Back in 1992 I read Peter Lynch's book "Beating the Street". It's a fun book to read; he explains how he came to recommend ~20 stocks in that year's Barron's "Roundtable". As the years passed though I kept noticing that stocks that he had recommended were falling by the wayside. One of them, Sun TV and Appliance, was a retailer in Columbus, Ohio, where I was living at the time, and not too many years after the recommendation, Sun crashed and burned. Similarly I noticed bad things happening to Supercuts, which he recommended, and more recently Fannie Mae and GM both fell to zero-ish levels. So I've long suspected that overall his picks might have been sub-par, or a disaster, even.

Today I finally got had the time and energy to test it. I know this is breaking the rules, but please refer to the attached spreadsheet, only 10 kB. The spreadsheet shows Lynch's 18 stocks (I excluded one stock because it traded in London and another because it was a "Class B" share, and I couldn't figure out what ticker to use in my database) and their tickers as of 1/31/1992.

Many, actually most, of the stocks did not continue as going concerns until today; they were either acquired, bankrupted, or whatever. I believe that my database (MarketQA) does a reasonably good job of giving my a terminal value, but beyond that I didn't attempt to find out what happened to each stock.

So the spreadsheet has a column for "months as a going concern", i.e. how long the stock lasted after 1/31/1992 until it was acquired, bankrupted, or whatever. Stocks that survived until now have lived for 229 months. The next column, "$1 grew to" tells you how much money you'd have if you invested $1 and held until the firm ceased as a going concern. The last column gives the compound return over the period as a going concern.

Lynch didn't do badly at all. The average stock grew $1 into $4.24. On average the stocks "lived" for 141 months as going concerns, and I did not give Lynch any credit for reinvesting the moneys after stocks died off. However there was an enormous variation among the stocks. Five of the 18 stocks lost more than 90%, but four multiplied your money by a factor of 10 or more.

The big winners were in the thrift / S&L stocks–on average they grew $1 into more than $8, and without them the average performance of the remaining stocks is not impressive.

Lessons? I guess these results give a pretty good feel for the wide variation in returns of individual stocks over long periods. It may also be surprising that stocks have such finite lifetimes, even when they work out well–e.g. First Essex turned your $1 into $20 before it fell off the radar about ten years ago, presumably after being acquired. Lynch himself always emphasizes that the occasional "ten bagger" can make up for a lot of sins elsewhere in the portfolio, and that definitely played out with his picks.

(If you can't handle spreadsheets, here it is as text, but I have no idea whether it will format properly for you.)

ticker as of 1/31/1992    company name    months as a going concern    $1 grew
to    compound annualized return while a going concern
GH    General Host    72    $0.80    -3.6%
PIR    Pier 1 Imports    229    $2.88    5.7%
SBN    Sunbelt Nursery    74    $0.03    -44.7%
CUTS    Supercuts    57    $0.72    -6.7%
SNTV    Sun TV and Appliance    82    $0.03    -40.0%
EAG    Eagle Financial    75    $6.34    34.4%
FESX    First Essex Bancorp    145    $19.57    27.9%
GSBK    Germantown Savings Bank    35    $3.67    56.1%
GBCI    Glacier Bancorp    229    $12.70    14.2%
LSBX    Lawrence Savings Bank    229    $10.54    13.1%
PBNB    People's Savings Financial    66    $3.97    28.5%
SVRN    Sovereign Bancorp    204    $1.03    0.2%
TLP    Tenera L.P.    139    $0.00    -42.8%
GM    General Motors    226    $0.01    -23.7%
PD    Phelps Dodge    182    $10.64    16.9%
CMS    CMS Energy    229    $1.74    2.9%
FNM    Fannie Mae    229    $0.04    -15.5%
COGRA    Colonial Group    38    $1.67    17.6%

       average    $4.24

Steve Ellison writes:

The median stock turned $1 into $1.70 and had a 4.4% CAGR. I got similar results when I checked stocks suggested by Jim Collins in Good to Great. A small number of big gainers made the portfolio as a whole above average. Maybe there is a lesson here.

Tim Melvin comments: 

If you study Mr. Lynch's results much of his success was a result of playing the mutual thrift conversion game. His fund had deposts in just about every mutual thrift in the country so he could buy the conversion offering. Almost universally these stocks were HUGE winners. That game is very much back to life today as new regs are pretty much forcing many thrifts to convert…..most can be bought after the offering at a still sizable disocunt to tangible book value.

Charles Pennington writes: 

Of the four "ten baggers", two would have gotten stopped out at very disadvantageous (roughly break even) prices…

I would have guessed that those conversions had limits on how much stock a customer could buy, and with those limits in place, how could they make a dent in the performance of a large fund?

According to the Cramer book ("Confessions.."), which is very entertaining, much of the good performance of his fund was also due to holding thrifts, but he almost went under when redemptions threatened to force him to sell those very illiquid stocks.

Apart from the initial "pop" after a conversion, I don't see why thrift stocks would continue being cheap. Isn't this a very well-known idea, given that I've heard of it?

Victor Niederhoffer writes:

Now the professor is going to compute the market value of the individual stocks and tell me that the average market value of the ones that went down 100% at inception was not different from the average market value of the ones that were 10 baggers and kept him from reading books. 

Charles Pennington responds: 

The Chair's point is that most of the 10 baggers mostly started out as impossibly-small-to-buy stocks, and that is correct. Here are the 10-baggers and their market caps in January 1992:

First Essex (FESX) $21 million
Glacier Bancorp (GBCI) $32 million
LSBX $12 million
Phelps Dodge (PD) $2.6 billion

The only non-micro cap is Phelps Dodge.

Here are the January 1992 market caps of the stocks that lost nearly 100%:

SBN $60 million
SNTV $109 million
TLP $30 million
GM $19.9 billion
FNM $17.7 billion

George Coyle writes: 

Food for thought since I don't have access to data, certain funds and firms have size restrictions on what they can buy due to position sizing, liquidity, etc. It would be interesting to see if stocks which crossed over a given level in market cap ($100mm, $500mm, $1bb) subsequently saw inflows or outflows by virtue of qualifying as new investments for bigger buyers or being kicked out by virtue of falling below an acceptable cap level. Also, there are legal filing consequences of holding positions over certain sizes so I imagine patterns exist which are very real as firms alter position sizing to avoid regulatory filings (and ultimately position size disclosure on a non-quarterly basis). It is a bit of a momentum study meets the analysis below but with a legal/fund guideline slant. I believe Factset tracks historical cap sizes with some reasonable degree of accuracy/frequency but I no longer have access.

Phil McDonnell writes:

To throw a few stats on the table I am posting links to some work done by Eric Crittenden. He is a momentum quant with BlackStar Funds. He argues that trend following must work because long term stock distributions have very fat tails. He also argues that the negative fat tail implies that stop losses must work. One of the charts shows a huge right tail of three baggers or better. Another shows that all gains come from 20% of the stocks.
I have had the chance to review several of his studies in progress and Crittenden seems to do it right. He uses total returns and avoids obvious pitfalls like survivor bias etc.

Charles Pennington responds:

It seems kind of silly that they take this indirect route — "lots of big gainers and lots of big losers, therefore use stop losses". Why don't they just test the performance of some simple stop-loss rule? Jason proposed a trailing stop of 50%. That sounds ok to me. Then, whenever you're stopped out, use the proceeds to buy an equal weight (cap weighted) of the remaining stocks. Does that outperform or under-perform the equal-weight (or cap weighted) index?



 "Progress is cumulative in science and engineering but cyclical in finance"
-James Grant

Which part of this claim is more likely to be untrue?

JAB says it most briefly, "when you progress far enough, you arrive at the beginning". Very long term cycle he has in mind when he says this. Is progress in Science and Engineering really cylical? Does a new discovery or a new principle come by only after leading to unbearable frustrations as in expressed by "necessity is the mother of all invention?"

Perhaps we will all agree the cycles of finance are far shorter in span than those of Science and Engineering. Why?

Steve Ellison writes:

The scientific method leads to cumulative progress. To be tested scientifically, a proposition must be falsifiable. Are the Black Eyed Peas superior to Beethoven? There is no objective way to answer that question.

Much science is governed by unchanging physical properties, unlike finance. Once it is established that one can construct a heavier than air flying machine, later innovators can be confident that will continue to be true and move on to improving designs, for example increasing speed. There are no flexions able to change the characteristics of the atmosphere to prevent planes from flying.



Chair suggested this 2007 article of his (with Mr. Downing) on Dailyspeculations on the Fed Model (not the FRB/US econometric model) may be of interest to some.

Steve Ellison writes: 

12 month forward earnings estimate now: 87.63
Index close today: 1320.88
Forward earnings yield: 6.63%

Alex Castaldo adds:

Ten year Treasury yield: 3.662%



 Editorial comments: I wonder how many up Januarys have been followed by "a new or continuing bear market, a 10% correction or a flat year"–the probability of one of those events occurring in any year seems high. Note that those events are cited to partially excuse the wrong forecasts of 2009 and 2010. I assume the accuracy ratios are calculated using the usual wrong method of comparing the change in January to the change in the whole year, including January.

As January Goes, so Goes the Year, Jeffrey A, Hirsch, Editor

Devised by Stock Trader's Almanac founder Yale Hirsch in 1972, the January Barometer predicts that stock market performance during the month of January sets the direction for the entire year. In fact, every down January for the S&P 500 since 1950 has been followed by a new or continuing bear market, a 10% correction or a flat year.

Despite major errors the last two years, this indicator still boasts an 88.5% accuracy ratio. Even including the seven flat-year errors, where the S&P closed the year in the opposite direction of January, but was up or down less than 5% for the year, the JB still delivers a
77.0% accuracy ratio.

We don't know of many indicators with such a strong track record Of the last three down Januarys: 2008 was followed by a continuing bear market and a down year; 2009 was also followed by a continuing bear and an 18.1% S&P decline from January to the March low, but an up year; and 2010 was followed by a 16% correction from April to July and an up year.

Last week's uprising in Egypt shuttered economic activity in that country, jolted worldwide stock markets and heightened Mideast tensions. But despite the rumor of 1 million protesters gathering tomorrow in Egypt, calm has returned to Wall Street on the last trading day of January, registering the first positive January for the S&P 500 in three years.

Prior to the Egyptian civil unrest, on the wave of $600 billion in additional quantitative easing, the rally gathered momentum in December that has carried over into January. Both our Santa Claus Rally and First Five Days Early Warning System delivered solid gains. Despite Friday's selloff on the news of clashes in Egypt the losses were not catastrophic and the market has held on to January's gains.

Even without the trouble on the Suez Canal a market correction was brewing. Unless the situation spirals out of control in Egypt and other Mideast hotspots, the often typical late-January/February break will give way to a continuation of the rally we projected in our 2011 Annual Forecast last month to Dow 13,000-14,000 in the first half of
2011. We expect any break to be about 5% and bounce off the 50-day moving averages of about 1,245 on the S&P, 2,640 on NASDAQ and 11500 for the Dow. Our forecast remains on track and after some pause in February we expect the market to flirt with the 2007 highs before succumbing to another seasonal soft patch in the May-October period.


Victor Niederhoffer writes:

One can always make a fortune by speculating based on patterns that worked 11 to 20 years ago as opposed to the last 10 years. See hallmarks of pseudo science in edspec, and Martin Gardner's Fads and Fallacies in the Name of Science.



A few years ago, my local library held a sale to purge old books from the shelves. I bought a 1976 book by Norman Fosback, Stock Market Logic, for a quarter. If Mr. Fosback is still alive, he might make a good Spec List member. His book is full of data and testable hypotheses. Best of all from a statistician's point of view, Mr. Fosback has done much of the testing, and one can go directly to out-of-sample testing.

In a chapter on seasonality, Mr. Fosback wrote that the US stock market tended to rise on the last trading day of the month, the first four trading days of a new month, and the two trading days before the market is closed for a holiday. He found that these days, which were only about 28% of all trading days, accounted for the entire advance in the S&P 500 from 1928 to 1975.

Using Mr. Fosback's definition to identify favorable days, I checked recent S&P 500 futures returns:

                               Favorable  Unfavorable
                                days          days
12/10/04-12/31/05        5.7%         -2.3%
2006                           2.7%          7.2%
2007                           5.3%         -5.1%
2008                         -21.9%       -22.2%
2009                           5.6%         18.5%
2010                          15.5%         -0.7%

The favorable days were clear winners in three of the six years. In 2006 and 2009, the per-day return was roughly equal on favorable and unfavorable days (remember that there are many more unfavorable days than favorable days). In 2008, the favorite was beaten as the per-day return of the favorable days was much worse than the unfavorable days. Over the entire period, S&P 500 returns were 9% on favorable days and -9% on unfavorable days.

Lars van Dort comments:

A slightly adopted version of Mr. Fosback's hypothesis of favorable days was tested by me for the Dutch stock market using the CBS Reinvestment Index for the period 1981-2003.

My definition of favorable days only included the last trading day of the month and the first four trading days of a new month. I excluded the two days before the market is closed for a holiday from the definition. (There are different holidays over here and frankly it would be a lot of work to identify them for the whole sample).

In this case favorable days account for 23% of all trading days, as opposed to 28% in Mr. Fosback's definition.

The results:

average return favorable day: 0.16% average return unfavorable day: 0.03%

Over the full sample, being long only on favorable days leads to a cumulative return of 714%. For the unfavorable days this was only 144%, while taking more than 3x as many trading days for this.

Of course, I'm aware of ever-changing cycles, but if this result would still hold, things would be very easy. Buy at close of the next-to-last trading day of a month. Sell at close of the fourth trading day of a month.



I subscribe to an investment newsletter whose aggregations of insider trading data provide value to me. This newsletter also provides market commentary, some based on technical analysis. One indicator is the number of "buying climaxes" in individual stocks. A buying climax is defined as a week in which the stock makes a new 52-week high, but then closes lower than the previous week. This pattern is interpreted as bearish because it suggests that "distribution" is occurring, i.e., informed investors are selling to uninformed investors.

In each of the last two weeks, a buying climax has occurred in the S&P 500 futures. Is that bearish?

The average 6-month change in the S&P 500 futures since 1983 has been 1.9% with a standard deviation of 15%. There were 74 buying climaxes from 1983 to mid-2010. Six months after the buying climaxes, the S&P 500 futures were up an average of 1.8%.

Using only non-overlapping look-ahead periods, there were 23
non-overlapping buying climaxes, and six months later, the S&P 500
futures were up an average of 2.6%, insignificantly better than average with a t score of 0.51. In defense of my newsletter, it reports climaxes for individual stocks, which may be predictive for all I know.

For the futures, I do not conclude that a buying climax is bearish. The high level of insider selling in the past three months looks negative–but this must be tested.

   Date        next 6 months
 2/15/1985              -2%
 3/21/1986              -4%
 3/13/1987             10%
10/28/1988               9%
 5/26/1989               4%
   9/6/1991               3%
12/24/1992               2%
 9/17/1993               2%
 3/31/1995             15%
12/15/1995               6%
 9/27/1996               9%
 7/11/1997              -2%
 3/27/1998              -7%
   2/5/1999               3%
   1/7/2000              -1%
 9/12/2003               9%
11/19/2004               1%
 7/29/2005               3%
 3/24/2006              -1%
11/24/2006               8%
 7/20/2007            -16%
10/23/2009             13%
 4/30/2010               0%



The Edge Question of 2011 is, "What scientific concept would improve everybody's cognitive toolkit?"

Edge posed this question to some well-known scientists and thinkers, and their answers are at http://edge.org/q2011/q11_index.html

Here, for example, is Matt Ridley's answer

"…Human achievement is based on collective intelligence — the nodes in the human neural network are people themselves. By each doing one thing and getting good at it, then sharing and combining the results through exchange, people become capable of doing things they do not even understand. As the economist Leonard Read observed in his essay 'I, Pencil' (which I'd like everybody to read), no single person knows how to make even a pencil … The idea of bottom-up collective intelligence … is one idea I wish everybody had in their cognitive toolkit."

I have always thought the Pareto Principle is one of the great secrets of life, and Clay Shirky advocates it :

"You see the pattern everywhere: the top 1% of the population control 35% of the wealth. On Twitter, the top 2% of users send 60% of the messages. In the health care system, the treatment for the most expensive fifth of patients create four-fifths of the overall cost. These figures are always reported as shocking … Pareto distributions are nothing like [Gaussian distributions] — the recursive 80/20 weighting means that the average is far from the middle. This in turn means that in such systems most people (or whatever is being measured) are below average, a pattern encapsulated in the old economics joke: 'Bill Gates walks into a bar and makes everybody a millionaire, on average."

Pitt T. Maner III comments:

The concept of networks and how they grow is still being researched but it is important at many different scales in the biological, economic and sociological realms.



Amare is currently ranked #12 and Carmelo #25. At PER 20.68 Carmelo is currently a "borderline" all star. Melo looks to be rebounding quite well and that helps a team win. He did help lead Syracuse to a National Championship as a freshman— which might be a indication of future ability to raise the level of team play when in a supporting environment.

I can only conceptualize that for a trader it would be how efficient he performs within the boundaries of time, risk, trade size, contribution to portfolio winning percentage, etc. and all those advanced measures you experts use.

The basics of shot selection
, defensive play and positioning, "hustle", and judicious leveraging of innate abilities are pretty important in basketball.

The Player Efficiency Rating is ESPN Insider writer John Hollinger's all-in-one basketball rating, which attempts to boil down all of a player's contributions into one number. Using a detailed formula, Hollinger developed a system that rates every player's statistical performance

All calculations begin with what is called unadjusted PER (uPER).

Once uPER is calculated, it must be adjusted for team pace and normalized to the league to become PER: This final step takes away the advantage held by players whose teams play a fast break style (and therefore have more possessions and more opportunities to do things on offense), and then sets the league average to 15.00. Also note that it is impossible to calculate PER (at least in the conventional manner described above) for NBA seasons prior to 1978, as the league did not keep track of turnovers before that year.

George Parkanyi responds:

 It depends on how many people are directly or perhaps indirectly contributing to the final decision of a trade. For example, how many people have a touch in your organization Victor before you make the final decision to trade or implement a trading program? - research/set-up, analysis, programming, execution, and so on … Any one of the these factors could impact the success (profit) or failure (loss) of the trade.

Steve Ellison comments: 

"What is missing from formulas like Berri's is an account of what Anthony does to the rest of the Nuggets."

There is a hockey statistic called plus/minus to help assess exactly that. Every player on the ice when his team scores gets a plus one. Every player on the ice when the opponents score gets a minus one. The results are cumulative. A player who does not score much but has a high positive plus/minus total is presumed to be doing something right.

Victor Niederhoffer inquires: 

How could this immediately be applied to markets ? There are players on a team also. But rather than simply adding, would a regression work better?

Steve Ellison responds: 

 One might consider various market "players" and what happens when they are visibly "on the ice". For example, when the President is speaking, does the market go up or down? When the Mayor's news feed features the Sage, does the market go up or down?

Victor Niederhoffer writes: 

I would conceptualize that the other players on the team are the other markets. how often does the stock market , create wins for the oil market et al, and for the grains, and are there leads and lags?

T.K.marks comments:

Anecdotal evidence has long had it that the oft-retired Michael Jordan was the ultimate basketball player in terms of making teammates better players. Apropos of the discussion here, it's been suggested that his talent in that regard was not limited to the court, but instead, cross-market in its scope.

From Wikipedia:

"…Jordan's yearly income from the endorsements is estimated to be over forty million dollars… An academic study found that Jordan’s first NBA comeback resulted in an increase in the market capitalization of his client firms of more than $1 billion…"

The journal in which the study is found is a subscription so I'll take Wiki's word for it. Though it would be nice to know by comparison what the overall market cap did during that same time frame.



 I don't have kids, but this article on "Why Chinese Mothers Are Superior" seems to relate to some of what has gone around before about raising kids and Asian children generally being ahead of the curve vs their Western counterparts.

Nigel Davies comments:

The Chinese authoress, Ching-ning Chu, described this tradition as '5,000 years of child abuse.

Steve Ellison writes:

Since the reaction to this article so far seems 100% negative, I will put in a good word for it. My (Korean immigrant) wife and I had a similar parenting philosophy, although not as extreme. Most American parents demand far too little of their children. I appreciate the author making the point that parents have a right to demand high standards and achievement.

My son attends a school for highly gifted students. Even among this population, some parents complain there is too much homework. By contrast, we hosted an exchange student from Korea in our home. This student while in Korea had gone to school as required from 8:00 am to 3:00 pm every day and then attended another school until 11:00 pm every night to get ahead in academics. This regimen is typical for children of families of means in Korea.

The author of the Journal article came to the US not from the People's Republic or a Chinese-majority jurisdiction, but from the Philippines, where there is a small Chinese minority that is far wealthier than the general population and is hated for it. The author's aunt was murdered by a mob during ethnic violence. The approach outlined in the article was probably necessary to survive in the Philippines.

Nigel Davies writes:

I see your point Steve, but to me the whole thing looked like an ill-tempered rant because the lady concerned attracted disapproval at the party she went to.

As a chess teacher I've taught youngsters from many different cultures. The ones I turn down flat are the pushy ones who have decided their kid will be a champion. The reason I refuse is simple - I've seen these kids burn themselves out as they try to perform well enough to be loved. On the other hand there are kids that genuinely developing excellence with full parental encouragement and support.

These two approaches may seem very similar but they're most definitely not; one comes with conditional love. And I think that it may be more valid to try and correlate the article's recommended approach with the kind of political regime that exists in China; brutality fosters brutes.

Laurel Kenner writes: 

I am reading Battle Hymn of the Tiger Mother, the book excerpted in the WSJ article for which Mr. Coyle kindly posted a link. Aubrey is taking Mandarin from a disciplinarian Chinese native, and I said I'd be interested in her opinion. Her reaction to the article: She was furious. She had grown up under just such a mother, and it wasn't a happy memory. Her mother would say, "I would rather have given birth to a piece of roast pork than you" to shame her, and the recollection still stung, years later. We may admire the Chinese kids for their "A" report cards, but they in turn envy the American ability to think "out of the box," innovate and found big enterprises.

I like Ms. Chua's style, and the book certainly is thought-provoking. I agree that the best way to self-esteem is to master a skill.

However, the short biography she provides in the book provides an unwitting clue as to the drawbacks of the Chinese approach. At Harvard, she was unable to ask questions in class, as her instinct was to simply take notes on everything the professor said. When it came time for a job interview for a Yale professorship, she found herself tongue-tied and wasn't hired. (She did get the job seven years later, after writing a cutting-edge book on how ethnic conflicts doom democratic majority rule in the Third World.)

Charles Pennington writes:

This is a fascinating and valuable book, which I've halfway completed. It is a defense of her unfashionable parenting philosophy, and she is not afraid to describe how it works in real life, complete with many anecdotes that make herself look bad. I think adults end up appreciating the special efforts that their parents made to impart on them a special skill. Maybe by now even Andre Agassi can appreciate his father's unrelenting efforts to turn him into a great tennis player.

I value the book because it gives me a realistic picture of the trying times that my wife and I can expect when we harness and over-ride our children's impulses and push them in a better direction.

The article has generated thousands of written comments, many of them harshly negative, even vicious. Ms. Chua gets some extra points in my book for boldness and bravery.

Russ Sears writes:

Beyond talent, it take a combination of the three c's of developing and spotting genius are commitment, confidence and creativity. The trick is that non of these can be crammed down a child but nurtured and grown. Further, children will react differently to anyone method so the instructor/coach must tailor the methods to the child. Last, but also perhaps most importantly, each discipline, talent or endeavor each requires a different combination of these c's and a highly expert opinion of how when and where to apply them, in order to obtain greatness.

For example a high bar, can create drive in one kid, perfectionism in another and burnout (as Nigel suggest) and pattern of quitting in others. As the Chinese example shows simply demanding commitment leaves even the obedient fearful lacking in confidence and reliant on the instructor to guide them stifling creativity. Teaching a child to love a sport, hence commitment is a necessary groundwork, and a parent/ coaches first job, but not sufficient. The idea that you can out work everyone is a fatal flaw to many scholars athletes and business men. The greats are all highly committed and their love and understanding will always out perform those that simply are counting on toughness and commitment.

Confidence, however, is only in moderation or it become hubris. It too must be developed and work. Testosterone can give a nature edge. Steroid abuse on the other hand may give a physical edge, but also tends to develop overconfidence superman syndrome. This is why I believe most of the athletes that get caught started taking them after they already developed some level of greatness. However, if you are to thrive in times of great stress rather than choke you must have confidence. Enough confidence that you do not over think the process or the exam, but enough practice, talent and knowledge than your instincts are spot on. The opposite of confidence is of course anxiety or unnecessary fear. 1 in 8 American suffer from an anxiety disorders. This therefore would be a good place to start in understanding how behavioral psychology effects investors.

Creativity by itself generally need disciple of commitment and confidence to be applied right. When to make the exception to the rule? When to trust yourself rather than the authorities? What is the right question to ask? Answer these creative questions correctly and you are on your way to greatness. Creativity however, often is either completely ignored in recognizing genius. Or it is often thought to be the only thing that matters. Both views kill the budding geniuses.

Jeff Watson writes:

Reading all of this parental preparation makes me feel like I dropped the ball as a parent as I did very little except to minimize hangups, teach my son right from wrong and allow him to be the happiest kid I know with a million friends and several beautiful girlfriends.. His mother was instrumental in making him into a scholar and she didn't have to work at it very hard at guiding his inquisitive nature as there was genetically coded DNA ensuring his "Knack" for the classics. There was an expectation that he would always learn, do well, think critically, and we were not done with force, coercion,punishment, or any other psychological devices. I was there to teach him to be a man, to do sports, surfing, skimming, and skating, shooting, archery, golfing,, bandage his knees and elbows and tape up knees and shoulders. I was also his biggest cheerleader, proofreader, outline fixer, and science teacher, who also taught him to cook and bake like a chef and prepare BBQ like a Black Southerner from Memphis.. My son might not have Mandarin under his belt, but he has Latin, Greek, Spanish, French, Italian pretty well down, both conversational and written. The jury is still out as his grad school is looming and we don't know what will be his choice. I offered him a year off after school just to hang out and surf before he either resumes his career or schooling. I wish someone had given me a year long surf break at his age as I think I would have done better in all my business because I wouldn't have been uptight for a couple of years. Of course, the theories of Galton correspond with my family and the previous generations , and I expect them to continue into the future. Hopefully, the children of the list members can also improve their progeny by marrying well, creating the right circumstances, and not pushing the kids into overload as there's a delicate balance. Just being members of the list is indicative that your kids won't be hanging out in pool halls, OTB, Illegal Pokers and numbers games, and that's a very brilliant head start that 70% of the fellow New Yorker kids can't get.

Yishen Kuik writes:

Perhaps one notion that might be useful is the "casualty" rate.

When we say such-and-such a profession is a "rock star" business, we usually mean that the number of winners in that industry are few, most of the rest are struggling, and the winners take a massively disproportionate amount of the prizes in that industry. The "casualty" rate is very high. Being a musician or an artist is a rock star business, being a doctor is not.

In Singapore, parents push their kids and will go to great lengths to sacrifice for their education. In general, we are a law abiding, conscientious, well educated and pragmatic people. However we are not known for thinking big, taking risks or innovation. And while most Singaporeans are close to their extended families, dining with them once a week, it is unusual that parents enjoy close friendships with their children. The relationship is largely characterized by respect and filial piety.

Because of this system of strong family networks, strong interest in pushing children and demanding academics, not many Singaporeans fall through the cracks
- we are a low casualty rate society. Not very good at producing rock stars, but quite good at not producing bums. This is great for kids who need the discipline and guidance and would otherwise grow up to be bums, but one could argue limits the potential of those who could have been great.

This has worked well for our small country - a stable system and a non-striking, non-unionized, trouble free and educated labour force has proven to be a winning formula as a service providing small nation that supports business between larger nations. But clearly this is not a formula for a large industrialized country, which needs to depend on the innovation of the few to create sufficient large scale value. Perhaps a system that sacrifices the many in order to locate and promote the elite few is the natural solution for an innovation driven large economy? I do not know what the answer is.

Nonetheless, Singapore is a very young country and has only been wealthy since 1980. I would expect attitudes between parents and kids to shift in the next generation.

Alston Mabry comments:

Very nicely articulated, Yishen.

An interesting thread overall.

I heard the author of the book in question speak briefly on NKR today and heard that the subtitle of the book is:

This is a story about a mother, two daughters, and two dogs. This was
*supposed* to be a story of how Chinese parents are better at raising kids than Western ones. But instead, it's about a bitter clash of cultures, a fleeting taste of glory, and how I was humbled by a thirteen-year-old.

Jeff Watson adds: 

I don't know, all these people drag out scientific ways to raise kids to be smart, to be champions. They push the kids pretty hard , aiming for Harvard, Yale, etc and one might expect some blow-back from that harsh regimen.. Fact is that parenting isn't an exact science and if you raise a responsible, happy, free from baggage, healthy, well spoken kid, you have 80% of the battle won.(I don't know what studies show but would suspect that well adjusted, happy kids probably do better in college than their non-adjusted peers) The schools previously mentioned like a story for admissions, and not the same story and school path and activities to get there that the great washed multitudes present them. So many in this world are competing through their children and I suspect that the outcome in this type of contest will not bode well for either child or parent especially if the child doesn't get into the first couple of choices..

Sometimes, a kid just needs to take an afternoon off, lie on his back and look up at the clouds and just imagine. Does a world of good in so many ways. If a kid is meant for an IVY school, he will get into an IVY school as there's always more than one way to skin a cat.

Jim Sogi opines:

Many modern children are horribly spoiled. It doesn't do them any good in the future. Their parent's are afraid of harming their delicate psyche's and end up with spoiled monsters that no one likes. You don't have to lay weird trips on them either, mostly that has to do with withholding love, or disapproval both of which create their own sick repercussions. A simple well defined set of expectations and rewards and time out or denial of reward is enough. Love must be unconditional. I see parents doing the absolutely wrong thing all the time, rewarding bad behavior and ignoring the good.

David Hillman writes:

I don't have children either, but I'm not certain having children is a prerequisite for recognizing common sense and good parenting. Is it that difficult to distinguish the difference between yelling at a child who's about to put his/her hand to a hot stove and yelling at a child skipping up the aisle at Walmart harming no one, i.e., just being a child? Or, what about a swat on the backside when a kid is being particularly rowdy and inattentive to commands to stop versus a backhand across the face to "put the fear of God in him/her"?

It was my great fortune to be born to parents who loved unconditionally and nurtured, yet they employed measured discipline and never spoiled. They told us "you can be anything you want to be and do anything you want to do if you apply yourself". The sky was the limit and we believed them. The only thing they absolutely insisted upon other than a "yes, ma'am" and a "no, sir", was that we were going to college come hell or high water, but what we did with our lives beyond that was our choice and they provided appropriate guidance. They led by example, not by threat of punishment and in the end produced a couple of reasonably well-balanced and self-satisfied [term used rather than 'successful' as the definition may vary from one to another] offspring.

Still, to this day, they occasionally lament their parental failings ["in retrospect, we should have…", "if we had it to do over again,……"]. While I, too, recognize some of their missteps privately, I tell them no instruction manual pops out of the womb with a kid, they were great parents, did the best anyone could, which was better than most, and I believe that to be true.

This discussion of parenting methods brings to mind a couple of items from long ago that provide contrast.

One, the clarinet lessons of my youth. Sister Mary Rasputin, a wizened, 4' tall 80 pounder taught me to play using the 'threat of physical abuse and eternal damnation' method. Her metronome was a 15" wooden ruler slapped rhythmically in the palm of her hand. She 'coaxed' exercises and pieces from my ebony Schmoeller & Mueller Bb licorice stick with red-faced, narrow-eyed, bared-tooth, shrill, 100db, spittle-laden complaints, insults, beratings, accusations and threats. Instead of motivating, however, I found intimidation worked quite the opposite with me. No matter how prepared, I dreaded the weekly 'lessons', hated the practice assignments and fell out of love with the clarinet. Eighth grade graduation, still a few years off, couldn't come soon enough. Yet, as it came and went, this instruction appeared fruitful as I wound up with 1st place medals from statewide competitions and was seated 2nd chair in the high school orchestra. But, I learned by intimidation and rote, didn't learn much about music theory until decades later, played mechanically, not with passion, and can't help but think I'd have been better off sitting in my room studying my Rubank Elementary Method and mimicking my Acker Bilk records.

Fast forward to interaction between two former mutual acquaintances. One was a very assertive sort who grew up in a middle-class family with a 'tough love' father, the other grew up in a somewhat disadvantaged but reasonably loving family. The former had had some business success, but even his own brother once told me "He's a great guy to be around, but I'd never do business with him." The latter had not made his mark at that point. He was ambitious, but more or less muddled through life looking for the 'big hit'. The former had material goods and proudly showed them off. The latter judged his own self-worth by comparing what luxuries he didn't have with what others had. The former often publically berated and ridiculed the latter in an effort to motivate him. The latter did not respond well. All the berating did was help him feel worse about himself than he did and perform poorly.

For one who is not a parent, it is still comforting and often poignant, and it gives me hope for future generations, when I see parents stopping in the grocery to quietly instruct a child on proper etiquette or behavior rather than employing a 'terrible swift sword' approach to discipline. And, I will frequently approach that parent and complement him/her on the obvious parenting skill. The reaction is always positive. I can't help but think that kid is going to be of more use to society than will one who's had good behavior pounded into them.

Yes, fear can be a strong motivator. We all know that and there are plenty of clear examples of success and heroics motivated by fear. In my own case, tho', I went to college and have done well because of it, but I haven't played my clarinet in years. A persistent nurturing and explanations of 'why' seems to have won out over terror in the long term. That was what worked for me, not a good skull cracking.

The point is there are many methods of parenting and of motivating and of instructing. I've had some parents say to me, "Sometimes you just have to say 'Because I'm the mom!', and I suppose that is so. I suppose also some kids need a 2×4 upside the head to get their attention. But not all methods work for all people. The trick seems to be knowing one's child or student [or employee or patient or spouse or recruit or client or you name it] and trying to recognize and employ the method or combination of methods that will be most fruitful. Not the easiest task and the stakes are often extremely high, especially in the case of child-rearing.

I always thought I'd have been a good parent. Maybe, maybe not. It didn't work out that way. I was either too selfish or not courageous enough to pull the trigger. But, I've compensated by becoming every kid's favorite uncle. And, since I've learned through observation the best kids are like the best dogs and like friends with boats…..you get to enjoy them, but they go home with someone else who has to maintain them, being the favorite uncle works for me.

Yet, I have great respect for those of you who have chosen to repopulate this planet with your 2.1 kids and thank those of you who take the time to know your kids and raise them well and give them the tools they need to help them grow into decent human beings. 'Cause what they become, how they behave, and what they do, will in some way impact me and all of us in some way, and that kinda makes them my kids, too.

George Zachar writes: 

No amount of common sense, good intentions, or book research, prepares one for parenting. 

Jim Sogi comments: 

David's advice to patiently explain in detail the expected behavior is the proper method of parenting. The common wrong method is to say, "No, don't do that." It gives the child no clue as to the proper behavior. Set expectations in writing. For example: Wash dishes once per week, or no allowance. This is clear, since the consequence is obvious. The wrong way is to say, "You're lazy and no good, and I will withhold my love if you don't help around the house more." It is too vague, and the repercussions are not commensurate with the behavior. Yet it is the common tactic I see over and over.



You can get as-reported earnings for the S&P 500 from 1988 on at Standard & Poor's website.

Using 12-month trailing earnings for each year's September quarter (the last that would be known by Dec. 31) to calculate an E/P ratio for the S&P 500 as of Dec. 31, I get a somewhat positive correlation of trailing E/P to year-ahead returns with t=1.10, R sq=0.057, p=0.29, and N=22.

Larry Williams writes:

My model for the DOW suggests a 12.25% growth for the year, slightly above the long term average growth.

For the S&P, I get 10.6 % barely above the long term average.

Bruno Ombreux writes:

There are two things I don't like in P/E or E/P studies.

1) Your regression is in the form:

-1 + P(t)/P(t-1) = f[P(t-n)/E(t-n)] + e we have the same variable on both sides, and even if it is lagged I am not sure standard regression is OK to handle this type of formula. Just to give you an idea, multiplying both sides by P(t-1), it is actually P(t) = P(t-1) + P(t-1)* f[P(t-n)/E(t-n)] + P(t-1)*e

This is certainly amenable to study, but not with the standard regression toolbox.

2) Price is more volatile than earnings. There is a subtle bias introduced by the fact that over the estimation sample, high P/E will be naturally followed by lower P/E, and vice-versa. This is a bit like regression to the mean but more subtle. This can lead to spurious mean-reversion.

