Jul

29

 I am searching for a musical song that illustrates the constructal law.

The constructal law teaches us that anything that flows, which is just about everything, is 'alive' because it evolves as it flows. Life is the persistent movement, struggle, contortion, and mechanism by which animate and inanimate flow systems morph to generate better access for what flows. When the flow stops the configurations becomes a flow fossil (dry riverbeds, snowflakes, animal skeletons, abandoned technology, and the Pyramids of Egypt).

From Design in Nature

Victor writes to Rorianne Schrade: 

One wonders if there are any musical pieces that illustrate this idea.

Rorianne Schrade responds:

 Dear Victor,

I hope this finds you and all of your beautiful family doing well. My apologies for not getting to this sooner–you are always delving into such interesting topics. While I'm probably unqualified to comment in any depth on constructal law, I think music relates to ideas of flow in more ways than one could ever count. The first thing that pops to mind is the need to keep a single tone itself "alive" — something that in early music gave rise to all sorts of trills and embellishments for the prolongation of tones, the continuation of the melodic momentum, and the development of musical life in a composition or improvisation. Whole sets of variations could be used to illustrate this as well, the starting with a simple theme, the gradual building and elaborating all as a way of keeping the theme alive as well as creating new music. The "flow" may be interrupted with what seems like musical "death" (a "flow fossil" or "dry riverbed" as you mention– these are beautiful too, in their own ways) in the middle of a piece of music– but the flow somehow returns or survives until the end of the piece (and longer in one's mind) if I've got the right idea of what is meant here. Another illustration might be jazz improvisation on standard tunes … keeping it flowing in a single performance as well as keeping it "flowing" through the decades through variation and new interpretations… I must be oversimplifying, but thank you always for the food for though! love to you all, r.

Alston Mabry writes: 

Here are some musical pieces that I find illustrate constructal flow/order/disorder.

Starting off with the more challenging stuff:

Iannis Xenakis: Metastasis

Edgard Varese: Ionisation

Richard Carrick: Dark Flow - Double Quartet

And the more accessible:

Claude Debussy: Dialogue du vent et de la mer

Stravinsky: Le sacre du printemps

John Luther Adams: Dark Waves

Oregon: Yellow Bell

Cliff Martinez: Is That What Everybody Wants

Scott Brooks:

Here are two metaphorical songs about the flow of life's progressions

"Wasted on the Way
" by Crosby, Stills and Nash

"Nether Lands" by Dan Fogelberg

Both of these songs are two of my all time favorite.

I am especially fond of two sets of lyrics in Nether Lands where Fogelberg sings…

Anthem's to glory and anthems to love

And hymns filled with earthly delight

Like the songs that the darkness composes to worship the light

and

Once in a vision, I came on some woods

And stood at a fork in the road

My choices were clear, yet I froze with the fear, of not knowing which way to go

One road was simple acceptance of life

The other road offered sweet peace

When I made my decision my vision became my release

As I think about those lyrics, my mind wanders to the progression of life and how we end up where we are today. I think of many of the decisions, good, bad (and non-decisions that I wished I had had the courage to make) that I've made. I don't focus on how I would be happier or my life would have been different had I made other choices in my progression. For if I let me self start the "second guessing game", it will consume like a cancer.

Instead, I focus on what I've learned from all those decisions and how I can apply them to my progression going forward and, hopefully, improve my life, the life of my family, my clients and my friends.

I think that's what progression is all about.

Gary Rogan comments: 

Couldn't think of anything totally appropriate but this may come close (and it's The Surfer's favorite band)

"Natural Science"

By Rush

When the ebbing tide retreats
Along the rocky shoreline
It leaves a trail of tidal pools
In a short-lived galaxy
Each microcosmic planet
A complete society

A simple kind mirror
To reflect upon our own
All the busy little creatures
Chasing out their destinies
Living in their pools
They soon forget about the sea…

Wheels within wheels in a spiral array
A pattern so grand and complex
Time after time we lose sight of the way
Our causes can't see their effects

A quantum leap forward
In time and in space
The universe learned to expand

The mess and the magic
Triumphant and tragic
A mechanized world out of hand

Computerized clinic
For superior cynics
Who dance to a synthetic band

In their own image
Their world is fashioned
No wonder they don't understand

Science, like nature
Must also be tamed
With a view towards its preservation
Given the same
State of integrity
It will surely serve us well

Art as expression
Not as market campaigns
Will still capture our imaginations
Given the same
State of integrity
It will surely help us along

The most endangered species
The honest man
Will still survive annihilation
Forming a world
State of integrity
Sensitive, open and strong

Wave after wave will flow with the tide
And bury the world as it does
Tide after tide will flow and recede
Leaving life to go on as it was…

Jul

29

 Daily Speculations offer at 2,500 prize for the best lyrics for a song that captures the spirit of the endless and ephemeral movements of markets to Greek news over the past 6 months.

Here are past examples. Entries to be submitted by July 31.

Winner to be determined by popular vote.

I kept hearing this song overnight which inspired it: "It's Greece".

Thank you. Also, we'll have Kino and Jon Burr sing and play the song at the spec party September 5th.

Alston Mabry writes in: 

(sung to the tune of "The Major-General's Song")

I am the very model of a modern Brussels bureaucrat,
I've information technical, political and Eurostat.
When lunching with reporters I can sound just like a democrat
And dismiss any notions of a Continental coup d'etat.
I keep my Strasbourg mistress in a cozy little Neudorf flat,
(My wife could find it in the bills - I hope she doesn't think of that!)
I'm very well acquainted with the back seat of a limousine,
I never fail to have my way with any offered haute cuisine.

I'm veteran at promulgating regulations Byzantine,
Discretely lift my nose up to the mass of bourgeois philistine,
In short, in matters technical, political and Eurostat,
I am the very model of a modern Brussels bureaucrat.

Precisely I can calculate the solid waste municipal
Per capita for Capua, Montpellier and Dinkelsbühl.
So comprehensive was my last report on herb medicinals
That several of my colleagues thought my brilliance unforgiveable.
I'm called upon to explicate the latest fruit juice label scheme,
Then lecture on the trade gap between Luxembourg and Liechtenstein.
And then I'll do a scatterplot of Swedish satisfa-action,
Against the recent increase in French farmers' tractors' tra-action.

They wonder why I spend all day in study of parabolas,
Then I predict the future size of bathing suits in Malaga!
In short, in matters technical, political and Eurostat,
I am the very model of a modern Brussels bureaucrat.

When I can add my sister's husband's cousin and his son-in-law
To every second item on my monthly cash expense report,
When I can down my seventh glass of '08 Chateau Haut Brion
And still expound on Maastricht until half the room is comatose,
When I can differentiate a "bailout" from "austerity",
I'll also know the spread between employment and hilarity,
And when I know what's truly meant by "income inequality",
I'll know my income's getting close to where it really oughta be.

With all this Euro-knowledge in my brain where it's supposed to be,
I hope I don't get catatonic Euro-neuro-entropy,
But still in matters technical, political and Eurostat,
I am the very model of a modern Brussels Eurocrat.
 

Gary Rogan submits: 

I Dreamed a Dream (Fantine's song)

From Les Miserables (almost)
There was a time the EU was kind
When their voices were soft
And their words inviting
There was a time the Germans were blind
And Greece was a song
And the song was exciting
There was a time
Then it all went wrong
I dreamed a dream in time gone by
When the Euro was high
And life worth living
That Greece's dream would never die
I dreamed that the Germans would be forgiving
Then I was young and unafraid
And dreams were made and used and wasted
No margin call was to be paid
No song unsung
No wine untasted
But then the Greeks rebelled at night
With their voices loud as thunder
As the EU tore their hopes apart
As the markets turned my dreams to shame
They talked for days, they talked at night
They filled my days with endless wonder
They took the lying Greeks in stride
But all was gone when summer came
But I still dreamed they'd talk again
And we could trade for months together
But there are dreams that cannot be
And there are storms we cannot weather!
I had a dream my life would be
So different from this hell I'm living
So different now, from what it seemed
And Greece killed the dream I dreamed

also:

Not quite a show tune, but what the heck
Trade This Way

by Aerosmith (almost)

High risk lover never ready to cover
'Till I talked to my broker he say
He said, "You ain't seen noting
'Till you're out of margin
Then you're sure to be a-changin' your ways"
I met a cheerleader, was a real news reader
All the times I can reminisce
Ah the best shorts lovin'
With her sister and her cousin
Started with a little miss, like this
Markets swingin' with the news out of Greece
With the futures flyin' up in the air
Singin' hey diddle-diddle with the kitty in the middle
You be swingin' like you just didn't care
So I took a big chance that the Greeks will dance
With a frau who was ready to pay
Wasn't me that they were foolin'?
'Cause I knew what they were doin'
When they taught me how to trade this way
They told me to
"Trade this way, Trade this wayTrade this way, Trade this way
Trade this way, Trade this way
Trade this way, Trade this way"
Ah, just give me a kiss
Late night hustles they were meeting in Brussels
I remember I was betting on Greece
There was three young brokers at the airport locker
When I noticed they was lookin' at me
I was a market loser
Never once made a profit
Till the boys told me something I missed
That Greece had neighbour
Who also needed a favour
And the Germans will give'em a kiss, like this
Markets swingin' with the news out of Greece
With the futures flyin' up in the air
Singin' hey diddle-diddle with the kitty in the middle
You be swingin' like you just didn't care
So I took a big chance that the Greeks will dance
With a frau who was ready to pay
Wasn't me that they were foolin'?
'Cause I knew what they were doin'
When they taught me how to trade this way
They told me to
"Trade this way, Trade this wayTrade this way, Trade this way
Trade this way, Trade this way
Trade this way, Trade this way"
Ah, just give me a kiss

Franklynn Phan submits: 

"Ain't Misbehavin'"

(In the style of Louis Armstrong)

No one to talk with, all by myself
No one to shop with, cause I'm happier to sell
Ain't misbehavin', Savin' my cash for you

I know for certain, the top is in
I'm through flirtin' with down side predictin’
Ain't misbehavin', Savin' my cash for you
Like Old Hussman in a corner
Not “perma-bear”, but I don't care
Low valuations, worth waitin' for, believe me

 Don't be TOO long here, don't stop to buy
Know I’m alone dear, me and my bearish pride
Ain't misbehavin', Savin' my cash for you.

Scoobededa doot diddlee doot doot

Ken Drees pens to the tune of Supercalifragilisticexpialidocious: 

Drees "uberallymerkelisticgrexieurodoughshush"

It's uberallymerkelisticgrexieurodoughshush
Even though the thought of it is nothing like ferocious
If you trade it long enough, drool sideways bound neurosis
Uberallymerkelisticgrexieurodoughshush
 
Numb fiddle, fiddle fiddle, glum fiddle lie
Numb fiddle, fiddle fiddle, glum fiddle lie
Numb fiddle, fiddle fiddle, glum fiddle lie
Numb fiddle, fiddle fiddle, glum fiddle lie
 
Abuzz I was to trade the greek
Then just a simple fad
Thy market sent me up a creek
and sold me out twas sad
 
But when come May I burned a third
That graved forsaken close
The glibbest bird I never jeered
And hiss is how it blows, go
 
It's uberallymerkelisticgrexieurodoughshush
Even though the thought of it is nothing like ferocious
If you trade it long enough, drool sideways bound neurosis
Uberallymerkelisticgrexieurodoughshush
 
Numb fiddle, fiddle fiddle, glum fiddle lie
Numb fiddle, fiddle fiddle, glum fiddle lie
Numb fiddle, fiddle fiddle, glum fiddle lie
Numb fiddle, fiddle fiddle, glum fiddle lie
 
Greek raveled all abound and whirled
And derriere he spent
Greek 'buse his herd and all could bray
Share does a rarer cent
 
Then hoops and ouzoquaffage
alas the chime to pay writhe fee
Eye sway the speshill slurred
And then play mask-wee 'bout to pee
 
So uberallymerkelisticgrexieurodoughshush
Even though the thought of it is nothing like ferocious
If you trade it long enough, drool sideways bound neurosis
Uberallymerkelisticgrexieurodoughshush
 
Numb fiddle, fiddle fiddle, glum fiddle lie
Numb fiddle, fiddle fiddle, glum fiddle lie
 
So you can play it awkwards, which is doughshusheurogrexlisticmerkeallyrebu
But that's growing a wit too far, won't you wink?
 
So then the rat has shot your bung
There's no heed for delay
Dust coming up its blurred
And then move not a dot to play
 
But bettor ruse it warily
Or it could derange for strife
For example, jest, one night I fed it to a bar-girl
And now the bar-girl's my wife, oh, and a homely thing she's too
 
But
 
She's, uberallymerkelisticgrexieurodoughshush
Uberallymerkelisticgrexieurodoughshush
Uberallymerkelisticgrexieurodoughshush
Uberallymerkelisticgrexieurodoughshush

anonymous submits: 

Sung to the tune of "Rolling in the Deep" by Adele:

There's a crisis starting in my hinterland
Reaching a fever pitch, it's bringing me out the dark
Finally I can see you crystal clear
[Clean version:] Go 'head and sell me out and I'll lay your ship bare
[Explicit version:] Go 'head and sell me out and I'll lay your shit bare
See how I leave with every piece of you
Don't underestimate the things that I will do

There's a crisis starting in my hinterland
Reaching a fever pitch
And it's bringing me out the dark

The scars of your own failed loan remind me of us
They keep me thinking that we almost had it all
The scars of your own failed loan, they leave me breathless
I can't help feeling
We could have had it all
(You're gonna wish you never had lent me)
Rolling in the deep
(Ratings are gonna fall, rolling in the deep)
You had my mint inside of your hand
(You're gonna wish you never had lent me)
And you wagered it, to the limit
(Ratings are gonna fall, rolling in the deep)

Baby, I have no story to be told
But I've heard one on you
And I'm gonna make your cash burn
Think of me in the depths of your despair
Make a bank down there
As mine sure won't be repaired

(You're gonna wish you never had lent me)
The scars of your own failed loan remind me of us
(Stocks are gonna fall, rolling in the deep)
They keep me thinking that we almost had it all
(You're gonna wish you never had lent me)
The scars of your own failed loan, they leave me breathless
(Stocks are gonna fall, rolling in the deep)
I can't help feeling
We could have had it all
(You're gonna wish you never had lent me)
Rolling in the deep
(Bonds are gonna fall, rolling in the deep)
You had my mint inside of your hand
(You're gonna wish you never had lent me)
And you wagered it, to the limit
(Bonds are gonna fall, rolling in the deep)
We could have had it all
Rolling in the deep
You had my mint inside of your hand
But you wagered it, with no limiting

Throw your Euro through every open door (woah)
Count your Shillings to find what you look for (woah)
Turn my borrow into treasured gold (woah)
You've paid me back in kind and reaped just what you sowed (woah)
(You're gonna wish you never had lent me)
We could have had it all
(Metals are gonna fall, rolling in the deep)
We could have had it all
(You're gonna wish you never had lent me)
It all, it all, it all
(Metals are gonna fall, rolling in the deep)

We could have had it all
(You're gonna wish you never had lent me)
Rolling in the deep
(Currencies are gonna fall, rolling in the deep)
You had my mint inside of your hand
(You're gonna wish you never had lent me)
And you wagered it to the limit
(Currencies are gonna fall, rolling in the deep)

We could have had it all
(You're gonna wish you never had lent me)
Rolling in the deep
(Assets are gonna fall, rolling in the deep)
You had my mint inside of your hand
(You're gonna wish you never had lent me)

But you wagered it
You wagered it
You wagered it
You wagered it to the limit.

anonymous submits: 

(From Paint Your Wagon, "They Call the Wind Mariah"

Through unrest, we gave a name

To Pain and Hun and Liar,

The Pain is Debt, the Liar's Greece,

and we call the Hun Pariah.

Pariah throws the loans around

Then sends Hellene a-crying

Pariah makes accountin' sounds

Like mokes down here weren't trying.

Pariah, Pariah,

We call the Hun Pariah

Before I knew Pariah's name

And took to wealth enshrinin'

I took on debt and debt had me

And the Hun commenced his whinin'.

But then one day I left the whirl

And let it not define me

And now I’m lost, I’m oh so lost

No Gallic bawd can find me.

Pariah, Pariah,

They call the Hun Pariah

I hear they got a name for Pain

And Hun and Liar only

But when you’re broke and all alone

There ain’t no "yes" to "loan, please?"

Pariah, Pariah,

We call the Hun Pariah

Pariah, Pariah, - send a loan to me.

Now I’m a lost and lonely state

Without a fool to front me.

Pariah, float a loan to me

I need Bear-Stearns behind me

Pariah, Pariah

I’m loanless can’t you see

Pariah, O, Pariah

Please float a loan to me

Pariah, O, Pariah,

Please send a jubilee.

Jul

22

 This page on youtube has narrators talking about the best book they ever narrated. It has some very interesting vids!

anonymous writes: 

Two high-quality long time favorite podcasts of mine are:

1. New Yorker fiction podcasts: one famous author reads another's work aloud and discusses it, eg George Saunders, Roddy Doyle, Harold Brodkey.

2. In Our Time podcast: interviews with 3 professors at once on a subject of intellectual history, eg the Cavendishes, Francis Bacon, The Enclosures. Rarely or never found either programme to be a waste of time.

Jul

17

Are the entry and exit points determined by algorithm or by eyeball? If by algorithm, then one imagines changing volatility regimes, but also knows that a sharp trader would have that factored in.

If by eyeball, then of course that leads to interesting speculation about psychological regime changes.

Zooming out, there is the issue of ex post chart scanning, and seeing the "ideal" entry and exit points, and how the Mistress can take even a good trade and make you feel like you screwed it up.

Jul

6

Econ 101: price discovery has a cost.

Buy Low, Sell Prime

Sam Cohen's business works like this: He walks into a big retail store and buys a bunch of stuff. Then he sells it on Amazon for more.

This is a multimillion-dollar business for Sam — and for lots of other people who do the same thing.

How is this even a job, much less an industry?

anonymous writes: 

Pricegrabber and other broad product aggregators make price comparisons a near effortless task.

Jun

25

 Will someone explain to me why news of Greece no deal is bullish for bonds, i.e what it has to do with the long term rate of inflation? And why news of a deal is bearish for bonds? Also while at it, why no deal is bearish for stocks and deal is bullish?

John Floyd writes: 

A market pundit might say (not a personal explanation): "if there is no deal in Greece that is bad for Europe and the ECB will have to do more QE and buy European bonds to get confidence up, growth up, and inflation up, that would be bearish for the Euro, the uncertainty around no deal is bad for stocks in the short term." On the next contradictory headline you can expect the mirror image response.

Alston Mabry writes: 

From the cheap seats: no deal for Greece, or even Grexit, means a mini-catastrophe, where lots of players will be looking to get out of certain positions and move to safety until the smoke clears and we find out if a Greek exit actually raises the possibility of Portugal or Spain leaving, too. So in this case, Treasuries = safety.

John Floyd writes: 

As I sit and watch the headlines on Greece I can't help but recall similar headlines and market reactions prior to the Russian default on August 17, 1998. Hopefully I have learned at least one thing since then. While not financially ruinous, and actually profitable in many ways, it was amongst other things a tiresome and loathsome experience getting up at 1 a.m. NY time to watch the latest headlines and developments.

The first lesson would be to attempt to recognize an untenable position from a macro economic and geopolitical standpoint in the medium to long term. A corollary is to not position investments with the thesis that an untenable position will be resolved in the short term and provide profits.

The wolf of the markets will at some point overpower such a short term view. The PIGS in the periphery perhaps might have their houses and building materials tested further. The wolf will have to be careful though as the cauldron waits in a house and may try and stymy speculative avenues.

Jeff Rollert writes: 

In a "normal" world, a large debtor defaulting forces participants via systematic transmission to add Treasuries/AAA bonds to portfolios to return to the prior risk/reward or VAR state for a window of time until asset recovery levels become apparent.

Jun

22

 I like the part of The Boys in the Boat where the freshman coach pretends that Cal can beat them handily. The necks of Cal swell even further making it even for Washington to cut them off. I followed the same principle in squash, and never admitted that I had a chance to win. I also never admit to a profit in the market for the same reason. It will be interesting to hear what Mr. Rafter has to say about The Boys in the Boat because he has won many national rowing championships. In particular the wisdom and ability of George Peacock, the world's best boat builder, whose materials in wood have now gone with the wind.

David Lillienfeld writes: 

The beauty and terror of baseball is that there is no clock; and the second you stop thinking about the next pitch, you are on the way to losing no matter how big a lead you have.  What made last year's 7th game so good is that neither team ever once lost that focus; the game score was as close as one can be, but neither team ever for a moment got "tight" thinking about the end result before play was over.

Alston Mabry writes: 

Yes, in games like basketball or football or soccer, you can work the clock. But baseball and tennis have that exciting element of the game not being over until it's over.

anonymous writes: 

I have had the pleasure of seeing some true greats in action over extended periods of time in the markets. The only time these guys really lost any money was when they ignored time.

A fixed clock on any speculation in the organized macro markets is vital in my opinion and experience.

Unlike most things we discuss, the addition of fixed clocks (or predetermined holding periods for individual speculations) is actually countable and its efficacy is testable.

Jun

16

Looking at JNJ daily Closes from January, 2014 though 12 June, 2015
(arbitrary dates): JNJ went from a 46 handle up to a 109 handle,
crossing 63 whole number prices. If we look at Close-to-Close moves
where the price crossed one or more whole numbers, we find that out of
2880 tdays, there were 1337 whole number crosses (if a Close-to-Close
crosses two whole numbers, then it counts as two crosses, etc.).

One simple analysis:

63 whole numbers crossed with 1337 total crosses = 21.2 crosses per
whole number.

Pull out the tens "rounds": 50, 60, 70, 80, 90, 100 - 6 of them with a
total of 110 crosses, or 18.3 crosses per round.

The rounds:

100 - 36 crosses
90 - 11
80 - 1
70 - 9
60 - 49
50 - 4

Apr

2

 It is difficult for me to fathom why a now struggling toy company would pick a Greenwich, CT based 64 year old, classic corporate guy (who ran Pepsi for a few years) to be its CEO. Maybe he has grandchildren? Or great-grandchildren?

anonymous writes: 

They must think their problems are organizational.

But it got me thinking about how a modern toy company needs to focus on what kids want now, which made me think that AAPL should produce something like the iKidPhone, which would be a less-expensive, limited cell phone for little kids, with game and learning apps, and the ability for the adults to let the kids have just a specific set of numbers for friends and family that they can call. Might work. I know, I know, "it's called the iPhone 4". But AAPL might be able to create a specific product that would sell nicely and maybe cannibalize some of that hand-me-down business.

Mar

6

The value of commods varies so much with the attention the sector gets, and especially when there is so much money sloshing around, looking for an "investment", or players stocking warehouses full of copper as collateral against shadow-banking-system commitments, etc. The situation introduces so many orthogonal drivers of price beyond mere end-user demand.

Mar

5

Rocky Humbert says: "Commodities belong in your portfolio when they are cheap and/or rising in price"

I agree. The question is are they cheap now? A very naive approach looking at Oil as a proxy for the group and compare it on a long term basis with stocks or bonds, you can say commodities are as cheap (relatively) as they have been in the last 20 years (bottom 10% of the range).

What other ways of assessing the 'value' of commodities are out there?

Alston Mabry adds:

The value of commods varies so much with the attention the sector gets, and especially when there is so much money sloshing around, looking for an "investment", or players stocking warehouses full of copper as collateral against shadow-banking-system commitments, etc. The situation introduces so many orthogonal drivers of price beyond mere end-user demand.

Alex Castaldo adds:

Here is a quote: "For commodities, we define value as the log of the spot price 5 years ago (actually, the average spot price from 4.5 to 5.5 years ago), divided by the most recent spot price, which is essentially the negative of the spot return over the last 5 years." (Asness, Moskowitz & Pedersen). So that is one possible definition, but I am not sure it is a satisfactory one since it relies only on price. To me value involves the comparison of price to something else.

Jan

22

 QEe (QE euro) seems to be moving forward. So why did gold, which has had some strength over the past month, not budge at the news the way currencies did?

anonymous writes: 

The theory I am working on in my head and was hoping to have time to write about tonight is as follows:

QE depends upon a central bank "cartel" all agreeing to do it in unison and or in staggered phases. The cartel allows them to get away with this absurd policy without immediately wrecking the currency as compared to other currencies they don't seem to be devaluing.

Switzerland broke the cartel.

This means that the future of QE is in fact in jeopardy and will be more limited than otherwise.

anonymous writes: 

Isn't that the path off all cartels of > 1 players (Debeers),

Look at OPEC post 1974.

Like the prisoner's dilemma, the "cartel participant," game would call for a certain, upside price where the first member jumps ship, with a phony justification for their greed trumping the purpose of the cartel.

anonymous replies: 

Yes of course. Only in this case instead of restricting the supply, the deal was to expand the supply.

