Nov

21

 If

X= "I touched the stove"

and

Y= "I got third degree burns"

then I would NOT disregard the data set as "too small to be indicative".

Larry Williams writes: 

Yes, yes…one sample size is adequate–there seems to be a connection readily seen.

Leo Jia replies: 

My issue is when X is not exclusive to Y, I have not much clue on how X happens and whether Y has a rational reason to be linked with X. This can be possibly because if it is too clear it might very well be different later.

It is quite like a situation where I am a monkey in the zoo. Most of the time I am kept very hungry. The zoologists play a lot of games with me, delivering food here and there at times. During the last five years, I discovered this thing (which I have no idea what is but you humans call it "stove") 10 times in my play field. The 9 times I touched it, it was warm but not harmful and dispensed quite a lot of food, although one time it had no food and was hot so I got burnt then. I am not sure if this is part of the game, but I am clever enough to remember this.

I keep in mind that the stove was not the only thing I encountered that dispensed food. There have been a lot of other situations, one of which is that, quite frequently, you human spectators throw in bananas andvcandies though also often times with garbage which causes some real pain.

So in this case, how do I take into account the stove case?

Nov

4

 I admit I have difficulties separating myself from the monkeys.

During trading strategy development, most of the time I have found that a 'good' strategy by many criteria can't actually beat out the performance of the random trades by monkeys. So the question is what constitutes intelligence? Is performance the sole criterion that separates intelligence from non-intelligence? If not, what else? What can make me say, "ok monkeys, I can't beat you in performance, but this thing makes me much more intelligent than you"?

Marion Dreyfus writes: 

Monkeys' investments are hypothetical; no one has really actualized this hoary supposition. Your trades are measurable and real.

Et voila la difference.

Ralph Vince writes: 

Because you think too much.

No joke.

You look for an "edge," i.e. an asymptotic probability weighted mean that is > 0.

The monkey - he doesn't. He does not posses that great big brain that leads him to believe in the delusions (see previous line) that you do.

He is only concerned with a finite time horizon, one play (get the banana! Don't worry about the small probaiblity of a chock, get the banana), in his case. You, on the other hand, have used your big brain to lure yourself into thinking you will be around tomorrow, something you take for granted.
 

Oct

22

 I was reading this article and started thinking about the ten scariest things in trading: The Top Ten Things That Make Horror Movies Scary

1. Fear of Death.  This is the ultimate fear, both existentially and psychologically. It isn't really a horror movie if people don't get killed.

In Trading: fear of depletion of assets.

2. The Dark. From our earliest childhood we are afraid of the dark – not the dark itself, but what it hides. It makes horror movies even scarier to watch them in a darkened theater, or a dark living room, right?

In Trading: not knowing enough news

3. Creepy, Crawly Things. Snakes, spiders, rats, and other crawling things are scary in and of themselves, but when they touch the skin, in the dark, it amplifies this common phobia.

In Trading: monthly expenses

4. Scary Places. Horror movies are full of scary places – graveyards, old houses, overgrown forests, dungeons, attics, basements. These are dark places, where evil things can hide.

In Trading: instruments or markets that one had very bad experiences with.


5. Disfigurement. Many horror movies feature grotesquely disfigured antagonists (think Frankenstein's monster, the Phantom of the Opera, zombies). Studies in early development have found that young infants will react with fear to asymmetrical or disordered faces.

In Trading: any instrument that had a devastating history.

6. Dismemberment. Fear of dismemberment involves loss of a part of the self. The popularity (and horror) of the Saw movies involves self-dismemberment as the only way to escape death.

In Trading: stop loss.

7. Suspense (Anticipation and Expectations). The best horror movies are full of suspense (think Alfred Hitchcock). Suspense involves creating anticipation that something bad will happen, but not knowing when it will occur. Some of the most shocking horror movie scenes, create anticipation, but then violate the audiences' expectations (e.g., the hero gets killed; the killer is the one the audience least expects, etc.).

In Trading: market keeps going up with some bears talking about a crash.

8. Spooky Music. Music can create moods and elicit emotions. The music used in horror movies can be creepy, and can be used to accentuate the actions seen on the screen. Music intensifies feelings of suspense and shock.

In Trading: unfortunate family events.

9. Lightning and Thunder. Many people are afraid of lightning and thunder – sudden flashes of light, that can kill, and a sudden and deafening sound that accompanies the lightening. Flashing lights and loud noises create a startle response and they are a mainstay of the horror film.

In Trading: trading alarm.

10. Fear of the Unusual. We know that young children are often afraid of things that are different or unusual (such as a disfigured face), and highly unusual-looking things are often sources of fear. But a common theme in horror movies is to take something that is normally not scary (e.g., a doll, a child, a clown) and make it into a feared object. In other words, making the usual, unusual. This may explain the growing number of people who confess to a fear of clowns and dolls.

In Trading: everything unusual in the market.

Oct

10

 "How our brains trick us into ignoring movie doubles but let us recognise people we love":

Our brains are constantly perceiving the world as more stable than it actually is. Consider this: Every time the light hits your face differently, you look a little different - but people don't perceive you as having suddenly changed into someone else. In fact, they probably don't see your face as having "changed" at all. Without this neurological trick, the world would be a decidedly more confusing place.

But according to a study published this week in /Current Biology/, that mechanism - which researchers have dubbed the "continuity field" - can also steer us wrong, and have us convinced that two totally different faces or forms are the same.

"The brain is creating stability out of what's actually a very unstable system," said David Whitney, the senior study author and a University of California at Berkeley professor of psychology. His lab coined the continuity field term in a previous experiment. In that study, they observed the mechanism by which people meld similar looking objects together.

"When you're watching /Harry Potter/, you don't notice that his plain T-shirt changes to a Henley, for example," first author and doctoral candidate Alina Liberman said. "Your visual system is primed to see things as remaining stable. You have a bias towards ignoring small changes in your environment."

Leo Jia writes: 

I wonder if this has to do with focusing of attention.

For instance, if you focus on the nose of a portrait on a computer screen and then the nose changes color or shape, you should be able to notice that. But if in the mean time, the ears changed, then it is hard for the person to detect that because his attention was on the nose only.

Perhaps this is the evolutionary way of using resources efficiently because the brain's processing resource is limited. This must have proved to work well during, say, hunting. Men wouldn't easily lose focus of the rapidly running rabbit because they see changes instantaneously. What men perhaps don't easily see is that a cheetah starts to chase the rabbit from another angle.

In terms of reading the market, the reason I believe we often miss things perhaps has more to do with the fact that there are so many things going on at the same time that our attention can't handle them all. 

Oct

1

One lesson I am taking from the following article is that randomness is the safest and least damaging method after a series of losses. Of course it is better to have a strategy with an edge. But when you feel threatened or defeated any known strategies could take on a negative edge, so it is better to go random, which always has a zero edge that is better than a negative one. Species seem to have learned this through evolutions.

One other lesson perhaps is that randomness is a great mind opener if one is mindful enough. It is said that failure is an opportunity to learn, so maybe this lesson teaches us that randomness is the door to success.

"Strategic or Random? How the Brain Chooses":

Many of the choices we make are informed by experiences we've had in the past. But occasionally we're better off abandoning those lessons and exploring a new situation unfettered by past experiences. Scientists have shown that the brain can temporarily disconnect information about past experience from decision-making circuits, thereby triggering random behavior.

In the study, rats playing a game for a food reward usually acted strategically, but switched to random behavior when they confronted a particularly unpredictable and hard-to-beat competitor."

anonymous writes: 

An interesting thought that reminds me of modeling the Genetic Algorythm process. Throw in a random factor that ends up improving the search results.
 

Sep

21

 Last night just before going to bed, my iPad prompted me to update the operating system. So I did it without hesitation - Apple had built my trust through past experiences. This morning I found the iPad is dead - the update failed miserably. I then tried to restore it by connecting it to a computer, but had no luck. I searched and found news articles reporting large scale failures worldwide. It affects all iPads, and iPhones (if you have one, please don't update yet!). Problems appear not only with the update process, but also with loss of personal data and overall usability. Reportedly a lot of devastated people complain in social media.

Is this the beginning of the end of the iFervor?

Sep

3

 I have read about these top five regrets of the dying, and have wondered whether they might apply to myself.

I wonder whether people are all that similar. I observe vast differences amongst people, not only from individual to individual, but more importantly from groups to groups. There can be endless ways to group people: by social status, economic status, life style, fundamental belief, spirituality, sociableness, sensibleness, courageousness, risk tolerance, consciousness, and etc, falling under the normal bell curve with the majority of the people near the mean of each distribution. People near the mean of one gauge might be at the outlier of another gauge.

It is also not difficult to imagine that the answers to each of these regret questionnaires also fall under the bell curve. So the top answers are nothing more than a representation of the people close to the mean. Should one care to be normal? Or when they say, "I wish I'd had the courage to live a life true to myself, not the life others expected of me", should one simply say to himself, "I should have the courage to have my own wishes, not the ones most others had"?

Jul

22

Would anyone advise on how to determine backtesting periods?

I presume one should choose the most recent period because it may better correlate with the present situation. But is that really true? If it is, then how far back should one include, and how far in the future can it correlate? My experience seems to say that a short backtest period can lead to a very short future prediction or even a very poor prediction. On the other hand, a longer period often leads to poor performances during the present situation.

Shane James replies: 

At the Spec Party I had the privilege to spend a reasonable period of time one to one with the remarkable Sam Eisenstadt.

His work is likely one of the best examples of creative thought in the history of financial markets. He explained to me that there wasn't much backtesting to what he/they did. He came up with some principles that made sense to him and started applying them in real time.

Now, in our so called modern world, things may have moved on (Sam graciously stated as much to the room when he was giving his views on the modern markets). HOWEVER, maybe not so much…..

Try this:

1. If your trading idea has an average holding period of a few days (preferably less) then start from today and run it in real time for the next 90 days or so. By definition, the prices upon which you are testing your ideas did not exist when you had the idea so you have already eliminated most bias if you do this.

2. If you are happy with the structure of the returns (win, lose or draw) then consider if the results were biased by any factor during your live test phase and if related to long only stock index trading then make the requisite adjustments for drift.

3. Perhaps now consider a backtest.

The point being that I think it makes sense to test on data that did not exist BEFORE you perform the backtest.
Some like to 'exclude' certain data and 'pretend' it didn't exist so they can assume that the excluded data is 'out of sample'. For instance they may take 10 years of data and use the odd number years as test data and the even number years as 'out of sample'. This might be a reasonable idea to make yourself feel more comfortable but there is an intangible and very difficult to explain benefit to performing the kind of 'spontaneous' testing set out above on data that did not exist at the genesis of your idea before one starts seeing how well a set of heuristics performed in 1971!

Leo Jia responds: 

Hi Shane!

Thanks very much for the valuable advice.

Wow, Mr Eisenstadt! I would really love to thank him for my early success stories with referencing the Value Line. But I guess it wouldn't matter to him as he might have heard from too many!

Talking about my early experience (back in the 90's), I actually had been using your suggestion all along. There was never backtesting for me — I got an idea and went to buy the stock the next day. It actually worked well overall.

Should I go back doing the "novice" way? That becomes a question worth thinking now that you mentioned it. Perhaps this goes with the valuable lessons where having had enough struggles using complex ways, one discovered the neglected simple way being far superior. In Chinese culture, Tai Chi can be considered as that type of "simple ways".

Now, a couple questions about your suggestion.

1. By putting a new idea directly live, what problem is one trying to solve? Is it the concern that poor backtesting result may make one throw out potentially a good strategy? And is this concern because of the belief that past data are already different from the present situation?

2. In what ways can this idea that seemed to come from nowhere be better than the many ideas one gets by studying historical data? I know inspirations are invaluable, but one doesn't often get those inspirations that are not the results of study. So beyond the mistrust of the correlations between past data and present situation, are there any other reasons?

Thanks again for your thoughts.

Bill Rafter writes:

I am sorry to jump into this discussion late, but think there are a few points that can still be brought.  Looking for beta over a constant period of time (say 6 months) is somewhat meaningless and useless.  It’s a bit like describing a man with one foot in a fire and another in ice as at a tolerable temperature.  You have got fat tails with market volatility and a static window might be good for a journalist, but of limited value for a trader.

At a given time there is a time period over which the study of a market’s behavior will be significant.  And let’s say that at this time it really is 6 months, or 126 trading days.  Assuming no real changes, tomorrow that time window will be 127 trading days, and so on until you get a market change.

When the sea does change, bad things can happen in a hurry and beta value for the preceding 6+ months will be of little value.  Within the last week this happened with biotech:  it had been happily chugging along with good but not extraordinary outperformance of the indices.  Then it got clobbered with huge excessive relative volatility to the downside.  Had you been adapting your monitoring of volatility you would have been prepared, whereas if you stuck with your 6-month window you would have been clobbered along with the group.

My advice to you is to learn how to deal with the market adaptively.  I assure you that if you have a monitoring mechanism which you like, if you make it adaptive you will improve results dramatically. And it doesn’t matter which signal type (momentum, volatility, sentiment) or time frame (intra-day to weekly) you favor.

Jul

9

 Some commodity futures markets I have been trading just opened night sessions (from 9pm to 2am). That created some unknowns for me, as I don't know how the night sessions would affect the daytime sessions, particularly the opens/closes of the day sessions. The strategies I have been using are based on studies of the past 3 years' data. So I stopped trading these and just watch. Since these markets all have overnight overseas markets, I suspect the newly added night sessions would not make much difference to the day sessions.

Would anyone would share some experience on this?

Victor Niederhoffer writes: 

You should find markets that already have these sessions, and apply your methods to them which will work just as well as your normal. The volume in these abbreviated sessions by the way will be very low, and you won't be able to trade them. But the volume will be just enough to throw off all your opening regularities from the past.

Mr. Krisrock writes: 

Be aware that global futures markets are looked at as ONE MARKET. Time zones aren't important but prices and liquidity and price targets are very important.

Jun

4

I did some computation lately and found the following results about correlations. These results show me something I did not realize before.

Given time series A, B and C. Say Corr(A, B)=0.2, and Corr(A, C)=0.05. With this, one would think that to help understand A, C is useless. But that is not always the case. If one combines B and C and gets series D, where D = B & C, one may find Corr(A, D)=0.3, which means C actually can be very valuable in studying A. This can be understood as the combination of B and C and can eliminate some elements in both B and C that are negatively correlated with A.

Would anyone share further lessons on this?

Alex Castaldo adds:

Before I read this I had not realized that correlation is not transitive (i.e. if A is correlated to B, and B is correlated to C, it does not follow that A is correlated to C). It does not directly answer your question, but it shows that the behavior of correlation can be rather unintuitive.

May

30

 Any reflections on India? Reports about the new prime minister sound very promising. With a vibrant culture, India in my view could be in the spotlight at least in the coming 10 years, more so than China. Thoughts please?

Peter Tep writes:

I recently read a post by Martin Armstrong where he speaks about the difficulties facing India in the past. His main point was on language and that as more and more of the country learn and become proficient at English this will provide the platform for the next 'boom' - for lack of a better word.

Seems to make sense for opening up the skillset in the economy. Let's just say I wouldn't want to take on a young Indian in maths, programming or CFA calculations!

I did see that Modi's intention was to expand power access to the 700m+ population by focusing on solar. Purely from a headline perspective I'd be looking at which companies are set to benefit the most from that or whoever is closest to Modi and his administration.

May

5

 This was a very interesting article.

"A chinese mathematician figured out how to beat anyone at rock-paper-scissors":

"The pattern that Zhijian discovered — winners repeating their strategy and losers moving to the next strategy in the sequence — is called a "conditional response" in game theory. The researchers have theorized that the response may be hard-wired into the brain, a question they intend to investigate with further experiments."

Jordan Low writes: 

If I am reading it correct, the losers are basically choosing to display what won recently. Isn't it like using 3Y returns to pick mutual funds? Or did I get it wrong?

Steve Ellison writes: 

I don't play that game, but a good strategy might be to make selections as randomly as possible, for example by memorizing long sequences of digits of irrational numbers (Arthur Benjamin has a memory aid for how to do so).

Bill Walsh, the coach of the San Francisco 49ers football team in the 1980s, scripted the first 25 plays of each game in advance. This strategy made it harder for opponents to guess what play might be coming next. I have an idea that, if I could ever find enough trading systems with positive expectations, it might be good to randomly pick a sequence of systems to use in advance, in order to keep the crocodiles guessing.

Apr

29

 I was talking to an old friend of mine yesterday. He was a floor broker for Lehman Bros in the bond pit (he once sold me 500 calendar spreads while standing next to me at a urinal in the men's room). When he first left the floor he attempted to trade electronically and within a relatively short period of time went through all of his money. He had to take a job with the CME working at their help desk, and was eventually promoted to associate director of the Globex control center working the third shift from 3 a.m. to 11 a.m., and is now a senior director at the CME.

He told me an interesting story about his experience trading after he left the CBOT. It was about another ex-denizen from the floor. This individual, however, had worked as a clerk for a mutual friend of ours, who had been a trader. My friend went on to tell me how the ex-clerk had been making $1,000- $1,500 screen trading, per-day, like clockwork — averaging $25,000 per month for quite a period of time.

However, after my friend went through all his capital and stopped trading, he lost touch with this ATM of an ex-clerk. But serendipitously, ran into him the other day when he hopped into a cab. However, the ex-clerk was not another passenger, but the driver. Of course, there are quite a few lessons to take away from this story- not the least of which are:

- markets change and if a trader doesn't adapt, he'll be driving a cab
- becoming a successful trader is not easy, even if you're experienced
- core competency in one endeavor, does not guarantee competency in another
- working for a living sucks
- always be prepared to trade
- markets aren't the only thing that reverts to the mean
- not every cab driver in Chicago is from Pakistan or the Middle East

- never turn down an edge, no matter where you are, or what you have in your hand
- always wash your hands after making a bathroom trade

- success is fleeting, losing is forever

Leo Jia writes: 

Thanks Gary, for the interesting post.