Phil McDonnell adds:

The issue is not really the dependent variable. It is using the Shiller variable with its serial correlation. One way to use the Shiller variable would be to take every tenth month. That might work but you would have one tenth the data. You still might have the Holbrook Working flaw because of the averaging. The averaging also leads to the Slutsky-Yule effect which creates spurious sinusoidal artifacts in the adjusted variable when no such sinusoidal effect is actually present in the original data..



Here are racing-style past performance charts of recent 2-month market performances.

If one believed past results had any influence on future results, silver and agricultural commodities would look like superstars, bonds and currencies would look ho-hum, and natural gas would look like a filly running during mating season with one awful race after another.

Cotton             1/2 mo   1 mo 1 1/2 mo     2mo   2 mo change
Nov-Dec                 1       9       2       2          21.6%
Sep-Oct                 3       2       3       2          38.6%
Jul-Aug                13       8       4       3          10.3%

Gold               1/2 mo   1 mo 1 1/2 mo     2mo   2 mo change
Nov-Dec                 6       3       7       8           5.7%
Sep-Oct                10       9       8       8           3.6%
Jul-Aug                12      13      10      10          -2.3%

Silver             1/2 mo   1 mo 1 1/2 mo     2mo   2 mo change
Nov-Dec                 2       1       1       1          27.1%
Sep-Oct                 5       4       4       4          20.6%
Jul-Aug                10      12      12       5           1.2%

Soybeans           1/2 mo   1 mo 1 1/2 mo     2mo   2 mo change
Nov-Dec                 3       4       5       3          14.4%
Sep-Oct                 7       5       5       5          15.7%
Jul-Aug                 1       2       3       4           9.3%

Euro               1/2 mo   1 mo 1 1/2 mo     2mo   2 mo change
Nov-Dec                10      12      12      12          -2.5%
Sep-Oct                 8       8       7       7           4.7%
Jul-Aug                 5       5       7       6           1.0%

British Pound      1/2 mo   1 mo 1 1/2 mo     2mo   2 mo change
Nov-Dec                 7      10      11      11          -1.5%
Sep-Oct                 9      10      10      10          -0.3%
Jul-Aug                 6       6       6       8           0.2%

Sugar              1/2 mo   1 mo 1 1/2 mo     2mo   2 mo change
Nov-Dec                13      11       4       5          11.5%
Sep-Oct                 1       1       1       1          43.8%
Jul-Aug                 3       1       1       1          20.2%

Corn               1/2 mo   1 mo 1 1/2 mo     2mo   2 mo change
Nov-Dec                11      13      10       7           6.9%
Sep-Oct                 2       3       2       3          26.4%
Jul-Aug                 2       3       2       2          14.9%

Crude oil          1/2 mo   1 mo 1 1/2 mo     2mo   2 mo change
Nov-Dec                 4       2       3       4          11.7%
Sep-Oct                 6       7       9       9           3.5%
Jul-Aug                 7       9      11      12          -8.3%

S&P 500            1/2 mo   1 mo 1 1/2 mo     2mo   2 mo change
Nov-Dec                 5       5       6       6           7.9%
Sep-Oct                 4       6       6       6           7.9%
Jul-Aug                 3       4       5       9           0.2%

Natural gas        1/2 mo   1 mo 1 1/2 mo     2mo   2 mo change
Nov-Dec                12       8       9       9           4.2%
Sep-Oct                13      13      13      13         -14.2%
Jul-Aug                 9       7      13      13         -21.2%

10-year T notes    1/2 mo   1 mo 1 1/2 mo     2mo   2 mo change
Nov-Dec                 9       7      13      13          -3.0%
Sep-Oct                12      11      11      11          -4.1%
Jul-Aug                 8      10       8       7           0.9%

U.S. Dollar        1/2 mo   1 mo 1 1/2 mo     2mo   2 mo change
Nov-Dec                 8       6       8      10           1.1%
Sep-Oct                11      12      12      12          -4.6%
Jul-Aug                11      11       9      10          -2.3%




UPDATE 1/31/2011:

Contestants Summary:

- 31 Spec-listers contributed to the 2011 Investment Contest with "specific" recommendations.

- Average 4 recommendations per person (mean of 4.2, median and mode of 4) came in.

- 6 contestants gave only 1 recommendation, 3 gave only 2 and thus 9 out of the total 31 have NOT given the minimum 3 recommendations needed as per the Rules clarified by Ken Drees.

- The Hall of Fame entry for the largest number of ideas (did someone say diversification?) is from Tim Melvin, close on whose heels are J. T. Holley with 11 and Ken Drees with 10.

- The most creatively expressed entry of course has come from Rocky Humbert.

- At this moment 17 out of 31 contestants are in positive performance territory, 14 are in negative performance territory.

- Barring a major outlier of a 112.90% loss on the Option Strategy of Phil McDonnell (not accounting for the margin required for short options, but just taking the ratio of initial cash inflow to outflow):

- Average of all Individual contestant returns is -2.54% and the Standard Deviation of returns achieved by all contestants is 5.39.

- Biggest Gainer at this point is Jared Albert (with his all in single stock bet on REFR) with a 22.87% gain. The only contestant a Z score greater than 2 ( His is actually 4.72 !!)

- Biggest Loser at this point (barring the Giga-leveraged position of Mr. McDonnell) is Ken Drees at -10.36% with a Z Score that is at -1.45.

- Wildcards have not been accounted for as at this point, with wide
deviations of recommendations from the rules specified by most. While 9
participants have less than 3 recommendations, those with more than 4
include several who have not chosen to specify which 3 are their primary recommends. Without clarity on a universal measurability wildcard accounting is on hold. Those making more than 1 recommendations would find that their aggregate average return is derived by taking a sum of returns of individual positions divided by the number of recommends. Unless specified by any person that positions are taken in a specific ratio its equal sums invested approach.

Contracts Summary:

- A total of 109 contracts are utilized by the contestants across bonds, equity indices (Nikkei, Kenyan Stocks included too!), commodities, currencies and individual stock positions.

- The ratio of Shorts to Longs across all recommendations, irrespective of the type of contract (call, put, bearish ETF etc.) is 4 SELL orders Vs 9 Buy Orders. Not inferring that this list is more used to pressing the Buy Button. Just an occurence on this instance.

- The Average Return, so far, on the 109 contracts utilized is -1.26% with a Standard Deviation of 12.42%. Median Return is 0.39% and the mode of Returns of all contracts used is 0.

- The Highest Return is on MICRON TECH at 28.09, if one does not account for the July 2011 Put 25 strike on SLV utilized by Phil McDonnell.

- The Lowest Return is on IPTV at -50%, if one does not account for the Jan 2012 Call 40 Strike on SLV utilized by Phil McDonnell.

- Only Two contracts are having a greater than 2 z score and only 3 contracts are having a less than -2 Z score.

Victor Niederhoffer wrote:

One is constantly amazed at the sagacity in their fields of our fellow specs. My goodness, there's hardly a field that one of us doesn't know about from my own hard ball squash rackets to the space advertising or our President, from surfing to astronomy. We certainly have a wide range.

May I suggest without violating our mandate that we consider our best sagacities as to the best ways to make a profit in the next year of 2011.

My best trades always start with assuming that whatever didn't work the most last year will work the best this year, and whatever worked the best last year will work the worst this year. I'd be bullish on bonds and bearish on stocks, bullish on Japan and bearish on US stocks.

I'd bet against the banks because Ron Paul is going to be watching them and the cronies in the institutions will not be able to transfer as much resources as they've given them in the past 2 years which has to be much greater in value than their total market value.

I keep wondering what investments I should make based on the hobo's visit and I guess it has to be generic drugs and foods.

What ideas do you have for 2011 that might be profitable? To make it interesting I'll give a prize of 2500 to the best forecast, based on results as of the end of 2011.

David Hillman writes: 

"I do know that a sagging Market keeps my units from being full."

One would suggest it is a sagging 'economy' contributing to vacancy, not a sagging 'market'. There is a difference. 

Ken Drees, appointed moderator of the contest, clearly states the new rules of the game:

 1. Submissions for contest entries must be made on the last two days of 2010, December 30th or 31st.
2. Entries need to be labeled in subject line as "2011 contest investment prediction picks" or something very close so that we know this is your official entry.
3. Entries need 3 predictions and 1 wildcard trade prediction (anything goes on the wildcard).

4. Extra predictions may be submitted and will be judged as extra credit. This will not detract from the main predictions and may or may not be judged at all.

5. Extra predictions will be looked on as bravado– if you've got it then flaunt it. It may pay off or you may give the judge a sour palate.

The desire to have entries coming in at years end is to ensure that you have the best data as to year end 2010 and that you don't ignite someone else to your wisdom.

Market direction picks are wanted:

Examples: 30 year treasury yield will fall to 3% in 2011, S&P 500 will hit "x" by June, and then by "y" by December 2011.

The more exact your prediction is, the more weight will be given. The more exact your prediction, the more weight you will receive if right and thus the more weight you will receive if wrong. If you predict that copper will hit 5.00 dollars in 2011 and it does you will be given a great score, if you say that copper will hit 5.00 dollars in march and then it will decline to4.35 and so forth you will be judged all along that prediction and will receive extra weight good or bad. You decide on how detailed your submission is structured.

Will you try to be precise (maybe foolhardy) and go for the glory? Or will you play it safe and not stand out from the crowd? It is a doubled edged sword so its best to be the one handed market prognosticator and make your best predictions. Pretend these predictions are some pearls that you would give to a close friend or relative. You may actually help a speclister to make some money by giving up a pearl, if that speclister so desires to act upon a contest–G-d help him or her.

Markets can be currency, stocks, bonds, commodities, etc. Single stock picks can be given for the one wildcard trade prediction. If you give multiple stock picks for the wildcard then they will all be judged and in the spirit of giving a friend a pearl–lets make it "the best of the best, not one of six".

All judgments are the Chair's. The Chair will make final determination of the winner. Entries received with less than 3 market predictions will not be considered. Entries received without a wildcard will be considered.The spirit of the contest is "Give us something we can use".

Bill Rafter adds: 

Suggestion for contest:

"Static" entry: A collection of up to 10 assets which will be entered on the initial date (say 12/31/2010) and will be unaltered until the end data (i.e. 12/31/2011). The assets could be a compilation of longs and shorts, or could have the 10 slots entirely filled with one asset (e.g. gold). The assets could also be a yield and a fixed rate; that is one could go long the 10-year yield and short a fixed yield such as 3 percent. This latter item will accommodate those who want to enter a prediction but are unsure which asset to enter as many are unfamiliar with the various bond coupons.

"Rebalanced" entry: A collection of up to 10 assets which will be rebalanced on the last trading day of each month. Although the assets will remain unchanged, their percentage of the portfolio will change. This is to accommodate those risk-averse entrants employing a mean-reversion strategy.

Both Static and Rebalanced entries will be judged on a reward-to-risk basis. That is, the return achieved at the end of the year, divided by the maximum drawdown (percentage) one had to endure to achieve that return.

Not sure how to handle other prognostications such as "Famous female singer revealed to be man." But I doubt such entries have financial benefits.

I'm willing to be an arbiter who would do the rebalancing if necessary. I am not willing to prove or disprove the alleged cross-dressers.

Ralph Vince writes:

A very low volume bar on the weekly (likely, the first of two consecutive) after a respectable run-up, the backdrop of rates having risen in recent weeks, breadth having topped out and receding - and a lunar eclipse on the very night of the Winter Solstice.

If I were a Roman General I would take that as a sign to sit for next few months and do nothing.

I'm going to sit and do nothing.

Sounds like an interim top in an otherwise bullish, long-term backdrop.

Gordon Haave writes: 

 My three predictions:

Gold/ silver ratio falls below 25 Kenyan stock market outperforms US by more than 10%

Dollar ends 10% stronger compared to euro

All are actionable predictions.

Steve Ellison writes:

I did many regressions looking for factors that might predict a year-ahead return for the S&P 500. A few factors are at extreme values at the end of 2010.

The US 10-year Treasury bond yield at 3.37% is the second-lowest end-of year yield in the last 50 years. The S&P 500 contract is in backwardation with the front contract at a 0.4% premium to the next contract back, the second highest year-end premium in the 29 years of the futures.

Unfortunately, neither of those factors has much correlation with the price change in the S&P 500 the following year. Here are a few that do.

The yield curve (10-year yield minus 3-month yield) is in the top 10% of its last 50 year-end values. In the last 30 years, the yield curve has been positively correlated with year-ahead changes in the S&P 500, with a t score of 2.17 and an R squared of 0.143.

The US unemployment rate at 9.8% is the third highest in the past 60 years. In the last 30 years, the unemployment rate has been positively correlated with year-ahead changes in the S&P 500, with a t score of 0.90 and an R squared of 0.028.

In a variation of the technique used by the Yale permabear, I calculated the S&P 500 earnings/price ratio using 5-year trailing earnings. I get an annualized earnings yield of 4.6%. In the last 18 years, this ratio has been positively correlated with year-ahead changes in the S&P 500, with a t score of 0.92 and an R squared of

Finally, there is a negative correlation between the 30-year S&P 500 change and the year-ahead change, with a t score of -2.28 and an R squared of 0.094. The S&P 500 index price is 9.27 times its price of 30 years ago. The median year-end price in the last 52 years was 6.65 times the price 30 years earlier.

Using the predicted values from each of the regressions, and weighting the predictions by the R squared values, I get an overall prediction for an 11.8% increase in the S&P 500 in 2011. With an 11.8% increase, SPY would close 2011 at 140.52.

Factor                  Prediction      t       N    R sq
US Treasury yield curve      1.162    2.17      30   0.143
30-year change               1.052   -2.28      52   0.094
Trailing 5-year E/P          1.104    0.92      18   0.050
US unemployment rate         1.153    0.90      30   0.028

Weighted total               1.118
SPY 12/30/10               125.72
Predicted SPY 12/30/11     140.52

Jan-Petter Janssen writes: 

PREDICTION I - The Inconvenient Truth The poorest one or two billion on this planet have had enough of increasing food prices. Riots and civil unrest force governments to ban exports, and they start importing at any cost. World trade collapses. Manufacturers of farm equipment will do extremely well. Buy the most undervalued producer you can find. My bet is
* Kverneland (Yahoo: KVE.OL). NOK 6.50 per share today. At least NOK 30 on Dec 31th 2011.

PREDICTION II - The Ultimate Bubble The US and many EU nations hold enormous gold reserves. E.g. both Italy and France hold the equivalent of the annual world production. The gold meme changes from an inflation hedge / return to the gold standard to (a potential) over-supply from the selling of indebted nations. I don't see the bubble bursting quite yet, but
* Short gold if it hits $2,000 per ounce and buy back at $400.

PREDICTION III - The Status Quo Asia's ace is cheap labor. The US' recent winning card is cheap energy through natural gas. This will not change in 2011. Henry Hub Feb 2011 currently trades at $4.34 per MMBtu. Feb 2012 is at $5.14. I would
* Short the Feb 2012 contract and buy back on the last trading day of 2011.

Vince Fulco predicts:

 This is strictly an old school, fundamental equity call as my crystal ball for the indices 12 months out is necessarily foggy. My recommendation is BP equity primarily for the reasons I gave earlier in the year on June 5th (stock closed Friday, June 4th @ $37.16, currently $43.53). It faced a hellish downdraft post my mention for consideration, primarily due to the intensification of news flow and legal unknowns (Rocky articulated these well). Also although the capital structure arb boys savaged the equity (to 28ish!), it is up nicely to year's end if one held on and averaged in with wide scales given the heightened vol.

Additional points/guesstimates are:

1) If 2010 was annus horribilis, 2011 with be annus recuperato. A chastened mgmt who have articulated they'll run things more conservatively will have a lot to prove to stakeholders.

2) Dividend to be re-instated to some level probably by the end of the second quarter. I am guessing $1.00 annualized per ADS as a start (or
2.29%), this should bring in the index hugging funds with mandates for only holding dividend payers. There is a small chance for a 1x special dividend later in the year.

3) Crude continues to be in a state of significant profitability for the majors in the short term. It would appear finding costs are creeping however.

4) The lawsuits and additional recoveries to be extracted from the settlement fund and company directly have very long tails, on the order of 10 years.

5) The company seems fully committed to sloughing off tertiary assets to build up its liquid balance sheet. Debt to total capital remains relatively low and manageable.

6) The stock remains at a significant discount to its better-of breed peers (EV/normalized EBITDA, Cash Flow, etc) and rightly so but I am betting the discount should narrow back to near historical levels.

Potential negatives:

1) The company and govt have been vastly understating the remaining fuel amounts and effects. Release of independent data intensifies demands for a much larger payout by the company closer to the highest end estimates of $50-80B.

2) It experiences another similar event of smaller magnitude which continues to sully the company's weakened reputation.

3) China admits to and begins to fear rampant inflation, puts the kabosh to the (global) economy and crude has a meaningful decline the likes of which we haven't seen in a few years.

4) Congress freaks at a >$100-120 price for crude and actually institutes an "excess profits" tax. Less likely with the GOP coming in.

A buy at this level would be for an unleveraged, diversified, longer term acct which I have it in. However, I am willing to hold the full year or +30% total return (including special dividend) from the closing price of $43.53 @ 12/30/10, whichever comes first. Like a good sellside recommendation, I believe the stock has downside of around 20% (don't they all when recommended!?!) where I would consider another long entry depending on circumstances (not pertinent to the contest).

Mr. Albert enters: 

 Single pick stock ticker is REFR

The only way this gold chain wearing day trader has a chance against all the right tail brain power on the list is with one high risk/high reward put it all on red kind of micro cap.

Basic story is this company owns all the patents to what will become the standard for switchable glazings (SPD smart glass). It's taken roughly 50 years of development to get a commercialized product, and next year Mercedes will almost without doubt use SPD in the 2012 SLK (press launch 1/29/11 public launch at the Geneva auto show in march 2011).

Once MB validate the tech, mass adoption and revenues will follow etc and this 'show me' stock will rocket to the moon.

Dan Grossman writes:

Trying to comply with and adapt the complex contest rules (which most others don't seem to be following in any event) to my areas of stock market interest:

1. The S&P will be down in the 1st qtr, and at some point in the qtr will fall at least

2. For takeover investors: GENZ will (finally) make a deal to be acquired in the 1st qtr for a value of at least $80; and AMRN after completion of its ANCHOR trial will make a deal to be acquired for a price of at least $8.

3. For conservative investors: Low multiple small caps HELE and DFG will be up a combined average of 20% by the end of the year.

For my single stock pick, I am something of a johnny-one-note: MNTA will be up lots during the year — if I have to pick a specific amount, I'd say at least 70%. (My prior legal predictions on this stock have proved correct but the stock price has not appropriately reflected same.)

Finally, if I win the contest (which I think is fairly likely), I will donate the prize to a free market or libertarian charity. I don't see why Victor should have to subsidize this distinguished group that could all well afford an contest entrance fee to more equitably finance the prize.

Best to all for the New Year,


Gary Rogan writes:

 1. S&P 500 will rise 3% by April and then fall 12% from the peak by the end of the year.
2. 30 year treasury yields will rise to 5% by March and 6% by year end.
3. Gold will hit 1450 by April, will fall to 1100 by September and rise to 1550 by year end.

Wildcard: Short Netflix.

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

Equal Amounts in:

TBT (short long bonds)
YCS (short Yen)
GRU (Long Grains - heavy on wheat)
CHK (Long NG - takeover)

(Wild Card)
BONXF.PK or BTR.V (Long junior gold)

12/30 closing prices (in order):


Bill Rafter writes:

Two entries:

Buy: FXP and IRWD

Hold for the entire year.

William Weaver writes:

 For Returns: Long XIV January 21st through year end

For Return/Risk: Long XIV*.30 and Long VXZ*.70 from close today

I hope everyone has enjoyed a very merry holiday season, and to all I wish a wonderful New Year.



Ken Drees writes:

Yes, they have been going up, but I am going contrary contrary here and going with the trends.

1. Silver: buy day 1 of trading at any price via the following vehicles: paas, slw, exk, hl –25% each for 100% When silver hits 39/ounce, sell 10% of holdings, when silver hits 44/ounce sell 30% of holdings, when silver hits 49 sell 60%–hold rest (divide into 4 parts) and sell each tranche every 5 dollars up till gone–54/oz, 59, 64, 69.

2. Buy GDXJ day 1 (junior gold miner etf)—rotation down from majors to juniors with a positive gold backdrop. HOLD ALL YEAR.

3. USO. Buy day 1 then do—sell 25% at 119/bbl oil, sell 80% at 148/bbl, sell whats left at 179/bbl or 139/bbl (whichever comes first after 148)

wildcard: AMEX URANUIM STOCKS. UEC, URRE, URZ, DNN. 25% EACH, buy day 1 then do SELL 70% OF EVERYTHING AT 96$LB u http://www.uxc.com/ FOR PRICING, AND HOLD REST FOR YEAR END.

Happy New Year!

Ken Drees———keepin it real.

Sam Eisenstadt forecasts:

My forecast for the S&P 500 for the year ending Dec 31, 2011;

S&P 500       1410

Anton Johnson writes: 

Equal amounts allocated to:

EDZ Short moc 1-21-2011, buy to cover at 50% gain, or moc 12/30/2011

VXX Short moc 1-21-2011, buy to cover moc 12/30/2011

UBT Short moo 1-3-2011, buy to cover moc 12/30/2011

Scott Brooks picks: 


Evenly between the 4 (25% each)

Sushil Kedia predicts:


1) Gold
2) Copper
3) Japanese Yen

30% moves approximately in each, within 2011.

Rocky Humbert writes:

(There was no mention nor requirement that my 2011 prediction had to be in English. Here is my submission.) … Happy New Year, Rocky

Sa aking mahal na kaibigan: Sa haba ng 2010, ako na ibinigay ng ilang mga ideya trading na nagtrabaho sa labas magnificently, at ng ilang mga ideya na hindi na kaya malaki. May ay wala nakapagtataka tungkol sa isang hula taon dulo, at kung ikaw ay maaaring isalin ito talata, ikaw ay malamang na gawin ang mas mahusay na paggawa ng iyong sariling pananaliksik kaysa sa pakikinig sa mga kalokohan na ako at ang iba pa ay magbigay. Ang susi sa tagumpay sa 2011 ay ang parehong bilang ito ay palaging (tulad ng ipinaliwanag sa pamamagitan ng G. Ed Seykota), sa makatuwid: 1) Trade sa mga kalakaran. 2) Ride winners at losers hiwa. 3) Pamahalaan ang panganib. 4) Panatilihin ang isip at diwa malinaw. Upang kung saan gusto ko idagdag, fundamentals talaga bagay, at kung ito ay hindi magkaroon ng kahulugan, ito ay hindi magkaroon ng kahulugan, at diyan ay wala lalo na pinakinabangang tungkol sa pagiging isang contrarian bilang ang pinagkasunduan ay karaniwang karapatan maliban sa paggawa sa mga puntos. (Tandaan na ito ay pinagkasunduan na ang araw ay babangon na bukas, na quote Seth Klarman!) Pagbati para sa isang malusog na masaya at pinakinabangang 2011, at siguraduhin na basahin www.rockyhumbert.com kung saan ako magsulat sa Ingles ngunit ang aking mga saloobin ay walang malinaw kaysa talata na ito, ngunit inaasahan namin na ito ay mas kapaki-pakinabang.

Dylan Distasio comments: 

Gawin mo magsalita tagalog?

Gary Rogan writes:

After a worthy challenge, Mr. Rogan is now also a master of Google Translate, and a discoverer of an exciting fact that Google Translate calls Tagalog "Filipino". This was a difficult obstacle for Mr. Rogan to overcome, but he persevered and here's Rocky's prediction in English (sort of):

My dear friend: Over the course of 2010, I provided some trading ideas worked out magnificently, and some ideas that are not so great. There is nothing magical about a forecast year end, and if you can translate this paragraph, you will probably do better doing your own research rather than listening to the nonsense that I and others will give. The key to success in 2011 is the same as it always has (as explained by Mr. Ed Seykota), namely: 1) Trade with the trend.

2) Ride cut winners and losers. 3) Manage risk. 4) Keep the mind and spirit clear. To which I would add, fundamentals really matter, and if it does not make sense, it does not make sense, and there is nothing particularly profitable about being a contrarian as the consensus is usually right but turning points. (Note that it is agreed that the sun will rise tomorrow, to quote Seth Klarman) Best wishes for a happy healthy and profitable 2011, and be sure to read www.rockyhumbert.com which I write in English but my attitude is nothing clearer than this paragraph, but hopefully it is more useful.

Tim Melvin writes:

Ah the years end prediction exercise. It is of course a mostly useless exercise since not a one of us can predict what shocks, positive or negative, the world and the markets could see in 2011. I find it crack up laugh out loud funny that some pundits come out and offer up earnings estimates, GDP growth assumptions and interest rate guesses to give a precise level for the year end S&P 500 price. You might as well numbers out of a bag and rearrange them by lottery to come up with a year end number. In a world where we are fighting two wars, a hostile government holds the majority of our debt and several sovereign nations continually teeter on the edge of oblivion it's pretty much ridiculous to assume what could happen in the year ahead. Having said that, as my son's favorite WWE wrestler when he was a little guy used to say "It's time to play the game!"

Ill start with bonds. I have owned puts on the long term treasury market for two years now. I gave some back in 2010 after a huge gain in 2009 but am still slightly ahead. Ill roll the position forward and buy January 2012 puts and stay short. When I look at bods I hear some folks talking about rising basic commodity prices and worrying about inflation. They are of course correct. This is happening. I hear some other really smart folks talking of weak real estate, high jobless rates and the potential for falling back into recession. Naturally, they are also exactly correct. So I will predict the one thing no one else is. We are on the verge of good old fashioned 1970s style stagflation. Commodity and basic needs prices will accelerate as QE2 has at least stimulated demand form emerging markets by allowing these wonderful credits to borrow money cheaper than a school teacher with a 750 FICO score. Binds go lower as rates spike. Our economy and balance sheet are a mess and we have governments run by men in tin hats lecturing us on fiscal responsibility. How low will they go Tim? How the hell do I know? I just think they go lower by enough for me to profit.

 Nor can I tell you where the stock market will go this year. I suspect we have had it too good for too long for no reason so I think we get at least one spectacular gut wrenching, vomit inducing sell off during the year. Much as lower than expected profits exposed the silly valuations of the new paradigm stocks I think that the darling group, retail , will spark a sell-off in the stock market this year. Sales will be up a little bit but except for Tiffany's (TIF) and that ilk margins are horrific. Discounting started early this holiday and grew from there. They will get steeper now that that Santa Claus has given back my credit card and returned to the great white north. The earnings season will see a lot of missed estimates and lowered forecasts and that could well pop the bubble. Once it starts the HFT boys and girls should make sure it goes lower than anyone expects.

Here's the thing about my prediction. It is no better than anyone else's. In other words I am talking my book and predicting what I hope will happen. Having learned this lesson over the years I have learned that when it comes to market timing and market direction I am probably the dumbest guy in the room. Because of that I have trained myself to always buy the stuff that's too cheap not to own and hold it regardless. After the rally since September truly cheap stuff is a little scarce on the ground but I have found enough to be about 40% long going into the year. I have a watch list as long as a taller persons right arm but most of it hover above truly cheap.

Here is what I own going into the year and think is still cheap enough to buy. I like Winn Dixie (WINN). The grocery business sucks right now. Wal mart has crushed margins industry wide. That aside WINN trades at 60% of tangible book value and at some point their 514 stores in the Southeast will attract attention from investors. A takeover here would be less than shocking. I will add Presidential Life (PLFE) to the list. This stock is also at 60% of tangible book and I expect to see a lot of M&A activity in the insurance sector this year and this should raise valuations across the board. I like Miller Petroleum (MILL) with their drilling presence in Alaska and the shale field soft Tennessee. This one trades at 70% of tangible book. Ill add Imperial Sugar (IPSU), Syms (SYMS) and Micron tech (MU) and Avatar Holdings (AVTR) to my list of cheapies and move on for now.

I am going to start building my small bank portfolio this year. Eventually this group becomes the F-you walk away money trade of the decade. As real estate losses work through the balance sheet and some measure of stability returns to the financial system, perhaps toward the end of the year the small baileys savings and loan type banks should start to recover. We will also see a mind blowing M&A wave as larger banks look to gain not just market share but healthy assets to put on the books. Right now these names trade at a fraction of tangible book value. They will reach a multiple of that in a recovery or takeover scenario. Right now I own shares of Shore Bancshares (SHBI), a local bank trading at 80% of book value and a reasonably healthy loan portfolio. I have some other mini microcap banks as well that shall remain my little secret and not used to figure how my predictions work out. I mention them because if you have a mini micro bank in your community you should go meet then bankers, review the books and consider investing if it trades below the magical tangible book value and has excess capital. Flagstar Bancorp(FBC) is my super long shot undated call option n the economy and real estate markets.

I will also play the thrift conversion game heavily this year. With the elimination of the Office of Thrift Services under the new financial regulation many of the benefits of being a private or mutual thrift are going away. There are a ton of mutual savings banks that will now convert to publicly traded banks. A lot of these deals will be priced below the pro forma book value that is created by adding all that lovely IPO cash to the balance sheet without a corresponding increase in the shares outstanding. Right now I have Fox Chase Bancorp (FXCB) and Capital Federal Financial(CFFN). There will be more. Deals are happening every day right now and again I would keep an eye out for local deals that you can take advantage of in the next few months.

I also think that 2011 will be the year of the activist investor. These folks took a beating since 2007 but this should be their year. There is a ton of cash on corporate balance sheets but lots of underperformance in the current economic environment. We will see activist drive takeovers, restructures, and special dividends this year in my opinion. Recent filings of interest include strong activist positions in Surmodics(SRDX), SeaChange International (SEAC), and Energy Solutions. Tracking activist portfolios and 13D filings should be a very profitable activity in 2011.

I have been looking at some interesting new stuff with options as well I am not going to give most of it away just yet but I ll give you one stimulated by a recent list discussion. H and R Black is highly likely to go into a private equity portfolio next year. Management has made every mistake you can make and the loss of RALs is a big problem for the company. However the brand has real value. I do not want town the stock just yet but I like the idea of selling the January 2012 at $.70 to $.75. If you cash secure the put it's a 10% or so return if the stock stays above the strike. If it falls below I' ll be happy to own the stock with a 6 handle net. Back in 2008 everyone anticipated a huge default wave to hit the high yield market. Thanks to federal stimulus money pumping programs it did not happen. However in the spirit of sell the dog food the dog will eat a given moment the hedge fund world raised an enormous amount od distressed debt money. Thanks to this high yield spreads are far too low. CCC paper in particular is priced at absurd levels. These things trade like money good paper and much of it is not. Extend and pretend has helped but if the economy stays weak and interest rates rise rolling over the tsunami f paper due over the next few years becomes nigh onto impossible. I am going take small position in puts on the various high yield ETFs. If I am right they will explode when that market implodes. Continuing to talk my book I hope this happens. Among my nightly prayers is "Please God just one more two year period of asset rich companies with current payments having bonds trade below recovery value and I promise not to piss the money away this time. Amen.

PS. If you add in risk arbitrage spreads of 30% annualized returns along with this I would not object. Love, Tim.

I can't tell you what the markets will do. I do know that I want to own some safe and cheap stocks, some well capitalized small banks trading below book and participate in activist situation. I will be under invested in equities going into the year hoping my watch list becomes my buy list in market stumble. I will have put positions on long T-Bonds and high yield hoping for a large asymmetrical payoff.

Other than that I am clueless.

Kim Zussman comments: 

Does anyone else think this year is harder than usual to forecast? Is it better now to forecast based on market fundamentals or mass psychology? We are at a two year high in stocks, after a huge rally off the '09 bottom that followed through this year. One can make compelling arguments for next year to decline (best case scenarios already discounted, prior big declines followed by others, volatility low, house prices still too high, FED out of tools, gov debt/gdp, Roubini says so, benefits to wall st not main st, persistent high unemployment, Year-to-year there is no significant relationship, but there is a weak down tendency after two consecutive up years. ). And compelling arguments for up as well (crash-fears cooling, short MA's > long MA's, retail investors and much cash still on sidelines, tax-cut extended, employee social security lowered, earnings increasing, GDP increasing, Tepper and Goldman say so, FED herding into risk assets, benefits to wall st not main st, employment starting to increase).

Is the level of government market-intervention effective, sustainable, or really that unusual? The FED looks to be avoiding Japan-style deflation at all costs, and has a better tool in the dollar. A bond yields decline would help growth and reduce deflation risk. Increasing yields would be expected with increasing inflation; bad for growth but welcomed by retiring boomers looking for fixed income. Will Obamacare be challenged or defanged by states or in the supreme court? Will 2011 be the year of the muni-bubble pop?

A ball of confusion!

4 picks in equal proportion:

long XLV (health care etf; underperformed last year)

long CMF (Cali muni bond fund; fears over-wrought, investors still need tax-free yield)

short GLD (looks like a bubble and who needs gold anyway)

short IEF (7-10Y treasuries; near multi-year high/QE2 is weaker than vigilantism)

Alan Millhone writes:

 Hello everyone,

I note discussion over the rules etc. Then you have a fellow like myself who has never bought or sold through the Market a single share.

For myself I will stick with what I know a little something. No, not Checkers —

Rental property. I have some empty units and beginning to rent one or two of late to increase my bottom line.

I will not venture into areas I know little or nothing and will stay the course in 2011 with what I am comfortable.

Happy New Year and good health,



Jay Pasch predicts: 

2010 will close below SP futures 1255.

Buy-and-holders will be sorely disappointed as 2011 presents itself as a whip-saw year.

99% of the bullish prognosticators will eat crow except for the few lonely that called for a tempered intra-year high of ~ SPX 1300.

SPX will test 1130 by April 15 with a new recovery high as high as 1300 by the end of July.

SPX 1300 will fail with new 2011 low of 1050 before ending the year right about where it started.

The Midwest will continue to supply the country with good-natured humble stock, relatively speaking.

Chris Tucker enters: 

Buy and Hold


Wildcard:  Buy and Hold AVAV

Gibbons Burke comments: 

Mr. Ed Seykota once outlined for me the four essential rules of trading:

1) The trend is your friend (till it bends when it ends.)

2) Ride your winners.

3) Cut your losses short.

4) Keep the size of your bet small.

Then there are the "special" rules:

5) Follow all the rules.

and for masters of the game:

6) Know when to break rule #5

A prosperous and joy-filled New Year to everyone.



John Floyd writes:

In no particular order with target prices to be reached at some point in 2011:

1) Short the Australian Dollar:current 1.0220, target price .8000

2) Short the Euro: current 1.3375, target price 1.00

3) Short European Bank Stocks, can use BEBANKS index: current 107.40, target 70

A Mr. Krisrock predicts: 

 1…housing will continue to lag…no matter what can be done…and with it unemployment will remain

2…bonds will outperform as republicans will make cutting spending the first attack they make…QE 2 will be replaced by QE3

3…with every economist in the world bullish, stocks will underperform…

4…commodities are peaking ….

Laurel Kenner predicts: 

After having made monkeys of those luminaries who shorted Treasuries last year, the market in 2011 has had its laugh and will finally carry out the long-anticipated plunge in bond prices.

Short the 30-year bond futures and cover at 80.

Pete Earle writes:

All picks are for 'all year' (open first trading day/close last trading day).

1. Long EUR/USD
2. Short gold (GLD)

MMR (McMoran Exploration Corp)
HDIX (Home Diagnostics Inc)
TUES (Tuesday Morning Corp)

PBP (Powershares S&P500 Buy-Write ETF)
NIB (iPath DJ-UBS Cocoa ETF)
KG (King Pharmaceuticals)

Happy New Year to all,

Pete Earle

Paolo Pezzutti enters: 

If I may humbly add my 2 cents:

- bearish on S&P: 900 in dec
- crisis in Europe will bring EURUSD down to 1.15
- gold will remain a safe have haven: up to 1500
- big winner: natural gas to 8

J.T Holley contributes: 


The Market Mistress so eloquently must come first and foremost. Just as daily historical stats point to betting on the "unchanged" so is my S&P 500 trade for calendar year 2011. Straddle the Mistress Day 1. My choice for own reasons with whatever leverage is suitable for pain thresholds is a quasi straddle. 100% Long and 50% Short in whatever instrument you choose. If instrument allows more leverage, first take away 50% of the 50% Short at suitable time and add to the depreciated/hopefully still less than 100% Long. Feel free to add to the Long at this discretionary point if it suits you. At the next occasion that is discretionary take away remaining Short side of Quasi Straddle, buckle up, and go Long whatever % Long that your instrument or brokerage allows till the end of 2011. Take note and use the historical annual standard deviation of the S&P 500 as a rudder or North Star, and throw in the quarterly standard deviation for testing. I think the ambiguity of the current situation will make the next 200-300 trading days of data collection highly important, more so than prior, but will probably yield results that produce just the same results whatever the Power Magnification of the Microscope.

