kids–lots of running in the morning, tutoring–school, weightlifting, and hours and hours of hitting tennis balls. At the time Anna said she loved to play tennis and did not mind the practice. We watched as she played practice games in the afternoon against boys her age or slightly older.
At the end of 3 days my toenails were breaking off from my swollen feet (note to file–never come to a tennis camp with new tennis shoes!) I had experienced my first and only time with tachycardia after running side to side "suicides" on the court. My game had been broken down and I was now playing like a sorry 3.0 player and not able to incorporate or integrate all the intensive things that had been taught. There was a German banker who said he worked 60-70 hours a week at home and came to the camp for "relaxation"–masochism at its finest!
But the lessons were learned and not forgotten and months later my tennis game improved and my appreciation for the game greatly expanded.
Steve Scoles makes another point:
An important requirement of successful practice is getting proper feedback in a timely manner — touching a hot stove teaches you pretty quickly not to do it again. Markets, because of their probabilistic nature, are really horrible at given this kind of feedback. In investing and risk management, the short-term outcomes are often unrelated to the quality of your decisions and it may even take years to be proven "right" or "wrong". I don't think this is a new idea to the world of trading, but I have always found playing poker to be a good way of practicing dealing with the probabilistic nature of markets.
Poker has several similarities with investing with some key ones being:
- imperfect information
- probabilistic outcomes
- emotional involvement is in play as money is on the line and your failures and successes can be monitored & commented on by the other players.
The advantage of poker over the markets is that the decision-outcome relationship is usually more analytically simple to learn from and thus the feedback loop is a lot better than what you get from the markets.
Three things that I have found poker helps you develop that can be carried over to the markets are:
1) to learn and internalize how gains and losses are really probabilistic outcomes rather than successes or failures;
2) to improve your ability to evaluate decisions on a basis other than the outcome;
3) to improve your ability to maintain emotional stability through the various ups and downs.
Jim Sogi makes his second remark:
In Japan the Sumo wrestlers live a strict regimen of diet and training. They avoid emotional upset that might affect their appetite. This is like trading. It has to be approached as a competitive sport. Physical training, proper sleep, good food, avoiding drugs and alcohol are necessary during the trading week to be in top shape when in the fray. If something upsets me or I fall out of training, the trading can be affected.
Alan Millhone follows up:
I will speculate that the Sumo's do not watch much TV nor hear any negative news while in training ? Mental discipline in Sumo, trading, board games,etc. is critical. When I attend any Checker tournament I get my rest, eat properly, no TV when on the road. Mr. Sogi is correct that being upset is a big deterrent to functioning properly in any endeavor. Staying focused is Job # 1 and critical to proper performance. The avoidance of drugs and alcohol holds true in any event we pursue.
I have always been told by my father, who has been in the markets since the early 1950s, that bull markets try to scare you out by running too much and selling off quickly and hard, while bear markets fool you into staying in by easing down and promising recovery. I think both the credit crunch and today's quick slide qualify as bull market activity.
A three-week consolidation, including this week, would be natural as earnings are processed. To me this whole episode looks like the ease, hike, ease, pattern of late 1979 to early 1980, just after the S&P 500 hit a seven year high. This time the hike was in credit and the drop not quit as violent as then. The best thing Greenspan ever said was in 1998, that the solution to moderating and preventing crises is more equity.
David Higgs remarks:
ING Funds has a flier showing overall dividend yields over the past five years of an assortment of countries. New Zealand for the most part had the highest yield in 2006, 4.46%. Compare that to the USA at 1.76%, seems like the guy with the CD in the end wins over the big risk taker, as with the tortoise and hare. But how can a country of sheep farmers continue to be a payer of high dividends year after year?
I was reading CFO magazine and a story on how retailers are becoming more systematic in their application of markdowns. In fact, it mentions Oracles markdown-optimization software. It made me wonder if such strategies could be applied to a list of stocks. It mentions strength of inventory by store and item. It mentions categories by color, size, and style. It mentions optimizing inventory replenishment rates. In an analogy to trading, size and style are easy, but what would constitute location, color, etc..
"the software can monitor sales through the selling season, compare them to non-linear forecasts generated from sales of like items in prior years, look back to historical sales data, and predict how the item will sell fro the remainder of the season. If it looks like the product won't sell out, the software can look at how similar items responded to past marketdowns, then test a variety of pricing strategies to identify the one that will result in sell all the merchandise." [Read More]
Suzy Jagger and Gary Duncan
America's leading public finance watchdog has sounded a warning that the US economy is vulnerable to hostile financial actions by nations that are not its "allies".
David Walker, the US comptroller general, indicated that the huge holdings of American government debt by countries such as China, Saudi Arabia and Libya could leave a powerful financial weapon in the hands of countries that may be hostile to US corporate and diplomatic interests.
Charles Geist's Wall Street: A History notes that seven million of the original eight million dollar subscription for the Bank of the United States was held by foreign interests and that more than half the debt was held abroad in the early 1800s. America attracted risk-takers — and low interest rates simply do not excite them still.
While bonds rally on the subprime mess, one should note the historical tendency for the SOX index to be a leading indicator. A modern day blast furnace index!
I take the subway to work daily. While not the most prestigious means of transportation, it is definitely in my case the most practical, economical, and time saving. I happen to live three subway stops from the beginning of the line.
By the time I catch the subway, it is usually full with no seats available. Sometimes, I am in dire need for a seat to get a little nap, especially if I am caught trading overnight. An hour nap can do wonders in my case.
Out of this need I become more creative about finding this precious vacant seat. Knowing that the previous two subway stops to my own have only two sets of stairs closer to the front end of the train, I started walking all the way to the opposite end in hope that most people will go for the closer compartments. This is in fact the case except oddly enough that the farthest compartment is always packed.
My reasoning in this case is that most people play the same game I do hoping for the precious nap and seat. However, three cars away from the far end seems to be day after day the optimum solution to this game. Now that I choose the optimum car successfully, sometimes I still am not lucky enough to get a seat unless one of the passengers gets off the train.
I start analyzing the passengers’ profiles trying to figure out which ones are likely to get off the train first to sit in his or her place. This is not an easy task but some knowledge of the city and behavior can do the trick. For instance, I stay away from all people over 30 in business suits as chances are that they are headed to my same destination. Once this category is eliminated, I try to eliminate all university students by guesstimating their ages simply because four out of five universities are located downtown (at the end of the line) so the odds are clearly not in my favor there either. I try to spot two age groups. High school students and under since parents most likely prefer to send their kids to nearby schools so it is unlikely that this group will travel all the way downtown for schools. Also, the elderly group is most likely not traveling far either. This whole process usually takes few seconds since I usually get lucky enough to get a seat before we reach the next stop.
This process is very similar to gaming the mistress although I admit it's never this straight forward with her. Incentive, incentive and incentive. I play the market for monetary profits and only profits. I don't care what philosophical reasoning a speculator would give you a la George Soros; the bottom line is that it is all about the monetary reward. It is all about the nap in the case of my subway trip.
I always try to figure the line of least resistance in speculation, the car with the fewest passengers. This is usually the road least followed by the public. In search for prosperity, I have to copper the public play at all times (by going to the opposite end in the case of the subway), but sometimes the simple contrary play is not good enough to win the game. A little tweaking is often needed. In the subway example I had to go to the third car from the opposite end and not the last since some smart passengers figured out the "simple" contrary play by going straight to the last car.
Timing is also a very critical factor and can make all the difference between a win and a loss. In the case of the subway one has to process some information and position oneself accordingly in a few seconds before reaching the following stop. Flexibility is also a key to successful speculation as no fixed system will beat the market forever. In the subway example, my game plan is different on the way back home since a different crowd is taking the subway at that time.
Ever-changing cycles also plays a great role in this game. The last car was full as the public got wiser and I am sure the third will be one day and a new game plan and system will have to be developed.
Knowing who you are playing against is critical to any speculative game as is the case of the passengers' profiles of this subway. An extensive knowledge of the markets you participate in is essential to your success as is a knowledge of the different subway stops and what they represent to different passengers.
I will end this post here as I reached my subway stop and have to vacate my seat for the next player.
Sam Humbert comments:
In my Manhattan years, I'd often give up my seat to a person of gender or age. For me, the psychic pain of sitting whilst a pregnant woman or pensioner is standing outweighs the benefit of sitting down. Often I'd get the fish-eye from my fellow New Yorkers — they were silently thinking "he must be mentally ill." I'd sometimes make eye contact and explain "I'm not originally from New York," and this would calm them.
Craig Mee adds:
Watching commuters pile into the tubes in London, there is sheer brawn! Doors open at the station and boom, some people are fixed on the destination, i.e., empty seats and God help anyone getting in there road. Funnily enough this is usually concentrated to a certain gender. Some people like to try and muscle markets around too!
Chad Humbert adds:
1. Watch for mothers with small children. Sometimes a child will scurry, and the mother will have to leave her seat to retrieve him. Voila! Open seat!
2. The elderly are often slow. I've found I can often simply beat them to the open seat by walking somewhat faster. If I'm careful, I can make it appear that I passed them inadvertently. "Oh, were you going to sit here? I'm sorry! Do I need to move?" Most of them want to be polite, and they insist that I keep the seat. Copper the elderly.