In the old days when Kuwait broke from the cartel and cheated it brought oil down more than just by the amount of Kuwait's extra production because once one member of the cartel cheats everyone else is going to.

It's the same thing here. Once SNB broke, others will be tempted to as well.

This isn't talked about in the press because of the insane and incorrect notion that your currency going up is somehow a bad thing, so the mainstream all think that the Swiss are somehow hurting themselves.

Alston Mabry writes: 

But the alt version is that they weren't playing along because their EUR purchases were putting upward pressure on EUR, counter to ECB's strategy.

anonymous replies: 

What ECB, US, and Japan would have wanted is for the SNB to devalue along with them. SNB wasn't going to do that.

Now, all of QE depends on the big lie that you are not really printing money and not really devaluing the currency.

Any time someone says "you're printing money" the response is met with "you just don't understand" followed by a description of the complicated process of QE and how it's not really printing money.

But the fallback position for the QE'ers is "look, there's no inflation (no consumer inflation.. it's in assets) and "the currency isn't being devalued".

The SNB's peg kept the ECB being able to claim they weren't destroying the currency. The SNB undoing of the peg reveals that the emperor has no clothes and they are, in fact, going to destroy the currency.

Alston Mabry responds: 

It may be true that claims were made about the EUR on the basis of the CHF cross. But I find compelling the narrative that Mario called up Thomas Jordan and said "look, unless you're willing to print tens of B of extra SFrs a month, you're not gonna be able to keep up." And Jordan, knowing that technically the SNB could do it but politically internally couldn't, said "you're right" and they dropped the cap. 

Jan

15

Talking to a friend: "If a year ago somebody had said just put everything in zeroes and utilities and then forget about it until January 2015, what would we have thought of that suggestion?"

And then I wondered: What is it now that would sound just as stupid?

Jan

12

 I'm waiting for our specs to give me examples from any field of things as exciting as the S&P last week and these racket things from table tennis or this.

Boris writes: 

Lake Placid - Olympics final, Team USA vs. Soviet Union.

Laurel Kenner writes: 

How about the gladiator contests of ancient Rome? Fed would be the patron with the thumb. Up/down.

Alston Mabry writes: 

One of the exciting things about tennis (and similar racquet games) is a function of the game's structure: No matter what the score is in a tennis match, the player on the verge of losing can come back and win the match. Contrast this with a game like American football, where there is a clock, but also where a team far behind in the score can take big risks (long passes, onside kicks, trick plays) to try to get back in the game.

The natural question for a trader: Does the market have a game structure, say, during the course of a single trading day/week/month, that constrains the possible outcomes or the nature of risk-taking? For example, once the relationship of equities vs bonds (or USD vs the €Mark or crude vs whatever) gets to a certain point, does the game require that a rebalancing occur?

anonymous writes: 

America's Cup, 2013 with the U.S. having to win last 8 in a row to win 9-8.

Jan

5

 Here's my prediction: the DXY is on it's way towards 100…110 or 120. I'm buying calls on the UUP and will check in on them in about 90 days.

Alston Mabry writes: 

And if you wanted to hedge that bet, you could go long silver, in whatever safe format you prefer…calls on AGQ being a safer way to do it. But you'd need to check in on them often.Just in the spirit (ghost?) of making an actual call.

Jan

1

 This book was recommended to me:

Sleights of Mind: What the Neuroscience of Magic Reveals About Our Everyday Deceptions

Stephen Macknik and Susana Martinez-Conde, the founders of the exciting new discipline of neuromagic, have convinced some of the world's greatest magicians to allow scientists to study their techniques for tricking the brain. The implications of neuromagic go beyond illuminating our behavior; early research points to new approaches for everything from the diagnosis of autism to marketing techniques and education. Fun and accessible, Sleights of Mind is "a tour through consciousness, attention, and deception via the marriage of professional magic and cognitive neuroscience" (Vanessa Schipani, The Scientist).

Nov

24

 The money printing has driven up prices, the prices of paper assets, including the prices of Treasuries, which has to be the largest paper asset class globally. But the money that winds up at the banks has largely then been put back to the Fed for the interest it pays. Banks haven't been lending like crazy, so that mechanism isn't pushing inflation. Meanwhile, cheap money has allowed corporations to manage their PE ratios by buying back stock, again pushing up assets prices. And for broad inflation, you need upward pressure on wages, but globally for the last decade plus there has been profound downward pressure on wages caused by China dumping tens of millions of smart, motivated workers into the global labor market every year, not to mention the other emerging Asian countries. And speaking of China, that country has served as an inflation sink for years now, via there currency/import/capital controls policies - there is inflation, and a lot of it, in China.

Stefan Jovanovich writes: 

Big Al's analysis is perfect. But he is describing the short-term credits issued by central banks to float their national Treasuries' deficits. Money itself - cash and customer's bank balances - has not been increased dramatically. I realize this can be seen as a distinction without a difference in a world of fiat money, but it does highlight the difference between the present and the 1970s. Then central banks and rich people worried about whether or not U.S. currency would keep its exchange value, whether the dollar would continue to decline to oblivion as the franc, lira and mark had after WW 1. Now there is no reason for such outright fear because currency positions can be hedged fully and there is, in effect, a monetary Treaty of Vienna assuring a balance of financial power among the largest trading nations that allows them all to quantify credit as needed. As Big Al notes, that balance does not answer the question of how a commercial truce can be sustained under a 19th century combination of steadily declining prices for metals, fuels and grains and increasing prices for land and financial assets supported by public/private finance.

Oct

31

This CIA pub makes some great points: Psychology of Intelligence Analysis by Richards J. Heuer, Jr.

My favorite quote from Chapter 8:

Analysis of competing hypotheses involves seeking evidence to refute hypotheses. The most probable hypothesis is usually the one with the least evidence against it, not the one with the most evidence for it. Conventional analysis generally entails looking for evidence to confirm a favored hypothesis.

Sep

30

A study by Kora Reddy showed that for a sample of SPY days:

"4th trading day from the last trading day of the month (i.e 25th September 2014 in this month's case) is down and it is quarter ending (in the months of Mar, Jun, Sep, Dec)"

There were 45 instances, and all 45 had a higher close during the following 5 trading days.

For analysis, starting with all SPY days since 1993, we want to avoid overlap, so we pick every 6th SPY close and determine whether or not it had a higher close over the next 5 days.

Original study:

count: 45
with higher close next 5 tdays: 45
success rate: 100%

Non-overlapping SPY closes (every 6th):
count: 908
with higher close next 5 tdays: 863
success rate: 95%

To get a measure of the significance of the original results, we take our "every 6th SPY close" data set and assign a value of "1" for instances that have a higher high over the next 5 trading days, and "0" for instances that don't. Then we take that series of 1's and 0's and randomly pull 45 observations at a time (with replacement) for 1000 iterations.

Random runs: 1000
Mean sum (of the 45 values pulled): 42.77
SD: 1.437
z of original results (45): +1.55

So if we randomly pull sets of 45 non-overlapping SPY days, we would expect about 43 of them to be successes, i.e., have a higher high over the next 5 trading days. The original results have a z of +1.55 against our randomized runs, so they fall under the common +2 level of significance but are still positive.

To take the analysis one step further, we look at the size of the move from each SPY close:

Original study:
count: 45
mean move to 5-day High: 1.83%
SD: 1.15%

Non-overlapping SPY closes (every 6th):
count: 908
mean move to 5-day High: 1.65%
SD: 1.52%

z of original results (45): +0.81

So, analyzing the size of the Close-High moves shows that, while still positive, the z of the original results is much lower than that obtained by looking at the results as binary, hit/miss observations.

Sep

10

 The book The Power of Habit by Charles Duhigg, a journalist, is about the formation and the neurophysiological basis for habits and how to change them. I've been interested in this since I was younger. My essay to get into Reed College was about the neurophysiological changes in the brain of the Buddhist monks who meditate for hours everyday. It would take another 25 years before experiments shed any light on this subject. I've also followed behavioral psychology and thought there must be more to it than behaviorists documented.

Apparently the Basal ganglia, a primitive organ in the brain responsible for reflexes is changed when habits form. Habits form on a behavioral feedback loop where there is a cue, a routine and a reward. The habits are subconscious. There is no simple solution because habits are created in a complex environment. It's not always clear what the cue, the routine, or rewards are, and often they're not what first appears.

The author talks about simple habits, experiments with brain damaged patients, about alcoholism and AA, and habits of organizations. Everyone who reads the book wants a simple answer and cure to change their bad habits. It's not that simple. One has to look to see what the cues are and what the true rewards are. The book was a good read, and well documented with notes and sources.

Alston Mabry writes: 

The Power of Habit is a very interesting book. I would recommend, along with it:

Willpower by Roy Baumeister and John Tierney and The Brain That Changes Itself: Stories of Personal Triumph from the Frontiers of Brain Science by Norman Doidge M.D.

Jul

24

"You do not buy photographs from Otto Leipzip and you don't buy Degas from Signor Bonati."

Jul

13

I enjoyed this article: "Lionel Messi Is Impossible".

Jul

1

 "We thought trees and fungi were socialist, but they're actually capitalist"

The coexistence between trees and fungi is supposed to be very peaceful. Fungi grow on the roots of a plant, providing nitrogen to it in exchange for carbon, in a nearly perfect symbiotic exchange. Each individual fungus, traditional wisdom holds, works in tune with the root it grows in tandem with. But a new study presents a different model: The supposed buddies are actually acting like buyers and sellers in a capitalist market.

Led by IIASA Ecosystems Services and Management researcher Oskar Franklin, theSwedish study (paywall) started with a surprising observation. Root fungi were actually working to maintain nitrogen scarcity in the forest. When less nitrogen was available in the soil, fungi gave up less nitrogen to the trees. But when nitrogen was abundant, they built up their stores like speculators cornering the market in a commodity, effectively forcing the trees to get their nitrogen from the fungi no matter what.

"The new theory pictures a more business-like relationship among multiple buyers and sellers connected in a network," Franklin said in a press release. Instead of being a cooperative trade of carbon and nitrogen between organisms, trees are forced to export large amounts of carbon in order to unlock nitrogen stores from the fungi.

What's more, fungi can play clients off against one another. When different plants get their nitrogen from one fungal partner, the study states, the allocation of nitrogen to each of those plants isn't dictated by need or fairness. Instead, the fungus seeks the best possible return on investment. "Having multiple symbiotic trading-partners generates competition among both the fungi and the plants," Franklin said, "where each individual trades carbon for nutrients or vice versa to maximize profits, not unlike a capitalistic market economy."

This gives trees an incentive to offer up more carbon than their neighbors. The trade isn't always beneficial for both parties. In fact, plants and fungi could get locked-in to a mutual trade agreement that isn't optimal for either party. The authors compare this to carbon lock-in, where industries are stuck in a fossil fuel-based system, even when other energy options are superior.

And while trees may thrive from this exchange, the fact that the fungi hoard nitrogen "traps the whole forest in nutrient limitation," Franklin said. In general, the authors stated, how fungi collect and distribute resources is largely unexplored.But this should change. If we don't understand the market structure of the fungi and trees, Franklin said, won't really know how forests will react to the changes in carbon availability that climate change could bring about.

Jun

6

 Each bar is a day where that S&P Close was never breached afterward (to date) (i.e. S&P never fell below that level up to now).

Kora Reddy writes:

Adding to the fun, I looked at whether and when a newly crossed round number is revisited again.  All except the crossing of 200 and 500 were revisited at some point in the future ranging from 1 to 812 calendar days.

May

12

 I read and loved this excerpt from A Jewish Peddler's Diary, (1842-1843).

Last week in the vicinity of Plymouth I met two peddlers, Lehman and Marx. Marx knew me from Fürth, and that night we stayed together at a farmer's house. After supper we started singing, and I sat at the fireplace, thinking of all my past and of my family….

Today, Sunday, October 16th, we are here in North Bridgewater, and I am not so downcast as I was two weeks ago. The devil has settled 20,000 shoemakers here, who do not have a cent of money.

Suppose, after all, I were a soldier in Bavaria; that would have been a bad lot. I will accept three years in America instead. But I could not stand it any longer.

As far as the language is concerned, I am getting along pretty well. But I don't like to be alone. The Americans are funny people. Although they sit together by the dozen in taverns, they turn their backs to each other, and no one talks to anybody else. Is this supposed to be the custom of a republic? I don't like it. Is this supposed to be the fashion of the nineteenth century? I don't like it either.

"Wait a little! There will be more things you won't like." Thus I can hear my brother talking.

The week from the 16th to the 22nd of October found me feeling pretty cheerful, for I expected to meet my brother. Ah, it is wonderful to have a brother in this land of hypocrisy, guile, and fraud! How glad I was to meet my two brothers in Boston on Saturday, the 22nd! Now I was not alone in this strange country.

How much more could I write about this queer land! It likes comfort extremely. The German, by comparison, hardly knows the meaning of the word. The wife of an American farmer can consider herself more important than the wife of a Bavarian judge. For hours she can sit in her rocking chair shaking back and forth as she thinks of nothing but beautiful clothes and fine hairdo. The farmer, himself, unlike the German farmer who works every minute, is able to sit down for a few hours every day, reading his paper and smoking his cigar.

Here is a little about the Peddler, Kohn, from the introduction.

In 1842 Kohn was twenty-three years of age when he left the Bavarian village of Mönchsroth and sailed to seek his fortune in the new world. Less than two years later he was already located in Chicago as the proprietor of a store.

Kohn had a strong sense of Jewish loyalty which caused him to be one of the fourteen men who in 1847 were founders of Chicago's first congregation, the Kehilath Anshe Ma'ariv, now popularly known as K.A.M. Kohn became president in 1853, and, in the words of Hyman L. Meites, the historian of Chicago Jewry, he "placed the congregation on a firm foundation."

Kohn took his American citizenship as seriously as his Jewish ties. Because he refused to accept a second-class status for the Jews. He was prominently identified in the campaign to obtain for Jewish American citizens the right to reside in Switzerland. He was elected city clerk of Chicago in 1860, and showed himself an enthusiastic Republican and ardent advocate of that party's presidential candidate, Abraham Lincoln of Springfield.

Kohn's admiration for the new president resulted in a gift that brought him some national attention. He sent Lincoln an American flag on whose red stripes he inscribed six of the verses from Joshua 1, including the stirring words: "I will not fail thee nor forsake thee. Be strong and of good courage." This was indeed a fit message for the leader embarking on a desperate war to preserve the Union.

Apr

21

 I have been very much enjoying this lecture series on Ancient Greek history.

CLCV 205: Introduction to Ancient Greek History:

This is an introductory course in Greek history tracing the development of Greek civilization as manifested in political, intellectual, and creative achievements from the Bronze Age to the end of the classical period. Students read original sources in translation as well as the works of modern scholars.

Donald Kagan is Sterling Professor of Classics and History at Yale University. A former dean of Yale College, he received his Ph.D. in 1958 from The Ohio State University. His publications include The Archidamian War, The Peace of Nicias and the Sicilian Expedition, Pericles and the Birth of the Athenian Empire, On the Origins of War and the Preservation of Peace, and The Peloponnesian War. In 2002 he was the recipient of the National Humanities Medal and in 2005 was named the National Endowment for the Humanities Jefferson Lecturer.

(It's also available on iTunes.)

Apr

17

 Cicero made some of his speeches as prosecutor in the extortion court of Rome. In Verrem is a set of speeches made against Verres, a man accused of many crimes committed during his governorship of Sicily. Cicero's initial oratory was not about the facts of the case itself, but rather about the state of the judicial system in Rome:

That he [Verres] was not taking money for himself alone, but had his three-year governorship of Sicily parcelled out in such a way that, he said, he would be doing very nicely if he kept his gains from the first year for his own use, handed over those of the second to his advocates and supporters, and reserved those of the third year - the richest and most lucrative of the three - entirely for his jurors.

This prompts me to tell you of a remark which I recently made before Manius Glabrio when the rejection of jurors was being held, and which I noticed made a profound impression on the people of Rome. I said that I thought there would come a time when foreign peoples would send delegations to Rome to request that the extortion law and this court be abolished. For if there were no courts, they believe that each governor would only carry off enough for himself and his children. With the courts as they are now, on the other hand, they reckon that each governor carries away enough for himself, his advocates, his supporters, the president of the court, and the jurors - in other words, an infinite amount. Their conclusion is that they are capable of satisfying the avarice of one greedy individual, but incapable of subsidizing a guilty man's acquittal.

Cicero, Political Speeches, pp 25-26 trans D. H. Berry Oxford's World Classics

Mar

12

I would like to share some thoughts regarding present and past market correlations. One of my mother's sisters, aunt Franca, spent her life with my grand father, taking care of his many vices. She used to tell me that to have an edge on events they used to check share activity in Textiles and Heavy Industry in order to anticipate probable war declarations, or military activity. The rationale is clear.

The government ordered uniforms and mechanical spare parts before undertaking belligerent efforts. The same went for paper and other similar indicators that showed some kind of economic activity. For this reason I have given a look, first at the long term graph of copper, then added the S&P index.

The resulting picture gives an idea of a total and sudden decorrelation of the stock market and price of copper since mid 2011. I'm sure that better statisticians will be able to justify such a strange phenomenon: economic prosperity and declining raw material prices.

And mind you, not any raw material, but copper, the dear metal, the center of the electronic and electric universe. The S&P has risen roughly 49 percent since September 2011, while Copper (COPA LN bbg ticker, etf quoted in $ in London) has lost 22 percent in the same period.

The visual shock is, of course, much stronger than the raw numbers. Is this predictive of a market correction?

Not sure about it, although the crowding effect of larger and larger troops of SPU bulls give me a chilling feeling down the spine and the uncomfortable "dejà vu" state of mind.

Alston Mabry writes: 

If one were to search the interweb for the "copper, china, collateral", one would find several stories claiming that copper is used as collateral in the "shadow banking system" in China and that sharp moves in price are due to such stores being liquidated.

Mar

11

 The market today is like a pretty girl. It is very attractive from the long side in many markets, but it gives you no opportunities to buy on the cheap. Where is Anatoly with his bargains outside of Hawaii and Disney today?

Larry Williams writes: 

One of our members has not had a losing trade in many years now; not a one in, I'm not sure, maybe 10 years. Ironically one of his clients, a large bank, closed out a few years back thinking something was wrong because of the excellent performance. Such is the life of a trader.

Alston Mabry writes: 

"The Holy Grail Of Trading Has Been Found: HFT Firm Reveals 1 Losing Trading Day In 1238 Days Of Trading"

You could argue that you don't need a transaction tax when it has already been levied by HFT firms.

Ed Stewart writes: 

Virtu's dividend paying history seems very aggressive to me relative to what looks like its operating earnings and net assets. Last year $250m of the $430m dividend payment was financed. $250 being very close to the firms book value equity while earnings were 180m.

2011 and 2012 had earnings near 90M and dividend payments of 120M and 130M. Around 1.5B total paid since 2006.

Is this the magic of steady returns + finance + limited liability?

Mar

5

 Just as a morning exercise to the the brain going…

Looking at SPY monthly 1993-2013, calculating Open-to-Low and then Low-to-next-High, sorting them all by O-L and getting means for the deciles, with the sd and z for the L-H column:

and here:

Now there is good criticism, especially for the z's, I think, but that's left as an exercise for the reader.

Oh, and Re the "should hit?" estimation…

the Feb high for SPY was 187.15. 

Feb

28

 The purpose of this post is to stimulate discussion about an important market development. It's not a prediction.

I believe that one of the most widely accepted memes in the financial markets over the past several years has been that the Chinese Currency was/is undervalued, manipulated and would not go down and must eventually go much higher. The fundamental arguments for this were the persistent balance of payments surplus, purchasing power parity, competitive advantage/cost, political pressure, the history of currency movements in places like Japan, relative growth rates and growth potential; monetary base; and the list goes on and on and on. In fact, I can't find any credible opinion to the contrary. (A couple of summers ago, Bill Ackman made a big PR splash buying "cheap" calls on the HK dollar predicting an inevitable and massive revaluation.)

Over the past few weeks, the Yuan has reversed course and started to decline. It has had a violent and 3 sigma decline in the past 3 days. The story is that the Chinese authorities are encouraging a "wider trading band."

I am not offering any predictions here. But it is striking that the impulse move is in the down direction, not the up direction … all the more so, when the universally accepted truth is that the Yuan can only rise.

Is this just a counter trend move? Or is something bigger going on? If the Yuan starts declining instead of rising, what are the second order effects on other markets? If this is more than a counter trend move in a secular bull market for the Yuan, then I believe there are some very important implications. Unfortunately, I'm not smart enough to know whether the supposition is true and/or what the second order effects may be.

A good place to start thinking about this might be historical analogs. What are the historical analogs? And when does the perma bull Yuan story get stopped out?

Alston Mabry writes: 

I agree. With all the issues out there on shadow banking, credit bubble, CBOC actions, ghost cities and shopping malls…who actually knows what's going on? If anybody "knows', it's the market itself. Once China frees up capital controls, import controls and currency controls and becomes relatively transparent accounting-wise…then the RMB will move on economics…mostly. But right now there are so many "shadow issues" in play that it's hard to assess the situation other than on a short-term trading basis.

Richard Owen writes: 

Disregarding the background 'China story' which is the key determinant of the secular factors (eg, do you believe China is massively insolvent or not, does it matter), when currencies are 'newly' brought to market (in the sense of being a new regime, if not a new currency), they often trade off initially. Domestic holders want to diversify and foreign buyers have no structural reason to accumulate inventory, thus have a 'show me' attitude on price. And since fx is a short duration asset, nobody is holding for the carry and a trend begets itself. Or to put it another way, as yuan trading is liberalised, does the marginal holder likely want to diversify out of existing stock more than a foreign holder wants to get into? Comparables are perhaps the euro introduction, where despite a hugely profitable convergence carry on long bonds, even underwritten by the ECB discount window, it initially sold off. Perhaps more analogously, when South Africa empowered its blacks, the Afrikaans community thought the end was nigh (as some chinese entrepreneurs do now) and began liquidating everything and selling into offshore currencies. They misread the situation, however, and the sandtown community provided a bid to the Afrikaans. My friend's uncle bootstrapped a working mans savings into a billion by buying the real estate liquidation, putting in newly arriving AAA multinationals as tenants and riding the yield curve down from teens to single digits.

anonymous writes: 

In the face of 2008 downturn, the Chinese government created more money than was done by the ECB or the Fed. The shadow banking system carried on making new loans to reestablish the housing bubble. Based on that slice of data, the RMB should not be rising against other foreign currencies, but falling.

Yes, trade surpluses are supportive to a currency, but China's big trade surplus with the US is balanced by some trade deficits with sources of raw materials, and production machinery, so that their trade surplus overall is not as big as with the US. The foreign direct investment into China has been very high as has the Carry Trade where borrowing in low interest rate countries like Japan and buying higher rate Chinese Treasuries, was profitable and gained even more as the RMB rose. This looks to be reversing and is thus a negative for the RMB and is big at maybe a half trillion dollars of hot money.

The image is of the Chinese government suppressing the currency to keep its exports growing and doing so by buying US Treasuries, and that was also pushing the image higher. But Chinese people are buying gold for safety, indicating that they have seen government spending and do not have confidence in the RMB. I think a downward spike in RMB could be followed by more selling if Carry Trade unwind becomes big. But PPP and Trade surplus will limit the move eventually, IMO.

anonymous writes: 

I also agree, (Chinese financial reporting is awful) but the assertion that we can know many outside variables from the US$ of the equation is very important. (Current account surpluses and deficits bear many similarities to double-entry accounting, in that aggregate balances in one direction or another should balance each other out.)

I submit that the current state of Chinese property and credit markets bear many similarities to what Hyman Minsky termed a "deviation amplifying" mechanism in his Financial Instability Hypothesis.

However, if asked how it will play out, my tendency is to say that at some point over the next few years, they are at substantial risk for a debt deflation. Personally, I'd have a tough time convincing myself to be short a deflating currency.

Charles Pennington writes: 

OK, here's an "N=1" kind of study…

Back in mid/late 2011 the Swiss franc ("CHF") was strengthening violently against the Euro, with the Euro almost going down to parity with CHF. Then the Swiss stepped in to weaken the CHF and forced the Euro back up to 1.2 CHFs. The Euro sat there, pegged at 1.2, but everyone feared that the risk was that the Euro would fall below 1.2. Instead the Euro ended up moving higher against the CHF in mid-late 2012 and 2013. Very similar to Rocky's China story.

Since mid 2012, EWL (the Swiss market etf) is up about 55% and FEU (the EuroStoxx etf) is up about 40%. EWL is probably a bit less volatile than FEU (though I didn't check), so EWL's gain is yet more impressive.

So the N=1 conclusion is that you should buy Chinese stocks.

Jan

27

SP500 index daily return series 1950-present was checked for close-close declines of more than 2+%. For each 2+% drop day, counted trading days into the past until the prior 2+% drop (wait time between 2% drops). For each drop, also counted trading days into the future to the next 2+% drop.