Long the U.S. Dollar. Don't bother with the rest of the world and concern yourself with which of the few other Socialist-minded Country currencies to short. Just Long the U.S. Dollar on Day 1 of 2011. Keep it simple and specialize in only the Long of the U.S. Dollar. Cataclysmic Economic Nuclear Winter ain't gonna happen. When the Pastor preaches only on the Armageddon and passes the plate while at the pulpit there is only one thing that happens eventually - the Parish dwindles and the plate stops getting filled. The Dollar will bend as has, but won't break or at least I ain't bettin' on such.

Ala Mr. Melvin, Short any investment vehicle you like that contains the words or numerals "perpetual maturity", "zero coupon" and "20-30yr maturity" in their respective regulated descriptions, that were issued in times of yore. Unfortunately it doesn't work like a light switch with the timing, remember it's more like air going into a balloon or a slow motion see-saw. We always want profits initially and now and it just doesn't work that way it seems in speculation. Also, a side hedge is to start initially looking at any financial institution that begins, dabbles, originates and gains high margin fees from 50-100 year home loans or Zero-Coupon Home Loans if such start to make their way Stateside. The Gummit is done with this infusion and cheer leading. They are in protection mode, their profit was made. Now the savy financial engineers that are left or upcoming will continue to find ways to get the masses to think they "Own" homes while actually renting them. Think Car Industry '90-'06 with. Japan did it with their Notes and I'm sure some like-minded MBA's are baiting/pushing the envelopes now in board rooms across the U.S. with their profitability and ROI models, probably have ditched the Projector and have all around the cherry table with IPads watching their presentation. This will ultimately I feel humbly be the end of the Mortgage Interest Deduction as it will be dwindled down to a moot point and won't any longer be the leading tax deduction that it was created to so-called help.


Short Gold, Short it, Short it more. Take all of your emotions and historical supply and demand factors out of the equation, just look at the historical standard deviation and how far right it is and think of Buzz Lightyear in Toy Story and when he thought he was actually flying and the look on his face at apex realization. That plus continue doing a study on Google Searches and the number of hits on "stolen gold", "stolen jewelery", and Google Google side Ads for "We buy Gold". I don't own gold jewelery, and have surrendered the only gold piece that I ever wore, but if I was still wearing it I'd be mighty weary of those that would be willing to chop a finger off to obtain. That ain't my fear, that's more their greed.

Long lithium related or raw if such. Technology demands such going forward.


Long Natural Gas. Trading Day 1 till last trading day of the year. The historic "cheap" price in the minds of wannabe's will cause it to be leveraged long and oft with increasing volume regardless of the supply. Demand will follow, Pickens sowed the seeds and paid the price workin' the mule while plowin'. De-regulation on the supply side of commercial business statements is still in its infancy and will continue, politics will not beat out free markets going into the future.

Long Crude and look to see the round 150 broken in years to come while China invents, perfects, and sees the utility in the Nuclear fueled tanker.

Long LED, solar, and wind generation related with tiny % positions. Green makes since, its here to stay and become high margined profitable businesses.


Short Sugar. Sorry Mr. Bow Tie. Monsanto has you Beet! That being stated, the substitute has arrived and genetically altered "Roundup Ready" is here to stay no matter what the Legislative Luddite Agrarians try, deny, or attempt. With that said, Long MON. It is way more than a seed company. It is more a pharmaceutical engineer and will bring down the obesity ridden words Corn Syrup eventually as well. Russia and Ireland will make sure of this with their attitudes of profit legally or illegally.

Prepare to long in late 2011 the commercialized marijuana and its manufacturing, distribution companies that need to expand profitability from its declining tobacco. Altria can't wait, neither can Monsanto. It isn't a moral issue any longer, it's a financial profit one. We get the joke, or choke? If the Gummit doesn't see what substitutes that K2 are doing and the legal hassles of such and what is going on in Lisbon then they need to have an economic lesson or two. It will be a compromise between the Commercial Adjective Definition Agrarians and Gummit for tax purposes with the Green theme continuing and lobbying.

Short Coffee, but just the 1st Qtr of 2011. Sorry Seattle. I will also state that there will exist a higher profit margin substitute for the gas combustible engine than a substitute for caffeine laden coffee.

Sex and Speculation:

Look to see www.fyretv.com go public in 2011 with whatever investment bank that does such trying their best to be anonymous. Are their any investment banks around? This Boxxx will make Red Box blush and Apple TV's box envious. IPTV and all related should be a category that should be Longed in 2011 it is here to stay and is in it's infancy. Way too many puns could be developed from this statement. Yes, I know fellas the fyre boxxx is 6"'s X 7"'s.


This is one category to always go Long. I have vastly improved my guitar playin' in '10 and will do so in '11. AAPL still has the edge and few rivals are even gaining market share and its still a buy on dips, sell on highs empirically counted. They finally realized that .99 cents wasn't cutting it and .69 cents was more appropriate for those that have bought Led Zeppelin IV songs on LP, 8-track, cassette, and CD over the course of their lives. Also, I believe technology has a better shot at profitably bringing music back into public schools than the Federal or State Gummits ever will.


Long - Your mind. Double down on this Day 1 of 2011. It's the most capable, profitable thing you have going for you. I just learned this after the last 36 months.

Long - Counting, you need it now more than ever. It's as important as capitalism.

Long - Being humble, it's intangible but if quantified has a STD of 4 if not higher.

Long - Common Sense.

Long - Our Children. The media is starting to question if their education is priceless, when it is, but not in their context or jam.

Short - Politics. It isn't a spectator sport and it has been made to be such.

Short - Fear, it is way way been played out. Test anything out there if you like. I have. It is prevalent still and disbelief is rampant.

Long - Greed, but don't be greedy just profitable. Wall Street: Money Never Sleeps was the pilot fish.

I had to end on a Long note.

Happy New Year's Specs. Thanks to all for support over the last four years. I finally realized that it ain't about being right or wrong, just profitable in all endeavors. Too many losses led to this, pain felt after lookin' within, and countin' ones character results with pen/paper.

Russ Sears writes:

 For my entry to the contest, I will stick with the stocks ETF, and the index markets and avoid individual stocks, and the bonds and interest rates. This entry was thrown together rather quickly, not at all an acceptable level if it was real money. This entry is meant to show my personal biases and familiarity, rather than my investment regiment. I am largely talking my personal book.

Therefore, in the spirit of the contest , as well as the rules I will expose my line of thinking but only put numbers on actual entry predictions. Finally, if my caveats are not warning enough, I will comment on how a prediction or contest entry differs from any real investment. I would make or have made.

The USA number one new product export will continue to be the exportation of inflation. The printing of dollars will continue to have unintended consequences than its intended effect on the national economy but have an effect on the global economy.. Such monetary policy will hit areas with the most potential for growth: the emerging markets of China and India. In these economies, that spends over half their income on food, food will continue to rise. This appears to be a position opposite the Chairs starting point prediction of reversal of last year's trends.

Likewise, the demand for precious metals such as gold and silver will not wane as these are the poor man's hedge against food cost. It may be overkill for the advanced economies to horde the necessities and load up on precious metals Yet, unlike the 70's the US/ European economy no longer controls gold and silver a paradigm shift in thinking that perhaps the simple statistician that uses weighted averages and the geocentric economist have missed. So I believe those entries shorting gold or silver will be largely disappointed. However in a nod to the chair's wisdom, I will not pick metals directly as an entry. Last year's surprise is seldom this year's media darling. However, the trend can continue and gold could have a good year. The exception to the reversal rule seems to be with bubbles which gain a momentum of their own, apart from the fundamentals. The media has a natural sympathy in suggesting a return to the drama of he 70's, the stagflation dilemma, ,and propelling an indicator of doom. With the media's and the Fed's befuddled backing perhaps the "exception" is to be expected. But I certainly don't see metal's impending collapse nor its continued performance.

The stability or even elevated food prices will have some big effects on the heartland.

1. For my trend is your friend pick: Rather than buy directly into a agriculture commodity based index like DBA, I am suggesting you buy an equity agriculture based ETF like CRBA year end price at 77.50. I am suggesting that this ETF do not need to have commodities produce a stellar year, but simply need more confirmation that commodity price have established a higher long term floor. Individually I own several of these stocks and my wife family are farmers and landowners (for full disclosure purposes not to suggest I know anything about the agriculture business) Price of farmland is raising, due to low rates, GSE available credit, high grain prices due to high demand from China/India, ethanol substitution of oil A more direct investment in agriculture stability would be farmland. Farmers are buying tractors, best seeds and fertilizers of course, but will this accelerate. Being wrong on my core theme of stable to rising food/commodity price will ruin this trade. Therefore any real trade would do due diligence on individual stocks, and put a trailing floor. And be sensitive to higher volatility in commodities as well as a appropriate entry and exit level.

2. For the long term negative alpha, short term strength trade: I am going with airlines and FAA at 49.42 at year end. There seems to be finally some ability to pass cost through to the consumer, will it hold?

3. For the comeback of the year trade XHB: (the homebuilders ETF), bounces back with 25% return. While the overbuilding and vacancy rates in many high population density areas will continue to drag the home makes down, the new demand from the heartland for high end houses will rise that is this is I am suggesting that the homebuilders index is a good play for housing regionally decoupling from the national index. And much of what was said about the trading of agriculture ETF, also apply to this ETF. However, while I consider this a "surprise", the surprise is that this ETF does not have a negative alpha or slightly positive. This is in-line with my S&P 500 prediction below. Therefore unless you want volatility, simply buying the S&P Vanguard fund would probably be wiser. Or simply hold these inline to the index.

4. For the S&P Index itself I would go with the Vanguard 500 Fund as my vehicle VFINXF, and predict it will end 2011 at $145.03, this is 25% + the dividend. This is largely due to how I believe the economy will react this year. 

5. For my wild card regional banks EFT, greater than IAT > 37.50 by end 2011…

Yanki Onen writes:

 I would like to thank all for sharing their insights and wisdom. As we all know and reminded time to time, how unforgiven could the market Mistress be. We also know how nurturing and giving it could be. Time to time i had my share of falls and rises. Everytime I fall, I pick your book turn couple of pages to get my fix then scroll through articles in DSpecs seeking wisdom and a flash of light. It never fails, before you know, back to the races. I have all of you to thank for that.

Now the ideas;

-This year's lagger next year's winner CSCO

Go long Jan 2012 20 Puts @ 2.63 Go long CSCO @ 19.55 Being long the put gives you the leverage and protection for a whole year, to give the stock time to make a move.

You could own 100,000 shares for $263K with portfolio margin ! Sooner the stock moves the more you make (time decay)

-Sell contango Buy backwardation

You could never go wrong if you accept the truth, Index funds always roll and specs dont take physical delivery. This cant be more true in Cotton.

Right before Index roll dates (it is widely published) sell front month buy back month especially when it is giving you almost -30 to do so Sell March CT Buy July CT pyramid this trade untill the roll date (sometime at the end of Jan or begining of Feb) when they are almost done rolling(watch the shift in open interest) close out and Buy May CT sell July CT wait patiently for it to play it out again untill the next roll.

- Leveraged ETFs suckers play!

Two ways to play this one out if you could borrow and sell short, short both FAZ and FAS equal $ amounts since the trade is neutral, execute this trade almost free of margin. One thing is for sure to stay even long after we are gone is volatility and triple leveraged products melt under volatility!

If you cant borrow the shares execute the trade using Jan 12 options to open synthetic short positions. This trade works with time and patience!

Vic, thanks again for providing a platform to listen and to be heard.


Yanki Onen

Phil McDonnell writes: 

When investing one should consider a diversified portfolio. But in a contest the best strategy is just to go for it. After all you have to be number one.

With that thought in mind I am going to bet it all on Silver using derivatives on the ETF SLV.

SLV closed at 30.18 on Friday.

Buy Jan 2013 40 call for 3.45.
Sell Jan 2012 40 call at 1.80.
Sell Jul 25 put at 1.15.

Net debit is .50.

Exit strategy: close out entire position if SLV ETF reaches a price of 40 or better. If 40 is not reached then exit on 2/31/2011 at the close.

George Parkanyi entered:

For what it's worth, the Great White North weighs in ….
3 Markets equally weighted - 3 stages each (if rules allow) - all trades front months
3 JAN 2011
BUY NAT GAS at open

BUY SILVER at open

BUY CORN at open
28 FEB 2011 (Reverse Positions)
SELL and then SHORT NAT GAS at open

SELL and then SHORT SILVER at open

SELL and then SHORT CORN at open
1 AUG 2011 (Reverse Positions)
COVER and then BUY NAT GAS at open

COVER and then BUY SILVER at open

COVER and then BUY CORN at open
Hold all positions to the end of the year

3 JAN BUY PLATINUM and hold to end of year.


. Markets to unexpectedly carry through in New Year despite correction fears.

. Spain/Ireland debt roll issues - Europe/Euro in general- will be in the news in Q1/Q2

- markets will correct sharply in late Q1 through Q2 (interest rates will be rising)

. Markets will kick in again in Q3 & Q4 with strong finish on more/earlier QE in both Europe and US - hard assets will remain in favour; corn & platinum shortages; cooling trend & economic recovery to favour nat gas

. Also assuming seasonals will perform more or less according to stats

If rules do not allow directional changes; then go long NAT GAS, SILVER, and CORN on 1 AUG 2011 (cash until then); wild card trade the same.

Gratuitous/pointless prediction: At least two European countries will drop out of Euro in 2011 (at least announce it) and go back to their own currency. 

Marlowe Cassetti enters:

FXE - Currency Shares Euro Trust

XLE - Energy Select

BAL - iPath Dow Jones-AIG Cotton Total Return Sub-Index

GDXJ - Market Vectors Junior Gold Miners

AMJ - JPMorgan Alerian MLP Index ETN

Wild Card:


VNM - Market Vectors Vietnam ETF

Kim Zussman entered: 

long XLV (health care etf; underperformed last year)
long CMF (Cali muni bond fund; fears over-wrought, investors still
need tax-free yield)
short GLD (looks like a bubble and who needs gold anyway)
short IEF (7-10Y treasuries; near multi-year high/QE2 is weaker than



The traditional explanation of a high put-call ratio was panic by the uninformed public. With the S&P 500 at a two-year high today, that scenario seems quite unlikely. Using another method to evaluate the little guys, the non-reportable positions in last week's COT report were net long 3.4% of the S&P 500 open interest (weighted average of bigs and e-minis). The non-reportable net long position has ranged from 0.9% to 5.2% in the past year.

Alston Mabry comments:

IMHO, the relationship between the ratio of leveraged-long instruments to leveraged-short instruments on the one hand, and the market on the other, went through a regime change this summer after the Flash Crash. To paraphrase Wally Shawn in The Princess Bride: "I don't think that means what I thought it meant."

William Weaver writes:

To pose another question to the list: What types of events can cause a regime change in a financial instrument?

To stick with equities, I use consumer spending data to define high vol and low vol regimes as I have found these fundamentals precede market action (not survey data).

Of my three business partners, two who have created models that best my own and use only price, volume, and open interest data.

Composition of OI? i.e. Commitment of Traders? Larry any thoughts on how a strategy may only work with one demographic instead of using the demographic as a signal itself? Maybe ICI data with fund holdings?

Sentiment data?

There was a company a few years back that suggested lookback periods consisted of all the data where a detrended version of price stayed within a standardized range, thus the last spike was the end of the prior regime. The flash crash could be a part of this.

Regulatory/mechanical changes: fractional to decimal, up-tick rule, naked short rules, no short rules, required reserves, etc.

So this gives us a few starting points: fundamentals, price/volume/OI related observations, demographic of a market, regulatory/mechanical, sentiment data and major dislocations in price (I believe this should be separated from the price category).

David Aronson replies: 


With regard to your question. We have recently added a type of modeling that searches simultaneously for an indictor to define distinct regimes (2 or 3) and then linear models that are optimal in each regime (distinct range of the regime indicator). I have not done much with it yet but we were motivated to add this tool because of the phenomena that you talk about in your post.



Mr. Round Day before end of month harmonizes.

Ken Drees adds:

It gave bears hope and bulls sustenance.

Dow 11000 fence straddle.

Bulls feel better below 11 and bears feel better above.

Basketball play where the team purposely slows the tempo and slowly walks the ball down floor for a planned play comes to mind here.

Steve Ellison comments: 

EUR/USD at 1.3002.

Gary Rogan writes:

It continues today: now S&P at 1200, dow at 11200. NAS can't quite find a really good round number after yesterday's 2500, but still glued to 2550.



The S&P 500 futures opened down on Globex and never traded above Monday's close all day Tuesday. After the last 13 Knicks-like performances, the S&P 500 the next day was up 6 times and down 7 times:

     Next day
    Date        change
 3/30/2009    1.3%
 4/20/2009    1.8%
 4/27/2009   -0.6%
 5/11/2009   -0.2%
 6/15/2009   -1.3%
 8/17/2009    1.2%
 9/24/2009   -0.3%
 2/25/2010    0.1%
 3/15/2010    0.8%
 4/16/2010    0.4%
 8/10/2010   -3.1%
 8/11/2010   -0.5%
11/11/2010   -1.3%



 My wife makes a suggestion. How about a list of the 100 most hated companies. Dilbert's Scott Adams points out that he hates Wells Fargo, because they bought all the companies that went bankrupt for him, including Worldcom and Enron, but their stock went up. And he hates Apple so he bought that one too. Taking a look at the companies that the sage owns, one would hate them, and even the average person must know what a sanctimonious self serving poseur he is. Perhaps they would be good ones to buy also. But how would you come up with the other 98% ?

Steve Ellison comments:

I would actually nominate Apple as one of the most loved companies, with many users having a near-religious devotion to Apple products. However, I have many politically liberal relatives and Facebook friends who regularly express outrage at "corporations" (said with a tone of disgust), especially the following:

1. Wal-Mart drives competitors out of business and allegedly underpays and denies health benefits to its employees
2. The entire "Big Oil" sector raises gasoline prices whenever it can and pollutes the environment; Exxon Mobil is the biggest company, but BP is now more hated.
3. Halliburton got no-bid contracts to profit from the war in Iraq
4. Monsanto develops genetically modified crops, never mind that humans have been genetically modifying plants and animals for over 10,000 years using lower-tech methods
5. Microsoft is a monopoly
6. The tobacco sector allegedly tried to suppress evidence that smoking is harmful to health
7. News Corp. owns Fox News and the Wall Street Journal
8. The utility sector raised rates and built nuclear power plants or CO2-emitting coal-fired plants
9. McDonald's serves unhealthy food that can lead to obesity; some interpret the sight of a McDonald's restaurant outside North America as a tragic destruction of local culture.

Jeff Watson writes:

Somehow, I suspect the most reviled companies are probably the best run, most profitable companies in their sectors. The general public always despise a winner that does it on their own terms, a la Readon. 

Ken Drees suggests:

Halliburton and BP are hated as enviro haters.



It has been three months since the confirmation of the Hindenburg Omen, and the S&P 500 is up 12% since then.

Larry Williams writes:

True on H Omen sell but….there was what I call a H Omen buy on 8/27 and 8/30. I am writing a paper about this.

Jim Sogi writes: 

Steve's point is why I believe that quantitative price analysis must be augmented with game theory such as Chair's infrastructural and and natural observations, but also with Mr. E's macro observation and political gamesmanship. This helps with the cycle analysis.



 Many assume the continuation of trends beyond their turning points. Such thinking is evident in the news. The opposite view is the statistical lack of trends and the assumption of reversion to the mean. However trends exist in a random or due to macro effect such as government (mis)policy or herding, none of which can be ignored except to one's detriment. The pure quantification of price makes discernment of the change of cycles hard to see except in retrospect, thus other forward and current input seem worthy to consider. There are tells to macro effects if they can be discerned. The random trends also may have their characteristics. Philosophers like to define their terms, and traders also need to define their time frames to clearly state the issues. This seems to be a common point of misunderstanding in debates on these issues.

Steve Ellison writes:

As long as governments feel the need to intervene whenever their economies are considered bad, there will be business cycles that result in multi-year trends in earnings and prices.

In a much shorter time frame, order flows can cause intraday trends. If a mutual fund has a quota to buy a certain number of shares before the close, the fund's buying may push the price up. When there was floor trading in cotton, the locals loved to push prices to levels where stop orders were clustered. Every once in a while, the price would rise or fall by several percentage points within minutes as waves of stop orders were triggered.

In academic theory and simulations, trends occur when markets are mispriced, as informed traders use market orders to buy undervalued assets or sell overvalued assets (see, this chart, for example).

Finally, as Mr. Sogi notes, some trends may be random. Professor Aronson suggests flipping a coin 300 times and charting the cumulative difference of heads and tails to get an idea of what a random walk can look like. My first attempt resulted in the attached chart, which appears to have clear trends even though the underlying process was random. 



 One advantage Apple has is that its CEO is its founder. From an abstract of a paper on this topic:

"Eleven percent of the largest public U.S. firms are headed by the CEO who founded the firm. Founder-CEO firms differ systematically from successor-CEO firms with respect to firm valuation, investment behavior, and stock market performance. Founder-CEO firms invest more in R&D, have higher capital expenditures, and make more focused mergers and acquisitions. An equal-weighted investment strategy that had invested in founder-CEO firms from 1993{2002 would have earned a benchmark- adjusted return of 8.3% annually. The excess return is robust; after controlling for a wide variety of firm characteristics, CEO characteristics, and industry affiliation, the abnormal return is still 4.4% annually. The implications of the investment behavior and stock market performance of founder-CEO led firms are discussed."

The agency problem, which founder-led companies avoid, is as vexing as ever. Conventional wisdom is that corporate governance is enhanced by outside directors and non-CEO chairmen of boards. Trojan academics find that actual results do not support this theory :

This paper investigates the influence of corporate governance on financial firms' performance during the 2007-2008 financial crisis. Using a unique dataset of 296 financial firms from 30 countries that were at the center of the crisis, we find that firms with more independent boards and higher institutional ownership experienced worse stock returns during the crisis period. Further exploration suggests that this is because (1) firms with higher institutional ownership took more risk prior to the crisis, which resulted in larger shareholder losses during the crisis period, and (2) firms with more independent boards raised more equity capital during the crisis, which led to a wealth transfer from existing shareholders to debtholders. Overall, our findings cast doubt on whether regulatory changes that increase shareholder activism and monitoring by outside directors will be effective in reducing the consequences of future economic crises.



It's generally accepted that large electric utility stocks are interest rate sensitive. They also have earnings growth based on a regulator-sanctioned "acceptable return on capital." The stocks are considered cheap when they are trading near book value (not now), and also when their yields are relatively high versus treasuries and bonds (yes now). There's some economic sensitivity to electric demand of course– but the stocks are still very low beta.

I posit that at their current relative prices, a basket of quality utility stocks should outperform TIPS… with similar risk and reward. The reason is not that utility stocks are particularly cheap, but rather because many TIPS have trivial and/or negative real yields. In a rising inflation environment, utilities should be able to get regulator approval to raise prices [to maintain their statutory ROE]– and in the current status quo environment, the stock yields will exceed the TIP yield.

At this moment, the 5yr Treasury has a 1.1% nominal yield, the 5 year TIP has a -0.50 real yield, and the UTY has a 4.34% nominal yield.

What am I missing here? Other than regulatory risks, in what environment will the UTY significantly underperform a 5-year TIP held to maturity?

Mr Krisrock comments:

In his book on theory, Ray Dalio of Bridgewater theorized that "stress testing" an investment theme by asking other unsuspecting traders their views, in effect is a surreptitious poll, as we note here in this textbook case of pedestrian "street begging".

Rocky Humbert responds:

Perhaps Mr. Krisrock will be so kind as to put a penny in this beggar's cup with an insight using all of his over-sized frontal lobe (and not just the amygdala).

I thank the speclisters who kindly pointed out (offlist):

1) During the 1930's depression, utility stocks held their dividends… And people who paid their bills saw higher rates to compensate for the people who did not pay their bills.

2) The TIPS will return par at maturity — there is no similar guarantee for utility stocks.

3) Because TIPS are currently trading at a premium to par, outright deflation can be injurious to their returns.

4) Utilities are taxed as corporations — and are also subject to the risks of cap&trade etc. However, the state rate-setting boards may/may-not compensate for the increased costs of cap&trade with rate hikes.

The daily and weekly statistical correlations between utes and tips are quite poor. But as the attached chart shows, they do seem to move in the same directions.Perhaps foolishly, I'm least worried about technological innovation– because the primary motivation for investing in a regulated utility is that they set rates based on a statutory ROE….

Jeff Watson writes:

Wireless electrical power transfer has been around since Leyden, Franklin, van de Graaf, and Tesla, just to name a few. Radio waves are a wireless electrical transmission system….just ask me, as a ham radio operator I have gotten many very nasty RF burns when my system wasn't properly grounded, or I stood directly in front of a beam antenna when someone keyed up the transmitter putting 2KW through the antenna. Further back was the study of charged amber by the ancient Greeks and the ability to turn static electrical potential into kinetic energy. The thermoelectric effect has reputedly been described since the middle ages. Now, the newest commercial application of wireless electrical transfer is with those new cellphone and iPod chargers where you just lay them on the pad and it magically charges the batteries with no electrical circuit. One might expect for more practical applications as time goes by and the market demands the convenience.  

Mr. Krisrock adds:

In India, for example, there are many rural areas without electricity or the likelihood of same. Some years ago we partnered with Reliance and built cell towers with solar panels that allowed locals to plug in their mobile phones into the cell towers to recharge them. Until we did this they had to send them back to the cell phone company to recharge them…clearly some pennies for the beggars cup…. 

Tyler Mclellan comments:

You're missing this. The future nominal rates are the sum of the short rates (at least to some point on the yield curve). If you finance the position at overnight money (which many marginal buyers do), you cannot lose money if the sum of the short rates is less than the yield. I repeat, no matter what happens to inflation etc…you cannot lose money so long as the short rates one finances at are less than the yield. Through one more iteration, TIPS work the same way.

So i suspect the answer to your question has to do with the nature of "return".

David Hillman adds:

Once we could not imagine a wheel nor a printing press nor telescopes nor electricity, nor steamships, nor the camera, nor the radio, nor the automobile, nor the incandescent light, nor telephones, nor submarines, nor television, nor computers, nor endoscopic surgery, nor nanotechnology.

The 4 ounce, 4.75"x2.5"x0.5" device clipped to my belt is a GPS, a voice recorder, an 8MP camera, a calendar, an alarm clock/stopwatch, a music/video/tv player, a language translator, a dictionary, an encyclopedia, a library, an internet browser, it allows remotely operating a computer half-way across the globe, it connects to gmail, to WiFi, it recognizes touch commands and voice commands, it will both convert the spoken word to text and vice versa, and oh, yes…..it's a telephone, too. The cost of entry is $99 + $55/mo. Such a device was not imaginable as recently as 20 years ago.

A world without a power grid depends upon a collective will to have it, vision, investment, R&D, innovation, efficient production, practicality, affordability, and profitability.There are many individuals moving "off the grid" now, some adopting current [no pun intended] technology, wind, solar, water, other renewable, that allows same, others eschewing that technology in favor of more basic passive and mechanical means, horsepower and elbow grease.

But while basic technology exists, instead of pursuing advancement in earnest, we persist in taking the easy, short-sighted, petroleum-based way out, screwing ourselves in the process.Still, given the history of technological advancement, one might suggest somewhat optimistically that, someday, we will will it and the question is less "could there be?" than it is "when?" Until then, we'll just plod along from crisis to crisis as we humans are wont to do. Plus ca change….. 

Jeremy Smith comments:

You wrote, "It's generally accepted that large electric utility stocks are interest rate sensitive. They also have earnings growth bas…"

"Generally accepted" is statistically incorrect, at least since 1994, which is a long time. Correlation to bond prices is actually negative. Utility dividends also increase. They can estimate 3-4% increase for an index of these, more for the better companies. Of course the longer you hold a higer yielding stock with dividend growth, the more hopeless fixed income is by comparison, especially with regard to income generated. As income rises it forces higher the value of the instrument producing the income, all other things being equal.

Phil McDonnell comments:

I do not think that it is generally accepted that utilities are negatively correlated with bonds but that appears to be the case. I picked idu for utils, tlt for 20+ treasuries and shy 1 yr treasury. For last 105 days of daily net changes we have the following co-terminal correlations:

idu    tlt idu
tlt    -59
shy - 54 74

Perhaps the utility– interest rate connection is more complicated than upon first reflection. 1. They are heavy borrowers for their capital equipment financing so one would think they are hurt by higher rates. 2. Their are regulated, so when their regulators are convinced that rates have risen they will often give them rate relief which means higher rates are eventually mitigate. 3. The stocks sell in competition for investment dollars with other income producing assets such as bonds etc. So they must be priced to yield competitive returns. 

Steve Ellison writes:

Could it be that there is little interest rate sensitivity when rates are very low? Or that the correlation was arbed away when everybody knew about it? Last year, I noted a similar regime change in the correlation of stock prices and interest rates.

Tyler McLellan writes:

Look, stocks and bonds have been Correlated negatively in price terms since 1999/2000, I would bet that utilities have been correlated enough to the market as a whole that they've been at least partially along for the ride.

One reason to suspect this? Maybe if equity price are set my marginal preferences of equity investors if tech stock a goes down and that makes people want to sell some ute b to buy more, it might not matter that bonds are twenty bps lower, especially when the bond buyers don't care about either.

Rocky Humbert writes:

I played with the data a bit more, and it looks like the Tyler and Steve's observations account for most of the the regime change. The Ute's stock market beta/correlation dwarf their bond market beta/correlation (notwithstanding the low stock mkt beta of Utes.) Since stocks versus bonds have gone their separate ways over the past 12 years– the ute's regime change riddle is mostly solved.

There is one last data point worthy of mention: more than 65% of the UTE's total return is due to their dividends…and the attached chart graphically illustrates investor preference for utility dividends versus bond market dividends. This chart highlights the fact that the mean dividend yield for utes is 69% of the bond yield … and we are currently 3 sigma cheap…on a yield comparison basis. But that's true of many stocks…

My intuition remains that Ute's will probably outperform 5-year TIPS from these relative prices, but it appears that this intuition is a restatement of my bias that stocks overall should outperform bonds from these relative prices. If Ute's get whacked because of a hike in dividend tax rates, this may provide an attractive entry point for Ute's on their own absolute-return merits.

I'd like to thank everyone for contributing their thoughts (especially when they disagree with my thesis). It's a pleasure and privilege to interact with a group of such intelligent, independent-thinking people.

Jim Sogi comments:

Undistributed power using local generation, solar, wind, battery, water will be what undermines the monopoly just as cell phone undermined the phone land grid. 

Stefan Jovanovich replies:

I think it is an exaggeration to argue that the cell phone has "undermined" the phone land grid. The "land" grid is, in fact, the backbone that now connects all the cell towers; if wireless were truly able to handle the data rates, the towers would be off the grid. They are not; and the "wholesale" wireless technology– microwave– has been the greatest single casualty so far during this wireless revolution. 



 One 's first thoughts upon a trip to Walt Disney World with a four year old son (and the 5 and 7 year old daughters of some very good friends) is that the magic and happiness trumps everything with the little boy and the parents settling into the rhythm of creativity, joy, excitement and healthfulness of the experience. The attractions are beautiful and modern, the cast is friendly and helpful, the little girls are all dressed in their princess costumes and the boys are screaming with delight at the thrilling rides, the parks are filled with an up to date diversity of fun and educational events, teenagers are reveling in their favorites shows and games, and the guests are a cross section of the world that makes you jump for joy at the down to earth enjoyment they can take in something this good, and their productivity in being able to afford this delight.

Particularly heartwarming is the effort taken to give the ubiquitous handicapped memories and undoubtedly the happiest times of their life. The parents were also pleased with all the modern efforts to provide healthy foods, with toffuti, hummus, fresh fruits, and sugar-free commestibles available at almost all locations.

I have 7 kids and all of them have been to Disney multiple times. They look back on their vacations there as among the best and most formative experiences of their life. The four year old boy at first was frightened by all the noise and the discordant notes of all the music, and scariness of the rides and the long waits. But after a few days, he settled into the rhythm and he particularly enjoyed the parades, the Jungle Cruise, the moving sidewalk, the movie ride, the circular garden dinner and fountains at Epcot.

 And yet, I was seething after visiting the Hall of Presidents. The show is narrated by Morgan Freeman, one of the 2 or 3% of the visitors there of his color. The history of the presidents presented would be something you'd expect from Russia in the 1970s with a skip from George Washington to Andrew Jackson and then to the two Roosevelts, with lionization of their efforts to stamp out monopoly, save the country from greedy businessmen, and attempts to take from the rich and powerful and give to the weak permeating and enveloping the whole thing. Particularly loathsome was that the talking was at least 50% devoted to the current president and FDR, the two most agrarian Presidents in history. The collectivist bias of Disney in this show was consistent with the anti business movie that Disney just released about Wall Street, the well known anti business attitude and ego mania of its previous president, and the scary remake of Alice in Wonderland that made the whole show a roller coaster ride of scary escapes rather than the coming of age and creative, thoughtful adventures of a girl trying to cope with the world of the original.

Walt Disney himself, after hatching the idea for Disney World in the 1950s, arranging the financing to buy 40 square miles of swamp land, planning every detail of its infrastructure, managing to buy the land through dummy corporations so that all the land holders were happy to sell out for a song the swamp land they bought in 1912 from the Munger corporation for 5 bucks an acre, never lived to see Disney built. Mrs. Lilian Disney said that he would have been happy to see how it turned out. But how he would turn over in his grave to see the anti business, collectivist bias of the executives who have taken over his idea and made it consistent with the idea that has the world in its grip. (It is interesting to note that Eisner refers to his partnerships with Warren Buffet and Charlie Munger as helping him climb the ladder of success at Disney).

Of course, the Disney parks are a mere 25%, of the total Disney revenue of 40 billion a year, and an even lower 15% of profits. Disney itself is mainly sparked by its 100 million cable television subscribers that accounts for 60% of its profits. When they bought ABC, Eisner admitted in that self deprecating mien of the chronic egomaniac that the top guys didn't even know what ESPN was. But now they do, and the analysts that follow Disney and their capital expenditures of 10 billion here and 5 billion there to develop content make the company a play on the public's addiction to sports. Not to be gainsaid of course is the incredible feat of their movie division to have two billion dollar + revenue producers in one year in Alice in in Wonderland and Toy Story. And they continue to follow their mantra of making all their movies for 1/2 the price of any other company, and then tying it in with every aspect of their operation from parks to gifts to licenses.

Indeed, Disney is the very model of a perfect modern corporation. Its stock at 33 is near its century high of 37. It's up some 3500 % from its offering of 1.3 in 1981. It's near its all time high of 43 from 1997, and its revenues and profits this year are up at least 15% in all areas except theme parks. You have to admire the way this company like Apple has adjusted to modern times, and captured the idea that has the world in its grip, and the things that animate kids of all ages in our current generation.

Tim Melvin adds:

 The best trip I ever took to Disney was in early 2009 with my adult children. They still thrilled at the spectacle but were able to appreciate the effort and industry that goes into the enterprise that is Walt Disney World. Thankfully the hall of Presidents was closed or odds are my Ayn Rand loving daughter would have gotten us all arrested. Disney will always be on my buy-in-a-crash list. My sum of the parts for this stock is right around $38 bucks and when it drifts below $20 in a melt down (this has happened twice in the last decade) it paid off huge on both occasions for those who saw the merits of the mouse at such a level.

Steve Ellison comments:

In the Disney parks, everything is part of the show. I was at Disneyland in 2000 watching Honey I Shrunk the Audience when suddenly the action stopped, and I heard an announcement: "We have had a power outage. Please exit through the doors on the right." I assumed it was part of the show and wondered what would happen next. It was not until the doors opened and people started walking out that I realized there really was a power outage (one of many in California after the failed attempt at partial deregulation of electricity). 

Anatoly Veltman writes:

I take my kids via motorhome every Winter and Spring breaks: can't beat this destination weather-wise. I don't deem them mature enough for busy Disney Parks; ever since my first visit in 1980, I always thought of Epcot (and later Studios and Animal Kingdom) as a prime education destination. Smaller kids love watery fun of Grand Floridian, Polynesian, Caribbean, Coronado, Saratoga, Boardwalk, Orleans, Key West, Swan/Dolphin. You can access all these via comp buses, boats, monorail. The only resorts really limited to guests are Beach and Yacht Club. Feel free to quiz me for hints, or read up some more general wisdom at MouseSavers.com

Vincent Andres adds:

The picture on DailySpec triggers some analogy. The river is fake and the little boat moves only thanks to a especially built Deus ex machina. Our occidental "capitalist" world is also, for long, a true Disneyland. The main Deus ex machina are our debts and all what our master fakers are able to do with our "major" currencies. But if the debt flow slows down, we'll soon have our little businesses/boats slowing down also.