I found your title (or the last lesson on your list) quite intriguing: "success is fleeting, losing is forever". Seems apparent in a lot of cases. But why and how is that true? Especially when we consider your other lesson: "markets aren't the only thing that reverts to the mean".

Anatoly Veltman writes: 

Isn't it true: even having made 5,000% on your money, once you lose only 100% - you got no money left. That is more like self-sabotage.

Leo Jia writes: 

Normally, if one wins/loses in percentage terms, one nearly never loses 100% - sure one may lose so much as to have not enough fund to continue trading.

Let's assume that he wins/loses 5% on each bet. To make 5000% in the fastest way, he needs 175 consecutive wins. From here, to lose all he has made and get back to his original amount (which is still enough for him to continue trading), he needs to go through 166 consecutive loses. If his wins/loses do not happen consecutively, which is normally the case, it might have taken him over thousands of trades on each way.

So in this process, even though losing takes fewer times than winning (166 vs. 175), winning and losing both take a long time. So the other lesson "markets aren't the only thing that reverts to the mean" could apply here: after losing some, one starts to win. I am not sure how one can conclude "success is fleeting, losing is forever".

In the worst god-given case where he has no edge at all and trades simply based on flips of a fair coin, he has equal chances of winning and losing.

The only case where "success is fleeting, losing is forever" is possible is when he always strives so hard to create a very large negative edge for himself.

J. Hughes comments:

 Interesting, but the distinction needs to be made, "he was a floorbroker", quite a different occupation than that of floor trader. It's easy to trade against an order deck.

Having done both job's, cabdriver, and trader, though for different reasons, I can state unequivocally, yes markets change and if traders don't adapt, they perish. But the bigger insights lie in how much cab driving is similar to trading. Both position risk capital upfront, the 3 G's, gates, gas and graft. Then there is risk control, it takes skill to size up an individual when one is traveling at 35 MPH and trying to cover the costs of the 3 G's. Then there is return on capital, I can say first hand, my return on capital as a cabbie, on a nightly basis, was far superior on a percentage basis and more consistent as a hack, than a trader. Although I am back to driving a computer once again, and there are times I wish I was back pushing a hack. Both positions are very much traders. It's a natural fit. The lesson is, "life is replete with vicissitudes."

Ed Stewart writes: 

The problem with making $ 1,000-2,000 a day is it is enough to provide a salve and decent quality of life that makes one feel like a professional, but this is not dentistry or a job at a federal regulator. IMHO the correct target is to get rich and become a real capitalist. How one does that, via trading, a service business, or a money manger (combining the two) does not matter so much as actually doing it by any means that is legal and ethical. Going for crumbs doesn't cut it.

Apr

22

 I have been thinking about what could be a good set of criteria to measure trading (strategy) performance for individual traders.

The criterion of average return divided by the variance of the returns seems to have its shortcomings. One reason is that some large positive returns can cause the variance to go up resulting in an indication by the criterion that the performance deteriorates. But some large positive returns are good to have.

Other criteria like Sharpe ratio seem more suitable for institutions.

I think using properties of the linear regression line of the cumulative return curve might be a better choice.

Two useful properties are the slope and the "width" of the linear regression line. By "width" I mean the deviation of the cumulative return curve around the linear regression line.

A good performance should have high slope on the one hand. And if we do not consider reinvesting profits, it should have narrow "width" around the linear line.

So then the value of slope/width seems meaningful.

If we take the linear regression line as a risk free benchmark, then this value may be very similar to the definition of Sharpe ratio, but practical for individuals.

Would anyone please comment on the pros and cons of this, or any other better ways to measure performance.

Alexander Good writes: 

Great post!

I think it makes sense to measure linearity of PNL and convexity separately so I agree with you that R sq is a good one to employ. I am curious how width differs from the strategy's std though…

One thing that you can do as a cheap proxy is median return * sqrt(252)/std return and then for skew then have a (rolling max peak to trough draw down)/(rolling max peak to trough draw up).

You can benchmark your strategy vs. bonds, the S&P and a traditional 60-40 mix or your other strategies. It's very hard to beat a vol weighted portfolio of stocks and bonds so it's a good benchmark in my humble opinion assuming you're trading your PA and you don't have large retirement holdings. I assign different weights to skew and median return depending on my portfolio construction.

In portfolio construction you'll often find things with strongly positive skew have good inverse correlation to market PNL series and are typically 'long vol' (idea ripped off AQR's value and momentum everywhere).

Trending strategies frequently have very positive skew (momentum) whereas mean reversion tend to have skew that looks like the S&P (value). So if I'm net long beta my marginal utility of doing trending models is higher whereas if I'm net short I tend to size up mean reversion strategies.

Would be curious to know what other people are using/ how other people think about this/ if they have good papers on the subject. 

Leo Jia writes: 

Aren't they different?

std of returns has this term: (Ri - mu)^2, where mu is the same for all i's.

The width has this term instead: (CRi - Vi)^2 where Vi is the value on the linear regression line at time i and is all different across all i's.

Alex Castaldo writes: 

Personally I just like to look at the equity curve visually, and it is not difficult to store large numbers of graphic files in a folder and quickly "flip" through them by hitting a key on the computer.

But for automated evaluation Leo's two criteria (slope of regression, and "width around the regression" (which is also called the SEE or standard error of estimate.in regression textbooks) make sense to me.

However I know there are many other criteria that have been proposed. There is one with a foreign name that I think starts with "v" but that I can't remember. I am sure some people here know what I am talking about, it was much blogged about 2 or 3 years ago.

In looking for it I accidentally googled another measure of equity quality, the k-ratio , that believe it or not has 3 different versions.

Any other ways to measure equity curve "quality"?

anonymous writes: 

As with many things involving non linear information, my experience suggests that one must mix, blend or combine different 'quantities' to form a unique and proprietary time series.

For example, some form of 3D 'curve' that combined the three quantities return, AUM & volatility that gets thicker as AUM in the strategy grows and changes colour as volatility of returns increases perhaps… 

Ralph Vince writes: 

percent of 6 month periods underwater
percent of 1 year periods underwater
percent of 2 year periods underwater

percent of time at equity highs
percent of time within 1% of equity highs
percent of time within 5% of equity highs
percent of time within 10% of equity highs
percent of time within 20% of equity highs

I have all of these programmed up in javascript which you can peruse at lspindexes.com and click the "compare" tab. 

Apr

2

 The lesson I would take is this.

Initially, people believed that the yuan had been manipulated (or in better word, controlled) at a very cheap level. So they invested in yuan. Then it has been so apparent to everyone that the smooth uptrend was due to control. So having witnessed the evidence of control twice, one should have envisioned that the same control could be against one's favor as well.

Mar

28

Data, from anonymous

March 28, 2014 | 2 Comments

 I often look at the amount of past price action used to attempt to predict future price action.

Some things that are useful to ponder, in my opinion, are:

1. Is more past data really going to help to make the future prediction more accurate?
2. Should there be a balance between look-back period and forecast horizon?
3. How important is data accuracy (tick level to daily range)?
4. Should reference points & times be changed every second, minute and hour of a day?
5. Should the definition of 'big move' and 'small move' be a fixed thing or relative to the market's current level?

For me, it's NO, NO, VERY, YES & RELATIVE.

Go Well.

Leo Jia writes: 

In Schwager's book "Hedge Fund Market Wizards", Jaffray Woodriff addressed this in the following way. Any comments? It does have to do with what one is trying to get, doesn't it?

"Do you give the same weight to data from the 1980s as data from the 2000s?

Sometimes we give a little more weight to more recent data, but it is amazing how valuable older data still is. The stationarity of the patterns we have uncovered is amazing to me, as I would have expected predictive patterns in markets to change more over the longer term."

Larry Williams writes: 

As I see it we certainly cannot compare data from the old pit sessions to today's electronic markets.

And how do we handle Saturday trading in the real old days or that markets were close on election day…or in 1967 the markets were close on Wednesday… or there used to be a massively important bond report the goosed bonds on Thursday??

We need to understand what the data represents.

Mar

23

TEASER ALERT: I am not about to write what you expect!!

A popular blog site recently posted a story that advocated people to tap their home equity and buy stocks. The link is here or if that link doesn't work, here. 

What I find interesting about this article is that it is being met with universal revulsion judging from the blog comments and other related postings. (Not naming names.) The so-called Pros are saying it's irresponsible, ludicrous, sign of a top, etc. etc. etc. And the so-called pros are also saying that people will get sued for giving this advice. (I have no opinion).

Let's ignore the fact that this column's recommendation was extremely good advice for the past 5, 10, 15, 20, 30, 50 years, and let's also ignore some of the weaker arguments in the story.

I think we should step back and analytically consider that there is actually some merit to the concept (for some people). (Caveat: I am not bullish on stocks).

Imagine the very responsible Mr X who every month took all of his extra income and paid off his mortgage early. He's now about 40 or 50 years old. And he owns no stocks. He owns no bonds. And he has no mortgage. And he's got enough cash to meet any emergency. I can make a very rational argument that Mr. X would be very well served to place a modest mortgage on his home and use the proceeds to acquire some financial assets. Not necessarily all stocks. But definitely some financial assets. There are several underlying arguments in favor of this: But first and foremost is diversification. We know mathematically, over time, diversification is the only free lunch.

So the authors of this controversial blog post got distracted by things like positive carry. And some other not-so-true things. But all of the readers spewed venom. And this reaction may have informative value.

Remember: A home is both a consumption good and a store of wealth. If someone put 100% of their net worth in a single undiversified stock, they are asking for trouble. And a home is really no different in that respect.

anonymous writes: 

I agree 100%.

The negative reaction, it seems, mistakenly seems to argue the case of not selling one's residence to buy stocks (which is clearly not what the author of the original piece advocated). Clearly, if one were to buy a second residence with that same home equity, in the case of agnosticism as to the direction of home prices and equity prices, would their reaction be the same?
 

Leo Jia writes: 

I think it all depends on who Mr X is.

If he is financially skilled (which seems not the case at all in Rocky's description), then maybe OK.

If not, then he should stay at where he is.

Or if he is really tempted, he should first spend a lot of effort in getting the skill. But Mr X should be well advised that he would still have no clue of what that skill is after many years of fooling around.

Do we all believe that investing is an easy job for everyone?

Different from the house, a financial asset is liquid and evidently volatile. Ordinary people can not tolerate the pain when the change of their asset value is vivid and clear. With the benefit of liquidity, the pain would cause them to do a lot of stupid things, which will then burn them out in no time.

Mar

10

"Reading, after a certain age, diverts the mind too much from its creative pursuits. Any man who reads too much and uses his own brain too little falls into lazy habits of thinking." - Albert Einstein

Stefan Jovanovich writes: 

This certainly explains why he and so many other brilliant people fall for the idiocies of socialism. As a system it is flawlessly logical; it lacks all the chaos, confusion, corruption that liberty produces. It requires more than a little reading to learn just how insanely vicious the logical systems of political economy all have been.
 

Mar

7

First order differential equations of the form:

the rate of change of a variable + the original variable x a constant equals a constant times a function, or

dy/dt + p * y =  k1 * q(t)

has wide applicability in all physical settings. it's used to model the cooling and diffusion equations for example, as Arthur Mattuck in a brilliant and relatively easy to assimilate lecture shows.

For what variable in the market does its rate of change depend on its level and the movements of a second variable. The moves of stocks relative to bonds and currencies comes to mind. Is it predictive in certain cases and how do random perturbations affect the solution and its predictivity? Are there any methods used to solve these first order equations that are useful for markets without regard to stochastic, useless solutions?

Leo Jia writes: 

I once attempted to use it to model the market, but I did not proceed. The reason is that I realized the solution would be a function of two coefficients, i.e. K and K1 in this case, and so by varying the coefficients, one can fit the solution well onto the historical chart. The way to fit it wouldn't be very distinct from that of fitting a moving average onto a historical chart. So to me it seemed to fall into the same dilemma as trying to profit from a moving average model. Would anyone correct me?

Feb

19

 Among the 4 Chinese companies on MIT's 50 Smartest Companies 2014 list, Tencent is very well positioned with their products and services. Its enhanced instant messaging service QQ has been the most popular by far in China for years, nearly used by everyone. In recent years, its new service WeChat which runs on both Android and iOS and includes free voice/video calls/messaging among members are gaining similar status. For sometime already, WeChat has been cutting revenues for mobile service providers. One interesting thing is that an elder man from Denmark whom I met recently in Thailand uses it. He said a lot of people in Europe use WeChat and regard it to be far better than Skype.

Alex Forshaw writes:

I use WeChat partly because I cover Tencent and partly because I need to stay in close contact with Chinese people, but I can confirm that more Westerners are beginning to use the service as well. The English version is very simple and effective. The Chinese version has a lot more features and is becoming the top mobile communications client in the world.

Globally, Wechat competes aggressively with LINE, a South Korean company that has locked up the Japanese market for this service. LINE, Wechat and WhatsApp are now in a worldwide land-grab over these services. WhatsApp seems to be a distant third in this niche.

Tencent is very intelligently turning Wechat/Weixin into a "mobile OS within a mobile OS," and it's beginning to up-end a lot of basic services in China. They are partnering with Dianping (Chinese Yelp + Opentable + GRPN component + others), Didi DaChe (Chinese Uber) and other local services companies to drive a lot of 'local business' traffic. The really big call option in Weixin is to turn it into a mobile payment client (a lot of Chinese make mobile payments thru their cell phone as opposed to with a credit card because of idiosyncrasies in the Chinese payments system.)

Analysts argue that within Tencent's current US$125bn market cap, $40bn or so is due to Weixin/Wechat. 

Peter St. Andre writes: 

Facebook is buying ~500 million locked-in users controlled by WhatsApp, so that they can add those poor souls to the 1+ billion locked in users already controlled by Facebook itself (although presumably there's some overlap in their users).

I'll note that, although both Facebook Chat and WhatsApp use modified versions of the chat technology I've worked on since 1999, I ain't seeing any of those billions of dollars. I am, however, probably having a lot more fun than the folks working at Facebook and WhatsApp.

Jan

23

I have been thinking about trying to use the 5 Whys Method to analyze trading errors on my account (and then check the "images" tab for actual users' examples).

But the exogenous events (Black Swans, terrorist actions, bad actors with undesirable or stupid agendas, etc) that are beyond a small investor's control, for example: Das Fed; China changing its economic or monetary policies seemingly at whim; whale trading errors; etc., leads me to think that without either (1) an ultra conservative approach that isn't going to yield much investment return, and/or (2) insurance like put-call strategies that I admittedly know little about, a simplistic equation might look like this:

P = G + D *a * b,        or    [1]
P = G + D * e              

where:
P = investment profit
G = growth of investment
D = dividends (if applicable)
(a) likely risks I know about that are possibly going to occur, and
(b) unknown risks I don't know about that might or might not occur
(a) and (b) collectively = e … an acceptable amount of uncertainty ("Implementing Six Sigma" by Breyfogle III, 2nd ed, Wiley, page 1029)

roughly translates to:

Investment Profit = growth of investment share price + dividends if applicable * risks I know about that are possibly going to occur (beta-likely things) * unknown risks I don't know about that are possibly going to occur (exogenous things)

I view these 'e' uncertainties of the market/s as gravitational-like-affecting forces, similar to a planet (the Market) and its multiple 'e' moons affecting the planet tides. Then, if one doesn't know the orbits of the moons (see 'a' above) and/or their respective orbits are random / erratic (see 'b' above), the 'e' effects exert influences that push and pull the market.  Sometimes the direction is good, sometimes not. 

Which all reminds me of the Chair's recent Lotak Volterra equations information, and a lecture during a university optimization class where Dr. Pugh (Indiana-Purdue Fort Wayne chair of Engineering Technology Dept) went through a very similar discussion about "Why Things that are Normally Stable Suddenly Change".  He was diagramming essentially identical graphs using Hare and Fox populations.

Leo Jia writes:

Why 5 whys?

Welcome to the list, Rich.
 

Dec

4

 I did an interview at the Metals and Minerals Investment Conference in San Francisco. I gave a talk with more details on gold at the same conference. I comment on stocks vs. bonds. This is my 11 minute interview starting 30 seconds into the interview time.

Comments welcome!

Leo Jia writes: 

That is a very interesting interview. Thanks Bud.

Regarding big banks' manipulation of gold and silver, I have read such speculations for a few years. I often wonder how this can be possible given that there are big capital in the world that is not part of the banks. Why wouldn't they come in and break the manipulations and make money at the same time? Perhaps in the way Soros broke Bank of England?

Bud Conrad responds: 

Yes, Leo, you have read those speculations for years — and for years those who put them forth have been viewed as members of a lunatic fringe. The most frequently heard dismissal of the case was, to the effect, "anything that big could not go un-noticed." Yet, as we have discovered in recent years, the LIBOR market and the swap markets have, in fact, been rigged. Each, as I understand it, are much larger and more vital than the gold/silver markets. Why anyone remains doubtful puzzles me…
 

Nov

20

 I watched the 3D version of the movie Gravity yesterday in a remote city theater in China. I noticed on IMDB that the official showing date is Nov. 20th. I wonder how it gets shown in China a couple days earlier. Perhaps because a Chinese satellite is featured in the film.

Anyhow, aside from a scene in space, the movie's story is very simple and nearly empty. It goes basically like this: while in the wild away from home, two teenagers suddenly discovered their bikes got ruined. To save the stranded girl, the boy surrendered his life. Then the girl struggled to reach to other unattended bikes. She finally got one (a Chinese one), and returned home with it.