3. I've found that the handicapped seating rules are rarely enforced, and when they are, it's just a small fine. I pay that fine many times over with the extra trading profits I generate from feeling refreshed after a nice nap.
Yishen Kuik offers:
Mr Saad's comment on how the farthest caboose is not the optimal choice because of gamesmanship, but rather some not so inconvenient caboose reminds me of a well known behavioral finance game.
Ask 100 people in the audience to pick a number between zero and 100. The winner is the one whose number is closest to two thirds of the average.
Eggheads will zero in on zero, but that answer merely demonstrates deductive abilities without canniness.
People with a more limited appreciation of convergent series might pick 33 instead, based on the assumption that the average will be 50. People able to think one more step ahead might pick eleven. People able to think one more step in the convergence series might pick nine, and so on.
The real challenge of the game is to guess the distribution of this gradient of deductive powers among the audience and weight one's answer accordingly.
e.g. If you think half the people in the room will guess 33 and the other half are extremely bright but guileless and will guess zero, you should guess eleven.
So perhaps if the challenge is given in a lecture room at MIT, guess one (zero is pointless because of the likely pot split). If the challenge is given to the general public, guess between ten and fifteen.
Philip Tetlock, whom I'm reading currently, reports that the most common winning answer is thirteen.
Barry Gitarts contributes:
Here are a few of my subway gaming experiences as they relate to the market.
Gain an edge by counting - I use the grip mats markers to note where the train doors open when the train stops, so next time I will be standing there well in advance of the train arriving. This prevents others from being the first in the door. This takes several observations, because the train never stops in exactly the same spot, but it’s remarkable how close to the doors you can be. Standing on different parts of the platform to observe which cars are the emptiest helps in figuring out which car you would want to focus on.
Work harder then the next guy and be prepared in advance - Even if you are the first in at your door, there will be others coming into the same car through other doors, competing for the same seats as you, this is why you must start looking for empty seats through the windows as the train is still pulling in so you know exactly which seat you need to go for, instead of walking in, looking around and then going for a seat. Those two seconds are the difference between sitting and standing.
Know the relationships between markets - I find that sometimes, especially during rush hour, it makes sense to take a different train one stop away from your destination so one can catch the transfer one stop before the mob boards.
Capitalize on the public fears long after the threat is gone - Unlike Mr. Saad, in my case the last two cars are the emptiest, because the train I take starts in a more unfriendly part of the city where people wouldn't want to be caught sleeping in the last car, so when the train gets to midtown, every car is packed like sardines except the last two which are near empty.
George Zachar strategizes:
As someone who sits most of the day in front of screens, my subway priority is not getting a seat but minimizing total transit time. I have a mental map of where the stairs are at my destination, and maneuver to get closest to the doors that will open nearest to my exit route.
Market lesson? Different players have different goals. Absolute or relative return? Style box restriction? etc.
John Floyd adds:
I spent one of my school day summers as a messenger in Manhattan. To increase efficiency I learned the exact subways, waiting positions on platforms for door openings, and the correct cars to place me near an exit that would easiest to get me to my destination. I did this for as many of the routes I traveled as possible.
The numbers of possible routes in terms of subways, exits, etc. are myriad. The proper choice allowed me to be the first off the car and up the stairs, oftentimes placing me right inside the building I needed to reach. This was an added benefit as I avoided the often hot, humid, and crowded streets. I would estimate that this on average increased my efficiency by 20-30% at least. Conversely when I rode my motorcycle across the country I looked at the map once in the morning to get a general idea on the direction I wanted to head and roads I might want to take and then just drove. My efficiency of time probably dropped by 50% but my efficiency of pleasure went up by equal.
When traveling now I try to use the time to read, listen to books on tape, or use the time as a period of thoughtful reflection. I do this mostly because I find it most productive for me given I do not find the sleep comfortable or useful to me in modes of transport. I can understand others find it as a useful battery charger that allows them to be productive later.
So I would extend the logic and say that while the goals –profits, learning, etc., may be the same, the path and methods to getting there may be very different. I think another important point is that one needs to decide and focus on what works best for them, as it may not be the same as what works best for others.
James Sogi comments:
We don't have subways here in Hawaii, but I try to find the best time to find uncrowded waves for surfing. The best bet is to take my boat to spots such as the nearby national park that has nice waves, but only with a long walk and even longer paddle which weeds most out. The boat takes me to the front row spot and a short paddle, with refreshments waiting.
The other method is to go right after lunch, but before school is out and before workers get out. That seems to be the old guys’ slot, and usually only one or two old guys like me are left still surfing.
The other odd thing, is that even if its crowded, many in water can't see where and when the wave will form and break. If you calmly paddle to the spot where the wave will form as you see it coming over the horizon before anyone else realizes where or when it will come, you will be right at the right spot as it breaks without paddling and catch the perfect wave with a single stroke without effort at the perfect spot while all the crowd is scrambling around trying to catch the wave in the wrong spot.
This of course takes about 40 years water experience and have obvious market application as well. Study of the bottom, which many in water don't bother looking at, triangulation of shore navigation aids, like palm tree lined up with volcano peak and far point, and timing of the waves and sets all help find the ideal entry point. I guess it’s like standing at the right spot on the subway platform.
Another method if the waves are small, or really big, is to use a big board. All the kids ride short boards and only have one board, so if the waves are mushy they can't catch rides, or if the waves are big, they can't catch rides, and with 12 different boards for each micro category of waves it’s easier to catch the nice ones. So really good equipment helps.
Another method is to exercise and train even when the waves suck, so when the waves come, you are in great shape and can charge while the kooks are gasping for breath. Of course pros like Shane Dorian exercise all day long lifting weights, and after surfing five hours, swim around Tavarua Island twice. Geeze.
There are a million ways to beat the crowd. The last one is move a million miles away. The market still reaches here in about 89 milliseconds.
Victor Niederhoffer extends:
These posts on how to get a good subway seat are a fine pyrotechnic display of native ingenuity. Presumably many of our readers, in their days as poor shavers, also had to apply these techniques to finding parking spaces, especially if they lived in urban areas and didn't want to pay $50 a day for a garage. What I'd like to ask, however, is how these ingenious delectations could be applied to getting a seat in the market. When someone is forced to get out at an unfavorable price, how do you know it's coming, like on the subway, and how can you take his place at a very favorable position to you? One hint is to study Michael Covel and his gurus.
Allen Gillespie replies:
In my experience, a sign of an open seat in the markets frequently presents itself when everyone sells a stock from news on a single company. A recent example is the retail selloff following SHLD's news — only to have WMT, HD, and retails sales numbers lead the market higher a few days later.
Questions I always try to ask myself in those situations:
1) Is the news company-specific or general?
2) Is the bad news the result of good play by a competitor?
3) Did the valuation make the news appear more important than it really is?
4) Which companies have future catalysts?
Hany Saad contributes:
A fund manager using a trading system that has been losing for more than three consecutive reporting periods is usually a good bet, especially if the majority of fund managers trading the system fall into the switch trap by moving to a different system (usually a very thorough read of the fund prospectus is necessary in this case). They usually give up on the first system at the exact wrong time when it is on the verge of a big win, falling into what Rob Bacon warned against in his wise words "beware of the switches", leaving a seat wide open for the wise observant player.
The same reason I wager that trend following will make a killing next year with the only reservation being that it should be on the long side.
Barry Gitarts adds:
I have tried to predict who would get up on the train, but such efforts have usually been futile. Instead I stand ready, knowing that anyone could be the next person to get up and I'll be ready to run for the seat. Of course this works better standing in the part of the car where there are fewer people, since there will be less competition for that seat when someone does get up.
In the market, this is like predicting the next big selloff. I can't predict when it will come, but I can be sure I have sufficient reserves for when the opportunity presents itself. As in the subway, this may work better where it is less crowded, and in stocks/markets with less media/analyst coverage.
There is always much debate whether to equal weight or cap weight indices. If there are 30 securities (country ETFs or stocks) in a portfolio, given that they have similar though different return distributions, what is a good way to estimate how frequently one would expect a cap weighted portfolio to outperform an equal weighted portfolio?
Scott Brooks writes:
It really comes down to what do you see doing better, the larger companies or the smaller companies (large or small in reference to that index/ETF that you are looking at).
If you expect the larger stocks in an index to do better, then go with the cap weighted. If you expect the smaller stocks to do better, then go with the equal weighted. For instance, RSP the SPEWI ETF has nicely outperformed the SPY SP cap weighted ETF for quite a few years now.
Alex Castaldo adds:
I would suggest a bootstrapping approach. Imagine the actual data arranged in a four column table:
Period Ticker CapWgt Return
1 GE 0.4 1.05%
1 IBM 0.2 -0.85%
1 XYZ 0.01 0.97%
From this table the cap weighted and equal weighted returns can be easily computed. Now generate artificial data by scrambling (i.e permuting) the entries in the return column while leaving the other columns unchanged; compute the cap weighted and equal weighted returns for the artificial table.
Repeat the process 10,000 times and see how the real-life returns stack up compared to the 10,000 artificially generated cases. Some details need to be filled in, but you get the general idea.