We though we were good car sellers, but was it really this difficult when our customers get /in fine/ there money thru loans or money printers ?

I'm confident our master fakers are doing all there possible for our deus ex machina to continue to work properly, but it seems the Mississipi debt river is now slowly founding more fertile soils to irrigate. (Spain just downgraded by moody's.) Let's hope our second fake motor will not also have problems.Little boats and there passengers begin to stamp.



 Wikipedia and Snopes cite his autobiography as denying he ever said he robbed banks because "that's where the money is."

"If anybody had asked me, I'd have probably said it. That's what almost anybody would say…it couldn't be more obvious.

"Or could it?

"Why did I rob banks? Because I enjoyed it. I loved it. I was more alive when I was inside a bank, robbing it, than at any other time in my life. I enjoyed everything about it so much that one or two weeks later I'd be out looking for the next job. But to me the money was the chips, that's all."

"Go where the money is…and go there often."

How many of us feel fully alive as we try to sneak a few coins out of the vault before the flexions notice anything is amiss?

According to Wikipedia, Sutton was arrested four months after Thomson's home run when a clothing salesman recognized him on the subway. The Mafia killed the clothing salesman a month later "because he was a 'squealer'".

I grew up in the Boston area, where the Irish tradition of contempt for informants was very strong. When my family moved west, I was astonished to see a sign on a highway in Washington state that said:

Fine for littering $250

Report violators: 1-800-xxx-xxxx



6.73%, from Steve Ellison

September 8, 2010 | 1 Comment

Where can one find a decent return on investment? 3-month U.S. Treasury bills yield 0.13%. 10-year U.S. Treasury bonds yield 2.71%.

The expected earnings of the S&P 500 over the next four quarters are 74.30. At current prices, the expected earnings yield is 6.73%, nearly 2 1/2 times the 10-year bond yield. This "Fed model" ratio was below 1 for years in the 1990s.

Alston Mabry writes:

In early 2000, if you aggregated the top 10 companies in the NASDAQ 100 into a single virtual company, that company had a market cap of $1.6T and sold for 14.7 times revenues and 83 times earnings, for an earnings yield of 1.2%. It seemed like a pretty rich valuation, but people were willing to pay it– for a time. Who's to say the yield on the 10-yr won't go to 1.2%?

Tim Melvin writes:

While not disputing that there are opportunities in today's market, anyone who bases any decision on expected earnings is making a foolish mistake. The margin of error on these estimates is incredibly wide. 

Stefan Jovanovich writes:

Big Al's speculation about how rich the valuation of bonds can get finds some confirmation in the modeling of Marcelle Chauvet — another of California's intellectual property imports.

Rocky Humbert writes:

Quick, back of the envelope, the R-squared between the professor's recession index and the closing monthly bond price is 0.18. The r-squared between the professor's recession index and the closing monthly spx price is .16. If I lag the bond price, the r-squared drops to 0.03

The Professor's Index seems to be as useful as a blind man looking in the mirror….

Which means ….that bonds may yield 1.2% … or 3.2% … or …. ???

Tyler McClellan writes:

Time for the repeating track,

The real return to bonds in the 20th century (relatively long time horizon) ex post does not substantiate the claim that we are at an unusual place vis a vis the return to savings in the government bond market, which is the market for which there is much ability to coerce the means of paying this debt regardless of the source of economic prosperity from which it does or does not arise (I am quite confident unique in that stead, and the reason why anyone who has done a deep study of social security/etc… know that there is very trivial difference in the end between fully funded, pay as you go, etc..we get the prosperity we get, period.)

Future inflation expectations do seem to be very historically unusual in both their low mean level and the historically unusual international dispersion around this level.



David FerrerAn article in the WSJ reports that there are certain players, Ferrer, for example, who do very well in minor tournament events but never get to the quarter finals in a major. The opposite is Serena Williams who never wins a minor but always wins the majors. One wonders how the bulls and bears of the markets are at winning on the big ones. What are the big ones and little ones? The big change days and small change days? The beginnings and ends of weeks? The days of the big announcements like yesterday. Are there hot hands that get used up after winning the majors. Once again the field of sports gives one a thousand useful hypotheses to test.

George Parkanyi writes: 

 This particular example may have to do with the ability to handle pressure. Some traders might perform quite well and consistently trading a relatively smaller amount of capital, whereas a few may be able to trade successfully in much greater size because they can stay calm and still function at a high level under the pressure of drawdowns and reversals. So position size would definitely be a big/little differentiator.

In sports, increased media scrutiny probably influences player performance. Another big/little differentiator could be the amount of external influences/distraction that might affect your decision-making. For example in a position trade, while, you're holding, you could be subjected to all sorts of external influences - economic news, personal life, someone's opinion. Let's call it noise. Will a big noise shake you out of your position? Will a series of little noises aggravate you out? Or can you hold/trade through it? Can you effectively differentiate between noise and something materially important?

Steve Ellison writes:

I once read a suggestion that golfers practice coming through under pressure by not allowing themselves to finish practice until they make 25 consecutive three-foot putts. The 24th and 25th putts simulate high-pressure situations as the golfer has to start all over if he misses.

In football, Joe Montana had an incredible knack for winning the big one. This trait was in evidence as early as his sophomore year at Notre Dame, when he came off the bench a few times and led comebacks from multi-touchdown deficits. Montana was probably an average athlete by NFL quarterback standards, certainly not as gifted as Dan Marino or John Elway. Yet, when he met these men in Super Bowls, Montana came away the winner.

As a counterexample, the San Francisco Giants had a pitcher who was notorious for coming apart under pressure. He was good enough to appear in the All-Star game, but gave up a grand slam in the game. I groaned when this pitcher was named as the starter for game 7 of the league championship series, knowing what would happen; sure enough, it did.



Here is a very interesting article I found on Information Theory:


The noisier the channel, the more extra information must be added to make error correction possible. And the more extra information is included, the slower the transmission will be. ­[Claude] Shannon showed how to calculate the smallest number of extra bits that could guarantee minimal error–and, thus, the highest rate at which error-free data transmission is possible. But he couldn't say what a practical coding scheme might look like.

Researchers spent 45 years searching for one. Finally, in 1993, a pair of French engineers announced a set of codes–"turbo codes"–that achieved data rates close to Shannon's theoretical limit. The initial reaction was incredulity, but subsequent investigation validated the researchers' claims. It also turned up an even more startling fact: codes every bit as good as turbo codes, which even relied on the same type of mathematical trick, had been introduced more than 30 years earlier, in the MIT doctoral dissertation of Robert Gallager, SM '57, ScD '60. After decades of neglect, Gallager's codes have finally found practical application. They are used in the transmission of satellite TV and wireless data, and chips dedicated to decoding them can be found in commercial cell phones.


The codes that Gallager presented in his 1960 doctoral thesis (http://www.rle.mit.edu/rgallager/documents/ldpc.pdf) were an attempt to preserve some of the randomness of Shannon's hypothetical system without sacrificing decoding efficiency. Like many earlier codes, Gallager's used so-called parity bits, which indicate whether some other group of bits have even or odd sums. But earlier codes generated the parity bits in a systematic fashion: the first parity bit might indicate whether the sum of message bits one through three was even; the next parity bit might do the same for message bits two through four, the third for bits three through five, and so on. In Gallager's codes, by contrast, the correlation between parity bits and message bits was random: the first parity bit might describe, say, the sum of message bits 4, 27, and 83; the next might do the same for message bits 19, 42, and 65.

Gallager was able to demonstrate mathematically that for long messages, his "pseudo-random" codes were capacity-approaching. "Except that we knew other things that were capacity-approaching also," he says. "It was never a question of which codes were good. It was always a question of what kinds of decoding algorithms you could devise."

That was where Gallager made his breakthrough. His codes used iterative decoding, meaning that the decoder would pass through the data several times, making increasingly refined guesses about the identity of each bit. If, for example, the parity bits described triplets of bits, then reliable information about any two bits might convey information about a third. Gallager's iterative-decoding algorithm is the one most commonly used today, not only to decode his own codes but, frequently, to decode turbo codes as well. It has also found application in the type of statistical reasoning used in many artificial-intelligence systems.

"Iterative techniques involve making a first guess of what a received bit might be and giving it a weight according to how reliable it is," says [David] Forney. "Then maybe you get more information about it because it's involved in parity checks with other bits, and so that gives you an improved estimate of its reliability." Ultimately, Forney says, the guesses should converge toward a consistent interpretation of all the bits in the message.

Jim Sogi writes:

I think that is why many market price moves come in threes as an error correction devise. Like the recent triple bottom.

Jon Longtin writes:

Very interesting articles on the history of encoding schemes.

One interesting thing to note is that if you take even a simple information stream and encode it with any of the numerous algorithms available, the encoded version of the information is typically unintelligible to use as humans in any way, shape, or form.

‘hotdog’ for example, might encode to ‘b$7FQ1!0PrUfR%gPeTr:$d’

These encoding algorithms work by rearranging the bits of the original word, looking for patterns, and applying mathematical operators on the bit stream.

Many of the financial indicators and short-term predicative tools that abound today are based on some combination of the prior price history, but often in a relatively simplistic way. For example, although the weightings may change for various averages, their time sequence, i.e. the order in which they are recorded and analyzed is the same: a sequence of several prices over some period is analyzed in the same order in which it was created.

Perhaps, however, there is some form of intrinsic encoding that is going in the final price history of an instrument. For example, it could be reasoned that news and information does not propagate at a uniform rate, or that different decision makers will wait a different amount of time before reacting to a price change or news. The result might be that the final price history that actually results, and that everyone sees and acts upon, is encoded somehow based on simpler, more predictable events, but the encoding obfuscates those trends in the final price history.

Maybe it is no coincidence that Jim Simons of Renaissance Technologies did code breaking for the NSA early on in his career.

Unfortunately reverse-engineering good hashing codes, particularly those designed to obfuscate, such as security and encryption algorithms are notoriously difficult to crack. (The encrypted password file on Unix machines was, for many years, freely visible to all users on the machine because it would simply have taken too long to crack for machines of the time.) On the other hand, the cracking algorithms often require little knowledge of the original encoding scheme, instead simply taking a brute force approach. Thus if there were such an underlying encoding happening with financial instruments—and the encoding might be unique for each instrument—then perhaps there is some sliver of hope that it might be unearthed, given time, a powerful machine, and some clever sleuths.

For all I know this has been explored ad nauseum both academically and practically, but it does get one wondering …



These were the top 5 lessons that the market taught me last week:

1. When the meme is to trade everything on the second derivate it doesn't matter that earnings beat by 114% as the container division in x did.

2. When the world is balancing between hope and despair (double dip) the risk premia ought to be very high and thus the risk reward owning equities unusually favorable.

3. It often pays to stick to your long term cases and not change around too often. xx lost a quarter of the market value last week. xxx finally moving higher etc…

4. Bad/ low quality companies have a tendency to be unlucky. xxxx comes to mind

5. Analysts have a predisposition not to care what is priced in. xxxxx is lower now than before the news that Finland will not implement the windfall taxes.

Steve Ellison writes:

The lesson I have learned this summer is that the counting trader should consider the data mining bias and expect that returns from a backtested method are likely to be lower in real trading than in the backtest. As Bacon recommended, having a trial period for a new method in which one paper trades or trades with tiny amounts can be valuable for assessing whether the method performs well out of sample.

Relatedly, I first heard of the Hindenburg Omen in 2005 (here is a link from that time. Therefore, while some suspect data mining or curve fitting, I am certain that at least the last four occurrences were out of sample. In 3 of those 4 cases, the S&P 500 was lower three months later (and I evaluated only three-month returns, not other intervals, which would have been another form of data mining):

 Date    S&P 500   3 Months  S&P 500
 of Signal   Close     Later     Close   Change
 10/5/2005  1207.8   1/5/2006  1281.3      6%
 4/18/2006  1324.5  7/18/2006  1245.7     -6%
10/19/2007  1515.3  1/18/2008  1325.3    -13%
 6/18/2008  1341.6  9/18/2008  1203.2    -10%



 I read an article "How Venice Rigged The First, and Worst, Global Financial Collapse" by Paul Gallagher. Whaddya think?

Bill Rafter summarizes:

Skimming the article one gets the opinion that the author blames most of the 14 Century economic failures on Venetian bankers rather than on the Black Death. 

Victor Niederhoffer writes:

We must hear from Stefan on this subject to get the truth, the whole truth and nothing but. 

Stefan Jovanovich commentates:

I am feeling damn near invincible this morning having had Susan's corn meal and flour drop bisquits for breakfast (also the 10-year old boy cat's favorites) so I am going to pretend that this opinion offers what Vic requested– "the truth, the whole truth and nothing but the truth". I have read Charles Lane's book , and I do know something about the period because my own faith comes closer to what is now called the Eastern Church than any other Christian sect; and I have always been curious about its fate. As Bill tactfully suggests, perhaps Black Death had something to do with the decline in European population that the essayist blames on those awful Italian bankers. The later Crusades and the mere Hundred Years war (which, together, had relative costs greater than WW II and the Cold War combined) may also have played a part. Blaming the bankers for the decline in food production that began around 1300 also seems more than a bit of a stretch. The farmers themselves thought that the end of the Medieval Warm Period was a more likely cause.

The author is right: there was a credit bubble. But like our most recent ones the bubble rose out of a dramatic reduction in the real prices for the things people lived by (computing for the tech bubble, household and home improvement goods from Asia for the consumer/real estate bubble). The rise of the Italian city-state bankers came from the dramatic declines in the costs of transportation and protein. (Archaeologists are finding that around 1100 Europe relatively suddenly went from eating freshwater fish to cod and other salt-water species.) These changes came from developments in naval technology and an outbreak of relative peace. The Italian bankers couldn't have been able to cheat poor King Edward if they hadn't had the means of getting themselves and their gold to London and back quickly without risk of having the Vikings waylay them.

The bubble continued and then broke because events moved against people and then as now, the bankers kept their mansions but most of them lost the better part of their fortunes.The essay assumes that there was ONE GIANT FINANCIAL VILLAIN without which the rise of benevolent national governments would have continued and everyone would have lived in peace and prosperity. This essayist blames the Venetians; others have blamed (who else?) the Jews. What is indisputable is that the bankers kept better books and minted more honest coin than the governments they lent to. How that allowed them to "control the Mongol Empire" and switch legal tender from gold to silver and back again remains unexplained. But, then, so does the modern notion that the Great Depression and the rise of the Nazis were mostly a function of the New York Fed's misadventures with the money supply.

The costs in blood and treasure of WW I, the influenza epidemic and the Tokyo fire and earthquake and the Mississippi Flood of 1927 were entirely incidental. What made people stretch so far for yield that they were willing to invest in match monopolies in the 1920s is the same cause that brought people to do serial refinances with the Bardi, Peruzzi and Venetian banks. Events had left most of them without the incomes they had come to expect so they borrowed and risked more and hoped to make it back when the weather changed and they won the next war.

Phil McDonnell adds:

I have to side with Bill Rafter on this. Arguably the Bubonic Plague may have begun in Europe when the Mongol Golden Horde laid siege to the nearby Genoan city of Kaffa in 1345. The siege was only broken when the Mongols were too badly stricken with the plague and forced to go home. Within a couple of years one third of Europe had died.

I think Plague and Mongols invaders would have a strong chilling effect on trade. Conversely, a banking panic cannot cause the Plague.

Steve Ellison comments: 

One of my pet peeves is the overuse of impenetrable equations in
peer-reviewed finance publications (and I think I'm pretty good at math;
I can still occasionally help my son with his calculus homework). To
cite a recent example, it would not seem to require calculus to explain
that spending on durable goods falls faster in a recession than other

Russ Sears replies:

Mr. Falkenstein's argument should be applied to all modeling, not just economic modeling. Even in a field with time tested product pricing models as actuarial science, I have found time after time that to truly add value, you must ask "where is the model blind spots?" People drove a convey of trucks through the MBS model's blind spot in pricing and ratings. And if left to their own devices FASB mark to market models would have driven all of us to a great depression. As I said at the time, (see A modest Proposal to the SEC)

They were blind to a liquid assets that can quickly turn illiquid and have huge liquidity premium on a mark to market model.Exploit the loopholes, and if nobody ask if this is simply a blind spot that you are exploiting, you will look great on paper like AIGFP… for awhile…until it become apparent that your resource allocation has a divide by zero error in it.

Modeling and regulatory modeling in particular, have replaced the central planner of the failed communist system.



vintage shredded wheat adI was taught in high school history that the evil corporations formed monopolies and gouged the common man until the government broke up the trusts. However, this 100-year-old advertisement seems to suggest that government trust busting was driving food prices sky-high.

Advertisement in Nevada State Journal, August 18, 1910:

Make Your "Meat" Shredded Wheat These are troublous times for the man who eats food. The government is after the beef trust, the poultry trust and "the cold storage egg." But while congress, state legislatures and grand juries are "investigating" the high cost of living, your meat bills and grocery bills are soaring higher and higher. The food problem is an easy one if you know SHREDDED WHEAT. It contains more real body-building nutriment than meat or eggs, is more easily digested and costs much less. Always clean–always pure–always the same price. Your grocer sells it.

Stefan Jovanovich comments:

The Robber Barons were scandalous precisely because their energy and enterprise and eye for innovation brought the Tonto question into sharp focus. When Ralph writes about "our" national parks, he is highlighting that same question. The recent debate on the List about the "ownership" of one's own body also raised it in detail.

Neither the Declaration of Independence nor the Constitution defines the right to property. Jefferson showed his precocious talents for propaganda politics by substituting "the pursuit of happiness" for "property" because he knew that the definitions of "property" were the very issues that divided the colonists. Sam Adams and his fellow radicals argued that regulations were as much property as physical stuff and that those regulations were the monopoly privileges of the Crown's favorites. The Tories argued that the Navigation Acts and other rules were necessary to preserve "the public interest".

a california sea lionAs a lifetime lover of marine mammals and the one-time joint keeper of Stevie, a Steller sea lion, I have spent 40 years living in California and watching the Tories of environmental regulation make the same snobbish arguments in favor of their superior pedigrees. Instead of examining and answering the basic questions of who owns the Pacific fishery and its mammal predators, the environmentally righteous have spent enough money on bureaucracies and international conferences and endless discussions to have bought out every whaling company and purse-seine trawler in the world. If the people who wanted to "save ANWAR" were as shrewd as they were righteous, they would be lobbying to define and auction off the specific property rights that are involved. Of course, what they would discover is that the greatest obstacle to such a process would come not from the E&P companies' unwillingness to preserve the environment but from the regulatory bureaucracies themselves. Like the tenants in a rent-controlled apartment, the people sitting in offices in Washington, D.C. and elsewhere get the most direct benefits from "preserving America" even as the place crumbles around them.

I agree with Ralph that all the arguments in favor of drilling in the name of reduced oil prices and "energy independence" are complete hooey; so were the Robber Baron arguments in favor of preferential as opposed to uniform tariffs. But, one can hardly blame the E&P companies for using the same fatuous logic of the collective "good" that their environmental opponents do; if the question of "who benefits" is to be ignored and never, ever reduced to an actual accounting, the forces of "evil" - i.e. people who want to drill for oil - will just as likely to resort to "public interest" arguments as anyone else. What is interesting is the historial contrast between the failure of preferential tariffs to gain much ground and the obvious success of the regulatory model. The explanation is simple: the advocates for favoritism in tariff rates had to answer the direct question of cost. The beauty of regulation is that it offers the benefits of ownership without all the fuss that comes from having to fess up about what it will cost. We are long past the age when a Vanderbilt could ask a journalist "when did 'the public interest' ever buy a ticket?" (That is the first part of his famous remark about "the public interest be damned" that never, ever gets quoted.)

As long as the questions of property (who exactly owns what?) can be avoided, the tragedy of the commons will continue. As long as the gullible and excessively schooled (often one and the same) can share the illusion that "we the people" will all be as happy, healthy and secure if only the government is allowed to make rules to abolish scarcity and evil, the greatest profits will come from working the system; and, when those rules fail to work, the diagnosis will always be the same as it was in the age of blood-letting: we need do more.

P.S. For those who don't know it, "the Tonto question" is the reply the Lone Ranger's faithful Indian companion allegedly gave when the two of them found themselves out of bullents and surrounded by Apache and the Lone Ranger bravely said, "We've come to the end of the trail, partner." "What you mean "we", white man? I was first told this joke by a member of the Taos tribe in 1965. What made it funny was that, as a Pueblo, Tonto would have enjoyed no better fate at the hands of the Apache than the Lone Ranger. The illusion of collective interest is always funny to people wise enough to appreciate actual human action.



July was a great month for agricultural commodities, led by sugar, up 22%. It was an awful month for precious metals.



 Recently I have posited that the market to an inordinate degree shows the main attributes in its daily moves of the most vivid sports game that has not been used. I would add to this that during each hour the market is likely to move to the rhythms and dynamics of the most likely classical music being played on a classical music station in home town, for example the former WQXR in New York, in full knowledge that these programs are often selected 2 months in advance, and noting that I was a subscriber to same when I was 12 years old.

I am adding to my list of mystical encampments and predictions that the fortunes of Apple and Lady Gaga will follow a similar arc in the future, and as soon as the Lady loses her luster, or a substantial base of her gay support, Apple will be ready to nose dive.

Do you feel that because of these ideas that I should resign my post as chair of Daily Spec which is designed to deflate bally hoo, or is this just a symptom of that predilection that old men such as the sage and the fake doc have to maintain their romantic aura?

Ken Drees writes:

Lebron James' Cavs win over the bulls to end that series correlates to the spy top (04/27/10). That was the zenith of his career in Cleveland. They were then going into Boston on a full tank of expectations. The last game (as a cav) in that series marked a secondary top 08/13/10–then the melodrama begins. His great choice to go to Miami did not mark the low but was the midpoint of the latest rally—he is losing his market moving mojo–his ability to focus the market energy . So now he has lost his core fan support like lady gaga at some point will lose her core fan base. No, I don't think the Chair is that off-kilter.

Popular culture icons somehow bleed into market consciousness.

Vince Fulco writes:

I've long thought that the culture has moved into a greater phase of bally hoo, perhaps a derivative of the Romans' 'Bread & Circuses'. We are now just starting to realize or are being forced to understand that flat incomes, poorly funded retirements and insufficient skills in the aggregate set against historically outsized obligations are a recipe for disaster. Fighting falsehoods would seem to be a necessity of survival and good investing for the long haul. Moreover, one has great opportunities to choose from post deflation.

Jim Lackey shares: 

Actually no. AAPL has talent and is'nt just a fad or a show. Not sayin' that the Lady doesn't have talent, but if and when I see her write and produce tunes for others and sing Jazz, then she will be an AAPL. But no! No I did buy AAPl in 2003 when Mr. Eyerman stood right here on list and said buy it now. Jobs is back, and Itunes is brilliant. It's been a ten bagger since, which is what got me to tell the father in law naaa na na no this Xmas as he was on visit to Music City and toyed with his new Iphone all week. He's a MD and a tech freak and he said, "you know what, I don't need a PC or internet at home anymore with this"

It's not CSCO when it was on the way to a trillion dollar market cap in year 2,000. It's post crash now. Also it's no shorted up fad stock, but yes it's a fashion device an ipod in all 3 colors for different outfits. If I had to guess its a DELL circa late 90's. It never crashed and burned until much later in the tech wreck. It just stopped going up and in these markets AAPL must trade 299.75 but not 300. ha. 

Craig Mee writes:

Just like Seinfeld had the bravery to sell the high and knock back the 10Mil for a tenth season, (one of a tiny minority who do) maybe the gagas and apples should too. To keep up the product development and create new bizarreness no doubt gets harder and harder with everyone hot on your tail. Im sure income changes, say for Seinfeld, from shows to marketing, but he has been smart enough to cut and run, and keep the value. A lesson for us all. 

Marlowe Cassetti writes:

The chair has touched on a point of interest that has bothered me. I don’t know about Lady Gaga, but Apple’s climb towards the top of market valuation appears to be inline with the phenomenon of a bubble. Yes, I understand that we cannot declare a bubble until it bursts, but let’s look at the facts:

There are some 47 stock analysts that cover AAPL, all but two have either a buy or a strong buy recommendation. It is the darling of the market. Its market cap is approaching $ ¼ trillion and at the rate it is moving it is on its way to challenge Exxon Mobile Corp. XOM produces stuff that the world needs, AAPL doesn’t produce stuff that the world needs just what they like to have, until something else strikes their fancy.

It reminds me in the 1980's when people couldn't buy enough Wang stock. You hadn't arrived if your office didn't sport a Wang word processor. The bubble will burst when the last fool buys in at a nose bleed price.

Thomas Miller writes:

 Sometimes one's instincts or gut feelings can't be counted or explained but you feel its true. Probably based on years of different observations made subconsciously. A trader may feel strongly a market is about to break without being able to explain exactly why, because subconsciously they have seen patterns many times before. Considering the source, I wouldn't immediately dismiss this as ballyhoo. Instead of resigning, further testing is called for.

Steve Ellison comments: 

Mr. Aronson noted in his book that it is no fun being a skeptic and that the scientific method leaves deep human yearnings unfulfilled. Facts are often tedious and dull, but stories are captivating, which is why people who have bought into a narrative continue believing it even when presented with strong counterfactuals. "Story stocks" have always been prominent in bull markets.


Marion Dreyfus writes:

A new study reveals that people are at their angriest on Thursdays. Thus, perhaps deals might better be made on Friday, when people are delightfully anticipating the weekend, or Monday, when they are somnolently reviewing the events of their past free-time indulgences.

interesting … We have been doing product development on a tool to gather data, and do reduction for self-introspection to find and permit prediction of cyclic true 'more productive' highs, and 'down in the dumps' lows.

Jim Wildman comments:

I've been thinking a lot about rhythms. I've noticed on the treadmill at the Y that people tend to fall into step with each other. Being on treadmills, this is easier since you can be running at different speeds, but the same step count. It creates an interesting effect when the treadmills are on a suspended 2nd story as it was at the last gym. I've wondered how many people it would take to collapse the floor.

This study seems to indicate that there are (at least tendencies towards) rhythms in 'group' emotions. What other rhythms are there and how do they affect me? How do they affect the markets?

Vincent Andres adds:

Here is a good paper on this topic of frequency coupling

Some more infor:

Steven Strogatz

Steven Strogatz's publications

A good book

TED video (look at the part on fireflies, near the 10th minute on metronomes (1st historical notice by Huygens), near the 13th minute and the bridge (not Tacoma … but not very far !)… in fact the whole video examples are interesting). 

Easan Katir writes:

In a year when Paul the Octopus correctly picked 7 consecutive wins, well-documented to the world, when the underwater plume in the Gulf of Mexican Oil matched the plume of gritty ash from Eyjafjallajokull, and the rig explosion coincided with the April market top, who can say anymore what is mystical and what isn't. Lead on, Chair! Lead on!

Craig Mee writes:

Looks like Schumacher should of stayed off the track, as HIS value, now may be plummeting: "For all his greatness, he never knows when to give up. He is a shadow of his former self," added hugely experienced former driver David Coulthard" Ouch!



 The action in the S&P 500 since the unemployment report brings to mind Ben Franklin's quip, "When all is said and done, a lot more is said than done." Conversely, a few months ago, there was very little back and forth, just a slow, steady upward grind.

I calculated a measure of market efficiency by dividing the absolute value of the daily price change by the "minimum path" that has been discussed here before. The equation for minimum path if today's net change was negative is: (absolute value of (today's high - yesterday's close)) + (today's high - today's low) + (today's close - today's low)

If today's net change was not negative, minimum path is: (absolute value of (yesterday's close - today's low)) + (today's high - today's low) + (today's high - today's close)

For example, today's efficiency was 16%. The absolute value of the net change was 9.9 points, and the minimum path was 60.5 points.

From 2004 to 2007, 10% of all trading days had an efficiency of 69% or more. At the other extreme, 10% of trading days had an efficiency of less than 5%. Results on the day following a very efficient or very inefficient day appear consistent with randomness.



I've been thinking a lot about exactly that in recent years — what criteria should one use in assessing the assumption of risks? Recently, on one of the lists there was talk about mathematical expectation as the primary criterion for risk assumption. I've put together a little, unpublished paper on exactly that. I have it at http://ralphvince.com and the link is about halfway down entitled "Mathematical Expectation as a Criterion for Accepting Risks; A Foundation for Risk-Opportunity Analysis."

I'm very interested in the comments of people on these lists about these ideas.

 Steve Ellison responds:

Interesting paper. It is claimed that trend following is difficult to stick with. Some of those who went through the Turtles training program failed because they simply did not execute the trades specified by the method. One reason for the difficulty might be that the expectation set of trend following trades is many small whipsaw losses and a few big gains (roughly similar to the example in the paper with the signs reversed). The overall expectation might be positive, but the probability of being a winner after a small number of trades is probably below 50%.



I am reading a very interesting book, The Score Takes Care of Itself by the late 49ers coach Bill Walsh. One of Walsh's key messages was that, at the highest levels of competition, victory cannot be summoned at will. Those who would achieve great success must endure failure. One must handle failure appropriately, learning lessons to improve future performance without becoming despondent.

Upon taking the reins of the 49ers, who had had the NFL's worst record the previous season, Walsh implemented his Standard of Performance, a set of expectations for continuous improvement for everyone in the 49ers' organization. The Standard of Performance detailed skills expected at each position and appropriate behaviors. "Winners act like winners (before they're winners)", said Walsh.

The standard was perfection. "If you aim at perfection and miss, you're still pretty good", wrote Joe Montana in the book's foreword. Walsh insisted on precise execution. If a play called for the receiver to turn after 12 yards, the receiver needed to turn after exactly 12 yards, not 12 yards and 15 inches.

Walsh prepared his team very thoroughly and had exhaustive contingency plans. He was known for scripting the first 25 offensive plays of each game in advance. This practice enabled the players to visualize the opening minutes of the game in advance and reduce pregame jitters. The contingency planning, done deliberately and thoughtfully in advance, led to much better decisions than those that might have been made on the spot under extreme pressure.

When Walsh found himself saddled with lemons, he found a way to make lemonade. Early in his career, he was the quarterback coach for the Cincinnati Bengals, an expansion team with little talent. The Bengals could not successfully run the ball against stronger teams. They would have to score by passing. Unfortunately, starting quarterback Virgil Carter was considered to have a subpar passing arm. Walsh noticed, however, that Carter had great composure, could read defenses well, and was very nimble. Walsh therefore designed plays that would make the most of Carter's abilities: short passes to any of four or five receivers spread out across the field. This strategy was the prototype of what later came to be known as the West Coast Offense.

Walsh treated his players and assistants well. When an assistant was considered for a head coaching job elsewhere, Walsh would give a good recommendation even though the assistant's departure might set back the 49ers. He reduced hard contact in practice in order to have the players healthier for games. Word spread quickly around the league, and many top players and coaches wanted to join the 49ers. Like Jack Aubrey, Walsh paid close attention to the leaders among the players, who might support or undermine his leadership. He was quick to remove bad influences from the team, even if they were talented players.

Co-author Steve Jamison previously collaborated on a similar book with John Wooden. The Score Takes Care of Itself is targeted at a business audience, but many of its insights might also be useful in our field.



a giant shrimpThis piece illustrates so many things that it must be shared. "Sorrows never in single spies…". Misery loves company. No contingency should be overlooked in efforts to help your position along. And the upside down fixed income trader formerly from Harvard says, "stock investors should brace for higher volatility ". et al.

Steve Ellison comments:

The last time I got my hair cut, it was cut by an older lady from the Mississippi Gulf coast who had lost everything in Katrina and moved west. She told me that many other people who had lost everything fell back on shrimping as the occupation of last resort and are now faced with a second wipeout.



 An analyst on CNBC yesterday was saying BP is cheap, and the dividend is secure. His interviewers (are they supposed to have an agenda of their own? Or is this just asking the tough questions?) kept hammering on their idea that it will be politically unacceptable for BP to pay dividends to its shareholders, a line of questioning that drew uncomprehending stares from the analyst.

George Parkanyi comments:

Yeah that makes sense… take a whopping out-sized risk on BP with its huge potential future liabilities, in a world economy and market possibly on the brink, where P&G can lose 35% of its value in 10 minutes, for a dividend. Where do I sign up?

Rocky Humbert comments:

 Here are some questions that one might consider before investing in BP. (No such analysis is required for a skilled trader who claims to be able to systematically buy low and sell high without regard to "fundamentals.")

1. Remediation costs and liability are related to a spill size both by physics, practice and statute. The Exxon Valdez had a defined amount of crude. How much crude will spill from the Deepwater Horizon?

2. What is the law regarding punitive damage penalties if gross negligence can be proven? Is it like a RICO case (4x)? Is it capped by statute? Or can it be unlimited (like an old Joe Jamail lawsuit)?

3. What is the law regarding punitive penalties if there is criminal liability? What is the worst case penalty? If the Goverment files an criminal indictment, what effect(s) will have on their business?

4. What effect will the overhang of litigation have on the cost of BP's financing of their regular business? If there is a risk of a $50+ Billion punitive penalty, what will the credit rating agencies do? And if BP's cost of financing increases by 100-300 basis points, what effect does that have on their exploration budget?

5. If they capped the well today, can one assess the risks of #2, #3, and #4 with certainty?

6. What is the risk/cost of a boycott of their service stations? Did Exxon experience a boycott? And if so, what impact did it have on their downstream operations?

7. What is the tail (in years) of the litigation? Will they be required to post a performance bond? And if so, what assets will they sell to meet the performance bond? More generally, is there a risk that they will have to sell assets to meet other liabilities? Or, can they almost certainty meet the expenses out of current cash flow?

8. How is BP's stock faring versus other companies with exposure (Anadarko, Cameron, etc.)? Will these companies present a unified defense? Or will they be pointing fingers at each other — further concentrating the litigation risk?

9. How has BP's stock performed versus other major oil companies? For example, if BP is down 35%, but Chevron,Exxon,Conoco are also down 15%, which of these companies represents the best relative value, given the facts and probabilities?

10. If I am leaving for a five-year vacation, would I be comfortable purchasing BP at the current price, and not looking at it until I return? Is there any price where I would buy a non-trivial amount of BP and not look at it for five years?

Vince Fulco writes:

 While I am no apologist for BP's seemingly high risk and perhaps incompetent procedures in the Gulf, I am also wondering about the proportionality of the public reaction (to the stock that is, not the beach pollution) vs. the total cost of the disaster. The company's mkt cap is down $70B since the explosion and is currently $115B for a company with $230B-ish in historical assets ($90B estimated in the US) and relatively low non-current debt levels. Moreover the company has a stand alone re-insurance company with $3.5B in assets. They may also have some additional cover which I am disregarding for now. As Ken has stated, halting the dividend brings $7-10B more to pay claims which I assume will have a somewhat long tail, say 3-5 years. And just because Chuck Schumer believes the payout should be halted, doesn't mean he knows anything about corporate finance strategies or management's responsibilities to its owners. More evidence of the worrying 'they came for…' behavior.

Given the rarity of the event, arguably the next comparable disaster naturally might be the Exxon Valdez (other smaller events could be chosen too). The best numbers I could find were a cost of roughly $5-7B stretched out over 20+ years. For argument sake, let's say the cost to BP is 10x as much or $50B; that would be roughly 1.6-1.8x mean operating income of the last 4 years.

I am not considering BPT in the conversation because it is a different animal and Rocky has addressed it well. Lastly, since our current admin seems to be in the business of picking winners and losers, are they ready to and can they kill a formerly $1/4T asset company 40% held by pensioners and retirement funds of our closest ally? It is also notable that LA's governor is already publicly complaining about the effect on jobs if a drilling ban is instituted for any length of time. Double edged sword indeed.

Disclaimer: This is absolutely not a recommendation for anyone but I am long right at these levels and would appreciate reasoned arguments against.

Rocky Humbert adds:

 One more thought on BP as I work through their financials: The company generated free cash flow of about $7 Billion last year and paid $10.5 Billion dividends.

Their next dividend will be announced on about July 27th with an ex-date of 8/4/10. Looking at the pricing of at-the-money options, it appears that the market has priced in a cut of their dividend by 50% (from .84/share to about .44/share).

Any spec-lister who has a variant perception on their dividend policy (either holding it at its current level, or reducing it more than 50%), can execute an direction-neutral options "conversion" to express this view.