The attached scatter plot shows each 2+% drop, according to wait from prior drop (X axis) and wait until subsequent drop (Y).

Alston Mabry writes: 

The thing about using an absolute value like -2% is that you have to also look at contemporaneous volatility. Here's a plot of the "days since last 2% drop" value for the S&P (since 1950), against the SD of the % changes for the previous 60 trading days:

And here's a closeup of the area nearer the x axis.

What's not surprising is that long waits occur when volatility is low, and short waits occur when it is high.

Jan

17

 Since you're talking about PEs, I will crosspost this bit:

Listening to Ed Hyman on Wealthtrack. Hyman says he thinks 2013 was like 1996 and that the next few years may turn out to be like the late 90s, as in: +20%, then +30%, +27%, +20% - he specified those percentages - which would mean for the S&P:

year close
2013: 1848
2014: 2218
2015: 2883
2016: 3661
2017: 4394

If you also plug in the earnings growth %'s from the 1998-2000, you get these stats for the S&P:

year: earnings, pe
2013: 107.45, 17.2
2014: 116.60, 19.0
2015: 117.08, 24.6
2016: 136.67, 26.8
2017: 148.44, 29.6

Considering Ed Hyman's comparison to 1996, one can't help but think, "yes, but"…back then we were looking ahead at the interweb and all its spinoffs, and investors thought tech companies would post astonishing future earnings, resulting in the fact that in early 2000, the top 20 firms in the QQQ had a combined PE ratio of 83. The future looked bright.

In the current world, what big factors could drive up the market PE to something like 30, as in the previous post? Two things come to mind in the macro sense:

1. "Developing" countries, especially India and SE Asia, really loosen up the regs and start to take off at an even steeper rate of ascent. Global GDP follows and grows at twice its "normal" rate.

2. A period of serious inflation.

What else?

Gary Rogan writes: 

Being able to map this year on some other years for the purposes of predicting the next few years sounds like wishful thinking. Multi-decade returns from this point on are likely to be subdued because this is somewhere between a "fairly valued" and relatively expensive market. This means little in the next few years, which are relatively "short term" for this purpose, and nobody really knows whether trend following or trend reversals will predominate. And since a number of surprises that will affect the treasury rates are in store, some of which will depend on the actions of a few men and one women, these short-term guesses are likely to remain nothing but guesses. 

Dec

11

 As of December 4, 2013, US banks had $2.493 trillion on deposit at the Fed. (Source: FRB H.4.1 Report). This amount includes required and excess reserves. The amount has increased by 63% over the past 12 months and approximately 300% since the Fed started paying interest on the balances. Bernanke started paying IOER during the financial crisis, but banks had wanted this for years. Some fraction of this reserve growth is due to QE and some fraction is due to the above-market rates that the Fed is paying. (This is the so-called IOER "Interest on excess reserves.") Right now, the Fed is paying about 0.25% on IOER and the t-bill rate is 0.02%. So the Fed is paying more than 0.23% above the market. On a balance of $2.5 trillion, this is a direct subsidy to FRB member banks of roughly $5.75 Billion per year and with each QE day, the amount grows.

This subsidy is theoretically being financed by the Fed's holdings of longer-dated securities so it's positive carry for the Fed. However, from the perspective of a risk-averse banker, and ignoring capital haircuts and the risks/spreads etc., a banker would need to buy treasury securities with a maturity of greater than 2 years to get the same yield as parking overnight money at the fed. So banks are behaving quite rationally.

The elephant in the room is the rate that the Fed pays on IOER. Talk is brewing that along with the announcement of a taper, the Fed will reduce the IOER rate. I submit that this is a highly unstable equilibrium and a change in IOER will have unintended (and unpredictable) consequences. Let's imagine that the Fed cuts IOER to zero. You will suddenly have $2.5 trillion looking for a new home. Where will it go? T-bills are already at 0 yield. So if banks just buy T-bills (even outside the fed) then that is a classic liquidity trap. Or, it's possible (but improbable ) that it will suddenly go into the real loan market. If that happens, the economy would go gangbusters with possibly little upward pressure on rates since $2.5 trillion in supply is a lot of money. Or, this gusher of ?dumb? money will listen carefully to the fed's forward guidance and collapse all rates towards zero out to the 2-year etc. I think this helps explains why Bill Gross is bullish on the front end of the curve because the curve is highly arbitraged between 2 years and 5 years. So it's possible that a taper announcement combined with a drop in IOER could turn out to be very bullish for the bond market. And this would persist until the Fed actually raises the funds rate.

Additionally, dropping the IOER might appease some critics about the size of the fed's balance sheet (ignoring the sheer quantity of bonds that remain). The IOER has been a subsidy to re-capitalize the banks. And now that this process is largely complete, the subsidy of $5.75 Billion/year should end and watching the gusher of $2.5 trillion leave the reserve account will be interesting, to say the least.

Bottom line: The IOER is a bigger deal than the taper announcement. The pundits will figure this out in due course.

Alston Mabry writes: 

"Remember that money we gave you, so you could give it back to us, and then we'd pay you for keeping it with us?"

"Yeah…."

"You can't have it back."

Bud Conrad writes: 

Rocky, Thanks.

The Fed has to buy up the new debt issuance from the government to keep rates low. It is also buying the MBS to keep mortgage rates low and to allow the banks to keep on their books holdings that might otherwise be declared toxic waste from being written off. So they can't stop QE purchases.

They have to fund the purchases some how. At present the Fed has been paying over market rate to keep the deposits of Excess Reserves to obtain the money to buy the Treasuries and MBS/Agencies. I don't see how the Fed balances its books if the banks withdraw $2.5 trillion. Then the Fed would look like a commercial bank that has a run from depositors and is quickly iliquid. The equity account is only $65 billion. The Fed is like a very leveraged hedge fund. If the depositors want to withdraw their money, the Fed would have to sell off assets or EXIT, which would cause panic in the markets.That seems even less likely. So Al is right: "You can't have your money" has to be the response.

So the Fed is trapped into continuing the payments on the deposits (IOER) as long as they have income from the Treasuries and MBS to pay for it. The idea that the Fed prints up currency is a little misleading because the actual physical demand for paper is decided by the public's conventions, and there is less use for the dollar bills with more transactions being done with credit cards. So as rates rise they will be raising the IOER rate, and at some point that gets so big that it uses all the asset income, and then the Fed has to go to the government for a bailout, which means the tax payer supports the banks getting their huge interest payments.

As an aside, does anyone know if the big banks can go to the Fed and add money to their deposits to earn the above market rate? Banks are supposedly free to with draw the accounts created out of thin air to pay for QE purchases, but can they add to those deposits? It would seem not because the amounts would rise even more dramatically.

Rocky Humbert replies: 

Bud: If your head is spinning, I suggest you sit down. If you look at the situation as I articulated it, then don't you agree with my analysis….? (This is a macro-economics conversation. No conspiracy theories allowed. ; ) Namely, the Fed could theoretically exist with only $1 of equity. Their equity is irrelevant because of their ability to print currency. And so long as the currency is accepted and relatively stable, everything works. For the Fed, currency is the same thing as a paper check. So if Citibank and the other big banks say "we want to withdraw $X trillion in excess reserves" the fed can hand them a check for $X trillion. And Citibank can take that check and spend it however they want. Whether the check has a picture of Ben Franklin or looks yellow or purple or is electronic is not material. It's credit creation… (This is when the S-Man chimes in.) I believe that before the Fed existed, this was how all banks operated — namely, there was essentially no difference between XYZ Bank's check/draft, their self-issued currency, etc etc.

Rudolf Hauser writes:

There is a bit of misunderstanding here. A reserve balance at the Fed is a bank's checking account at which it holds bankers money. That is the only money, other than currency, that another bank will accept in payment unless it is willing to keep a deposit in the bank that is in the negative position of the transaction. When a bank wants to reduce its balance at the Fed, it does so by buying other assets, such a T bills, or making loans. The seller or borrower now either deposits that money in their own bank or makes loans. This process continues if no other bank receiving deposits or proceeds of sales of assets to these spenders decides to hold excess deposits. Eventually enough ends up in checking accounts so that all the excess reserves reduced by the first bank have either become required reserves or held by other banks that have increased their excess reserve balances. The Fed does not have to sell any assets or pay out anything. The reserve balances just get moved around and converted from excess to required reserves. This of course increases M1 and M2 balances and is inflationary. If the Fed wants to avoid this it either has to make holding excess reserves more attractive by raising the rate it pays, selling assets it holds, borrowing cash via reverse repos or by converting excess reserves into required reserves by raising required reserves that have to be held against any checking or other accounts.

The risks are that eventually the banks might want to reduce excess reserves, resulting in a expansion in M1 and M2 that will be inflationary. Real growth is being held back by factors other than lack of liquidity. While faster M1 and M2 growth might push some demand forward in time resulting in some temporary faster real growth, the type of growth that would clearly have to lead to higher prices for either assets and/or goods and services. Alternatively, the Fed could take the measures noted above. It's ability to pay more on excess reserves is at some point limited by what the Fed earns on its assets and the amount of equity it has. But do not forget the first hit is on the U.S. Treasury which is currently getting large contributions from the Fed, which pays most of its profits to the Treasury. This is currently a large cushion. Selling assets will cause interest rates on those assets to rise, potentially considerably depending on how much the Fed sells among other factors. Even if the Fed does not try to upset the situation, rates might rise because of actual and expected inflation. This might create problems for some holders of long term debt and securities. The least destructive way might be to raise reserve requirements, but this might create problem to the extent that excess reserves are not evenly distributed among the banks. All these moves would be politically unpopular. This is why I am somewhat skeptical of the Fed to get us out of this situation. They could do it, but it will require a FOMC with a lot of wisdom, determination and courage to do so and a Congress that does not take away the Fed's nominal independence to pull off.

anonymous writes: 

Zerohedge quotes Bridgewater on the process of QE noting that not just the amount spent, but what it is buying dictates what the economic effects are. If the assets are more risky and less like cash, the effect is supposed to be more. Seems to me the creation of new money is the big cause of the effect. and then how that money is used is the other half of the equation. It's my view that the new money sits on the Fed balance sheet and impairs its inflationary effect. The reason it sits as excess reserves is that the Fed pays above market rate on the deposits. The $ 2.5 trillion times a reasonable interest rate in normal times of 4% would cost the Fed $100 B, and that is close to it current earnings for its assets of Treasuries and MBS Rising rates is not good for the Fed either.

Bridegwater and commentary:

In the past we have explained how QE continues to "fail upward" because instead of injecting credit that makes its way into the economy, what Bernanke is doing, is sequestering money-equivalent, high-quality collateral (not to mention market liquidity)- at last check the Fed owned 33% of all 10 Year equivalents - and by injecting reserves that end up on bank balance sheets, allows banks to chase risk higher in lieu of expanding loan creation. Alas it took a few thousands words, and tens of charts, to show this. Since we always enjoy simplification of complex concepts, we were happy to read the following 104-word blurb from Bridgewater's Co-CEO and Co-CIO Greg Jensen, on how QE should work… and why it doesn't.


The effectiveness of quantitative easing is a function of the dollars spent and what those people do with that money. If the dollars get spent on an asset that is very interchangeable with cash, then you don't get much of an impact. You don't get a multiplier from that.

If the dollar is spent on an asset that's risky and very different from cash, then that money goes into other assets and into the real economy. That's really how you see the impact of quantitative easing. What do they buy? Who do they buy it from? What do those people do with that money?

Of course, this is why sooner or later the Fed will proceed to "monetize" increasingly more risky, and more non-cash equivalents assets, until "this time becomes different." Which it never is, but the Fed will still try, and try and try.

Nov

25

 One thing I notice in unsophisticated investor-traders such as myself is that the positions one takes are usually supported by an unspoken prediction: "I will know when it is a good time to sell this and I will be able to do so."

Gary Rogan writes: 

The beauty of really long-term investing is that you don't have to have this unspoken prediction.

Victor Niederhoffer writes: 

And to add to Mr. Rogan's "beauty", you take full advantage of the most marvelous aspect of arithmetic, the power of compounding. And furthermore, you reduce to a minimum the vig from flexionic and top feeder activity.

Anatoly Veltman writes: 

Can't dispute all of the beauty. The problem is that only a narrow group is willing to commit: those who set aside slow money. Most suffer from the "hot money" bug: how to make money work its hardest. Willing for the money to die trying.

Gary Rogan writes: 

Very poetically put. It also illustrates the following point: in any kind of investing or trading the problems and solutions come in two flavors, namely those of competence and those of psychology. Even in long-term investing you still have to decide what to buy and when to buy it, so it's not immune from either category.

S. Humbert writes: 

Buy and Hold (for the medium term) is not, in my view, enough to earn a living from. Please let me explain before you fry my IP address.

In the past 30 odd years alone, even the unleveraged long only holder of US stocks has had many barren years (and multi year) periods when he lost or didn't make.

In my usual, inelegant fashion, what I am saying is that if you trade for a living — for yourself (i.e. at the sharp end of the game) then buy and hold alone doesn't cut it. (Unless you start in 1982 or 2009 or some other retrospectively chosen low). This does not dilute the effectiveness of the strategy, I'm just saying an individual's perspective and starting point dictate what weight one should give to the passive, low vigorish strategies.

Frankly, a low single digit return with a very poor Sharpe Ratio over the lady two decades LESS retail friction, well… I certainly couldn't have lived off that taking into account my extremely modest circumstances when I started my speculative business in 1990. Anyway — it's at all time highs now right!

Ralph Vince writes: 

Worse–you're still going to touch that money. You're going to take a morsel, or add a morsel, you can't sit there and forget about it.

Now you're on the curve.

Now, if you are 100% invested, you are completely doomed, and it isn't a matter of if.

Oct

2

 From the front page of The Arizona Republican, Phoenix, Arizona, May 19th, 1890:

WORK OF CONGRESS. Silver Legislation Has the Right of Way. Discussion of the Tariff to be Livelier. The River and Harbor Bill. Washington, May 18. - Silver will be the principal topic discussed in the senate again this week. The addresses in memorium of the late Representative Kelly, of Pennsylvania, will be delivered on Tuesday afternoon and Saturday will be devoted to the calendar. These are the only probably interruptions of the silver debate. The fist three days of the week in the House will witness the closing scenes of the tariff debate, which promises to become much more animated than heretofore. The river and harbor people are anxiously waiting for the first opportunity to call up their bill.

A TALK BY BISMARCK. Significant Remarks by the Old Soldier. Germany Will Never Attack France Unprovoked. The Empire Understands That The Czar Would Interfere In Behalf of France. PARIS, May 18. - Le Matin publishes an interview had with the French journalist, Des Soux, who was recently entertained by Bismarck. Bismarck referred to his resignation as a first class funeral, but added he was quite alive still. He declared, among other things, that Germany would never attack France or provoke France to attack her. Germany well understands that Russia would intervene to protect France, if attacked, just as Germany would aid Austria if Russia attacked her.

CUNNING SECRETAN. How the Frenchman bulled the Copper Market. Paris, May 18. - At the trial of the copper syndicate men it has been proved that Secretan, as director of the Societe des Metaux, distributed fictitious profits for 1887, and used improper means to bull copper, raising the price from 1000 francs per ton to over 2000 francs, and clearing within two months 10,000,000 francs. The defence is that the article of the penal code on the which the charge is based does not apply to this particular case. Hentsch, on being examined, admitted that while he was chairman of the Comptair Escompte he knew nothing of the dealings of that institution with the Societe des Metaux. He also testified that the board rarely listened to the manager's reports, simply letting things slide.

CHINAMAN BAPTIZED. He Sacrifices His Queue and Adopts the Christian Faith. Traver, Cal., May 18. - Yuen Lung, a Chinaman of more than ordinary intelligence, had his queue shaved off some time since, and to-day was baptized in the Christian faith by Rev. Mr. Hawkins. He has adopted the name of Charley Delzante. He conducts the dining room of the Delzante Hotel at this place.

WARLIKE ATTITUDE. The Czar Talks Business to the Porte. Constantinople, May 18. - The Porte has not yet replied to Russia's claim for the payment of the arrears of the war indemnity. The Russian Ambassador, in an urgent note to the Porte, demands the payment of arrears from the loan, otherwise, he adds, Russia will reserve the right to take further measures.

AN OCEAN RACE. Three Great Atlantic Steamers Struggling For Supremacy. London, May 18. - The Anchor Line steamer City of Rome sailed from Queenstown at 12:30 to-day. The Guion Line steamer Alaska sailed at 12:30 and the the Cunard steamer Aurania at 2 p.m. All went ahead on full steam directly after they cleared Queenstown harbor. There is heavy betting on the result of the race.

Sep

2

The dreaded September effect reminded me of "Sell in August and Go Away?" but certainly bears rechecking.

Ralph Vince writes: 

I think Dr Z's study focuses on 2000-2013.

Curious and needing to do some counting, however simple, I looked at SPY monthly moves 1993-present, and got these stats.

May

29

ES up overnight, as if many anticipating another up Tuesday…but then ES down Open-Close (ditto oil)…and for the real twist of the knife, T10yrs down almost a point, too…and not to mention gold trying to bullwhip the weak hands…ouch! 

May

2

 It is rumored that AAPL placed their 10-year paper at 10yrTbond+75bps, which means about a 2.4% rate, if I'm reading the screen correctly. Given that the yield on AAPL's equity is about2.9%, that's a nice positive-cash-flow way to conduct a buyback and still keep your overseas cash hoard protected from taxation. Not that it matters (or has any magical power), but for the equity to get to a2.4% yield, with a divvie payout of $12.20, it would need to hit about $508.

One wonders how many other firms are doing, or considering doing, this type of buyback financing.

Rocky Humbert writes: 

For the period January 2008 to June 2012, Apple stock rose at a compounded IRR of 40% for a price change of 331%. For the same period, the Nikkei declined at -1% …. for a price change of -12%.

For the period June 2012 to present, Apple stock declined at a compounded IRR of -27% for a price change of -25%. For the same period, the Nikkei rose at a compounded IRR of 34.5% for a price change of 26%.

Who in "their right mind" would argue that the Japanese aversion to iPADS does not fully account for this statistically significant negative correlation?

Furthermore, with respect to your comment about my trade in Apple stock (which I ka-chinged yesterday as it finally valued the arbitrage accretive value of the buyback with no regard for growth prospects about which I have no opinion): I would note that Warren Buffet argued cogently that Apple should use its cash pile to buy back stock when it's below intrinsic value and create wealth when Mr. Market is irrational. As Apple followers know, there was much speculation about Apple's cash deployment plans — and that the behemoth actually traded down on the morning following this announcement shows that it took some time for Mr. Market (as distinct from the HFT bots) to correctly assess the significance. If Hewlett-Packard had followed the same path, instead of literally throwing out billions on (what turned out to be) a fraud acquisition in England, I might still own that stock and it would likely be trading in the 40's today. Instead I sold it "horribly" at 27 on the news of the acquisition and incurred a loss and the ridicule of many on this site.

Apr

17

 There are some traders who make money based on news events. Please tell me how an analysis of the recent news could have been beneficial to traders who analyze news. The first reaction was a drop of 1 % in the last hour in S&P and a rise of a corresponding amount in gold. The reaction overnight was the opposite. Why was this news so bullish overnight? Is all news just an opportunity to do the opposite of the initial reaction? What do you think? Is there a systematic way to profit from news announcements? The 9-11 was not a temporary thing. Was that the clue?

Steve Ellison writes: 

I would hypothesize that any market reaction to a news event that triggers strong emotions should be faded because of the availability heuristic (people tend to give too much weight to dramatic but rare events).

I would also hypothesize that any market reaction to government statistics should be faded, since they have margins of error and are often significantly revised later. However, when I tested this proposition using the government report that routinely provokes strong market reactions, the monthly US unemployment report, it was not clear there was any edge to trading in the opposite direction of the S&P 500's move on the report day.

Jeff Watson writes: 

I generally don't fade USDA crop reports after they come out and grains are offered limit down. However, I've been known to buy wheat right at the top just before the report and have it go limit down on me. I hate that feeling as the noose tightens when the trapdoor opens. In fact that just happened to me on the last go-around.

Alston Mabry writes:

How do you test news events? First, you have to immediately and accurately evaluate what effect the event "should" have, ex ante. And then at some future point in time, compare the predicted to the actual effect the event "did" have, ex post. As there is no objective measure to use for the first step, you wind up simply testing whether or not you're any good at predicting the effects ex ante.

Steve Ellison writes: 

I tested using the following logic. If the absolute value of the change from Thursday's close to Friday's close on an unemployment reporting day was greater than the median of the absolute value of the daily change in the previous month, I assumed the market was reacting to the unemployment report and selected that day. For all the selected days, I backtested a one day trade entering at Friday's close and exiting at the next trading day's close, positioned in the opposite direction as Friday's net change. That is, if the net change on Friday was positive, the hypothetical trade was a short. The results were consistent with randomness.

Sushil Kedia writes: 

News is a rare commodity in today's world. We are inundated with broadcasts today. Any media missives that bring by a communication of fact and those amongst the fact-set that are beyond the expected may still have some market moving value. The durability of that fact or how out of line of anticipations it was may perhaps have some effect on how much and for how long the prevailing state of prices will be affected. Those broadcasts that provoke emotion are likely that are worth inspecting a fading trade. Whether news of war, crop-failures or any such genre' of information flows that produce an instant or moment of endocrinal rush.

The fine art of speculations rests on anticipations. Broadcasting media would never report what is coming to happen tomorrow, but only what may have (no guarantee that the broadcast is totally factual, since we have more "viewspapers" today than newspapers) already happened. Those who rely more on figuring out what they ought to anticipate on such resources are often the food for those who would rely on these broadcasts to figure out where the likely dead bodies will be buried. Price may not have all the information of what keeps happening every moment, but does have more information than any other resources of what is expected to happen.

Event Study Method may be a decent tool to evaluate the statistical behaviour of specific kind of events that occur repetitively with varying outcomes and of studying the repetitive actions of specific mouth-pieces than of studying erratic and randomly occurring news.

In a highly inter-connected markets' world and where the risk-free rate itself has a volatility the comforts of isolating non-random abnormal returns' evidence too is fraught with risks of playing on a frail advantage that keeps fluctuating in its expected value with ever-changing cycles if not fading away. Thus, it seems fair to me rather than an over-simplification that the most important factor for the next price is the price at this instant or any distant instant is the price at this moment and in the prior moments.

Rocky Humbert writes: 

I have one secret on this subject that I will share. Well, actually it was explained by Soros and Druck as the "Busted Thesis Rule." I think I've written about this previously on the Dailyspec.

If there is a news event that SHOULD BE unequivocal in it's meaning (i.e. bullish or bearish), and the market after a bit of time starts going in the opposite direction to the consensus meaning, then it's a wonderful opportunity to throw your beliefs out the window and go with the short-term direction. Many important big moves start this way. For example, XYZ is bullish news, yet the market after a little pop starts going down, down, down, …. don't fight it. Rather, "Sell Mortimer Sell!" P.S. I learned this lesson the hard way when Bell Atlantic made its ultimately ill-fated bid for TCOMA and Bell Atlantic's stock when straight up instead of what it "should" have done … which was go straight down. I won't describe the censure I received by my legendary boss at the time. Amusingly, neither of these companies still exist. Bell Atlantic became Nynex which became Verizon. And if memory serves me, TCOMA was bought by AT&T when they got into the cable tv business…

Gary Rogan writes: 

In a similar type of episode, when 3Com spun off 5% of Palm thus giving it a market valuation, and the resultant value of Palm significantly exceeded the value of 3Com that still owned 95% of Palm, this marked the end of the dotcom era.

Mar

12

One of the most valuable things I learned from the Chair is how not to do a study.

Let us summarize how to do a study. First define a pattern or event of some type. Then calculate the expected return subsequent to that event when the event happened. Then compare that return to the returns for all other non-event time periods. Do a t-test to establish significance at the 95% level.

That said the real problem is how can we insure ourselves against the possibility of biasing our study or otherwise completely messing up. the first thing that comes to mind is to never include data in your decision process that was not known at the time. For example Enron went bankrupt and then several years later after an audit the financial results were released showing that the original releases had been fraudulent. You cannot use the adjusted data based on the argument that it is the best data. Only the original data was known at the time so you must use that.

The same thing goes for price data. You have to use the prices that were known at the close if you are doing a buy at the close study. You cannot use retrospectively adjusted prices when the data is adjusted later than the supposed decision was made.

Always use tradeables. For example the S&P 500 index does not trade as an index. The S&P futures do and SPY does as well so one would use either of them as data for your study. The reason is that individual stocks can have stale quotes. Some of the smaller stocks in an index do not trade nearly as often as the larger caps. Thus the index can be behind the true position of the market. The tradeables trade and thus are subject to arbitrage that tends to keep them in line with the real market level.

