February 14, 2007 | 1 Comment
Adventures of a Red Sea Smuggler, by Henry De Monfreid.
I came across this great book a while ago and for all those who enjoy books like horse-trading, this is a winner. There are more than the obvious analogies to speculation. The book is set in a world where the price of goods, like mother of pearl, can crash from 7500 francs to 1500 and then climb back again.
I loved his quotes about human nature, gems like, "I dared not be happy; for all my life I have had to pay with sorrow for every bit of happiness I have ever known. That is the fundamental law of the destiny of man." Also, "There was no use worrying about the possible difficulties to come, they always loom very large and terrible in the distance, but when one arrives at the foot of a wall there is always some foothold that enables one to climb it."
This book is about a bored French farmer who decides to embark on a life of smuggling in search for meaning in his life. It is set in the 1920s in, as the cover says, a world populated by Chinese hermits, Greek priest smugglers, Arab robber barons and Bedouins. A classic written by a guy who ended up living well into his 90s and writing over 40 volumes of his adventures.
February 8, 2007 | 9 Comments
There has been entirely too little thought given to the mechanism, pathways and reasons that negative feedback works in markets. Perhaps the main reason is that the feeding web is based on a reasonable stability in what and how much is being eaten and recycled.
The people who consume and redistribute must maintain a ready and stable supply of those who produce. They develop mechanisms to keep everything going. One of them is the specialization and great efficiency in their activities. If markets deviate too much from the areas and levels within which the specialization has developed, then much waste and new effort and mechanisms will be necessary.
Aside from the grind that trend following causes (i.e. the losses in execution), and the negative feedback system of movements in the supply and demand schedules that equilibrate, which Marshall pioneered and are now standard in economics, and the numerous other reasons I've set forth (e.g. the fixed nature of the system and the flexibility to profit from it), this appears to me to be the main reason that trend following doesn't work.
Here are a few interesting articles on the subject:
Bill Rafter writes:
Dr. Bruno had posed the idea of beating an index by deleting the worst performers. This is an area in which we have done considerable work. Please note that we do not consider this trend-following. The assets are not charted, just ranked.
Let us imagine an investor who is savvy enough to identify what is strong about an economy and invest in sectors representative of those areas, while avoiding sectors representing the weaker areas of the economy. Note that we are not requiring our investor to be prescient. He does not need to see what will be strong tomorrow, just what is strong and weak now, measured by performance over a recent period.
What is a market sector? The S&P does that work for us, and breaks down the overall market (that is, the S&P 500) into 10 Sectors. They further break it down into 24 Industry Groups, and further still into 60-plus Industries and 140-plus Sub-Industries. The number of the various groups and their constituents changes from time to time as the economy evolves, but essentially the 500 stocks can be grouped in a variety of ways, depending on the degree of focus desired. Some of the groupings are so narrow that only one company represents that group.
Our investor starts out looking at the 10 Sectors and ranks them according to their performance (such as their quarterly rate of change). He then invests in those ranked first through fourth (25 percent in each), and maintains those holdings until the rankings change. How does he do? Not bad, it turns out.
From 1990 through 2006, which encompasses several types of market conditions, the overall market managed an 8 percent compound annual rate of return. Our savvy investor achieved 10.77%. A less savvy investor who had the bad fortune to pick the worst six groups would have earned 7.23%. Those results are below. (Note, for comparison purposes, all results excluded dividends.)
How can our savvy investor do better? By simply sharpening one's focus, major improvements can be achieved. If instead of ranking the top 4 of10 Sectors, our savvy investor invests in a similar number (say the top 4, 5 or 6) of the 24 Industry Groups, he achieves a 13.12% compoundedannual rate of return over the same period. Note that the same stocks are represented in the 10 Sectors and the 24 Industry Groups. At no time did he have to be prescient.
One thing you will notice from the graphs above is that the equity curves of our savvy and unlucky investors mimic the rises and declines of the market index itself. Being savvy makes money but it does not insulate one from overall bad markets because the Sectors and even the Industry Groups are not significantly diversified from the overall market.
Why not keep going further out and rank all stocks individually? That clearly results in superior returns, but the volume of trading is such that it can only be accomplished effectively in a fund structure - not by the individual. And even ranking thousands of stocks will not insulate an investor from an overall market decline, if he is only invested in equities. The answer of course is diversification.
It is possible to rank debt and alternative investment sectors alongside equities, in the hope of letting their performances dictate what the investor should own. However the debt and commodities markets have different volatilities than the equities markets. Anyone ranking them must make adjustments for their inherent differences. That is, when ranking really diverse assets, one must rank them on a risk-adjusted basis for it to be a true comparison. However if we make those adjustments and rank treasury bonds (debt) against our 24 Industry Groups (equity) we can avoid some of the overall equity declines. We refer to this as a Strategic Overlay:
Adding this Strategic Overlay increases the returns slightly, but more important, diversifies the investor away from some periods of total equity market decline. We are not talking of a policy of running for cover every time the equities markets stall. In the long run, the investor must be in equities.
Invariably in ranking diverse assets such as equities, debt and commodities, our investor will be faced with a decision that he should be completely out of equities. It is likely that will occur during a period of high volatility for equities, but one that has also experienced great returns. Thus, our investor would be abandoning equities when his recent experience would suggest otherwise. And since timing can never be perfect, it is further likely that the equities he abandons will continue to outperform for some period. On an absolute basis, equities may rank best, but on a risk-adjusted basis, they may not. It is not uncommon for investors to ignore risk in such a situation, to their subsequent regret.
Ranking is not without its problems. For example, if you are selecting the top 4 groups of whatever category, there is a fair chance that at some time the assets ranked 4 and 5 will change places back and forth on a daily basis. This "flutter" can be easily solved by providing those who make the cut with a subsequent incumbency advantage. For a newcomer to replace a list member, it then must outrank the current assets on the selected list by the incumbency advantage. This is very similar to the manner in which thermostats work. We have found adding an incumbency advantage to be a profitable improvement without considering transactions costs. When one also considers the reduced transaction costs, the benefits increase even more.
Another important consideration is the "lookback" period. Above we used the example of our savvy investor ranking assets on the basis of their quarterly growth. Not surprisingly, the choice of a lookback period can have an effect on profitability. Since markets tend to fall more abruptly than they rise, lookback periods that perform best during rising markets are markedly different from those that perform best during falling markets. Determining whether a market is rising or falling can be problematic, as it can only be done with certainty in retrospect. However, another key factor influencing the choice of a lookback period is volatility, which can be determined concurrently. Thus an optimal lookback period can be automatically determined based on volatility.
There is certainly no question that a diligent investor can outperform the market. By outperforming the market we mean that he will achieve a greater average rate of return than the market, while limiting the maximum drawdown (or percentage equity decline) to less than that experienced by the market. But the average investor is generally not up to the diligence or persistence required.
In the research work illustrated above, all transactions were executed on the close of the day following a decision being made. Thus the strategy illustrated is certainly executable. Nothing required a forecast; all that was required was for the investor to recognize concurrently which assets have performed well over a recent period. It is not difficult, but requires daily monitoring.
Charles Pennington writes:
Referring to the MathInvestor's plot:
At first glance it appears that the "Best" have been beating the "Worst" consistently.
In fact, however, all of the outperformance was from 1990 through 1995. From 1996 to present, it was approximately a tie.
Reading from the plot, I see that the "Best" portfolio was at about 2.1 at the start of 1996. It grew to about 5.5 at the end of the chart for a gain of about 160%. Over the same period, the "Worst" grew from 1.3 to 3.2, a gain of about 150%, essentially the same.
So for the past 11 years, this system had negligible outperformance.