In my humble opinion, a 50% cut in the dividend seems entirely reasonable to satisfy all of the different constituencies. And, in assessing the future behavior of the stock, one needs to consider that Mr. Market has already discounted this news.

Before you invest in BPT, I suggest you get an objective estimate of the reserve tail in the Prudoe Bay field. I studied this several years ago and there is a NAV based on the dwindling reserves and foward curve in the crude market at various discount rates.

The field should start tailing off in 2011 or 2012 and the stock will be worthless certainly by 2020 so you need to value not only the current and future crude price but also the decline rate. I'd also suggest that you look at their financing and change of control provisions as well as cross default issues. Lastly, I owned BPT when it was at a substantial discount to its NAV at a large discount rate (versus crude futures), but could not short it when it went to a large premium because the shares could not be borrowed.



The S&P 500 had an outside daily bar on Thursday with the close above the high of the previous day. Here are the last 12 days that followed an outside daily bar with the close above the high of the previous day. 6 were up, and 6 were down.

   Date  change
3/13/2009    0.8%
3/18/2009    2.1%
 4/2/2009    3.3%
 5/7/2009   -1.1%
5/19/2009   -0.1%
5/27/2009   -1.8%
6/30/2009   -0.6%
7/14/2009    0.6%
9/29/2009   -0.4%
11/6/2009    0.3%
 1/8/2010    0.4%
5/13/2010   -1.1%

Average       0.2%
Standard d    1.4%
t             0.49
N               12

Jonathan Bower writes:

I don't think one is precluded from defining what ever time-sliced relationship one is interested in evaluating. For example in forex you could define "daily bars" that encompass Asia, Europe, and/or US time horizons, they could even be overlapping if it suited your needs. So an "outside day" is in the eye of the beholder and depends entirely on how they define "a day".

Whether it contains relevant information is, of course, a whole other ball game. I believe the original thread demonstrated that the outside day that was measured provided very little in the way of useful/tradeable/actionable information. Of course depending on ones trading methodology, perhaps it did….



pez dispenser dispensing viagraHere are some poignant things to reflect upon about yesterday, May 21, I think:

0. The low of the day was below the low on the Flash Crash day.

1. A Millstein occurred, was it bullish or bearish and as of when.

2. The set up at the beginning of the day was highly similar the previous day. How best to define similarly without a neural net.

3. The low was not quite equal to the low of the year on Feb 7.

4. The interactions with bonds and oil and copper and the dollar was predictive.

5. It followed a series of disastrous Thursdays, with double digit S&P declines.

6. The sponsor said he wouldn't buy stocks.

7. A promoter said he sees S&P below 950 in fib retracement. Another sage from a broker's house saw stocks rallying. Presumably their disseminated views caused spikes at the time of announcement. Was there anything predictive in comparing the reaction.

8. The S&P pit opening followed the biggest decline in a year.

9. The fixed income prices opened at an all time high, and closed at an all time high but managed to drop a percentage regardless.

10. The flash rise occurred with 20 minutes to go from a 1.5 percentage drop in afternoon after a vastly different experience in prior days.

11. The courage to not be dissuaded out of your position from the other broker, or the inner survival man, or your assistant who always wants to take profits as of Friday 3:40pm would have been redoubtable.

12. Mr. Vix and Mr. Vic opened at one year highs and followed a similar trajectory to the fixed income.

13. A 10 percent correction occurred; is it bullish or bearish or random. Same for breaks of the long moving averages.

14. To what extent did May options expiration have a predictive effect.

15. Were the movements in the Euro and Asian markets overnight a pilot fish?

16. Was revulsion from the increases in "sharings" and "service" scheduled for the beginning of 2011 a factor?

17.  What political factors relating to the approval of bailouts by houses in Europe and reforms in the US played a part?

18. How do predicted earnings increases factor into the Fed Model and should the Shillerian 10 year p/e calculation be obfuscated with the man.

19. It was the biggest decline in a week in the year.

20. There had been a run of multiple intervals of declines in a row.

21. How did all this affect and react to the moves in individual stocks?

Inquiring robots within and without the mind wish to know the answer to such questions on a scientific and or useful basis for future input. What approaches and other more poignant queries should be proffered or gainsaid?


22. The sage likes to compare the stimulus bill to taking 1/2 a tablet of Viagra and then diluting it with candy. We need more he said.

What are the natural reflections engendered by such an utterance?

I'll give a prize at the annual spec party for the best such reflection.

Pitt T. Maner comments:

Bob Dole petting a dog on the headThe potential stimulative effects of lower oil prices come to mind. There are more scholarly sources to be found, but here is a snippet of thought.

"Every $1 per barrel drop in oil's price increases U.S. GDP by $100 billion per year and every 1 cent decrease in gasoline's price increases U.S. consumer disposable income by about $600 million per year."

Lower oil prices like Viagra would seem to be useful for the longer term mechanism of action effects but its the lowering of obesity (and sugar consumption) and belt-tightening of runaway spending that may be more important in the long run.

An image of Bob Dole petting his dog on the head comes to mind. 

Martin Lindkvist writes:

The sage seems to know a lot about the right dose of……candy. Some questions remain to be answered though. When he said "we need more", was he referring to the stimulus bill or the stimulus pill? And who are we? Should the market mistress be jealous? 

Sushil Kedia adds:

The mythical character James Taggart in Atlas Shrugged would have said so had Viagra been available in that age. Might I extend the tautomerization such that the James Taggarts hidden all over "in the system" are as sagacious as the sage or perhaps the other way round that the sagacity of the sage is a Taggartian mumble.

He never believed that anyone should be paying taxes. At least that's what he positioned to imply by never giving out dividends. He could have little regard for those who indeed tax their finances and their bodies to experience the pleasures of achievement and the achievement of pleasure, respectively.

Give me more! This ain't enough!!

Jack Tierney comments:

"Our first stimulus bill, it seemed to me, was sort of like taking half a tablet of Viagra and having also a bunch of candy mixed in as everybody was putting it into their own constituencies. It doesn't have quite the wallop." - Warren Buffett

A spoonful of sugar helps the medicine go down
In this instance, Mr. Buffett is borrowing from the equally iconic Mr. Disney and his tune "A Spoonful of Sugar Helps the Medicine Go Down." However, since so many different and divergent candies were necessary to satisfy the various "constituencies," few were pleased with the aftertaste. Mr. Buffett has suggested a second dose and "taking it straight" since July of '09. Unfortunately, inherent in his initial support and subsequent carping is the unavoidable insistence that there exists a stimulus package, which properly configured, will work. This is unfortunate because it foretells that something, something equally stupid, will be done.

The suggestion (whether sugar coated or not) is flawed on two counts (at least). First, the same "smartest guys in the room" who created the disease and subsequent medicine are once again heading up the project. Secondly, the historical record contains numerous examples of "stimulus programs" which have two things in common: they have been designed and promoted by the very brightest and they have all failed.

Further, if we are to adhere to our commonly held characterization of the market as The Mistress, then Mr. Buffett's Viagra suggestion is obviously misdirected. Although the recommended medication might do wonders for the stimulators, the only important response is hers (and I'm sure that I'm not alone in observing that on occasions, rare occasions, our enthusiasm just isn't enough).

At some times (perhaps at all times) we must let the Mistress work it out on her own. If TV ads and infomercials are to be believed, modern self-applicable developments have added to the numerous nostrums, aids, and approaches already available. Checking the historical record once again, we find that her response times can be capricious. But she alone determines the timing; the addition or withholding of a spoonful of sugar won't speed things along.

Steve Ellison comments:

"The set up at the beginning of the day was highly similar the previous day. How best to define similarly without a neural net."

A simple calculation of open relative to the previous close would have shown the similarity of Thursday and Friday. For example: "a 10 percent correction occured, is it bullish or bearish.or random. same for breaks of the long moving averages."Dr. Zussman showed last July that several moving averages from 40 to 70 weeks had good predictive value, so I would interpret the break of the 40-week average as bearish.

"the sponsor said he wouldnt buy stocks."

So what? He's a bond guy.

"What approaches and other more poignant queries should be proffered or gainsaid?

At the beginning of May, I posted the performances of 13 asset classes in a horse racing format. I suspect that some important "forms" in the markets last about two months. That is why I showed two-month performances and chose to post them at the beginning of a new two-month period. The S&P 500 had the second best return of the 13 asset classes in March and April. Furthermore, the form in March and April was a slow and steady upward trend. The public would be looking for more of the same in May and June, so something very different was guaranteed to happen.



Past performance charts for various markets showing their positions in the last two 2-month "races" at half-month intervals. Which asset will perform best in the next two months?

Cotton           1/2 mo    1 mo  1 1/2 mo   2 mo   2 mo change (currency
Mar-Apr               7       5       7       6           3.7%
Jan-Feb              11      10       6       1           9.6%

Gold             1/2 mo    1 mo  1 1/2 mo   2 mo   2 mo change
Mar-Apr               8       8       4       4           6.4%
Jan-Feb               3       5       4       3           3.7%

Silver           1/2 mo    1 mo  1 1/2 mo   2 mo   2 mo change
Mar-Apr               2       2       1       1          13.8%
Jan-Feb               1       8      11       7          -0.3%

Soybeans         1/2 mo    1 mo  1 1/2 mo   2 mo   2 mo change
Mar-Apr              10      10       5       5           4.1%
Jan-Feb              12      12      12      12          -7.2%

Euro             1/2 mo    1 mo  1 1/2 mo   2 mo   2 mo change
Mar-Apr               3       6       9      10          -1.3%
Jan-Feb               8       6       9       8          -3.3%

British Pound    1/2 mo    1 mo  1 1/2 mo   2 mo   2 mo change
Mar-Apr               9       7       6       8           1.2%
Jan-Feb               7       4       8       9          -3.9%

Sugar            1/2 mo    1 mo  1 1/2 mo   2 mo   2 mo change
Mar-Apr              13      13      13      13         -30.7%
Jan-Feb               2       1       1      10          -4.8%

Corn             1/2 mo    1 mo  1 1/2 mo   2 mo   2 mo change
Mar-Apr              11      11      11      11          -5.2%
Jan-Feb              13      13      13      11          -6.7%

Crude oil        1/2 mo    1 mo  1 1/2 mo   2 mo   2 mo change
Mar-Apr               4       3       3       3           8.2%
Jan-Feb              10      11      10       6           0.5%

S&P 500          1/2 mo    1 mo  1 1/2 mo   2 mo   2 mo change
Mar-Apr               1       1       2       2           8.8%
Jan-Feb               5       7       7       5           1.1%

Natural gas      1/2 mo    1 mo  1 1/2 mo   2 mo   2 mo change
Mar-Apr              12      12      12      12         -20.2%
Jan-Feb               4       9       5      13         -11.0%

10-year T notes  1/2 mo    1 mo  1 1/2 mo   2 mo   2 mo change
Mar-Apr               6       9      10       7           1.3%
Jan-Feb               6       2       2       2           4.8%

U.S. Dollar      1/2 mo    1 mo  1 1/2 mo   2 mo   2 mo change
Mar-Apr               5       4       8       9           1.0%
Jan-Feb               9       3       3       4           1.8%



Logo of American and Foreign Power CompanyHow does a company like DuPont have a book of 5 bucks a share when it's been earning 2.00 a share for 100 years? Part of it is that it pays dividends of 85% of earnings. The kind of stock my grandfather would have recommended for me along with American & Foreign Power. Couldn't go wrong with that 10% dividend — until they were nationalized. That corporation was another of his favorites besides Union.

Rocky Humbert comments:

DuPont has been a poster child for the Modigliani-Miller theorem. They've been increasing leverage and buying back stock for years, which — depending on the price paid — can cause a perverse and self-reinforcing decline in book value. And even with a low book value, about 61% of their shareholder equity is goodwill. But their ROE looks very sweet at 25+%.

Ironically, DuPont was originally a dynamite manufacturer. Dynamite funded the Nobel Prize. Modigliani-Miller won the Nobel prize in 1985. So the circle is unbroken. 

Yishen Kuik writes:

A more extreme example is Colgate Palmolive, which at one time had negative book value. The shareholder's equity portion is still a negative number, and the persistent accumulation of retained earnings has since brought book value back to positive. It still probably has some fantastic price to book ratio.

Rocky Humbert adds:

The following stocks all have market caps over $1 Billion and negative book values:


The significance of this phenomenon is left as an exercise for the reader.

Sushil Kedia comments:

Historical Accounting leaves disproportionate under-priced assets due to inflation on the books making book-value appear to be very small in comparison to earnings, for very old and profitable companies that distribute large dividends.

For younger companies in fortune businesses such as exploration, new molecule discovery etc. anticipations of a breakthrough can have large market caps and low hard assets.

Franchise businesses, including those that thrive on brands such as Colgate, customer loyalty concepts etc. will have a very large proportion of assets that are intangible and never appear on the books of accounts making book values very small.

Companies that have dominantly assets with large depreciation rates allowed too will have lower than average b/p price ratios.

Companies that have taken over larger companies would have a lot of ethereal assets termed as "goodwill" making low b/p ratios again.

Phil McDonnell writes:

I note that Colgate has a return on equity of 90% according to Yahoo data. Big Blue reported today. They currently have a respectable 77% ROE. They are paying an increased dividend and buying back stock. To me it is interesting that the large stable companies that are doing this also have fairly large goodwill entries, as Sushil noted. For example Colgate has about $2B in goodwill on the books. Usually this means they paid too much for an acquisition. Too much means they paid more than the book value of the assets acquired. But in the case of stock buyback if the company buys its own stock at market, which is higher than its book value per share then presumably that shortfall is recorded as goodwill. If the stock rises or has risen in the past then that may mean there is hidden asset value on the books in some sense.

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

Steve Ellison observes:

I am looking at Oracle's 10K. Oracle used $3960 million of cash in 2009 to repurchase shares. On the statement of stockholders' equity, Oracle reduced common stock by $550 million and reduced retained earnings by $3410 million. Thus the effect of share repurchases was to reduce stockholders' equity, but this effect was more than offset by the increase in stockholders' equity from net income of $5,593 million. 

Sushil Kedia comments:

If Inflation Accounting seminars held by so many august Accounting Bodies all over the world in the last two decades could not decipher how it could really be done, assume for a moment at some point it will be done correctly.

But then the book-keepers that produce the inflation estimates and keep revising them invariably all over the globe (I guess all gummints are at least alike on this parameter whether they be Capitalists or Communists) are also just book-keepers.

So, this one conundrum will never be solved.

In recent decades there have been some high-brow management consultancy firms that are peddling ideas of Brand Valuation. But then if a company could own a brand worth a Billion Dollars and make only continuous losses their ability and talent at producing so much red is eventually leaving a value on the table of that Brand at just a risk adjusted present value aggregate of these losses as a negative number only. Brand Valuation as an Accountancy tool has no place in the Accounting World, save for nice trips to Bermuda for such conferences.

Replacement Cost Theories have been used and rather mis-used to pamper the valuations of cash-loss generating companies on an idea that it would cost so much to build this same factory today at the extreme end of bull-runs.

Then they say Cash is King. But the King everywhere in this Universe has been only trashing cash ever since it was invented. So, we go back to the beginning of this note. All roads lead to Rome, in the world of Fundamentals.

So what Fundamentals are we talking about at any point and under any framework?

At least the price followers, even if prices are manipulable and get manipulated every now and then are having a far simpler illusion of suffering from knowledge and the best part is this manipulation keeps coming regularly, tick by tick. The follower of price action recognizes if there is an incentive to an economic activity, it is happening already. So, irrespective of whether prices are manipulated or they are not, the stimulus to any system of taking decisions is consistent.

The Fundamental Manipulations are erratic, supposed to be non-existent until an Enron comes by every now and then while they are happening throughout erratically and then with an endless battery of ideal world assumptions the whole Art of Fundamental Analysis has such elegant and consistent formulae for everything. The quantitative screens in each and every idea in the universe of fundamentals is so self-sufficing and yet this form of art never could get known to be any variation of Quantitative Finance.

I am not against Fundamentals at all, but just wish my elegantly consistent brothers and sisters in this art form acknowledge the fool's paradise they are keeping building.



 One is astonished at how far the subject of position sizing has come since Robert Bacon in 1940 when he suggested 2% of your money on each bet, then a buck on the races so you could lose 50 in a row before going under.

How about an approach where position size was a variable that you put in your statistical return and reward space to start with, then examine the distribution of returns with various positions sizes and determine how your utility fits in with the distribution.

For example, today a 20 day high of 230, indeed a 1½ year high. What is the distribution of the six such?  Max 4.8, min -5, moves to relevant endpoint 2, 5, 2, 2, 1, 5, -2, 3. No trade from Bacon. Wait for overlay. Pittsburgh Phil in the background.

Phil McDonnell writes:

The hard truth, to me, is that it is all position sizing. –Ralph Vince

I agree with this only up to a point. In order to have a winning strategy one must have an edge in a statistical sense. You cannot win with a losing system. One needs both a winning system with an edge and a solid money management system. Neither one alone is sufficient.

After one finds a winning system then you must also have a money management system that does not expose you to ruinous losses. If you graph the expected amount of money you make at various position sizes for any winning system you will find that it looks like a mountain. The peak of the mountain occurs at precisely the positions size Ralph calls optimal f. But if you also look at a chart of risk (stdev) you find it is a monotoncally rising function of position size. Thus as you continue past the optimal f point you are giving back return but still increasing risk. It is the worst of both worlds. If you go far enough past it you can actually wind up losing money even with an overall winning system. That is why I prefer to call the optimal f point the point of maximal investment return.

kahneman receiving nobel prizeWith respect to Vic's comment about utility, there is much merit to this approach. None of us truly knows our utility function and if you believe Kahneman and Tversky it is probably irrational anyway. So then the next best thing is to construct a rational function mathematically from some logical first principles. The three most obvious choices are Sharpe ratio, log, and my favorite is log log Sharpe ratio. Except for the simple log function, one invariably finds that using these utility functions one chooses a point on the mountain graph somewhat to the left of the optimal f peak. So in that sense optimal f is really only 'optimal' for the case of maximizing compounded portfolio return but is sub-optimal and dangerously past the optimal point for maximizing any utility which explicitly takes risk into account.

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

Ralph Vince adds:

I agree with most of what you say here. Like the old Frenchman used to say, "Most people don't know what makes them tick; they only know that they tick."

Most people do not really know what they are in the markets for — and I think there are very many different and good reasons for being in the markets aside from mere growth maximization. But most don't know what they are here for.

I think until someone can answer that they're probably better off not being in this arena. But I no longer think one needs a winning strategy, and I beg to differ with the notion that you must have a positive expectation (and, this too further indicates that timing and selection are subordinate to sizing). Ultimately, you are in this for a finite number of holding periods or trades (call this T) , and given that you have control over your quantity, you seek to come out at T (or before, if you have achieved the objective of your criteria) with the objective of your criteria.

Again, and I will use this for illustration of the idea — if I could do a full martingale on my capital, and I had unlimited capital, and my goal was to accumulate, say, X……

I could then do a full martingale on a losing system, and when X was achieved (or at necessarily time T) leave the game.

I know for years I too bought into the idea that you have to have a winning system. But I am seeing guys who have specified their criteria well, and are getting astounding results, and are trading approaches that are, at best, feeble. 

Ralph Vince is the author of The Leverage Space Trading Model, Wiley, 2009

Phil McDonnell replies:

I would love to see an example of a system that had a negative expectation but could somehow be turned into a positive expectation through money management. The martingale example is a system that exchanges a high probability of winning a small amount for the small probability of losing a large amount.

Examples of such 'systems' with skewed distributions would include:

  1. Selling out of the money options.
  2. Setting a profit target of $1 with a stop of a $10 loss.

Until I see one I shall remain skeptical that one can reliably expect to profit from a losing system simply through money management.

Rocky Humbert:

As a philosophical matter, I question whether a system can truly have a negative expectation. Because if you take a system that supposedly has a negative expectation and simply do the exact opposite, you should have a system with a positive expectation. I am skeptical that any market participant believes that his approach has a negative expectation.

If you have ever tried to play checkers to lose (instead of win), you'll see just how difficult this can be.

(Note that I am excluding transaction costs from this discussion. But there should be no a priori (efficient market) reason to believe that always buying out of the money options should have a better result than always selling out of the money options– unless there is a systematic mispricing.)

Steve Ellison comments:

crapsAny casino game is a system with a negative expectation for the player (except a blackjack card counter). In craps, one can bet against the shooter, but the expectation is still negative. The only way to take the other side is to be the house. 

George Parkanyi writes:

In my REAP system (Relational Equity Allocation Program), I made the position size a function of the relative separation ( % move of X minus the %move of Y determined the % of position X to sell to fund the purchase of position Y) between two securities made over time. You can re-allocate based on a specific net separation (e.g. 30%) or re-allocate at specific time periods come what may. This has a positive expectation over long periods, because there is dollar-cost averaging dynamic involved - a more aggressive version because fewer shares are sold of the relatively higher security, and more shares bought of the relatively lower security, and the wider the separation the larger the re-allocation size. The compounding over time depends on the volatility (and therefore degree of divergence and funds transfer) between the matched securities.

Trade sizing can also be used for money management in trend following. The simple principle of scaling into a position as it rises keeps your risk relatively low on initial entry, and there is a cushion of profit to fund the risk of subsequent higher-up scaling purchases. Here again, you can optimize by how high you go before adding, and what tranche sizes you add at each level. The trade-off is that you limit your profit potential by scaling, but your stop-outs are cheaper, and waiting to add provides confirmation of the trend.

I currently am using a 40-30-30 scaling sequence, using a specific setup pattern rather than a fixed % rise (e.g. 0%, 10%, 20%). You could use a relatively wide stop on the first tranche, or really keep your costs down and use a very tight stop that allows several inexpensive stop-outs before you "latch". The latter is a better way to go I think if you are trading breakouts and strength patterns. A good break-out doesn't look back, so your tight stop doesn't factor in. If you have to stop out 3 to 4 times before you catch it, you can still keep your misfire costs low.

Rocky Humbert:

Fair point. I was referring to the financial markets (and not casinos,) but you can indeed buy and hold the shares of publicly traded casino companies and you are taking the other (positive expected) side.

Turning a system upside down highlights an additional phenomenon: path dependency can determine whether one is a trading "genius" or "moron."

Nigel Davies comments:

Fascinating discussion.

If I might offer my two cents I've found that in my field there are an immense number of practical difficulties in bringing a nice piece of theory to the board. From my amateur perspective I see many issues with regards to the subject under discussion:

a) A maximum loss size implies that you have a clearly defined exit point, i.e you are trading with stops of some kind and these can nonetheless leave you a winning system.

b) Assuming you have your exit point, how realistic is it that this will be achieved (slippage etc).

c) Does assigning all trades the same position size represent maximum efficiency? I suggest that some are much better than others and should therefore be weighted more heavily.

I'm sure that readers of this site can think of many more issues such as these. This in turn makes me wonder about the utility of trying to apply very precise mathematics to practical and very messy issues. Surely it should come with a good sized dollop of common sense and flexibility in which good lab experiments are regarded as mission statements rather than straight jacket rules.

Of course doing this is an art in itself which will extends into all sorts of psychological nuances. If anyone is unable to do this they should be looking to work on themselves rather than 'the system'. Discovering the reasons why people can't operate effectively under pressure is very valuable, both in the markets and in life.

Craig Mee responds:

Fair call, Nigel, though the one thing I would have to agree about on the surface but disagree on is "I suggest that some are much better than others and should therefore be weighted more heavily."

It had been my humble experience that the trades I thought were crackers ended up as duds, and those I thought were tradable, but just above the criteria, turned out to be 4-10 baggers. Setting the same cash risk, at the start was imperative across the board.

Nigel Davies writes:

 Well, yes, that can be a tricky one. But if one's assessment of bullitude/bearitude is unreliable vis a vis degree, what makes you so sure that they're not completely the wrong way round!? It could be that 'sure thing' trades lower one's vigilance in which case we're back to the human factor. Anyhow, now I'm more awake I can think of some other flies in the ointment in this position sizing debate. What about:

a) The good part time trader with a day job who wants to build up capital. Perhaps he should he push the boat out more at first so as to get a big enough account to go professional.

b) The improving trader; shouldn't he trade small size whilst learning?

c) The successful professional trader who wants to protect capital. Shouldn't he gradually reduce size rather than have his entire wealth and livelihood on the line.

Don't get me wrong, I think that an understanding of position size risks is essential. But there's a lot more to this than just numbers.



an illustration of momentumTo what extent is there momentum in the surprise of quarterly earnings reports and is it reflected in similar moves in individual stocks or stock markets?

Steve Ellison writes:

I studied the impact of earnings by comparing the movements of the S&P 500 during the second half of the first month of each calendar quarter, when the market receives much new information about earnings, with the subsequent 2½-month period in which there is much less earnings news. For 2003 through 2009, I found a negative correlation with a t stat of -2.18. Interestingly, when I repeated the same test with 1990s data, I got a positive correlation with a t stat of +2.11 — changing cycles, again.

Philip J. McDonnell comments:

I would conjecture the Sarbanes Oxley Act of 2002 may be the line of demarcation between positive and negative correlation.



Many of you have heard me rail about the misapplication of the Kelly Criterion in trading, having witnessed firsthand how many funds are misapplying it. A typical conversation starts out with my being asked what someone should do when his allocation, as given by the Kelly Criterion, "…is greater than 100%." Repeatedly I have made the argument that the Kelly Criterion is not Optimal f, and that people conflate the two. A paper on my web site finally articulates that. Scroll about halfway down the page, in the "Related" section is a link to my paper "Optimal f and the Kelly Criterion."

Max Dama comments:

I really like your exploration of the leverage curve and I'm glad I have someone to talk to about these things. Sometimes I feel that public debate is too sharp, but it's not meant to be that way.

A few things worth noting:

1) (p5) You said, "Since the Kelly Criterion, (1,1a,1b[r=0]), requires percentage returns as input, whereas the more general Optimal f solution requires raw data points." Kelly can be similarly calculated based on raw data, as I showed in a note on my blog post Practical Kelly Betting II.

2) (p13) f is not bounded to the left by the Kelly Criterion. For example in the case of an even bet on a biased coin with probability of heads p, Kelly's f=2p-1<=0 for p<.5, as we intuitively expect — basically short the game if possible.

3) Bounding Optimal-f between [0,1] is simply a change of units. I wouldn't say that one or the other is better. Both have very good arguments in their favor. It's good to be aware of the merits of both. Perhaps both should be given on any fund prospectus.

4) What I don't like about your W, i.e. max loss, is that it is hard to specify. An example is in trading GOOG: The maximum you could lose is 100%, right? since it's equity and if the company goes bankrupt you potentially get nothing. You might argue to base it on historical data, but that's bad too — let's say it's one week since GOOG's IPO. Then your historical data are useless. The point is that W doesn't help, and only adds another hard to specify number into the objective function. The beauty of Kelly is that it crystallizes the essence of risk and leverage so you can see their exact interplay.

In general I would like to see more unification, rather than divisiveness. This is merely a semantic difference of course, but to move the field of risk management forward, it would be nice if the three big factions - Leverage Space, Markowitz, Kelly — could pool resources and ideas.

Max Dama blogs as Max Dama on Automated Trading

Ralph Vince replies:

These issues are addressed in the paper.

I wrote it because I was seeing the possible future damage that was likely to befall people and funds due to the misapplication of the conflated notion of the Kelly Criterion and the Optimal f notion. The values returned by the two are not the same, except in what I refer to in the paper as the "special case." It is only in the special case that the Kelly Criterion solution equals what is the optimal fraction of a stake to risk. In all other cases, it yields a greater number (with no upper bound), representing a leverage factor, and that leverage factor is the same value as the optimal fraction to wager only in the special case. This is the problem that spawned the paper as I repeatedly saw people and funds who were way over-leveraged (where there is never any benefit, only the assuming of potential future danger) because they were unaware of what the Kelly Criterion was an answer to (a leverage factor as opposed to the optimal fraction to wager).

And I find this misguided concept pervasive in the industry as well as academia. Kelly himself refers to it as the optimal fraction, but it is not. Rather, in the "special case," it is a value equal to the optimal fraction (and in all other cases, if someone thinks that are using the optimal fraction, based on the Kelly Criterion solution, they are dangerously over-leveraged beyond what is the optimal fraction).

(Incidentally, if anyone on the list is not aware of Max's blog, it is perhaps the most interesting and meaty reading out there and you're missing something terrific if you don't visit it. And Max, get back to posting on it!)

And this now addresses the notion of "more unification rather than divisiveness which you bring up." Yes, the two can be used interchangeably, and the formulas for converting between the two are provided in the paper. But why would I want to do that?

The answer provided in the objective function of the Kelly Criterion solution is the expected value of the sum of the logs of my returns (this is a meaningless value). The objective function of the Optimal f is the multiple I make on my stake on each play. This value clearly does have a certain, useful meaning. Secondly, there are many virtues to having a number bound between 0 and 1 as opposed to a value which I would have to convert to get to between 0 an 1 (these issues too, addressed in the paper, i.e. the singularity, which, if you start to examine a very bright mind as yours will find tremendous real-world benefits to this, which we won't go into right here, but I just know you will see it and fly with it), as well as allowing a combining of the assets comprising these bound values together.

(You might think I am railing against these things, but the enthusiasm to this end is, hopefully, the fuel to elicit critical examination of these existent concepts. This critical examination was clearly missing or I would not have encountered so many people and funds which were mistakenly over-levered as they were.) Divisiveness, in this aspect, is my responsibility(!) How you perceive these things — how they fit together in your mind and what you do — is your prerogative entirely. I am trying to foster your critical thinking on these aspects. Having met you, it is precisely those (far-too-rare) younger guys like yourself I am trying to stir, and the ultimate unification of these ideas will be the product of your good minds. The older fellows — we won't be here long enough to give a rat's butt what they think!

Lastly (and you mentioned Markowitz), and you have heard me rail that unlike an LSP/Optimal f -based portfolio, it does not address leverage directly. And I say that because the latter has Variance embedded (negatively) in its return aspect, rather than juxtaposed to it. Recall the Pythagorean relationship between the geometric mean, arithmetic mean, and standard deviation in the holding period returns and this becomes evident.

And when I do this, and introduce a risk metric other than variance to juxtapose it to, I find I have optimal allocations which are not on the efficient frontier of a mean-variance configured portfolio (as in the chart which follows this posting, which you have seen, for two 2-1 coin toss games played simultaneously. The mean variance portfolio, which would lie upon the diagonal line — and would, in fact, find the optimal portfolio upon it –does not when a risk metric like drawdown is imposed).

The unification of these ideas is up to guys like you. I'm just an old guy standing on the bus, stepping on people's toes. (That's my job here!) I AM trying to get you stirred and thinking on these things (and I can be, and frequently am, wrong on some of these things and other things too). From where I stand, to have guys like you thinking, critically, on all of this, and putting it together (and sharing your thoughts on it all as you do!) is infinitely better than watching people walking into the paths of loaded guns because of the very ignorance surrounding these matters that precipitated this paper.

BTW — The sun is just peeking through here, it's birdland out there. The dark, spooky Buckeye Trail is calling me, and I am going on a long, slow, indulgent slog — a sabbatical from the world for the better part of today. What could be better than that?

Steve Ellison writes: 

As a math enthusiast, I love the Optimal f formula. I have been using, it since I started trading in 2006. My biggest challenge as a practitioner has been changing cycles, i.e., the edge I thought I had based on the historical data did not continue going forward. No doubt my lack of proficiency was to blame, but several such experiences have made me more conservative about position sizing. I want a fudge factor to allow for the possibility that I might be completely wrong. At one point, I explicitly included a fudge factor in the Optimal f calculation itself, by for example adding the 22% drop in the S&P 500 on October 19, 1987 as an extra result if I was evaluating a one-day trade. Doing that sometimes turned the entire profit expectation negative, and the Optimal f calculation would quite sensibly not recommend any position size greater than zero.

I have also noticed that if I include stops as part of a trading strategy, the worst result is approximately bounded by the positioning of the stops. In such cases the Optimal f calculation sometimes seems to indicate I should use leverage. The Optimal f is between 0 and 1, but the position amount per contract is less than the dollar amount of one contract, so I would be trading on margin. If, for example, I have a worst loss of 2%, Optimal f may suggest an f$ unit of 6%, which I could interpret as 3x leverage if I understand correctly.

Ralph Vince comments:

Interesting post — but as for the bounding of f values, it turns out they are not between 0 and 1, but rather, between 0 and the sum of the probabilities of winning holding periods.

Thus (and this is where I am hoping Max and his good mind and find something new to augment what they are learning and work with in new ways I have never though of) the notion that everything is terrible sensitive to W isn't quite so (W, in fact, determines where the peak is in that window between 0 and the sum of the probabilities of winning holding periods.). Further, W is innately embedded in the Kelly Criterion calculation as well as you are working with returns (returns based on what? Well, traditionally, on the value of the underlying (times -1), or, in gambling W=-1. But, sensitivity to W isn't the biggest problem (in my humble opinion — I could be wrong, again, I throw this stuff out because I have been working with it). The biggest sensitivity is to:

the sum of the probabilities of winning holding periods (and, if holding periods are trades, assuming you are trading only 1 component, then it would be the percentage, say, of winning trades). That is what determines the upper bound.

But, in discussions with Larry Williams, because he wants weapons that won't jam when you pull them out, he wanted to know what a quick-n-dirty way to determine the Optimal f in the future would be (this really is a vital question, because what you make is predicated to where you are on the curve of f(0..1). And it turns out we can minimize the damage caused by missing the peak in the future (because we don't know where it will be) by using a value in the middle of the window, in other words, by using an f value of the sum of the probabilities of winning holding periods divided by 2.

And this is amazingly simple. And if you are right about the the sum of the probabilities of winning holding periods in the future, you have minimized the price you pay in the future by not being at the optimal f (and, you may well be at it. At worse, you will miss it by the sum of the probabilities of winning holding periods / 2 ).

And so the criticism of W in the equation really becomes not so problematic as what the the sum of the probabilities of winning holding periods will be. And if you can nail that, you've essentially predicted (as close as I can) what the optimal f in the future will be.

Ralph Vince comments:


Ouch! I was just coming back here as I really don't feel right not answering your questions — so I'll try here now.

You wrote: "[regarding the application of optimal F]…If you want to be in this game and do it mathematically correctly, expect to be nailed for equity retracements of from 30% to 95%." You go on to write, "Most brokerage firms will not even look at a CTA who has historically had a 30% drawdown, nor will they promote a futures pool or fund that has had such a drawdown."

Pretty much, though I think risk tolerances, at least for commodity funds, has gotten better. Earlier in the decade many soverign wealth funds sat through drawdowns of around 50%…..and what happened after that, in energy, the dollar, precious metals, etc., is history.

1) I have never seen a market professional recover from a 95% drawdown (without raising new capital) or a individual recover (without putting fresh capital into his account).

I personally know of two individuals who have. The mathematics of achieving such a recovery are improbable. I disagree entirely. It may seem emotionally improbable, but certainly not mathematically.

If one should "expect" to be nailed for such an outcome, please explain why optimal F approach is more than just a theoretical/mathematical construct…i.e. it's too dangerous to be used in real life? (I ask this with the greatest of respect.)

I think it's too dangerous for anyone who is NOT seeking growth optimality. And growth optimality may NOT be the criteria most funds operate upon. In fact, it's not the criteria most individuals operate upon, although I must say I see some younger guys nowadays who, understand the mathematics and the swings involved, are implementing this. Again, it's only germane if growth optimality is the criteria. HOWEVER, the framework it provides allows us to seek OTHER criteria aside from growth optimality. I have met a couple of individuals who are using this to achieve other criteria with astonishing results.

That is, if one takes the Optimal F, and then cuts the position size back by XX% (as Steve below suggested), does that harm the intellectual integrity of its application?

I don't think it harms things, but to position oneself at a different point on the curve or N+ 1 dimensional surface (where N = number of components) simply to mitigate risk, and picks this point as a mere fraction of the optimal fraction, is doing themselves a disservice. There are other viable points, significant points to be at rather than the optimal point (again, in pursuit of different criteria) but notions like the so-called "Half Kelly," etc. are silly and based in not understanding the dynamics of the curve.2) If your answer to #1 is that there is nothing inherently wrong with a 95% draw down, what sort of long term (compounded) returns do you think a
manager should achieve if he is taking that sort of risk/volatility?

Let me say this. It depends on the individuals criteria. Now, some might argue that this is appropriate for young investors (perhaps, but first, in my humble opinion, only after loading up on whole life insurance with all they can) There is a lot more to the dynamics of this stuff, Rocky, than I can describe here (Frankly, I give 2-day courses in this stuff, and always fear that it is NOT enough time to cover all I want to cover!).