I noticed it is rated 8.5/10 on IMDB, an unbelievably high score. It seems like a scam to me. I would give it 5 only for the space scene, otherwise just 2.

Sep

27

I remember some stories in American history where farmers have lost big in playing agriculture futures. It looks like the same will happen to the coal riches in China. A new chapter in wealth transfer is likely starting.

Sep

18

Attached is a weekly chart of CSI300 index (representing 300 large stocks on Shanghai and Shenzhen exchange) from January 2007 to now.

Would anyone call an upcoming bull market from this?

Perhaps the chart is not too obvious yet. Fundamentally, it is true that many foresee a slowdown in GDP growth in the coming years. But what is important now is that people can anticipate some structurally healthy growth. And this is very different from the past 5 years when the growth seemed high but the market mainly saw it as unhealthy and stayed essentially hopeless. The new government seems to deliver a lot more confidence to the market with a new direction for the economy.

Any thoughts?

Bill Rafter writes: 

One suggestion I have is that you ask yourself two questions:

1. Consider the participants in that market; what time frame do they typically observe in terms of long term perspective (i.e. lookback period), and

2. How frequently do they watch the market?

The reason to care what others do is because they are your competition. The money you make, you get from them. Thus, know them!

Point #1 may also be related to taxation. Is there a period of time in China such that if a position is held that long it qualifies for a tax break? In the U.S. that means it qualifies as a "long term capital gain" with a significantly reduced amount going to the confiscatory government.

If there is no such period, then it's nice to see history going back to 2007, but it is irrelevant to what is happening now. However it is good to have history as you can easily see with a visual how a market behaves with the signal process you use. You should statistically test, of course, but a quick look is valuable. (Tukey said so, and he is a god in this area.)

Thus your window of observation for decision making (as opposed to history) should not go back perhaps more that 50 percent greater than the period identified in point #1. In our case (in the U.S. with equities), we do not look back farther than a year and a half. Frequently as little as four days.

Point #2 is the shorter end. If everyone watches the market every day, then by limiting your snapshots to weekly, you are discarding valuable information. Ask yourself, "Why would you ever want to eliminate valuable data?" You would not do that with a neural net, so why do it with real intelligence? Some would posit that weekly information (data or charts) eliminates some noise. However we would argue (and have demonstrated) that it is impossible to separate signal from noise. Specifically I would suggest that if someone gave me what they considered noise, I could find some signal within. It may not be the best example of signal, but it's in there.

Leo Jia adds: 

Thank you very much, Bill, for the precious advice.

There are a couple reasons for me to have attached the weekly chart starting from 2007.

1. I look for a possible multi-year bull market, and for that to me the trend looks clearer on the weekly chart.

2. One key reason for the past few years' laggard market, aside from those fundamental reasons I outlined, is the bull-run and crash in 2007-2008. The bull-run was solely due to the government reform initiative in the stock market which tried to ensure all shares (government shares and floating shares) to be equal. The crash then was mainly due to market suspicion that the resulting floatable government shares would subsequently flood the market. Now 5 years over, the flooding of the government shares, if that happened indeed, is likely to have settled down.

To answer your two questions:

1. There is no tax incentive in China encouraging people to hold longer. Holding period are generally much shorter. It can be as short as a few months for funds, and as short as a few days for individuals.

2. Most participants watch the market everyday.

Perhaps one thing different in China's market is that large market movements are all initiated by government policies. Market enthusiasm are only summoned when the imagination of a government direction as positive.

I am not a government analyst, but traditionally, each government in its 10 years tended to create at least one big upward move in the market. Looking at this government, its initial months already showed signs of its focus on finance (along with new direction on economy). The recent launch of bond futures is one such key move.

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Sep

18

This is a great TED talk on "How to Make Stress Your Friend":

Stress. It makes your heart pound, your breathing quicken and your forehead sweat. But while stress has been made into a public health enemy, new research suggests that stress may only be bad for you if you believe that to be the case. Psychologist Kelly McGonigal urges us to see stress as a positive, and introduces us to an unsung mechanism for stress reduction: reaching out to others.

To your health!

Sep

16

 There have long been debates on whether people are rational or biased and irrational. Works by Tversky, Kahneman and et al seem to have directed our view toward the latter. But which view is really correct? Are we admirably rational in our choices, as the classical economists assume, or are we hopelessly irrational, as the behavioral economists claim? The author of this article "Sex, Murder and the Meaning of Life: the evolved wisdom behind our seemingly stupid decisions" is contending an alternative view that "our decisions are in fact biased, but in ways that reflect an evolutionary Deep Rationality".

As this would fundamentally affect our way of trading, I really would love to hear Dailyspecs' comments.

In addition, does the trading community today mainly believe that people are rational or biased and irrational? To your understanding, is there any view that dominates the trading community at the moment?

Aug

16

Attached is 15-minute chart of Shanghai A-Share Index, starting from morning of Aug. 5th to 1:50pm today [August 16, 2013]. If you can not read the numbers very well, the highest is marked as 2191 and the lowest (about the 10th bar from the right starting at 10am today) is 2061. The 5th bar from the right starts at 11:15am and is the last bar before lunch break at 11:30. The 4th bar from the right starts at 1pm and is the first after the lunch break.

There were some huge and sudden buy volumes on large cap stocks right before lunch break. The reason is unclear at this time.

(A small note about this chart: in China rising price bars are red, falling price bars blue or green).

Alex Castaldo adds:

See  this news article "China Trading Error " for a possible  (after the fact) explanation.

Leo Jia follows up:

Everbright Securities has admitted it as a trading error and has petitioned to the authorities to void the trades, but it seems that the authorities didn't approve.

But the complication is what happened after the "error". All stock trades are T+1, so Everbright could not sell what it bought on Friday. To the best it could, it redeemed as many stocks as it could to ETF shares and sold the ETF shares on Friday. It also greatly increased its short positions in the index futures, resulting it being the largest short position holder of the index futures with a total of 7130 contracts. Everbright claims these are all defensive activities.

Clearly all these will cause more stir in this coming week. But what is important is to see how the authorities will treat this case after their investigations. The short positions give people reasons to question that it could very well be a calculated activity to manipulate the market. The hope is that the authorities doesn't open a door now for similar type of manipulations in the future.

Aug

15

 I'm just curious: why is the rice market small when the crop is so popular all over Asia and Asia has so much population? Is is because the Asian country make it a priority to be as self-sufficient as they can be even when it's not economical?

Leo Jia writes: 

As a picky rice eater, I think the large varieties of rices segment the rice market. All these rice are not the same at all though they may look very similar. The majority of rice produced in China is a hybrid rice developed by a contemporary Chinese scientist named YUAN Longping. Its mouthfeel is horrible, but it is much cheaper and contributed largely to feeding the large population in the country. Sogi-san commented that rice in Japan costs 4x or more than it does in the US. I am not sure if he referred to the same rice, but to my taste, some Japanese rice are much better than the American one.

There are two rice futures in China, but to my understanding they are both of some small varieties and therefore traded thinly.

Jeff Watson writes: 

Rice is a thin market because the insiders want to keep it that way, and the export market is small compared to other staple grains and grasses. Furthermore, rice tends to be consumed in the country of origin. We export around 3 million metric tonnes if memory serves me correctly, which is about half the US crop.

Aug

14

According to my reference "A Market Profile is an intra-day charting technique (price vertical, time/activity horizontal) devised by J. Peter Steidlmayer".

Price is plotted on the y axis.  At the end of the day using tick data a histogram or probability density is plotted in the x direction showing essentially how much time was spent (or how many contracts were traded) at a given price level. (For those interested there is a video presentation on the CMEgroup web site).

Some Chinese trading software has this feature built in. The volumes corresponding to price levels can be shown together with the price chart.

Years ago when I first discovered it, I was very fascinated as it appeared to work very well as a very good indicator for support and resistance levels. But later I found that it was only calculated (or simulated) and did not contain real facts, and I haven't paid too much attention since.

The issue I had is this. Say at some point someone bought N number of shares of a security at price X. Clearly, the software has no problem of recording volume N at price X, but the problem it has is to correctly remove the volume of the current seller(s) that was previously recorded when they bought. As a result to me, the volume profile might just be a guess work.

Did I miss something? Any comments on how one can better use this feature?

Aug

14

Morgan Stanley states: "China relies more on indirect or transaction-based taxes, such as business tax, VAT, and consumption tax".

I just noted during the last few days that retail sales tax is about 20% in China. I wasn't quite clear about this number before as Chinese stores never charge for tax, i.e., tax is never itemized on the receipt. Plus, all merchandise are marked with prices including the tax.

I only noticed this at the cashier of Metro (the German warehouse store) when she told me the total price was 630 yuan but I saw on her monitor a number of 530 yuan. Looking carefully, the total of 630 included a tax of 98.

Ironically, the Chinese prefer a quoted price including the tax. The first culture shock for American businesses as I experienced years ago was that Chinese buyers don't like to see a quote with tax listed as extra.

This is an interesting article: "How China's Tax Structure Crushes the Poor".

Aug

6

To give a fuller perspective of the Chinese stocks, I attach some charts of the different markets. All these are weekly charts from 2006 to now.

To start with,the first here is the Shanghai-Shenzhen 300 Index, comprising the 300 largest stocks on both exchanges. This is the base of the Index futures currently traded on Shanghai Financial Futures Exchange.

Sh Sh 300

 
The Second is the Shanghai 50 Index, comprising the 50 largest stocks on the Shanghai Exchange.

Sh 50

Most stocks in the above two indexes are of state owned enterprises.

These stocks and the index futures are only available to domestic Chinese and are priced in Chinese Yuan.

As we can see, both are at quite depressing levels.

Third is the index of small caps on the Shenzhen exchange. This comprises stocks of all small, and most importantly, private businesses. Again these are only available to domestic Chinese and are priced in Chinese Yuan.

small cap

To compare with the two large cap indexes, this is not nearly as depressing. 

Now here are two indexes of stocks priced in other currencies and available for international traders.

The first is Shanghai B-shares index. It comprises all of the less than 100 stocks priced in USD on the Shanghai exchange.

Shanghai B

The second is the Shenzhen B-shares index. It comprises all of the less than 100 stocks priced in HKD on the Shenzhen exchange.

Shenzhen B

While the Shanghai index not too depressing, the Shenzhen index is actually somewhat strong.

Aug

6

 I just stumbled upon this inspiring post: "20 Ways to Get Good Karma" by the Dalai Lama. Many teachings can be directly applied to trading, such as:

1. Take into account that great love and great achievements involve great risk.

2. When you lose, don't lose the lesson.

3. Follow the three R's:
- Respect for self,
- Respect for others and
- Responsibility for all your actions.

5. Learn the rules so you know how to break them properly.

7. When you realize you've made a mistake, take immediate steps to correct it.

8. Open your arms to change, but don't let go of your values.

18. Judge your success by what you had to give up in order to get it.

Jul

17

 Laurel told me her flight to Shanghai from the regional airport of Yichang was delayed 20 hours. I must admit I don't fly very frequently (thank God), but none of my flights in recent years were on-time, and this is countrywide not only in Beijing and Shanghai. Best delay was 3 hours and worst was 12 hours. This is much worse than say 5 years ago. It is a serious detriment to businesses and I believe it serves as a big drag to the economy. The key reasons as cited in the article are poor air traffic control and the occupation of the air space by the military.

Victor Niederhoffer writes:

I have heard that it is impossible to check your bags through from one country in China to the other and this adds to the number of delays which I have also heard comes from the restricted air space with the rest allocated to flexions.

"China's Airports, World's Worst for Delays"

Jul

17

I believe the sun combined with a comfortable climate is key for happiness. People, and all organisms, are just more active in it. Places like Boston or New Jersey just don't have it. A former classmate couple who moved from Chicago to Silicon Valley told us their feelings during the initial days was always like "Oh, the weather is great today, let's go do something" until they found the weather is always great.

Jul

16

 I found there are many similarities between trading and playing poker (Texas Hold'em).

1. In both games, at first one is presented with an opportunity. In trading, this is the time one starts to decide whether one should make an entry; and in poker, this is when one is dealt with the first 2 cards. One calculates at this time the chances and the expectations and makes a decision on whether to proceed and how much money to put in.

2. While holding, one is constantly presented with the potential possibilities to win or to lose. In trading, this is reflected by the ups and downs of the equity value; and in poker, every new card coming to the table alters one's chances. During this time, one constantly calculates the chances and the expectations and makes decisions on whether to continue holding and whether to add or reduce one's position (in poker one can't reduce).

3. At closing, in poker, this means the final showdown; and in trading, this is when one has to close out the position. Only at this point, the possibilities to win or to lose are realized.

Probably one crucial difference is that in trading one does not have a way to bluff, unless one is a heavy weight in the market. But it is quite the same in both games that one is often bluffed at.

John Netto responds: 

I feel compelled to respond given I have used both mediums as a way to make a living. No comparison between poker and trading is complete without examining the ancillary issues such as transactional costs and liquidity.

In poker, the house takes a rake on every pot and for every orbit (time the dealer button goes around the board), a player must post a big blind and a small blind. The rake can be as small as 5% and as high as 20 percent given the venue and size of the pot.

In trading, one might pay a small fee for software or data, but on a percentage basis, this is substantially less. Overall, these are real factors for a number of professional cash game players in computing their positive expected return.

Liquidity is another issue. You are at a table with 8-9 other players and the higher the stakes go, the more seasoned and experienced the players are.

Therefore, assessing the "volatility" of a table is critical as a trader who likes to be long a lot of gamma, I like to be in games where the players are looking to gamble and mix it up in a lot of pots and chase down their draws at bad payouts.

Jun

7

 The Fortune Global Forum 2013 is being held at the Shangri-La Hotel in Chengdu between June 6th and 8th.

Someone has started a new campaign to name Chengdu (a 2,500 year old name, which literally means "becoming a capital") City of Fortune and Capital of Success.

The participants in the forum are listed here and the agenda is here.

From Xinhuanet: "This is the 12th annual forum held by Fortune magazine. It's also the first one hosted by a western Chinese city, following Shanghai, Hong Kong and Beijing. Chengdu is the capital of Sichuan Province and is a rising economic engine in China's "West Development Strategy". Last year, Sichuan Province ranked in the top 10 in terms of foreign direct investment utilization."

From China Daily's article "Chengdu gains from Fortune Global Forum":

More than 600 state leaders, CEOs of world-class companies and economists from around the world have registered for this year's event under the theme "China's New Future".

The city will enrich the forum, as it is pertinent to its theme and this year's core topics: sustainable development, innovation and technology.

The city's good infrastructure, convenient transport links and logistic systems, comparatively low labor costs and efficient administration system have attracted 238 companies out of the world's top 500 to the city. Chengdu's GDP was 800 billion yuan ($127 billion) in 2012, accounting for one third of Sichuan province's economy and 8 percent of western China's GDP.

May

28

Aversion to losses or aversion to risk? Which of the two is addressed by willingness and ability to close out losing trades?

Well, without invoking mathematics where it is not necessary, it is common and logical to place on the table that when a losing trade is closed one has the willingness and aversion to the risk of the persistence of loss becoming into a bigger one and one does not have aversion to the present level of loss in being accepted.

Now on the other hand, unwillingness to stop out a losing trade is indeed loss aversion.

The computations that show that having utilized some sort of mechanical rules for stopping out adverse incursions actually increased the probability of meeting with adverse incursions is totally flawed abuse of statistics.

Several arguments:

1) Historical data analysis does not undertake the "uncertainty at a given moment to decide upon" into account and is definitely incorporating hindsight 20:20 vision mind-set.

2) Any measurements of uncertainty and thus risk are never definite, since measurement of uncertainty too will be having an uncertainty of its own. So a trader in the middle of a losing trade has to decide that the level of uncertainty in his method, mind or cognition regarding the calculation of the "value of uncertainty" in his trade has become too high for him to handle. That's where humility, the currency that prevents others from profiting more from your mistake, can come into play and allow the willingness to hit the stop.

3) However, when either with or without the illusions of statistical computations of stop losses increasing the probability of meeting with more losing trades, one fails to control the human weakness of loss aversion, to somehow and anyhow turn that loss into a profit, one is becoming totally risk-insensitive. From skill, the turf changes to the power of prayer. The game begins to change from action to hope. Inconsistency of thoughts thus turns one into a trader who is continuing to hold on to risk without a mental apparatus to assess it or react to it. As the loss continues to grow not only the lack of willingness to take it hurts, the ability to accept the increasingly bigger loss also dwindles rapidly.

I am ready to be thrown before any firing squads of mathematical minds and ideas on this list if they can with or without numbers help me learn how come this list celebrates and cherishes a human value of humility and yet indulges in an idea that staying on in a trade that has incurred a level of loss greater than anticipated when the trade was opened are mutually consistent.

I would close my submission for now with one thought:

When loss aversion creeps in it makes a decision system (mind) risk-insensitive and with no respect for risk, returns are impossible. Yet, if a mind continues to be risk-averse it does not have loss-insensitivity and in humility such a mind closes out risk that has turned out to be less than comprehensible.

Phil McDonnell responds: 

Since I am the well known culprit I shall give Mr. Kedia a reply. If the probability of a decline art the end of a period of time equal to your stop is p then the probability of losing the stop amount with a stop loss strategy is 2 * p. It is simply a derived relationship. It is what it is.

It is not a misuse of statistics but rather a description of how a stop loss exit strategy will change the distribution of returns. Larry Connors studied over 200,000 trades from a winning system and compared the results with and without stops. He found the use of stops increased the probability of loss and reduced the expected gain.