One should also consider that the "Best" portfolio benefits in the study from stale pricing, which one could not capture in real trading. Furthermore, dividends were not included in the study. My guess is that the "Worst" portfolio would have had a higher dividend yield.
In order to improve this kind of study, I would recommend:
1.) Use instruments that can actually be traded, rather than S&P sectors, in order to eliminate the stale pricing concern.
2.) Plot the results on a semilog graph. That would have made it clear that all the outperformance happened before 1996.
3.) Finally, include dividends. The reported difference in compound annual returns (10.8% vs 8.0%) would be completely negated if the "Worst" portfolio had a yield 2.8% higher than the "Best".
Bill Rafter replies:
Gentlemen, please! The previously sent illustration of asset ranking is not a proposed "system," but simply an illustration that tilting one's portfolio away from dogs and toward previous performers can have a beneficial effect on the portfolio. The comparison between the 10 Sectors and the 24 Industry Groups illustrates the benefits of focus. That is, (1) don't buy previous dogs, and (2) sharpen your investment focus. Ignore these points and you will be leaving money on the table.
We have done this work with many different assets such as ETFs and even Fidelity funds (which require a 30-day holding period), both of which can be realistically traded. They are successful, but not overwhelmingly so. Strangely, one of the best asset groups to trade in this manner would be proprietarily-traded small-cap funds.
Unfortunately if you try trading those, your broker will disown you. I mention that example only to suggest that some assets truly do have "legs," or "tails" if you prefer. I think their success is attributed to the fact that some prop traders are better than others, and ranking them works. An asset group with which we have had no success is high-yield debt funds. I have no idea why.
A comment from Jerry Parker:
I wrote an initial comment to you via your website [can be found under the comments link by the title of this post], disputing your point of view, which a friend of mine read, and sent me the following:
I read your comment on Niederhoffer's Daily Spec in response to his arguments against trend following. Personally, I don't think it boils down to intelligence, but rather to ego. Giving up control to an ego-less computer is not an easy task for someone who believes so strongly in the ability of the human mind. I have great respect for his work and his passion for self study, but of course disagree with his thoughts on trend following. On each trade, he is only able to profit if it "trends" in a favorable direction, whether the holding period is 1 minute or 1 year. Call it what you will, but he trades trends all day.
He's right. I was wrong. Trend following is THE enemy of the 'genius'. You and your friends can't even see how stupid your website is. You are blinded by your superior intelligence and arrogance.
Victor Niederhoffer responds:
Thanks much for your contributions to the debate. I will try to improve my understanding of this subject and my performance in the future so as not to be such an easy target for your critiques.
Ronald Weber writes:
When you think about it, most players in the financial industry are nothing but trend followers (or momentum-players). This includes analysts, advisors, relationship managers, and most fund or money managers. If there is any doubt, check the EE I function on Bloomberg, or the money flow/price functions of mutual funds.
The main reason may have more to do with career risk and the clients themselves. If you're on the right side while everyone is wrong, you will be rewarded; if you're on the wrong side like most of your peers you will be ok; and if you're wrong while everyone is right then you're in trouble!
In addition, most normal human beings (daily specs not included!) don't like ideas that deviate too much from the consensus. You are considered a total heretic if you try to explain why, for example, there is no link between the weak USD and the twin deficits. This is true, too, if you would have told anyone in 2002 that the Japanese banks will experience a dramatic rebound like the Scandinavian banks in the early '90s, and so on, or if you currently express any doubt on any commodity.
So go with the flow, and give them what they want! It makes life easier for everyone! If you can deal with your conscience of course!
The worse is that you tend to get marginalized when you express doubt on contagious thoughts. You force most people to think. You're the boring party spoiler! It's probably one reason why the most successful money managers or most creative research houses happen to be small organizations.
Jeremy Smith offers:
Not arguing one way or the other here, but for any market or any stock that is making all time highs (measured for sake of argument in years) do we properly say about such markets and stocks that there is no trend?
Vincent Andres contributes:
I would distinguish/disambiguate drift and trend.
"Drift": Plentifully discussed here. "Trend": See arcsine, law of series, etc.
Basically, our tendency is to believe that random equals equiprobability everywhere (2D) or random equals equiprobability everytime (1D), and thus that nonequiprobability everywhere/everytime equals non random
In 1D, non equiprobability everytime means that the sequence -1 +1 -1 +1 -1 +1 -1 +1 is in fact the rare and a very non random sequence, while the sequences -1 +1 +1 +1 +1 +1 -1 +1 with a "trend" are in fact the truly random ones. By the way, this arcsine effect does certainly not explain 100% of all the observed trends. There may also be true ones. Mistress would be too simple. True drift may certainly produce some true trends, but certainly far less than believed by many.
Dylan Distasio adds:
For those who don't believe trend following can be a successful strategy, how would you explain the long-term performance of the No Load Fund X newsletter? Their system consists of a fairly simple relative strength mutual fund (and increasingly ETF) model where funds are held until they weaken enough in relative strength to swap out with new ones.
The results have been audited by Hulbert and consistently outperform the S&P 500 over a relatively long time frame (1980 onwards). I think their results make a trend following approach worth investigating…
Jerry Parker comments again:
All you are saying is that you're not smart enough to develop a trend following system that works. What do you say about the billions of dollars traded by trend following CTAs and their long term track records?
Steve Leslie writes:
If the Chair is not smart enough to figure out trend following, what does that bode for the rest of us?
There is a very old yet wise statement: Do not confuse brains with a bull market.
Case in point: prior to 2000 the great tech market run was being fueled by the hysteria surrounding Y2K. Remember that term? It is not around today but it was the cause for the greatest bull market seen in stocks ever. Dot.com stocks and new issues were being bought with reckless abandon.
New issues were priced overnight and would open 40-50 points higher the next trading day. Money managers had standing orders to buy any new issues. There was no need for dog-and-pony or road shows. It was an absolute classic and chaotic case of extraordinary delusion and crowd madness.
Due diligence was put on hold, or perhaps abandoned. A colleague of mine once owned enough stock in a dot.com that had he sold it at a propitious time, he would have had enough money to purchase a small Hatteras yacht. Today, like many contemporary dot.coms, that stock is essentially worthless. It would not buy a Mad magazine.
Corporations once had a virtual open-ended budget to upgrade their hardware and software to prepare for the upcoming potential disaster. This liquidity allowed service companies to cash in by charging exorbitant fees. Quarter to quarter earnings comparisons were beyond belief and companies did not just meet the numbers, they blew by them like rocket ships. What made it so easy to make money was that when one sold a stock, all they had to do was purchase another similar stock that also was accelerating. The thought processes where so limited. Forget value investing; nobody on the planet wanted to talk to those guys. The value managers had to scrape by for years while they saw their redemptions flow into tech, momentum, and micro cap funds. It became a Ponzi scheme, a game of musical chairs. The problem was timing.
The music stopped in March of 2000 when CIO's need for new technology dried up coincident with the free money, and the stock market went into the greatest decline since the great depression. The NASDAQ peaked around 5000. Today it hovers around 2500, roughly half what it was 7 years ago.
It was not as if there were no warning signs. Beginning in late 1999, the tech market began to thin out and leadership became concentrated in a few issues. Chief among the group were Cisco, Oracle, Qwest, and a handful of others. Every tech, momentum, and growth fund had those stocks in their portfolio. This was coincident with the smart money selling into the sectors. The money managers were showing their hands if only one could read between the lines. Their remarks were "these stocks are being priced to perfection." They could not find compelling reasons not to own any of these stocks. And so on and on it went.