Charles Pennington adds:
Alex is sending you on a snipe hunt. It is obvious by symmetry that the required probability is 50%.
Something about communist countries making cars reminded me of this one and how so many ended up in dumpsters or were recycled into who knows what. How about resurrecting a hybrid Trabant? Lawnmower racing anyone?
"…With a body made of fiber-reinforced plastic, known as Duroplast, the Trabant really has more in common with a lawn mower than with a modern car. With its two-stroke engine, it accelerates from zero to 60 miles an hour in a leisurely 21 seconds."
Allen Gillespie writes:
You just better make sure it comes with a great roadside assistance plan. US cars lost to the Japanese when they lost the perception of quality. Quality car companies are profitable (Porsche, BMW, etc.). Everyone thinks it is about costs, but it is really about costs relative to quality. High costs with bad quality makes for bad business. Low cost with low quality make for poor business. And high quality with low costs equals great business. As my tech guys tell me you can have it:
In my work, long rates do not matter to housing because everyone financed with short term ARMs. That is the reason others missed the bust whereas I caught the top on TOL's stock split in 2005. The central banks have tightened enough to address the immediate inflation issues, but are trapped by the structural inflation issue. I suspect the Fed will cut as the housing bust forces the issue.
The mistake the market made was to assume that Fed cuts would lead to lower long rates even though long term historical averages suggest 4.50% on overnight and 5.25% on long paper is a reasonable price, and a history of rates going to 6% during times of conflict. Five-year continuous bond futures charts since 2001 look like the Dow from 1998 to 2002. I believe we are on the tail end.
You never hear much about the real facts when people are trying to waft a detrimental meme past you. Now that inflation is all the rage again and people are fearful that there is going to be a terrible thing happening — not sub-prime, not China, not earnings slowdown, but inflation — don't expect anyone to point out that bonds closed the month at 111.24, a 35 calendar high, and up a bit on the year.
Perhaps the adjusted deflator index for March or April of this or that seasonally adjusted economic series would be more meaningful, as well as a parsing of the forces that will beset Bernanke. It is such a pleasure to have at the Fed a real economic man, who seems truly interested in providing the backdrop for a proper growth and inflation, rather than his predecessor who was always posing and always had a hidden agenda. The fake doctor reminded me of one of the old men who sat at the club windows on fifth avenue and commented on the mini skirts and diversity walking by these days.
Note the freqeunt high fives the fed boys gave each other under Dr. Greenspan when he used to tell them that by fooling the market one way or another he was able to avert upward movement.
There are many circuits in electricity and biology where the energy and health of a system is not complete until a clearing event has occurred, (I would very much like some good examples from the specs). It is interesting to speculate if such a clearing event can be described and used predictively for market movements. I would think it worth much study.
Hint … One such clearing event occured today.
Jim Sogi writes:
On the inflation meme, I was astounded at how cheap a car went for. It seems less than they cost years ago. Cars now are bigger, better, more engine, last longer for less money. Go figure.
On clearing, forest fires are a great example. There has been a debate for years in the US Forest Service on fighting fires. The policy before was to fight all the fires. The policy cost lives and in fact made the fires later worse because the underbrush grew creating tinder. The natural fires clear out the underbrush and give way to new growth and healthier forests. The policy now is to allow more natural fires to run their course to have a healthier forest. This is true with markets. A few little fires here and there help to clear out the dead wood, leaving the healthier more vibrant life. Some forests need fires to regenerate.
On that subject of running their courses, these long bars are always of interest. My favorite biochemist studies how to attach new molecules to the molecules that they want to track and follow in the body. The ones they want to track try to hide and avoid detection. The only was to find them is to cut and that is no good. The scientists attach a "handle" or a long bar molecule sticking out of the diseased molecule. To that handle they attach something like a glowing chemical or tracking device so they can see the disease in the body without cutting. This is my layperson's simplification of a complex process, but in my mind at least describes the process. Molecules operate on a very physical level, like a key in a lock. The long bars are a kind of handles that help track the market and are good handles to tag to follow the market.
David Lamb adds:
To add to (and hope not diminish from) Mr. Sogi's comments, I quote from a Botany textbook I received from Arizona State University.
Many viable seeds do not germinate right after they are shed from the parent plant, nor do they germinate during the following growing season. Seeds can lie dormant for many years before conditions are suitable for their germination. Everywhere that seed plants grow, the soil contains viable, ungerminated seeds in natural storage-that is, a seed bank.
Seeds in a seed bank may be dormant because of their own inhibitors, as in many desert plants. Ecologists can sometimes determine what kinds of seeds are in the seed bank of a particular habitat by removing the shrubs from a small area. When a new growing season begins, the seeds of many annual plants germinate. Such experiments simulate what happens, in part, when fire sweeps through an area. In addition to eliminating the source of potential germination inhibitors, fire also releases the nutrients contained in plants. Thus, annual plants grow abundantly in burned areas during the first growing season after a fire. As perennial plants become reestablished, the newly replenished seed bank of annual plants once again goes into natural storage until the next fire."
Seed banks that require favorable environmental conditions to germinate can be compared to the famous caneology. Some of the lesser plants that do not have strong enough roots to withstand the "heat" can be cleared out in order for those other plants, the plants that have been leaning on their canes for quite some time, to show up on the stage.
Vincent Andres writes:
There are many circuits in electricity and biology where the energy and health of the system is not complete until a clearing event has occurred.
Some rough thoughts. I would distinguish at least 2 kinds of clearing events, based on the event's duration.
1. Long clearing events:
Biology: at the end of the day we sometimes get tired, e.g., quite unable to solve a problem. A good night sleep and the problem gets solved. I think most of the night "clearing" we use our energy for our brain/body reparation/maintenance/etc.
Mechanics: I ask a bit too much to my motorized cultivator or my chain saw. So it becomes dangerously hot and I have to give it "clearing" time in order to cool a bit.
In both above cases, the clearing event is quite long. At least it has some proportionality with the working time.
Maybe markets also need to rest or to cool.
2. Short/instantaneous clearing events:
Electrical: e.g., the soft reset or hard reset on some computers. Necessary to bring a computer out of a endless loop etc. The clearing event is very short, but this effect may be very beneficial. The computer system is rebooted to an initial state.
Biology: Sometimes our mind gets confused. A problem seems very difficult. We try many issues and none work. And suddenly in the middle of the confusion a little detail, a little connection occurs, and we understand. I believe that in fact, the understanding was already here, already present, but hidden in the confusion/drafts of the work. The clearing event is maybe the moment where we decide to wipe out the useless stuff. A clearing event may also be the recognition/awareness, of denial. It's a short instant, but it may have great consequences. But, I think it would be erroneous to believe that all occurs just during the short instant. All is already prepared. The question is "when will we look at it?"
The straw that breaks the camel's back catches our attention, but the responsibility is not the straw's. And detecting the straw is probably much more difficult than noticing that the camel is overloaded.
Maybe markets have also some trigger or revelation.
I think markets are concerned by both kind of clearing events but I'm respectfully curious about precisely which kind of clearing event you were thinking of?
"For fifteen days I struggled to prove that no functions analogous to those I have since called Fuchsian functions could exist; I was then very ignorant. Every day I sat down at my work table where I spent an hour or two; I tried a great number of combinations and arrived at no result. One evening, contrary to my custom, I took black coffee; I could not go to sleep; ideas swarmed up in clouds; I sensed them clashing until, to put it so, a pair would hook together to form a stable combination. By morning I had established the existence of a class of Fuchsian functions, those derived from the hypergeometric series. I had only to write up the results which took me a few hours."
Victor Niederhoffer adds:
It is interesting to speculate if such a clearing event can be described and used predictively for market movements. I would think it worth much study. Hint: One such clearing event occurred today.
David Wren-Hardin writes:
There are many circuits in electricity and biology where the energy and health of the system is not complete until a clearing event has occurred.
The first that comes to my mind is both electrical and biological. When our nerves send a signal, it's sent by an action potential. A neuron maintains a potential difference across its membrane through the use of a Na/K pump; it pumps Na out of the cell, and K into the cell. The action potential is kicked off by a signaling event, and the gates in the cell membrane open, and Na floods into the neuron, causing a rise in voltage. The Na gates are sensitive to depolarizing events, and a positive feedback circuit ensues, where more and more Na channels open, causing a spike in voltage — the action potential.
The Na channels don't just stay open, however. After depolarization and opening, they are inactivated in a voltage-dependent manner; the very process of opening and depolarizing the cell leads to their own inactivation. Another action-potential is only possible after the Na/K gradient is re-established, and the refractory period ends. In other words, more activity is only possible after a clearing out of the activity of the previous event.
One could also see the action-potential itself as the clearing event. A large potential is built up over time, and with a seemingly small synaptic event, a cascade begins that triggers a large event.
The Collaborator and I recently had dinner with Louis Gave, one of the three principals of GaveKal, and found ourselves in agreement about almost everything in the world of markets, even though we had reached our conclusions by completely different means. The amazing thing was to find Louis talking about the weaknesses of such things as the Shiller predictive work on returns based upon 10 year averages, the importance of the February 27th decline as the key to a bullish future, the differential between bond yields and earnings price ratios as an upward driver, and the coming under performance in commodity prices.