In my opinion the best way to trade is to reduce position size so that no one loss hurts your account too badly. That means many small positions to me.
 

Larry Williams adds:

Ahhh here I go off on a rant; please excuse a tired old mans bitterness at system vendors who claim stops hurt performance.

Yes, they are correct in that the statistics of your system will look better if one) you don't use a stop and two) your use a market with a perpetual upward bias like the stock indexes have been, usually.

They are absolutely totally incorrect in terms of living the life of a trader. So what if I am long in a position that eventually shows a profit but because I did not have a stop loss that one trade moved against be 20,000 or $30,000 and it took a year or so to get out of? Yeah, the numbers look good (high accuracy) with no stops but it's one hell of a lifestyle.

High accuracy is a false God.

Consistency and never being in a place where you can get killed is more critical. Perhaps Mr. Connors has never sat through the reality of a large loss, especially in a large position. I have; I would rather battle the devil at midnight on a new moon with both hands tied behind my back.

It's one thing to have a system with "good numbers" it is quite another thing to be a trader and have to deal with reality.

It only takes one bullet in the chamber to kill you when playing Russian roulette. As near as I can tell trading without any stops, in any way whatsoever, is just the American version of this form of spinning the wheel.

Play the game as you wish but please heed the warnings of an old man.

Leo Jia adds: 

I have been studying the use of stops. Due to loss aversion I guess, I would like to use narrow stops. But among the various strategies I have yet found one working well with narrow stops. Good stops have to be relatively wide in my cases, but having no stops or stops that are too wide clearly hurts results (my trades are time limited). So a good choice for me is to size the position according to the stop size.

Sushil Kedia writes: 

If you reduce position size can it be argued that a position of Size N reduces to N-n implies that you took a stop loss on n lots out of N you held. Then too, it validates the fact that you do take stops.

Anatoly Veltman writes: 

Larry covered main bases (different markets, different position sizes, different lifestyles) pretty well. I just want to be sure that reader doesn't end up with wrong impression. I think the best conclusion is "it depends".

And because my act follows Larry's (who is certainly biased in favor of stops), let me try this. If you enter based on value (which is certainly against trend), then there is no justification available for a stop. Unless you argue that this stop proves you were an idiot on the entry. But if you are an idiot on value entries, then why play value…

Anton Johnson writes: 

 The problem with using Conners' simulation as evidence that placing a trade stop-loss reduces returns is that he tested a winning system that likely had never experienced any 5-sigma negative excursions prior to the test date. And of course there are no guarantees that his strategy, or any unbounded trading strategy, will perpetually avoid massive drawdowns.

When implementing a strategic trade, a good compromise between profit maximization and loss mitigation can be achieved by balancing trade size along with a stop-loss, which when placed at a level that only an extreme event will trigger, will likely contain losses to a predetermined range, and also prevent getting stopped-out of a potential winner. If one is disciplined, maintaining a mental stop-loss level is preferable to an order pre-placed in the book, and available for all the bots to scan.

Larry Williams adds: 

But speaking of stops, I go back to my litany, my preaching the essential reason for never putting stops on an exchange server, or even your brokers server. Putting stops on servers means that your stop becomes part of the market. And not in a positive sort of way either. Pick a price, hit the button, and take the hit. Discipline is key here.

Ed Stewart writes: 

A trader needs a decision process for managing the expectation or expected value of the trade as well as the equity position. The problems occur when these two things are in conflict.

The thing with stops is that at times it makes no sense to get out of a trade when the expected value is still good. What is the difference between exiting at a small stop-loss point 4X in a row vs. one loss of that same size? Well, if at each "stop out" point the expected value was favorable, it makes no sense, one is just locking in losses. At times the best "next trade" is simply staying in the current trade.

However, I see Larry's point and it is a good one. Yet, the example of letting a loss get huge or holding an underwater position for a year is to me something of a false alternative. No exit strategy but hoping for a profit at some point is not a reasonable alternative.

What maters, I think, is the expected value of the trade at each moment, and balancing that against equity and a margin or error to ensure, "staying in the game".

Given this I always trade with mental stops, if not on individual positions, on total account equity. Having that "self-preservation" discipline is useful.

Jeff Watson writes: 

I learned very early on in the pit on how to go for the stops, and that weaned me off of stops completely (except in my head).

May

14

 I first saw the 'dead eyes' look of a poker player/loser when I was 13 or so. Still gives me restless nights and I know I cannot become that way.

My dad took me into the "stockman's bar" in Billings, Montana to impress upon me what degenerate, greedy people turn into.

Probably another sleepless tonight tormented by that devil.

Gary Rogan asks: 

What is the real difference between gambling and speculation (if you take drinking out of the equation)? Is it having a theory about the odds being better than even and avoiding ruin along the way?

Tim Melvin writes: 

I will leave the math side of that answer to those better qualified than I, but one real variable is the lifestyle and people with whom one associates. A speculator can choose his associates. If you have ever been a guest of the Chair you know he surrounds himself with intelligent cultured people from whom he can learn and whom he can teach. There is good music, old books, chess and fresh fruit. The same holds true for many specs I have been fortunate to know.

Contrast that to the casinos and racetracks where your companions out of necessity are drunks, desperates, pimps, thieves, shylocks, charlatans and tourists from the suburbs. Even if you found a way to beat the big, the world of a professional gambler just is not a pleasant place.

Gibbons Burke writes: 

 Here is something I posted here before on this distinction…

Being called a gambler shouldn't bother a speculator one iota. He is not a gambler; being so called merely establishes the ignorance of the caller. A gambler is one who willingly places his capital at risk in a game where the odds are ineluctably, mathematically or mechanically, set against the player by his counter-party, known as the 'house'. The house sets the odds to its own advantage, and, if, by some wrinkle of skill or fate the gambler wins consistently, the house will summarily eject him from the game as a cheat.

The payoff for gamblers is not necessarily the win, because they inevitably lose, but the play - the rush of the occasional win, the diversion, the community of like minded others. For some, it is a desire to dispose of money in a socially acceptable way without incurring the obligations and responsibilities incurred by giving the money away to others. For some, having some "skin in the game" increases their enjoyment of the event. Sadly, for many, the variable reward on a variable schedule is a form of operant conditioning which reinforces a compulsive addiction to the game.

That said, there are many 'gamblers' who are really speculators, because they participate in games where they develop real edges based on skill, or inside knowledge, and they are not booted for winning. I would include in this number blackjack counters who get away with it, or poker games, where the pot is returned to the players in full, minus a fee to the house for its hospitality*.

Speculators risk their capital in bets with other speculators in a marketplace. The odds are not foreordained by formula or design—for the most part the speculator is in full control of his own destiny, and takes full responsibility for the inevitable losses and misfortunes which he may incur. Speculators pay a 'vig' to the market; real work always involves friction. Someone must pay the light bill. However the market, unlike the casino, does not, often, kick him out of the game for winning, though others may attempt to adapt to or adopt his winning strategies, and the game may change over time requiring the speculator to suss out new rules and regimes.

That said, there are many who are engaged in the pursuit of speculative profits who, by their own lack of skill are really gambling; they are knowingly trading without an identifiable edge. Like gamblers, their utility function is not necessarily to based on growth of their capital. They willingly lose their capital for many reasons, among them: they enjoy the diversion of trading, or the society of other traders, or perhaps they have a psychological need to get rid of lucre obtained by disreputable means.

Reduced to the bare elements: Gamblers are willing losers who occasionally win; speculators are willing winners who occasionally lose.

There is no shame in being called a gambler, either, unless one has succumbed to the play as a compulsion which becomes a destructive vice. Gambling serves a worthwhile function in society: it provides an efficient means to separate valuable capital from those who have no desire to steward it into the hands of those who do, and it often provides the player excellent entertainment and fun in exchange. It's a fair and voluntary trade.

Kim Zussman writes:

One gambles that Ralph and/or Rocky will comment.

Leo Jia adds: 

From the perspective of entering trades, I wonder if one should think in this way:

speculators are willing losers who often win; gamblers are willing winners who often lose.

David Hillman adds: 

It is rare to find a successful drug lord who is also a junkie. 

Craig Mee writes: 

One possible definition might be "a gambler chases fast fixed returns based on luck, while a speculator has time on his side to let the market decide how much his edge is worth."

Bill Rafter comments: 

Perhaps the true Speculator — one who is on the front lines day after day — knows that to win big for his backers, he HAS to gamble. His only advantage is that he can choose when to play. 

 Anton Johnson writes: 

A speculator strives to be professional, honorable, intellectual, serious, analytical, calm, selective and focused.

Whereas the gambler is corrupt, distracted, moody, impulsive, excitable, desperate and superstitious.

Jeff Watson writes: 

I know quite a few gamblers who took their losses like men, gambled in a controlled (but net losing manner), paid their gambling debts before anything else, were first rate sports, family guys, and all around good characters. They just had a monkey on their back. One cannot paint with a broad brush because I have run into some sleazy speculators who make the degenerates that frequent the Jai-Alai Frontons, Dog Tracks, OTB's, etc look like choir boys. 

anonymous writes: 

Guys — this is serious, not platitudinous, and I can say it from having suffered the tragic outcomes of compulsive gambling of another — the difference between gambling and speculating is not the game, the company kept, the location, the desperation or the amounts. The only difference is that a gambler, when asked of his criterion, when asked why he is doing this, will respond with "To make money."

That's how a compulsive gambler responds.

Proper money management, at its foundation, requires the question of criteria be answered appropriately, and in doing so, a plan, a road map to achieving that criteria can be approached.

Anton Johnson writes: 

It's not the market that defines whether a participant is a Gambler or a Speculator, it's his behavior.

Gibbons Burke writes: 

That's the essence of my distinction:

"gamblers are willing losers who occasionally win"

That is, gamblers risk their capital on propositions where the odds are either:

- unknown to them
- cannot be known

- which actual experience has shown to have negative expectation
- or which they know with mathematical precision to be negative

They are rewarded for doing so on a random schedule and a random reward size, which is a pattern of stimulus-response which behavioral scientists have established as one which induces the subject to engage in the behavior the longest without a reward, and creates superstitious as well as compulsive behavior patterns. Because they have traded reason for emotion, they tend not to follow reasonable and disciplined approach to sizing their bets, and often over bet, leading to ruin.

"speculators are willing winners who occasionally lose." That is, speculators risk their capital on propositions where the odds are:

- known to have positive expectation, from (in increasing order of significance) theory, empirical testing, or actual trading experience

They occasionally get unlucky, and have losing streaks, but these players incorporate that risk into the determination of the expectation. Because their approach is reason-based rather than driven by emotion, they usually have disciplined programs for sizing their bets to get the maximum geometric growth of their capital given the characteristics of the return stream, their tolerance for drawdown.

If a player has positive expected value on a bet, then it is not a gamble at all. The house does not gamble. It builds positive expectation into its games. It is a willing winner, although it occasionally loses.

There are positive aspects of gambling, which I have pointed out earlier in the thread and won't belabor. To say that "all gambling is bad" is to take the narrowest view. Gamblers who are willing losers (by my definition all are) provide the opportunities for willing winners (i.e., speculators) to relieve gamblers of the burden of capital they clearly have no desire to hold onto, or are willing to trade in a fair exchange for the excitement of the play, to enable their alcoholic habit, to pass the time, to relieve their boredom, to indulge delusions of grandeur at the hoped-for big win, after which they will quit playing, or combinations of all of the above.

Duncan Coker writes: 

I found Trading & Exchanges by Larry Harris a good book on this topic and he defines all the participants in the exchanges and both gambler and speculators have a role to play. Here is something taken from page 6 that make sense to me: "Gamblers trade to entertain". Speculators to "trade to profit from information they have about future prices."

He divides speculators into those that are well informed versus those that are not. One profits at the expense of the other. Investors "use the markets to move money from the present into the future". Borrowers do the opposite.

Apr

30

 "Those well-known experts who had pulled off a big windfall by going against the tide and winning were, over the long term, the worst at forecasting."

That sounds understandable to me, and there is a research to prove it.

The original article on Harvard Business Review requires registration.

Victor Niederhoffer writes:

This article provides confirmation of the idea that has the world in its grip. Egalitarianism prevails. Especially at Harvard. I will have to read the article to see all its biases. But it was guaranteed to be published in the HBR.

Rudolf Hauser writes: 

Not having read the HBR article, I cannot comment on that particular study. But I would note that the nature of the forecast and time frame are important considerations. The news article did note that the study only looked at three years of data. If the forecast related to only quarterly trends the conclusion that it might have just been a fluke forecast could be valid. But say someone had predicted the financial collapse we saw in 2008 with valid reasoning but was off in timing. In that case his or her forecast would be wrong for part of the time but someone who acted on it might have had some years of underperformance but avoided the debacle that was to come. That forecaster might be someone to listen to in the future. But even being right once for the right reasons does not mean that the person will be correct all the time on such major calls or even that they will ever be right again. In the end, one should listen to the reasoning but make one's own decisions.

Apr

29

 I heard someone the other day say the "wrong route be easy" whereas the "right path will be hard." I challenged them to defend this principle!!! This is an annoying empty platitude. Both in markets and in life.

If you want to be a poet, please recite the rhyme of the ancient mariner instead. If you want to be an ascetic, please get your philosophy correct. If you want to be a trader, recognize that pain means you were WRONG.

On what basis do you argue that "on the wrong road, you find success and happiness initially but in the end you lose; whereas on the right path, you suffer but eventually win."

By this standard, if you allow me to hold your head underwater for the next 2 hours, it's a winning "position".

PLEASE!!!

Perhaps I should go back into my brain hibernation — from which you awakened me 50 hours ago!!!

Leo Jia writes:

Thanks for the wonderful argument, Rocky.

On a single trade, I am totally with you in that one should quickly recognize and correct mistakes. But on an entire trading career, this is generally not the case. I don't know how you learned to trade, but along my experience, which I believe is also quite similar for many successful traders, there have been a lot of difficulties. Should I or those many others have better quit early along the way? One simple example that perhaps best reflects this in life is on choosing careers. The easy (and likely the wrong) route is to get employed. The hard (and likely the right) route is to start one's own venture.

Stefan Jovanovich adds: 

I am the 3rd generation of Jovanovich to subscribe to the belief that "good business happens quickly". Depending on how you would include joint ventures/partnerships in the count, Eddy's Mom and I have started between 8 and 12 businesses and run them until they were either sold, shut down or the Peter principle applied to our management skills. In every one the test was the same: you made money within a matter of a few months or you never made it at all. These rules do not apply to venture capital or any other start-up where the loss of the money invested would make no difference to the lives of the investors. They apply absolutely to the opening of noodle stands ("broth runs deep in our veins, son") and other enterprises that start from scratch without any scratch.

The other rule is that sick businesses cannot be cured or "turned around"; they can be liquidated, as Secretary Mellon advised; but they cannot be saved as enterprises once the rot has set in.

Apr

26

 "Bringing People Back From the Dead" :

"While 45 minutes is absolutely remarkable and a lot of people would have written her off, we now know there are people who have been brought back, three, four, five hours after they've died and have led remarkably good quality lives,"

"after the brain stops receiving a regular supply of oxygen through the circulation of blood it does not instantly perish but goes into a sort of hibernation, a way of fending off its own process of decay."


It would be very interesting to know how long the brain can stay in this hibernation state. 

Apr

26

"How Knowledge Can Make You Stupid" :

Being unable to assess somebody else's beliefs with 100% accuracy is a problem, and if it's your own knowledge that get in the way, that means it's even more important to ensure the beliefs you hold are the correct ones.

This research is very interesting. How can we know better where the market will go? Does it pay for one to know more than what the market does? Or is it worth it for a trader to spend all his effort to absorb all the information? The research seems to say no. Knowing more doesn't make one more correctly predict what others would do.

Another situation to which this may apply is financial bubbles. We believe that bubbles are caused by people's irrationality. But perhaps that understanding is not enough. A bubble may just be caused by people's inability to judge others' thoughts. Since mostly everyone knows something that others don't, that information gets magnified in the bubble when people who know it assume that others would also use it to value the situation when in actuality those others don't really have that information.

Apr

1

Does anyone feel like an idiot when your system encounters a series of losses? I know it is not warranted, but subconsciously I have that feeling and I don't have a good way of getting rid of it. Any advice please.

Mar

22

"Computer Simulations Reveal Benefits of Random Investment Strategies Over Traditional Ones"

There is a link at the end of the article to the original research paper.

Would love to hear all dailyspec readers comments.

Alex Castaldo replies:

This article is written by some Italian physicists who like to play with stock market data. It does not tell me anything about real world investing.

The title of the original paper is "Are random trading strategies more successful than technical ones?". Somehow in the news article "technical strategies" was changed to "traditional strategies", distorting the meaning. The specific four strategies considered are 7-day momentum, RSI (relative strength index), reversal of the previous day and MACD (Moving Average Convergence Divergence).  (How many traditional investors such as mutual funds or pension funds use MACD etc. to manage their billion dollar portfolio?).

The paper measures "success" by the percentage of times the subsequent direction of the market was correctly predicted (a number between 0 and 100%). In the real world success is measured by the amount of money made, not just the success ratio and it has to be judged in view of the level of risk taken (which the paper does not consider at all).

This is an example of an impressive looking paper, with beautiful figures and charts, numerous (55) footnotes but *SIGNIFYING NOTHING* and having no value to investors or traders. It does not even tell us whether the technical rules would have worked or not with real money.

Mar

13

 I spoke with a dear friend in the SF Bay area. He's a real estate agent on the peninsula south of San Francisco. He indicated that the housing market there is so hot, it's hotter than it was in 2006-7, and rivals that of 1998-9, when houses on the peninsula and in Silicon Valley were sold within hours of listing. This seems to me to be unsustainable, except he said there's lots of demand from Chinese immigrants paying in cash, as well as other Asian immigrants putting down 60-70 percent of the purchase price and financing the rest. I don't think this will have a pleasant ending.