After 9/11 markets and industries began to collapse. The travel industry became almost nonexistent. Even Las Vegas went on life support. People absolutely refused to fly. Furthermore, business in and around New York City was in deep peril. This forced the Fed to begin dramatically reducing interest rates to reignite the economy. It worked, as corporations began to refinance their debt and restructure loans, etc.
The coincident effect began to show up in the housing industry. Homeowners refinanced their mortgages (yours truly included) and took equity out of their homes. Home-buyers were thirsty for real estate and bought homes as if they would disappear off the earth. For $2000 one could buy an option on a new construction home that would not be finished for a year. "Flipping" became the term du jour. Buy a home in a hot market such as Florida for nothing down and sell it six months later at a much higher price. Real estate was white hot. Closing on real estate was set back weeks and weeks. Sellers had multiple offers on their homes many times in the same day. This came to a screeching halt recently with the gradual rise in interest rates and the mass overbuilding of homes, and the housing industry has slowed dramatically.
Houses for sale now sit on the blocks for nine months or more. Builders such as Toll, KB, and Centex have commented that this is the worst real estate market they have seen in decades. Expansion plans have all but stopped and individuals are walking away from their deposits rather than be upside down in their new home.
Now we have an ebullient stock market that has gone nearly 1000 days without so much as a 2% correction in a day. The longest such stretch in history. What does this portend? Time will tell. Margin debt is now at near all-time highs and confidence indicators are skewed. Yet we hear about trend followers and momentum traders and their success. I find this more than curious. One thing that they ever fail to mention is that momentum trading and trend following does not work very well in a trendless market. I never heard much about trend followers from June 2000 to October 2002. I am certain that this game of musical chairs will end, or at least be temporarily interrupted.
As always, it is the diligent speculator who will be prepared for the inevitable and capitalize upon this event. Santayana once said, "Those who cannot remember the past are condemned to repeat it."
From "A Student:"
Capitalism is the most successful economic system in the history of the world. Too often we put technology up as the main driving force behind capitalism. Although it is true that it has much to offer, there is another overlooked hero of capitalism. The cornerstone of capitalism is good marketing.
The trend following (TF) group of fund managers is a perfect example of good marketing. As most know, the group as a whole has managed to amass billions of investor money. The fund operators have managed to become wealthy through high fees. The key to this success is good marketing not performance. It is a tribute to capitalism.
The sports loving fund manger is a perfect example. All of his funds were negative for 2006 and all but one was negative over the last 3 years! So whether one looks at it from a short-term one year stand point or a three year perspective his investors have not made money. Despite this the manager still made money by the truckload during this period. Chalk it up to good marketing, it certainly was not performance.
The secret to this marketing success is intriguing. Normally hedge funds and CTAs cannot solicit investors nor even publicly tout their wares on an Internet site. The TF funds have found a way around this. There may be a web site which openly markets the 'concept' of TF but ostensibly not the funds. On this site the names of the high priests of TF are repeatedly uttered with near religious reverence. Thus this concept site surreptitiously drives the investors to the TF funds.
One of the brilliant marketing tactics used on the site is the continuous repetition of the open question, "Why are they (TF managers) so rich?" The question is offered as a sophist's response to the real world question as to whether TF makes money. The marketing brilliance lies in the fact that there is never a need to provide factual support or performance records. Thus the inconvenient poor performance of the TF funds over the last few years is swept under the carpet.
Also swept under the rug are the performance figures for once-great trend followers who no longer are among the great, i.e., those who didn't survive. Ditto for the non-surviving funds in this or that market from the surviving trend followers.
Another smart technique is how the group drives investor traffic to its concept site. Every few years a hagiographic book is written which idolizes the TF high priests. It ostensibly offers to reveal the hidden secrets of TF.
Yet after reading the book the investor is left with no usable information, merely a constant repetition of the marketing slogan: How come these guys are so rich? Obviously the answer is good marketing but the the book is moot on the subject. Presumably, the books are meant to be helpful and the authors are true believers without a tie-in in mind. But the invisible hand of self-interest often works in mysterious ways.
In the latest incarnation of the TF book the author is presented as an independent researcher and observer. Yet a few days after publication he assumes the role of Director of Marketing for the concept site. Even the least savvy observer must admit that it is extraordinary marketing when one can persuade the prospect to pay $30 to buy a copy of the marketing literature.
Jason Ruspini adds:
"I attribute much of the success of the selected bigs to being net long leveraged in fixed income and stocks during the relevant periods."
I humbly corroborate this point. If one eliminates long equity, long fixed income (and fx carry) positions, most trend-following returns evaporate.
Metals and energies have helped recently, after years of paying floor traders.
I don't agree with all the points above. For example, the beauty of capitalism is not its puffery, but the efficiency of its marketing and distribution system as well as the information and incentives that the prices provide so as to fulfill the pitiless desires of the consumers. Also beautiful is in the mechanism that it provides for those with savings making low returns to invest in the projects of entrepreneurs with much higher returns in fields that are urgently desired by customers.
I have been the butt of abuse and scorn from the trend followers for many years. One such abusive letter apparently sparked the writer's note. Aside from my other limitations, the trend following followers apparently find my refusal to believe in the value of any fixed systems a negative. They also apparently don't like the serial correlation coefficients I periodically report that test the basic tenets of the trend following canon.
I believe that if there are trends, then the standard statistical methods for detecting same, i.e., correlograms, regressions, runs and turning point tests, arima estimates, variance ratio tests, and non-linear extensions of same will show them.
Such tests as I have run do not reveal any systematic departures from randomness. Nor if they did would I believe they were predictive, especially in the light of the principle of ever changing cycles about which I have written extensively.
Doubtless there is a drift in the overall level of stock prices. And certain fund managers who are biased in that direction should certainly be able to capture some of that drift to the extent that the times they are short or out of the market don't override it. However, this is not supportive of trend following in my book.
Similarly, there certainly has been over the last 30 years a strong upward movement in fixed income prices. To the extent that a person was long during this period, especially if on leverage, there is very good reason to believe that they would have made money, especially if they limited their shorts to a moiete.
Many of the criticisms of my views on trend following point to the great big boys who say they follow trends. To the extent that those big boys are not counterbalanced by others bigs who have lost, I attribute much of the success of the selected bigs to being net long leveraged in fixed income and stocks during the relevant periods.
I have no firm belief as to whether such things as trends in individual stocks exist. The statistical problem is too complex for me because of a paucity of independent data points, and the difficulties of maintaining an operational prospective file.
Neither do I have much conviction as to whether trends exist in commodities or foreign exchange. The overall negative returns to the public in such fields seem to be of so vast a magnitude that it would not be a fruitful line of inquiry.
If I found such trends through the normal statistical methods, I would suspect them as a lure of the invisible evil hand to bring in big money to follow trends after a little money has been made by following them, the same way human imposters work in other fields. I believe that such a tendency for trend followers to lose with relatively big money after making with smaller amounts is a feature of all fixed systems. And it's guaranteed to happen by the law of ever-changing cycles.
The main substantive objection to my views that I have found in the past, other than that trend followers know many people who make money following trends (a view which is self-reported and selective and non-systematic, and thus open to some of the objections of those of the letter-writer), is that they themselves follow trends and charts and make much money doing it. What is not seen by these in my views is what they would have made with their natural instincts if they did not use trend following as one of their planks. This is a difficult argument for them to understand or to confirm or deny.
My views on trend following are always open to new evidence, and new ways of looking at the subject. I solicit and will publish all views on this subject in the spirit of free inquiry and mutual education.
Jeff Sasmor writes:
Would you really call what FUNDX does trend following? Well, whatever they do works.
I used their system successfully in my retirement accounts and my kids' college UTMA's and am happy enough with it that I dumped about 25% of that money in their company's Mutual Funds which do the same process as the newsletter. The MFs are like an FOF approach. The added expense charges are worth it. IMO, anyway. Their fund universe is quite small compared to the totality of funds that exist, and they create classes of funds based on their measure of risk.