After we left the meeting, Louis and I crossed emails, with me telling him that the Collab. and I agreed that the smartest thing that kids could do was wait for a big decline in the market and then buy a distant futures contract, or spider, and roll and hold forever. Louis wrote that he planned to buy some long term calls on the Hang Seng next time there was a big decline and invest the billions of ultimate profits in land for the kids.
I wish to say up front that it is embarrassing in a sense to trumpet the agreement of someone widely respected like Louis, who runs a big and important business that has put clients with many hundreds of billions under management with the weather gauge, and myself who is a poster boy for how to take undue risks. And yet, because I like to fan that image I thought I'd take a crack at memorializing some of the things that I know something about, on which our consilience was based. I immediately point out however, that there is no reason to believe that anything I say about macroeconomic policy or Asian markets or the dollar has any positive or predictive information content, and I am truly embarrassed to find myself in agreement with Louis based on my views on those specific matters (as opposed to the one or two things I do know about) since as far as I can tell Louis and his team have done about as much good as the weekly financial columnist has done harm.
Gavekal produced an ad hoc comment dated April 4th named 'Why we remain bullish', in which Louis points to five trends as the cornerstone of his belief. In a previous back and forth on this site with Louis he kindly offered limited availability to our readers for his reports, but I will summarize this particular one here. The backdrop is that he finds that the wisest people he knows agree that they should all have been more bullish during the last 5 years, but now they are worried that prices are too high. He believes however that the trends in the world economy are better than ever now because of globalization, emerging markets finally emerging, a financial revolution becoming established, and montetary policy is now on the right track. As for gloablization he has some nice quantitative work showing that volatility of output in the US has decreased markedly in the past 25 years,and as a consequence corporate profit margins have gone from the lower left to the top right of the chart. He elicits a host of factors ranging from increased trade with Asia, to the movement towards a knowledge based economy.
While I am not knowledgeable enough to appreciate fully the implications of his platform company model, or monetary base adjusted for volatility, we found ourselves toasting each other on the idea that rational expectations is such that there is no reason to believe that bankers and consumers always do the wrong thing. Quite the contrary, they are behaving very rationally considering the enormous increase in wealth that has been generated from increases in asset prices like bonds, stocks, and real estate.Louis has an infinite amount of what seem to me insightful ideas about how interest payments and corporate taxes are much less, and therefore profits have much more mojo in the future. However, as he puts it "most importantly our economy has evolved to a knowledge based economy where one only needs ideas and good people, and from these the returns can be enormous."
Next they cover the emergence of emerging markets with many beautiful charts about industry, agriculture, education, investments, expressways, and productivity in China. For obvious reasons I am not competent to comment on the predictive accuracy of such charts.
Next, the financial revolution. He has a startling chart showing that mortgages as a % of real estate values are very low all over the world except in the U.S. and the Netherlands, and he points out that if the trends to increased mortgage in various countries continues, unfathomable spending and better deployment of assets will be released. It is in the area of the financial revolution that Louis comes up with the shocking statement that the February 27th decline is a key to his bullishness. He believes that when huge declines like this are quickly reversed it shows the resilience of the financial system. My contribution to this is the tested assertion that after startling declines, anything that looks like it has the slightest similarity to the preconditions of the past decline is a high expectation relative to risk buy.
I believe that in one day, the February 27th decline duplicated the whole pusillanimity of the spring of 2006, the summer of 2002, and yes, the aftermath of October 19th, 1987 after which all big Friday declines led to to so much more gain on the subsequent Monday than the decline of the terrible day itself.
Louis has a nice table of the kinds of things that chronic bears have predicted during the last five years, and shows that they have happened and the market has withstood them with aplomb. I would point out what we have shown in our bear corner often that what has happened negatively in the past 10 years, has happened in the previous 100, in each of the years, and that conditions are not any more negative now than during the Dimson 10,000 fold return century.
Amazingly Louis had come to his conclusions about the resilience of returns and the case for long term bullishness without reading the Dimson work, which probably is a plus since the great triumvirate in my opinion suffers from a certain belief system all too common in France as opposed to the entrepreneurial ethos in Siliconia.
Another plank in the Louis case for bullishness is that we are going to have lower inflation in the future. He has many simple facts and tables about the trade balance and the hypotenuse of, to me a G and S, nature that support his point. I always find it amazing that with all the brain power devoted to fixed income anyone could believe that they could come up with a better forecast of where inflation could be than the long term bond rate, which gives a 3% or so expected real return and at 4.7 % is consistent with 2% a year inflation.
A final trend that follows from this in the Gavekal analysis is that because bond yields are so much lower than earnings yield, that all sorts of liquidity will come in to buy stocks from such sorts as private equity funds, and pension funds. Our own work on the differential which is posted in our quantification of the Fed model with actual prospective forecasts of e/p as the basis, shows that during times like these when the forecasted earnings yield (without regard to its accuracy) is a few % over the bond yield, the expected rate of return on stocks is some 20% a year, with an incredibly high accuracy. Amazingly again, Louis had come to the same conclusion based on qualitative analysis of such things as the actual level of savings in the US ("Why do we have all the big mutual funds, the Fidelities, the Alliance capitals, and the Vanguards in the US if the US isn't saving").
I cannot begin to do justice to the Gavekal case for bullishness except to say that I would consider his book "The End is not nigh" one of the 6 most important and helpful books for the investor to own, and that in the course of a rather encompassing career of over 50 years on Wall Street, and in the groves of academia, I have not come across any individual, (except for my friend from Mount Lucas), with sounder insights into the forces that shape investment returns.
Allen Gillespie adds:
Long bonds are not the only markets with implicit inflation forecast. The currency markets clearly have a relative inflation expectation as do the gold market. I would posit that gold, which has risen $140 since helicopter Ben became chair (that would be up at a 13% annual rate), or the dollar index which has fallen at a 7% rate, are telling us something about long term inflation expectations that are in opposition to long bonds.
This is not to say that higher inflation rates are clearly bearish, or that bonds are necessarily wrong, but to point out that the long bond's 2% expectation, which is consistent with the Fed's expectation, may be standing in opposition to other forecasts which may prove more accurate. In fact gold at $680 up from $20.67 in 1900 computes to a 3.3% compounded inflation rate. At the peak in 1980, gold implied a compounded rate closer to 5%. Gold has been rising at a 13% rate since the new chair, and I do not believe this should be ignored. I posit that a new high in gold would complicate the Fed's calculations.
In addition, momentum screens currently are being dominated by inflationary and recessionary sectors, and arbs (which tend to rise during market stress, because of their fixed income, like return profiles).
George Zachar remarks:
The Dallas Fed agrees with the Specs and GaveKal,
As knowledge spreads in our globalizing economy, it unleashes powerful forces that redefine fundamental economic relationships.
In one industry after another, lower transportation and communication costs have knit together far-flung companies and workers, expanding local markets into worldwide ones.
A more integrated global economy generates new competition, identified since the days of Adam Smith as a key to delivering more output at lower prices.
Larger markets bolster incentives for innovation, the wellspring of economic progress. They open new possibilities for specialization, which channels factors of production to their most efficient uses.
Globalization boosts foreign investment by freeing scarce capital to seek its highest return anywhere in the world. Companies can find and manage a broader range of inputs, the raw materials for more efficient production methods.
Where fixed costs are high and marginal costs low, globalization extends economies of scale to output levels beyond the scope of national markets. The connection of competitors and capital from all parts of the world reduces entry barriers in high fixed-cost industries, eroding the monopoly power that keeps prices high.
Knowledge and technology spread more readily, loosening the restraints that shackle progress. Production becomes more efficient…
From Russell Sears:
This may be blasphemous for the gold bugs, but:
Gold is a physical commodity, which historically has implied wealth. When my maternal forefathers fled Russia, invading northern Finland, with as much gold as they could carry, it was due to inflation expectations of currency. Now when gold is hoarded, it is more likely due to the bling factor, not that US currency can't be trusted due to the inflation expectations.
In fact I would argue the opposite. The last 25 years have trained most to think the feds will always be pushing inflation down on the whole. But this causes pockets of inflation and deflation to spring up. Gold, like most items purchased to advertise your wealth, is experiencing high inflation, as the pool of wealth has spread. Gold is still a hedge for the wealthiest against inflation expectations, but not the economy as a whole.
Rather than a sign of coming Armageddon, it's a sign of spreading capitalism.
Nigel Davies adds:
One minor point after a mere six weeks cogitation, is that it seems like quite a contradiction to believe that consumers act rationally here but that the public always acts wrong where stock purchases and sales are concerned. Especially when one considers that stock buyers are likely to be relatively sophisticated individuals compared to the man on the street with a credit card.
I suggest that they will act more or less like sheep in both cases. Perhaps the difference with stocks is that someone may try to deliberately mislead them rather than participate in the shared risk of them overspending.