This is a short list of things not to do. However it is representative of the fact that it is harder to learn what not to do than what to do. Other contributions would be welcome.

Victor Niederhoffer adds:

Always simulate what the chances were that your observed results were due to pure luck and take into account the path that your results would take and what that would have required of money management.

Consider the impact of retrospection on your results. The human mind is capable of ascertaining many regularities that occurred in the past, and is good at uncovering them in a study after the events occurred, but not very good at uncovering predictions based on new data that they are not already privy too. Never use range forecasts as they don't tell you whether you would have made or lost. Be aware of the difference between description and prediction, and statistical significance versus predictive distributions.

Never be overconfident. Do take account of the drift in your data, and the shape of the distributions you are drawing from. Mr. T, is not very good if only 2 or 3 observations removed from your sample would change the results.

To what extent are the regularities you believe you have uncovered been extant in the literature or the knowledge of shrewd fast moving traders. That changes things. What is the extent of regression bias in your results? 

Alston Mabry comments:

Something else, basically another riff on the Chair's comments: I find that statistics like means and correlations are, of course, useful, but they almost always hide important, idiosyncratic structure in the underlying data. In a sense, summary statistics are "intended" to do that, but I find it useful to unpack them and examine the structure in the data series, how the summary stats change over time, etc.

Anton Johnson writes: 

A couple of important things to consider.

Large changes in outcome resulting from small adjustments of a parameter is a sign of over-fitting and usually bodes badly for real-time results. Sometimes eliminating or finding a suitable replacement for the sensitive parameter will result in a more robust and usable model.

As a general rule, the number of parameters used in a study should be FAR fewer than the number of resulting trade signals.

Ken Drees adds:

Coach Bob Knight's new book The Power of Negative Thinking mentions "NO" being safer than yes. You can always more easily change a "no" into a "yes" versus the opposite–deciding to change your mind from positive to negative.

The gist of the book is to tamp down the uber positive thinking crowd–no, you can't do anything you want, no, you can't magically power your way to a fine end. PONT, Power of Negative Thinking is how Knight coached. He explains it that you must limit faults, limit mistakes–if we don't do these things then we have a chance to win. He keys on dealing with negatives to achieve a positive. He must have come across a lot of less disciplined approaches to coaching in order to come up with an against the grain type philosophy (PONT).

A lot of his points are probably already in the quiver of the sharpened spec. His hyper worried routines, careful study of the opponent, downplaying of good fortune and constant moving of yesterday's win into the rearview mirror broadens out into that persona you conjure when you think of him–that brooding face, those searching eyes–never smiling. The idea of "can't do it" was probably the most different from what we hear today–most are afraid to say "can't–that it means "I won't". Knight loves the honesty of a player saying I can't understand that assignment, or I can't push myself any farther. I would not recommend the book to cross over into speculation, but it's a quick read and there are more than some items to enjoy.

During it, I thought about player health in relation to speculating. I am my own coach. It's a luxury to have someone call your number and sit you down for a breather, to know you may need rest over more drill. How do I know that I am playing/ trading fatigued—only after a poor result? Knight seems to have the keen memory still in gear. There are some interesting stories about his games and Big 10 accomplishments.

Coach Knight will definitely tell you "No".  

Leo Jia writes: 

Very interesting, Ken. Thank you for sharing.

There seems to be some rationale in being positive. As I understand it, when one says "yes, I can do it" and envisions the actual doing, he actually plants a seed in his subconscious brain. The subconscious brain can be more powerful in many ways than the conscious. So planting a seed there is to use the additional powers of the brain, which are not accessible by the conscious mind normally, and thus increase one's chance of achieving a goal.

Feb

11

 While most of you don't play racketball, I believe the hobo's history of racketball on site was very educational for those with kids who wish to play it or anyone who plays any racket sport. The torque and the backswings on the backhand and the bends in the pictures are most enlightening. One notes that there have been 4 champions who ruled the racketball world for about 5 years each, winning almost every tournament. I noted the same thing in squash, and tennis isn't too far away in that area also.

One wonders if a similar phenomenon relates to markets. e.g. is there one stock that can outclass all the others in performance for a certain number of years, like Hogan, Swan, and Kane. Eventually those champions receded due to age, competition, or injury. Is there a predictable turning point?

Alston Mabry writes: 

Obviously, AAPL is the current version of this. And looking at AAPL, one sees an example of a company that stumbles as it fails to effectively deploy the very capital it accumulates due to its success. 

A commenter writes: 

This is the measure of how good a CEO Jobs was. He may have been a great innovator and manager, but he may not have been that strong of a CEO. A good CEO assures succession, and it isn't clear that Jobs was successful in this regard. The same was true of RCA and David Sarnoff, By comparison, Alfred P. Sloan accomplished this task for GM, Adolph Ochs for the NY Times, Hershey with Hershey Foods, and the Mars family with the Mars candy business. That hasn't been the case with Apple, at least not yet. Any guesses on how long the Board waits until Cook is replaced?

David Lillienfeld writes: 

There will always be outliers.

There are also companies at the other tail with managements performing more for "enjoyment" (like me athletically–I suck at racketball but I very much enjoy playing it and when I've had access to a court, done so for 3+ hours a week). Are there stocks in which management is in it for fun rather than shareholder value "enhancement"? Sure. It isn't hard to identify underperforming companies.

As for a predictable turning point, there should to be tells in each industry, but that doesn't address your question about one sentinel stock. I don't think there is a sentinel today the way GM was in the 1950s and 1960s. (Some might argue that Johns-Manville was a better sentinel. Either way, there was a single stock.) You've got a globalized market and no one company occupies a dominant position in a sentinel industry (such as autos in the 1950s and 1960s). Of course, implicit in this uninformed comment is that a connection exists between stock performance and corporate performance.

Or have I misunderstood your question?

Alston Mabry writes: 

Just to do a little bit of counting, here are the 48 non-financial US-based cos with cash of $5B or more, with LT investments added in. The amounts are in billions of dollars, and the list is sorted by the Total column.

total cash: 729.4
total LT inv: 337.7
cash + LTinv: 1067.1

Ticker/TotalCash/LTinv/Total

AAPL   39.8  97.3  137.1
MSFT   68.1  9.8  77.9
GOOG   48.1  1.5  49.6
CSCO   45.0  3.7  48.7

XOM   13.1  35.1  48.2
CVX   21.6  26.5  48.1

GM   31.9  14.4  46.3
WLP   20.6  22.1  42.7
PFE   23.0  13.4  36.4
ORCL   33.7  0.0  33.7
QCOM   13.3  15.1  28.4
KO   18.1  10.2  28.2
IBM   11.1  15.8  26.9
F   24.1  2.7  26.8
AMGN   24.1  0.0  24.1
MRK   18.1  5.6  23.7
INTC   18.2  4.4  22.6
HPQ   11.3  10.6  21.9
JNJ   19.8  0.0  19.8
BA   13.6  5.2  18.8
CMCSA   10.3  6.0  16.3
DELL   11.3  4.3  15.5
UNH   11.4  2.6  14.1
NWSA   7.8  5.2  13.0
EBAY   9.4  3.0  12.5
LLY   6.9  5.2  12.1
ABT   11.5  0.4  11.9
AMZN   11.4  0.0  11.4

GLW   6.1  5.2  11.3
EMC   6.2  5.1  11.3

HUM   9.3  1.0  10.3
FB   9.6  0.0  9.6
UPS   9.0  0.3  9.3
WMT   8.6  0.0  8.6
SLB   6.3  1.7  8.0
DVN   7.5  0.0  7.5
S   6.3  1.1  7.5
PEP   5.7  1.6  7.3

PG   7.0  0.0  7.0
UAL   6.7  0.0  6.7

HON   5.3  1.3  6.5
DISH   6.4  0.1  6.5
RIG   6.0  0.0  6.0
ACN   5.7  0.0  5.7

COST   5.6  0.0  5.6
NTAP   5.6  0.0  5.6

DE   5.0  0.2  5.2

Richard Owen adds: 

This is a brilliant list with many lessons.

- 80/20 rule: $2tr of surplus cash is bandied about as the figure for US corporations. Here are 50 covering over half of that sum.

- The 1% have an internal dissonance. Here is their accumulated share of National Product, all stored up and failed to be reinvested. The 1% neither wish to reinvest their cash, to reduce their share of Product, nor to have GDP decline, nor to run deficits. This is in aggregate impossible.

- By giving you will receive. By being cowardly, you will realise your fear. Tim Cook is hoarding his cash out of fear. Nobody has EVER put that kind of cash to work successfully. Not even Warren Buffett could do it on his best day. If Apple attempts to do so, they will end up hanging themselves. David Einhorn is so on the point with his analysis. And for once an activist is helping make management's jobs more secure, not less. They just need to listen. Take some options, recap the stock, make yourself heroes. Don't think you can use that cash to buy another magic wand. You will end up buying a pup. The most recent example of what might happen to Tim Cook if he doesn't see the light is the CEO of Man Group. They totally feared that AHL would stop working. They grasped at their cash looking for any credible diversification. They bought GLG at totally the wrong multiple. And then it all fell apart. All totally well intended, all well thought through. But if they had just recapped the stock - "coulda been heroes". Get out of your own way.

Steve Ellison writes: 

A couple of theories:

The crossover point from innovator to mature company occurs when revenue from continuing product lines becomes large enough that it dwarfs revenue that could realistically be expected from starting up a new product line in a new niche, was the theory in the innovation class I took in business school. Let's say that a company might develop a completely new line of business. If it were successful, it would be doing very well to get to $1 billion per year of sales of the new line within 5 years. If the company already had $20 billion per year in revenue, management would probably devote more attention to nurturing and further developing the cash cows that bring in the $20 billion than to a risky venture that might, if all goes well, add 5% to existing revenue. One might test this proposition by setting an arbitrary sales per year threshold and checking stock price movements of companies after they move past this level.

Adoption of new technologies follows an S curve pattern, driven by a small number of early adopters followed by more cautious but herdlike technology managers at large businesses, was the theory advanced by Geoffrey Moore in Crossing the Chasm. One might test this theory by looking for companies whose sales growth decelerated to less than 20% of the maximum growth rate of the past 5 years.

Jan

22

Not all right wing radicals are forecasting inflation. Many of us are of the other side of that coin. The conservatives are back to the old argument that money supply creates inflation.that argument was destroyed since the Big O took office. M1,2,3,4 increases did not produce inflation. Gee whillikers, what does that mean?

They should go back to the drawing boards, but instead beat the same old drums, preach the same old mantras.

Alston Mabry writes: 

In the present regime, the Fed is increasing the money supply only by the amount of interest they are paying the banks to park at the Fed the very money the Fed shovels at them.

Mr. Allen writes:

The mistake is to think the inflation must show up in rates like in the 1970s. in the 1940s, the last time we had a significantly managed economy rates averaged 2.5% but inflation average 5.5% for the decade. That can occur when there is anchoring or when people think the inflation is transitory in nature. Under a gold standard, which is what inflation targeting is - short rates were volatile but long rates flat as a board because there was no systemmic inflation. Also, you can get stagflation which are higher prices and lower output which is more of what we have experienced as taxes, insurance costs, etc. are up but unit output for many industries flat. Also, do not fail to realize how empty the bucket was in 2008 v. now, Continentals did not immediately loose their value but there were $350 mil of those which in today's dollars is $3.5 trillion, so the Fed may in fact just now be crosses the Rubicon.

A commenter writes:

And 30-100% increases y-o-y in health insurance premiums for independent contractors and other small biz types. why? because they can under the guise of obamacare. really putting the squeeze on some average joes I know.

Jan

14

 One concept common in turf handicapping is the speed rating. It's not so much whether the horse wins the race, but what its fastest time was for a given quarter or some such. One wonders what the ideal predictive speed ratings for markets are. If we come up with the answers, we may be able to contribute to the ecology of the system and possibly prevent our losses from being as great as the public.

Gary Rogan asks: 

At first glance, I'm wondering is the history of speed ratings for any markets likely to be as predictive of the future as it is at the track?

Russ Sears writes: 

When someone is starting training for distance running, it is important to understand the maximum heart rate. Then training is geared around this number. The pace you should run to achieve different objectives is a range of percentage of this number. For example a speed workout, you might want to hit 90-95% of this rate. For a recovery run, maybe 60%. As you learn the pace to achieve these objectives you can stop measuring your heart rate and then go off feel.

However, as you get fitter, it becomes more about the recovery time to a base rate. The time it takes for your heart to get close to pre-workout rate will get shorter as your fitness increases. Then as this get shorter, you can increase the pace or shorten the recovery time between faster intervals.

It would be interesting to carry this over to individual stocks with volatility analogous to heart rate. Shocks such as earning numbers analogous to workouts. I hypothesis "fit" companies are ready to take more risk and have higher expected earnings. Whereas those whose long vols are increasing may be more likely to fall apart if they take more risk.

Anatoly Veltman writes: 

I think that Chair is often faced with an exit problem. Statistics prompt justifiable entry– but then one is prone to take profit too quick, or not be sure what to do about a loser, which only looks statistically better and better the more it's losing.

Therein lies the huge difference between binary outcome in most sports/games, and the investment field. I recall one Palindrome saying: "it's not whether you've picked a loser or a winner; it's more important how much you have ON when you're having a real winner".

An avid observer of track and field legends since watching my first Mexico Olympics live on Soviet TV in 1968 (the black power pedestal protest contributed to airing of that broadcast!), I always attempted to grade medal performance against the world records. I can name dozens of great Olympians, who peaked out during certain Games (sometimes 4 years apart, and even 8 years apart!) — and never held a world record in their event; and vise versa…phenomenal record holders, who've failed to taste Olympic success. But most of them did achieve both — which, again, makes statistical sense.

Alston Mabry adds:

A core "speed rating" question is around the effect of news events such as earnings surprises. The nature of earnings surprises has changed over time, as companies have learned to manage earnings more precisely: "Rich Bernstein Explains Why Missing Earnings Estimates These Days Is Such A Disaster". And then there is an assumption that market efficiency means any true surprise will be reflected in the market within minutes. But is this true?

Dec

26

Where the interests of signaler and signal receiver diverge, there exist both incentives and opportunity for manipulation by sending misleading information. Deception is the major obstacle to information sharing. And the living world is rife with deception. From the lure that an anglerfish uses to attract prey, to the false alarm that a flycatcher raises to dissuade competitors, from bluegill sunfish males that sneak matings by masquerading as females, to the mimic octopus that can imitate a wide range of poisonous creatures and other underwater objects, from the false mating signals of carnivorous fireflies, to the shame regenerated claw of a fiddler crab, from the chemical mimicry that caterpillars use to invade the nest chamber of ants, to the bluffing threats of a molting stomatopod, organisms deceive one another in every imaginable way in order to attain every conceivable advantage ".

From Carl Bergstrom's Dealing with Deception in Biology

What is needed is a model and practical means for dealing with deception in markets.

Gary Rogan writes: 

Perhaps whats needed first is classifying the different classes of market deception. At the very least there are two very distinct classes: deliberate and evolved. "Deliberate" comes in many flavors, like "flexionic"/insider where some privileged few act on advance information as in the recent "fiscal cliff" related flash crash or "accounting fraud" when a company (or a government agency) puts out deliberately distorted information. It seems like various market patterns that evolve/appear for some internal and often not clearly understood reasons are often not related or only peripherally related to the deliberate types, but still act to draw in the unsuspecting/unduly exposed and provide an energy source to the markets as opposed to benefiting some specific perpetrators.

a commenter writes: 

Good idea, Mr. Rogan. Other categories might be subdivided:

1) company specific deception which affects only a company stock price (HLF)

2) macro-economic deception which affects entire indices (fiscal cliff).

So, in order to beat deception, it is critical for one to fully understand the mentality of the targets (oneself at times when one is the primary target) as well as that of the deceiver.

When we come to model deceptions in markets, modeling the mentality of the crowds is perhaps much less of a challenge than objectively modeling the subjective nature of one's own mentality.

Alston Mabry writes: 

The biggest deception is self-deception: We are much more likely to believe a lie that we *want* to be true. Make a promise, charge a fee. The bigger the promise, the bigger the fee.

Self-deception can apply powerfully to things like chart patterns, or tempting but shadowy cause-and-effect relationships that you can almost tease out of the data. The market displays a pattern. Then displays it a second time. The third time you put a little money on it and score. So the fourth time you go in large, but unfortunately….

Dec

10

 There is something idempotent with the Knicks performance against Chicago and the 75 page paper by Hou, Xue, and Zhang.

They both start out so hopefully, and end up to me with a wimper. They suffer from look back effects, regression biases, part whole biases, multicomparison problems, and most of all basing a prediction on past results which contain many random factors.

The regression biases are overwhelming. How do the Knicks expect to win relying on a man like Smith whose shooting percentage is south of 30%? Why he did well the previous game, when the three percentage was almost 50%. Don't they realize that when they score that kind of % in a previous game, luck was involved to a large effect, and it is random, or negative serially correlated because the other team tries harder to defend against the threes and the Gallinari types like Smith are over confident.

Similarly in the Zhang studies, don't they realize that of course their results will appear significant if they base it upon already published results showing effects for the periods included in their study. Don't they realize that within a month, all the results of companies with different balance sheet characteristics are highly correlated and clustered, and that by the time they sort by dozens of variables with split after split they are left with few independent observations—certainly not enough to make meaningful significance. The companies in their various sorts don't change much from month to month, so they are measuring the performance of a small number of companies similar in style for say six months in the future…the tests, are certainly not enough to make any sort of meaningful predictions.

There is something to be said for their independent finding of change in assets divided by assets as a measure of past success and similarly for returns on equity. As far as I can see, however, they use a retrospective compustat file rather than the as is file and that makes all their results meaningless as companies with seemingly high returns on equity like Rimm often go from the black to the red and they appear to eliminate such companies from their comparison. Debt is not considered and with a retrospective file like Compustat, the value stocks will look great until they are delisted and not covered because of problems.

The study should have been performed with a given universe of large stocks with prospective data and data covering only the future years for their anomalies that were not already shown to have significant effects in past studies. Watching the Knicks hapless performance so typical of the Antoni led team of the past and reviewing this heroic but flawed study by Hou, Xue, and Zhang leaves relatively contemporaneousy leaves one with a certain sense of displeasure if not revulsion.

Alston Mabry writes:

Are papers like these read and digested and used by finance professionals? Who are these guys? This quote makes me think they are taking their own work quite seriously:

"Our work has important implications for academic research in finance and accounting. The qfactor model can be used as a new workhorse model of expected returns. Any new anomaly variable should be benchmarked against the q-factor model to see if the variable provides any incremental information above and beyond investment and ROE. More important, the vast anomalies literature in empirical finance and capital markets research in accounting should be reevaluated with the new expected-return benchmark provided by the q-factor model. Much work remains to be done."

Nov

27

A post purporting to show that buy and hold investing does not work has appeared on our list. It is reprehensible propaganda and total mumbo. They do not take account of the distribution of returns to investing over long periods that have been enumerated by the Dimson group and Fisher and Lorie. It is sad to see this on our site. The arguments against buy and hold seem to be that the professors found that short term investing didn't work so they erroneously concluded that long term investing must be the alternative. Shiller is mentioned and cited with approval.

Alston Mabry writes: 

To explore this issue numerically, I took the monthly data for SPY (1993-present) and compared some simple fixed systems. In each system the investor is getting $1000 per month to invest. If during that month, the SPY falls a set % below the highest price set during a specific lookback period (the 3, 6, 12, 18, 24 or 36 months previous to the current month), then the investor buys SPY with all his current cash (fractional shares allowed). If the SPY does not hit the target buy point this month, then the $1000 is added to cash. Once the investor buys SPY shares, he holds them until the present.

For example, let's say the drop % is 10%, and the lookback period is 12 months. In May of year X, we look at the high for SPY from May, year X-1, thru April, year X, and find that it is 70. We're looking for a 10% drop, so our target price would be 63. If we hit it, then spend all available cash to buy SPY @ 63. Otherwise we add $1000 to cash.

Each combination of % drop and lookback period is a separate fixed system.

Over the time period studied, if the investor just socks away the cash and never buys a share (and earns no interest), he winds up with $239,000. On the other hand, if he never keeps cash but instead buys as much SPY each month as he can for $1000, then he winds up with over $446,000, which amount I use as the buy-and-hold benchmark.

If the investor uses the fixed system described, he winds up with some other amount. The table of results shows how each combination of % drop and lookback period compared to the benchmark $446,000, expressed as a decimal, e.g., 0.78 would that particular combination produced (0.78 * 446000 ) dollars.

Results in this table
.

The best system was { 57% drop, 18+ month lookback }, or just to wait from 1993 until March 2009 to buy in. Of course, it's hard to know that 57% ex ante. The next best system was { 7% drop, 3 month lookback } coming in at 0.99.

This study is just food for thought. It leaves out options for investing cash while not in the market. And it sticks with fixed %'s without exploring using standard deviation of realized volatility as a measure. So, there are other ways to play with it.

Charles Pennington comments: 

Thank you — that is a remarkable "nail-in-the-coffin" result.

Nothing beat buy-and-hold except for the ones with the freakish 57% threshold, and it won by a tiny margin, and it must have been dominated by a few rare events–57% declines–and therefore must have a lot of statistical uncertainty..

That's very surprising and very convincing.

(Now some wise-guy is going to ask what happens if you wait until the market is UP x% over the past N months rather than down!)

Kim Zussman writes: 

Here are the mean monthly returns of SPY (93-present) for all months, months after last month was down, and months after last month was up (compared to mean of zero):

 One-Sample T: ALL mo, aft DN mo, aft UP mo

Test of mu = 0 vs not = 0

Variable      N      Mean     StDev   SE Mean  95% CI            T
ALL mo     237  0.0073  0.0437  0.0028  ( 0.0017, 0.0129)  2.58
aft DN mo   90   0.0050  0.0515  0.0054  (-0.0057, 0.0158)  0.92
aft UP mo  146  0.0083  0.0380  0.0031  ( 0.0021, 0.0145)  2.65

 The means of all months and months after up months were significantly different from zero; months after down months were not.

Comparing months after down vs months after up, the difference is N.S.:

Two-sample T for aft DN mo vs aft UP mo

                  N    Mean   StDev  SE Mean
aft DN mo   90  0.0050  0.0515   0.0054   T=-0.53
aft UP mo  146  0.0084  0.0381   0.0032

Bill Rafter writes: 

A few years ago I published a short piece illustrating research on Buy & Hold. It contrasted a perfect knowledge B&H with a variation using less-than-perfect knowledge using more frequent turnover. Here's the method, which can easily be replicated:

Pick a period (say a year) and give yourself perfect look-ahead bias, akin to having the newspaper one year in the future. Identify those stocks (say 100) that perform best over that period, and simulate buying them. Over that year you cannot do better. That's your benchmark.

Then over that same period do the following: Buy those same 100 stocks, but sell them half-way thru the period. Replace them at the 6-month mark with the 100 stocks perfectly forecast over the next 12 months. Again sell them after holding them for just half the period. Thus the return from the stocks that you have owned and rotated are the result of less-than-perfect knowledge. Compare that return to the benchmark.

Do this every day to eliminate start-date bias, and then average all returns. The less-than-perfect knowledge results far exceeded the perfect-knowledge B&H. Actually they blew them away in every time frame. It's really obvious when you do this with monthly and quarterly periods as you have so many of them.

The funny thing about this is the barrage of hate mail that I received from dedicated B&H investment advisors, who somehow felt their future livelihoods were threatened.

If anyone wants that old article, send me a message off the list. We called it "Cassandra" after someone with perfect knowledge that was scorned.

Anton Johnson writes in: 

Here is a link to BR's excellent study "Cassandra", as it lives on in cyberspace.

Nov

4

 I have recently read several biographies of Caesar including Caesar by Colleen McCullough. I found this brief review on Wikipedia illuminating. While I am not very knowledgeable about military strategy or Roman History, I saw many examples of Caesar's genius that were applicable to trading. I thought it might be helpful to list 10 things that helped him rise to the top and win battles that extended Roman territory to the Rhine and English Channel, and conquered 3 million of enemies, killed or captured more than a million of them, and brought back vast wealth to Rome.

1. High Frequency Execution.

He used high frequency weapons. The soldier's weapons were much shorter and lighter than the enemies. His used the Javelin and a short sword called the Gladus. The enemies used two foot spears. The Romans got to wound the enemy much faster and were able to fight much longer and fresher because they carried lighter weapons.

2. The Roman Logistics.

Legionaires had much better logistics than their enemy. Caesar always paid greater attention to food and living arrangements than his enemy. His men were healthier and stronger for battle and were able to escape quicker when defeat was imminent. The importance of a proper foundation for trading is emphasized. Make sure you have proper equipment, capital, and infrastructure before you start trading.

3. Alliances.

He was a master of making alliances, no matter the virtues of his allies. He formed an alliance with Pompei when it was in his interest, married his daughter to him, established peace with hostile Germanic tribes to defeat the Helvetias and the Gauls.