This is what they say is their process. When friends ask me what to buy I tell them to buy the FUNDX mutual fund if their time scale is long. No one has complained yet!
It ain't perfect (And what is? unless your aim is to prove that you're right) but it's better than me fumfering around trying to pick MFs from recommendations in Money Magazine, Forbes, or Morningstar.
I'm really not convinced that what they do is trend following though.
Dylan Distasio Adds:
For those who don't believe trend following can be a successful strategy, how would you explain the long-term performance of the No Load Fund X newsletter?
Michael Marchese writes:
In a recent post, Mr. Leslie finished his essay with, "I never heard much about trend followers from June 2000 to October 2002." This link shows the month-to-month performance of 13 trend followers during that period of time. It seems they did OK.
Hanny Saad writes:
Not only is trend following invalid statistically but, looking at the bigger picture, it has to be invalid logically without even running your unusual tests.
If wealth distribution is to remain in the range of 20 to 80, trend following cannot exist. In other words, if the majority followed the trend (hence the concept of trends), and if trend following is in fact profitable, the majority will become rich and the 20-80 distribution will collapse. This defeats logic and history. That said, there is the well-covered (by the Chair) general market upward drift that should also come as no surprise to the macro thinkers. The increase in the general population, wealth, and the entrepreneurial spirit over the long term will inevitably contribute to the upward drift of the general market indices as is very well demonstrated by the triumphal trio.
While all world markets did well over the last 100 yrs, you notice upon closer examination that the markets that outperformed were the US, Canada, Australia, and New Zealand. The one common denominator that these countries have is that they are all immigration countries. They attract people.
Contrary to what one hears about the negative effects of immigration, and how immigrants cause recessions, the people who leave their homelands looking for a better life generally have quite developed entrepreneurial spirits. As a result, they contribute to the steeper upward curve of the markets of these countries. When immigrants are allowed into these countries, with their life savings, home purchases, land development, saving and borrowing, immigration becomes a rudder against recession, or at least helps with soft landings. Immigration countries have that extra weapon called LAND.
So in brief, no - trends do not exists and can not exist either statistically or logically, with the exception of the forever upward drift of population and general markets with some curves steeper than others, those of the countries with the extra weapon called land and immigration.
A rereading of The Wealth And Poverty Of Nations, by Landes, and the triumph of the optimist may be in order.
Steve Ellison adds:
So Mr. Parker's real objective was simply to insult the Chair, not to provide any evidence of the merits of trend following that would enlighten us (anecdotes and tautologies that all traders can only profit from favorable trends prove nothing). I too lack the intelligence to develop a trend following system that works. When I test conditions that I naively believe to be indicative of trends, such as crossovers of moving averages, X-day highs and lows, and the direction of the most recent Y percent move, I usually find negative returns going forward.
Bacon summarized his entire book in a single sentence: "Always copper the public play!" My more detailed summary was, "When the public embraces a particular betting strategy, payoffs fall, and incentives (for favored horsemen) to win are diminished."
Trend Following — Cause, from James Sogi:
Generate a Brownian motion time series with drift in R
MU<-.15*DELTAT;SIG<-.2*sqrt(DELTAT);TIME<-(1:1024)/252 stock<-exp(SIG*RW+MU*TIME) ts.plot(stock)
Run it a few times. Shows lots of trends. Pick one. You might get lucky.
Trend Following v. Buy and Hold, from Yishen Kuik
The real price of pork bellies and wheat should fall over time as innovation drives down costs of production. Theoretically, however, the nominal price might still show drift if the inflation is high enough to overcome the falling real costs of production.
I've looked at the number of oranges, bacon, and tea a blue collar worker's weekly wages could have purchased in New York in 2000 versus London in the 1700s. All quantities showed a significant increase (i.e., become relatively cheaper), lending support to the idea that real costs of production for most basic foodstuffs fall over time.
Then again, according to Keynes, one should be able to earn a risk premium from speculating in commodity futures by normal backwardation, since one is providing an insurance service to commercial hedgers. So one doesn't necessarily need rising spot prices to earn this premium, according to Keynes.
Not All Deer are Five-Pointers, from Larry Williams
What's frustrating to me about trading is having a view, as I sometimes do, that a market should be close to a short term sell, yet I have no entry. This betwixt and between is frustrating, wanting to sell but not seeing the precise entry point, and knowing I may miss the entry and then see the market decline.
So I wait. It's hard to learn not to pull the trigger at every deer you see. Not all are five-pointers… and some will be bagged by better hunters than I.
From Gregory van Kipnis:
Back in the 70s a long-term study was done by the economic consulting firm of Townsend Greenspan (yes, Alan's firm) on a variety of raw material price indexes. It included the Journal of Commerce index, a government index of the geometric mean of raw materials and a few others. The study concluded that despite population growth and rapid industrialization since the Revolutionary War era, that supply, with a lag, kept up with demand, or substitutions (kerosene for whale blubber) would emerge, which net-net led to raw material prices being a zero sum game. Periods of specific commodity price rises were followed by periods of offsetting declining prices. That is, raw materials were not a systematic source of inflation independent of monetary phenomena.
It was important to the study to construct the indexes correctly and broadly, because there were always some commodities that had longer-term rising trends and would bias an index that gave them too much weight. Other commodities went into long-term decline and would get dropped by the commodity exchanges or the popular press. Just as in indexes of fund performance there can be survivor bias, so too with government measures of economic activity and inflation.
However, this is not to say there are no trends at the individual commodity level of detail. Trends are set up by changes in the supply/demand balance. If the supply/demand balance changes for a stock or a commodity, its price will break out. If it is a highly efficient market, the breakout will be swift and leave little opportunity for mechanical methods of exploitation. If it is not an efficient market (for example, you have a lock on information, the new reality is not fully understood, the spread of awareness is slow, or there is heavy disagreement, someone big has to protect a position against an adverse move) the adjustment may be slower to unfold and look like a classic trend. This more often is the case in commodities.
Conversely, if you find a breakout, look for supporting reasons in the supply/demand data before jumping in. But, you need to be fast. In today's more highly efficient markets the problem is best summarized by the paradox: "look before you leap; but he who hesitates is lost!"
Larry Williams adds:
I would posit there is no long-term drift to commodities and thus we have a huge difference in these vehicles.
The commodity index basket guys have a mantra that commodities will go higher - drift - but I can find no evidence that this is anything but a dream, piquant words of promotion that ring true but are not.
I anxiously stand to be corrected.
Marlowe Cassetti writes:
"Along a similar vein, why would anybody pay Powershares to do this kind of work when the tools to do it yourself are so readily available?"
The simple answer is if someone wishes to prescribe to P&F methodology investing, then an ETF is a convenient investment vehicle.
With that said, this would be an interesting experiment. Will the DWA ETF be another Value Line Mutual Fund that routinely fails to beat the market while their newsletter routinely scores high marks? There are other such examples, such as IBD's William O'Neal's aborted mutual fund that was suppose to beat the market with the fabulous CANSLIM system. We have talked about the great track record of No-Load Fund-X newsletter, and their mutual fund, FUNDX, has done quite well in both up and down markets (an exception to the above mentioned cases).
For full disclosure I have recently added three of their mutual funds to my portfolio FUNDX, HOTFX, and RELAX. Hey, I'm retired and have better things to do than do-it-yourself mutual fund building. With 35 acres, I have a lot of dead wood to convert into firewood. Did you know that on old, dead juniper tree turns into cast iron that dulls a chain saw in minutes? But it will splinter like glass when whacked with a sledgehammer.