All news is not equal. Some news tells you what has happened in the past, other news tells you what is coming in the future. Some news becomes important again, like knowing the Sage had bid 15% below asset value for LTCM. That's where the market cleared in 2002. For example, on 9/11 there was news about the attack that drove stocks like INVN from $8 to $50 over the next three months, because it led to the installment of baggage screens at every airport. It led to a fundamental shift in air travel demand leading to airline bankruptcies.
Other news, like the Congressional hearings and the questioning of high profile investment bankers in July 2002 signaled a market low of significance. Currently, news of the Fed pause has led to expectations of a Fed rate cut, which subprime reinforced, so if there is news that shifts that expectation it would be dramatic — much as Clinton shifted expectations at the high in 2000 with a comment on genomics. That's why I continue to watch gold closely here, because the expectation is for an easing of inflation and gold at a new high would shatter that expectation.
Gregory van Kipnis remarks:
Words betray us and never seem to mean what they intend. What is meant by news, what is meant by prices? Here are the principles that guide me:
First, There is something called analysis; analysis of news or analysis of prices.
Second, if markets are very efficient there will not be many occasions when the analysis of news or prices will yield predictive insights.
Third, "news" is generally used to refer to fundamentals, i.e., events that shift supply or demand or any of the assumptions that govern the stability of prices. Prices, on the other hand, refer to the unfolding outcome of changes in views about fundamentals.
Fourth, most fundamentals are discounted, so prices move in advance or swiftly. Therefore, I rarely get an information edge about changes in fundamentals. Nonetheless, the persistent analysis of human action yields insights, from time to time, to the prepared mind. But there are false positives. Monitoring prices in relation to quantitative tripwires can also signal a fundamental is changing, but here too there are many false positives. I may never know why views are changing, so I would have to satisfy myself that it is sufficient to figure out that others are valuing things differently and that is all I need to know.
So I pick my poison.
I would always prefer to have an independently obtained opinion about the likely causes of changes in equilibrium rather than constantly trying to figure out if others are changing their minds about what to value, and never understanding why. However, there is a caveat. Just as when driving on a busy highway, to use an analogy, fundamentals first –but also a wary eye always cocked to discern technical signs to avoid risk. I don't have to know if a bad driver was drunk or having a heart attack, I just have to pick up quickly that something is wrong and make sure he doesn't take me out on his way to his maker.
Hany Saad replies:
News does not drive prices. I would like to see empirical evidence to the contrary.
Prices predicted 9/11 and other events if you look close enough at the options markets. Now, if you suggest that 9/11 drove prices with an open gap down when the market finally opened, how would you have profited as an operator? In retrospect you were handed the same cards every other operator was and you had to make a decision based on your historical views, your system, your statistical edge — but not on news.
Even if news drives prices, it is very questionable that an operator will be able to benefit from public news from off the floor. Can one really profit from the news in real time? Yes, news might have an effect on price but this ignores the main use of news for the speculator — profitability. The correct question is whether a speculator can trade profitably using news.
I maintain that prices predict news, and trading on statistical patterns and measuring psychological biases is the only good niche in a market where there are more newswires than brokerage houses.
David Higgs adds:
It's the interpretation of when good news is bad news and bad news is good news. Changing cycles, sea changes. Those with the knack of getting these right become wizards.
In one of Patrick O'Brian's typically hilarious touches, in HMS Surprise, Maturin is on a rock collecting boobies with Nichols, before he is eaten by sharks due to despondency over his wife's infidelities and the typhoon. He tells Nichols about an Urdu English phrase book he is reading. "I believe it must have been compiled by a disappointed man." Here are some phrases:
My horse has been eaten by a tiger/leopard/bear.
All my money has been stolen.
I wish to speak to the collector.
The collector is dead sir.
I have been beaten by evil men.
I wish to hire a palanquin. There are no palanquins in this town sir.
Yet salacious too
Woman, wilt thou lie with me?
I immediately thought, what would a comparable phrase book be like for a trader entering the speculative arena? Perhaps it would include the following examples:
I have no money left. I lost everything when my stops were elected right before it turned.
The margin clerk is off duty sir, so it is not possible to delay getting your money.
The locals have given me a beating in the market.
I wish to enter a market order to sell. — There are no market orders possible sir. It's limit down.
There is 5000 bid ahead of you.
You are filled at your price, and I'm afraid it has continued down.
Yes, it went through your limit, but we're going to get them to take that price down.
Goldman against you on the offer 10000 to go.
It traded at that price, sir but there was a fat finger error and they're canceling all the trades at your price and below.
The Fed just acted and I'm afraid the market is very much against you.
I suggest you use stops next time on your orders, sir and that way your losses will be limited.
It did trade at that price, but your order was canceled at 5:30 due to computer bookkeeping.
Price hit a pivot point and immediately gapped 2% against you.
A domino effect was triggered and it went against you.
Sorry, that fill was for your brother not you.
They revised the previous months number against you, and I guess that 's considered more important now.
I'm afraid you were in over your head.
Your order was rejected by the compliance department.
You can't take money from your account until you get back to initial.
It was too late to cancel sir.
I am open to other appropriate items for such a phrase book.
Allen Gillespie adds:
We listened to the tape and it went against you.
Craig Mee writes:
Only in trading the Mib (Italian index futures) "yes sir, it opened higher than your sell level, but due to the mathematics of the opening print, nothing done"
I haven't quite worked that one out.
George Zachar adds:
It's a fast market. Nothing done.
Markets went subject just before your order. Nothing done.
That printed on globex. Your order went to the pit. Nothing done.
We don't show that expiry on our system.
That account is closeouts only.
Fed funds options? The local is in the toilet.
There is no market in that spread, sir.
The events of the last two weeks are startling and disruptive. No matter how many counts others and I adduce, that show that after a 5% decline in a week there is on average a 2.5% rise, relatively continuously over the next 10 days during the past seven years, someone's going to say that this one is different — the old rules don't apply. We have to go back to 1987 or 1929 of course, as the chronic bear weekly columnist said on March 2nd, when the March S&P was 1398.
He is bearish now because even his good friend who caught the decline was expecting a little rally before the ultimate swoon. As he said last week, there is a time to reap, a time to sow, and a time to panic. And that time is now.
In the back of our collective memories are the many occasions when a terrible end of world like decline such as this has occurred before, then there was a bit of a rally in the week following, and then subsequently a huge decline occurred again. Such a decline, which I liken to the tortures of the inquisition where they put you through one torture and then brought you back again for worse tortures when you thought that it all had ended, occurred subsequent to the May 2006 declines.
This also characterizes many of the big declines in 2000, when the NASDAQ 100 went from an adjusted 5209 on March 24th, to 4540 on April 3rd, up to 4742 by April 7th, but was then followed by a decline of 25% in the week of April 14th, and continued to plummet to 1600 by April 4th, 2001.
As I said when we compared those early 'naughties' declines to the end of the world, parts of the first movement of the Fifth Symphony, the melody, the hopeful march of fate, was rejoined. But there is the eerie knowledge for those who know, that Beethoven is not yet through with such despair. In this light, where counting is superseded by fear, I thought it might be helpful to turn back to something I am more expert at, the lessons that you might apply to this situation that you learned as a kid.
For guidance I turned to Roberg Fulghum , who said, Everything I need to know I learned in kindergarten . I also look to my own extensive training in street games: Street games have been designed to teach kids what they are going to need to know to succeed in life. I believe I am on firm ground here.
The first lesson to learn in street games is to look both ways. One can see the wisdom in this by seeing what happens if you don't look both ways. You're likely to be hit by a car, or almost as bad in truly competitive games, tagged out by the opponent who was hiding on your blind side.
After a decline of this current magnitude, one should always think about what could happen if the market continues to go down, or reverses and goes up. Are your positions so life threatening that a further small decline could take you out of the game? If so, it's only a matter of time until they do you in as the odds are about one in four that big cane calling declines will continue into the next week after the initial decline. You may only have a one in four chance of withstanding four declines in a row, but on the other hand, there is a three in four chance that you'll make money by keeping your position into the next week. And there is a 10% drift per year.
If you're not at the wolf point, like those who are in danger of margin calls might be, then by all means, this is a great chance to take account of the Dimsonesque ten thousand fold a century returns.
Another rule is to always put things back where you found them. If you don't put the equipment back after the game is over, you won't be able to play again. Or worse, you could be banned from playing at the night center, and then become x on the block, as often happened to me. When you have a position, and you're forced to lighten it due to money management, do get ready to put it back on as soon as your liquidity and ability to withstand loss is greater.
Perhaps you're one of those prudent people who have followed the message of the doomsdayists to keep 50% of your portfolio in fixed income. If now that bonds have gone up about 2% and stocks have gone down 5% you're 51% bonds 47% stocks, you have to do some switching and increase your stock exposure by 5%. Know when you do this that you will have the wind at your back, because in times like this when the estimated earnings yield is some two percentage points higher than the bond yield, the returns from stocks these years have averaged some 15 percentage points. You don't have to follow Abbey Cohen to get such a forecast for this, but merely turn to the Collab, Mr. Downing, and my quantification of this through regression forecast and bin analysis on our web site under the Fed model links .