4. Training in the trenches.

He fought as a common soldier from the age of 20. He lived with the soldiers, ate their food, and battled with them. He was captured by pirates and was able to talk his way out of capture with a ransom and then caught the pirate ship and executed them. He had down to earth habits in his food and living. A trader who wants to succeed can't rise to the top withouot trading himslef, and developing economical habits.

5. Engineering.

Caesar loved nothing more than a complicated engineering problem. When he coudn't pursue the Germans by land he built a bridge over the Rhine. He left enough space on the other side so that he couldn't be captured again. He was able to move his army over the Alps in two days to defeat Pompei in Spain. He was trained as a scientist before becoming a soldier and applied the disparate disciplines of engineering, medicine, and architecture to better prepare for battle. The best training for a trader comes from fields other than finance,— physics, ecology, biology, music.

6. Celerity.

He moved his Legionnaires faster than his enemies. They frequently marched 60 miles in a day. He made decisions quickly and brought his legionnaires into the fray quickly when it was time to rout the enemy.

7. Speculation.

Time and time again he gambled and took bold strokes. If you are going to be a speculator you have to speculate you can't grind like Pompei, a much more experienced commander, did.

8. Incentives.

The legionnaires and he were entitled to a % of captured lands, jewelry and slaves. Each hand had a share of the spoils and this made them fight harder. At the end of their stay in the legionnaires they were promised land for retirement and many remains of their homes and belongings show that they lived relatively as well then as retired military today.

Alston Mabry notes: 

Twenty or 25 miles a day would be a substantial march, especially carrying all the gear they had.

In broad terms, the key to Roman battlefield success was their tactic of fighting in very close formations, even with overlapping shields. Essentially, they had more "swords per yard" at the front of a unit. This was very effective against enemies who fought in loose mobs, like the Gauls.

As for Caesar, an interesting topic of study is the battle of Alesia.

Phil McDonnell writes:

When I attended high school in NJ I had the pleasure of reading some of Caesar's writings in Latin. In particular I was struck by how he opened his account of the Gallic Wars. the opening three sentences were:

Veni. Vidi. Vici.
They translate as: I came. I saw. I conquered.

In many ways it is the height of confidence, even arrogance. Undoubtedly his confidence was one of his greatest aspects but it also lead to his hubris. One imagines that he was truly shocked when they assassinated him in the Senate chambers.

Oct

1

 What are the common errors, the improprieties, the lack of attention to proper mores, the p's and q of trading that cause so much havoc and could be rectified with a proper formal approach? Here are a few that cost one fortunes over time.

1. Placing a limit order in and then leaving the screen and not canceling the limit when you wouldn't want it to be filled later or some news might come out and get you elected when the real prices is a fortune worse for you

2. Not getting up or being in front of screen at the time when you're supposed to trade.

3. Taking a phone call from an agitating personage, be it romantic or the service or whatever that gets you so discombobulated that you go on tilt.

4. Talking to people during the trading day when you need to watch the ticks to put your order in.

5. Not having in front of you what the market did on the corresponding day of the week or month or hour so that you're trading for a repeat of some hopeful exuberant event which never happens twice when you want it to happen.

6. Any thoughts or actual romance during the trading day. It will make you too enervated or too ready to pull the trigger depending on what the outcome was.

7. Leaving for lunch during the day or having a heavy lunch.

8. Kibbitsing from people in the office who have noticed something that should be brought to your attention.

9. Any procedures that violate the rules of the British Navy where only a 6 inch plank separated you from disaster like in our field.

10. Trying to get even when you have a loss by increasing your size and risk.

11. Not having adequate capital to meet any margin calls that mite occur during the day, thereby allowing your broker to close out your position at a stop while he takes the opposite side. What others do you come up with?

Jeff Watson writes: 

I don't know if it is an error or a character flaw, but freezing will create mayhem with your bottom line.

Alston Mabry comments:

"Do Individual Investors Learn from Their Mistakes?"

Steffen Meyer, Goethe University Frankfurt– Department of Finance Maximilian Koestner, Goethe University Frankfurt - Department of Finance Andreas Hackethal, Goethe University Frankfurt - Department of Finance

August 2, 2012

Abstract:

Based on recent empirical evidence which suggests that as investors gain experience, their investment performance improves, we hypothesize that the specific mechanism through which experience translates to better investment returns is closely related to learning from investment mistakes. To test our hypotheses, we use an administrative dataset which covers the trading history of 19,487 individual investors. Our results show that underdiversification and the disposition effect do not decline as investors gain experience. However, we find that experience correlates with less portfolio turnover, suggesting that investors learn from overconfidence. We conclude that compared to other investment mistakes, it is relatively easy for individuals to identify and avoid costs related to excessive trading activity. When correlating experience with portfolio returns, we find that as investors gain experience, their portfolio returns improve. A comparison of returns before and after accounting for transaction costs reveals that this effect is indeed related to learning from overconfidence.

Kim Zussman writes: 

Trading a market, vehicle, or timescale that is a poor fit for your personality, temperament, and utility, exacerbated by self-deceptive difficulties in determining this.

George Coyle writes: 

Speculation by definition requires some amount of loss otherwise the game is fixed. However, I believe loss can be broken down into avoidable loss and unavoidable loss. Unavoidable loss is, well, unavoidable. But in my personal experience (and based on pretty much all speculative loss I have seen or read about) all avoidable speculative loss is traced back to some core elements/violations: not being disciplined (many interpretations), getting emotional and all of the associated errors and mistakes that brings, sizing positions too big so that regardless of odds you eventually have to reach ruin, not being consistent in your approach (the switches), not managing your risk adequately either via position sizing or stop losses, finally you have to be patient for the right pitch whatever that may be for you. 

Jason Ruspini writes: 

A similar distraction comes from making public market calls.

Jim Sogi writes: 

The Sumo wrestlers' trainers in Japan are conscientious about avoiding mental strife in their fighters since it affects their performance. Sometimes when other life issues intrude, like getting up on the wrong side of the bed, it is better to refrain from entering a large position. You're off balance. How many times have I thought to myself, "I wished I had just stayed in bed this morning"?

William Weaver writes:

Mistakes I'm working on:

-execution error
-having too much size too early — the first entry is usually the worst
-not being able to add size when appropriate — need to add to winners; understanding when to retrade and why — why did the trade fail, was it me or the trade?
-not taking every trade
-need to adjust orders when stale
-not touching orders when not stale
-not getting excited about trades
-not holding until appropriate exits, especially winners — disposition
-not accepting the risk. Must accept the risk.

When we fear, we fail. But we cannot be courageous without risking overconfidence because it leads to recklessness (at least I cannot). So how to not fear and not be courageous at the same time? One of the best traders I know is indifferent to any trade, yet he is excited by his job. He also has (and shoots for) only 40% winners but simultaneously is profitable on a daily basis (and expects to be). These were contraditions to me 8 months ago, now they are just fuzzy in my mind and I understand them but cannot explain them.

Jun

12

I question if I am being too cynical if I assume that the government is simply another "player in the game"? Talking about it in abstract theoretical terms seem to leave out that dynamic. Politics is like the weather: It changes all the time; there's not much you can do about it; and the main thing is to make sure it doesn't kill you.

Easan Katir comments: 

Not an economist am I, but sometimes one thinks about the velocity and turnover of currency: each time a dollar changes hands it is taxed in some way, whittling it away to a stump of value.

 

Feb

13

 Aubrey learned a good lesson today. I took him to buy ticket scalped to the Knicks/Lakers game at 5 pm yesterday. Game starting at 7 pm.  Our first con man insisted on the street that tickets were 400 a piece but we should be very careful because there were disreputable people selling tickets. When I told him I only had 400 bucks, he introduced us to one of his colleagues who pointed to the pizza joint north east and told us to wait there and he would see what he could do. He then came back and told us, "I have to tell you and repeat that these tickets are for the third upper level. Is that okay?". I appreciated his honesty and turned over the 400. When I looked at at he tickets when Aubrey said "let's go to our seats" I noticed that they were for a Bucks game that had transpired 2 weeks prior. I went to look for him on the corner but he and his accomplice had disappeared. I felt it was a great lesson for Aubrey that I wish I had learned from my dad many years before as it would have saved me tens of big. I believe the lesson has enormous market implications and I will test a few things in its honor.

What I liked most about the con was the attempt to show their honesty by pretending to be super scrupulous in telling me that they weren't giving me the best tickets. I guess this is like the broker who tells you that most customers lose. Or the market that tells you that you're selling below the previous high et al.

T.K Marks writes: 

 Many years ago I fell for a similar switching con, one perpetrated by a deft band of street entrepreneurs.

It happened at the end of the day as I made my way to the E train entrance in the World Trade Center. Amidst the rush hour bustle were two guys with two cartons from which they were purportedly selling phone answering machines for 10 bucks apiece, a bargain price at the time. Being familiar with the wily ways of the City I would ordinarily be somewhat circumspect about these type of retail circumstances, but my fears were allayed by the fact that the things were in official looking boxes, each sealed in shrink-wrapped plastic. But the thing that really sold me on the deal was the weight of the box — It clearly wasn't empty and in fact appeared to weigh almost exactly what a phone answering would.

So I bought the thing and got on the subway.

Upon reaching my apartment I got a knife, cut through the plastic wrapping, and opened the box.

Inside, gingerly swathed in a cushion of some Chinese newspaper, was a brick.

It wasn't even a new brick, it was an old brick.

 Rather than get furious with the situation I just sat there and smiled wanly, admittedly impressed with the creative lengths the "retailers' how gone to to pull this routine off. They had picked the right place, the right time of day, somehow came up with the real boxes, and then topped it all off with the plastic shrink-wrapping gimmick so that none of the customers could inspect the goods right on the spot. Balanchine couldn't have choreographed this ballet any better.

After proper reflection though, I learned a little lesson though. Given that the store price for these things at the time was about $60, I should have realized that at10 bucks, those street guys were selling the stuff too low.

One should always be wary about buying anything offered beneath the bid.
 

Russ Sears writes: 

Scalping tickets is legal in Indiana (at least it was when I lived there) and therefore apparently much safer and honest transactions more likely to occur. Sellers often sell in front of the police to insure honesty and safety for both sides. Family guys will routinely offer to sell a ticket for you if you cannot make it to a big game at Purdue or IU. Not sure if this has changed in Indianapolis due to the Final Four and Super Bowl.

Alston Mabry writes:

I would say that asking you the question whether upper-level seats are okay is not so much to demonstrate honesty as it is to control your attention. I think a critical part of any con is to control the mark's attention and direct it away from the incriminating part of the trick. As I understand it, this is how good magicians work, too.

 

Jan

31

 Let's play a little game — it's called “Baron Rothschild” — who once said “I made my fortune by selling too early” (a comment also made by Bernard Baruch)… Suppose that the dealer lays cards down, one after another. Each is an annual market return. At any time, you can call out “Baron Rothschild” and go to a defensive position, or you can gamble and get the entire market return the dealer shows next. The gain cards read, say, 15%, 20%, 25% and 30%. If you're defensive, you lag the market by 10% when the market return is a gain, but you get, say, 5% if the market return is a loss. There is one -20% loss card. Once it appears, the game ends and everyone counts their dough, compounded. It turns out that if the loss comes anytime before the 5th card, you're almost always ensured to beat or tie the dealer by immediately blurting out “Baron Rothschild” even before the first card is shown. For example,

20%, 20%, 20%, 5% beats 30%, 30%, 30%, -20%
15%, 15%, 15%, 5% beats 25%, 25%, 25%, -20%
20%, 10%, 5%, 5% beats 30%, 20%, 15%, -20%
5%, 5%, 5%, 5% ties 15%, 15%, 15%, -20%

You can easily prove to yourself that even for a six-year market cycle, you still generally win even if you call out “Baron Rothschild” after year two. It just doesn't pay to risk the big loss. The point of this isn't that investors should always take a defensive stance — some market conditions are associated with very strong return/risk profiles that warrant substantial exposure to market fluctuations. The point is that the avoidance of significant losses is generally worth accepting even long periods of defensiveness. Because of the mathematics of compounding, large losses have a disproportionate effect on cumulative returns. Remember that historically, most bear markets have not averaged 20%, but approach 30% or more. A 30% loss takes an 80% gain and turns it into a 26% gain. It's difficult to recover from such losses, which is why the recent bull market has not even put the market ahead of Treasury bills since 2000 or even 1998. So again, the point is that the avoidance of significant losses is typically worthwhile even if, like Baron Rothschild, one is defensive "too soon." With regard to present stock market conditions, it would take a correction of only about 10% in the S&P 500 to put the market behind Treasury bills for the most recent 3-year period. That's not an empty statistic given rich valuations, unusual bullishness, overbought conditions, rising yield trends, and a market long overdue for such a correction. Given the average return/risk profile those conditions have historically produced, it makes sense to call out "Baron Rothschild" even if we allow for the possibility of a further advance, in this particular instance, before the market inevitably corrects.

1) Let's assume that one's goal is to beat some passive index (it doesn't have to be stocks; it could be the Yen or Natgas) over an X month period. And let's further assume that one is willing to engage in "selling early." And lastly, let's assume that "selling early" is sometimes the "right" thing to do due to the essay above. As a statistical matter, what is the likely minimum value for X … that permits the speculator to beat his passive index?

2) Let's assume that one's goal is to beat a passive index (again, it doesn't have to be stocks) over an X month period. And let's further assume that one is willing to exit the market "early," but also "buy early." Obviously, if one exits, re-entering is a necessary thing to do. As a statistical matter, what is the likely minimum value for X … such that the speculator can beat his passive index?

3) As a purely statistical matter, which should be better/worse : Buying early and selling early? Or, buying late and selling late ? And, again, what is the minimum X month performance period where either strategy has a chance to beat the passive benchmark.

William Weaver writes:

1. Disposition Effect

2. Great essay and the observation of defensive over aggressive is very good but I can't agree with purely taking profits unless there is a reason to exit. Assuming sufficient liquidity, in my humble opinion, it might not be bad to tighten stops (volatility historically has fallen as equities rise - though high levels in the late 1990's - so stops based on standard deviation should tighten anyway) allowing one to lock in profits but continue to profit from any trend that develops or continues. This seems to be a prominent trait of the most successful traders I've met; allowing profits to run by controlling for risk instead of picking a top.

3. The saying "There is nothing wrong with taking small profits" is a great way to lose everything if you don't also control for losses. In this essay there is only an early exit for profits.

4. His analysis of the equity premium to Treasuries is very insightful but I will leave that to the list for independent testing.

5. Every trader is different and must play to their own personality. For me, when trading intraday (which I am new to and still not the biggest fan of but am coming along) I will take off part of a position when anything changes, and this helps manage risk (leads to a larger percentage of profitable days). But will wait for long term momentum to reverse before exiting the last half as this is where the majority of my monthly profits come from. This way I can be a wuss and still profit.

6. Read The Disposition Effect if you have not and are interested in any type of trading/speculation. (To add to things to do to become a successful speculator: know, understand and be able to identify behavioral biases both in your own trading, and in the market).

Leo Jia writes:

I don't fully understand Rocky's 3 questions at the end. Guess they are meant for some real speculations, rather than for the Baron Rothschild Game, right?

If so, then I take Will's approach as described in his Point 2, except that I don't exit on instant stops, but on closing prices of certain intervals (30 minutes for instance for position trades) if the means of the intervals trigger my stops. My feelings about instant stops are that 1) they tend to have more execution errors (due to price chasing), and 2) either they get triggered more often or I have to set them wider (meaning more losses). I don't have concrete results about this and would love to hear other opinions.

I can't see how the game closely resembles trading. From what I understand about it, there seem to be many more winning cards than losing ones. So a strategy of simply selling on random cards gives one an easy edge to beat the dealer (though not necessarily achieving the best result). Am I missing something there?

Steve Ellison adds:

Turning to writings from 100 years ago, a friend found this book in his attic in Montana and gave it to me: Fourteen Methods of Operating in the Stock Market.

The first article in this book was A Specialist in Panics, which has been discussed on the List before. This method is to buy when there is a panic.

There was another article by H.M.P. Eckhardt, "Plan for Taking Advantage of the Primary Movements". He advised buying during steep market declines, as the Specialist in Panics did, but also suggested selling if a rapid rise brought profits equal to the interest the investor could have earned over three or four years. Mr. Eckhardt surmised that, with his money already having earned its keep for at least three years, the investor would probably get a chance to put it back to work in less than three years when another panic occurred.

For these sorts of techniques, Rocky's X is the length of a business cycle, which is unknowable in advance, but would normally be at least 48 months.
 

Alston Mabry writes:

Let's say you start at January, 2004 (arbitrarily chosen start date, but not cherry-picked, i.e., not compared to other possible start dates), and you go to January 2012. You have $100 a month to invest. You can buy the SPY and/or hold cash. You have a total of 97 months and thus, $9700 to invest. If you buy the SPY every month (using adjusted monthly close), you wind up with:

$11,451.37

But being a clever speculator and wanting to buy the dips, you come up with a plan: You will let your monthly cash accrue until SPY has a large drop as measured by the monthly adjclose-adjclose; each time the SPY has such a drop, you will put half your current cash into SPY at the monthly close. To decide how large the drop will be, you compute the standard deviation of the previous 12 monthly % changes, and then your buying trigger is a drop of a certain number of SDs. Your speculator friends like the plan, but disagree on the size of the drop, so each of you chooses a different number of SDs as a trigger: 0.5, 1, 1.5, 2, 2.5, 3, and the real doom-n-gloomer at 4.

The results, showing the size of the drop in SDs required to trigger a buy-in, the final value of the portfolio, and the average cash position during the entire period:

SD / final value / avg cash
0.5  $11,522.13    $543.03
1.0  $11,328.42    $737.77
1.5  $10,885.80  $1,351.02
2.0  $10,884.15  $2,083.36
2.5  $10,655.96  $2,711.34
3.0  $11,005.72  $3,704.12
4.0   $9,700.00  $4,900.00

You, of course, chose 0.5 SDs as your trigger and so come out with the biggest gain. But your friend who chose 3 SDs says that he *could* have used his larger cash position to invest in Treasuries and thus have beaten you. You say, "Coulda, woulda, shoulda."

Mr Gloom-n-Doom cheated and bought the TLT every month and wound up with $14,465.56.
 

Jan

30

 I am often asked what ten steps one should take to become a successful speculator.

I would start by reading the books of the 19th century speculators, 50 Years in Wall Street, The Reminiscences of a Stock Operator by Markman, and others.

Next I would read the papers of Alfred Cowles in the 1920s and try to compute similar statistics on runs and expectations for 5 or 10 markets.

Third I would get or write a program to pick out random dates from an array of prices, and see what regularities you find in it compared to picking out actual event or market based events.

Fourth, I would read Malkiel's book A Random Walk Down Wall Street and update his findings with the last 2 years of data.

Fifth, I would look at the work of Sam Eisenstadt of Value Line and see if you could replicate it in real life with updated results.

Sixth, I would start to keep daily prices, open, high, low, and close for 20 of so markets and individual stocks and go back a few years.

Seventh, I would go to a good business library and look at the old Investor Statistical Laboratory records of prices to see whether it gave you any insights.

Eighth, I would look for times when panic was in the air, and see if there were opportunities to bring out the canes on a systematic basis.

Ninth, I would apprentice myself to a good speculator and ask if I could be a helpful assistant without pay for a period.

Tenth, I would become adept at a field I knew and then try to apply some of the insights from that field into the market.

Eleventh, I would get a good book on Statistics like Snedecor or Anderson and be able to compute the usual measures of mean, variance, and regression in it.

Twelfth, I would read all the good financial papers on SSRN or Financial Analysts Journal to see what anomalies are still open.

Thirteenth, of course would be to read Bacon, Ben Green, and Atlas Shrugged.

I guess there are many other steps that should be taken that I have left out especially for the speculation in individual stocks. What additional steps would you recommend? Which of mine seem too narrow or specialized or wrong?

Rocky Humbert writes:

 All the activities mentioned are educational, however, notably missing is a precise definition of a "successful speculator." I think providing a clear, rigorous definition of both of these terms would be illuminating and a necessary first step — and the definition itself will reveal much truth.

Anatoly Veltman adds: 

I think with individual stocks: one would have to really understand the sector, the company's niche and be able to monitor inside activity for possible impropriety. Individual stocks can wipe out: Bear Stearns deflated from $60 to $2 in no time at all. In my opinion: there is no bullet-proof technical approach, applicable to an individual enterprise situation.

A widely-held index, currency cross or commodity is an entirely different arena. And where the instrument can freely move around the clock: there will be a lot of arbitrage opportunities arising out of the fact that a high percentage of participation is inefficient, limited in both the hours that they commit and the capital they commit between time-zone changes. Small inefficiencies can snowball into huge trends and turns; and given the leverage allowed in those markets - live or die financial opportunities are ever present. So technicals overpower fundamentals. So far so good.

Comes the tricky part: to adopt statistics to the fact of unprecedented centralized meddling and thievery around the very political tops. Some of the individual market decrees may be painfully random: after all, pols are just humans with their families, lovers, ills and foibles. No statistical precedent may duly incorporate such. Plus, I suspect most centralized economies of current decade may be guilty of dual-bookeeping. Those things may also blow up in more random fashion than many decades worth of statistics might dictate. Don't tell me that leveraged shorting and flexionic interventions existed even before the Great Depression. Today's globalization, money creation at a stroke of a keyboard key, abominable trends in income/education disparity and demographics, coupled with general new low in societal conscience and ethics - all combine to create a more volatile cocktail than historical market stats bear out. 2001 brought the first foreign act of war to the American soil in centuries. I know that chair and others were critical of any a money manager strategizing around such an event. But was it a fluke, or a clue: that a wrong trend in place for some time will invariably produce an unexpected event? Why can't an unprecedented event hit the world's financial domain? In the aftermath of DSK Sofitel set-up, some may begin imagining the coming bank headquarter bombing, banker shooting or other domestic terrorism. I for one envision a further off-beat scenario: that contrary to expectations, the current debt spiral will be stopped dead. Can you imagine next market moves without the printing press? Will you find statistical precedent of zooming from 2 trillion deficit to 14 trillion and suddenly stopping one day?

Craig Mee comments:

 Very generous post, thanks Victor…

I would add, in this day and age, learn tough typing and keyboard skills for execution and your way around a keyboard, so you don't wipe off a months profit in the heat of battle. I would also add, learn ways of speed reading and information absorption, though these two may be more "what to do before you start out". 

Gary Rogan writes: 

Anatoly, I don't think really understanding the sector and and the niche is all that useful unless one knows what's going on as well as the CEO of the company, which means that in general understanding quite a bit about the company isn't useful to anyone without access to enormous amount of information. It's the subtle, little, invisible things that often make all the difference. There are a lot of people who know a lot about pretty much any company, so to out-compete them based on knowledge is usually pretty hopeless. It is nevertheless sometimes possible to out-compete those with even better knowledge by sticking with longer horizons or by being a better processor of information, but it's rare.

That said, it has been shown repeatedly that some combination of buying stocks that are out of favor by some objective measure, possibly combined with some positive value-creation characteristics, such as return on invested capital, do result in market-beating return. Certainly, just about any equity can go to essentially zero, but that's what diversification is for.
 

Jeff Watson adds: 

 In the commodities markets it's essential to cultivate commercials who trade the same markets as you(especially in the grains.) One can glean much information from a commercial, information like who's buying. who's selling, who's bidding up the front month, who's spreading what, who's buying one commodity market and selling another, etc. When dealing with a commercial, be sure to not waste his time and have some valuable information to offer as a quid pro. Also, one necessary skill to develop is to determine how much of a particular commodity is for sale at any given time…. That skill takes a lot of experience to adequately gauge the market. Also, in addition to finding a good mentor, listen to your elders, the guys who have been successful speculators for decades, the guys who have seen and experienced it all. Avoid the clerks, brokers, backroom guys, analysts, touts, hoodoos etc. Learn to be cold blooded and be willing to take a hit, even if you think the market might turn around in the future. Learn to avoid hope, as hope will ultimately kill your bankroll. When engaged in speculation, find one on one games like sports, cards, chess, etc that pit you against another person. Play these games aggressively, and learn to find an edge. That edge might translate to the markets. Still, while being aggressive in the games, play a thinking man's game, play smart, and learn to play a strong defensive game……a respect for the defense will carry over to the way you approach the markets and defend your bankroll. Stay in good physical shape, get lots of exercise, eat well, avoid excesses.

Leo Jia comments:

Given that manipulation is still prevalent in some Asian markets, I would add that, for individual stocks in particular, one needs to  understand manipulators' tactics well and learn to survive and thrive under their toes.

Bruno Ombreux writes:

Just to support what Jeff said, you really have to define which market you are talking about. Because they are all different. On one hand you have stuff like S&P futures with robots trading by the nanosecond, in which algorithms and IT would be the main skill nowadays, I guess. On the other hand, you have more sedate markets with only a few big players. This article from zerohedge was really excellent. It describes the credit market, but some commodity markets are exactly the same. There the skill is more akin to high stake poker, figuring out each of your limited number of counterparts position, intentions and psychology.