Leo Jia writes: 

It looks the Chinese buying will continue for sometime. They are crazy about housing. The decades or centuries of housing shortage must have altered their genes. And now when some have some money, they will chase at any price what they feel missing mentally. America (particularly the west coast, traditionally with more Chinese) clearly is a top choice for many.

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.

Mar

10

Here is another inspiring article for musicians, artists, and everyone else including traders.

"When You Win, Don't Atop: Tips for classical Musicians" by Cesar Aviles

Mar

6

"3D Printed Car is Strong, Light and Close to Production":

The car is strong as steel, half the weight of a conventional vehicle, and can be manufactured in a warehouse full of plastic-spraying 3D printers.

The teardrop-shaped 3D-printed car is an ecologically sound hybrid, and it looks cool, too.

Aerodynamic and futuristic, this car could be a total game-changer for the automobile industry, leading to a rise of small-batch automakers.

Mar

6

 You may be extremely upset by serious troubles just happening, but in 10 years, you will be feeling just fine about the current events.

"Persist until you bleed — otherwise it's not hurting enough." This article is for musicians, but I think it applies well for traders as well.

"Fly First, Then Land: Tips for Classical Musicians" by Cesar Aviles

Mar

4

 Complicated things of high quality don't just break down in a big cataclysm. Take a modern car. They are well built. The engine will last for half a million miles if properly maintained. However it is the little things that start breaking: the plastic ashtray falls out, the rubber seals wear, the bearing start getting loose, the fabric tears. These little things can get more serious. If the seal leaks, and the oil is low, the engine can wear prematurely. The shocks wear, and the ball joints go. The steering gets loose. Small things can lead to bigger problems. Take a modern city, like New York in the 70s. First it's some graffitti, then some broken windows, soon vagrants move in, garbage piles up and the city head to bankruptcy. It's the small things first. Take a huge economy like the US. The GDP isn't going to fall apart. Employment probably won't go off a cliff. It's going to be small things first. Take a corporation. The earning won't collapse right off. It will be receivables up, inventory up, sales down, or even smaller things. Maintenance up, or down. Take a market like the Nasdaq.

Leo Jia writes: 

These are very insightful. Our bodies are about the same. And while the destruction process happens this way, it is interesting to note the creation process is also quite like this. First, small trivial things get created, then the large more significant things. All things seem to move like this in circles. Bubbles start small, grow big, then shrink a little, then burst.

Jim Lackey adds: 

Hold on ther' hoss. The first thing we do, it wash, feed and stable the horses before the cowboys. This car post caught my eye. If the simplest part breaks, a mass air flow sensor, the engine runs rich and bad things happen. Yet we have a dummy light! Even back in the day we had dummy lights for high temp, or low oil pressure. These little 25-200 dollar parts break on brand new machines. Take the worn out 100k 7 year old car. Yes what you say is true. 35 years ago the 100k car may be dead in the crusher for scrap. Today what people thing of the heart of the car is the engine. With CNC , CAD and CAM all short for, computers do not have UAW contract for, tired nor sick nor go out of whack and slap together the last V-8 at the end of bowling night. Therefore the engines are designed and build and installed to Engineer spec. They do last for 250k. Most but not all of them do 250k except for the short cut copy cat Far East red flag waiving commies BYD my 6.

The little things that are build to spec yet cant possibly last for 7-12 years as you say rubber O rings, Balls joints, tie rod end,s brake rotors struts all must be changed or maintained. The most complex and weakest link of the chain on new cars is automatic transmissions. I made one the of the worst mistakes trading this week. I was taught about racing cars bikes and anything with an engine, failures. In a way we kept track of the max min wait time on a failure of a part. We change them at or before the median failure time. I forgot all about that for our trading. Didn't lose, it was much worse than that to a racer not winning is as painful as being on fire.

One spec posted a customer service report on cars and diamonds weeks ago. The gist was one man said change all parts. The other man said wait 5,000 miles. The implication was the second man said wait, and was best. What wasn't taken into account was two things. The performance of the car and his safety and time of a second trip to the shop. Other was the parts probably were not in stock at dealer B. There fore the guy simply told what most want to hear, no money today rather than we will have to keep your car over night as the parts are coming off the ship from Japan.

The discussion also goes to medical. too much of medicine is based on illness. When talking to my Docs and their ranges for normal I burst out and said, your kidding right? How do basic stats escape Medical training? How much better can we all feel if we did X and Y do the the people all wait until a breakdown and see the Doc for solution which prescribed as X. I know why. I did the same thing last week on my trading. I didn't consider wellness. I was waiting for the market to become sick then do trade X. My trading doc even warned me and kept me from having a bad loss. He was focused on wellness ( is best I can describe) I was looking for the illness. (Okay so the markets went 1530 to 1490 and I said why not wait for 1475 to come in? I pull my racing pits cap over my head and tell the wife, at least I didn't lose short)

How much better will a car perform with New tires brakes and rotors vs a car with 5,000 miles of anecdotal testimony to wait. I can give you the stats on new vs 20k or 40k miles and after one race on a real car. Racers change brakes and tires after each and every weekend. We rebuild engines most every weekend depending on class. In some pro classes we rebuilt engines after every single 1/4 mile run, new pistons, rods and bearings, Valve sprints and retainers, all seals and gaskets.

What the anecdote above states is the engine will run for 250,000 so then to should the car. Yet the car will not move with a broken ball joint. The engine will die with a broken timing belt and over heat with a bad water pump, that now last to 110,000 miles. So the engine system is still only good to run for 110,000 miles. The trans and rear end gears all die at 125-150 and the fuel pumps and all do the same. The catalytic converters die way before this. Most cars have a 5 year 100,000 mile warranty on the drive train. Its only 3/36 or 5/50k on bumper to bumper.. The emission control systems or parts are now only good for 80,000 miles.

So in theory your car is now worse than a 1969 model. It will break down and be non drive able 20,000 miles before the 1969 model died and went to the crusher. Yet your correct, at 80k miles your car will be fixed for 1,000 bucks and in 69 you needed a new engine trans and every hose belt and switch was dead.

This entire deal of failures was burned into my trading memory banks for life. I used it in some ad hoc way since MR Vic showed me in 2004. Yet the advances in his technology on how to quickly repair the trading engine and have it on the road to profitability was lacking by lackey.

The story I wrote about my teenager failing to appreciate the need for trans fluid made me dump the BMX van for 25% above scrap rates to a new friend. I am now shopping for a good used van. There is also a meme on pricing of used vs new cars. We try not use never always when it comes to life. Yet the financial advice out there has man a never and always do.

Too many men are all over the past 10 year return of stock at or about nil. The we are in a range trader calls have been falsified many times this decade. The SPU made a high in 07 the Russel or what ever made a high this year. Yet its true and maybe always is tr that not all stocks make a new high as the joke is many stocks fail to exist, survivor ship bias. Its all mumbo as they use all or this or that index.

Then to say all new cars have engines that run to 250k miles and do not fall apart all at once.. is also false. A brand new car has the ability to shit down or go into safe mode. Its broken according to our ladies who drive. It can only be idled at 35mph to your local shop. With palladium and platinum are such high prices the emission control systems are too expensive. The cars heart is not the engine, it never was the brain. It used to be the driver and the mechanic. Now its a computer. We have fire trucks that will not start if the diesel engines emission system is on soot burn mode.

Now we have computers in control of making markets for the global stock and futures markets. All economic reality seems to be lost in the short term. If political hack from Berlin says A and EU hack said confirm A and US is about to have a press conference you can forget about the next four hours prices being predictive. The markets computers go into safe mode. They will move and shut down quickly and we must, as traders idle at 35 MPH to our local dealer of data to find out what happens next after that part failure.

For what ever reasons I have gained my passion for markets back. Of course we know where we lost it. What makes men take risk? What makes risk takers skip a generation? Is that true? I had a friend as me this week about becoming a spec. I asked him to answer this one question. Would you rather trade your money and take risk per 500k account to eeke out a living or use another mans money and take 20% of profits yet no fees? I have asked this Q so many times and it reveals much about a mans capacity to take risk, yet most important to take pain. Ya see racers, we do not care about losing crashing or getting hurt. Its part of the game. We do not like losing, yet not winning that is so painful, like I said we wear fire suits and not winning is as bad as completely destroying your car on driver error and being on fire.

The gist of the answer is if your rather trad OPM you do not belong in the hours 1/2 day markets, ever. Do not do it..It has to be the hardest way to make a living. The easiest way if you have any capacity to sell or raise money is ride the tides and collect a fee. I am sure you can find a way to make a firm stand on the middle ground. Some fine research and pick some fine stocks and short some over plus commodities after the bubble has been busted and hold that roll that for years. Now you have the ability to take down a small fee and a profit incentive.

What has changed my attitude is being certain about one thing. These markets change direction and patterns change so quickly its fast, like racing and Fun! Where in the hades have I been the past few years not to look at all of this as a positive thing for, me. I love to go fast. lack

My motivational quotes for this week attached.

August 1908 issue of a periodical for bicyclists called "Bassett's Scrap Book". A short item contrasted the modern age to ancient times and presented a variation of the epigraph:

"Naram Sin, 5000 B.C. We have fallen upon evil times, the world has waxed old and wicked. Politics are very corrupt. Children are no longer respectful to their elders. Each man wants to make himself conspicuous and write a book."Johnson's often-quoted definition of genius, "the infinite capacity for taking pains."

"genius is inspiration, talent and perspiration." Kate Sanborn

The President of the Old Speculator's Club, Jack Tierney, writes: 

I seem to recall the name

Carnegie's "Gospel of Wealth" idea took his peers by storm at the very moment the great school transformation began—the idea that the wealthy owed society a duty to take over everything in the public interest, was an uncanny echo of Carnegie's experience as a boy watching the elite establishment of Britain and the teachings of its state religion…Since Aristotle, thinkers have understood that work is the vital theater of self-knowledge. Schooling in concert with a controlled workplace is the most effective way to foreclose the development of imagination ever devised. But where did these radical doctrines of true belief come from? Who spread them? We get at least part of the answer from the tantalizing clue Walt Whitman left when he said "only Hegel is fit for America." Hegel was the protean Prussian philosopher capable of shaping Karl Marx on one hand and J.P. Morgan on the other; the man who taught a generation of prominent Americans that history itself could be controlled by the deliberate provoking of crises. Carnegie used his own considerable influence to keep this expatriate New England Hegelian the U.S. Commissioner of Education for sixteen years, long enough to set the stage for an era of "scientific management" (or "Fordism" as the Soviets called it) in American schooling. Long enough to bring about the rise of the multilayered school bureaucracy. But it would be a huge mistake to regard Harris and other true believers as merely tools of business interests; what they were about was the creation of a modern living faith to replace the Christian one which had died for them. It was their good fortune to live at precisely the moment when the dreamers of the empire of business (to use emperor Carnegie's label) for an Anglo-American world state were beginning to consider worldwide schooling as the most direct route to that destination.

Mr. Krisrock writes: 

This happens when there is a world price for labor…that American foundations arranged for 100 years.

Jack Tierney responds:

I'll go along with the parts played by American foundations, but not the 100 years. In a recent book by David Horowitz, "The New Leviathan," he points out that many of the great foundations we still hear so much about have wandered substantially from the goals envisioned by their founders.

Among them are the Ford and Rockefeller foundations, as well as those of Pew and John MacArthur. Each accumulated substantial fortunes in very capitalistic endeavors…and expected their trusts to continue to promote efforts in that direction.

At first this worked as the initial appointed trustees were chosen by the benefactor. Over the years, however, (and this relates to my initial post) subsequent trustees went off in their own, very contrary direction. inevitably, they labeled these modifications as "progressive," a catchall phrase that seems to excuse almost any perversion of original intent.

Most of these changes in direction have occurred over the last 50 years as the original trustees passed away or retired. Only Olin was prescient enough to "sunset" his trust to forestall this drift.
 

Mar

1

 Irving Kahn is the oldest trader on Wall Street.

Here is a picture of Irving Kahn included in special free section of Nature on aging.

Mr. Kahn is now 107.

Correction:

World's oldest Value Investor. Duly noted (hat tip to Mr. Melvin) that Irving Kahn is a former Ben Graham assistant and likes to buy and hold for long time– and not really a "trader" per se.

From the WSJ:


Discipline has been a key for Mr. Kahn. He still works five days a week, slacking off only on the occasional Friday. He reads voraciously, including at least two newspapers every day and numerous magazines and books, especially about science. His abiding goal, he told me, is "to know much more about the stock I'm buying than the man who's selling does." What has enabled him to live so long? "No secret," he said. "Just nature's way." He added, speaking of unwholesome lifestyles: "Millions of people die every year of something they could cure themselves: lack of wisdom and lack of ability to control their impulses."

Here is a link to his current portfolio (he includes a land-based driller). 

Leo Jia adds: 

Wondering if the strategy of buy-and-hold can make one live longer than the strategies of short-term trading. It may seem to have some merit in the sense that a buy-and-hold'er has a very long-term prospect, and the long-term mind in-turn affect his body in ways of body-mind interaction.

Feb

26

 "What These Ants Can Teach Us About Problem Solving"

Swarm Intelligence: a single ant or insect probably isn't very smart, their colonies are.

Perhaps one can learn from this for trading in that one trading system might be somewhat dumb but a group of those can be intelligent.

Gary Rogan writes:

The way I look at it is this: the goal of most (although definitely not all, but the vast majority) of the market participants is to profit from the difference between the current price and some future price. As such, their collective goal is to discover the future price. While certainly they have no desire to willingly cooperate, their use of error averaging and cancellation and applying any real information to the goal is little different than some ants trying to move a large piece of food towards the colony.

Feb

1

 I am reading Ari Kiev's book The Psychology of Risk.

He argues that goal setting is most important in trading success. Instead of trading passively at what the market offers, one should first set his own goal, then develop a strategy based on the goal, commit enough risk, and trade with faith toward the goal.

Does anyone have any experience or thoughts in this approach?

Gary Rogan writes:

Leo, I just found it interesting that the language sounds like the industry-standard language of "financial planning", other than the faith part, in that that language involves "understanding the customer's goals", "finding their risk tolerance", "establishing a plan to achieve the customer's goals based on their risk tolerance".

Does he believe in some sort of "you dial the risk, you'll get the return if you believe hard enough" kind of thing? As he explains it, is the purpose of "faith" so that you don't chicken out when things get tough or as something else?

Ralph Vince writes: 

From the time I was 19 or 20 years old and a coffee-cranked margin clerk, until now, I have witnessed that the number one determinant of success or failure is a defined criteria (or lack of).

As Kerouac put it:

Two flies, You guys, What are you doing here?

So what are you doing here? If you're just here "To make a better return on your money," you may want to give your criteria a little better consideration.

What are you willing to accept as risk, how will you contain the risk to that? What's the time horizon? (the most overlooked aspect in investing, bar none. We live on a planet of delusion where people are using asymptotic, long-run values which often diverge greatly from the reality of finite time).

Pension funds are able to do this — articulate their criteria, as well as anyone. They need to keep to a specific liabilities schedule. Institutions tend to trump individuals in this regard.

You can tell the compulsive gamblers — the individuals without a specified criteria, disaster is imminent.

So…what are you doing here and when do you need to get it done by?

Gary Rogan replies:

But Ralph, and I'm not at all trying to be facetious, what if I have a hundred bucks, willing to lose fifty and want ten million in a year? Aren't your capabilities/means/methods at least as important as all the other factors put together?

Ralph Vince replies: 

Gary,

Ha! Maybe your plan is a deep OTM option….parleyed 6 times in a row, with half the $100 ?

Without a specific, detailed, articulated criteria, I cannot determine my exposure plan. I don;t have control over what the markets will do
– I DO have control over my exposure.

The whole thing gets you out onto that lumpy landscape I call leverage space, and without getting into the nittygrittynasties of that (and acknowledging you are IN leverage space whether you like it or not, and it is applicable to you whether you acknowledge it or not), let's say your criteria is exactly as you defined. Well that sounds like some sort of portoflio insurance, yes? Your strike price on that is $50. Now, given that there is a peak to leverage space, portfolio insurance runs from that peak (as a % exposure) to 0 (as a % exposure) as your equity decreases to $50 (where your exposure is 0).

So now, given that you have articulated a criteria, you can plot a path through leverage space. In other words, you can create a specific plan to achieve that criteria in terms of your desired exposure.

Leo Jia adds: 

Gary,

I am only a quarter into the book, so still can't comment on all your inquiries.

You are right, it does sound somewhat similar to the financial planning language. The difference perhaps is that the goal is meant for a daily goal or very short-term goal. It should be set at a level as high as one can stretch. One should clearly envision the realization of the goal to make sure that he WILL achieve it. Only by doing this, one can be ensured to devote all his power to achieve the goal.

The faith is to ensure that one does not get chickened out easily. It helps one to steer away from common beliefs one grow up with, such as staying safe.

Victor Niederhoffer writes: 

The power of prayer in markets and life for extending life and gains was well studied by Galton who noted that insurance companies did not reduce the rates for boats owned by divines nor was their life expectancy greater.Having faith in a market reaching a goal, will not alter the counts as to whether to hold for the end or the middle or the reverse. It will just cause unnecessary vig.

Leo Jia asks: 

What about the faith not in a religious sense? Shouldn't one have faith in oneself, in one's well-designed strategy, and in one's ability to reach the goal?

Ralph Vince writes: 

I return to this thread, which, despite it sounding like a hokey, self-help sort of thread, is, as I mentioned, the single-greatest determinant I have witnessed through the peephole of my own experience watching and participating in the trading world. It is what transforms those who are lured here for all the wrong reasons, into dull successes at this endeavor.