One thing that all kids should know is to look out for traffic, but there are big boys who have every reason to go for broke when doomsday is in the air. First there are the chronic bears, those who are almost broke from fighting the almost 75% rise during the last three years — put a beggar on horseback and he'll gallop. Then there are those who have lost almost everything and will be taking no prisoners in their desperate attempt to get back their chips and reputation. They will be joined in this by the hundreds of billions of delta neutral money, and funds of funds with short exposure, who must or at least should justify their existence at times like this by pointing to the immense losses that those who played the long side only were exposed to during this squall.
One can expect them to pull no punches in mounting the pulpit to talk about how great their 5% a year returns in the last four years really are, compared to the 15% a year for stocks, because of such declines. They will certainly be joined in this chorus by the big trading firms who always have a bearish bias because they find so many things wrong with our situation that they accept the sacrificial egalitarian idea that has the world in its grip.
The problem is that these speculators will have to be particularly mobile around this time because stocks have such a high return relative to bonds, and because the public is beginning to believe that stocks aren't so bad after all, especially with the 6% earnings yield + 5% growth yield built into the average stock versus 4.5% 10-year bonds. If the market goes down gradually the public is going to come in and prevent the trading firms from getting out of their positions at a profit, so the only hope for the bearish forces is that their lieutenants can fan the flames of fear and take the market down so violently that the public will be too frightened to come in.
This brings us to a fundamental law of street games, which is not to panic. In the games of slap ball I played on a 25-foot long cross street on Brighton 10th court, and other venues, there was always one very big guy twice our age and size who could sometimes be induced to play. In my case it was Alfred Evaso who at fourteen, five foot eight and 150 pounds was twice my weight and one foot taller. He had a way of advancing to third when I was the catcher and then madly running like a steam roller for home on a steal. The obvious course was to panic. But wily players knew that the best way was to step out of the base path, yell for a pitch out, and take a fast pitch and tag him on the ass as he passed you. Such would be very helpful in the market as you wait for all days of decline to occur, and then come in at the close.
The final rule, from Fulghum this time, is to hold hands and stick together. In such conditions as these we have done well, as panic has not occurred and the call that it's every man for himself has not been given by the Captain.
Allen Gillespie adds:
My father always told me a bull market will try to scare you out, but a bear market will slowly devour you. The reason this sounds reasonable to me now is that bear markets relate to prolonged economic weaknesses; hence, time is a critical, but slow moving factor. Alternatively, bull market liquidation is all about margins and stops that are all quickly hit.
March 2, 2007 | 1 Comment
The years most closely correlated with 2007 YTD, through February, are: 1911, 1946, 1989, 1934, 1936, 1980 and 1989.
February 20, 2007 | Leave a Comment
Is ROIC (return on invested capital) a viable alternative to measures such as information ratio, Sharpe ratio, etc.? It appears to me that even some of the marquee hedge funds employ a lot of capital in order to realize ordinary returns.
Should one be using net exposures or truly looking at gross exposures, or are there alternative measures that would be useful?
Gordon Haave notes:
The problem with ROIC is that it doesn't account for the level of risk the capital was exposed to in order to generate the returns.
Does anyone have any comments or suggestions on breaking through psychological barriers? I have been stuck at a particular equity level now for an extended period and each time I start to break through I get sucked back down. So everyone can thank me for yesterday’s volatility, as I came in long the NASDAQ ran up to my wall, so I then sold at the peak, only to buy back too soon or else too heavily into the decline. I have tried sneaking through this wall with small trades. I have tried jumping through with larger trades. I have tried not even looking at my equity for a while.
I am beginning to feel as I did when I was a little kid and my brother (who is five years my senior) used to play goal line defense against me. I would try to make it over the couch while he pushed me back, but I never could.
Dr. Mark Goulston adds:
I think one of the keys to overcoming psychological barriers is to have a clear and specific a vision (vs. merely the desire) of where you want to get to, that is both compelling and convincing to you over a prolonged period of time. That is usually necessary to generate the requisite commitment (i.e. focus, concentration, persistence and perseverance when you hit walls). Then have a step by step plan for getting there with back up plans for any and every setback you can imagine. Then re-evaluate periodically whether you’re staying with that plan and don’t change it without good reason (especially true for plans you have checked with trusted advisors whose input you listen to).
My personal vision is to develop deep, sustained and mutually rewarding relationship with some of the most respected and powerful people and then influence them in a way to make the world better. Maybe a little idealistic, but I’ve become friends with Warren Bennis from USC and am working on relationships with Jim Sinegal from Costco, Bob Eckert from Mattel, Frances Hesselbein from the leader to leader institute (formerly Peter Drucker Foundation), and Marshall Goldsmith the internationally renowned executive coach, so I think I’m off to a pretty good start. A big help has been my partnering with Keith Ferrazzi, author of best selling book, Never Eat Alone which I urge all of you to buy and read.
Grandmaster Nigel Davies Comments:
I believe the key to psychological barriers in most fields is down to our expectations of ourselves. Kids and adolescents haven’t learned ‘their limits’ so they tend to improve very rapidly. Older folks (20+) have a problem in that they ‘learn their place’. So typically you see acts of self-sabotage by players who are outperforming (see Icarus) whilst those having a bad tournament will fight like tigers to reach their norm.
The feedback one gets from one’s peers can tend to reinforce these feelings. So to improve it’s useful to acquire an excellent peer group for whom success is normal. For this reason I always tried to hang out with the Russians rather than the weak Westerners, and they normally tolerated me because of wanting to improve their English. And I posit that we are in the right place for similar reasons.
But what you may be experiencing may not be this kind of psychological barrier. The problem I’ve found with markets is adjusting to the ‘phase shifts’ when it starts to behave quite differently. A model which suggests that individual striving is the key may be too one dimensional, and perhaps what is required is to dance.
Jim Sogi offers:
The New Year kicked off a new phase shift, or a return to the old. Anecdotally, regular people are starting to get interested again in the new market highs and small cap techs after having stayed away during the steady but slow gains of the last 4 years of worry. Even the hoodoo who lost all his money is getting people at the beach to trade on hot tips. Things that make you go Hmmm.
Different tactics may need to be considered and tested. The issue may not be psychological.
Steve Ellison adds:
In “Secrets of Professional Turf Betting,” Bacon proposed varying tactics through the year based on the improvements of 3-year-olds, variances in weight allowances, effects of mating season, etc. For phase shifts such as the shift from winter to summer tracks, Bacon proposed general methods that could be used at any time, but were particularly useful at times when data was insufficient to evaluate the new regime. One such method was to pick the horse with the highest percentage of races won in the past year. Another was to note which horses had begun working out earliest at a new venue and study their workout times.
My understanding is that Chaos theorists argue there is clustering of big events, as evident in flood records, though I do not know enough to say for certain that this is their argument.
I do, however, have an uncle who is a farmer near the coast of Alabama and who has collected amazing yield data from his own operation and his friends over the past 30 years. The issue is that 1 event has long run effects on future yields unless corrective actions like irrigation and fertilization are employed. Each corrective action, however, has an associate cost which must be weighed. In addition, I think he would say that there does seem to be clustering for farmers, (because it is generally a terrible business), maybe hurricane, disease, drought, etc.
I think his data would also argue that the yield to a plot of land follows an S-curve with adverse events knocking you away from the curve and corrective actions moving you closer. The best time to buy insurance is when you are close to the curve (since insurance does not help your output) and the best time to buy fertilizer and water is when you are away from the curve.
There is nothing more thrilling in gambling than stepping up to a craps table to wager a few chips on the roll of the dice. The dynamics of the game are absolutely fascinating, and can be quite confusing for the neophyte gambler. Chips are flying around from seemingly everyone, gamblers are placing their chips all over the board and people are screaming and yelling out catchword phrases like ” 7 come 11, baby needs a new pair of shoes, box cars, 8 hard 8″ and many others. The action can be furious when suddenly a shooter gets hot and money comes from everywhere around the table in the hopes of cashing in on this blessed event.
In dice, practically everyone at a table is betting along with the shooter. That is to say that they are putting their money on the pass line, taking odds, betting the points, and playing the hard ways in the hope and dream that the longer the shooter stays alive the more money they can rake in.
However, a player can also take the other side of the wager and be a “wrong way” better. They can bet on the don’t pass bar 12, the don’t come bar 12 , and the prop bets that are one time bets such as any craps and any seven.
The “wrong way” betters at craps are the most unpopular people at the table. They are called a variety of names, “coolers” and a host of others normally reserved for biker and country and western bars. If you have ever tossed a chip out on a table during a shooter’s hot streak and yelled out ” any craps” you will know what I mean. You will receive stares, threats, innuendos and quite possibly be doused with a cocktail if the bet gets paid off while everyone else’s money gets cleared off the table after a shooter craps out.
Interestingly the don’t pass and the don’t come bets carry the same odds of success as their counterparts the pass and the come bets which as many people know are the best wagers based on the odds in a casino that a gambler can make. This is approximately 0.6% in favor of the house. However they are the least played areas on the layout. Everyone would much rather bet alongside the shooter. It is generally seen as un-American to bet against a shooter.
This reminds me of those who choose to bet against the shooter so to speak or against the stock and be short sellers or contrarian investors. They are many times going against the consensus or the implied bullishness of the times yet they can have an equally positive payoff, and in many cases a greater payoff than the field in general.