Kim Zussman writes:
…about the great track record of No-Load Fund-X newsletter and their mutual fund FUNDX has done quite well in both up and down markets… (MC)
Curious about FUNDX, checked its daily returns against ETF SPY (essentially large stock benchmark).
Regression Analysis of FUNDX versus SPY since inception, 6/02 (the regression equation is FUNDX = 0.00039 + 0.158 SPY):
Predictor Coef SE Coef T P
Constant 0.00039 0.000264 1.48 0.14
SPY 0.15780 0.026720 5.91 0.00
S = 0.00901468 R-Sq = 2.9% R-Sq (adj) = 2.8%
The constant (alpha) is not quite significant, but it is positive, so FUNDX did out-perform SPY. Slope is significant and the coefficient is about 0.16, which means FUNDX was less volatile than SPY.
This is also shown by F-test for variance:
Test for Equal Variances: SPY, FUNDX
F-Test (normal distribution) Test statistic = 1.17, p-value = 0.009 (FUNDX<SPY)
But t-test for difference between daily returns shows no difference:
Two-sample T for SPY vs FUNDX
N Mean St Dev SE Mean
SPY 1169 0.00041 0.0099 0.00029
FUNDX 1169 0.00045 0.0091 0.00027 T=0.12
So it looks like FUNDX has been giving slight/insignificant out-performance with significantly less volatility; which makes sense since it is a fund of mutual funds and ETFs.
Even better is Dr Bruno's idea of beating the index by deleting the worst (or few worst) stocks (new additions?).
How about an equal-weighted SP500 (which out-performs when small stocks do), without the worst 50 and double-weighting the best 50.
Call it FUN-EX, in honor of the fun you had with your X that was all mooted in the end.
Alex Castaldo writes:
The results provided by Dr. Zussman are fascinating:
The fund has a Beta of only 0.157, incredibly low for a stock fund (unless they hold a lot of cash). Yet the standard deviation of 0.91468% per day is broadly consistent with stock investing (S&P has a standard deviation of 1%). How can we reconcile this? What would Scholes-Williams, Dimson, and Andy Lo think when they see such a low beta? Must be some kind of bias.
I regressed the FUNDX returns on current and lagged S&P returns a la Dimson (1979) with the following results:
Multiple R 0.6816
R Square 0.4646
Adjusted R Square 0.4627
Standard Error 0.0066
df SS MS F Significance F
Regression 4 0.0444 0.0111 251.89 8.2E-156
Residual 1161 0.0511 4.4E-05
Total 1165 0.0955
Coefficients Standard Error t-Stat P-value
Intercept 8.17E-05 0.000194 0.4194 0.6749
SPX 0.18122 0.019696 9.2007 1.6E-19
SPX[-1] 0.60257 0.019719 30.5566 6E-151 SPX[-2] 0.08519 0.019692 4.3260 1.648E-05 SPX[-3] 0.04524 0.019656 2.3017 0.0215
Note the following:
(1) All four S&P coefficients are highly significant.
(2) The Dimson Beta is 0.914 (the sum of the 4 SPX coefficients). The mystery of the low beta has been solved.
(3) The evidence of price staleness, price smoothing, non-trading, whatever you want to call it is clear. Prof. Pennington touched on this the other day; an "efficiently priced" asset should not respond to past S&P price moves. Apparently though, FUNDX holds plenty of such assets (or else the prices of FUNDX itself, which I got from Yahoo, are stale).
S. Les writes:
Have to investigate the Fund X phenomenon. And look to see how it has done in last several years since it was post selected as good. Someone has to win a contest, but the beaten favorites are always my a priori choice except when so many others use that as a system the way they do in sports eye at the harness races, in which case waiting for two races or two days seems more apt a priori. VN
I went to the Fund X website to read up, and the information is quite sparse. It is a very attenuated website. I called the toll free number and chatted with the person on the other line. Information was OK, but, in my view, I had to ask the proper questions. One has several options here. One is to purchase the service and do the fund switching themselves based on the advice of their experts. The advisory service tracks funds that have the best relative strength performance and makes their recommendations from there, www.fundx.com.
Another is to purchase one of four funds available. They have varying levels of aggressiveness. Fund 3 appears to be the recommended one.
If one purchases the style 3 one will get a very broad based fund of funds. I went to yahoo to look up the holdings at www.finance.yahoo.com/q/hl?s=FUNDX.
Top ten holdings are 47.5% of the portfolio, apparently concentrated in emerging markets and international funds at this time.
In summary, if money were to be placed into the Fund X 3 portfolio, I believe it would be so broad based and diversified that returns would be very watered down. Along with risk you would certainly be getting a lot of funds. You won't set the world on fire with this concept, but you won't get blown up, either.
Larry Williams adds:
My 2002 book, Right Stock at the Right Time, explains such an approach in the Dow 30. The losers were the overvalued stocks in the Dow.It is a simple and elegant idea…forget looking for winners…just don't buy overvalued stocks and you beat the idex.
This notion was developed in 1997, when i began actually doing it, and written about in the book. This approach has continued to outperform the Dow, it is fully revealed.
Craig Cuyler writes:
Larry's comment on right stock right time is correct and can be used to shed a little bit of light on trend following. This argument is at the heart of fundamental indexation, which amongst other points argues that cap weighting systematically over-weights overvalued stocks and under-weights undervalued stocks in a portfolio.
Only 29% of the top 10 stocks outperformed the market average over a 10yr period (1964-2004) according to Research Affiliates (this is another subject). The concept of "right stock right time" might be expressed another way, as "right market right time." The point is that constant analysis needs to take place for insuring investment in the products that are most likely to give one a return.
The big error that the trend followers make, in my mind, is they apply a homogeneous methodology to a number of markets and these are usually the ones that are "hot" at the time that the funds are applied. The system is then left to its own devices and inevitably breaks down. Most funds will be invested at exactly the time when the commodity, currencies, etc., are at their most overvalued.
Some worthwhile questions are: How does one identify a trend? Why is it important that one identifies a trend? How is it that security trends allow me to make money? In what time frame must the trend take place and why? What exactly is a trend and how long must it last to be so labeled?
I think it is important to differentiate between speculation using leverage and investing in equities because, as Vic (and most specs on the list) point out, there is a drift factor in equities which, when using sound valuation principles, can make it easier to identify equities that have a high probability of trending. Trend followers don't wait for a security to be overvalued before taking profits. They wait for the trend to change before then trying to profit from the reversal.
Jeff Sasmor adds:
As a user of both the newsletter and the FUNDX mutual fund I'd like to comment that using the mutual fund removes the emotional component of me reading the newsletter and having to make the buys and sells. Perhaps not an issue for others, but I found myself not really able to follow the recommendations exactly - I tend to have an itchy trigger finger to sell things. This is not surprising since I do mostly short-term and day trades. That's my bias; I'm risk averse. So the mutual fund puts that all on autopilot. It more closely matches the performance of their model portfolio.
I don't know how to comment on the comparisons to Value Line Arithmetic Index (VAY). Does anyone follow that exactly as a portfolio?
My aim is to achieve reasonable returns and not perfection. I assume I don't know what's going to happen and that most likely any market opinion that I have is going to be wrong. Like Mentor of Arisia, I know that complete knowledge requires infinite time. That and beta blockers helps to remove the shame aspect of being wrong. But there's always an emotional component.