Rocky Humbert adds:

I note that the Chair ignored my request to precisely define the term "successful speculator," perhaps because avoiding such rigorousness allows him to define success and speculation in a manner as to avoid acknowledging his own biases. I'd further suggest that his list of educational materials, although interesting and undoubtedly useful for all students of markets, seems biased towards an attempt to make people to be "like him."

If gold is up a gazillion percent over the past decade, and you're up 20%, are you a successful speculator?If the stock market is down 20% over a six month period, and you're down 2%, are you a successful speculator?If you have beaten the S&P by 20 basis points/year, ever year, for the past decade, without any meaningful drawdowns, are you a successful speculator?If you trade once every year or two, and every trade that you do makes some money, are you a successful speculator?

If you never trade, can you be a successful speculator?

If you dollar cost average, and are disciplined, are you a successful speculator?

If you compound at 50% per year for 10 years, and then lose everything in an afternoon, are you a successful speculator?

If you lose everything in an afternoon, and then learn from your mistake, and then compound at 50% for the next 10 years, are you a successful speculator?

If you compound at 6% per year for 10 years, and never have a meaningful drawdown, are you a successful speculator?

If the risk free rate is 6%, and you are making 12%, are you a more successful speculator then if the risk-free rate is 0% and you are making 6%?

If you think you are a successful speculator, can you really be a successful speculator?

If you think you are not a successful speculator, can you be a successful speculator?

Who are the most successful speculators of the past 100 years? Who are the least successful speculators of the past 100 years? 

An anonymous contributor adds:

 In conjunction with the chair's mention of valuable books and histories, I would append Fred Schwed's Where are the Customers' Yachts?.

While ostensibly written with a tongue-in-cheek hapless outsider view of 1920s and 1930s Wall Street, it has provided as many lessons and illustrations as anything by Henry Clews. In this case, I am reminded of the chapter in which Schwed wonders if such a thing as superior investment advice actually exists.

Pete Earle writes:

It is my opinion that the first thing that the would-be speculator should do, even before undertaking the courses of actions described by our Chair, is to open a small brokerage account and begin plunking around in small size, getting a feel for the market, the vagaries of execution quality, time delays, and the like. That may serve to either increase the appetite for such knowledge, or nip in the bud what could otherwise be a long and frustrating journey.

Kim Zussman adds: 

The obligatory Wikipedia* definition of speculation is investment with higher risk:

Speculating is the assumption of risk in anticipation of gain but recognizing a higher than average possibility of loss. The term speculation implies that a business or investment risk can be analyzed and measured, and its distinction from the term Investment is one of degree of risk. It differs from gambling, which is based on random outcomes.

There is nothing in the act of speculating or investing that suggests holding times have anything to do with the difference in the degree of risk separating speculation from investing

By this definition one must define risk and decide what comprises high and low risk — which may be simple in extreme cases but (as we have seen repeatedly) is not very straightforward in financial markets

*Chair is quoted in the link 

Alston Mabry writes in:

I'm successful when I achieve the goals I set for myself. And rather than a target in dollars or basis points or relative to any index or ex-post wish list, those goals may simply be to act with discipline in implementing a plan and then accepting the results, modifying the plan, etc.

Anatoly Veltman adds: 

And don't forget Ed Seykota: "Everyone gets out of the market what they want". I find that everyone gets out of life what they want.

Plenty a market participant is not in it to make money. Fantastic news for those who are!

Bruno Ombreux writes:

This will actually bring me back to the question of what is a successful speculator.

In my opinion success in life is defined in having enough to eat, a roof, friendships and a happy family (as an aside, after near-death experiences, people tend to report family first). You can forget stuff like being famous, leaving a legacy or being remembered in history books. If you are interested in these things, you have chosen the wrong business. Nobody remembers traders or businessmen after their death except close family and friends. People who make history are military and political leaders, great artists, writers…

So you are limited to food, roof, friends and family. Therefore my definition of a successful speculator is a speculator that has enough of these, so that he doesn't feel he needs to speculate. I repeat, "a successful speculator does not need to speculate."

Paolo Pezzutti adds:

I simply think that a successful speculator is one who makes money trading. Among soccer players Messi, Ibrahimovic are considered very successful. They consistently score. They experience short periods without scoring. Similarly, traders should have an equity line which consistently prints new highs with low volatility and a short time between new highs. Like soccer players and other athletes it is their mental characteristics the main edge rather than knowledge of statistics. One can learn how to speculate but without talent cannot play the champions league of traders and will print an equity line with high drawdowns struggling losing too much when wrong and winning too little when right. Before dedicating time to find a statistical edge in markets one should assess his own talent and train psychologically. In this regard I like Dr Steenbarger work. In sports as in trading you very soon know yourself: your strengths and weakness. There is no mercy. You are exposed and naked. This is the greatness and cruelty of markets and competition. This is the area where one should really focus in my opinion.

Steve Ellison writes:

To elaborate a bit on Commander Pezzutti's definition, I would consider a successful speculator one who has outperformed a relevant benchmark for annual returns over a period of five years or more. Ideally, the outperformance should be statistically significant, but market returns can be so noisy that it might take much of a career to attain statistical significance.

Jeff Rollert writes:

I propose a successful speculator dies wealthy, with many friends. Wealth is not measured just in liquid terms.

Should a statistical method be preferred, I suggest he is the last speculator, with capital, from all the speculators of his college class.

In both cases, I suggest the Chair and Senator are deemed successful, each in their own way.

Leo Jia adds:

If I may wager my 2 cents here.

I would define a successful speculator as someone who has achieved a record that is substantially above the average record of all speculators in percentage terms during an extended period of time. The success here means more of a caliber that one has acquired which is manifested by the long-term record. Similarly regarded are the martial artists. One is considered successful when he has demonstrated the ability to beat substantially more than half of the people who practice martial arts, regardless of their styles, during an extended period of time. It doesn't mean that he should have encountered no failures during that time - everyone has failures. So, even if that successful one was beaten to death at one fight, he is still regarded as a successful martial artist because his past achievements are well revered.

With this view, I will try to answer Rocky's questions to illustrate.
 

Julian Rowberry writes:

An important step is to get some money. Preferably someone else's. [LOL ]

Jan

22

 I am researching and reviewing my contact with hats over a not uneventful life. I am considering their value, their uses, their symbolic significance, the great people I know who have worn them, the hat corporation of America I bought as my first trade, the hat that Tom Wiswell always wore to prevent sunburn and cover up baldness, the hat that Shane wore that made him an icon, the hat that the accountant in Monte Walsh wore that Hat Hendersson just couldn't resist noting was just right for a pistol shot, the hat that I wear now to show my respect for those previous, the man I called Hats H.  because he always had a million different conflicts of interest while working for us. The importance of a hat outdoors in the West to shield from rain, sun, and the elements. Et al. What value do you see in hats these days? What anecdotes? They seem to have gone out of style because of the automobile. You don't need protection from the elements any more. Also they're hard to store. How do they relate to markets?

Alan Millhone writes:

Mr. Millhone

Dear Chair,

I remember well the hat Tom wore. The ball cap I wear has a board on it (see picture). The Market trader might wear such a hat to remind them to look ahead and make the right moves (trades).

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Sam Marx writes: 

On the subject of "Hats". I am reminded of the aversion that John F. Kennedy had to hats and the picture that has stayed in my mind, since 1961, is of his carrying and not wearing his hat at his inauguration. I believe it was his attitude that caused the downswing in hat wearing in the U.S.

Tim Hesselsweet writes: 

 Seems like a good example of ever-changing cycles. The hat has been making a comeback for the last several years. Kate Middleton has become a popular figure and she frequently wears hats. Upscale department stores like Saks now carry a large selection of hats as well.

Alston Mabry responds: 

Yes, but…mens hats are a different dynamic:

Look at this photo of mens hats at a Liberty Rally in Columbus Circle, 1918, and mens Hats at the Horse Races 1920s style, and 1950s Men with hats.

Scott Brooks writes: 

When I graduated high school, the guy who measured my head for my mortar board said, "Young man, I've been doing this for 35 years and you have the biggest head I've ever measured".

 As a result of my freakishly large cranium, hats rarely fit me. I wear one from time to time, but only out of necessity, and occasionally for functionality.

Necessity is when I need to keep my bald head from burning in the sun or freezing in the winter or dry in the rain. Never under estimate the insulating and protective qualities of hair.

Functionally is because I need a hat when I hunt to keep the sun out of my eyes when I'm scanning for game, peering through my scope to place the cross-hairs on the shoulder of my intended quarry, or placing the aiming pins of my bow in the middle of said quarries chest cavity.

I avoid hats otherwise as I can rarely get one big enough to fit. If I wear one too long, it gives me a headache. Therefore, when it comes to trading, if you see me placing a trade while wearing hat, fade my position as I'm likely making a losing trade because my mind is clouded by the hat that is squeezing my brain all to tightly.

Pete Earle writes: 

I wear a hat, and have for seven or eight years. When I began to wear one, I expected to be lightly razzed by friends; that not only didn't deter me, but never occurred. Instead I've received unexpected compliments, and over the last few years other have seen a higher frequency of hat wearers in Manhattan, Washington D.C., and even when I'm down in Auburn and Atlanta.

Christopher Tucker writes: 

The grandfather of my best friend from college was one of the kindest and most sensible men I have ever met. He was a traveling sales rep for the John B. Stetson company. The man always had the best (the absolute BEST) hats.

GAP Capital comments:

 Born and raised in Chicago, so "hats" remind me of only one person…Dorothy Tillman!!!

Anton Johnson writes: 

"By some accounts, Christopher Michael Langan is the smartest man in America……….he has a fifty-two-inch chest, twenty-two-inch biceps, a cranial circumference of twenty-five and a half inches–a colossal head, more than three standard deviations above the norm"

Esquire article on "The Smartest Man"

Alan Millhone sends another photo:

Here is Tommie Wiswell with his trademark hat tilted back.  Might also been used to keep
overhead light from his eyes while he focused on the many boards.

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Russ Herrold writes: 

 I am traveling, and so cannot conveniently post, but I placed orders this week for a new Stetson, a couple of Fedora designs, and some other … I forget …and have in my car, for the conference I am at this weekend, easily 5 or so, which I use both for their protection of my head from the cold, and also so I can 'do some branding' work in the community the conference represents (I also have other 'branding' in my clothing, and appearance), such that people I deal with, who don't know me by sight, can recognize me anyway.

Marion Dreyfus adds: 

I think I am fairly well known as a hat person, and have been since I wore unusual chapeaux /to synagogue and school when 12 or 13.

Aside from style and stating an individualistic aspect, I think a hat harks back to a gentler, more mindful age, perhaps 100 years ago. It also keeps the head, inside of which are all these excellent ideas and scenes for a better tomorrow and a niftier evening today, comfy-cozy. Hats also show, oddly enough, respect. Hatless men in the 1970s were declaring their freedom from the mindfulness of suit and hat, and perhaps we are the poorer for having abandoned hats.

They also keep milliners in funds, and milliners I went to grad school with in the early 90s were aghast at the drop in hat-wearing citizens, alleviated only by temporary crazes or fads that fade as swiftly as they arise.

As a biker, for me, even mild days produce a breeze when one is on that leather seat, and a hat prevents sunstroke and sun in one's eyes as well as too much wind over one's head.

In the Orthodox world, wearing a hat connotes one is married, so it may be foolish of me to wear hats, because i communicate a status I do not currently entertain. But i do like the fashion and focus statement being made by wearing a lid, many of which, actually, i create myself.

Finally, one can maintain a superior air of mystery in a hat, which is impossible to the same degree in a hatless state.

Alan Millhone adds:

What really amazes me on hats are the clods at football games I attend who don't remove their head cover when the National Anthem is played.

Ken Drees muses:

 The baseball cap trend: rappers wearing the caps askew, wearing caps with logos of designers and companies, wearing caps for status/advertising, caps as gang signal, wearing caps in restaurants/indoors, wearing hoodies in lieu of caps, caps as fashion, caps on backwards, caps with brim curved just so, it all has to do with being cool. Lebron James wears Yankee cap to Indians games–it's all about me, fool.

Gary Phillips writes: 

"Wearing a cap backwards is a baseball fan tradition that started with Yankee fans. It wasn't because they liked Yogi Berra, either. The Yankees and Red Sox have a century-old rivalry. A group of young guy Yankee fans, around 1980, took the train up to Boston to catch a couple of games. Boston fans are loud and boo other teams. The young Yankee fans were seated in front of loud Bostonians. The New Yorkers didn't want to start an altercation, but made statement. Those guys turned their Yankee caps around backwards to show the Bostons that they were Yanks fans and proud of it."

Anton Johnson writes: 

On baseball's rally cap superstition:

"A rally cap is a baseball cap worn while inside-out and backwards or in another unconventional manner by players or fans, in order to will a team into a come-from-behind rally late in the game. The rally cap is primarily a baseball superstition."

And hockey's Hat-trick.

Victor Niederhoffer writes:

It would be nice if this worked in the market. But then the adversary could always tell if you were weak or strong, especialy if signals could be reflected from the hat. I was surprised to see that in all the uses for hats I have collected, including flopping the rump of your horse, and fanning a fire, and collecting water from a stream or the rain, I did not see many variants of using it as a signal to get a cab or alert a Native American that a interloper was near, or to collect bets, or to conceal a salt shaker. This latter is particularly effective in the west because to ask a man to remove his hat is akin to a date with boot hill. 

Gary Phillips adds: 

 Surely not a hat, barely a cap, let us not forget the kippah or yarmulke. The Talmud says that the purpose of wearing a kippah is to remind us God is the Higher Authority over us. He alone is Lord of Lords and King of Kings. When we pray and worship with our heads covered, we are saying that we are in total and complete submission to the will of God Almighty now and forever.

I was recently in the hunt for 2 of the crocheted variety for my 2 and 4 year olds to wear to school. My elder son demanded that the kippah be white with a blue Magen David. The synagogue gift shop was unable to fill our order, so I turned to a higher authority - E-bay. As J. Peterman would say, it is 6" in diameter — one size fits all. Handmade in Israel with a *very small* fine stitch. The yarmulkes are from Israel and are made by people who have made Aliyah; low income and handicap people, generating income to make a living.

I grew up and observant Jew until I had my first taste of bacon and blondes, and I never looked back. However, I now find myself lighting the candles, saying the hamotzi, and making Kiddish on Friday nights… Nice.

Jim Sogi writes: 

 A hat is essential in Hawaii to keep off the sun, rain and wind, to keep glare out of your eyes, and at night on the mountain for warmth when it gets cold. There are different hats for different situations. A baseball cap is good all around since it keeps the sun off your face, stores easily, can be worn in a car and is cheap and stays on in a brisk wind. A good brim hat is good to keep the sun and rain off the back and shoulders as well. A nylon hat is light and can be washed. A waterproof rain hat is good for extended rain, and a light nylon brim is good for hot sun. A small brim bucket with a strap is worn in the water while surfing to keep intense sun at bay for hours in the water, and to stay on in the surf. A knit or fleece watch cap is good for boating at night or sleeping in the cold. A helmet is good for sports to protect the skull from boards, rocks, trees and impact. The Original Buff is an adaptable piece that can be worn as a hat, scarf, or facemask. A balaclava is good for winter conditions and can be used as a hat, or face mask in windy conditions. I must have 20 or more hats.

As with all equipment, each type of hat is specialized for specific conditions, and there is not one that is good for all conditions. As with markets, its good to have specialized systems and rules for the differing conditions or cycles and no one rule is good in all conditions but must be tailored to match the expected conditions.

Rudy Hauser writes:

I do not wear a hat indoors with the exception of trains and planes or if there is no good place to put the hat. If there is a draft from air conditioning it helps to keep me from getting a headache. But more important is that unless I just want to hold my hat in my hands there is no good place to put it. I prefer to read, not hold a hat. I once made the mistake of putting a Panama hat in the overhead rack in a plane. The motion of the plane bounced it around enough to ruin it. That gives me little choice but to wear it. If I have a hat without a brim, such as my winter hat, I can a do take it off aside from trains which are not that warm.

Bill Rafter adds: 

 Glare, particularly from lensed overhead lights or high-hat floodlights can cause headaches and eyestrain. That can easily be counteracted by wearing a baseball cap or other large-brimmed hat indoors. I have kept one at my desk for decades.

For years I noticed that whenever I saw a certain actor & director, he was always wearing a hat, even indoors. Then I saw him entering a food emporium at a ski area and he removed his hat. I immediately understood why he always wore one — his particular baldness aged him at least 10 years. So his vanity choice was either a wig or a hat, and he chose the hat.

Hats indoors also provide a level of anonymity for those who do not want to be recognized in an airplane or robbing a bank.

My first "real" hat was a Homburg, which was required for one of my college jobs: pallbearer.
 

Jan

14

The attached charts the ratio SPY/TLT 2002-present [The S&P ETF vs the US Treasury ETF]. The current ratio of about 1.06 is near the bottom of the post 08-09 crisis range, but still far from the bottom reached in March 2009.

Victor Niederhoffer writes: 

This illustrates the wisdom of the proverb "there is always a web between markets but the web is always changing". Conversely nothing exemplifies this proverb better than the shifting relation between fixed income and stocks.

Alston Mabry adds:

Just as an exploratory reminder to myself, attached is a chart showing the variations in 60-day correlations between two 1000-day series (of % changes) generated randomly but with an overall correlation of -0.3.  In other words the true correlation is -0.3 but we pretend we don't know that and measure the 60-day sampled correlation.

Ken Drees adds: 

Zussman's chart makes one think about potential energy–the buildup of potential change as one sector grows larger than the other.

Alston Mabry adds: 

And again, just to see what it looks like, here's the rolling 20-period correlation for the weekly % changes of Dr Z's SPY and TLT.

Finally, one last chart, combining the previous two ideas: the rolling 20-week correlation of SPY and TLT, graphed with the rolling 20-period correlation of two random series with the same overall correlation as SPY-TLT (-0.41).

Dec

22

 1. There is a critical point in the market, a critical decision that the market gods weigh on a scale like Zeus with his balance scale deciding whether Achilles or Hector will win, that determines the market fate, and it is key and should be the focus of all news stories and market considerations but never is.


2.
Never trust anyone but your family and best friend because everyone is disloyal in a pinch. Peleus was left for dead by his father in law after killing his brother in law to become ruler and this led to the Trojan war. Caesar trusted his best friends but they turned on him when an opportunity for power, money, and romance reared its ugly head.

3. Deception is key. The most successful Greek was the Deceiver Odysseus, and he tricked everyone he dealt with as the market tries to trick you with Odyssean power.

4. The goal is always to come home. Odysseus went home, as does the market. The only loyal ones were the wife and son and the best servant. The market retraces and comes home to break even an inordinate number of times.

5. Never mix romance with business or the market. The Trojan was was started by Paris intervening in romance and being swept off his feet by Aphrodite, and Achilles killed tens of thousands and prolonged the war by 10 years when Menelaus stole his mistress.

6. Don't try to walk with the Gods. Peleus married a half God and married her the last time the Gods and mortals mingled at a celebration and it caused him to be the most distressful of men. Trying to emulate Soros or the other greats is the seed of destruction.

7. Okay, give me the rest. And correct and tighten the above. I'm out of my depth but wanted to get the gist across.

Ken Drees comments:

 Like using a mirror against Medusa, one must plan against the adversary and sometimes use their expected attacks to beat them. Like shielding oneself from the siren song, one must be totally prepared, seek council before the journey (the trade) about what dangers are expected.

Also, it seems every entity in mythology had a weak spot. It's probably best to note these weaknesses in your thinking and in your emotions, not how can I beat the market, but how can the market beat me today?

Bill Rafter writes:

The greatest two rules:

(1) nothing to excess and (2) know yourself.

Pete Earle writes:

One lesson from mythology which resonates with me is the oracles/prophets/predictors almost always forecast correctly, but rarely in an obvious or immediately relevant way. The predictions made are usually realized, but not before taking extremely circuitous, and usually counterintuitive ways to reach fulfillment.

In my experience, predictions regarding the direction of equities or commodities inferred from option markets so often prove accurate…but only after traveling in the most wrong, most unanticipated ways.

Alston Mabry responds: 

 Pete, I think of that as "shaking the tree", i.e., we're gonna get there, but we're gonna shake out as many weak hands as we can along the way.

Peter Earle replies: 

Absolutely. Stop-running and the like as the "gods" way of seeing who's "worthy"; who can withstand the flood, the fire, the sturm und drang.

Jim Lackey writes: 

In 2008 I learned from Ryan Carlson– Sisyphus. There is a little useless book Wit and Wisdom from Wallstreet. So many of the quotes are the exact opposite from 3 pages ago… yet for a day they are seemingly sage advice. Worse for the long term. It's all good advice, yet in the mean time we must eat, and in the long term we all end up dust in the wind.

Traders lament when we miss profits. We are miserable when we lose. If we are not careful we are never happy. I have the habit of having to work myself up into a fury to win a race, pass a test or trade. My wife calls it "business mode" everyone else calls it being a jerk. Finally this year I have the ability to take a loss and this week miss a glorious rally and profit… yet at 4:20 PM its over. I am done pushing the boulder back up the hill for the day. I will return at 1:30am or by 7am, all but two business days a year. It can be torture if you do not like to trade, but if you love it…

Here is a quote from my kids music, "This is Our Science" by Astronautalis: "Our work is never done/ We are Sisyphus".

p.s I notice that if I don't like the rap beats I miss quite a bit of new poetry. I hear my teenagers say random lines and say what! That is amazing. Then I hear the song and say no wonder I never heard that line before. Damn drum machines.

Jack Tierney adds: 

Recently I've been reading up on complexity, system dynamics, and the unpredictable consequences that occur when tinkering with non-linear systems. The markets seems subject to all and, if I'm even remotely correct in interpreting the literature, there's only one certainty: expecting linear consequences (e.g, provide banks with more liquidity, bringing about an increase in business borrowing, resulting in a resurgent economy) is rarely, if ever, realized.

Instead, the unseen effects on unimagined factors, almost always derails the logic train. A source I've referred to on occasion is "Cassandra's legacy." Appropriately enough, the custodian of that site provides an interesting historical allegory, in the form of Goth Princess/Roman Empress, Galla Placidia, and her part in the demise of the Roman Empire. It's a very lengthy read and, unless history like this interests you, tough going. So, a few highlights:

"Managing any large structure is difficult and we tend to do it badly; a whole empire may be an especially difficult case. To do it well, we would need to use a method what I mentioned before: system dynamics; which is a way to describe systems and the relation of the various elements that compose them.

"…every time that the Romans fought the Barbarians, they could win or lose, but each battle made the Empire a little poorer and a little weaker. The empire was using resources that could not be replaced; non-renewable resources, as we would say today….the solution was not more troops but less troops. It was not more imperial bureaucracy but less imperial bureaucracy, not more taxes but less taxes.

"In the end, the solution was right there and it was simple: it was Middle Ages. Middle ages meant getting rid of the suffocating imperial bureaucracy; it meant transforming the expensive legions into local militias; have people paying taxes locally, in short transforming the centralized empire into a decentralized constellation of small states. Without the terrible expenses of the Imperial court and of the Imperial bureaucracy, these small states had a chance to rebuild their economy and start a new phase of prosperity, as indeed it happened during the Middle Ages.

"What Placidia could do as an Empress was, mainly, to enact laws….It seems that Placidia was acting according to her style; ease the unavoidable, don't fight it….Placidia forbade the coloni, the peasants bound to the land, to enlist in the army. That deprived the army of one of its sources of manpower and we may imagine that it greatly weakened it. Another law enacted by Placidia, allowed the great landowners to tax their subjects themselves. This deprived the Imperial Court of its main source of revenues."

Stefan Jovanovich comments:

As much as King George's scribbler Edmund Gibbon despised Christianity, he had the Middle Ages even more because its bureaucracies were the worst of all — local and mean and stupid.

Professor Bard should revise his history. What he wrote here — "Middle ages meant getting rid of the suffocating imperial bureaucracy; it meant transforming the expensive legions into local militias; have people paying taxes locally, in short transforming the centralized empire into a decentralized constellation of small states. Without the terrible expenses of the Imperial court and of the Imperial bureaucracy, these small states had a chance to rebuild their economy and start a new phase of prosperity, as indeed it happened during the Middle Ages." - is nonsense.

The Roman Empire's tax collections were always "local"; that is why Roman politicians were willing to pay such enormous bribes to be appointed provincial governors. The legions were also "local"; the Empire's expansion came from granting "foreigners" - i.e. the people we would today call Spaniards, French and Syrians - the privileges of citizenship, which meant they were also qualified to serve in the local legions. This was equally true under the Republic; "crossing the Rubicon" would not persist as a bad metaphor if Rome's soldiery had been centralized.