It takes a certain strength of character to short a stock that has risen meteorically and breaks its trendline. It takes equal strength to invest in a company that has fallen upon hard times, replaced management, restructured, just come out of bankruptcy and is unloved and its stock price is sitting at multi-year lows. However, properly done it can also be very financially rewarding if one succeeds in pulling it off.
Mr. Leslie has given us a primer on dice psychology, but I believe that his analogy breaks down on the short side because the grind and drift are much bigger than on the long side.
Allen Gillespie responds:
The allure of the short side, however, is that the declines tend to be much swifter than the rises. For example, in counting swing magnitudes and durations of both the market and high volatility stocks we have found rallies and declines to be only slightly different in magnitude (but favorably tilted for the rises) but significantly different in average duration with declines lasting about 2/3 the length of time as the rallies.
Prof. Gordon Haave responds:
Let me clarify: I have nothing against telling someone who can afford it “just invest say 2K per month, and do it every month, regardless of market conditions”. That is fine.
There are a lot of people, with the lump sum, however, who get the bad advice to dollar cost average. I see it all the time even with large consulting clients. They get the advice to take their money and “dollar cost average it in” over say 12 months. All that does is leave much of their money in cash instead of the market. Any possible benefit from dollar cost averaging in such a case is built into the probability that over the course of the year there will be some opportunities to get in cheaper than if you went all in at day 1. However, the probability of that does not over come giving up the 10% drift with some of your money for some of the time.
Steve Leslie responds:
I think rather than splitting hairs on where performance is better with dollar cost averaging or lump sum investing, and making this a full blown debate:
In my view:
This is more of a philosophical based decision rather than a performance based issue. People do not invest because they are afraid of being wrong more than they want to be right. Fear always trumps greed. Many are more interested in the return of their capital rather than the return on their capital. They really don’t know what the return of their money is anyway so speaking in percents is a complete waste of time in the majority of cases.
Therefore if one can devise a “scheme” to make the process less painful then where is the harm. In sales the technique is “reduce it to the ridiculous.” It is easier on the psyche to say to the client “I want you to invest $2000 pre month, for a year.” rather than “I want you to invest $24000″. It is less invasive less of a shock to the system.
Nobody buys a $30,000 car, they make monthly payments of $400 a month for 6 years. Nobody buys a $400,000 apartment, they buy a mortgage. People look backwards and do the math of what they can afford on a monthly basis and make their purchase accordingly. Most live off a budget so when you talk to the client in those terms they can relate more easily.
Furthermore, in the clients eye, it takes away the timing aspect of investing. Instead of professing to know the correct time to buy, essentially a financial advisor is stating that nobody knows the right time to invest, especially me so lets put a little in over a long time rather in all at once. In psychological circles this is eliminating “all or nothing” thinking. Plus it takes away the reply “I think I am going to wait until next week, month, year, to put the money to work, because I think the market is going to be lower then.”
My father, one of the great salesman I have known said that the client buys emotionally but justifies logically. Try to see things from the clients viewpoint rather than your own.
He also used to say “The husband buys but the wife confirms.” It is far easier for the husband to go home and tell the better half that this is a plan that is the foundation of virtually all retirement plans in the world. Plus, he doesn’t have to look at his statement and explain to the wife why their $50,000 is now worth $40,000.
In summary, working with individuals requires a far different set of skills than working with institutions, Institutions will tell you what amount they are looking to place with you. They are transactional based and are bottom line people. They are brutal, because they have a board to answer to and they eliminate warm fuzzies from the equation. Just as quickly as they hire you to manage money they will just as quickly fire you. Nothing personal but as I like to say “That’s how they do things downtown.”
Individuals are more interested in relation based investing. One of the great statements about relationship based selling that the client must settle in their mind is “Do you care about me and can I trust you?”
Some might say that this is fluff and takes away the substance of the investing. My reply would be ask the Chairman who his first client was and why he chose to stay with him through the good times and the bad for so many years.
November 22, 2006 | Leave a Comment
Gold has gone up 23% on the year and 11% since the Fed got a new chairman. By making the actions of the Fed transparent, and hence the cost of money completely predictable, assets are being driven to their maximum valuations because there is no uncertainty to be discounted. This I believe has raised the market’s crash potential should a change in expectations occur. And while I have long believed the Nasdaq could potentially make it back to the lows of its crash at 3042, I also think gains from this point in time will prove to be fleeting a few years hence as yields have a tendency to chase speculative activity.
A new patent index was recently launched by Ocean Tomo:
The Ocean Tomo 300(TM) Patent Index, which is priced and published by the American Stock Exchange(R) (Amex(R)), is a diversified market-weighted index of 300 companies that own the most valuable patents relative to their book value. The 300 member companies have an average market capitalization of $21 billion and a median market capitalization of $7 billion. The Index is split equally between small cap, mid cap, and large cap stocks. The smallest member company has a market capitalization of $400 million.
According to the site, over the last 10 years it outperformed the S&P by 3.10% annually.
However, I have the following observations of this:
- Though this is one “value” index, a growth guy may embrace it as a measure of “growth” potential. I wonder if it suffers from the common value survivorship bias problem — especially when one considers that 2000 seems to account for its outperformance.
- Though it attempts to “measure” patents, I am not sure I endorse their measurement method. It would prove much more useful if it was somehow weighted by this measure, instead of simply market weight.
- Eyeing the comparison chart to S&P over last 10 years, it appears that it tracked closely until 2000 when it outperformed before underperforming through the 9/11 drop and then it outperformed again since late 2002. But this is hard to say without numbers.
- Considering the notion that stopping to tie your shoelaces hurts you only if you are going intellectually fast, (i.e. laying off people) I wonder if the outperformance in 2000 is due to employee job security in these companies and how the individual components are ranked on this basis. Though I suspect the stock and the index lead the lay-offs.
- It seems to be best of both worlds — it tracks the S&P when it dominated with growth stocks, and it outperforms the index when it dominated by “value”.
It seems a good idea, but hard to perfect, to try to measure a patents worth.
Allen Gillespie replies:
This is something we have been trying to understand for awhile, because I once read an article about the development of the steam engine. The idea was developed and patented in 1818 but not commercialized until 1831. There is a difference between having a patent and successfully monetizing a patent.
In short, I believe there are lags in the value of patents. Some patents turn out to be valuable, some do not. Sometimes managements reward shareholders, sometimes they do not. During the internet bubble (’99) we conducted a study of biotech stocks from the early 1990s. In our study we found purchasing a basket at the top eventually yielded a return over 7 years roughly equal to the risk free rate and closer to the market rate over 10 years, however, your results were completely driven by the success of a few ideas like Amgen and Biogen which developed multi-billion dollar products. Buying the same basket at the lows, when the market had sorted out what was valuable and what was not, produced returns in excess of 40%/year. Even the successful stocks like Amgen experienced 70+% drops.
Our study of Biotech and subsequently Internet stocks shows a similar pattern. An initial flurry in the stocks based on concept, followed by capital raises by investment bankers, a fall due to lack of profits, taming of euphoria by the increased supply of stocks, and finally recovery as the ideas begin to bear profits and managements are forced to show profits as opposed to developments.
One of the things we have noticed in our momentum studies is the tendency for certain stocks to reappear after a number of years on a much sounder financial basis (though it frequently doesn’t look like it at the time). For example, energy trading companies were high momentum stocks during the bubble period, collapsed, but then reappeared in 2003 as high momentum stocks as distressed recovery names.
Another company which illustrates the concept is SEPR. The company for years as been run more like a research company than a business, as they have maintained a very high plowback ratio into new ideas, now however management is beginning to run it like a business for the shareholders rather than the lab. Here are the earnings and stock price:
Year EPS High Low
1999 -2.77 70 29
2000 -2.80 140 45
2001 -3.19 81 23
2002 -3.11 59 3
2003 -1.33 32 9
2004 -2.05 59 23
2005 -0.11 66 48
2006 1.31 2007 2.18
Important times in the life of a stock are inflection points like when earnings can be anticipated to begin recovery or decline (because this creates an earnings slope) - at year end 2002 you had inflection from 2001, crossovers into profitability, and eventually new highs in profitability matter because the valuations get more compressed if the stocks do nothing or go down. Companies with new highs in earnings power can recover quickly from some fantastic declines.
Steve Ellison adds:
Patents are a one-dimensional view of intellectual property. Intellectual property also includes trade secrets, processes, and expertise. Pepsi has enormous intellectual property, none of it patented. Dell and Southwest Airlines became successful by perfecting processes that their competitors could not imitate because of constraints imposed by the ways of doing business that had made the competitors successful.
A patent measure can be gamed.
An ex-CEO trumpeted increased patents while cutting research.
November 7, 2006 | Leave a Comment
An incredible run. The Dow made a new high today 79 days since its last 14 day low, and it has covered just of 14% during this move. Given that there are only 8 rallies in history that have carried on as long and as far without a correction to the three week low, one must be impressed that it happens on election day.
October 30, 2006 | Leave a Comment
2004: St Louis Cardinals
Regular season: 105-57
Best record in baseball.