As someone who is not a financial professional, but who is asked what to buy by friends and acquaintances who know I trade daily (in my small and parasitical fashion), I have found that this whole subject of investing is opaque to most people. Sort of like how in the early days of computing almost no one knew anything about computers. Those who did were the gatekeepers, the high priests of the temple in a way. Most people nowadays still don't know what goes on inside the computer that they use every day. It's a black box - opaque. They rely on the Geek Squad and other professionals to help them out. It makes sense. Can't really expect most people to take the time to learn the subject or even want to. Should they care whether their SW runs on C++ or Python, or what the internal object-oriented class structure of Microsoft Excel is, or whether the website they are looking at is XHTML compliant? Heck no!
Similarly, most people don't know anything about markets; don't want to learn, don't want to take the time, don't have the interest. And maybe they shouldn't. But they are told they need to invest for retirement. As so-called retail investors they depend on financial consultants, fee-based planners, and such to tell them what to do. Often they get self-serving or become too loaded with fees (spec-listers who provide these services excepted).
So I think that the simple advice that I give, of buying broad-based index ETFs like SPY and IWM and something like FUNDX, while certainly less than perfect, and certainly less profitable than managing your own investments full-time, is really suitable for many people who don't really have the inclination, time, or ability to investigate the significant issues for themselves or sort out the multitudes of conflicting opinions put forth by the financial media.
You may not achieve the theoretical maximum returns (no one does), but you will benefit from the upward drift in prices and your blended costs will be reasonable. And it's better than the cash and CDs that a lot of people still have in their retirement accounts.
BTW: FOMA = Foma are harmless untruths, intended to comfort simple souls.
An example : "Prosperity is just around the corner."
I'm not out to defend FUNDX, I have nothing to do with them. I'm just happy with it.
Steve Ellison writes:
One might ask what the purpose of trends is in the market ecosystem. In the old days, trends occurred because information disseminated slowly from insiders to Wall Streeters to the general public, thus ensuring that the public lost more than it had a right to. Memes that capture the public imagination, such as Nasdaq in the 1990s, take years to work through the population, and introduce many opportunities for selling new investment products to the public.
Perhaps some amount of trending is needed from time to time in every market to keep the public interested and tossing chips into the market. I saw this statement at the FX Money Trends website on September 21, 2005: "[T]he head of institutional sales at one of the largest FX dealing rooms in the US … lamented that for the past 2 months trading volume had dried up for his firm dramatically because of the 'lack of trend' and that many 'system traders' had simply shut down to preserve capital."
I saw a similar dynamic recently at a craps table when shooters lost four or five consecutive points, triggering my stop loss so that I quit playing. About half the other players left the table at the same time. "The table's cold," said one.
To test whether a market might trend out of necessity to attract money, I used point and figure methodology with 1% boxes and one-box reversals on the S&P 500 futures. I found five instances in the past 18 months in which four consecutive reversals had occurred and tabulated the next four points after each of these instances (the last of which has only had three subsequent points so far). The results were highly non-predictive.
Starting Next 4 points
Date Continuations Reversals
01/03/06 3 1
05/23/06 1 3
06/29/06 2 2
08/15/06 2 2
01/12/07 1 2
Anthony Tadlock writes:
I had intended to write a post or two on my recent two week trip to Cairo, Aswan, and Alexandria. There is nothing salient to trading but Egypt seems to have more Tourist Police and other guards armed with machine guns than tourists. It is a service economy with very few tourists or middle/upper classes to service. Virtually no westerners walk on the streets of Cairo or Alexandria. I did my best to ignore my investments and had closed all my highly speculative short-term trades before leaving for the trip.
While preparing for taxes I was looking over some of my trades for last year. Absolute worst trade was going long CVS and WAG too soon after WalMart announced $2 generic pricing. I had friends in town and wasn't able to spend my usual time watching and studying the market. I just watched them fall for two days and without looking at a chart, studying historical prices and determining how far they might fall, decided the market was being stupid and went long. Couldn't wait to tell my visitors how "smart" a trader I was and my expected profit. It was fun, until announcement after announcement by WalMart kept causing the stocks to keep falling. The result was panic selling near the bottom, even though I had told myself before the trade that I could happily buy and hold both. Basically, I followed all of Vic's rules on "How to Lose."
Trends: If only following a trend meant being able to draw a straight line or buy a system and buy green and sell red. The trend I wrote about several months ago about more babies being born of affluent parents still seems to be intact. I have recently seen pregnant moms pushing strollers again. Planes to Europe have been at capacity my last two trips and on both trips several crying toddlers made sleep difficult, in both directions. Are people with young children using their home as an ATM to fund a European trip? Are they racking up credit card debt that they can't afford? Depleting their savings? (Oh wait - Americans don't save anything.) If they are, then something fundamental has changed about how humans behave.
From James Sogi:
My daughter the PhD candidate at Berkeley in bio-chem is involved in some mind-boggling work. It's all very confidential, but she tried to explain to me some of her undergrad research in words less than 29 letters long. Molecules have shapes and fit together like keys. The right shape needs to fit in for a lock. Double helices of the DNA strand are a popular example, but it works with different shapes. There is competition to fit the missing piece. They talk to each other somehow. One of her favorite stories as a child was Shel Silverstein's Missing Piece. Maybe that's where her chemical background arose. Silverstein's imagery is how I picture it at my low level.
Looking at this past few months chart patterns it is impossible not to see the similarity in how the strands might try fit together missing pieces in Wykoffian functionality. The math and methods must be complicated, but might supply some ideas for how the ranges and strands in the market might fit together, and provide some predictive methods along the lines of biochemical probability theory. I'll need some assistance from the bio-chem section of the Spec-list to articulate this better.
From Kim Zussman:
Doing same as Alex Castaldo, using SPY daily change (cl-cl) as independent and FUNDX as dependent gave different resluts:
Regression Analysis: FUNDX versus SPY ret, SPY-1, SPY-2
The regression equation is FUNDX = 0.000383 + 0.188 SPY ret - 0.0502 SPY-1 - 0.0313 SPY-2
Predictor Coef SE Coef T P
Constant 0.000383 0.00029 1.35 0.179
SPY ret 0.187620 0.03120 6.01 0.000* SPY-1 -0.050180 0.03136 -1.60 0.110 SPY-2 -0.031250 0.03121 -1.00 0.317 *(contemporaneous)
S = 0.00970927 R-Sq = 3.2% R-Sq (adj) = 3.0%
Perhaps FUNDX vs a tradeable index is the explanation.
December 1, 2006 | Leave a Comment
It is interesting that there is no comment on currencies with respect to the dollar. Are there any specs that trade currency?
For months the dollar vs. G7 has been at vol. lows with very little activity. Just as the so called “experts” like BCA and Goldmans for example, started putting forth dollar bullish views, and the COT data analysis started showing that specs were record long EUR and GBP … and just as technicians were pointing out that the Dollar Index was at 10 year lows and should bounce, and the fundamentalists were pointing out that with economic growth slowing around the world the dollar would strengthen because it is a counter-cyclical currency … just as all this evidence was on balance pointing to the probability of the dollar strengthening — it then breaks out, giving us the strongest move in years from the GBP, which is making 15yr highs.
I wonder if the much talked about central bank diversification is not taking place (United Arab Emirates for example still has 98% of its reserves in USD, yet has targeted a 50% USD holding), and if currencies like the GBP are quietly becoming the new safe havens.
With vol. picking up and the outlook for rate cuts in the US to begin in June, the carry traders must be feeling pretty uncomfortable. So too the ‘commercials’ who have been buying dollars since April this year. The Fed fund futures are now pricing in a 70% probability of three .25% rate cuts starting in June next year. One of the more interesting currencies right now is the CAD which is weakening along with the dollar. This has got to do with the US government’s decision to change the taxation policies on Canadian Trusts. This will manifest itself in CAD weakness, as billions will now flow back out of these trusts to wherever they came from.