Especially as an individual trader, it's so easy to get sidetracked, derailed, spun around and disoriented by the markets. And if we agree that quantity is, over the course of N trades, at least as important as direction (the latter of which we don;t have much control over, and that a gentleman's bet and betting the house — the spectrum across there determines the weight of the specific risk on us), and that quantity is specified by a plan to achieve our criteria, then it is exactly the execution of that "plan," which becomes the vital exercise in trading. And without a goal, without specific, well-articulated criteria, you cannot craft the plan to execute — you are just waffling, flailing.

(And these goals the individual can craft should be more clear than that specified by the investment committee of an institution, because as individuals, you can set a higher bar than a committee of bureaucrat-types).

The exercise then becomes one of executing the plan, something quite boring and clerical, but, to me, something that has resulted in extreme trading success. I won't elaborate further, there are plenty, always, not experiencing success and my aim in this note is to point them in the right direction to achieve one pathway to that success (as I believe there are likely many, though I am only familiar with this one). Granted, I am very familiar with the linkage between achieving a criteria, specifying a path to achieve it, in terms of simple mathematics, but this is not something someone cannot learn and familiarize themselves with to a greater level than i have.

Since doing so, I have encountered success with this that I did not think was possible. The execution of the plan turns you into a trading apostate, relegating most market-related exercise, entry & exit, selection, etc., to their rightful place as secondary or tertiary concerns, contrary to what most believe.

No, I'm not going to detail my specific plan — it's unique to the criteria I am seeking to achieve, and the point of this note is to further highlight the critical importance of criteria and plan. Along these lines, what I later found echoed what I was discovering about my plan in a book called "Great By Choice," by Collins and Hansen, specifically the "20 Mile March" notion as it pertains to specifying such criteria-plan relationships as detailed here for trading and their execution.

I doubt most will bother with what I write here. Growing up in the raucous world of Italians and Jews and their gambling, the lure of a little self-created danger and excitement — the little rush of that, is what draws most to this arena and keeps them here, though they don't see it that way.

Gibbons Burke writes: 

Great post, Ralph. It brings to mind CompuTrac/Telerate's Teletrac software, which was originally named TradePlan. It was built to facilitate putting into practice the old Frenchman's wizened admonition "Plan your trades, and trade your plan." Unfortunately it was a bit weak in an area you championed, sizing your trades appropriately, but in many other respects its design remains one of the best for indicator and rule based analytics.

Ralph Vince writes: 

And, if the Chair will grant me a pardon just this one last time (regarding the French, a topic of seemingly poisonous exosmose to our regarded Chair) the number one rule I have learned of the markets and life: "Never face the Old Frenchman. Never. In anything."

Leo Jia comments: 

Hi Ralph,

Thanks very much for the inspiring posts on this thread.

Your point (if I understand correctly) is that the single purpose of a goal is to define the size of the trades. I understand size is very important but am not very clear on how exactly a goal works on that.

According to some literatures (yours as the most prominent), size is determined by how much one want to lose on each trade based on his strategy, and to win more, one has to increase the size, but there is an optimal size beyond which one's return will diminish. Isn't all that simply mathematics and how aggressive one want to be? How does a goal serve here?

On the other hand, how aggressive one want to be is very much influenced by his faith (or his illusion) on how successful his strategy will be. A key question I often have is how one can be so sure that his strategy will work as tested so that he can simply increase his size to the optimal level in order to maximize his return? And this doubt also applies to execution.

Would you kindly explain?

Ralph Vince responds: 

Leo,

You're asking me to explain an awful lot, too much for a simpled response I fear. Let's say there is a risk proposition, a potential trade or wager. If I am going to play it one time, what I stand to make as a function of what I risk is a straight line (from a gentleman's bet, i.e. risking nothing, where f, the fraction of our stake we risk, is zero, to risking the house, f=1.0, where the line goes from 1, that is, risking nothing we make a multiple of 1 on our stake after the proposition, to some value > 1 where we risk the entire house).

For a subsequent play, where what we have left to risk is a function of what ocurred the first play, a curve begins to form (and thus you can see how the notion of a "horizon," that is a finite number of plays is an important parameter in all of this). No longer is the peak at f=1 when we have more than 1 play. The peak begins to move from 1.0 in the direction towards some value > 0 .

And I can show mathematically (because this is NOT a story about may, but about graphic visualization) that, absent knowing where that peak will be in the future, that the long-term best guess for this peak is p/2, that is the percentage of winning periods divided by 2. If I expect 50% of my plays or periods I have a position to be winning, then the best guess for this peak is 50% / 2 = .25. I am not going into the mathematical reasoning behind that here.

There's more….a lot more now. A curve has formed. The curve has a shape, and the story is in the shape of the curve and all the geometrically important points therein (I have catalogued these and discussed them at length to a disinterested world). And you are neccesarily on this curve when you trade this instrument, whether like or not, acknowledge it or not, and likely moving about this curve — and you are paying the consequences and reaping the benefits of where you are on this curve.

And here's the thing — you have control over where you are on the curve, and where you are moving on it. You don;t have control over the trade. And the thing you have control over is the difference between a gentleman's bet (where nothing is at risk) and having your entire life at risk.

Now, you have a criteria. Someone asked earlier on this thread for a particular criteria, which sound like a sort of portfolio insurance, and thus, a path can be plotted on this curve to accomplish precisely that.

There's a lot more to the geometry of this, and the paths on the curve (or surface in N + 1 dimensions, where N is the number of components you are trading), but people prefer to be blind to this but they do so at their peril and cost.

Newton Linchen writes: 

Ralph,

When I finally understood Kahnemann's proposition, that people (including and - specially - me) are not "risk averse", but "loss averse", and later recognize that was this "loss aversion" that caused me to lose more than I needed to, (since I have always researched trading strategies), the next logical step was to dive into your work.

I'm now at the point of embracing your ideas about the leverage space "for good", because I finally realized that trading requires so much toil… that it's simply not worth it if you don't aim for the maximum goal.

In other words, trading is difficult regardless of anything else… So why not do it for the maximum available profit?

That of course, requires courage, since humans have a great deal of loss aversion - and it's only possible when one realizes that it's just not worth it if you don't aim at the zenith.

Ralph Vince writes: 

If you want to Newton, and you have the stomach for it. If that's your criteria — growth maximization and drawdown be damned, then yes, you want to be at what you expect the peak to be over the future horizon of holding periods you are going to engage over.

Me, I'm old and cowardly. I like to sit on park benches with a shawl on…

Leo,

These are already things everyone is already doing, i.e. they ARE moving around in this leverage space, like it or not, likely moving about it, paying the consequences and reaping the benefits of a location in a geometry which has extreme bearing on his fulfillment (or not) of his criteria. Your guy employing the mean variance approach has, as his criterion, maximizing expected (1 period!) gain with respect to variance (usually within some specified other constraints, like without using margin, without more than x% in any one group, no short sales, etc). He is still invariably in leverage space, moving about it. (Further, in assuming the main facet of his criteria, maximizing return vis-a-vis risk, wherein he specifies risk as variance in that return, is mathematically misguided as variance is a diminution in [consecutive] return, and not risk, i.e. it is already baked into the return portion, i.e. the altitude in leverage space, as one considers consecutive return [i.e. reinvestment]).

It's not a matter of maximizing return, alone or with respect to something — unless that is ones criteria. Regardless, we are in leverage space, moving around, and can craft our plan our path through or stationary location within this space to satisfy our criteria.

And, absent a criteria, a "goal," the virtue of which was questioned at the trailhead of this thread, there can be no plan as nothing is being sought (other than perhaps entertainment or some form of self gratification). And if one does have a goal, a plan can be crafted to try to achieve that goal.
 

Jan

30

If you look at it in a slightly different way could it not also suggest that you buy stocks NOT based on publicly available information on some upcoming near-term changes (that if you are not yourself privy to some difficult-to-get information) but instead based on negative sentiment coupled with some well-known value parameters.

How can that be an advantage for individual investors? I am sure many contrarian funds also do that. They have the advantages of visiting the company, calling the CEO and analyzing the entire industry for instance, which are only possible for perhaps large investors but clearly not possible for the ordinary individual investors.

Gary Rogan writes:

An individual investor isn't "graded" every quarter, he/she may hold forever instead of trying to get in and out. There is a well-known asymmetry (in individual investors' favor) that for many institutional managers constantly approximating the metrics they are graded against is preferable to swinging for the fences because reliable mediocre performance isn't likely to result in two or more bad quarters in a row that may get the manager fired. This may or may not be relevant in this case, but if a manager can figure out what everyone else is doing it may be in his interest to just follow that. Also the point is, that after a long time the bet may stop being contrarian and with enough diversification the portfolio starts behaving more index-like but with a built-in positive bias that may take years to play out. The survivorship bias also will eventually favor the winners over the losers, if there are enough of both. Over the long term at least.

The individual investor doesn't get hit by additional decision-making without much information. And finally, negative sentiment is sometimes more powerful than all the buying by all the contrarian funds put together.

Jan

30

 I thought that there had been some consensus emerging that China wasn't headed for a hard landing. Maybe it isn't landing at all? I don't know China that well, but there are many who I think do. Any thoughts?

Leo Jia writes:

Hello David,

I don't have much in-depth analysis to offer, but based on the experiences in China, I don't see much evidence of landing lately, let alone a hard one, though there were worries about it a year or so ago. Things seem OK now. Real estate is picking up speed. The multi-year depression in the stock market seems coming to an end, very likely reflecting some optimism on the new leadership's capability in handling the social issues that threaten the ongoing economy. In any regard, the worries about a hardlanding are being pushed forward.

I can't read Prof. Pettis's post as his blog is blocked lately. But here is a post by Stephen Roach on the same topic, which argues that a reform is still critically needed in order to avoid crashes.

Jan

28

 I have been doing auto trading of Palm Oil futures for some time using a self-developed system. The system works on the continuous data of the contracts and trades on the most liquid contract.

One morning last week after I started the software before the market open, to my surprise, I discovered the prior day's data was of the wrong contract month. It was not the same as that during the prior day's trading session. Seeing an anomaly of the data, I disabled auto trading prior to the market open.

When the market opened, I saw the system gave a short signal that I believe was due largely to the influence of the wrong data of the prior day. But gradually, it turned out to be a good signal. By the close of trading when the system signaled to closeout the trade, it was a 10% profit. Although I understand that it should not be my expected profit, I was feeling a little upset for not taking the trade.

Then the next day when I started the software, the data was corrected. With the corrected data, the system showed a trade on the past day of actually a 4% loss. I felt a little relieved.

Kim Zussman writes:

This is where the mistress speaks to us. In between the rationally testable segments; where the discretion of experience, discipline, and morality are challenged every day.

Jan

20

 The book Rational Herds: Economic Models of Social Learning by Christopher Chamley has many stories, models, and algorithms, that are helpful for gaining insight to markets. The stories start with the penguins standing on the edge of the ice, needing to get food but not knowing whether a killer whale or seal is waiting for them underneath. The first penguin to dive in provides much information for all the others. But it's not advantageous for him. The asymmetry between what's in the interest of the individual and the group and the advantages of social learning are readily seen by this example. The solution is for the other penguins to push the unlucky one in. The analogy of running the stops in markets with the first one to do so possibly losing money, but the others all gaining from the information is seen.

Another story is based on yellow cabs being 90% probable in a city. But an accident happening and the observer saying it was a red cab that caused it. Problem is that the observer's is only right 4/5 of the time. Bayesian analysis shows that after the first observation it's 9/13 that the yellow cab hit him. But after two reports the probabilities drop to around 48. The rate of convergence to red versus yellow follows a definite process which leads to all sorts of implications for cascading, herding, randomness, and social learning. Many examples of investment decisions based on following the leader and false decisions making from random events are given.

One wishes that the author would have followed some of the stories that motivated the book and shown how all the formulas would work for the simple examples above. The book is intended mainly for economics, social psychologists, finance people, and statisticians. But it's also relevant for anyone interested in how information travels. It's not easy reading and requires pencil and paper and working out a few examples to get much benefit from it.

I alternated reading it with modern times, and books on plants in my recent visit to Chicago. Glad to be back with you.

Jim Sogi writes: 

Sitting in LA traffic a few days ago got me thinking about individuals in a group. Ants probably think they are pursuing their own individual interests to be fed, to be safe, to have friends. But looking down on them from above shows a different picture. Each car in traffic has their own individual desire and plan but looking down at traffic patterns shows a different picture. Each investor or speculator has their own reason to buy or sell, for ex, personal reasons, business, family, taxes. But looking at the aggregate shows a different picture.

Gary Rogan writes: 

Worker ants can't reproduce and cant think. Their only genetic purpose is to help the colony survive so that the queen propagates her genes by producing a relatively small number of fertile descendents. Human beings can think and reproduce, thus even genetically they have a very different purposes, closer to the ant queen but with thinking abilities. Their natural goals are not those of the collective. 

Leo Jia comments:

I've come to think that perhaps no human can step out of the herd no matter how hard he or she tries. While there are many who realize the disadvantages of herding in a modern society and try to break free, they nevertheless follow another herd, trying to break away from the traditional ones.

I was thinking about this the other day. We understand how cells serve the functioning of our lives. They are alive themselves but work selflessly in ways defined for them to serve the body and mind. Can they be said to be herding?

Are we here to serve some upper life like ants serve the colony? That is a hard question, but if it were true, perhaps herding would be not only inevitable but also necessary. It would ensure we live by the rules, which are the only basis for our lives. By that logic, being selfish would only serve ourselves negatively.

Dec

31

 Just learned there is a severe shortage of natural gas in many cities in China.

In a large southwestern city with a population of about 10M and near huge NG fields in the country, the NG usage is up 400K cubic meters per day over same period of last year. As a result, the municipal NG company has a shortage of 300K cubic meters per day, and has to cut off services to various sections in the city everyday.

The increase of demand is likely a major trend for the coming years. More and more people's homes in cities and towns are furnished with NG pipes in recent years for home cooking. A major reason in my view has to do with winter heating. The country provides public heating only to towns and cities in the northern part of the country, leaving those in southern part (roughly half of the country size) and all villages with no public heating. That has been the case all along the many decades. The northern villagers generally have to burn in house whatever they can find cheap (usually wood).

In northern cities, partly due to calls for better air quality in recent years, some public heating facilities have switched from coal to NG. Take Beijing for example, the NG usage for the city on December the 24th is 62.57M cubic meters. Shandong province has seen the annual NG usage reaching 4B cubic meters, an increase of 20% over 2011.

Traditionally, all southern people spend the winter in the cold (temperatures may stay in the single digit or 10'es Celsius for various length of the time in a year, usually a few months) without any heating. This was not because it was not cold enough for them, but because they could not afford any heating without government's provision. Only in recent years, as city people get richer and move in to their new housing, many install in-house burners for winter heating (in place of or in addition to air conditioners). A predominant choice of fuel for these burners is the NG as it has been very cheap relatively (on average, the residential price is about 2.3 yuan per cubic meter).

NG price in China are priced in cubic meters, which is argued to be abnormal. One report cited the wholesale price in China is about US$3.34 ~ US$6.81 per million BTU in 2011, much lower than US$11.15 in Germany for instance in the same period.

Dec

20

 It is called in China "Shizi", in Japan "Kaki", and in Isreal "Sharon fruit".

I generally have liked the fruit since my childhood, but until recently, I had never had any special feelings for it.

Don't know for what reason, but there are a lot of high quality persimmon fruits on the market this year. They are large, delicate, beautiful, colorful, bright, shiny and almost translucent. Put in the mouth, they are so tender, meaty, sweet, and have no seeds or core.

The Greek regard them as "divine fruit" or "the fruit of the gods". I feel they well deserve the titles.

a little about the health benefits from wikipedia:

The Sharon fruit was found to contain high levels of dietary fiber, phenolic compounds, potassium, magnesium, calcium, iron and manganese. They are also rich in vitamin C and beta carotene. Regular consumption of the fruit is believed to reduce the risk of atherosclerosis heart attacks. A separate research project showed that a diet rich in Sharon fruit persimmons improved lipid metabolism – the way the body copes with fat – in laboratory rats.

The fruits of some persimmon varieties contain the tannins catechin and gallocatecin, as well as the candidate anti-tumor compounds betulini acid and shibuol.

So ladies and gentlemen, bon appetit et bonne sante!

Dec

17

Attacked, from Leo Jia

December 17, 2012 | 1 Comment

 This article is an incredible story, likely being told by a neuroscientist, on how the fear mechanism in the brain helped a woman escape from the jaws and paws of a mountain lion.

A few lessons are quoted below:

1. When the fear brain's responses align with the crisis at hand and we follow its instincts, we can become virtually superhuman.

2. In the first flush of terror, the body releases two powerful substances into the body: cortisol and adrenaline. Cortisol prepares the muscles for vigorous activity by releasing their key fuel, glucose, into the bloodstream. Adrenaline further prepares the body by revving up the heart rate, constricting blood vessels and opening airways. In the brain, a variant of adrenaline wipes out pain and fatigue and focuses concentration on the threat at hand.

3. When panic is triggered, it overrides the complex reasoning of the logical mind and switches on a suite of automatic behaviors. These can feel so overwhelming—and so un-willed—that it's like being taken over by an outside force.

4.
Tonic immobility, better known as playing possum, is an ancient behavioral strategy that's designed to fool a predator into believing that its prey is already dead and therefore not palatable. Tonic immobility is a long-shot strategy. The only way it will work is if it lulls an attacker into letting its guard down.

5. Somehow during her blackout, her midbrain had switched to a fourth panic mode. Now every fiber of her being was geared up to fight.