3) Can you explain how optimal-F addresses market volatility at the time a trade is entered; or changes in market volatility subsequent to the trade entry?

Is the largest expected loss, the worst-case scenario you envision over the time horizon you plan to trade, affected by the volatility? Volatility doesn't alter what the optimal fraction to wager is — it CAN alter, however, what that translates to in terms of position size. 



 Aubrey sold lemonade in the heart of Wall Steet today and made a 40% on his cost which the collab put at 50 cents a cup. His selling techniques included doing a dance after each sale and hawking loudly "lemonade for sale." As Millhone would say, "I don't believe that the economy has bottomed yet" as the decline did not affect sentiment on Wall Street. Nor were competitors offended by his competition with them at the 75 cents selling price. As the bearish Barron's columnist would say, "There are still pockets of exuberance out there and until they're completely stamped out, we have not seen the lows."

John Tierney responds:

Here's another opportunity for Aubrey to pick up a little extra spare change:

(CNSNews.com) – President Obama's Environmental Protection Agency is encouraging the public to create video advertisements that explain why federal regulations are "important to everyone."

The EPA is managing the contest, part of the government’s eRulemaking program, on behalf of the entire government.

As explained in the EPA press release announcing the contest, the purpose of the videos will be to remind the public that federal regulation touches “almost every aspect” of their lives and to promote how important those regulations are.

“The contest will highlight the significance of federal regulations and help the public understand the rule making process. Federal agencies develop and issue hundreds of rules and regulations every year to implement statutes written by Congress. Almost every aspect of an individual’s life is touched by federal regulations, but many do not understand how rules are made or how they can get involved in the process.”

“Regulations have the power of law. Breaking them can result in fines and even jail time. Regulations outnumber Congressional statutes. For every statute passed by Congress and signed into law by the President, federal agencies create about 10 regulations, each of which have the force of law.”


Steve Ellison comments:

In my town in which home prices have dropped 60%, and an estimated 70% of mortgages are underwater, my wife thinks it is a good time to buy. She is finding that houses are selling quickly, and she cannot delay if she wants to visit a house she likes before it is sold. There are plenty of Millhonian signs, such as the notice of foreclosure taped to the front door of one house we drove by (when we called the agent, we found the house had already been sold), but the market is working as textbooks say it should: when prices decrease, demand increases.

I suspect there is a cognitive bias regarding change. It is very easy to notice the negative or threatening aspects of any change and who the losers might be, since we tend to think in terms of the status quo. However, it is much harder to spot the opportunities and who will benefit from the change. There are people in my town who did not go deeply into debt and still have jobs who can now afford much nicer houses.

Donald Sull, in his book The Upside of Turbulence, recounted that a business school class was assigned a project to advise Lakshmi Mittal about his steel company. The students nearly unanimously recommended that Mittal exit the steel business because severe disruptions in the industry were destroying profitability for nearly everybody. In the context of the assignment, the students had every reason to know that the main disruptive force in the industry was Mittal himself, and his company was prospering mightily. Somehow, the students could not see any benefits of industry upheaval, even when advising the chief beneficiary.



DJIA1. One notes a too smart by half breach of the round today in the DJIA. What fools the g_ds must think the mortals must be.

2. For yet another time, the bonds have suffered a grievous decline before 10 and 30 year auctions, threatened breaching the 4% and 5% levels, and bounced back with alacrity to levels that do not threaten the economy. How many times can history repeat? One is reminded of Crocodile Steve who always said that when he ran the show, the crocs were particularly vicious because they all remembered it was he who caught them. Thus, he never entered the arena at the same spot twice as they waited in ambush for him at the last place.

3. We frequently talk about what fields as disparate as rodeo and radio can teach us about markets, but not as often do we consider what we can learn about life from markets. One has been considering the general question of happiness. What can we learn about it from markets?

Here's a interesting gambit. It is well known that after monthly maximums the variance of the move in the S&P the following day is considerably less, indeed 1/5 as great as the variance after monthly minima, and a mere 40% as great as after normal days. The standard F tests for comparing equality of variances by looking at their ratios, which has a critical value of 1 at the 1% level of significance show that these divergences are quite impossible under randonmess. What does this tell us about human happiness, and yes, what does it tell us about markets, also taking into consideration that the maxes occur twice as frequently as the mins over the past 15 years. 

4. "The Knicks never lead, falling behind 4-0 in a sign of things to come" in losing 118-90 to Portland on March 31. What can we learn from that?

Jeff Watson writes:

Steve IrwinA corollary to point number 4. In 1969, the Chicago Cubs were in first place all season long. At the beginning of September, they had a 84-52 record and were a solid 5 games ahead of the NY Mets. By mid-season, the Cubs were already getting ready for the series, and they even wrote many songs about them.The Cubs choked and lost 17 of their final 23 games while the Mets went on a tear with a 23-7 record, overtaking the Cubs and ultimately finishing 8 games ahead. The Mets ultimately went on to win the World Series, while the Cubs quickly regained their status in the cellar. Still, Chicagoans love the Cubs, win or lose, as there's nothing like a good day at Wrigley eating hot dogs, peanuts, cracker jack, and plenty of beer to wash it down.

Nick White responds:

I immediately think of case studies of Olympians– especially Olympic Champions– as they try to adjust back to normal life, post-Games. It's not an easy transition. Post-competition depression is a real thing and the market being what it is, probably can teach us much about how to handle ourselves after a major peak or trough.

Livestrong gives a good summary of the problem:

Many athletes spend years preparing for a narrow window of opportunity–a college career, the Olympics or professional sports limited to certain ages. Intense preparation, daily practice and adjusting life to meet the sport's needs may dominate an athlete's life. After the particular event, an athlete may lose his sense of purpose and have a hard time reintegrating into a routine that does not focus solely on the sport. An athlete may experience depression if he is unprepared for the transition.

To follow the example you provided, on the day (or weeks) following their victory, Olympic champions are unlikely to go 'round the village, find their competitors from the event they just won, and then challenge them to repeat their world-best performance again…there's consolidation, reflection, relaxation. An entirely appropriate response. Without further stimulus there is rapid atrophy and de-training. There are dozens of studies of the de-training effect. With well-timed, appropriate breaks there will almost certainly be the possibility of greater physiological improvements (see any of the literature following Bompa et al on training macro, meso and micro - cycles).

This sounds remarkably like the behaviour of the market. The sports physiology literature probably has much to teach us about the extrema of markets and the conditions of extension in such situations.

Furthermore, not everyone puts themselves into an intense period of stress and competition that they have been preparing for for a prolonged period of time, yet the market does this reasonably frequently. So, being a collective representation of human emotions and biases, it's probably fair to hypothesize that the manner in which the market responds after minima or maxima is probably a fair aggregate of how we can expect humans to behave on aggregate when experiencing highs or lows in their personal lives. Hence the market can perhaps teach us something and, from that base, we can then perhaps devise strategies to more efficiently handle such periods in our personal lives.

What also of the incidence of disorder when a highly focussed instrument loses its purpose–temporarily or permanently? But, your proposed study begs a question of logic– is it possible for the market to teach its creator something directly? The market doesn't have independent existence from its participants or a character of its own any more than a violin is capable of playing music lest someone pick it up and play it. So is it better to just to review the behavioral literature directly?

Rocky Humbert writes:

The question posed is a variation on the much debated question as to whether stock markets decline faster than they rise. The past 19 months are additional fodder for those (including myself) who believe that they do.

Because the phenomenon of lower volatility at monthly maximums is much less prevalent in commodity futures markets, I posit that the phenomenon is related to the three facts: (1) that the S&P is a "net long" market; (2)fear is a stronger motivator than greed; (3)stop/loss sell stops are more prevalent than take/profit limit orders.

I'm not being facile when I observe that the reason most people own stocks is to make money. Hence after markets are rising for a time, most people sit back, relax, and enjoy the ride. However, when markets are declining, the fear instinct kicks in– and people feel the need to "protect their gains," "stop the bleeding," or the all-too-familiar, "I can't afford to lose any more money."I would additionally observe that markets which go a long time without a correction have more violent corrections. This can be quantified and is consistent with all of the observations above.

I have been an unabashed bull on these pages for the past two years, largely because I believe that the valuation and sentiment at one's entry point are the best determinant of one's long-term return. I am now growing more cautious– and just as I was buying stocks on a scale-to-oblivion in February, 2009, I am starting to sell-long on a scale-to-oblivion now. I am not shorting. Rather I simply observe that the same simple and timeless logic that predicted a 5 year double-digit return during the dark hours, now predicts a low single-digit return over a 5 year time horizon. I wish I knew where the S&P will be in a week, a month, or a year — but any claim of that ability would be pretense.

Ultimately, the markets' lesson of the past 24 months has once again been, "Be greedy when others are fearful, and be fearful when others are greedy."

Sam Marx writes:

I believe one more stock market action occurs that was omitted in paragraph four. That is in a rising market when there is pullback or slight sell off, buyers come in to buy the dips and the market starts its upward climb again.

Fear kicks in when the market continues to dip, maybe around 10% down, and then selling picks up.

Steve Ellison writes:

Many athletes go into sales after their playing days are over. In sales, like athletics, all that matters is performance, and the top salesman makes far more money than the VP of sales. Some sales managers go out of their way to hire athletes because athletes are competitive, disciplined, and focused. 

Jeff Watson adds:

There were a lot of athletically inclined people on the trading floors back in the day. It took an athletic person to handle the rough and tumble of the pits, even the smaller pits. A four hour trading session in the pit would be like a 15 hour shift in any other job. It was absolutely physically and mentally exhausting. 

Rocky Humbert writes:

 One answer might be that miners are lured into a false sense of security when their canaries are singing a cheerful melody– comfortable in the knowledge that the levels of methane, hydrogen sulphide, and carbon dioxide are within acceptable bonds — but over time, becoming increasingly oblivious to the growing risks of mining-induced seismicity and unstable mine stopes– until there is a violent catastrophe.

Likewise, the increasing happiness of market participants in a low-volatility, monotonically rising market are like the miners with their singing canaries– the violence and magnitude of the potential, but unpredictable and unknowable and unnecessary tragedy is directly related to the length of time between tragedies as the institutional memory of previous tragedies fade. The miners are alert after a recent tragedy, but after months/years of traquility, the happiness may mask carelessness.

The recent tragedy is probably still too fresh in the institutional memory to be immediately repeated — but those with excess liquidity were able to profit from the most recent tragedy, and those with excess liquidity will be able to profit from the next tragedy. These men are like spiders — patiently waiting for opportunity that only occurs once every several years.

The wisest man can see the future, he is indeed a happy man.

Victor Niederhoffer comments:

One would adduce inspired by the token liberal rocket scientist that the ratio of variances during the past 3 years has been 9 as opposed to the paltry 5 previously addresses. And his very interesting post brings back many pleasant memories of the meetings of the Royal Society adduced by O'Brian. A certain member when talking about nondescript features of this or that mollusk on the Mauritius was well known to steer the transactions and his talk into a discussion of the nesting y practices of a certain species of bird that I believe liked to test in coal declivities. What does the reduced variance following the bigs have to do with the tendency for declines to be more violent? A talk at the Society might be apt.

Stefan Jovanovich writes:

What miners have been saying is that "yes, setting off explosives will shake the ground" but it does not "cause earthquakes or increase their frequency". The miners - poor fools - have some direct experience with the amount of force it takes to move rock so they find the direct causal association between their cat-scratchings in a litter box and an earthquake a bit laughable. What defeats their sense of humor is the realization that "mining-induced seismicity" is yet another scientific theory whose postulate is close the mine. "Mining induced seismicity" in the sense that blasting = greater probability of earthquakes has not been proven; on the contrary, most of the statistical evidence suggests that this is an affinity fallacy: man-made explosions shake the earth, therefore naturally-occurring earth-shaking is caused by man-made explosions. The quality of science that accepts this fallacy seems to be on a par with the fans of CO2-induced global warming. (What a surprise!)

What has been helpful is to measure earth-movement activity as a predictor of roof-falls using fuzzy logic.

Of course, CO2 is a problem in mines, but it is not a "worry" compared to methane. If the ventilation fails, then people die from the same cause that occurs when they fall into a brewing vat or get stuck, without an oxygen supply, when cleaning out a grain storage bin or cargo hold. It the lack of oxygen kills them, not the CO2. Acidosis is unpleasant but it is not often fatal. The reason they put CO2 in fire extinguishers is that it is the one safest, most non-toxic gas that can be stored and then used under pressure to displace the oxygen supply.



 By the time the NCAA Men's Division I basketball tournament gets down to four teams, is it a toss-up as to which team wins? In other words, does each team have a 1 in 4 chance of winning?

Steve Ellison responds:

This is an excellent situation to apply the binomial theorem. In E****, you can write a formula: =BINOMDIST(s,t,p,c), where s is the number of successes, t is the number of trials, p is the probability of success, and c indicates whether to calculate the cumulative result (1=yes, 0=no)

Our null hypothesis is that the probability of success (winning the Final Four) is 0.25.

For example, for the teams that have made only one trip to the Final Four, the formula is =BINOMDIST(1,20,0.25,1), resulting in a p value of 0.024. This result appears to be statistically significant, but the significance is questionable given that we are doing multiple comparisons.

Teams that have made at least four trips to the Final Four have won more than a quarter of the time, so we can check the probability of winning 21 times or less and subtract it from 1, using the formula =1-BINOMDIST(21,65,0.25,1), which results in a p value of 0.070.

Russ Sears comments:

This is retrospective, and has "survivorship bias" or winner's bias.

This would be true if the championship wins and returning to the Final Four where independent. But they are not. If you win one year, the record most likely show you have a better chance of repeating in the final four.

You need stats that show winner only in their first appearance or second appearance, etc.

Here are the Final Four champs by appearance order:

appearance  count champs  binomdist

1st                  97     13          0.4%
2nd                 55     15         71.3%
3rd                 32      8          59.4%
4th                 24      9          94.5%
5th or more      80     25         92.0%
4th or more     104    34         97.0%

Alston Mabry adds:

Looks like an opportunity to run a quick sim. The sim sets up the Final Four participants for each year 1979-2009, randomly assigns the National Championship to one of the schools, and then records whether that school was one of the schools that actually went to the Final Four just once, twice, three times, or four or more times. Results of 1000 runs:

schools that went to the Final Four just once
count: 20
actual championships: 1
mean # of championships in 1000 sim runs: 5.00
sd of this distribution: 1.68
z score of actual # of championships compared to sim distribution: -2.38

schools that went to the Final Four exactly twice
count: 9
actual championships: 2
mean # of championships in 1000 sim runs: 4.49
sd of this distribution: 1.73
z score of actual # of championships compared to sim distribution: -1.44

schools that went to the Final Four exactly three times
count: 7
actual championships: 6
mean # of championships in 1000 sim runs: 5.33
sd of this distribution: 1.92
z score of actual # of championships compared to sim distribution: +0.35

schools that went to the Final Four four times or more
count: 11
actual championships: 22
mean # of championships in 1000 sim runs: 16.19
sd of this distribution: 2.53
z score of actual # of championships compared to sim distribution: +2.30



Can readers help me understand the meaning of backwardation vs contango in the past in the ES? Why is it negative now? Does it mean people think it's going to go down, or are the rates that low? I've studied, but don't really understood the formulas for computing the values of the future contracts or why there is a negative spread now when is was +4 points or higher spread in 2007 as the market topped on the rolls.

Nick White lends a hand:

Garden variety futures valuation is just a simple cost of carry model: the price of the underlying today adjusted for the cashflows you expect to pay/receive until expiry. The whole bundle is then appropriately adjusted via interest rates for time — effectively, the exact same as any other asset.

Intuitively, this is easy to understand if you think of how NPV — or a DCF model — works and then team it up with the laws of arbitrage. What is your asset worth today given what you will spend and receive for it over a given period, adjusted for interest rates? If your asset can be exactly replicated, is the price of that replication worth more or less than the original? If so — ceteris parabus — you can arb it.

The proviso to the above is that not everybody has the same interest rate in their model… your cost of funding may be very different to mine, which will be very different to GS's. I would argue that — care factor on Index Arb notwithstanding — one's ability and inclination to practice any form of index arb depends vitally on this cost of funding rather than some point spread in the rolls… and that in turn "depends" on whether the arb is long stock / short future or vice versa. Risk free rates are just a proxy.

So, if you cannot perform index arb… what is this info useful for? Knowing the fair value spread might give you a few ticks edge when placing an order because the future may already be a bit over/under extended vs the cash market. So, to provide an example, if you're buying, you may be better to place your order — per the Chair's admonition — a couple of ticks behind the BBO if the fut is over-extended vs the cash. Otherwise, you might want to lift the fut if the cash has moved and the future is lagging.

Very simplistic — but backwardation and contango are just natural progressions of these pricing models, adjusted for the vagaries of short-term supply and demand.

Steve Ellison comments:

 Philip L. Carret, in his 1931 book The Art of Speculation, considered it very bullish when stock dividend yields exceeded the margin interest rate. In such circumstances, he said, stocks "carried themselves", i.e., one could buy stocks on margin and pay the interest on the loan using dividends. Backwardation indicates that S&P 500 futures now carry themselves.

The S&P 500 futures began trading in 1982 and almost never traded in backwardation for the next 20 years. They went into backwardation in mid-2002 and stayed in backwardation for most of the next two years, advancing 53% during this time. They have been in backwardation continuously since October 17, 2008, advancing 25% during this time.

Russ Sears interjects:

 I have seen some option quotes on Enron, that had calls, same strike, different maturities (I believe it was Oct and Dec maturities) that apparently had some time arbitrage. Not sure they were actionable though. In 2000 I bought some deep deep out of the money long term custom interest rate options, that later became in the money, for my old company. The selling counterparty called in 2003 and begged us to sell them back, because they were very difficult to hedge. He told me they were so far out of the money that they sold them thinking they would never have to actually hedge them. I suspect in both cases the option seller, simply booked the premiums as 100% profit, so the theory really went out the door.

Quant Chicken writes in:

The personal impression I formed when I reviewed the empirical academic literature 4-5 years ago was that the forward is not an unbiased predictor (contrary to the theories of FX I had learned in school). The "forward premium puzzle" has been confirmed using so many different statistical tests (some quite esoteric) that I came to believe there is something to it.

I was getting interested in investing real money in this anomaly when I was dissuaded by wiser colleagues, who pointed out that this "carry trade" idea (borrow in low yielding currencies, invest in high yielding ones) was getting crowded, everyone was getting into it, DB started an ETF to allow public to participate (this was in 2006), etc. And statistically the evidence was not very strong. In retrospect I am glad my friends advised me to stay out of it.



buy low, sell high cufflinksBuy Low and Sell High. It is the oldest maxim on Wall Street. The trouble is that it is difficult to do without a copy of tomorrow's newspaper. Even better would be a copy of next year's paper.

An article cited by a reader claimed that buying at the low in the second year of a Presidential cycle and selling at the high produced superior returns. To test whether there really is something remarkable about the second year of the Presidency we can compare the return in that year to the results for all years again assuming the unrealistic advantage of knowing when the annual low is and the next year's high.

The results for all years:

average      41.4%

std             25.7%

count          81 %

Up           100%

t-stat        14.50

Minimum   11.0%

The results for the second year of any presidency:


std           18.5%

count         20 %

Up            100%

t-stat        12.13

Minimum   16.9%

The second year slightly outperforms by 8.8% but that hardly seems significant compared to all years. The t-stat for all years is better primarily because of the larger n. Again we are reminded of the Chair's admonition that of the four possible hypotheses (1st year, 2nd year, etc.) one of them had to be the best.

When we consider the claimed monthly seasonal study the picture is even murkier. We recall that there are twelve months. But that is not 12 hypotheses. That is 12 possible starting months. There are also 12 possible ending months. This gives us a combined total of 144 (12 x 12) hypotheses. The article then assumes that using only 100 data points is sufficient to test 144 hypotheses. It sounds like junk statistics to me.

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

Steve Ellison replies:

I have tested the presidential cycle. Comparing the actual prices of the S&P 500 index to a 4-year centered average, I got the following t scores for 1950-1983:

Election year t plus score

0 2.95
1 0.78
2 -6.97
3 0.30

There was a clear tendency for highs to occur in presidential election years and lows to occur in midterm years. However, when I did the same analysis for 1984-2003, the results were not statistically significant:

Election year t plus score

0 -0.25
1 -0.56
2 -1.52
3 0.05

An investor who noted the presidential cycle in the early 1980s when its wonderful record became clear would not have profited much from it, sitting out not only the terrible decline of 2002, but also double-digit advances in 1986, 1998, and 2006. I have heard of the presidential cycle many times, but never of the caveat that it should be ignored in a second term, which makes me suspicious the caveat is retrospective curve fitting.

Another indicator that was strongly correlated with stock price changes until 1983 was the 12-month change in the US unemployment rate. From 1948 to 1983, there was a strong positive correlation between changes in the unemployment rate and subsequent changes in the S&P 500, i.e., when unemployment went up, stock prices followed. However, from 1984 to 2008, that relationship was also statistically insignificant; in fact the correlation was slightly negative.

Alston Mabry responds:

The "Xth year of the presidency" strategy debate brings to mind the "sell in May and go away" strategy.

To analyze the "buy and hold for 6 months" strategy (for all years, not just 2nd-year-of-presidency), I look at all the Dow months since October 1928 and calculate the return for each of the 12 strategies that correspond to "buy on the open of month Y, and sell on the open of month Y+6". Here are some stats:

For each month, showing the total return (since Oct 1928) for the strategy where that month is month Y, the average return for all the 6-month periods with that month as month Y, and the SD for those 6-month periods:

Jan  673%  +3.51%  14.30%
Feb  829%  +3.42%  11.48%
Mar 1604%  +4.47%  15.09%
Apr  295%  +2.86%  15.48%
May   19%  +1.03%  12.57%
Jun  142%  +2.04%  13.61%
Jul  349%  +2.95%  14.12%
Aug  241%  +2.55%  13.77%
Sep   91%  +1.84%  13.82%
Oct  926%  +3.89%  13.93%
Nov 3134%  +5.28%  13.09%
Dec 1370%  +4.42%  14.15%

In the actual data, November is a clear winner, though March and December are nothing to sneeze at. But how to get a context for the significance of November's outperformance?

Just can't help but run a quick simulation, and the easiest thing to do is to take all the percentage gains for all the possible 6-month periods and randomly reshuffle them, so that a 25% gain that historically fell in the November column might wind up in lowly May, and so on.

Running that 1000 times produced the following results: For all 1000 runs, the smallest maximum total return was 1072%. In other words, each run produced a set of 12 total return percent figures, one for each month. Looking at only the maximum return in each run produces a set of 1000 maximum return observations. The smallest of these was 1072%.

For these 1000 maximum returns, the mean was 5035% and the median was 3943%. So the actual total return for November was below the simulated median and well below the simulated mean.

This was surprising because when you reshuffle data like this, you tend to reduce the overall volatility by mixing volatility regimes. Also, the actual data series of all possible 6-month % changes is highly auto correlated (+.84 at a lag of 1).

So, another way to try to establish a random benchmark is to take the month-to-month percent changes in the actual data and reshuffle those, creating a new series of 6-month % changes each time, with each simulated series being highly autocorrelated like the actual series. Running that simulation 1000 times produced the following stats:

smallest maximum (of 1000 total): 1289%
mean of 1000 maximums: 5045%
median of 1000 maximums: 4153%

Again, the actual data for November are well below the mean and median values in the runs. So, the results of these simulations do not provide any support for the idea that the November-April holding period is outside what one would expect from a random process.



I have updated my market standings at 5:30 pm Eastern Time.



Here is an attempt at sports-style standings for markets, as suggested by the Chair.

The 10-year US Treasury bond moved into first place on Friday as Sugar suffered a huge defeat and fell all the way from first to fourth place.

I may have overcomplicated things by adjusting for currency, but I often felt in recent months that the S&P 500 was going up largely because of dollar devaluation.



(Caveat: easier said than done)

SPY monthly returns (1993-present, with div) were checked for a normalized proxy of intra-month range = (H-L)/C. The series was then ranked by range, along with corresponding monthly returns. These monthly returns were multiplied for the entire 17 year period, which gives a total return of 3.35 ($100 became $335). This was then repeated after successively skipping first the highest range month, then second, all the way to skipping the highest 100 range months. This allowed evaluation of the effect of being "out of market" on final compounded return - whether or not the high range months were up or down.

The graph below shows the effect. Cpd return is the green line, which rapidly increases by skipping (and investing in "cash" = multiplicative return of 1.00) the highest range several months, and continues to outperform B/H up to 100 months skipped. Range of skipped months is plotted in red; for scale on this graph multiplied X10 (eg, range of 0.34 shows as 3.4).

Here are the compound returns, successively skipping the top 20 range months, with dates:

Date             ret       H-L/C     CPD
10/01/08    0.83    0.34    3.35
11/03/08    0.93    0.29    4.01
07/01/02    0.92    0.24    4.31
09/04/01    0.92    0.21    4.68
03/02/09    1.08    0.20    5.10
02/02/09    0.89    0.19    4.70
08/03/98    0.86    0.18    5.27
09/02/08    0.91    0.17    6.14
01/02/09    0.92    0.17    6.77
10/01/98    1.08    0.17    7.38
03/01/01    0.94    0.17    6.83
10/01/02    1.08    0.16    7.23
10/01/97    0.98    0.15    6.68
01/02/08    0.94    0.15    6.85
09/03/02    0.90    0.15    7.29
08/01/02    1.01    0.15    8.14
04/02/01    1.09    0.14    8.09
03/01/00    1.10    0.14    7.45
04/03/00    0.96    0.14    6.79

In fitting with decline = volatility, only 6/20 biggest range months were up.

Steve Ellison writes:

Using Dr. Zussman's results as a starting point, since I am not very good at determining the monthly range before the month begins, I checked what would happen if one skipped the month after a month with a high range. SPY total return including dividends from the end of 1993 to the end of 2009 was 3.14, for an average monthly return of 1.0060. If one held cash in all months following a month in the top 10% of ranges to date, and held SPY in all other months, total return would have been 1.98, with 140 months in the market and 52 months out. Average monthly return would have been 1.0049.

Since the end of August 2007, however, the average monthly return following a month with a range in the top 10% of historical values has been 0.9707, while the average monthly return of other months has been 0.9992. Thus, substantially all the losses of the last two years occurred in months following months of very high ranges.


 Month ending   H-L/C   H-L/C Position Return

    9/30/2008    0.18    0.13     in     0.9058
   10/31/2008    0.35    0.13    out   0.8349
   11/28/2008    0.30    0.14    out   0.9303
   12/31/2008    0.12    0.14    out   1.0098
    1/30/2009    0.18    0.14     in     0.9179
    2/27/2009    0.19    0.14    out    0.8925
    3/31/2009    0.21    0.14    out    1.0833
    4/30/2009    0.12    0.14    out    1.0993
    5/29/2009    0.08    0.13     in     1.0585
    6/30/2009    0.08    0.13     in     0.9993
    7/31/2009    0.13    0.14     in     1.0746
    8/31/2009    0.06    0.14     in     1.0370
    9/30/2009    0.08    0.15     in     1.0354
   10/30/2009    0.08    0.14     in    0.9809
   11/30/2009    0.08    0.15     in    1.0615
   12/31/2009    0.04    0.16     in    1.0191

Rocky Humbert asks:

Is this study and its results more than a reflection that (historically) a higher VIX → lower return?

Bill Rafter comments:

VIX is simply one form of volatility. It is logical to assume that some of the other forms may lead VIX, and that those may be causative and have predictive value. If they have predictive value for VIX and VIX is coincidental with declining equities, then you have something on which to build.

Dr. Rafter is President of Mathematical Investment Decisions, a quantitative research consultancy



 Checklists have been shown to reduce errors, improve accuracy, and increase profits in many fields. Most recently, a study in the New England Journal by Atul Gawande shows that use of a 19 point check by surgeons could reduce deaths by 30% and save billions. Such simple things as knowing all the names of your colleagues and being sure that an adequate supply of blood and respiratory equipment is available are useful.

When it was suggested to me that a checklist for my own trading might be useful, I originally had the same reaction as the doctors. "I've flown with the eagles, climbed the highest mountain, captured the mountain lion, been a member of all the exchanges, played 12,000 refereed matches, went to Harvard." But then I read the reaction of the Drs. "I'm from Harvard. I don't need such a list. But if I was operated on, I'd like such a list."

Here's a list I came up with for the forgotten man, the hundreds of thousands of traders in stocks, futures and options.

Before the Trade

1. Do you know the name and numbers of all your counterparts, especially if your equipment breaks down?

2. When does your market close, especially on holidays?

3. Do you have all the equipment you'll need to make the trade, including pens, computers, notebooks, order slips, in the normal course and in the event of a breakdown?

4. Did you write down your trade and check it to see for example that you didn't enter 400 contracts instead of the four that you meant to trade?

5. Why did you get into the trade?

6. Did you do a workout?

7. Was it statistically significant taking into account multiple comparisons and lookbacks?

8. Is there a prospective relation between statistical significance and predictivity?

9. Did you consider everchanging cycles?

10. And if you deigned to do a workout the way all turf handicappers do, did you take into account the within-day variability of prices, especially how this might affect your margin and being stopped out by your broker?

11. If a trade is based on information, was the information known to others before you?

12. Was there enough time for the market to adjust to that information?

13. What's your entry and exit point?

14. Are you going to use market, limit or stop orders?

15. If you don't get a fill how far will you go? And what is your quantity if you get filled on all your limits?

16. How much vig will you be paying if you use market or limit orders and how does that affect the workouts you did knowing that if you use stops you are likely to get the worst price of the day and all your workouts will be worthless because they didn't take into account the changing price action when you use stops, to say nothing of everchanging cycles?

17. Are you sure your equipment is as good and as fast as the big firms that take out 100 million a day with equipment that takes into account the difference between being 100 yards away from an exchange and the time it takes the speed of light to reach you?

18. Are you going to exit at a time or based on a goal? And did you take into account what Jack Aubrey always did which is to have an escape route in case all else fails?

19. What important announcements are scheduled? and how does this affect when and what kind of order to use? For example, a limit before employment is likely to be down a percent or two in a second. Or else you won't get filled and you'll be chasing it all day.

20. Did you test how to change your size and types of orders based on announcements?

21. What's the money management on this trade?

22. Are you in over your head?

23. Did you consider the changing margin requirements when the market gets testy or the rules committee with a position against you increases the margins against you?

24. How will a decline in price affect your margin and did you take into account what will happen when you get stopped out because of margin?

25. What will happen if you need some money for living expense or family matters during the trade? Or if you have to buy a house or lend money to a friend?

During and After the Trade

1. What's your game plan if it goes against you and threatens your survival?

2. Will you be able to get out? Did you take that into account in your workout?

3. More typically, what will you do if it goes way against you and then meanders back to give you a breakeven? Or if it immediately goes for you or aginst you?

4. Would you be willing to take a ½% profit if you get it in the first 10 minutes?

5. Did you test whether taking small opportunistic profits turns a winning system into a bad one?

6. How will unexpected cardinal events affect you like the "regrettably," or the pre-annnouncement of something you expected for the next open? And what happens if you're trading an individual stock and the market goes up or down a few percent during the day, or what's the impact of a related move in oil or interest rates?

7. Are you sure that you have to monitor the trade during the day? If you're using stops, then you probably don't have to but then your position size would have to be reduced so much that your chances of a reasonable profit taking account of vig are close to zero. If you're using 10% of your capital on a trade, they you'll have to monitor it for survival. But, but, but. Are you sure you won't be called away by phone calls, or the others?

8. Are you at equilibrium in your personal life? You're not as talented as Tiger Woods, and you probably won't be able to handle distressed calls for money or leaks on the home front. Are you sure that if you're losing you won't get hit on the head with a 7-iron, or berated until you have to give up at the worst possible time?

9. After the trade did you learn anything from the trade?

10. Are you organized sufficiently to have a record of all your trades for your accounting and learning?

11. Should you modify your existing systems based on it?

12. How does recency and frequency and value affect your future?

13. Did you fit your after activities to your mojo?

14. If you made a good profit, did you take some capital out of the fray for a rainy day?

15. Have you learned to say "fair" whenevever anyone asks you how you're doing and are you sure that you don't spend a fortune after a good trade, and dissipate your profits with non-economic activities?

16. Is there a better use for your time than monitoring the ticks or the market every minute of the day if you do, and if you don't, do those who do so and have much faster and better equipment than you have an insurmountable advantage against you?

Well, specs, that's what I come up with off the top. How would you improve or augment it?

Nick White comments:

If a position begins moving against beyond what was anticipated in the workout can one, through either contacts or acquired counting skills, figure out as fast as possible why the move against is occurring? With that information, can one then discern whether or not such a move needs to be heeded, faded, or left alone?

What legitimate information sources can one leverage to better understand a particular trade? A buddy who is a floor trader, a mentor, a high ranking friend of a friend in a central bank?

Are one's current skills commensurate with one's trading goals and ideas? Perhaps, more importantly, are one's trading skills of the same league and caliber as those one is competing gainst in a particular market? If not, surely best to wait and keep capital safe until one is sure of one's edge. This strongly accords with Chair's admonition to never get in over one's head, and to not spend inordinate amounts of time watching each tick when that time could be more profitably invested in training and developing new and existing skills — counting, programming, etc.

Make the strongest effort possible to find out whether the tail wags the dog in a particular instrument that you're trading. If it turns out that it does, does it happen with significance at a particular time, such as expiry? Or after a particular event? Can it be exploited after costs or is it better to fade it after the fact?

If one asks these questions and takes note of them in the essential lab notebook that ought to be at one's fingertips during all trading and researching activities, have those questions subsequently been answered by oneself? I have found this to be the most fertile soil for developing new insights and ideas. If you observe it, note it and question it — hypothesize about it and answer it.

Alston Mabry comments:

Here's one: Don't fool/confuse/tire yourself by making your execution more precise than your analysis. If your target is 2% within the next five trading days, then chasing two bps on the entry isn't going to make or break the trade.

Easan Katir adds:

  1. If you trade odd hours, get enough sleep and appropriate caffeine dosage.
  2. One well-known S&P pit trader advised two bowel movements in the morning before setting foot on the floor.
  3. Start the day with a centering routine — affirmations and goals. Remind oneself of one's larger purpose.
  4. List important times and dates on an online calendar with appropriate alerts: government numbers, earnings, ex-dividend dates.
  5. Rehearse successful behaviors and outcomes. And disaster recovery.
  6. Minimize other life stressors: long commutes, family arguments, risky vices, debt.
  7. Test backup equipment and systems regularly. I test my diesel backup power generator weekly.

Victor Niederhoffer responds:

I would add a small point. Trading foreign markets always seems much more difficult than domestic ones. For one, you never know what the important announcements are. For two, you get killed on the spread on your foreign exchange prices. For three, it seems to be 100 times more time-consuming to get into the queue than even the 1/100 of a second that's enough to give the domestic high frequency traders an insurmountable edge on you. For four, you have to go without sleep for at least one night, and then on the second night when you can't stay up the required 48 hours without sleep the move you expected and closed out is sure to happen.

Alan Millhone writes:

Checker master Tom Wiswell said to always keep the draw (escape) in sight.

Scott Brooks adds:

I have to disagree with Easan on the caffeine. I know there are many people that have to have their morning cup(s) of coffee to get their day going, and without it, don't feel/function right.

I do not want to go through life being so dependent on something that I have to have it to make myself feel right, let alone function right. I know this will be anathema to most (everyone?) that reads this, but I have to say it.

When I removed the caffeine addiction from my life (and don't fool yourself, it is an addiction…..if you have to have it everyday and then quit it, you will go through withdrawals……it is an addiction), my life changed so much for the better. I can think clearly. I can process information more quickly, and I can see solutions with greater clarity.

And your sleep will improve immensely. I suffered from severe insomnia for years. Kicking caffeine out of my life has lead to my being able to fall asleep, usually within minutes and being able to get up earlier and feel more refreshed!

You will find a level of "mental processing" that you never thought possible when you replace coffee and caffeine with purified water (I drink around a gallon a day) and a glass or two day of the organic juice of your choice.

But be prepared, you will likely have around two weeks of headaches when you go through caffeine withdrawals (you know, from the caffeine that you're not addicted too).

Nick White agrees:

Ditching caffeine is a good move. Best to save it for when may really need it on an overnight (or two) session. As mentioned in the past, Dr. Shinya is fervently anti-caffeine. Like many others, I found Dr. Shinya's principles promoted many positive health benefits for my wife and me.

On that note, i find that the Shinya nutritional principles — when moderated by the ideas behind the paleo diet — are a real winner; the increased "good" protein from the Paleo program does much to mitigate weight gain from increased carbohydrate consumption when kicking off on the Shinya program. There is a Paleo program for those involved in elite endurance sports.