Larry Williams answers:
I trade the dollar index as well as currencies. There have been several great plays in the current market. The easiest is to be long the Australian Dollar or British Pound against the Swiss Franc or Japanese Yen.
Commercial activity and seasonals have a heavy influence in these markets… at least that is how I see it.
November 14, 2006 | Leave a Comment
I received a book recommendation from Stefan Jovanovich who, like Jim Sogi, utters something of profundity whenever he speaks. He recommends historical books by Peter Green and J. S. Holliday as models of good scholarship. I call on him and others for some good historical books that I can read and augment my library with and share with my children, who are studying history in school, and regrettably have been brainwashed by politically correct curricula, starting with Squanto as the archetypical American hero.
I recommend the book Lessons of History by Will Durant as well worth reading for its lessons on markets as well as a honest attempt to review the lessons from a life long study of the sweep of history in conjunction with this request.
Alston Mabry replies:
Inventing America is a textbook that has an interesting approach and might be an alternative for homeschoolers:
Book Description; W. W. Norton presents Inventing America, a balanced new survey of American history by four outstanding historians. The text uses the theme of innovation–the impulse in American history to “make it new”–to integrate the political, economic, social, and cultural dimensions of the American story. From the creation of a new nation and the invention of the corporation in the eighteenth century, through the vast changes wrought by early industry and the rise of cities in the nineteenth century, to the culture of jazz and the new nation-state of the twentieth century, the text draws together the many ways in which innovation-and its limits-have marked American history.
Some other longtime favorites are The Making of the Atomic Bomb by Richard Rhodes, The Devil’s Horsemen: The Mongol Invasion of Europe by James Chambers, and King Harald’s Saga: Harald Hardradi of Norway: From Snorri Sturluson’s Heimskringla by Snorri Sturluson. You can get the wiki overview here, but the saga itself is a quick read and an amazing story.
Another audio book I have thoroughly enjoyed listening to on cross-country drives is Simon Schama’s A History of Britain. The audio book is in 3 volumes. Schama, a professor at Columbia, is such an excellent storyteller that I would pick up anything he has written. The television series of the same name is also available on DVD and is outstanding.
Stefan Jovanovich replies:
Simon Schama has the gift of charisma. When you watch his narration of the video documentary of the History of Britain, you are instantly aware of it. The trouble is that his histories are not to be trusted. At their worst they are little more than royalist propaganda. Too often he writes the story that the Queen would like to read, not the one that happened. Even though Cromwell was the first head of the United Kingdom to allow Jews to openly practice their religion, Schama finds the Great Protector to be a far greater villain than any of the crowned heads who so routinely persecuted the children of Israel. He is equally severe in his criticisms of those greedy speculators of the Dutch Republic who left Spinoza free to grind his lenses; in Schama’s eyes, those Dutch Reform bigots were guilty not only of inventing capital markets but also of buying too much stuff. The common thread in Schama’s works is the notion that sectarian Christians, with their notions of free markets, are to be feared as dangerous, greedy fanatics who will upset the natural order of the world. The meme continues with Rough Crossings. Schama makes a great deal of the fact that the British offered freedom to slaves who would join the Royalist forces in fighting Washington’s Army while failing to note that the Confederates ended their struggle with the same concession to the dire necessities of war. In general, Schama finds the Christian deism of the slave owning signers of the Declaration of Independence proof of their hypocrisy and, by extension, that of the American nation as a whole. The fact that, for another half century, neither the Archbishops of Canterbury nor the Kings of England had any problem with sanctioning and enforcing slavery in their remaining territories is somehow put aside. So are the origins of the anti-slavery movement in both England and America (those dreadful Methodists). The nearly two centuries old Anglo-American naval alliance (the longest-lived military confederation between democracies in recorded history) had its origins in the anti-slavery patrols off West Africa by both fleets that began in the 1820s. Those were initiated as a political concession in both countries to those same cross-bearing nutballs who thought that the “common” people should have the right to vote even if they did not own a carriage. Ain’t history grand?
Tom Ryan suggests:
Daniel Boorstin’s three books, The Americans, written before 1973, provide a refreshing take on American history in my opinion. I recommend the third in the series, “The Democratic Experience”, which covers the 1870-1970 period in American History. It is unconventional in the sense that it focuses on the stories of the individuals who built, invented, and created this country, the untold stories of the individuals as it were, rather than the typical history of Washington political leadership that is regularly fed to children in grades 4-12.
Steve Ellison adds:
I highly recommend British historian Paul Johnson’s A History of the American People, which goes into detail on many topics, including the relentless economic growth that occurred almost from the outset. A small sample:
By the third quarter of the 18th century America already had a society which was predominantly middle class. The shortage of labor meant artisans did not need to form guilds to protect jobs. It was rare to find restriction on entry to any trade. Few skilled men remained hired employees beyond the age of twenty-five. If they did not acquire their own farm they ran their own business.
Rodger Bastien responds:
I just completed Rubicon: The Last Years of the Roman Empire by Tom Holland. I highly recommend this historical narrative of the final days of the Republic which deals with primarily the years 100 B.C. to 14 A.D. For me, the book brought to life this period which I knew little about but was arguably as important to subsequent civilizations as any period before or since. Caesar, Marc Antony and Cleopatra may have existed centuries ago, but to me those centuries somehow feel a little shorter.
Gibbons Burke replies:
I am finding I am enjoying first-person narrative accounts of historical events and times, so, with that in mind:
- Sufferings in Africa: The Astonishing Account of a New England Sea Captain Enslaved by North African Arabs by Captain James Riley
- Exploring the Colorado River: Firsthand Accounts by Powell and His Crew by John Wesley Powell
- Life on the Mississippi by Mark Twain
and one that’s not a first person, but which is fascinating and has many meals:
- Salt: A World History by Mark Kurlansky
John O’Sullivan replies:
I recommend two books by Anthony Beevor: Stalingrad and The Fall of Berlin 1945. Both mesh grand strategy with individual detail and amazing narrative momentum. I also like three Middle & Far Eastern travelogue/history/biographies by William Dalrymple : Xanadu, From the Holy Mountain and White Mughals. Dalrymple has created his own genre and its a rich mix.
MacNeil Curry replies:
I would have to recommend Bury My Heart at Wounded Knee: An Indian History of the American West. Not only is it a fascinating account of the West from a different perspective, but it highlights quite well that there are two sides to every story and that both must be carefully studied before one can truly come to there own conclusion.
Tyler McClellan replies:
Speaking of John Wesley Powell, Beyond the Hundredth Meridian: John Wesley Powell and the Second Opening of the West by Wallace Stegner is a book with many practical lessons for investing and life that used to be required reading for the history of the American West.
Craig Cuyler replies:
My favourite historical novels are without doubt the three part trilogy by Neil Stevenson called the Baroque Cycle. This body of work, over 2500 pages long, covers life in 17th-century in England, Europe, Russia with special reference to natural philosophy & science. Stevenson weaves in his ideas about currency, calculus in speculation which took place around the central characters like Isaac Newton, Huygens, Hook, Leibniz. The courts of Louis XIV in the battle for the monarchy in England feature strongly. The Baroque Cycle is to science what the Lord of the Rings is to fantasy. Fantastic read!
To me the most significant lesson of recent international military undertakings has been how a country's taking action risks sacrificing what that country previously enjoyed in the power, reputation and deterrence of potential action.
For example, going back to the 1967 and 1973 wars, the Israeli military had the reputation of being unbeatable by its Arab neighbors. This gave Israel very valuable deterrent protection against its hostile, far more populous enemies.