6. One of the many incredible powers that the fear response unleashes is imperviousness to pain.

7. Gone was the mental fog of panic that had gripped her just a moment ago. Now she saw everything with crystalline clarity, as if the world were moving in slow motion.

8. Still, the one part of that day that Groves holds valuable is the insight it gave her into her own resilience, into the powers of her own fear mind, a part of herself she'd never experienced until that day.

Dec

10

50/50, from Duncan Coker

December 10, 2012 | 2 Comments

 Jeff's coin proposition bet illustrates a nice lesson for me when applied to trading. That is, even if probability is favorable, there can and will be streaks against. So, there needs sufficient N and staying power for probability to work in trading. So all the seasonal or studies that trade once or twice a year probably don't have a statistical edge.

The inverse lesson is that sometimes it is good not to trade when the probability is not in favorable, as in never take a proposition bet against a Florida surfer with a low handicap, (humor intended).

Jim Sogi writes: 

I read that in a sample of 10^10 binomial chances, there can be a run of a 1 million 1's.

The idea that in an infinite random time series every possibility will occur, such as the history of the earth, kind of worries me. There seem to be laws of nature, but are they? Will they change? Do they?

Ralph Vince writes:

James,

Yes, and it is man's innate ability to asses such probabilities (and hence, the fallacy of Huygens and Pascal — that risks should be assessed based on mathematical expectation) that is the most fascinating thing about the entire story of evolution (again, to me).

Why do you get on an airplane when it can crash? Why do you get in your car and go out to buy a quart of milk? We have evolved over eons to pursue often time-critical rewards on a risk-laden planet — it IS how we operate or we would be still cowering agoraphobically in the shadows of a primeval world. This notion fascinated me (and the reason I wrote a book on it in 2011), and the more I dove into it, the more I saw that the answer to it — i.e . the fundamental equations we posses innately for assessing risk, pertains to all other mathematical decision (game theory is rife with concepts that are tuned to the Huygens/Pascal model, not our innate model) and ought to be reassessed under the lens of our superior, realistic model (and yes, it is superior, or we would all be looking for termites to eat up in a tree some place.

Leo Jia writes: 

Ralph,

Your notion about man's innate ability to assess probabilities is fascinating to me. I hope to read your new book soon (I presume it is Risk-Opportunity Analysis.)

It is clearly phenomenal that the human species was able to advance over other species. It is not as clear though whether it was man's special innate ability that made man evolve or it was the evolution process that gave man the innate abilities. Regardless of whatever came first, I think many of man's innate abilities that exist today were largely fostered by the evolution process. While this was wonderful, it is perhaps also very discomforting to learn that many of our innate abilities were more meant for the environment of the wild, not really for the modern times as the modern couple hundred years is far too short in evolution terms. It begs the question of what of the very innate abilities are really useful and what are not. Whether we realize what abilities we have or not perhaps is not a big issue as we naturally use them in life. It does become more important for us to know what of our innate abilities are actually harmful to ourselves today.

Leo Jia adds: 

I did a test. It went like this:

1) toss a coin 10 times,
2) if there is 5 heads then add 1 to a record do the above 2 steps 1 million times.

The chance that in ten tosses one gets exactly 5 heads and 5 tails is 24.5539%. 

To be more comprehensive with the test results:

4 heads and 6 tails: 20.4194%

6 heads and 4 tails: 20.5125%

3 heads and 7 tails: 11.7019%

7 heads and 3 tails: 11.7010%

2 heads and 8 tails: 4.4018%

8 heads and 2 tails: 4.4145%

1 heads and 9 tails: 0.9783%

9 heads and 1 tails: 0.9830%

0 heads and 10 tails: 0.1004%

10 heads and 0 tails: 0.0968%

Easan Katir writes:

Thank you, gentlemen. This is good info to ponder and apply to trading. For my part, I found a shiny Lincoln-cent and spun it 10 times. Result: 7 heads.

Jeff Watson writes: 

But there is also another trick of spinning a coin very fast, get down to coin level on the table and observe carefully, and if you get a blurring image of tails, call tails…same thing if you see heads, call heads. Since the coin spins at a slight angle, the side that you can see the image will be what lands.

Ralph Vince adds: 

Gentlemen,

As far as coin tosses and trading — and this may be redundant information to many of you — to me, personally (in my sciatica and failing vision nowadays) I find the largest implication pertains to the nature of the equity curve and expectations, and the deceiving nature of randomness.

We know if we plot out the equity curve of consecutive coin tosses (with heads +1, and tails, -1, say) and we plot this out, we can then draw bands around the mean expected value (0 in this case) of standard deviations. Thus, we can draw a one standard deviation band above and below.

Such a band will be parabolic, like a parabola resting on its side, rightward-facing, opeining up as time or trades or plays go by. That is, the upper band will always be ever increasing albeit at an ever decreasing rate. Thus. to be ahead of the expectation by play number X to the tune of 1 standard deviation, is below being ahead of the expectation by play X+1 or X + N where N is any positive number.

Couple this now with the Second Arc Sine Law*, which pertains to such randomly-generated equity streams and tells us (the essence of The Second Arc Sine Law) that we would expect both the peak and nadir of equity stream to occur least likely towards the center (time-wise) and most likely near the start or finish of such a stream.

These two principles, take together, warn us that in a stream of randomly-generated outcomes (coin tosses, or trading if/when the outcomes occur with randomness) we should expect the rightmost endpoint to be at or near the very top (or bottom) of the entire equity run, deluding us into conclusions, "This works!" or "This fails," that have no basis in a causal existence, but are merely the artefacts of randomness.

*The First Arc Sine Law buttresses this further, this law being that we should expect the ratio of the cumulative equity line (comprised of X number of plays) least likely to be above the expectation X/2 number of times, and most likely to be above or below X or ) number of times — the same Arc Sine distribution as the Second Law. Thus, say, if I toss a coin ten times, it has an expectation of 0 (given the caveats mentioned in this thread!) and I would expect with highest probability that ten of those tosses see the cumulative equity line above (or below) the expectation line of 0 and with the least probability, see 50% of them above and below the expectation (0) line.

Dec

7

As one enters a trade, one is making a bet– he is not sure if it is a good trade. My question is then after the entry, what would make him more sure that it is a good trade so that he would add to his positions? Is it the condition that the position is in profit, or that it is in a loss, or regardless? If regardless, then what else?

The conventional wisdom seems to say that one should never add to a losing position citing martingale reasoning on random bets. While I understand the logic, I don't know how to accept the reasoning in trading. Perhaps my question is whether trade results are really random or not. The evidence that with the right strategies many are making consistent money trading clearly says no to that. My own test also can not prove that adding to a losing position would clearly lead to failures.

So how should one really determine how to add to his positions? Would someone kindly advise on this matter?

Dec

6

 A beautiful book "The Earth as Art" is available for free download:

"This book celebrates Earth's aesthetic beauty in the patterns, shapes, colors, and textures of the land, oceans, ice, and atmosphere. The book features 75 stunning images of Earth from the Terra, Landsat 5, Landsat 7, EO-1, and Aqua satellites. Sensors on these satellites can measure light outside of the visible range, so the images show more than what is visible to the naked eye. The images are intended for viewing enjoyment rather than scientific interpretation. The beauty of Earth is clear, and the artistry ranges from the surreal to the sublime. "

Nov

29

 I found this interesting post on Seth Robert's blog:

"The Emphasis on Education in China"

One of my students grew up and went to high school in Nanjing,
population 8 million. Her acceptance to Tsinghua was such a big deal
that when her acceptance letter reached the local post office they
called to tell her.  The post office also alerted journalists. When the
letter was delivered to her house, there were about 20 journalists on
hand. One of them, from a TV station, asked her to say something to
those who failed.

Russ Sears writes:

I found it a very sad piece of social commentary. At some point it becomes not about your ability to think, but only about what you know they want. It becomes less about answering the question than knowing what questions the test giver will ask and answering it strictly as they want. You begin by eliminating the questions that cannot be tested.

Where are the questions that take a lifetime to answer?

Where are the questions that do not have a standard knowable answer?

Leo Jia responds:

 Well, it surely does not find an Einstein.

But society is not all about geniuses. It requires the performances of normal people on a much larger scale. In that regards, one shouldn't underestimate the advantage of someone's ability in passing intensive multi-disciplinary tests on high scores.

It takes tremendous discipline, dedication, and hard work. But it is not simply about memorizing answers. More importantly, the abilities to plan, to achieve, to think smart, to always be confident, to stay away from distractions, and to beat out stresses along the way are all crucial. It is about winning a game, a mimic to some of the games that are crucial at various stages in life.

Is it worthwhile for all the kids to spend all the efforts in order to pass the tests? Definitely not to those who lost — a high percentage of the people involved actually. They are clearly not good at the game (perhaps they have learned a lesson through the failure). So overall, the society has wasted quite substantial energy — the energy spent by those on the wrong game. But perhaps that energy can not be saved anyhow. It is just like the market where there are winners and losers, and the losers are required there to supply the liquidity and to make the winners winners.

I fully agree about the deficiencies of the education system, in the sense that it does not serve individual talents very well.

But unfortunately, the modern education system since its inception in the Industrial Revolution is more on social conditioning than anything else. We perhaps shouldn't expect more from it. The Chinese, finding that it fits well into its own tradition, have just pushed it more to the extremes. I don't know how to abolish it all together and what to put in its place. Would a system that only focuses on producing talents (we have to define the meaning here) work? It most likely would for the talented individuals. But overall? Certainly, a lot people have various kind of talents. But don't we agree that a high percentage of the population don't have much talent? If a system is only for talent, then what to do with these people? Moreover, talented people generally tend to be somewhat eccentric. Can a society endure too much eccentricity?

Oct

12

Thie largest building in the world is expected to open right before Chengdu, a city in the southwestern Sichuan province of China, hosts the Fortune Global Forum in June of 2013.

This video is a virtual reality tour of the compound.

Steve Ellison writes:

It will be the largest building, not the tallest building, so it may be exempt from the Chair's theory that constructing the world's tallest building is a sign of hubris (for example, the Empire State Building was begun near the end of the 1920s boom and finished just as the Great Depression was intensifying).

Oct

10

 I just found a tuition and fees announcement from an Ivy League website:

The Board of Trustees announced today that undergraduate tuition for the 2012–13 academic year will be $43,782, an increase of 4.9 percent (or $2,046) over the current year's tuition rate. Undergraduate tuition, room, board, and fees for the coming academic year will be $57,998, a 4.8 percent increase from the current year.

What I found more interesting is the following:

Tuition, room, board, and fees cover about half the full cost of the education, with the balance met primarily through gifts, endowment income, and other revenues.

I think we should all be grateful to those who contributed to this second half. This is about the best part of America's higher education. Because of this, many can afford to attend. Because of this, the American universities are free to teach what they believe is important (not like their counterparts in some other countries where communist propaganda are mandatory courses). And because of this, students can choose which schools best fit them. All these I believe made the America's higher education to stand out as the best in the world.

Like many others, I am doubly grateful because my first half was also paid for by scholarships.

But, people's enthusiasm about their beloved alma mater isn't about the money they paid or received. Just as I, a scholarship recipient, am proud of having attended the schools I love, others seem doubly proud as they often wear college sports shirts with "Tuition Payer" printed below their beloved college name.

What we have decided to study in college is not that critical looking back through life. I don't deny there are some fortunate ones having set their life's path on a straight line starting with their college education. But most of us have an experience of life that is unexpectedly dynamic. To rephrase Steve Jobs, one can only connect the dots looking back through life.

The real things people learn are certainly not through mindlessly attending college courses. They are through clicks in unexpected moments in life when one's mind is clearly present. It is mindlessness that makes everything worthless.

I now think that people's enthusiasm about their beloved alma mater is more about passion, perhaps not really the passion to study, but that of one's belonging, a belonging to a famous heritage, a prestige, a powerful network, a mental foundation, an incubator, a statement about life, and a perfect blossom basin.

In this sense, the $57,998 per year expense is cheap if that is what one needs, not because the other $57,998 per year is paid for by contributions, but because fulfilling one's life passion is priceless.

Sep

27

 The markets will be closed from Sept. 29th through Oct. 7th. It is a combined holiday of the Mid-Autumn Festival and the National Day.

Apparently a stimulus for consumption, the government issued an order that all toll roads (which include nearly all highways) in the country are toll-free during this period. Many famous tourist sites lows charges also for the period.

All this is highly cheered by people everywhere. A lot of places (cities, hotels, travel agencies, tourist sites, restaurants, shops etc.) are looking forward to the upcoming huge crowd. It is reported that some rent cars have doubled the normal prices for the feast.

Sep

21

 Having internalized some basic aspects of wave counts, such as alternation of corrective waves within a motive wave, coming back to the counts produced by Advanced GET is a strange experience, as the software-generated counts seem quite wrong.

Have others, as I now have, given up using software to mark the key wave points? Of course one would still use a software grid to mark Fibonacci retracements.

Anatoly Veltman writes: 

Actually, Advanced Get by Tom Joseph was very good when first introduced in late 80's-early 90's. Trick was that one should have also attended Tom's weekend workshop (mostly held near an airport in Ohio), to be tipped on the whole essence: type 1 and type 2 trades, wave 4 index and oscilator. Without figuring out when Wave 4's odds diminish to unacceptable — there is no reliable Elliott Wave trading. And Fib retracements are great — but ONLY if EW type 1 or type 2 trade has first been isolated. I taught Tom's methods for about 15 years. Not sure if any of my students succeeded in black-boxing the entire methodology.

Tim Melvin writes:

Did someone really say fibonacci on the spec list? This could get interesting if it is anything like the old days…

Anatoly Veltman writes: 

Well, that's the whole point. Loving to say Fib doesn't test well– when the wrong application was tested to begin with.

Phil McDonnell writes: 

To be sure one must test something according to the right way of doing things. However that is exactly the problem with wave counts and the like. The rules are so arcane and convoluted even so called experts disagree on them.

If you get 5 different Elliot exerts in a room you will get 5 different wave counts at the same time. It is a bit like the game of Fizzbin. The rules keep changing and are unnecessarily complex. 

Leo Jia writes: 

I think one probably should take this argument as a not-bad news for Elliot theory or any theory that gives non-consenting results. It means that it likely has some statistical truth in it that is worth one's effort in seeking. Don't we agree that a market theory delivering definitive results does not exist or, if exists, ought to be thrown out?

Steve Ellison writes: 

Trying to stay in line with our raison d'etre, I have been coding a method for retrospectively identifying highs and lows of multiple levels of significance.

My approach is to go bottom up, starting with an idea I got from one of the Senator's books. A local high is a bar whose close is higher than the closes of both the previous bar and the following bar. A local low is a bar whose close is lower than the closes of both the previous bar and the following bar (a sequence of 2 or more bars with equal closes count as one bar for this purpose).

After identifying the local highs and lows, I move up a level. A 2nd level high is one that is higher than both the preceding local high and the following local high. A 2nd level high cannot be recognized until one bar after the lower local high that follows the 2nd level high. I record the time at which the 2nd level high could have been recognized.

I follow similar rules to identify 3rd level, 4th level, etc., highs and lows and the times at which they could have been recognized in retrospect.

I haven't finished yet, but this method should give me a platform for testing hypotheses about "primary trends", etc.

Anatoly Veltman writes:

Tom Joseph's contribution to E.W. trading, in my view, was much greater than Prechter's or RN.Elliott's. Tom basically said with his excellent refined Type 1 trade: don't ever place any bid, unless:

1) you've already observed a valid impulse (with extended third wave)
2) a correction is currently in progress, approaching 38% of preceding rally
3) you're filtering this correction with oscilator return to 0, and fourth-wave index still sufficient for fifth wave
4) fifth wave projection extends to at least 2:1 profit/loss ratio, incl. all possible slippage.

I say: if all these conditions are not met (and this may not occur every day) - never place a bid at 38% retracement. If all these conditions are not met, you'll have to bid only at near-100% retracement. What does this principle have to do with popular E.W. or popular Fibonacci methods. Nothing!!
 

Laurence Glazier writes: 

Sure, things are complicated and one would not wish to poke a stick into a hornets nest, but … some things are complicated.

It took hundreds of years to elicit the laws of harmony from the canon of classical music (many to this day deny their existence). Put five composers in a room and have them harmonise a tune (the non-believers might refuse to!), and they will do it five different ways, but they will all have added to the map of knowledge.

Even knowing those laws, one could not reasonably predict how a piece of music would continue if Pause were pressed (unless it were minimalist) - but one might anticipate it would return to the tonic key, and that the free fantasia would not be over-long, and so on.

Those laws are difficult, unprovable, and without material substance but are the result of empirical observation.

Gibbons Burke writes: 

CTA E.W. Dreiss used, in the 1990s, a very similar way to count waves in the market using what he called the Fractal Wave Algorithm (FWA), and he traded futures breakouts from FWA-n magnitude highs and lows. Did quite well, but like all trend followers, it is a bumpy ride.

He also came up with the Choppiness Index, which sums the true ranges in the last n periods, and takes that as a ratio of the n-day range.
 

Jason Ruspini writes: 

This is the natural approach that I took as well. Ignoring the "correct" 1-5 definitions, I just looked for a run of higher such double-X highs and higher double-X lows identifiable with the necessary lag, with attention to what happens when you eventually get a lower major high/low, breaking the "wave" run count, which can keep going after 5. What I found wasn't very interesting, in-line with my previous comment. I'm still unclear if anyone is actually trading a tested (complicated) system or just applying versions of rules with discretion. If it is a tested system, why is it better than a simple long-term momentum system?