George Parkanyi writes:

On any project or major activity, the first question I ask is how much time I have. That frames everything that is to come.

The very next thing is to build a contact list with names, phone numbers (backup phone numbers) and email addresses (and account numbers and passwords). This is also true in Scouts, where we need to have that information at our fingertips for safety reasons — in fact for every camp we have to draft an emergency plan — police, hospitals, parents, primary first aid responsibilities, etc. In a trading operation this is critical. If you have key support resources who have to act on your behalf at a moment's notice, then they need to be available, you need to able to access them, and if not, there must be a ready backup contact and plan B, even C. Chair's point about having a pen available can even be a critical detail — what if, in the heat of battle, you have to write down, say, a wire transfer number? In my case, reading glasses would be another.

Kim Zussman comments:

As a periodontal surgeon, I have found it much easier to stay composed and rational during difficult surgery than unruly trades. Chair's excellent list hints at why, in the form of the question "how do you know?".

Surgical complications follow rules of biology, and mistakes usually come when overlooking something or miscalculating the compounded risk of several factors. One can and should practice with a large margin of safety, which in almost every case is easy to determine. Biology is almost immutable, but markets morph wildly in real-time. It is very difficult to stick with a position if you are honest about your cluelessness and unwilling to go down with the ship. When the trade goes bad:

1. What was your hypothesis? How many others had your idea too? Or the opposite one? Are they right? What do they know that you don't? What is the source of your confidence that you can out-smart (or out-run) the million-mind-march?

2. Did you test properly beforehand? Did you miss something; a signal from another market, a subtle backdrop to your traded market? What is the chance this time is different, and should this doubt change your mental stop?

3. How heavily is your market being manipulated? By government? Big banks? Goldman's trading desk? Does persistent manipulation / insider trading change your hypothesis or render hypothesis formation useless?

4. How do you know whether the move is merely noise of your correct hypothesis, or part of a regime change you have not noticed?

5. Deep and abiding doubt is essential to science, but how do you incorporate doubt into market prediction when most of the movement is random?

6. Does the non-linear, mostly random reward system of trading corrupt your judgment (sleep, personal life, etc)? Do some people lead a happy, well-rested life with long periods of gut-wrenching loss alternating with gain, and are you one of them?

7. What unalterable beliefs are necessary to trade successfully? If you hold them, are you sure they are the right ones? Should some beliefs be discarded as a result of a changing world? Are there new ones you should know, and are you confident you will see them when they develop?

Steve Ellison adds:

Margin of safety is a key concept in many fields. While skiing, I put on the brakes a bit earlier than I absolutely must so that if I miss my footing or hit a patch of ice, I have another chance to avoid the hazard (e.g., other skier, tree, out of control speed). Graham and Dodd wrote about margin of safety in investing. Rather than buy a stock that is below book value, a value investor might wait for an opportunity to buy a stock below 80% of book value.

If I ski 10 times a year, even on the same mountain I am likely to encounter 10 different sets of conditions — temperature, wind, length of time since last snowfall, etc. One day last year, the fog was so thick I could not see the trees on either side of the trail. Some conditions dictate caution; others are more forgiving and allow me to be more aggressive. A warmup run is an excellent way to get a feel for conditions.

Nigel Davies proposes:

Checklists are very good whilst learning, but I believe that one should ultimately aspire to be able to do without them because everything has been internalised. In my own field I tend to believe that conscious thought of any kind can be a distraction, which is why I don't like the old Blumenfeld Rule (a checklist used before playing a move).

Ken Drees writes:

I just did an experiment with my son with one of his Christmas presents, an electronic learning kit. We have learned so far the basics of how electricity works. Resistors (series and parallel), Capacitors, etc. Each lesson has a page explaining the experiment, a schematic, a drawing of the circuit in relationship to how water moves through pipes — the water analogy for electrical flow resonates with my son. And each experiment has an electronic "wiring checklist'.

The checklist comes in handy since its easy to forget a connection, misrun a wire, or leave an extra connection from a previous experiment in the lab circuit.

I associate checklists with "must have"–high accuracy functions. Like programming, wiring, piloting, fixing a car, cooking –its all routine, but items can be omitted, done wrong and can be forgotten due to human error. The checklist is a tool, an aide that removes ego from the scenario. Used in trading it helps set the trade up, helps initiate or close the trade, and removes emotion from what needs to be done automatically. A checklist in the grey area of a trade like the middle game in chess, or an operation where the patient is being worked on really doesn't help much–you need to make gut-inferred decisions, unless your trade is so automated that you remove yourself from the trade entirely and rely upon a program.

Using trading checklists help bring focus and energy towards the trading exercise. Using checklists of some sort during the "live–life of its own phase of the trade" must be explored further. Maybe there are ways to check off your decisions, check your options, use your skills with the pressure of time taken into consideration–during this live phase.

But when your hand is on a hot stove, trade going wrong, does one need to look at a post-it-note do determine if one should remove hand from stovetop?

FYI: a 9 year old boy is understanding electricity –public school may teach a child these ideas in 7th grade. I am amazed at what can be taught to children that most think is way over their heads.

Alan Millhone adds his two cents:

I will add my two cents. Some years ago I bought an International dump truck and it has air brakes. My late father and myself drove it for use in our construction projects. Because it has air brakes you need your class B driver's license to be legal. We drove it several years without the proper license. Finally my father got the book and studied and took the written part for class B. After he took that part he gave me the book and I studied and took the test and passed. Quite a book to study.

Now the second part was an over the road test with the instructor in the truck with each of us. He said he had never given a back to back test to a father and son. Dad and myself had to back the truck then drive to the right close as we could to an orange cone– without touching the cone. Then each of us had to do a 50 point check list of our truck that we earned (I still remember the list ) and still check my truck before taking it onto the road. So checklists are valuable in many applications ranging from dump trucks to the Market.

On a side note, dad and I rode to the test center in our dump truck without the proper license. The instructor said he was not going to ask how we got there.

David Brooks comments:

All very good ideas. I wish there were some good way to test Atul's theory historically. Why? Because I am convinced that poorer outcomes in the last decade come from fragmentation of the system - shift work, decreased work-hours by house staff, the high volume being forced through the system and de-professionalation of nurses.

Alas, we can't measure the past, but I am convinced that the hospital I started in (The Peter Bent Brigham of the early to mid 70's) was a safer, more humane place with better (allowing for technological changes) outcomes.

All the same, the reason we have embraced checklists a la airlines has to do more with the aeronautical outcomes than medical outcomes. The amount of information that a pilot has to process is order of magnitudes more than what a surgeon has to process. Furthermore, when a pilot fails completely 300 lives are lost, and when a surgeon completely fails, 1 life is lost. The former is far more dramatic, of course.

It's nice to know the anesthesiologist's and scrub tech's name, but it's hard to believe that that is going to affect the outcome of a significant number of operations.

That said, I have the greatest admiration for Atul. He sits a short distance from me, and I am proud to have had even a small role in training him. He is a remarkable young man and we will being hearing from him for many years to come.

Newton Linchen comments:

Once I took an airplane pilot course, and I was amazed how everything was done with checklists. Actually, the first time I heard the word 'checklist' was there. (Even here in Brazil they keep all the terminology in English, for standard procedure). I realized how checklists can keep you out of trouble and save your life. In markets, perhaps a great deal of losses could be avoided if I followed my own trading checklists.

Russ Sears writes:

Checklists can be very useful in an emergency. I have found that a simple checklist was valuable in a race. When the going gets tough it is easy to panic. The list It went something like this 1. relax 2. pump the arms smoothly 3. breath in normal rhythm (One hard puff out, relax in). It is easy to panic on the edge of your limits. These 3 things are the first signs that you are starting to panicking, subconsciously without knowing it.

Runner, use checklist often as part of their diary. Each day you check your weight, evaluate your nights sleep and your overall mental state. You check your diet and fluid intake .

Before a race you follow your pre-race checklist from what to pack, to when and what to eat, and when and how you should be warming-up and stretching.

Then after the race you check how well you followed the plan, where the plan worked and where if failed.

Finally at the end of the year you check the philosophical underpinnings of your training. Your goals, why you are doing it all, what are the cost that you are willing pay and what is the best path to get there.

So checklist have there place, but you need to 1. put them in the right point of time in the process, 2. not let them lose their relevance and meaning . 3. keep them simple at critical points, simple enough that they are potent.

Easan Katir adds:

Thinking about checklists, and watching the Haiti disaster coverage, made me think about a checklist for emergencies. Then thought about a list of the various types of emergencies one might encounter, big and small. What came to mind:






home invasion


mistaken id

false accusation






missing person


currency replacement/devaluation

market crash

partner deceit


power outage




i suppose each needs its own checklist, though some may overlap. What did I miss?

Scott Brooks adds:

The best checklist you can have is to either be a great leader or be around a great leader.

It's been my experience that average and ordinary people need checklists (which they rarely if ever have or use…which is one of the reasons why they are average and ordinary), but smart people with leadership skills don't need a checklist when it comes time for a disaster.

Most disasters/problems rarely follow a fixed pattern. It takes a leader who is capable of thinking on his/her feet who can stand up, take charge and direct people as to what they need to do.

And this doesn't have to be right all the time, he just needs to make decisions and get people moving and be willing to take responsibility and shrug of criticism of the naysayers…..while listening to them to extract the wisdom that might be contained in their "naying" (I think I have just made up a word).

A leader has to have insight and the ability to see several moves ahead. A leader has to be able to see correlations and connections between seemingly disparate pieces of information.

A leader has to then take this data and formulate a solution and then direct people to execute the solution….and if possible, get people to see the vision of the completed project so that they can begin to work towards that goal with minimal supervision.

But most importantly, a leader has to be willing to make a decision when it comes time to make a decision even when the solution is not apparent. A course of action that fails is better than inaction that is guaranteed to fail.



 In discussions of humor, Tim Slagle in Liberty Magazine has what I believe is an important insight. He says that everyone knows that it's important for the comedian to be liked by the audience. Since he says all comedians must have one of seven deadly sins, this requires work. However, even more important is for it to be clear that "the comedian likes the audience." "When I found that out, that changed everything," he says. He goes on to say "it is important to remember in marketing that even though you might be a niche product, you still want that niche to be as large as possible." A similar idea is made in the Ursut le May introduction to Rabelais. Something like: "you must roll around with your audience, make them feel that you are one of them, that you share their likes and weaknesses, and can together look at the human predicament as wonderful in its folly and greatness." I believe that this might be a partial key to successful companies and stocks. What do you think?

Steve Ellison replies:

All businesses try hard to be liked, even those that seemingly do not need to be liked, such as the regulated monopoly utility company I once worked for that advertises incessantly on television.

Alvin and Heidi Toffler in Revolutionary Wealth compared the pace of change in business to a car speeding at 100 miles per hour. They found change occurring almost as fast in "civil society… a burgeoning hothouse sector made up of thousands of churning and changing nongovernmental grassroots organizations". By contrast, the Tofflers found government so slow to change (they rated it three miles per hour) that they predict a Constitutional crisis at some point in the U.S. as events outrun government's ability to respond.

Nongovernmental organizations exert much influence over businesses because the nongovernmental organizations can persuade some consumers that particular companies are good or bad. For example, there were boycotts of Nike products in the 1990s when it was found that some of Nike's subcontractors in China had sweatshop-type conditions at their factories. To prevent a similar public relations catastrophe, the technology industry formed a set of certification standards for suppliers, complete with audits to ensure compliance.

Similarly, many companies are trying to improve their impact on the environment because environmentalism is an important value for many consumers, who would rather spend their money at a company that shares their values. To be effective, businesses' environmental initiatives must be real because sophisticated nongovernmental organizations request audits of, for example, reduced energy usage or carbon emissions.

Jim Sogi adds:

Another example of a company reacting to public pressure is described in The Botany of Desire where McDonald's stopped using GMO potatoes for their fries after large public outcry over their nondisclosure of the use of GMO products. Government regulation did not require disclosure of the percentage they used.

Alston Mabry writes:

I enjoy the humor that Patrick O'Brian injects into his narrative. The sly humor of Maturin, the buffoonish and navy humor of Aubrey.

Just listening again this afternoon to the sequence in HMS Surprise where they approach Bombay and then Maturin immerses himself in the city. If I were to pick a passage to demonstrate what a good writer O'Brian is at his best - his use of description, pacing, character, historical interest — I would likely pick the Bombay passage. (And Tull reads it so well.)

Thomas Miller writes:

The Postal Service is an exception. They don't care what the public thinks, hence the long lines in many offices. If the government is driving three mph, the PO is doing at least 50 mph — in reverse. The death spiral for the PO is moving forward and picking up speed. Survival of the fittest will prevail as always.

George Parkanyi adds:

Laughter is a surprise response, and we all like to be (non-threateningly) surprised — case in point being the hundreds of billions of dollars poured into the Christmas holidays just now. In humour, the surprise comes from the connection of two or more unrelated ideas and/or the linking of two or more unrelated contexts. Timing is used to enhance the surprise element. For the humour to work however, it is very important for the audience to recognize and understand the ideas and the contexts, which is why good comedy with broad appeal comes from day-to-day experiences such as being in the check-out-line at the grocery store. I've seen comedians do very funny routines just around that alone.

Since we like to be surprised, and to laugh, a comedian that can do that early on will be instantly liked. He is giving us an enjoyable experience. Comedians that are too abrasive (e.g. relying too heavily on swearing or making fun of an audience member for example) can quickly lose an audience by making them uncomfortable. I've seen examples of all of this in our past two evenings at Comix on 14th Ave in New York the past two nights. (What can I say, I like comedy - and so do the kids.)

The biggest take-aways from comedy that I can think of for trading are definitely the connection of unrelated ideas (and markets), but also the agility and quick-thinking required to deal with adversity. A comedian that has been interrupted and/or loses his train of thought must factor that in as part of the game, and deal with as quickly when it comes up. Timing is useful too.

Another take-away perhaps is not to take the ups and downs of trading too seriously. If you did nothing but throw darts at a quote screen, your odds would be 50-50 less transactions costs (and the cost of replacement monitors), so the markets are not necessarily an evil conspiracy or epic fight to the death. You think more clearly when not overly stressed.



 I was very impressed the week before last at how Barrick Gold picked the top of the recent gold rally. With great fanfare on Dec 1 they announced they had completely eliminated their hedge book ahead of schedule and were now fully exposed to the upside potential of gold — and, took a $6B charge to do so. That's some stop-loss! Three days later gold tanked spectacularly and has been going down ever since. Awkward.

It reminds me of the time back in 1996 when oil was $10 and the Economist did a huge spread on how the oil market was now permanently confined to structurally low prices for all sorts of wonderful fundamental reasons. That was the very week oil started its huge bull market that ended 12 years later in a price 15 times higher. When I heard the Barrick story on the news, this immediately leapt to mind, and I remember thinking "You know, I bet this is where gold coughs up a lung."

But maybe Barrick was its own worst enemy. After all, they were admitting that they had eliminated all commitments for future delivery, and were now in a position to dump their full production on the open market at any time. Well thought out. My question is, how'd they ever get so big?

Steve Ellison writes:

The Commitment of Traders report has recently been showing commercial short positions at multi-year highs. Apparently while Barrick was trumpeting the end of its hedging program, other producers were quietly increasing their hedges. Maybe it was Barrick's short covering that drove gold above 1200.



 Just got in from a basketball game at Ohio University vs. Lamar. Noticed the basketball coaches wear suit and tie. The baseball managers wear the team uniform. The majority of football coaches dress casually (except Tom Landry). I wondered why the difference in dress among these three sports?

Victor Niederhoffer adds:

And what is significance of the terrible millhonian fact that 99% of the people in any mid-level restaurant these days are wearing black? Is it the consequence of a lagging response to a recession — a harbinger of a deep pessimism, of a boat about to capsize, a conventicle of worship for the higher blackness in our midst, a signal that stocks are still not invested with much of a risk premium, or whatever cultural straws in the wind are you seeing of this subdued nature? And what does it mean?

Dan Grossman replies:

1. On the coaches, it's much colder outside on the football field and easier to dress warmly in casual clothes. A suit and overcoat would look ridiculous.

2. In the restaurants, dressing all in black signals the maitre'd and staff you are someone not to be trifled with. You are more likely to get a table without a reservation, or a faster/better table with one. Black says you are from town, perhaps even an artist, writer or in the fashion industry, not from the sticks or the burbs.

Dean Davis writes:

Supposedly black is a slimming color. Perhaps those that frequent comfort food restaurants like those found at the mid-price level have something to hide. I have heard that the quality of diets slide in poor economic times.

David Wren-Hardin writes:

Baseball has a longer, and more recent, history of player-managers. Pete Rose was, I think, the last one. Football seems to reflect the average dress of the time. Back in the fifties, all men wore suits. It may look formal to us now, but the suits were probably pretty standard, not the same as Pat Riley's Armani suits, for example.

As our culture has become more casual, so has the football coaches' dress, especially since they are outside. I think they may even be prohibitied from wearing suits. I recall a coach last year (Jack Del Rio?) who wanted to wear a suit to honor his father, and either had to get a waiver, or paid fines.

You can see similar dress cultures in trading. Traders associated with banks tend to dress more formally than traders in hedge funds. In my current firm, wearing jeans and t-shirts is an expression of pride. If I wear khakis, everyone wonders where I'm going after work. At my last firm, a European owned group, we never wore jeans, and if the bosses from Amsterdam were in town, we wore suits.

Essentially, it seems to have settled out where if you deal with customers, you wear a suit, and if you are a trader, you dress down. The more powerful/profitable you are (or think you are) the more you dress down.

To make it more personal, does how we dress affect how we trade? If I'm more formal, am I less prone to risk-taking? If I'm dressing down, am I more relaxed and making better decisions?

Steve Ellison shares:

That has been the case at MIT for years. From Fred Hapgood's 1993 book Up the Infinite Corridor: MIT and the Technical Imagination:

In his time Ernesto Blanco has designed robot arms, a lens for cataract operations, steerable catheters (that can navigate inside arterial branches), a microstapler for eye surgery, a stair-climbing wheelchair, a forklift truck, film-processing equipment, high-voltage transmission line connectors, a helium pump, and a raft of devices for the textile industry — from pile stitchers to faulty needle sensors. So he has earned the right, which he exercises, to dress his barrel chest and ramrod carriage in rich blue blazers and snowy shirt linens, silk ties, Italian leathers, and flawlessly crease flannels. In this he faces against the winds of fashion at MIT, where an Armani suit suggests not success or achievement but a serious problem with self-esteem, a lack of confidence that the product, the work, will be adequate to win the desired rewards. The psychology expresses itself as a fashion paradox: at MIT you dress up, you dress for success, by dressing down. So in this sense Blanco is like a banker who wears jeans to work; he is good enough to wear what he likes, and what he likes is Fifth Avenue.

Phil McDonnell comments:

The black-is-slimming meme has been around for several years. The older Seattle Grunge look may have spawned an idea that casual is good and, perhaps more importantly, colors that blend in are good. Some time ago I ate at one of the nice Google restaurants and did a quick Galtonesque count of the number wearing black. It was nearly 100%. I was the exception. Many of these young people are from India, China, Russia and elsewhere so it is not just California. In some circles they say that gray is the 'new black'.

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



VNI often find that without the privilege of talking to the Secretary of the Interior every day, I have to look for other fields to attempt to stay even with the fray. I always find it easier to learn about how not to lose than how to win, so I like to study how the Knicks and Jets, two of New York's worst teams, manage to lose so often. It's easy with the Knicks. They have no foundation to their game. Their men are overextended, their shots are random from 100 feet out, there's no percentage. Sort of like the man who has leverage of 10 to 1 near the close, and is waiting for the other side to stop him out. That's easy. Near the end of a season, a game, a fray, the other team, which has a foundation, can overrun them at will. But for the Jets, one has to delve deeper, as sometimes they win. It was with pleasure therefore that in looking at the results of their Nov 15 loss, I learned a few things about how to lose. The Jets were up 22-21 with a minute to go. The Jags on the Jets 14 yard line. The Jets coach Ryan tells the Jets to let them score. But Jones-Drew refused to score stopping at the 1 yard line to set up a field goal with 2 seconds left. they made the field goal and won 24-22. Okay, both coaches used second and third level deception. First the Jets trying to let the Jaguars score, and then the Jaguars refusing to score the touchdown. There has to be a market situation. Let's take all the times very near the end of the day when the market is down just a hair compared to the times the market is up just a hair. Which is better? As you guessed, the coaches had it right. With the market down a hair, I find a 0.05% rise in the last x minutes before the close with a z of 1. With the market up a hair, I find a very different situation with a z of -2… The situation calls for further study.

 Steve Ellison comments:

Turnovers are a good way to lose. The San Jose Sharks turned the puck over in the defensive zone last night in overtime, and within two seconds the Chicago Black Hawks put the puck in the goal to end the game. Roy Longstreet's 1967 book, Viewpoints of a Commodity Trader, which I have quoted here before, has a chapter on how many games the Bart Starr-era Green Bay Packers won simply by making fewer mistakes than their opponents. There are numerous unforced errors a trader may make that are analogous to turnovers. For example, deviating from my trading strategy and entering impulsive trades have cost me money nearly 100% of the time.

 Ryan Carlson responds:

I'm fortunate to have Blackhawks season tickets and spend many nights deriving speculative analogies from watching such games. Last night in particular was fruitful because the Sharks are the best team in hockey so the margin for error was particularly slim for the Hawks although they were able to win.

Some other insights from last nights game was the Sharks scored their second and third goals 45 seconds apart to pull ahead 3-1. Quite often, it's easy to get down after a bad trade and be unfocused like the Hawks were after each of the three unanswered goals and that lead to getting them further in the hole.

Another potential Sharks goal was later considered "inconclusive" by video review and that kept the Hawks from getting buried further with a three goal deficit. Using the break they were given, the Hawks came out flying for the rest of the game and finished hard for the win. Sometimes, the market lets a guy out and when that happens, it has to be used to it's full advantage.

The Blackhawks have a great team to watch and one of the best to observe different combinations of risk and reward in their entire group of Defenseman. Some of the defensive corps is paid to strictly move the puck up ice to the forwards with high risk/reward but they are paired w/more steady and defensive players who cover for the risk. No matter which defenseman hangs back, they always ensure that they never leave their goalie exposed no matter how enticing an offensive opportunity is.This year my best insights have come from watching 21 year old Patrick Kane who is only 5'10" and 178 lbs. Granted he has amazing hands to stick handle and shoot with but that along with his instincts were all honed to survive as a small player. Since he doesn't have the size to compete for the puck, Kane has developed an amazing sense of where to be or not to be. Similarly, I've found that a good trading niche for me is to focus on where not to be and work on staying flexible to handle quick opportunities as they arise.Recently I read a book about another smaller player, 5'6" 180lbs Theo Fleury where he noted that the reason why 6'5" 244 lbs Eric Lindros suffered so many concussions was that he could skate w/his head down and get away with it in junior hockey as others would just bounce off him. Once Lindros got to the NHL and played against guys his size or bigger, he was unable to break that habit and those concussions ended his career and his brother's as well who played a similar style. Fleury noted in Playing With Fire that if he himself played that way, he would've gotten killed.Last nights Sharks/Blackhawks game was fittingly Jeremy Roenick night so we were treating to lots of video showcasing the dedication, passion and perseverance that it takes to become a impact player like Roenick. Looking back on his sacrifice and dedication, it was clear in Jeremy's eyes that it was all worth it when he met the crowd.

Somewhat relatedly, an interesting article linked below came out on the Blackhawks and the superstitions of each player. I personally rub the cornucopia of a statue outside the office and won't touch anything on my way in each morning with that hand, not too bizarre I don't think.

Steve Ellison responds:

The Sharks' TV announcers commented that they had not seen any team persist in attacking Sharks' defenseman Douglas Murray the way the Black Hawks did. Douglas Murray is a very tough player who, when he sees an opponent about to check him, likes to brace himself and move his upper body explosively in the direction of the opposing player, sometimes leaving the would-be checker sprawled on the ice.

On Mon, Nov 16, 2009 at 1:41 PM, Ryan Carlson <racarlson@yahoo.com> wrote: I'm fortunate to have Blackhawks season tickets and spend many nights deriving speculative analogies from watching such games. Last night in particular was fruitful because the Sharks are the best team in hockey so the margin for error was particularly slim for the Hawks although they were able to win.



In yesterday's S&P 500 futures pit session, every 30-minute bar had a higher high than the previous bar. I don't recall having seen this occurrence previously.



In Vegas over the years I used to play a little roulette. Odd or even or red or black and you have a 50/50 chance of winning on your bet. Reminds a novice like me of the market yesterday and today. Yesterday I would have been a hero and today a heel if playing. No thanks!

Steve Ellison notes:

Because the 0 and 00 are neither red nor black, your chance of winning on either red or black is only 18/38=47%, in the U.S. at least. That's a 5%-plus vig, which is why I never play roulette. In craps, a pass line bet with double odds has only about 0.6% vig, but beware of the suckers' bets such as field and hardways that have more than 10% vig.

Allan Millhone replies:

Still looks like roulette stands a better chance with an average guy like me. Odds are in favor of the house. But with insider trading deals to me it appears the market is heavily weighted towards the Big Boys with the inside track.



An article in Technology Review highlights research into the tissues connecting neurons in the brain and their effect on intelligence. If the market is smarter than any of its participants, what can a trader observe about its information paths?

"But what if the key to intelligence is neither an individual area of the brain nor its total volume but the network over which information is transmitted and integrated? In 2007, [Rex Jung, a neuroscientist at the Mind Research Network in Albuquerque, NM,] and Richard Haier, now professor emeritus of psychology at the University of California, Irvine, developed the first comprehensive theory drawn from neuroimaging of how the brain gives rise to intelligence. Gathering information from 37 published papers that had used imaging to study intelligence, they mapped out the brain areas that had been pinpointed in at least a third of the studies to sketch a network of regions spanning the frontal and parietal lobes.

The network consists of about 10 nodes, or clusters of cells, that had been linked to attention, working memory, and facial recognition, among other cognitive functions. Applying existing theories of how information flows in the brain, Jung and Haier hypothesized that neural signals travel from nodes near the back of the brain, where sensory data is collected and synthesized, to those in the frontal lobes, which are responsible for decision making and planning. The connections between these nodes, they argued, are just as critical as the nodes themselves. 'If the nodes of a network aren't communicating effectively and efficiently, then the network won't function efficiently,' says Jung."

"Some of the newest theories of intelligence suggest that the crucial factor may be how efficiently information moves around the brain, rather than just how quickly. In a recent study led by Martijn P. van den Heuvel, a neuroscientist at University Medical Center Utrecht, in the Netherlands, researchers defined efficiency as the number of links it takes to get from one node to another–both in specific brain areas and all over the brain. Just as a direct flight from Paris to Chicago would be considered more efficient than one with a layover in London, a direct link between two parts of the brain would be more efficient than an indirect route."



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

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

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

Steve Ellison is more pessimistic:

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



14A friend who has moved multiple times in recent years was finally opening some long-packed boxes. His daughter found a little book titled Fourteen Methods of Operating in the Stock Market, published in 1918 by The Magazine of Wall Street. My friend thought I might be interested in the book.

The first chapter was "A Specialist in Panics," which the Chair brought to our attention two years ago. A quote by the panic specialist might be applicable now: "Among other things I had learned that insiders keep things looking very blue over a long period while they are quietly buying stocks."

There was a chapter by Richard D. Wyckoff on "The Breadth of the Market." The meaning of breadth was a bit different then; it meant how many stocks traded on a given day. Wyckoff posited that a price rise accompanied by a rising breadth was bullish as it meant money was flowing into a greater number of stocks.

Other chapters presented a variety of techniques that are clearly recognizable as early versions of strategies used today. In "Principles of Price Movements," Thomas F. Woodlock presented a pre-Elliott theory of waves: changes in the economy and interest rates drive the major bull and bear markets, but there are periodic "eddies" that take prices in the opposite direction of the "main current." In "Methods of Successful Traders," a Mr. G wrote, "The only thing that will carry [a trader] through is to know the trend at all times, and follow it."

An architect traded successfully using principles of architecture. "The stock being traded in must be treated as a 'force' applied on the axis or average for a 'bear' day and the force applied from under for a 'bull' day. The movement of previous three days, previous week and month is also necessary to determine distance covered in points, together with weight (volume) applied… I consider that the market can be calculated exactly as a person would calculate a wood joist. The joist will safely hold just so much, and its factor of safety when encroached upon is on the side towards danger, and when exceeded the joist will break; so will a stock in the stock market."

All in all, a fascinating book.



S EllisonA recent Wall Street Journal article discusses findings that children born in the winter do worse in school and earn less than children born at other times of year. The first reaction was to search for environmental factors. Did lack of sunlight in infancy cause lasting damage? Did being in the same grade with younger students limit achievement?

Further research showed that heredity might play a role. Births to highly educated women peaked in May each year, while births to less educated women peaked in January. The likelihood that a woman giving birth was married was 2 percentage points less in January than May.

Nigel Davies reacts:

I learned recently that 75% of a child's IQ is from the mother, so it may be purely an IQ thing. As May minus 9 months = September maybe smart women tend to schedule their baby production after their summer holiday!?

David Wren-Hardin queries:

I read the same article, and saw nothing in there about heredity playing a role. It did say, as you say Steve, that the winter-born babies tend to be born to less-educated women. Education is, obviously, something someone does, not something someone inherits.

And to Nigel: Who told you 75%?!

Nigel Davies replies:

A reliable source.

Alex Castaldo adds:

I think I could guess the source's gender.

Gordon Haave is not amused:

Obviously none of you have read The Bell Curve by Richard Herrnstein and Charles Murray.

David Wren-Hardin comments:

David W-HI've read parts of the book. There are some interesting conclusions, but they fall far too far on the intelligence is pre-determined and we can do nothing about it spectrum. Are we blank slates? No, but our intelligence is highly tuned by our environment. That's actually great news — we don't have to simply accept that some people are "stupid", shrug our shoulders and move on. Everyone can become smarter and realize more of his potential.

A more recent book that analyzes some new studies and takes a fresh look at old ones is Intelligence and How to Get It by Richard Nisbett, a Distinguished University Professor at Michigan.

More and more study is showing that IQ is much more malleable to environment than previously thought. For example, twin-studies had been used to state that IQ must be inherited since twins raised in different environments have similar IQs. However, once you control for the selection bias in adoptive parents — people who adopt tend to be more highly educated and have more resources — a great deal of the "heredity" effect goes away. It's still there, just not as strong as previously assumed.

There have also been studies showing how the "culturally unbiased" tests, the ones that are supposed to tease out untaught learning from innate intelligence, are actually highly affected by previous exposure to various spatial concepts.

Yishen Kuik summarizes:

YishenFrom what I remember about studies of intelligence, the key findings were:

1) The correlation of IQ scores by adopted siblings & their natural siblings was 0.0 (ie no different from strangers), whereas those between natural siblings was about 0.6.

2) The correlation of IQ scores of monozygotic twins separated at birth was 0.9 vs dyzygotic twins raised together at 0.6.

Those were the strong conclusions used to argue that environment had far less impact on how well someone scored on an IQ test, compared with their natural endowment. (Note that this does not imply they inherited their intelligence from intelligent parents). How does Prof. Nisbett's findings about cultural biases or the fact that adopters tend to be well educated / wealthier alter these findings?

Stefan Jovanovich writes:

This may not answer Yishen's question directly, but what follows is the sum of what my father told me about IQ tests. Dad had, I think, some credibility on the subject; he made his fortune from running the only for-profit publisher who competed successfully with ETS. He was also smart enough never, ever to voice these opinions to anyone until the year and a half before his death when he decided that he would indulge himself in the luxury of telling himself and anyone who would listen the absolute, unvarnished truth about what he knew from half a century in the book and test trades.

1) IQ tests are unpopular precisely because they are brutally honest and cannot easily be rigged. No one likes their results. The students hate them because they show us all how rare exceptional intelligence really is. The teachers hate the IQ tests because they find that the brightest students are most often not the diligently obedient pupils who copy down everything the teachers say and repeat it back to them on the exams. Instead, the tests suggest that really bright people are unruly and more interested in their own thoughts than other people's. The parents hate them because the test results shout that money alone cannot buy brains. The school boards and administrators hate them because the test results indicate that most of the time spent in class is utterly wasted.

2) There are only three reliable correlations between inputs and measurable academic achievement — the IQ of the child, the IQ of the parents and the IQ of the teachers. Every other metric — class size, spending per pupil, curriculum models (new, new vs. old, old math) have not statistical importance. Dad would hardly have been surprised by Dr. Nisbett's findings since the IQ of adoptive parents is significantly higher than the general population. He would, I think, have disagreed strongly with the assertion that "a great deal of the 'heredity' effect goes away." By far the most important single cause of success was the IQ of the child.

David Wren-Hardin replies:

I agree with most of what you said earlier; IQ is measurable, and people don't like that. What I want to add is that it is modifiable. But past certain points, it may not make a difference on life outcomes. Other traits, such as persistence and the ability to delay gratification, may have greater effects.

I'm not going to speak for Dr. Nesbitt, but on this last point I'd say that the child's IQ has already been set by the environment he came from. My argument doesn't necessarily help the education debate, it may, in fact, it may make it bleaker: Compared to the effect of a child's surroundings in his early years, public education comes in with too little, too late. "Low IQs" are still the parents' fault, but not necessarily because of genetics.

But the take home message to me, and what I tell my kids, is that they can always be better at something than they are now, if they apply themselves at the limits of their ability.

Stefan Jovanovich sums up:

Dad would certainly have agreed with David. He thought that modern teachers' refusal to "teach to the test" was an indication of how corrupt education had become. IQ can be "taught" in the same way that people learn alphabets and sums; be repeated trial and error — taking tests again and again. It appalled him that school was made over into something that was "fun" and "self-discovery." Learning was work, and that is why the students should be paid for their results, even as early as kindergarten. That would, Dad thought, teach persistence and the ability to delay gratification — which, as David notes, are "lessons" that are vital to the growth of human happiness and accomplishment.



Everything you need to know about markets you can learn at rock concerts. From a combination of circumstances, I had the good fortune to attend five rock concerts in the last few weeks with my young son Aubrey, and I have learned so much about markets from each of them that I could write a book about the lessons. If only I had learned these lessons before! When you go to the concerts, the rules are the key. I've found scalpers outside of each, and the prices are always considerably less and the time saved considerably more valuable than the tickets themselves. At first I made the mistake of going to these concerts at the stated time, but I found that the main act always goes on at midnight, and all the preliminary acts, like the undercards on a boxing match or the picadors at a bull fight, are meant only to whet the appetite. Similarly, the market activities before the open are all a facade to get you in, and the main events happen well into the show, usually at the encore, when the audience thinks the game is over, but then the stars play their main song.

YahuI knew that I was going to learn much from them when I attended a Matisyahu concert with Aubrey which I thought was going to be an Asian show. I couldn't understand the language but was surprised to see half the audience in yarmulkes. I asked one of the tens of thousands in attendance, and he told me the language was Yiddish and Yahu was very sagacious and his Yiddish rap contained much sentience. He then opened his arms like King Canute by the sea and asked the audience if it was time to jump in. A frenzy occurred and 25 security guards rushed to the middle and he jumped in, much to Aubrey's delight. "He just jumped right into everybody and they're carrying him on their shoulders." The frenzy is exactly like the POMO that is so current these days with the preannounced $1 trillion that they're going to buy coming every few days, with $7 billion here and $10 billion there, with the cash that's coming in being available for 20 to 1 leverage buy equities. The effect is the same, with much good music coming afterwards with a z of 1.5 or so, but many people getting hurt as they try to stampede in to pass the star down the line. Of course the scholarly Yahu is a stand-in, art imitating markets, of the scholarly Israeli market that exactly foretells the opening on Monday with its Sunday moves and is generally accurate as to what is going to happen in New York from 11 a.m. to the close with its early Israeli close, as presumably they read our mail and don't want to be caught in a state of detallises.

We went next to a TV On the Radio concert which was almost as frenzied as the Yahu one and Aubrey was the only one who liked the music because it was exactly like the amplified electronic beeps that his switch-on electronics for 2-year-olds plays, with no harmony or timbre to it, but strictly rhythm and tones. It's apparently just as much the rage as the Yiddish rapper and of course its the analogue of the electronic algorithms' robotic activity that currently dominates futures and individual stock trading. The best sounds came during the 1 1/2 hours it took each group to set up all their equipment, and I guess the group with the best amplifiers and lighting is the most favored the same way the robots near the exchange and the "banks" that have their debt guaranteed by the Fed so they have all the capital in the world to shake out the mere public who don't have the electronics or funds to compete with them.