Playoff record: 7-8
World Series: swept by Boston
2006: St Louis Cardinals
Regular season: 83-78
Worst record of all playoff teams, requiring a last-game loss by Houston to Atlanta to get into the playoffs at all, and Houston lost that game by out-hitting Atlanta 9-3 but leaving 11 men on base. Playoff record: 11-5
World Series: beat Detroit in five games
There must be some market lessons in there somewhere. Probably about randomness.
Steve Leslie replies:
I am not sure as to the market lessons here. However I do know something about playoffs in baseball.
Baseball is unique from the other two sports. In baseball the regular season record is completely meaningless. Due to one major factor. In the other sports, home field advantage is critical to getting to the championship series. In baseball, it is all about qualifying for the playoffs. After that, anything can and does happen.
Basketball is the most critical for regular season success. Without home field advantage you are swimming upstream the whole way. There is perhaps no greater factor in predicting a winner than looking at who has the home field advantage.
In football, if you have the best record, you are rewarded in two ways. First you get a bye week to get well and rested (and after 20 games this goes a long way to making your team well) and secondly, you don’t have to travel at all. When the regular season concludes, you can be at home for 3 weeks and only have to play 2 games. Plus your team is usually designed with the type of home field you play on.
Winning baseball games in the postseason is all about two things: Pitching and momentum. If you pitching comes out strong, like Boston two years ago or the Tigers this year, you can get on a roll and continue on a roll. Anecdotally, the Tigers lost their momentum by having to wait a week for the Cardinals to conclude their long 7 game series with the Mets.
Furthermore in baseball you can win a series by having your #1 and #2 pitcher carry the series. Who can forget Schilling bleeding in his ankle and giving the pitching performance of a lifetime. Or Kenny Rogers coming out of nowhere and pitching an amazing number of scoreless innings.
So if there are corollaries to be made to stocks, I will submit these two suggestions:
Pitching = earnings. great stocks have great earnings. They get their earnings from a great product with great margins. Microsoft in the 1980’s. Xerox in the 1960’s and Resorts International in the late 1970’s. I find it interesting that GE wanted to be #1 or #2 in the fields that they chose to compete. They were not interested in filling out the roster for the sake of filling out the team. The moral is if you have a great franchise coupled with a great product line, this will translate to success in the stock.
Momentum = trends. Stocks once they get on a roll, stay on a roll for some time. Look on Taser a few years ago. Oil stocks for the last year. Stocks tend to take on a character all its own when they become in favor.
There a many more examples and I hope I have stimulated some thought for additional corollaries.
Allen Gillespie responds:
Having the pain of being a Braves fan, I can tell you what it is. The regular season is long, so a deep pitching rotation is more important than a lot of good bats as the weaker teams you will beat with either and the stronger teams may or may not be focused on a particular night. So, if you have a strong 3 or 4 pitcher, then you will likely win one of those two games giving you a solid record. In the play-offs, however, pitching rotations are shortened so the best guys get on the mound more. In fact, it has been demonstrated that two really good pitchers are about all you need in the play-offs. You need, however, bats that go at least 5 deep with some moderate production 6-8. The one year the braves had 6 decent bats, they won, the other years, check the record. Painful.
The lesson I think is that for long pull trading, statistics and time work for you, while in short term trading and series being able to score quickly is critical.
Larry Williams responds:
Baseball has more stats than stocks; some are just obvious: for example, teams that reach the playoffs can be quite different later in the year due to injuries and trades — good to great pitchers are added to the roster of teams headed for the playoffs so the team then has more “mound power”. Case in point this year was David Wells going to San Diego.
It’s not just all numbers…
Steve Leslie replies:
My points are not assertions not supported by anything. I am not sure what you want to have counted. However if you want to go into greater detail about sports betting, I can tell you that it is an interesting exercise and in all likelihood futile because I have never met anyone who had a successful career as a sports handicapper. There are countless books on the market that one can research on the subject. I can not reference any since I learned years ago that sports bettors are losers.
I can tell you that the Yankee offensive lineup was so lethal this year that everyone went in thinking that they would overpower their opponents. They were overwhelming favorites to win the series. Until the pitching took over. In 2004 Boston was down 3-0 and won the series against the Yankees and went on to win the World Series. Thus momentum took over.
It is a fact, that good pitching trumps good hitting. This has been proven I don’t know how many times. Look back to Arizona Diamondbacks beating the Yankees and The Florida Marlins last World Series championship. Their team was loaded with young and great “arms”
As far as stocks are concerned. William O’Neill proved overwhelmingly that stocks that are in the highest quintile in earnings growth and relative strength outperform all other stocks. so when you combine these two facets your chance of success goes way up. especially in the long run which as far as I am concerned is a minimum of 9 months and longer. Read his books
Read William O’Shaughnessy book How to retire rich. He has some great strategies for success in selecting stocks. Look at an extremely successful no load mutual fund the Cornerstone Growth Fund offered by Hennessy Funds. This is a quant fund. or Bernstein’s book Against the Gods. The remarkable story of risk.
Other than that I am not going to type endlessly in an exercise to convince one of anything. If one does not agree with my points so be it.
As they say “That’s what makes markets.”
Professor Charles Pennington replies:
It is always tempting to say that some particular field, in which one thinks he has a special understanding, can not be approached through counting, but it’s usually not true, and especially not here.
For the examples here:
In baseball the regular season record is completely meaningless.
A rudimentary, better-than-nothing way to test this would be to look at the playoff series for the past N seasons and count the fraction of them that was one by the time with the superior preseason record. If it’s not substantially bigger than 50%, then that would support the claim.
[In basketball] there is perhaps no greater factor in predicting a winner than looking at who has the home field advantage.
Here you could take all NBA games played over the past N seasons and count the fraction that were won by the home team. If it’s greater than 50%, that would show that playing at home is an advantage. But is there “no greater factor”? Hard to prove, but you could try to DIS-prove it by looking at some other factor that might be important. For example, it’s possible that knowing which team has the best record over the past 100 games is more important. That could be tested as well.
Winning baseball games in the postseason is all about two things: Pitching and momentum.
For pitching: The question, I guess is whether pitching is more important than hitting in the post-season. You could take the past N series and count the fraction that was won by the team that had the better ERA during the regular season. Then you could count the fraction that was won by the team that had the highest number of runs scored per game during the regular season.
For momentum: For each series, calculate the fraction of games won by a team for the full series, call that Y, then calculate the fraction of games that they won when they also won the previous game, and call that fraction X. Now calculate X/Y for each series over the past N years. If X/Y, averaged over the past N years, is much bigger than one, then that would support the momentum idea.
Chris Cooper replies:
In contradiction, I have a close friend who has made a nice living for 15 years exclusively from betting football in Las Vegas. He is not a “handicapper”, though. He applies a computerized, brute-force strategy to tournament-style contests.
September 28, 2006 | 1 Comment
Differences in s-xual appetite may be driven by evolution. A woman's s-x drive begins to plummet once she is in a secure relationship, according to research.
Researchers from Germany found that four years into a relationship, less than half of 30-year-old women wanted regular s-x.
They found 60% of 30-year-old women wanted s-x "often" at the beginning of a relationship, but within four years of the relationship this figure fell to under 50%, and after 20 years it dropped to about 20%.
Thus, men should create a financial crisis to disavow the perception of financial security every four years!
September 11, 2006 | Leave a Comment
I asked myself this morning why all the attention, as opposed to the 4th, 6th, or some other random number. As best I can tell from my internet research, it is because the number five seems to be used as the number of humanity given that the body has five appendages (two arms, two legs, and a head) and five senses (hearing, sight, small, taste, touch). The fifth appendage provides the body symmetry. Thus remembering a fifth anniversary date must somehow reconnect us with our humanity. In music, the fifth is important because its addition makes a chord.
For the spec then, one might consider testing five market combinations like gold, bond, stocks, oil, the dollar for opportunities.
Michael Olds mentions:
Just one little note here. Five (actually probably any number) as standing for 'Man' is culture-specific. In Buddhist cultures it is six. There the mind is considered the sixth sense (and, unlike here, Man is considered to have one … little joke).
As alien as it may seem to most of us, the mind as a sense is considered to operate like all the other senses.
We have mind and we have mental objects. Mental objects coming into the range of mind, together with consciousness [an element, just like earth, water, fire and wave-form, and subject to 'conservation' (recycling) just like those elements] produce consciousness of ideas. String together consciousnesses of ideas, given direction by the specialized consciousness idea called intent, and what we get is what we know as thought.
How is this relevant to speculation and trading? One way is in how the idea could be used to free the trader from error bound up with ego. Ego brings bias, and bias ruin. Seeing the process in the way described above is seeing without the notion of ego. There is mental object data, mind data, consciousness data. There is no 'my mental object data' [let alone the truly messy 'I think'] to cause possessiveness and the resultant hesitation to let go of a bad idea…it is all just data.
Five is important because it is the hand. Half of two hands. Half of 10, on which our number system is based.
Five is the number of "comprehensive and yet simple" unity or a set; it is applied in all cases of a natural and handy comprehension of several items into a group, after the 5 fingers of the hand, which latter lies at the bottom of all primitive expressions of No. 5.
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