George Parkanyi writes:

I like to keep it simple. Many years ago, I read something written by Larry that said, when the commercials are generally substantially more net long or short than specs - that tends to stop trends and turn markets the other way. He admitted it was a rough rule of thumb - that it may take a while to turn the tanker - but I pay attention and time after time I've got to say it works. So right now two markets that fit that profile are coffee and to a little lesser extent sugar. (Oh yeah, VIX as well) I've been long both for a couple of weeks with modest starting positions, and just had a nibble at VIX. I don't know when the trends will turn and I may have to take a stop or two, but I like the chances for a good position-trade in these two markets - and VIX as a bet on a short-term post-Fed hang-over. I checked back to when coffee started this particular big decline - and it was within two weeks of when commercials were selling the crap out of it and their net-short positions had peaked. Gold and a number of other commodities did the same thing at the beginning of this rally that began in May - except that the commercials were the only buyers at the time. It may be a dumb-as-dirt perspective on my part, and will likely set off Anatoly - but its one thing that has stuck with me from reading a number of Larry's books.

Sep

19

 As precious metals continue their ascent, yesterday evening I enjoyed an award-winning movie, Empire of Silver, a historical account of Confucian banking clans in 1899 Shanxi, China, which tells the tale of silver-based economy, government-issued paper money, human frailty and greatness.

In that era, the Confucian bankers were trained from age twelve, and expected to adhere to high moral and ethical principles. All in Chinese with subtitles, this viewer found the story fascinating.

Leo Jia adds: 

Empire of Silver can be watched online here.

Shanxi used to be home to many of China's riches (not counting the royals and the officials). It is very interesting today the people there are no longer good at the game of banking. Instead, they mostly rely on mining coal, which made Shanxi not a very pleasant place to visit. Unfortunately, coal can not restore their old glories for being very rich. Today, Zhejiang (on the eastern coast just south of Shanghai), which mostly relied on making something cheap to export, is home of many China's riches (also not counting the royals and the officials).

In case others outside of China can't view that link, a search on Youtube with the Chinese title "白银帝国" results in the following 8 parts of the film:


Part 1/8
 

Part 2/8 

Part 3/8 

Part 4/8 

Part 5/8 

Part 6/8 

Part 7/8 

Part 8/8

Leo Jia adds: 

 There are quite a few scenes in the film showing an amazing road with tunnels running on the side of a cliff. I believe it is the famous Guoliang Tunnel Road located in Henan Province, south of Shanxi Province. That road was just featured in "10 Gorgeous Roads For The Drive Of A Lifetime", of which the Guoliang slide (Slide #10) is quoted below (with a correction of the province name).

Googling for "Guoliang Tunnel" yields more pictures of it.

Using this road in the film clearly presents a dislocation in time, because the road was actually built between 1972 and 1977. The Wiki page about it is Guoliang Tunnel Road, China.

It was built by only 13 local villagers in just five years! Located in the Henan province of China, this can be considered to be a sacrificial road of sorts. Many villagers lost their lives due to its construction, but the work went on. The tunnel itself is 1,200 meters long, 5 meters high and 4 meters wide.

It's called the most dangerous road in the world despite its scenic beauty and as a wise man once said, 'the road does not tolerate any mistakes.'

Sep

11

 I think we can all agree that pursuing one's conviction in life or even a demonstrated talent is hard. Most successful people would contend that the key is through perseverance, resilience and so on. In other words, one should not give up during hard times. I think this should be true for most successful people on this list who have indeed withstood some hardship in the early career but never given up.

This is in sharp contrast with the mostly agreed approach for trading, where quickly admitting mistakes and reversing course is very key. I don't deny that someone may be doing it through perseverance (is Buffett doing this way?). Even Soros has remarked that admitting mistakes is key for his success. It is interesting here that admitting mistakes only applies to every single trade, but not really to the hardships in one's career.

There is the saying about when to hold and when to fold. For career success, the focus seems to be "hold" on, but for trading success, the focus is to "fold" quickly.

How would one reason about the two different approaches or philosophies (perseverance vs. change)? Is one of them wrong?

Craig Mee writes:

Leo, I would humbly say, one is a number game, and the other is what you do…and with that you can certainly do some fine tuning. Problems may arise from a number of things not central to what your preferred "business" is.

Russ Sears writes: 

As a marathon runner who use to be national class, it has been my experience that persistence is only part of the battle. It is very easy for a proclaimed prodigy to persist. What is hard is learning to turn a short term loss into a long term lesson for life. If you watched the Olympics here are a few things that the athletes seemed to do differently than most people.


1.
They embraced the pain. Training and hard work was enjoyed. But they also learned from their losses, injuries and general hardships in life. Perhaps these fires are the purifying necessary part of the upbringing that the prodigy misses. Learning to believe in yourself despite what others say, turning losses into a chance to strengthen weaknesses. Things whose first order effect is negative but whose second order effect can be positive are highly favored.

2. They were optimistic about their chances, with a healthy dose of realism about their abilities, their current condition and plan. Before and after the event there were no excuses. They had a plan, believed in the plan and stuck to the plan.

3.
There were very few people's opinion that mattered to them, their coach, their immediate family (Dad, Mom, Husband or Wife). They did not care what the critics said, they did not depend on crowd support and were not disheartened by disfavor.

4. There were many opportunities from competition. They found their niche from competing more. While the Olympics may be the showcase for their event they were not dependent solely on its outcome. Worries melted in abundance of gratitude to coaches, training partners, family, other supporter, G_d, and country

5. They were focused on the task at hand. They knew how to avoid the distractions and discount the hype. Yeah, this may be the defining moment in their lives and how they may build their fortune, but as the song says "there will be time enough for counting, when the dealings done."

6. There appeared to be admiration for their fellow competitors. This Olympics were notable in that there were fewer accusation of doping, tainted judges (with a few exceptions about some referee) and general cheating scandals. The badminton scandal being the biggest scandal, suggests to me that the athletes were into the competition more so than the best way to game the system. Perhaps this is an inverse reflection of the markets. Or perhaps simply the media has become part of the cover-up captured by the hype, rather than the watch-dog.

Sep

4

 There seem to be some noticeable changes from last year. Below are data on a few 5-star hotels in the same city. All numbers include tax and service changes. US$1 = 6.3 CNY.


Kempinski Sunday brunch
: 298CNY including alcohols including some American wines and Qingdao beer (the draft Paulaner is extra). 216CNY not including any alcohol. Seems not much change from last year.

The Holiday Inns Crown Plaza
: No Sunday brunch is offered. The regular lunch buffet is 129CNY not including alcohol - a change from 99CNY of last year but not much change with the food.

Shangri-La
: The Sunday brunch was about 240CNY last year, but they stopped offering it this year. Only regular buffet lunch is served for 159CNY including some basic domestic beer.

Sofitel Sunday brunch
: 219CNY (same as last year) including basic domestic beer. The food is largely worse than last year. The very popular seafood section with lobsters and crabs is reduced to have only some small fish. The fine roast beef is replaced with roast pork. Appetizers and desserts are much poorer. The coffee remains the best among the peers though.

The diners are generally very light (perhaps one fifth full). Although I can't conclude about the comparison with last year as I don't go to them regularly, it does appear that there are fewer people (who are most Chinese) this year.

Aug

29

 Heraclitus said, "everything changes except the law of change" and "you cannot step in the same river twice."

The river changes every second and so does the man who stepped in it. Life is ceaseless change. The only certainty is today. Why mar the beauty of living today by trying to solve the problems of a future that is shrouded in ceaseless change and uncertainty–a future that no one can possibly foretell?

-Dale Carnegie

Leo Jia writes: 

I have also been studying the topic of change lately.

Just as Heraclitus said about the river, the ancient Indian Veda teaches that even the human body does not have the same flesh and bones as those a moment ago — it is constantly changing. This constant change has made the concept of death (as we know it) less dramatic. Because death happens at every moment as the change of the body goes, the final physical death becomes no more a distinguishing event.

The very nature of change has led Gautama Buddha, who started as a Hindu monk, to believe that there is no self, contrary to the Hindu belief that there is the eternal soul which is the self.

I believe this ancient concept of change has very good reflections in modern sciences of molecular biology and quantum theories. At the atomic and molecular levels, the body is constantly reshuffling and exchanging, at a very fast rate, the atoms and molecules with the surroundings. This has not only made one body not containing the same atoms and molecules from moment to moment, but also made one body to share the same basic components of life with others in the surrounding. At the subatomic level, the change is even more profound, as quantum theory teaches us. The particles become waves or energy and the waves or energy become particles at all times. With this, the body is no more that physical as we see and feel it. It becomes more of a congregate of energy. And the energy is not in closed form - it is open and exchanging with all in the universe. In this sense, the separation of the bodies amongst us becomes less meaningful.

Isn't there the new concept that information is the change of energy? With that, we no longer need to search or absorb information, the information becomes us and we becomes the information.

Why is it hard to believe? Because we confine ourselves to only rely on our physical perceptions. The physical perception is just that — physical. How do we perceive otherwise? That is what I need to learn, and I look forward to someone enlightened sharing the wisdom.

Aug

27

 The news of Neil Armstrong's death hit me hard. He played an important part of my life and it was like losing a close friend, although I wasn't a close friend but rather an associate.

As a teenager I read about Neil's Korean War flying mishap in Popular Mechanics. Somehow I remembered his name probably because I was a fan of the radio serial, Jack Armstrong, the All American Boy.

I was an engineer at NASA in Houston when the second group of astronauts was announced and I learned that Neil was selected. I was selected to teach the group about flight mechanics with emphasis on launching into orbit. Neil had a great grasp of the subject. All the astronauts were active duty military and Neil was the sole exception. He was a civilian NACA/NASA test pilot who was famous, within aeronautical circles, for piloting the X-15 rocket powered research vehicle.

Neil and I crossed paths at various times within the context of mission planning for the Gemini and Apollo programs. I was pleased that he was selected to fly on the first lunar landing mission. I believe he was the best choice out of the very talented and capable group. My faith in his ability was validated with his successful mission performance.

Looking back, I see how the manned space program changed the trajectory of my life in a good and wonderful way. Goodbye Neil Armstrong, you are someone I admired and respected.

Victor Niederhoffer comments:

Inspired by Mr. Cassetti's post, I have a Neil Armstrong letter I wold like to share.

Dear David,                                                      Sep 12, 1986

"I am saddened to hear of your illness. Your father told me you are interested in the mission of Apollo 11. Apollo 2 was of course the high point of my life. When the rocket lifted off the launch pad I must confess that I was not sure I'd have the distinction of being the first man to step foot upon the moon. In every flight there's the possibility of risking one's life. As you may have studied, I had a close call aboard Gemini 1 when the craft started to roll violently. It could have ended in disaster. But Dave Scott and I lived to tell about it. The good Lord had something to do… being on the moon was somewhat like standing on the high desert of new Mexico on the night of the full moon, only it was much brighter. Looking back on the video tapes of it, earthlings didn't quite get the breathtaking spectacular of it, on their tv sets. The moon's surface was very powdery with fine granules that made beautiful footprints. And since there's no wind on the moon, my footprint will last much longer that I will. Maneuvering around on the moon was tricky at first. While the gravitational pull is only a sixth of the earth's, it was a bit of a trick keeping balance. It was a skill we mastered quickly. David, you asked me if there was any funny moment on the moon. The one thing that stands out is the fact that with all the engineering and calculations that the lem would sink more than it did into the moon's surface. The last rung of the ladder was about three feet off the ground. I remember wondering if this first historic step was going to be a big flop before the whole world. Later, I recall how ironic now that big first step was then accompanied by, "that's one small step for men, one giant leap for mankind. It's been over 17 years since Apollo 2 and while the details of it are vivid in my mind, it's still quite hard for this Ohio boy to believe he actually made the trip. Through a telescope, I can pick out the spot on mars transquilliitatis where the eagle landed. I'm still very awestruck in retrospect. The excitement of actually being there was overshadowed to a great degree by the the overwhelming tasks that were required of Buzz and I. I wish you well, David. You are a very brave little boy. I will keep your well being in my thoughts and prayers, keep up your studies and I'm sure you'll get to visit the moon someday.

Sincerely yours,

Neil Armstrong

Easan Katir adds:

Neil Armstrong should rightfully be remembered as a world hero, along with—far beyond actually— Christopher Columbus and Ferdinand Magellan.

Leo Jia replies:

Wasn't the greatness of Columbus due to the fact that he had a vision and then acted upon it which led him to realize that vision? The land he discovered is a treasure to mankind which later nurtured a great country and wonderful people. I am not sure if he would still have obtained the prestige if the land were a totally uninhabitable piece of waste, or if the land were still unreachable by people by a long shot.

Aug

24

 A common mistake that stock people do I think is to pay attention to the increase in sales numbers. What does this have to do with future profits? I would think there is zero correlation given the earnings change since sales are so easy to manipulate by such things as discounts, pre-orders, and incentives for early buying, and reducing inventory et al. How did this ridiculous emphasis on the sales increase become as or more important than earnings relative to expectations in affecting stocks after the earnings report? I recently met with a pairs trading outfit and gave them 100 reasons I don't think it works, but it was from the seat of my pants. The main reason was of course that it goes against the drift. It hedges against the 10,000 fold return.

Gary Rogan writes: 

If sales increase while profits are decreasing, that's a bad sign. However when profits increase while sales are decreasing, this may be very good, but it can't go on too long. Sales trends gained influence as a counterbalance to profit growth being fudged. When you have profits, sales, and cash flows all increasing in unison and indebtedness not increasing, that's as good as it gets. 

Jeff Watson comments: 

Profits increasing while sales are decreasing are usually a sign of increased productivity, better inventory management, better management of labor, and better management of capital. Although Gary says this scenario can't go on too long, it really can go on forever. 

Gary Rogan replies: 

Well clearly it's mathematically possible to decrease sales by .1% per year and increase profits by .1% per year close to forever so "too long" was perhaps a bit harsh, but at some point in the real world gross margins become so high as to make further advances impossible due to competition or substitution. My statement was prompted by not being able to recall a real scenario of sustained profit growth and sales decline resulting in a good outcome having looked at hundreds of income statements, but I've never made a study out of it nor have I looked at multi-year trends. When customers are buying less of your stuff year in and year out that usually means they are not excited about your stuff, because they don't like it but perhaps in this case because the price is too high for them to use more of it. When customers get into the habit of using less of your stuff, that's hard to fight. 

Jeff Watson adds:

The Chair is 100% correct. Going back to Sears as an example…their aggressive pricing will only squeeze their retail operation out of business(if continued long enough), as prices this low are unsustainable in the long run. If a store has a 30 percent increase in sales after implementing a big sale, but it's gross profit goes from 22% to 6% or less, is that a good business plan? Even though Sears is not increasing labor to handle the increase in sales, the model is still badly flawed. I understand that one of the most important things in retail is buying right, but I suspect that most of the things Sears is selling is a loss leader. Maybe they are subscribing to the old cliche, "We might be losing a little money on each sale, so we'll make up for that with the increase in volume."

Russ Sears writes:

Coming from the world of insurance, when things sell unexpectedly well the actuaries double check their pricing. The agents and the market will quickly spot when you are selling $1 or risk coverage for 99 cents. When I started, before rate books were online, a printing error cut-off the $1 handle of 70 year old women term life insurance rate per $1,000 (this was highest age we sold term to). The month after the book went out we had more 70 yr. old women apply for insurance than we had in the past several years combined.

In other words sales increases often indicate increase in claims volatility. Sales increases make me wonder if management really knows what they are doing. One wonders if this rule holds for the retail and stocks in general. 

Carder Dimitroff adds: 

I may be naive, but in some sectors I believe the top line could be critical for long term investments. I'm thinking of regulated and capital intensive companies like electric utilities, gas utilities, water utilities, pipeline companies, transmission line companies and MLPs. In a different way, I'm also thinking of non-regulated utilities, such as independent power producers, refineries and REITs.

In all these cases, if the top line falls, the bottom line is plagued by fixed costs, such as interest, ad volerem taxes, depreciation and amortization.

The second derivative of revenues in such cases is capacity factor. Low revenues suggest low capacity factors. Low capacity factors suggest troubled assets and long-term challenges. The assets could be partially stranded by market conditions.

An example is marginally efficient coal plants. With low market prices for natural gas, many coal plants find themselves out of merit and not dispatched (zero earnings for producing energy). When natural gas prices return, marginal coal plants are again deep in the merit order and they are dispatched frequently or continuously.

Julian Rowberry writes: 

An internet marketing equivalent of over valuing sales figures is over valuing social media subscribers. Twitter followers, facebook likes, page views, ad clicks etc are all very easily manipulated.

Leo Jia adds: 

Here is my two cents regarding growth vs non-growth.

The present value of a business without growth is much lower than that of a similar sized growing business. So one obvious question to any business owner is whether he would like to receive more money or not if the business is to be sold today. The answer is obvious. But one may counter: since he is making good profits on the business, why would he sell it today? Well, isn't that the beauty of modern finance produced through Wall Street? To sell it today, the entrepreneur can collect today all his future earnings projected based on the best periods of his business performance, and with that reward, he can move on with his life, rather than be tied up by the business which may turn sourer later and cause him to suffer.

Why would Wall Street care more about growing businesses? Those people who bought out the entrepreneur have an even higher reward outlook than his and would seek higher profit on the investment.

Art Cooper writes: 

An example of this currently in the news is Hormel Foods, described in the article "Spam Sales Boost Hormel's Profit" on p B4 of today's WSJ.

The article notes that Hormel's Q3 earnings rose 13%, led by strong growth in products such as Spam and Mexican salsas, continuing a trend of higher YoY earnings. "Even so, rising commodity costs and shoppers' resistance to higher prices are pressuring its profit margins, which could affect its results in future quarters."

HRL's price has been roughly flat for a year.

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