I next attended a Don McLean concert and heard his song American Pie, which reminded me so much of all the trendfollowing books that I've read which did so much good 50 years ago and have been voluminous though completely out of date since. Apparently McLean was once a great, and had a hit song, the same way the large man once made a fortune by buying beans on the way up and shorting them on the way down.

Regrettably I did not get to see the pre-concerts of Michael Jackson although my daughter Katie once attended his father's 50th birthday party and got a private showing of the zoo when I was a star. Jackson was once a great, then lost everything and had as his best friend a chimpanzee, and liked to dress up funny and play with youngsters. He was in eclipse a non-entity, but then when he died, he became the most loved and revered of them all. My goodness, I heard this exact story before. Morse is back. He first was famous for bulling up Trolley and Canal in the 1870s but then lost everything in the panic of '77 when Livingston got his start. But then he was a ghost. Still he was spotted while a ghost walking down Wall Street and Radio immediately went up 15% thinking that Morse was back. Well, you get the picture.

I also went to Frankie Valli but he only performed after midnight the same way you have to wait for the close these days to have all the big boys try to switch you out. I'll report on the other rock things I went to, and quantify a few of these things after I get readers' insights.

Steve Ellison adds:

CornI saw REO Speedwagon and Styx last month. REO played first, and apparently many of the holders of the most expensive reserved seats right in front of the stage were Niederhoffering. The section was nearly empty. After a few songs, Kevin Cronin said that he hated singing to empty seats and encouraged others to move forward. However, he had not consulted security. Within minutes, hundreds of people were moving forward, but ushers blocked the aisles, only allowing those who had tickets for the front rows to enter. An analogous event occurred two weeks ago when corn broke above its 10-day high at 340 and moved up to 376 within two days. Alas, the hopes inspired by the breakout were dashed as the price collapsed to below 330 by the end of last week.

Allston Mabry asks:

Ever consider taking young Aubrey to one of Levon Helm's Midnight Ramble shows up in Woodstock? You'd both get a kick out of the rustic intimacy of the barn ambiance, and the music is sublime. At turns, hues of rock, jazz, country, and classical, all in one evening. It's a unique venue and vibe, and the lineup of artists that regularly perform there is a joy to behold. Great spot, cool town.

GM Nigel Davies reflects on performers' reputation after death:

The taboo about not speaking ill of the dead works very well for controversial characters, except of course that they're no longer around to enjoy it. And when there are direct beneficiaries from the sales of the controversial one's products some new dynamics come into play, the thought that the death of the controversial one would considerably enhance sales (I bet many in the Jacko camp considered the possibility these last few years) resulting in extreme guilt (and ever greater praise) should that actually happen.

It surprises me that there hasn't been at least one known (to me) example of an over-the-hill celebrity faking their deaths and then channeling their funds to a new incarnation as this is such a genius career move.

GM Davies is the author of Play the Catalan, Everyman, 2009

Andrew Moe reports on his concert-going experience:

On their current US tour, Coldplay moves from the main stage to several smaller stages positioned well out in the cheaper seats of the venue. In San Diego, they went so far as to set up shop for a few songs at the base of the lawn area that lies behind the assigned seats.

During a particularly engaging number, one observed security quietly clearing a path from the main stage. As the lights went out, the band quickly and easily moved through the packed venue. Once their new positions were established, on went the lights and the crowd went wild. Reminds me of the clearing of the way for certain banks to take positions they later flip to the government for immense profits.

Traffic patterns in and out of a concert offer the opportunity to study drivers under pressure in an unfamiliar environment. This is quite different from the regular commute where a fair percentage of the drivers know both the route and the daily tendencies. The best opportunites in markets come when you have a group (or groups) in unfamiliar territory reacting to intense pressure.



The Fed has the most control over the Monetary Base, less control over MZM and even less over M2.  Interestingly the Base has doubled with the Fed’s activities, but those activities have had a much reduced effect on MZM and almost negligible effect on M2.  This means that the extra money is being held on deposit by the banks (helping their bottom lines).  With no bank-lending-created expansion of money, any inflationary or bubble argument is diminished.

Dr. Rafter is President of Mathematical Investment Decisions, a quantitative research consultancy

Steve Ellison recalls:

I feel like I have seen this movie before. In the early 1990s the banking system was in trouble, and the Fed's actions were considered ineffective — "pushing on a string". The next phase was the jobless recovery, in which Bill Clinton was elected on the platform of "it's the economy, stupid" 18 months after GDP growth turned positive. As late as the fall of 1993, Barron's ran a cover story on efforts to rescue homeowners with negative equity. This entire period was a great time to own stocks. It wasn't until the economy was unmistakably strong that the stock market ran into trouble in 1994.

Bill Rafter adds a picture to his comment:

I refer you to this graphic that will illustrate the point.

As you will see, M2 is below its target rate of growth. That’s contraction from a monetary policy standpoint. That means no inflation.

What would happen if there was an increase in bank-lending-created money? Well, what do you get when you increase a fiat money stock without an increase in goods and services? Increases in prices; loss of confidence in the currency.



Risk Aversion is the central assumption for expected behaviour of market participants. Loss Aversion is considered an anomalous behaviour. However the pursuit of any enterprise including trading and investing is profit seeking and not loss avoiding. So, like all ideas in Economics, there is a Buddhist middle path where logical conflicts are minimized. As long as there is a reasonable tolerance for losses, risk aversion works.

Within expected, expectable, tolerable, reasonable ranges of losses or risks, they are inversely correlated to each other. However, at the extremes, i.e. beyond the tolerable ranges of either losses or risks, they are not negatively correlated. “Not a negative relationship”, is not necessarily a positive relationship at or beyond the extremes. It could be that beyond the extremes, there is no relationship, undefinable relationship or a positive relationship.

The whole problem is made “intellectually” consistent by seeking refuge in quantifantasizing (quantifying & fantasizing) that an investment utility curve is unique to each unique individual in the markets and that helps define and quantify what is a numerate idea of reasonable, tolerable, expectable losses or risk.

Reality is we are using some undefined or undefinable quantities. I would like to add to the Behavioural Finance Terminology, thus the term Quantillusion since Perversions don’t exist in markets is the assumption.

Beyond the tolerance point, for some there is a stop loss wherein risk-aversion starts going close to infinity. For some, risk aversion instantly reaches infinity (read undefinable) and they live with the loss making trade until the margin calls cannot be met. There are a rare few for whom Loss Aversion and Risk Aversion are positively related in the zone of fat tails. Such rare men and women have gone to a point of no return to win yet unknown lands, discover yet not known molecules, find yet not imagined axioms.

The rarest of the rare among men and women thus are playing on that very infinitesimal probability where readiness to take a larger loss (losing it all, including oneself) while engaging in increasing risk still leads to a productive outcome. My question, is as traders and investors, does any one of us in the markets have that mandate?

So, loss aversion is not really an anomalous behaviour but only symptomatic of the anomaly of most people not wanting to know their own limits of excursions.

The sagacious Steve Ellison adds:

There are probably as many answers to this question [how loss aversion works] as there are market participants, but behavioral finance researchers have found that people value things they own more highly than non-owners would value the same things. In addition, Kahnemann and Tversky found that the pain of a loss is twice as intense as the pleasure of a gain of equal magnitude. These biases result in asymmetrical responses to risky investment situations. An investor who buys a stock that goes down is likely to stubbornly believe that the stock must be worth what he paid for it and hold on. Conversely, an investor who buys a stock that goes up becomes fearful that he will lose what he has gained and is likely to sell for a small profit.

By trading, I have gained a much deeper understanding of risk than I had before. I think most investors who are not professionals have a very shallow understanding of risk. They look at the long-term upward drift of the stock market and think about the potential profits. They smile and nod their heads when told about the periodic declines, but do not think carefully about how they will feel when the inevitable decline occurs. It is easy to understand the logic of dollar cost averaging, but hard to understand what it will feel like to continue putting money into the market when one's previous investments have shrunk dramatically in value.

I have become a believer in stops, not because they are intrinsically profitable, but because they allow me to keep losses small enough that I stay rational. They prevent trading mistakes from metastasizing into psychological mistakes.



Circuit boardDuring controversies about outsourcing, an executive I knew liked to hold up a 10-year-old circuit board next to a current circuit board. Typically the newer board was much smaller and had only about one tenth the number of components.

"What happened to the manufacturing of all these parts?" the executive would ask.

Slowly, the realization would dawn on the audience. "It is gone!" 90% of the manufacturing was not gone to China, it was just gone.

Stefan Jovanovich writes:

W TOur staff is 10% of what it was, but we still have the capacity to handle 75% of the unit volume we ramped up to during the dot.com boom. What used to be done by people with clipboards is now done by custom-designed software running on computers with wireless bar code scanners. What used to require hundreds of square feet of linear space can now be handled in 15% of the area using vertical storage and retrieval. The enterprise is now a joint venture (like the Pequod) with no "payroll" employees; the tax savings alone are greater than our net profit was during the last year (FY 2008) under the old structure. As Steve might have put it, the "jobs" (sic) are gone; and they are not coming back.

And we are not the only light industrial business in Califormia going virtual:

"The U.S. industrial [real estate] market has recorded negative absorption in four out of the last five quarters, third quarter 2008’s 38 million of positive absorption being the sole exception. Second-quarter 2009 saw 49 million square feet in negative absorption, a new high for the decade following the first-quarter's minus-48 million square feet." CoStar Group.



Species and stocks move around. They go up and down during the day, frequently starting high and ending low or starting low and ending high. They can move slowly, quickly, step by step, jump or fly. Species can swim or be dispersed by wind and stocks can be carried along by movements in the general market itself or related markets such as interest rates, oil, or Asian markets. Many species like to go back to their nests or dens and many stocks like to move back to some quieter place at the end of their day. Birds and fish often migrate back to the equator or northern regions during the winter and summer and stocks often move in opposite directions in the colder months and warmer months.

 Occasionally a species moves into a new area. It invades a new territory. And if it proliferates in space and numbers, we say it's a pest. Famous invasive species in the literature include the sea otter in California, the muskrat in Europe, the European starling in North America, deer in the Northeast suburbs, and innumerable plant and insect species. As Charles Elton said "a hundred years of faster and bigger transport has kept up and intensified the bombardment of every country by foreign species."

Two excellent books on biological invasions are Biological Invasions: Theory and Practice by Shigesada and Lawasaki, and Biological Invasions by Mark Williamson. The former is a primer on mathematical modeling of invasions and the latter is an impressionistic summary of the state of the field with numerous biological examples by a leading field researcher.

The main principles that the books teach is that most invasions fail, when they don't most become pests, and when they do become pests — about 1/10 x 1/10 of the time – they diffuse in space and numbers according to the square root of time and the growth rate adjusted by a standard logistic factor based on how close they are to carrying capacity of the area they invade.

Invasions are close to the heart of every market person. The qualitative invasions that constitute the bailouts for the cronies is a new factor in the United States that should be analyzed with the same care that ecologists traditionally place on the badger.

Other invasions that market people might well study are the recent invasion of the Nikkei to 10000. The move last year to gold above $1000, and oil above $150 and below $40, and the always threatening long 10 year bond yield of 10%. Such questions as: Why did some of these fail, and what other markets did they carry along with them, and when will they come again, lead to many other interesting lines of inquiry.

SLETo put some numbers on the table I decided to study the invasion of big stocks to the rarified areas of the turbulent landscape around the number 10. I looked at the S&P 100 as of the beginning of the year and found one stock below 10, Sara Lee at 9.80.

From December to January, Sara Lee moved to 10.03, making one invasion from below to up. Dell, Alcoa, and B of A moved down, making an invasion of three down. In February, GE and Dell and Dow all fell sharply from above 10 to below 10. This invasion failed, as all three rose sharply from the below 10 territory to above in March. In subsequent months, the invasion below 10 has petered out to extinction with B of A moving above in May and Sara Lee in June.

It is interesting to speculate on the invasions of small stocks like those in the S&P Midcap to these levels during these and other time periods. And to plot the diffusion and expectation of these invasive species when then tread on these highly fugacious territories.

I would be interested in other applications and examples of invasion theory in markets.

P.S. I will post the month end prices and names and dates at an appropriate time.

Steve Ellison adds:

CheatgrassInvasions that might fail under normal circumstances can be successful when additional disruptions occur. When settlers brought cattle to the steppes of southern Idaho, the cattle ate the dominant crested wheatgrass and provided an opening for cheatgrass, an invader from Russia. Cheatgrass altered the fire dynamics by being highly combustible and having fire-resistant seeds. After a fire, cheatgrass quickly became dominant.

Interestingly, one of the best places to find samples of the original native plant species is the cemetery in Virginia City, Nevada, (web site1, web site 2) which has been kept from grazing and defended from fires for 150 years.

Russell Sears writes:

Alien species are the second leading contributing factor in extinction. For about half of the species listed as endangered, alien species are contributor to their demise.

But even more pronounced is the 85% contribution of habitat destruction or change of living environment.

Clearly the regulatory environment is changing for financial companies. The securitization process will forever change. Which I would classify as habitat destruction.

AOLHowever, back to the alien species, it would seem to me, more akin to the game changing technologies invading established territories and market share. The late 1990s early 2000s we saw the game changing technologies in telecoms. There are of course companies that are experts in introducing these game changers, Apple and Google come to mind. But many tech companies have hit the scrap heap, because they couldn't maintain a constant acceleration of products. (Remember when AOL was going to rule the world?) Even retail tech companies have a difficult time staying on the cutting edge, as Radio Shack and Circuit City seem to display.

The drug companies, and bio-tech have similar potential if the regulatory environment can be deciphered… although I certainly don't have the expertise to predict what can make it through this maze. But have known traders with enough organic chemistry knowledge to make fortunes, and vice-versa; organic chemists that have made some nice trades.

Perhaps, invading products contribute to the death of more companies, and birth and growth of new industries. Environmental changes contribute to the destructive effects, but with much more sterilization of productive potential.



C MI've been thinking about whether there's a correlation between trading success and intelligence. Do people with high IQs do better at the trading game than those with low IQs? I wonder if high intelligence is a prerequisite for trading success, or if it even fits into the equation.

Are traders in some markets smarter than those in other markets? Are the index or currency guys smarter than the grain crowd, for instance? Are the upstairs guys smarter than the floor guys? Does higher education really matter, or even have a correlation with trading success? Has any of this ever been measured before? An interesting thing to ponder is if there might be a correlation between juvenile behavior and trading success. Perhaps the most important traits for traders are balance, emotional intelligence, the ability and discipline to execute a plan successfully, and courage. Some of the smartest people I've ever known have been really bad traders, whereas I've known very successful ones who don't exhibit outward signs of extra intelligence.

Newton Linchen adds:

This is a great issue. How many times we sit and shout "why oh why didn't I trade the way I said (plan)?" This happens despite our intelligence — one thing is to be able to "understand" or predict markets — other is to be able to translate this view into action. Perhaps the best strategist is not the best fighter — and it's very unusual to see a strategist-fighter or fighter-strategist.

Generals plan their moves at night, in the tents, but they send the soldiers to do the job the next day.

GM Nigel Davies replies:

Even in a supposedly intellectual game like chess, character plays a much larger part than intelligence. A major part of it is in whether someone can bring himself to falsify his ideas or instead uses what intelligence he has to justify them.

Steve Ellison observes:

I suspect that practical intelligence (synonyms: business savvy, street smarts) is more important to trading success than the type of intelligence measured by IQ. Ben Green, in the preface to Horse Tradin', noted that horse dealers had to know about many factors such as demand, climate, crops, and soils, but then went on to say:

For a big dealer in a central market to be successful he also had to acquire a keen understanding of human nature… None of the knowledge needed by a high-class horse and mule dealer could be learned from books or schools, and it would be well understood that these men were usually middle age or over.

Last but not least, he had to be a man with a lot of nerve, who was willing to back his own judgment and that of his buyers and to face the risks involved in shipping, loading, and unloading (together with the possibility of various shipping diseases) that were a hazard of the business… It is easy to see that with money going out in both directions it took larger amounts of capital, accompanied by a good nerve and judgment, to be a successful central market dealer.



In short one is forced to agree with the German historians […] who see long-distance trade as an essential factor in the creation of merchant capitalism and in the creation of the merchant bourgeoisie. — Fernand Braudel [French historian].

I recently read A Splendid Exchange by William J. Bernstein and found it a quite interesting history of trade. Before the modern era, trade was difficult and dangerous. "Traders did not venture abroad without letters of introduction to expected business contacts, or without letters of safe conduct from the local rulers along their route. Otherwise, they were certain to be robbed, molested, and murdered." Even then, "merchant ships provided corrupt government officials with easy targets."

"Were the trader lucky enough to complete the journey with his cargo and person intact, ruin could still come at the hands of a fickle marketplace. … Why would anyone risk life, limb, and property on journeys that might carry him from hearth and home for years on end, yielding only meager profits? Simple: the grim trading life was preferable to the even grimmer existence of the more than 90 percent of the population who engaged in subsistence-level farming. An annual profit of one hundred dinars–enough to support an upper-middle-class existence–made a trader a rich man."

An interesting tidbit about currency is that a one-eighth ounce gold coin has typically been the standard medium of exchange through the ages. Silver coins of similar size roughly corresponded to a day's wages before the last few centuries.

In a chapter on ancient Greece, Mr. Bernstein notes that poor soil drove the strategic imperative of Greek city-states to develop empires to secure adequate food supplies. Athens imported much of its grain from the Crimean peninsula. Along this route were numerous narrow passages, particularly the Bosporous and Hellespont in modern Turkey. To assure its food supply, Athens had to establish military outposts or cultivate allies at these "choke points". The need to prevent closure of choke points became an important strategic consideration for later Western powers, and remains so to this day.

The founder of Islam was a trader, and Islam dominated medieval trade. The largest trading system in the medieval era was in the Indian Ocean, where trade moved to the annual rhythm of the monsoon winds. Sailing ships traveled east and north as far as China during the summer monsoon and west and south to return to Baghdad or Arabia during the winter monsoon. Europeans were forcibly kept out of this system until Vasco da Gama rounded the Horn of Africa in 1498.

By the 1600's, the Dutch East India Company had become the dominant force in world trade. The Netherlands had the best foundation for building wealth and prosperity–"advanced political, legal, and financial institutions."

"In England, reputable borrowers (that most certainly did not include the crown) paid 10 percent on their loans, versus 4 percent in Holland, with the Dutch government getting its credit at the lowest rates of all. By contrast, in England, where the crown could, and often did, repudiate its loans, lenders charged it higher rates than those for good comercial borrowers." This difference in interest rates gave the Dutch a huge advantage over the English.

Mr. Bernstein weighs the historical evidence and finds mercantilism wanting. Henry Martyn, an early British advocate of free trade, "saw clearly that mercantilists, by equating gold with wealth, repeated the mistake of King Midas. Precious metals are useful only because they can be exchanged for things we want or need. A nation's true wealth, Martyn realized, was defined by how much it consumed".

For as long as there has been trade, there have been local producers harmed by competition from better or cheaper imports, leading to calls for protectionism. In Britain, the Corn Laws heavily regulated agriculture, generally for the benefit of the landed aristocracy, for centuries before they were repealed in 1846. At one point during the debate to repeal the Corn Laws, a parliamentarian suggested it would cost the nation less to buy off the aristocrats than to continue to block imports of cheaper grain from the Continent.

Research by Jeffrey Sachs and Andrew Warner found a strong positive correlation in developing nations between free-trade policies and increase in GDP between 1960 and 2006. Mr. Bernstein also notes a positive correlation among rich countries between international trade as a percentage of GDP and government spending as a percentage of GDP, suggesting that, as international trade expands, so does the need for assistance to people put out of work by foreign competition.

My brief review cannot do justice to the many topics covered in this book, including slavery and the spread of diseases. On the latter, suffice it to say that the risk of a deadly epidemic is far less today than during 1300-1800, when previously localized diseases spread worldwide, and the populations in the newly affected areas had no immunity.



22In thinking of long distance shooting I thought of the technique that I was taught by my PaPa. He taught the popular BRASS acronym: Breathe, Relax, Aim, Slack, and Squeeze. I from young age till now if I picked up a rifle would go through this as if it was second nature. The two Ss are the hardest for me, the slack to those not in the know is the give in the trigger up to the point of release, the squeeze is preferred to a Pull so as not to move shot to the right (righthanded shooters). I learned this with a .22 hunting squirrels from 50 to 100 yards, no sight.

Similarly I was taught a golf swing by my Uncle Wayne with similar ritual though no acronym. Five step dance. First grip the club, second address the ball, third place right foot, fourth place left foot, fifth swing the club. Though it isn't as robotic and choppy as when I learned I still have this same approach to a golf ball today. It is much more fluid and effortless but the same five stages are there.

The training of those two things in my life came with practice and a quasi-scientific approach. What idiosyncrasies do you have for trading?

Mine are:

  1. hypothesis
  2. test
  3. confirm
  4. place trade
  5. monitor trade
  6. exit trade

Steve Ellison adds:

PDSAA technique taught in Six Sigma quality methodology is Plan, Do, Study, Act (PDSA).

Plan: Decide a course of action, and predict the results. The first three steps in Mr. Holley's list could be input to a trading plan.

Do: Place, monitor, and exit the trades.

Study: After a reasonable number of trades, analyze results. How profitable were the trades? If they were not profitable, why not?

Act: Based on what you learned, make an improvement to your trading process.

A typical improvement effort might have many cycles of PDSA. A good starting point for more information about PDSA is here .



Today 2009/07/08 was a "Just in Time" day, recalling the song performed by Laurel Kenner and Ming Vandenberg at Delmonico's a few years ago:

Just in Time
(Music by Jules Styne; original lyrics by Betty Comden and Adolph Green)
(These lyrics by V. Niederhoffer and L. Kenner)
A. Just in time,
Stocks rallied just in time
Before they rose my funds
Were running low.
I was lost
The losing dice were tossed
My brokers all were cross
Nowhere to go

B. Bulls in debt
The stocks looked like they could be heading
Down still lower yet
But something changed
Stocks rallied just in time
They rallied just in time
And put me in the black that happy day.

C. Just in time,
Stocks rallied just in time
To save me from
That margin call
Five down days
My mojo went away
It looked like fund flambe'
I tried to stall

D. Clearing [firm] said,
You'd better lighten up or
Else we'll all be in the red.
Then something changed
Stocks rallied just in time
They rallied just in time
I had a nice bounce back that happy day.

B. Bulls in debt
The stocks looked like they could be heading
Down still lower yet
But something changed
Stocks rallied just in time
They rallied just in time
And put me in the black that happy day.



In decades past, lower interest rates were highly bullish for stocks. However, in running a regression of 4-month S&P 500 changes versus the change during the previous 4 months of the 3-month Treasury bill yield, I found that since 1996, the S&P 500 has been more likely to go up after interest rates rise. Following are the most recent data points.

.            4-month change in
.            —————–
.                      3-month
. 4 months   S&P 500    T-Bill
.   ending   futures   yield %
. 8/29/2003             -0.14
.12/31/2003     10%     -0.05
. 4/30/2004      0%      0.04
. 8/31/2004      0%      0.62
.12/31/2004     10%      0.61
. 4/29/2005     -5%      0.66
. 8/31/2005      5%      0.59
.12/30/2005      2%      0.55
. 4/28/2006      4%      0.67
. 8/31/2006     -2%      0.26
.12/29/2006      8%     -0.02
. 4/30/2007      3%     -0.17
. 8/31/2007     -2%     -0.73
.12/31/2007     -2%     -0.85
. 4/30/2008     -6%      -1.8
. 8/29/2008     -8%      0.35
.12/31/2008    -30%     -1.57
. 4/30/2009     -3%



 My simple query about what baseball can teach us about markets has tapped into a beautiful reservoir of insights and consiliences. In that spirit, and I honor Larry Ritter, who challenged Collab and me to come up with 100 relations before he told us the truth about the "doctoral degree" he awarded to the former Chair, as his thesis adviser. I am going to sponsor a contest similar to the one we sponsored about whether prices tend to Lobagola. For the best little paragraphs, hopefully with some numbers that show what we can learn from baseball about markets, I will award a $500 prize. All entries will be published. The deadline will be June 15. The judges will be me, Doc, and the east coast surfer.

Nick White clarifies:

Two quick things:

1) Must we limit the baseball contest to baseball, or might we generalise to the wider lessons that elite sport in general might teach?

2) A repeat of the best, most fundamental lesson: while waiting for our GDP number to come out, I cut my position till the print. I loaded my order into the screen and hovered my mouse over the trigger for when the number hit the wires. However, I hadn't noticed that I'd accidentally right clicked while staring at the screen until 2 seconds too late…after 22 lost points an d much cursing I recalled that one is always handsomely rewarde d for checking their equipment prior to taking the field….No more trading for me today as I'll be far too tempted to chase.

Steve Ellison adds:

Rule changes, environmental changes, and new techniques can greatly affect the game, in baseball and in markets. Jeff Pearlman wrote an article for The Sporting News in April entitled "The Death of the Stolen Base". Mr. Pearlman presented some statistics about the decline in stolen bases in major league baseball over the past two decades and then looked for reasons for this decline. He singled out two major factors.

There are increasing numbers of baseball parks with retro designs, such as Camden Yards. These parks typically have smaller dimensions than the generic stadiums of the 1960s and 1970s, increasing the value of power and decreasing the value of speed both on offense and defense.

Pitchers responded to the baserunning havoc wrought by Rickey Henderson and Vince Coleman in the 1980s by developing the slide step, a technique that shortened the pitching motion and hence the jump a would-be base stealer could get.

Alston Mabry adds:

Regarding the article "the death of stolen base", does it mention that the Bill James and the sabermetrics folks have been arguing against stealing for years because of success rate doesn't justify the cost of an out. They may be having an effect on manager thinking.

Stefan Jovanovich interjects:

Saber metrics can be a bit like the joke about the 3 actuaries at the carnival shooting gallery (the 1st misses 1" to the left, the 2nd 1" to the right, the 3rd says "we won the prize"). What James' statistics don't adjust for is that the "success rate" for steals includes the runners thrown out on missed swings on hit and runs. A good base stealer (one who is safe 80% or more) is worth the risk because, with his speed at 2nd base, a run can be manufactured with one hit instead of two. Since competent pitchers average 1 hit per inning, stealing from first to second is worth the risk. So, for that matter, is stealing from second to third with less than two out. The decline in stealing is a function of the fact that base stealing takes practice, and few managers even at the high school level are willing for accept the error part of the "trial and error" process - even though it is the one skill that gives the ordinary hitting team a chance to defeat a superior pitcher. Also, at least here in the U.S., the kids with the smaller frames and quickness that you need to be a good base stealer are playing soccer and basketball. There is hope, however; Ichiro is now the model for the Japanese leagues. Somewhere in Osaka Prefecture a kid is probably studying Maury Wills video right now.



MitGiven that one can listen at low cost/free on the Internet to the best professors in the country giving courses in many leading subjects (MIT has all its courses free online, Yale and Stanford some of theirs), how long will consumers be willing to pay $200,000 for four years of Ivy League and other leading private courses often taught by uninspiring assistants and graduate students — often, in the case of math and science courses, mumbling foreign graduate students whose English is incomprehensible? I well realize that a degree from a leading private university is a considerable signal to employers, potential spouses and others, of one's intelligence and diligence (and I also realize that the $200,000 cost is usually not borne by the consumer him- or herself). But still, how long in this age of technology, outsourcing and arbitrage can such a differential persist?

Steve Ellison reports:

In an NBER paper, Avery and Hoxby state:

If [a student with very high college aptitude] acts as a "rational" investor, not bound by credit constraints … then he need make only two calculations for each college in his choice set. Supposing that the student has figured out the cheapest way to attend each college, given the aid offered him, his first calculation is the present discounted cost of attending each college j …

His second calculation is the present discounted value of the consumption he enjoys at college j plus the present discounted value of the stream of income generated by the human capital invested in him at college j …

Jeff Sasmor reacts:

What college student thinks this way? As someone who has just gone through this process with an intelligent child entering college (Barnard) next fall, the decision involved more emotional choices than rational ones.

1. What school best fits what I think I want to do with my life?

2. What school has the type of people I want to hang out with for the next four years?

3. I want to get out of NJ. Even though I was accepted into Rutgers' Honors program I don't want to go there, yuk. I want to go to a brand-name school. I want NYC because I want to experience an urban lifestyle. You know, I'll need a bigger allowance!

4. Don't lecture me, I don't care what it costs.

Riz Din shares:

I was painting our fence the other day while listening to a variety of quality podcasts and lectures (painting a fence takes longer than I thought) and I had similar thoughts.

The differential has to fall over time because the act of standing in front of a group of people and lecturing them is outmoded in today's world and is fast becoming commoditised through technology. The idea of an institution herding students into a room at a fixed time and having a one-sided conversation with them while they rapidly jot down all the salient points just doesn't hold water when there are much better, more productive ways of teaching. I start to drift after the half hour mark in many lectures and being able to press 'pause' on the lecturer would have been a real boon.

Universities can be extremely slow to adapt (e.g. Latin was standard at Oxford and Cambridge several hundred years after other places of learning adopted English), so overhauling the entire way of teaching may be some years in the making. Nevertheless, I think the education establishments are going to have to figure out how to better differentiate themselves because we thankfully live in a world where one's prospects depend less on one's place of learning or social standing and more on one's capability. Just as increased competition in the forex world led to massive spread reductions over the years, forcing many banks to evolve and differentiate their forex offerings with value-added propositions such as better research, option strategies, trading systems, etc., so universities and other places of learning must adapt their models. As a hybrid model at least, I can foresee on-line lectures combined with seminars and other, more interactive modes of learning. In today's world, perhaps knowledge isn't power because it isn't scarce, and the emphasis is increasingly on the the application of knowledge.



MasaOne always expects the Japanese to be very honest. It is well known that if you lose your wallet loaded with cash in Japan it will be returned to you a year later intact, and that the only place as safe as Japan is Arthur Avenue in the Bronx. The idea of even looking at a dinner tab to check its correctness is certainly inappropriate since 95% of the customers are Stuyvesant and Julliard blood brothers. So I was stunned when eating at Masa the other night where the price had recently been reduced from $500 to $400 to find the following item printed on the check as it was handed to me, and had to look at it closely since I am over 40 and don't wear glasses. "There is a service charge of 20% added to the check. But it is not a gratuity. It covers the administrative and operating expenses of the restaurant and is not shared with employees." What a way to end a beautiful dinner. Presumably other restaurants and other businesses have operating expenses also? And presumably when one is told there will be a 20% service charge, one would expect it to be a gratuity? There are all sorts of new ways for companies to survive the recession. Restaurants in New York are taking to adding a surcharge onto the bill if you wish or eat bread or drink water. But most businesspeople know that making a customer feel that he's been gipped is not a long run way to success. On the contrary, the customer should always feel he's getting more than his money's worth. I would be interested in other special shortsighted recession-beating forays that our specs have been exposed to.

Steve Ellison writes:

LuggageAirlines seem to go the extra mile to make customers feel gipped. On a recent trip, U.S. Airways charged me $25 to check one bag. As I was checking in for a redeye from L.A. to Boston, United Airlines offered to upgrade me to a seat with a few more inches of legroom for $25. When planning this trip I used a search engine that showed both the airlines' stated prices and the real prices after adding on surcharges and fees. In some cases the real price was nearly double the stated price.

Craig Mee comments:

Another twist on this is completely the opposite: 'pay what you think it's worth.'

The example I link to is in kiwi land, but I've heard exactly the same happening in London, and with the manager staying most of the time there in front, while their people look after them. If I ran the restaurant, I'd just make sure that the tables were as far away from the exit as possible, so anyone who tossed you five pence had the walk of shame to deal with it (i.e the opportunity for waiting staff to throw them that knowing look of "thanks for nothing").

Vince Fulco writes:

MonitorsMost recently while shopping for multi-monitor video cards from numerous manufacturers, critical cables for the interfaces were not included. They easily added 30% to the overall cost, and I assume the resulting markup is many times greater vs. if everything were included with the device itself.

There seems to be a not too subtle attempt at teaser prices even in more traditional venues. Southwest Airlines is a great example. New to Minneapolis, they're heavily advertising their summer fares to Chicago for $49 among other attractive deals. Not surprisingly, any 'deal' requires traveling at the worst possible times and multiple interim stops; sometimes as many as three or four. Not a way to start a relationship with newer customers and a disconnect from their message of being clear about the total prices vs. the other guys.

Another current example is a regional furniture company advertising all products at 77 cents on the dollar. What marketing psych service advertised the switch from the old N% off sale? It doesn't resonate well.

Marion Dreyfus adds:

TzooTake advantage of the numerous specials in travel now, especially pre-summer. TravelZoo offers a raft of deals that are good, though you are warned about taxes that can make a huge difference in the stated to real price. Also note that some fail to include key variables that change the price. Departure days can be irregular, inconvenient or uncomfortable, double occupancy at a hotel may be expected. You may be expected to rent a car.



 Einstein purportedly said that compound interest was the most powerful force in the universe. I challenge his statement and offer the hypothesis that the vig is the most powerful force in the universe, exceeding that of even free market forces because it's always there. Exerting a constant force on every trade, transaction, purchase, sale, or any human activity of any kind, the vig is always first in line to get paid.

The vig is a powerful enough force that both winners and losers pay, without even realizing it in many cases. The vig has clever ways of hiding and disguising itself but is always there. From the widening and narrowing bid/ask spreads in the market, to the 35 to 1 (or even more insidious 35 for 1) payout on a single number on the roulette wheel, the vig constantly grinds out and extracts it's percentage on every trade or activity. Like the steady beat of a metronome, the vig is just extracted, extracted, and extracted some more.

The general public has little awareness of the vig, but the vig takes a huge toll from the unsuspecting public. All of the great deals offered the public generally have a higher vig, although even the professionals must pay it. Games with longer odds such as trifecta pools, keno, and lotteries charge high vig, while short games and trades usually have much lower vig. Games that advertise that they're commission free usually charge the highest vig of all, such as those bucket shop Forex places that are sprouting up like mushrooms all over the place. The vig allows the beautiful Vegas casinos to exist, Churchill Downs to run it's card, and allows the temple at Wall and Broad to continue it's operation day and night.

I contend that although the electronic trading is supposed to increase liquidity and eliminate the vig charged by the locals, thus benefiting the public, the opposite occurs. The apparent percentage takeout of the vig might be reduced, but the increase in the velocity of trading, with a smaller vig collected each round trip, more than makes up the difference, sort of a Laffer Curve applied to the vig.

One can easily see this by looking at the volume and revenues at places like the CME where volume has exploded and the market cap of those high temples of finance has gone into the stratosphere. Those beautiful buildings have been built by the pennies per transaction takeout from everyone, every trade, and it all adds up. The apparent reduction of vig has allowed the online poker sites to flourish with advertised low rakes versus the brick and mortar clubs. People think they're getting a great deal with such a low rake but don't realize that they're playing at a rate six times faster than in real life and probably paying out more vig than they would in Vegas, Atlantic City, or the numerous underground clubs I used to frequent in my misspent youth.

Although the vig is a constant fixed percentage in sports betting, in the markets it is ever changing. With the advent of the electronic markets, I have a certain difficulty these days in calculating the amount of vig I pay every trade, although I have a general idea. I have some pretty sophisticated math that's supposed to help me figure out the vig I pay, but even that's just an approximation When I was a local, I knew how much vig I collected down to the quarter cent depending on what type of trade I was accepting. I collected a certain amount of vig buying a spread, selling a spread, trading with little locals, and fading paper from the public. I offered discounts in vig for size, and would give up a quarter cent if I knew I could bag a big order. I also knew how much vig I would have to pay and the percentage that might change if I were desperate enough. Even though I collected vig every day, I also knew how precisely much vig I would have to fork over at the end of the day to play in the pit, because everybody has to pay tribute to someone. Since every player pays vig in trading, the money has a way of working it's way up, to some unknown repository somewhere. All of this paid tribute and upward movement of money feels like it has a part in a certain Francis Ford Coppola movie that was so popular in the 1970's.

Free market forces do affect vig, widening and narrowing the percentage, but while free market forces might disappear for awhile due to governmental regulations and laws, the vig will always be around. Vig shows up in many other clever disguises such as lower yields on fixed investments, taxes, assessments, points, fees, payoffs, and graft. Vig has to be calculated into every transaction, and must be figured into every apparent overlay one might spot.

My late, great, grandfather used to cite the old axiom that "There's two kinds of people in this world, those who pay interest and those who collect interest." While he was spot on with reciting that observation, he sadly neglected to tell me that everyone has to pay vig, a hard lesson that I had to learn for myself.

Steve Ellison writes:

A traditional recipe for business success: reduce the price of a product and thereby generate much greater demand and higher profits.

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