As for economics, whatever the "terrible expenses of the imperial court", they were nothing compared to the ravages of coin clipping. The solidus of the Eastern Empire maintained an unchanged weight and measure for 4+ centuries - a record that is likely never to be broken. (It exceeds the span of sound money for the British Empire and the United States of America put together.) After Princess Placida's day coinage, under the wonderful decentralization of the Middle Ages, effectively disappeared.

"Dearth of provisions, too, increased by degrees, and the scarcity of good money was so great, from its being counterfeited, that, sometimes out of ten or more shillings, hardly a dozen pence would be received. The king himself was reported to have ordered the weight of the penny, as established in King Henry's time, to be reduced, because, having exhausted the vast treasures of his predecessor, he was unable to provide for the expense of so many soldiers. All things, then, became venal in England; and churches and abbeys were no longer secretly, but even publicly exposed to sale." - William of Malmsbury wrote this in 1140 AD - the period that Professor Bard praises so highly for its progress over the degeneracies of the Empire.

Hume deserves the last word on this and most other subjects that interested him.

"Mankind are so much the same, in all times and places, that history informs us of nothing new or strange in this particular. Its chief use is only to discover the constant and universal principles of human nature."

Easan Katir adds: 

The Greeks have fooled people since the Bronze Age. Instead of a horse, they now have Trojan bonds.

Steve Ellison comments: 

Jack, the Atlantic had an article about why projects that had successful pilots often failed when rolled out to the general population.

Why Pilot Projects Fail– Here are some excerpts:

Promising pilot projects often don't scale … Rolling something out across an existing system is substantially different from even a well run test, and often, it simply doesn't translate.
Sometimes the 'success' of the earlier project was simply a result of random chance …

Sometimes the success was due to what you might call a 'hidden parameter', something that researchers don't realize is affecting their test. Remember the New Coke debacle? …

Sometimes the success was due to the high quality, fully committed staff. …

Sometimes the program becomes unmanageable as it gets larger. You can think about all sorts of technical issues, where architectures that work for a few nodes completely break down when too many connections or users are added. …

Sometimes the results are survivor bias. This is an especially big problem with studying health care, and the poor. Health care, because compliance rates are quite low (by one estimate I heard, something like 3/4 of the blood pressure medication prescribed is not being taken 9 months in) and the poor, because their lives are chaotic and they tend to move around a lot … In the end, you've got a study of unusually compliant and stable people (who may be different in all sorts of ways) and oops! that's not what the general population looks like.

Dec

16

 This paper from the New York Fed blaming the real estate crisis partially on the flippers (speculators) is actually a rather sensible paper that makes some obvious and more subtle points. Most interesting is they quantify the extent of speculative purchase activity during the bubble years in some creative ways.

They note:

1. Housing is both a consumption good and an investment/store-of-wealth. During the bubble years, the latter trumped the former and attracted speculative/investment interest. i.e. irrational exuberance.


2.
Investment/Speculative buyer motivation can be based on (1) rental income; (2) buy and hold for long periods; (3) buy & flip. #3 grew to be a major factor near the zenith.

3. They demonstrate that 1/3 of ALL home purchases were 2nd buyers during the bubble years, AND, in the worst states (NV, AZ, FL etc), more than half of the purchasers were second home buyers and/or flippers and/or multiple lien holders.

They are quantifying what we already knew — that the seemingly endless demand for homes was coming from investment/speculative buyers. However, unlike during the internet bubble, these speculators walked away (as many had no-money-down) and they handed the keys to the banks…

It would be analagous to having a leveraged trading account with no initial margin….!

Stefan Jovanovich comments: 

And, no recourse. If the speculators were clever/dishonest enough to state on the disclosure forms that they were buying the properties as principal residences, here in California and Arizona and the other non-recourse states, their liability was limited to their option payment - er, their down payment (which could be as little as 3%). Here is the list of the non-recourse states:

Alaska (AK)
Arizona (AZ)
California (CA)
Connecticut (CT)
Idaho (ID)
Minnesota (MN)
North Carolina (NC)
North Dakota (ND)
Oregon (OR)
Texas (TX)
Utah (UT)
Washington State (WA)

The rumor is that the AGs have reached a settlement.

The settlement of $25B is not going to make much of a dent in the outstanding mortgage deficiencies that are recourse. Core Logic says that 10.7 million houses (22.1% of all residential properties with a mortgage) were in negative equity at the end of the third quarter of 2011 and an additional 2.4 million properties (5% of all mortgaged residences) had less than 5 percent equity. The negative-equity and near-negative equity mortgages accounted for 27.1 percent of all residential properties with a mortgage nationwide. But there is good news - Core Logic says the 27.1% is down .4% from the total in the 2nd quarter.

Also, the Federal Reserve's calculation of "owner equity as percentage of household real estate" was 38.6% as of Q3 this year; in 2005 it peaked at 60%. Approximately 1 out of 3 homes in the U.S. has no mortgage. I may need Big Al's help (as I did when calculating the current market price of the U.S. Treasury's gold reserve) but my handy calculator suggests that this leaves 40% of homes that are "conventional" - i.e. neither free and clear nor so leveraged that they have negative and near-negative equity. The bad news is that, after you subtract 33% from 38.6%, that means the average cushion for the conventionally-mortgaged homes is 5.6%/40% - 14%. Didn't someone say something about this being a solvency problem and not a liquidity problem?

Final random thinking:

According to the folks at Calculated Risk, there are now 4.1 million seriously delinquent loans (90 day and in-foreclosure). In a "normal" market there a 1 million seriously delinquent home loans. Recently, there was "good news" (sic) about the decline in the numbers of REO properties held by Fannie (in Q3 their REO inventory fell to 122,616 houses, a decline of 10% from the number at the end of Q2). That made it the 4th straight quarter in which Fannie's REO inventory declined. One small problem: this is the same period during which foreclosures ground to a halt because of the litigation over mortgage servicing (robosigning, etc.). While it is likely that some of the seriously delinquent loans will cure as part of the settlement (see below), many more will go into foreclosure; and Fannie's inventories will rise. 

Alston Mabry writes:

In Phoenix the RE bubble started in the valley and then moved up into the mountain towns 2-3 hours away, where people have summer homes to escape the heat. It was like a tide of money that rose up the mountainside. In August/September 2006, I was driving around and listening to NPR, when a report came on about the local RE market.

A woman who was a broker in the mountain towns said that business was absolutely booming…oh, except that last week there was nothing…strangest thing…but we're sure it will pick up again next week, after the kids are settled in school, etc etc.

An image popped into my mind: A flipper had an open house, but the only people who showed up were other flippers, and by that time they all knew each other. They looked at each other and said, "Holy sh*t…", and got in their cars and left, wondering how quickly they could unload their properties. It was over. And the tide rolled back down the mountain.

Dec

2

 To what extent can the concept of epidemics be useful in considering the performance of individual stocks? The key variables being the number of infected, the chances that a person with a disease will have contact with the next, and the chances that once a contact occurs that the disease will be transmitted with its consequences, and the time to incubate once contact is made, and finally the chances of becoming immune once contacted. The comparable things would be a product that good or bad in the case of that notorious company that's caused such damage, the chance the good product will be noted and passed on by a customer, the chance that the product will be bought by the next customer, et al.

Alston Mabry writes:

Here is a nice brief explanation of epidemic waves.

Gary Rogan writes:

To be thought of as an epidemic, the company should have a ground-breaking new product and, preferably but not at all necessarily, itself be relatively new. It helps if the product appeals to young people, it also helps if there is a social aspect to the product, either in the form of communications, fashion, status. The vast majority of such companies are either in the technology or fashion business, with most of the rest in some sort of end-consumer business. Most companies don't seem to fit any of these descriptions. They grow or fail by finessing their business or strategy without any type of sudden dramatic growth.

Russ Sears writes:

It would appear to me that any attempt to consider how infections spread within the financial world should start with the investor, and their attempt to pick the strongest, shun and avoid the infected, and attempts to acquire herd immunity by grouping with those who appear to have a natural immunity. Any "epidemic" to an individual stock, sector of stocks, or even market often seems to be a meme caught by the investor, creating the sickness of fear, and damaging the stock.

Dec

2

 Good afternoon everyone,

Would anyone be able to suggest any alternatives to the US dollar that I would be able to put my money into? What currencies or commodities would be worth using to reduce the risk of dollar? I must admit I know very little about this particular subject. I'm not necessarily looking at this as an investment in which I'm trying to get rich, I'm just looking for something that will hold its value better than the US Dollar. As I put money aside for various things in life, I would hope there is something I could have that would be worth the same ten years from now as it would today. Any insights or suggested reading material would be appreciated.

Thanks!

Corban

Tyler McClellan comments: 

If you want to buy things in dollars in the future then you'll want to hold dollars.

Gary Rogan counters: 

That's like saying, "if you want to put gasoline in your car in the future you need to own gasoline today". Given the 90%++ loss of purchasing power of dollars in the last 100 years there just could be better alternatives than holding them today. If the point is that nobody knows what they are with any degree of certainty, that's a valid point. 

Anton Johnson writes: 

Inflation protected (at least to the extent of official figures) US series I savings bonds seem to be a decent savings vehicle, especially when they are accumulated over time. Unfortunately, there are minimum ownership periods and the maximum annual purchase is limited to 10K per person.

Craig Mee advises: 

Beware of selling the low, Corban, effectively adding size in a market that's been trending south for some time.

If Euro goes to the dump, and USD goes bid a la 2008-09, then that may be a nice way to offload USD then and say buy Aussie at 60c to the USD. (We do have stuff in the ground that helps, although with interest rates cuts just coming through, it appears some goodwill that was present at the start of the year is being priced out of the market against the USD).

Good luck. Oh…beware of the Fed, or in this case FEDS, to up end things at any time…. though if history only always repeats to the letter, it would make investing a wee bit more straight forward…

Alston Mabry writes: 

With a decent time horizon, you could put some money into corporate bonds and good divvy-paying stocks. That way you get the divs and also exposure to cap gains. just happen to be researching some recently, so here is a diversified group of sample tickers:

IVHIX
PIGLX
PAUIX
NLY
MAPIX
IDT
TEF
HPT
CQP
MSB
VIV
CINF
RDS.A
PM
KMB
SYY
JNJ
ABT
INTC
PSB
PEP
COP

Leo Jia adds: 

Corban,

This is an age of vast changes. For that reason, we can easily lose our vision into the future in terms of what will be more valuable. Even though there are many discussions around the topic, I can't decide easily if the US dollar will be more valueless than any other currencies in the future. Many argue that it will lose more value, but I tend to think that it perhaps will be more valuable than most other sound currencies, for the very simple reason that the US has a more fundamentally solid mechanism of being a most promising country. The very fact that the people with big money are not running away from the US demonstrates it.

There is the notion (as Gary Rogan pointed out) that the dollar has lost 90% of its purchasing power over the last 100 years. While I agree that there has been a devaluation process going on, I don't think the notion should really be understood literally. Many things around any purchase (including venue, environment, safety, transportation, etc) have vastly changed from 100 years ago. All these add legitimate values to the product and hence cost for the purchaser. One can argue that the egg he buys today is not that different from that his grandfather bought 100 years ago. Yes, sure, but things in a social economy can not be taken separately. Many things in it are vastly different from 100 years ago: farmers' lives, air-condition for the chickens, refrigeration along the transportation, etc.

As to what can hold value better for the future, I would like to have agricultural commodities (hope to hear other arguments). I buy into the view that because people in China and India (accounting for nearly 40% of the world population) are getting richer, they will be demanding more higher-scale food like meat which then will demand more amount of lower-scale produces like corn or wheat (I have been actually experiencing the above view personally for the last 10 years in China). Sadly, the production of these lower-scale produces can not be increased easily, so these prices must go up. In the long term, the pressure for the price rise due to the imbalance of demand and supply will be added to the legitimate price rise (as I seasoned in the last paragraph), resulting in much higher prices in dollar's term. One note to add is that the inherent volatilities associated with these commodities along the way should be carefully considered.

Additionally if I may add as an option to where to put your money, it should be into your life, your personal and business interests, and perhaps some interests of any community you are in. My feeling is that this might be more important than anything else.

Laurel Kenner writes: 

 There are no safe havens any more. People have been remarkably complacent about the obvious rigging and zombization of financial markets, the transfer of power to lawbreaking elite firms, the restrictions on capital movement out of the country, the baldfaced lies about the nonexistence of inflation, the steady fiscal confiscation of personal assets, The fact that we still can have a meal at pleasure and joke about our plight means nothing in terms of economic freedom. Unfortunately, the one point that holds true is that the foundation of individual liberty is economic liberty. We have merely slipped back into the iron pattern of historical kleptocracies. Maybe that is why there has been so little effective resistance. Those who protest are marginalized by the mainstream propaganda machines. Case in point: Did the Fed just bail out Europe without anyone blinking an eye, and what does that mean for the global future?The only advice that I have found to make sense at all lately is "Be flexible." We are playing against a relentless statist enemy. Some Specs recommend Australian and Canadian currencies. That's merely a play on commodities. I need not remind anyone here that in the past century, the U.S. government made it illegal to own gold, and that a few upward ratchets on certain margin requirements would kill the commodities market. I don't speak from lack of experience. We are all traders; we all like the freedom that brings; and our livelihoods are in jeopardy.

Good luck to us all. The world has changed, and continues to speed with reckless blindness toward a future that I doubt will turn out well.

Alston Mabry writes:

Here is a question that might elicit some interesting answer:

Let's say you have $X (USD) that you must commit for the next five years. Where would you put it? Leave it in dollars? (Though a 5-year Treasury would make the most sense for "cash" with a 5-year lockup.) Gold? Stocks? Some other currency? Norway bonds? And why?

I don't have a good answer to that yet.

Steve Ellison writes:

My starting point on this question would be that diversification, including international diversification, reduces risk. The US economy and the Eurozone have roughly equal GDPs. Japan and the UK are smaller but still quite significant. China is tied to the US dollar. Therefore, a diversified cash portfolio might be 40% US dollars, 40% euros, and 5% each of yen, pounds, Swiss francs, and gold (in recognition of gold's historical role as a form of currency). One could fine tune this allocation to include small percentages of currencies such as the real and Canadian dollar. I would think of this allocation as the equivalent of an index fund, before considering the insights of the many on this list that know more about currencies than I do.

 

Nov

29

 Here's a shocker:

Take the Confidence Board Consumer Confidence raw number from May, 2010, through November 2011, and calculate monthly % changes; then regress against that series the previous month's % change (close-close) in the S&P…and you get the previous month's change in S&P being an excellent predictor of the CC change!

multiple R: +0.69

R squared: +0.48

…and just to be humorously over-precise:

CC%chng(month[1]) = -0.00498 + 1.8*S&P%chng(month[0])

Jeff Rollert writes: 

I cannot recall when that strong a relationship didn't hold, so much so I stopped doing the calculations.

One of my current stat problems is finding data sets that do not have some strong feedback dynamics, where a strong data point is reflected in market prices and becomes non-predictive. The expansion of SAP, ORCL and other large data set manipulation/analytic engines seems to be one of the culprits.
 

Oct

2

Unless I am mistaken, the "twist" is not duration neutral; whereas
real bond investors tend to be duration sensitive. That is, selling $1
billion at the short end and buying $1 billion past the 10 year is
roughly equivalent to putting 7x the amount of real investor money into
the market. This is a point that has not been widely discussed — and
may explain why the bearish effects at the short end will be dwarfed by
the bullish effects at the long end.

Alston Mabry replies:

If 'duration' is the sensitivity of price to a change in 100 basis points of yield, and the Fed sells 2's and buys long bonds in equal amounts, and the Fed is effectively increasing their portfolio duration, does it follow necessarily that the Fed is putting around 7x more money into the bond market?

Doesn't it matter how the rest of the market participants decide to adjust to what the Fed is doing? What if long rates go up? I'm not saying they will, just wondering. Once QE2 was announced, the 5-year rate went up and stayed up until the end of QE2 was in sight. Now the Fed was actually printing money with QE2, and so the rise in the 5-year rate was coincident with a huge run-up in the stock and commodities markets. But it wasn't unreasonable to predict that QE2, aimed at 5-6 year maturity, would push the 5 year yield down.

Paolo Pezzutti writes:

For those who want to try and find quantitative relationships between Fed intervention and market moves…this operation schedule may be useful.

Bud Conrad writes: 

I still wonder how they sell off the short end and maintain ZIRP. Something will have to give, and I expect it to be the selling of short term. 

Sep

25

 I'm skeptical of the eurobond idea because I don't think it addresses what to me is the underlying problem. The problem is not, for instance, "Greek debt". Rather, the issue is who owns the Greek debt, i.e., the banks. The problem is not whether the Greek government (or the Portugese or the Irish) is insolvent and should default — of course they are and should — but rather what the knock-on effects will be.

The Germans should put up a big chunk of money, and get others (France) to contribute what they can, and then do a Bernanke and announce a schedule by which they will purchase over time €X of PIIGS bonds from the eurobanks. They could drain the problem paper from the financial system, with some haircut for the bondholders, after which they could restructure that debt as they pleased, meanwhile putting some downward pressure on rates, but also allowing the market to continue to discipline profligate governments.

Germany gained the most from the €Mark, in one sense, so they are now in a position of paying off the problems created. I think the ECB sees US-style QE as poison, and that's why the ECB is not allowed to be the buyer of bad bonds (even though they have been, in fact, doing it under the radar to keep the banks from folding). So, put the money into the EFSF, buy the bonds back directly in the marketplace, and then restructure them as needed, while redesigning the "system". Moral hazard, for sure, because some players will think it's okay to lend to the PIIGS again because the bad bonds will be bought back -hence the need for some kind of haircut, enough of one to send the message that, "whenever we have to buy bonds back, the bondholders will take some kind of hit, so don't count of this as anything but a money-losing strategy". You've cleaned out the bulk of the Greek (or Portuguese, etc) balance sheet, and then they are left to the bond markets and must adjust their fiscal reality. And lenders know to be skeptical, but the eurobanks are on better footing. Then the Greeks get to decide whether they want to become more like the Germans, or whether they want to go "back to the drak".

Sep

12

 I read this interesting article lately that posed the question:

Is it possible that student loans are to some extent simply replacing unemployment insurance as a source of subsistence income? If so, we may be creating another asset bubble of sorts, with consequences much more dire to the debtors than anything we have seen before. Thanks to the “bankruptcy reforms” of 2005, those student loans cannot be “cleared” by bankruptcy, no matter how hopeless the situation. We may have simply created a new version of a Dickensian “debtors’ prison” that may ultimately imprison an entire generation of young borrowers."

source

The answer is yes. 

(Department of Education) The U.S. Department of Education today released the official FY 2009 national student loan cohort default rate, which has risen to 8.8 percent, up from 7.0 percent in FY 2008. The cohort default rates increased for all sectors: from 6.0 percent to 7.2 percent for public institutions, from 4.0 percent to 4.6 percent for private institutions, and from 11.6 percent to 15 percent at for-profit schools.

And keep in mind student loans are still expanding in this crisis. While every other sector of debt is contracting this is the only area growing. What is worse is that the earnings for recent college graduates doesn’t reflect the higher costs of college:

Since 2000, in real terms college costs are now up by 23% Since 2000, in real terms real pay for college graduates is down by 11%

The reason when we look back and see greater earnings for those who go to college is the reality that many never came out with so much debt. Decades of data are being used and applied to the current rip off and high cost model that has never been seen in the past. Plus, you had a tightly regulated market and for-profits were nearly unheard of.

Alston Mabry writes:

Also, as I understand it, the default rates, especially for for-profits, are understated, because the DOE only looks at default rates within a certain period after the student leaves the school (two years, I believe). And so the schools have programs to keep people out of default until they fall out of the counting period, after which they are on their own.

Jordan Neuman adds: 

It is like anything else, whether you want to call it a "bubble" or "ever-changing cycles." In the late-90s the argument for stocks was that they had never had a down 15-year period. By definition, then, no price was too high for stocks if held for the long-term. Of course taking the yield down to 1% was never part of stocks' history. The same goes for housing in the last decade. Housing prices only go up over time!

The reasons that college educated workers have done better historically is that the college degree served as a screening mechanism when fewer went to college. Now that everybody goes the screening is worth less to employers. But colleges are charging, and are abetted by Government policies, for the old promise. Just like health care and housing, government policies have distorted the pricing mechanism enough to wreck the whole system.
 

Aug

29

And since the Fed has guaranteed free money through mid-2013, all gold has to do is about 50% a year between now and then to hit the $4000 mark much bandied about by a certain hedge fund manager famous for making a killing off of whomever Goldy could get to take the long side of the synthetic CDO trade.

Aug

23

 It's my experience that if you need to sell a portion, even if that portion is 100%, via a stop order, you're in too heavy to begin with. Being in too heavy is to be too dependent on luck.

Dylan Distasio writes: 

Ralph,

Can you expand on your definition of "need"? Let's use the case of HPQ as an example. x had an investment hypothesis that no longer necessarily holds true after the potential value destruction of recent company decisions. As a result, he decides to liquidate half. Maybe someone else gets in a few weeks ago after the discussion on HP here, as they agree it looks like a value play, but they have a rule to always attempt to minimize losses on new positions to a flat 10% to protect capital and to always use stops because they need them for discipline. So they get a ~20% haircut after getting stopped out on the gap down.

I'm not sure either situation of a 50 or 100% liquidation was based on what I would call need, but rather some kind of capital preservation or very basic risk management rules.

In all serious, how would you define need as I think it is worth looking into this further? Potential loss of all capital? Forced margin liquidation? I agree that being in with too much leverage or too large a position opens you up to getting taken out by noise, but what is need versus risk management?

Chris Cooper writes: 

I took a big loss on Monday of the week before last. I then cut my trade size in half, and manage to end up flat at the end of the week. The week actually would have been very profitable had I been willing to stay with my original sizing. But Ralph is correct, and I decided that if I am getting scared by a big daily loss, I'm trading too heavy, so I have left the trade size at that halfway point.

On the other hand, one might choose a rule that pares back the trade size when volatility increases. These were intraday forex trades, and clearly that week was exceptional in terms of volatility. The problem is that the volatility spikes that kill me do not appear to be predictable. Therefore I have to trade most of the time at a level that seems relatively placid in order to avoid being frightened into damaging behavior occasionally.

Gary Rogan writes:

I think this illustrates the point I was trying to make originally about the lack of logical underpinnings in the "sell half" decision: it's an emotional decision because you (a) get scared by the suddenness and violence of the move an its effect on your net worth (b) belatedly realized that you were in too much. Now the second part is sort-of logical, but it really points to the lack of imagination about what a position can do when you get into it: you imagine a slow gradual move and the thing suddenly loses a big chunk of its value without much warning. This is not theoretical for me, because for the first time ever I have faced the following: two days after buying a stock it suddenly loses 25% of it's value in a day. This happened TWICE in a row on top of that, and only underscored to me that you never know enough to say with confidence that you will not lose all, and quickly. Therefore you should assume that that's the case from the very beginning. 

Ralph Vince replies:

Dylan,

I'm really referring to liquidity concerns; Rocky's decision to liquidate half, I assume, is a risk-management procedure here, as opposed to a strategic one based on changed fundamentals (I may be, and, in retrospect, likely am wrong about this!).

Any risk-management concern where someone "needs" to get out, shy of that investment being entirely wiped out, will, in time, be entirely wiped out, or damn near whether by an Enron, or those gilt-edged AAA GM bonds at one time.

Dylan Distasio responds: 

Gary,

Although I don't typically trade that way, I don't think the sell half is necessarily an illogical or emotional decision depending on the scenario. We have no way of knowing what the reason behind selling half is for a given individual. Reducing a losing position size is, in my mind, a way to mitigate risk of additional loss while still having some skin in the game. Keeping some powder dry is (I would imagine as an amateur) one of the more important survival skills in this game. The person selling half doesn't have to be in too deep to their overall capital pool to want to protect half of what remains of that position based on changing circumstances. Losses do add up over time.

Alston Mabry writes: 

I have found that trading breaks down into (1) analysis, and (2) execution. With "analysis" being a period of calm, quiet reflection (maybe with a cold beer) over a crowded spreadsheet; and "execution" being whatever I have to do to manage my lizard brain once there is real money at stake. They can be such radically different modes of being that sometimes it's very difficult to establish a link.

If I make "analysis" and "execution" the axes of a graph, I can place each of my trades on the graph in the appropriate quadrant: {analysis(good), execution(good)} = exhilaration, {analysis(good), execution(bad)} = regret, {analysis(bad), execution(good)} = relief, {analysis(bad), execution(bad)} = self-loathing.

The challenge of trading is that there is only one quadrant you *want* to be in.

Chris Cooper adds: 

Rocky wrote:

"I challenge anyone to demonstrate a single person who blew up while sticking to the rule: "Only add to a winning position.""

I can't meet your challenge, but I did have a week where I lost 50% of my equity. Your observation does not apply to those trading with leverage. I am now learning to scale back the leverage, make adjustments in trade size more frequently than weekly (should be real-time), and to write models which account for higher correlations during times of stress.
 

Jul

28

I always enjoy finding interesting resonances from the past…

Here is Peter Bernstein, writing in the 1960s, in A Primer on Money, Banking and Gold, pp 165-7:

We know that interest rates reflect the interaction of the demand for and supply of money. With business activity rising so slowly, the need for cash to finance expanding production during the 1930s was obviously also growing at a slow rate. With ever-rising amounts of money in the checking accounts of individuals and corporations, those who held these idle dollars pressed to find some employment for them. Long-term yields on corporate bonds had been above 4 percent when Roosevelt took office in 1933; by 1938 they had fallen to little more than 3 percent and at Pearl Harbor were down to only 2 3/4 percent. At the same time, yields on short-term paper, which had run well above 4 percent before the crash of 1929, fell to nearly zero.

Yet, while the pattern of interest rates conformed to the theoretical proposition that yields will go down when the supply of money exceeds the demand for it, the most striking feature of this period from our viewpoint was really the degree to which the banks and their depositors were willing to hold dollars idle. Despite the avalanche of reserves that the gold rush brought to the banks, the banks were willing to lend and invest only a small part and were content to let cash resources in the billions sit idle, earning nothing. Even though the money supply rose about one-third faster than the output of goods and services from 1933 to 1941, the decline in interest rates was persistent rather than precipitous. Finally, it was clear that the sheer pressure of funds was by no means a sufficient condition to drive business activity upward to its full potential - nobody's money seemed to be burning a hole in his pocket.

Monetary policy as a means of stimulating business activity fell into wide disrepute as a result of this combination of circumstances. Some people saw little point in efforts to increase the the supply of money if no one wanted to spend those additional dollars on goods and services. What was the point of giving banks the resources to buy bonds that people wanted to sell of the sellers just sat on the proceeds instead of spending them? Others argued that the banks were clearly unwilling to buy long-term bonds at low interest rates; therefore, no means existed to push interest rates down far enough to encourage businessmen to take the risks of borrowing and investing money in new factories to create new jobs.

Indeed, as a result of both a general sense of insecurity and of a basic reluctance to part with cash for such a small reward in interest, the fetish for liquidity during the 1930's was extraordinarily powerful — the simple creation of money (or receipt of money from abroad in the form of gold) was no guarantee that it would be spent. Some observers compared the stimulus of monetary policy with the effectiveness of pushing on a string. As a result, increasing interest and attention was focused on Government spending in excess of tax revenues - deficit financing, as it came to be called — in which the Government would borrow the idle dollars no one else wanted to use and spend them for things the community needed.

Jul

15

 I never look at the news, but I usually can tell what the news is from the market moves, and I would guess at 7 pm, S&P issued their catch up warning on rating change, and yes, I would guess that those selling at 3:55 pm bringing the market to 1301.5 knew that the S&P would join. But they were temporarily discommed by the Google announcement but then baled out by the 7 pm announcement, and then people thought that the first announcement by Moodies did not make the market open down, so maybe like the last announcement that dropped the market to 1301 this one will not have a staying influence, and then the problem is that the options expiration is tomorrow and the "market makers" usually have positions bearish when the market has been going down and 1300 is a target. How to play it? What evil lies in the hearts of men. Only the Shadow knows.

Ken Drees writes: 

Skulduggery indeed. That darn Google is messing up my arrangements. Tessio, the underboss who brokered the meeting with Barzini.

Alston Mabry writes:

This sounds like revolution to me. Bond vigilantes riding through the night, striking fear into the hearts of the king's men.

Kim Zussman adds:

"why Moody's or S&P or Fitch or anyone else's rating on US Government debt should have had, or continue to have, any obvious and/or immediate effect on the S&P500 price"

Perhaps in part a conservation process: a back-and-forth conversion of equity capital to political capital. Markets regained much of 08-09 losses in great measure due to government interventions, creating a debt for the beneficiaries. Payment by the class that owns stocks can take the form of higher taxes or lower asset values, in either case accruing to the creditors.
 

Jul

9

Mr Ellison's home run indicator got me hungry for looking at some sports stats, so first I downloaded Sean Lahman's baseball database. Then I looked at the team stats and calculated the bases per game:

(singles + 2xdoubles + 3xtriples + 4xhomers) / number of games

for each team, and then the average bases per game for all teams for each year 1970-2010. Attached is the chart, and it shows interesting fluctuations. Big jump in the early '90s. Tapering off now.

Jul

4

Recently, Dr Z chastised justly, with: "What happened to numbers on the table?" Mea culpa. So here is some counting:

Russ's post from a couple of weeks ago, on inside and outside days, got me thinking and counting. Russ's stats showed that there were an unusually small number of Mondays that qualified as outside days. I ran a sim that randomly resorted the actual weekday designations among all the actual days (e.g., a Tuesday might be randomly reassigned to be a Friday, etc.), and then counted the number of Monday-inside days, Monday-outside days, Tuesday-inside days, and so on, for each run of the simulation, to 10,000 runs. The sim results confirmed all of Russ's binomial calculations closely, using SPY data from 1 January, 2000, to 22 June, 2011:

weekday-type/total/%tile
Mon-in  68  84.93%
Mon-out 35   0.01%
Tue-in  65  41.85%
Tue-out 80  99.30%
Wed-in  54   2.77%
Wed-out 82  99.65%
Thu-in  63  36.56%
Thu-out 54  10.77%
Fri-in  72  85.36%
Fri-out 55  15.51%

There were only 35 Monday outside days, and this number was at the
0.01%tile of the distribution of 10,000 sim run results (the minimum total for Monday outside days in the 10,000 sim runs was 34). Why? Is Monday less volatile than the other days? Mr. Sogi did some counting that indicated not. What other factors could be involved?

It turns out that SPY tends to go ex-div on Fridays, so could that be the reason for so few Mondays being outside days? A quick check of the 35 Mondays that followed ex-div Fridays shows that two of them were outside days. That's 5.7%, which is consistent with the 6.4% outside days in the total sample of 543 Mondays. So no indication that ex-div Fridays are a factor.

But inside and outside days are like a basketball going through a basket: the ball has to be small enough to fit through the basket, the basket big enough to let the ball through. But what if you also
*move* the basket? To account for "basket movement", we also have to look at the Close-to-Open moves preceding the days in question:

SD of Close-Open % moves:

(Note that holidays are included, so that some "Mon-Tue" moves are actually "Fri-Tue" moves, etc.)

Fri-Mon: 0.829%
Mon-Tue: 0.705%
Tue-Wed: 0.626%
Wed-Thu: 0.633%
Thu-Fri: 0.811%

So we see that the SD of the Friday-Monday move is the largest. To explore the effect of the Close-Open gap, I ran another simulation that used the actual Fridays and Mondays, but replaced the actual Close-Open % move with a value drawn from a normal distribution with the same mean and SD (+0.038% and 0.829%, respectively) as the actual Friday-Monday Close-Open values. The sim randomly assigned new Close-Open % changes to the actual data and then counted the number of inside and outside days in each of 1000 runs:

mean # inside days: 58.4, sd: 6.08
mean # outside days: 40.8, sd: 5.27

Then I ran the sim again, changing the SD of the Close-Open distribution from 0.829%:

SD: 0.629%
mean # inside days: 64.6, sd: 6.15
mean # outside days: 44.7 sd: 5.27

SD: 0.429%
mean # inside days: 71.1, sd: 6.32
mean # outside days: 49.4 sd: 5.21

We can see that the number of inside and outside days increases as the Close-Open gap gets smaller.

When the SD for the Close-Open distribution is set to the actual value of 0.829%, the sim doesn't produce the same result as the actual data. This is because the Close-Open % changes are not normally distributed; rather, the distribution has long tails. Here are probability plots for three sets of Close-Open % moves for the actual SPY data: Friday-Monday, Monday-Tuesday, and Tuesday-Wednesday:

The distribution of Close-Open moves for Friday-Monday has a greater range and denser tails, and the additional extreme values, or extra "basket movement", reduces the number of Monday outside days.

Monday also has the smallest mean High-Low range of all the weekdays:

mean High-Low ranges:

Mon    1.502%
Tue    1.571%
Wed    1.602%
Thu    1.636%
Fri    1.559%

So, between the greater volatility of the Friday-Monday Close-Open move, and the smaller Monday High-Low range, we seem to have a pretty good explanation for the low count of Monday outside days.

Jun

29

Some hypotheses regarding the reaction to information? Case very similar to the flexionic move down when the bailout was passed. Since it was known to all flexes, they had to liquidate when they realized that what they positioned for happened? Of course there was the certainty that the new man of change would be elected also? Or was it a case of going up whenever it looked likely that the vote in Greece would be positive, and then when it happened, …as Dooley would say "how will they make it happen? What you think?".

Alex Castaldo writes: 

Most were positioned in expectation of a favorable vote: long stocks and short bonds/bunds.  For a while it seemed the markets cared about nothing else.

At 6:41 am ET Papadimitriou (from the opposition party) announced that he would vote for. The S&P vaulted past 1300 and the Bunds future fell below 126.  The size of the market reaction perhaps incongruent with an announcement from a single politician. 

Then the voting started.

At 8:45 Kouroublis voted against, and there was a noticeable sudden decline in stocks and rise in bonds, bunds. This did not last long.

At 8:56 Athanasiadis, who had been expected to vote against, voted in favor, with the opposite (though smaller) effect.

After the 9:04 announcement that the votes are available to guarantee passage, there was a period of hesitancy and then an attempt by the majority to make a dignified exit now that the expected had happened, only to find the exits rather more crowded and disorderly than hoped…  The stock investors, especially, experiencing some downdrafts. 

Alston Mabry writes: 

Given the news about previous governments in Athens cooking the books to get into the €mark in the first place, and then all the reports of tax evasion and government benefit exploitation and so forth, it's easy to be skeptical, and even cynical, and take the view that things like "negotiated agreements" and "midnight parliamentary votes" and "austerity budgets" are things that politicians use as their own currency, and that they keep trying to spend this currency in an alternate imaginary world in which they believe they can hold off hard consequences with soft ideas. (See: "Munich agreement".)

Jun

3

Presumably the Tues move up and the Wed move down in SP were triggered by fixed speculators with systems to buy the turn of the month.

Alston Mabry writes:

Well, you had the last day of the month a Tuesday right after a 3-day weekend…just before the first day of the month being a Wednesday…and 30 days from the end of QE2…with a spattering of bad economic news thrown in for good measure– what am I leaving out? Talk about needing a good system for combining your forecasts…..

Gary Rogan writes:

The House rejecting the debt limit increase? Last time (fall of '08) the spineless tried to grow a spine the language of the falling markets was used to explain to them the error of their ways.

MUST…SAVE…COUNTRY…MUST…PASS…DEBT…LIMIT 

May

31

 There is nothing more competitive then tech: the smartest people from around the whole world trying to destroy each other globally, huge rate of innovation guaranteeing quick obsolescence and a killer breakthrough-based knock out punch that can come at any minute, lots of unpredictable trends and fashions with the "coolness" factor often ruling the day, very little customer allegiance, and what's there often turning to vengeful disdain when the expectation are not fulfilled even by a little bit. Yet Rocky evidently disagrees that tech cash flows are fleeting.

Alston Mabry adds:

Technological Revolutions and Stock Prices Lubos Pastor University of Chicago - Booth School of Business; Centre for Economic Policy Research (CEPR); National Bureau of Economic Research (NBER) Pietro Veronesi University of Chicago - Booth School of Business; Centre for Economic Policy Research (CEPR); National Bureau of Economic Research (NBER) February 12, 2008

Abstract:

We develop a general equilibrium model in which stock prices of innovative firms exhibit "bubbles" during technological revolutions. In the model, the average productivity of a new technology is uncertain and subject to learning. During technological revolutions, the nature of this uncertainty changes from idiosyncratic to systematic. The resulting "bubbles" in stock prices are observable ex post but unpredictable ex ante, and they are most pronounced for technologies characterized by high uncertainty and fast adoption. We find empirical support for the model's predictions in 1830-1861 and 1992-2005 when the railroad and Internet technologies spread in the United States.

May

12

 UPDATE:

The Winners of the least effort contest were jointly in a tie. Mr. Gary Rogan and Mr. Steve Ellison. I will split the prize between them. The creative and physical ideas of Mr. Rogan were very excellent and best of all, but there was no testing. Mr. Ellison gave a great test, and a complete answer, but Rogan can't be denied his place either. vic

I'll give a prize of 1000 to the person or locus of his choice that comes up with the best way to test the principle of least action or a related principle of least effort.

It's in honor of my grandfather. Whenever I'd ask him which way he thought the market would go he'd say, "I think the path of least resistance is down" starting with Dow 200 in 1950. We need some more quantification around here.

You might consider max to min or a path through a second market back to home. Or round to round? Or amount of volume above or blow. Or angle of ascent versus angle of descent. Or time to a past goal versus the future? Or some mirror image or least absolute deviation stuff?

Sushil Kedia writes:

With utmost humility and clearly no cultivated sense of any derision for the Fourth Estate, I would submit that since it is the public that is always flogged and moves last, the opinions of all media writers, tv anchors are the catalysts, the penultimate leg of the opinion curve. A test of the opinions of the fourth estate on the markets would provide the most ineffective wall of support or so called resistances. Fading the statistically calculated opinion meter (if one can devise one such a 'la an IBES earnings estimate a media estimate of market opinion) and go against it consistently over a number of trades, one is bound to come out a winner. Can I test it? Yes its a testable proposition, subject to accumulation of data.

Alston Mabry writes:

The following graph (attached and linked) is not an answer but an exploration of the "least effort" idea. It shows, for SPY daily since August last year, the graph of two quantities:

1. The point change for the SPY over the previous ten trading days.

2. The rolling 10-day sum of the High-Low-previous-Close spread, i.e., "max(previous Close, High) minus min(previous Close, Low)". This spread is a convenient measure of volatility.

Notice how these quantities move in tight ranges for extended periods. These tight ranges are some measure of "least effort", i.e., the market getting from point A to point B in an efficient fashion. As one would expect, the series gyrate when the market takes a temporary downturn. Also note how when one of the quantities swings above or below it's mean or "axis", it seems to need to swing back the other way to rebalance the system.

Bill Rafter writes:

 This nicely illustrates how relative high volatility is bearish on future price action.

Jim Sogi writes:

The path of least resistance would be the night session. Low liquidity allows market mover to move market. Every one is asleep. Dr. S did a study some years ago. Updating shows total day sessions yielding 94 pt, but night session yielding 232 points. Don't sleep…stay up all night or move to Singapore. Recent action is in line with hypothesis.

Bill Rafter writes:

Haugen's "The Beast on Wall Street" (i.e. volatility) came to the conclusion that if you want less volatility in the markets, keep them closed more, to essentially force the liquidity into specified periods. That is, 24 hour markets promote volatility. Or a corollary was that a market is never volatile when it is closed. [this is from memory and I may also be regurgitating from a personal conversation with him]. An oft cited example is the period in the summer of 1968 when equities were closed on Wednesdays to enable the back offices to get up to date with their paperwork and deliveries. During that time the Tuesday close to Thursday opening was less volatile than expected (twice the daily overnight vol).

One could take this thought and stretch it to say that the periods of least resistance would be those without heavy participation. One could easily compare the normalized range (High/Low) of those periods versus the same of the well-participated periods.

Craig Mee writes: 

Hi Bill,

You would have to think that in 68 there was sufficient control of price and news dissemination. In these times of high speed everything, that this could create bottlenecks and add to the volatility. No doubt a bit of time to cool the heels i.e limit down and up for the day restrictions, is a reasonable action, even if it goes against "fair open and transparent markets" but unfortunate it seems little is these days.

Bill Rafter replies:

I should have been more specific about the research: take the current normalized range for those periods of high liquidity (when the NY markets are open) and compare that to the normalized range of the premarket and postmarket periods. Do it for disjoint periods (but all in recent history) so you don't have any autocorrelation. My belief is that you will find there is less volatility intra-period during the high liquidity times. While you are at that you can also check to see during which period you get greater mean-reversion versus new direction.

If that research were to show that (for example) you had greater intra-period volatility during the premarket and postmarket times, and that those times also evidenced greater mean-reversion, you could then conclude that those were the times of least resistance. That would answer Vic's question. Okay, now what? Well you could then support an argument that with high volatility and mean reversion you should run (or mimic running) a specialist book during those times. That's not something I myself am interested in doing as it would require additional staff, but those of you with that capacity should consider it, if you are not yet doing so.

Historical sidebar: '68 was a bubble period caused in part by strange margin rules that enabled those in the industry to carry large positions for no money. The activity created paper problems as the back offices were still making/requiring physical delivery of stock certificates. The exchanges closed trading on Wednesday to enable the back offices to have another workday to clear the backlog. The "shenanigan index" was high during that time.

Phil McDonnell writes:

Bill, you said "During that time the Tuesday close to Thursday opening was less volatile than expected (twice the daily overnight vol)."

For a two day period and standard deviation s then the two day standard deviation should be sqrt(2)s or 1.4 s. So the figure of twice the volatility would seem higher than expected.

Or am I missing something? 

Steve Ellison submits this study:

The traditional definition of resistance is a price level at which it is expected there will be a relatively large amount of stock for sale. 
Starting from this point, my idea was that liquidity providers create resistance to price movements. If a stock price moved up a dollar on volume of 10,000 shares, it would suggest more resistance than if the price moved up a dollar on volume of 5,000 shares.

To test this idea, I used 5-minute bars of one of my favorite stocks, CHSI. To better separate up movement from down movement, for each bar I calculated the 75th and 25th percentiles of 5-minute net changes during the past week. If the current bar was in the 75th percentile or above, I added the price change and volume to the up category. If the current bar was in the 25th percentile or below, I added the price change and volume to the down category.

Looking back 200 bars, I divided the total up volume by the total up price change to calculate resistance to upward movement. I divided total down volume by the total down price change to calculate resistance to downward movement. I divided the upward resistance by the downward resistance to identify the path of least resistance. If the quotient was greater than 1, the past of least resistance was presumed to be downward; if the quotient was less than 1, the path of least resistance was upward.

For example:

                           Previous 200 bars
                                                        Up
   Date     Time     Up Points Volume  Down Points Volume Resistance

3/25/2011   15:50   53   6.49  99431    61  -7.38  149867     15311


   Down       Resistance     Actual
Resistance      Ratio      net change
     20310       0.754       -0.03

Unfortunately, the correlation of the resistance ratio to the actual
price change of the next bar was consistent with randomness.

May

11

 I keep wondering if AAPL will be the first $1T-market-cap company. It's hard to accept that number if you're an old fart with a set of mental reference points that do not encompass market caps that begin with "T".

Right now AAPL has ttm net income of about $20B, and sells for 16x that number. So at the same multiple, $1T in market cap would require roughly $65B in net income. Is it possible they could get there in the next 3-4 years? They may break $100B in revs in calendar 2012. They also have $65B in cash on the balance sheet right now. By 2015 that will be…$150B? $200B?

The first $100B market cap was a big deal, too, though I don't remember which company it was.

Tyler McClellan writes: 

The reason apple will never get close to a 1 trillion market cap is very intuitive.

At that level they would be the largest net lender to the U.S. economy other than Japan or China. What are the prospects of a company that lends all its profits to the U.S. at zero percent interest rates. 

In fact, I will go further and say that the cash on the balance sheet at Apple is exactly equal to the amount of savings that society wants to do and apple refuses to accommodate.

For all of you who think you understand economic theory very well. What company supplies net capital to the economy at ever increasing rates even as its own prospects continue to improve vis-a-vis the economy?

Apple is a great lender to you and me, who have no need and no want for these lent funds, in exactly the opposite proportion to the amount you and I want to save in apple given its huge scope of opportunities.

Apple positively refuses to allow people to save. They force people to dis-save.

And for those of you who think the impetus to competition makes up for this (i.e., inducement effect of high market cap). Microsoft makes more net cash flow than all of the venture capital in the united states.

Apple itself makes nearly as much in free cash flow as the entirety of venture spending (that's in all categories at all stages).

Jeff Rollert writes:

Aren't market caps just measures of human preferences? If so, then they are good measures for where you are, not where you will be, as much of this behavior mapping is coincident.

A trillion seems to trite these days. 

Alston Mabry writes:

I think size matters.  Here are some more stats for AAPL:

last two quarters' YOY rev growth: 70%, 82%
last two quarters' YOY earnings growth: 74%, 91%
annualized growth rate of net income since 2005: ~60%

PE based on most recent 4 quarters: 16.3
PE after backing out $65B in balance sheet cash from mkt cap: 13.2

Now, imagine you saw those growth rates for revs and earnings, and that PE ratio, in a company with a $1B market cap, a company that had relatively limited market penetration for most of its products. "Is that something you might be interested in?"

So why aren't we more interested? Because people think AAPL is too big already. But maybe we have entered a new era of an expanding global economy in which there will be many companies with trillion-dollar market caps. As a popular and much-quoted writer and self-styled philosopher called it: the "JK Rowling Effect".

At one point in January 2000, the top ten (or twenty…I can't remember) stocks in the Nasdaq 100 had a total market cap of $1.6T and aggregate net income of about $19B, for a PE of 83. AAPL's current ttm net income is $19.5B, it's market cap $320B.

Frame of reference…point of view…big round numbas….

Alston Mabry asks: 

So you're assuming that rates will still be zero in, say, 2016? Could be. But what if the whole curve is pushed up two or three hundred basis points by then?

Tyler McClellan writes: 

Their actions as representative will force the rates to be low.

If the worlds most rapidly growing large enterprise refuses to borrow funds at 70% internal growth rates and is more than happy to lend them at 0% interest rates, then what possible companies demand to invest more than their willingness to supply savings?

It's a big fake that no one is supposed to talk about, our best companies don't want any money no matter how fast they grow, and in fact the faster they grow the less money they want. But wait, that's great, you say, because it means they create value out of nothing, and that what economics is. And isn't it true that companies can have value only if the sum of their discounted cash flows are positive, so doesn't that mean were wealthier if all of our companies have really high net cash flows.

And of course the answer to the above is categorically no, but I don't suspect what I've written to make a bit of difference, so back to my little day solving equations. 

Rocky Humbert writes: 

Tyler: I'm not sure it's appropriate to generalize from AAPL to the entire economy. AAPL is sitting at the top of the technology food chain, and they are benefiting from the investments being made underneath them. It's surprising, but Apple is NOT investing in R&D in a meaningful way… and this demonstrates that they are much more of a marketing company (like Proctor&Gamble) than a technology company. Hence they will eventually need to either buy back stock or pay a dividend….

R&D as a Percent of Revenues:
AAPL: 2.7%
P&G: 2.5%

INTC: 15%
MSFT: 13.9%
GOOG: 13.0%
IBM: 6%
(Source: Bloomberg, FA IS page, trailing 12 months)

May

10

 Just got an earful about Comex manipulators. Care to put a few holes through it?

Really? It's always a conspiracy when the market moves against you? I really have no explicit knowledge one way or the other about silver but people sure do like conspiracy theories– in government, in finance, etc. Plenty of this sort of "journalism" in the blogger financial press– it draws in the eyeballs.It always seems that people like to rationalize that it's someone else's fault where losing money is concerned since no one wants to face the shame of admitting a mistake. I have this theory that people like to use financial advisors so that they can blame someone else when their investments lose money: "That damn stockbroker sold me that loser, honey; it's not my fault".

Jeff Watson comments:

Having been on a margin committee (among many other exchange committees) before, my experience is that the margin will always be set in a way that will protect the exchange clearing house, the membership of the exchange, and to a lesser extent, the trade, end users, or what have you. Plus, the membership usually has an inkling that margin rates will be changed, no real surprises there.

Alston Mabry writes:

I love the author's analysis: in hindsight we shouldn't have gone long when we did. We should have gone long at the bottom and also a lot bigger.

And the conspiracy is:

1) Either using control over the exchange committee system to induce sudden hikes in performance bond requirements, or opportunistically using such hikes….

2) Using analysts to make extensive commentary to the mass media to the effect that the "silver bubble has burst" in the hope of inducing fear in the marketplace….

3) Using trading "bots" to transiently create thousands and, sometimes, tens of thousands of intra-day short positions….

4) Closing most intra-day positions into the mass of involuntary liquidations.

my favorite bit is "or opportunistically using such hikes".

Interesting profile, by the way:

Avery B. Goodman has been a licensed attorney for 26 years, and has concentrated in securities law related cases. He holds a B.A. in history from Emory University, and a Juris Doctorate from the University of California at Los Angeles Law School. He is a member of the roster of neutral arbitrators of the National Futures Association (NFA) and the Financial Industry Regulatory Authority (FINRA). He has also been an independent investor for many years. Snapshot Description: Independent / boutique research firm analyst. Trading frequency: Infrequent

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