But when Israel launched a major attack on Hezbollah in Lebanon and was unsuccessful in that Hezbollah was able to fight it to a draw, major damage was done to Israel's military reputation and deterrent power. Israel is now far more vulnerable to attack by hostile neighbors and by major terrorist organizations. With the benefit of hindsight, Israel should never have risked its reputation and deterrent power in a voluntary war unless it was virtually certain of prevailing and thus keeping its reputation for invulnerability and deterrence in effect.
Similarly, after the First Gulf War, the bombing campaign in Bosnia and the impressive early destruction of the Taliban in Afghanistan, the US had an awesome reputation of being the world's sole superpower, with virtually unlimited high tech military power several orders of magnitude above that of any other country.
But for the US to undertake a major invasion of Iraq that turns out unsuccessful, to become bogged down in a losing war against militarily unimpressive enemies, has done incalculable damage to the US's ability to cow hostile nations with its military potential. Again with the benefit of hindsight, the US should have thought long and hard about risking the unparalled military reputation and deterrent strength it enjoyed.
Now that the US's perceived military strength and ability to deter is far less, Iran can do what it wants in developing nuclear weapons and funding/arming Hezbollah, and even North Korea can feel pretty safe in its provocations. The degraded military reputation of the US also gives it far less ability to influence Russia and China to help with Iran and North Korea. And Russia can also feel free to strongarm our ally Georgia (the country, not the state) with little or no complaint from the US.
(I am not dealing here with the question, moral or libertarian, of whether the US should be attempting to deter or influence other countries. Only with the question that if it wants to, whether it has the power to do so.)
Finally, the relevance to investing of giving up the power of potential is, I believe, tenuous. It is true that when one moves from cash to a committed investment not easy to sell, one loses the potential to invest in other things or to remain in cash. But there is no reputation or deterrent value that one is giving up, since stocks and other investments are not capable of being threatened or deterred. (Except perhaps in rare cases where an extraordinarily rich investor like Icahn or Kirkorian is threatening to buy a massive amount of a company's stock if the company refuses to do what he wants.)
Prof. Marion Dreyfus replies:
A deterrent power that is never invoked, on the other hand, becomes a straw man, and ankle-biters will proceed to a series of provocations to test the level of tolerance of that so-called massive deterrent potential. Israel had been repeatedly provoked by thousands of Kassams and Katyushas against northern cities, and precisely how many thousands of incursions it can sustain is not an exact science. Nor is it in her interests to permit little gangrenous groups to pick off her soldiers and murder them at will.
This leaves out the concomitant scandalousness of the unpreparedness of the IDF. Both in terms of tank platoons and soldiers guarding the perimeter, there was a feebleness of deployment that stuns most of us familiar with the power of the IDF. A major contributor to the lack of overwhelming force and the triumph of the IDF, too, was the constant effort to save civilians, which is no way to win a war against soulless automata. had the Israelis conducted the war in the way most nations would and do, it would have won inside of a week.
Craig Cuyler replies:
These points could also be related directly to proper means of speculation, ballyhoo deflation and scientific method in trading. The US government has ignored almost every rule of proper speculation and here are just a few off the top of my head:
1. The US got itself into a war based on spurious correlations (the link between Bin Laden and Hussein)
2. Hindsight bias (Bush snr's previous Iraqi war in which the US came out relatively unscathed with its reputation intact)
3. Data mining (the Hunt for WMD's and the Yellow Cake uranium from Niger, both which didn't exist)
4. The doomsday scenario (pre-emptive attack on Iraq would prevent further attacks on US) - Iraq was never going to attack the US it didn't have the means,
5. Trading on tips and unsubstantiated rumours (the US being conned by Big Oil and others with their own agenda),
6. Trading with too much leverage and no risk management (how long can the taxpayer pay for this mess in Iraq, how many more innocent people on both sides must die before the stop loss is hit?).
As Dan says, the situation has weakened America's military position and standing in the global community and the direct beneficiaries are the Iranian Mullahs and psycho's like Kim Jong Ill who are now emboldened to develop their own nuclear arsenals. This is similar to when hedge funds like Amaranth get themselves into trouble and the market knows that it can press its advantage until the protagonist capitulates - this is what Iran, Jordan, Hezbollah, Taliban, North Korea and others will do. When an investor or a speculator puts on a trade for the above reasons there can be only one outcome - failure!
Stefan Jovanovich responds:
The 1973 war (what the Israelis call the "Yom Kippur War" and their opponents call the "Ramadan" or "October" War) was the worst crisis in Israeli military history. Within the first week the Egyptians crossed the Suez Canal and breached the Bar-Lev fortifications in what was probably the greatest feat of Moslem arms since the Turkish defense at Gallipoli. The Bar-Lev fortifications had cost $500 Million (in today's dollars roughly 1/3rd of the 2007 Israeli defense budget) but they were breached with water cannons, rubber rafts and hand-carried weapons and the battalion holding them was effectively wiped out. There are other details of the war that match the failure of the Bar-Lev line, but it is enough to note that, immediately after the war was over, a special commission headed by Chief Justice Shimon Agranat of the Israeli Supreme Court was appointed to investigate "why Israel had been caught by surprise and why so much had gone wrong during the war itself". The commission's report, completed in January 1975, was highly critical of the performance of the IDF on several levels, including intelligence gathering, discipline within the ranks, and the mobilization of reserves. Among the facts in the report was the disclosure that the IDF needed the emergency airlift of $1 billion of ammunition (in 1973 dollars) from the United States to avoid literally running out of bullets. To gain a proper sense of the scale of this potential disaster, it is useful to know that the entire cost of the war for the Israelis was $5 billion. (One of the bitter reflections that we Viet Nam veterans try to avoid considering is whether the 1975 Democratic Congress would failed to fund the reinforcement of the IDF as cavalierly as they refused to resupply the ARVN.) The Yom Kippur War ended the political future of Moshe Dayan. Ariel Sharon was lucky enough to have retired as commander of the Southern front 3 months before the war began. Had he remained in command, he, too, would have seen the end of his career as a figure in Israeli politics.
The tactical difficulties the IDF experienced against Hezbollah have a great deal in common with the mistakes of the Yom Kippur war. The Israelis badly underestimated the usefulness of anti-tank weapons against infantry (most of the IDF casualties were from blast and shrapnel, not bullet wounds) just as the IDF underestimated the lethality of Sagger missiles.
As for American bombing in Bosnia (sic) (the air strikes were in Serbia proper), the American after-action reports are almost sarcastic in their assessments. The Serbs, displaying their native criminal ingenuity, managed to shoot down an F-15 using cell phones and 1970s-era Soviet missiles. The USAF was unable to even "bounce the rubble" since most of the "targets" destroyed in Kosovo turned out to have been decoys. The U.S. Army had to wait a month to cross the Danube while the combat engineers (not under fire) rebuilt the bridges. When they finally made it across, they discovered (surprise, surprise) that their M1A1s were too heavy for the roads. The war ended General Wesley Walker's military career and began his political one.
Fortunately, both the IDF and the U.S. armed forces have learned from their mistakes and will continue to do so. The wars being fought in Iraq and Lebanon (yes, it is still going on) have taught both militaries that tactical intelligence can no longer sit even at the brigade level; it has to be down at battalion and even company level. Both militaries have also learned that they have to have the ability to jam enemy electronic signals not just in the air but at the street corner level. These are revolutions in military affairs comparable to the development of armor and automatic weapons.
To conclude that "US's (and, I presume, Israel's) perceived military strength and ability to deter is far less" is to go against all the known facts of what those countries' enemies are actually doing. Both the Russians and Chinese are working as fast as they can to abolish conscription and reduce overall troop strengths. Both have effectively conceded to the Americans permanent air and space superiority by ending their next generation fighter programs. The field strength of Hezbollah, Al Qaeda, Taliban and the Baathists has been reduced to the level of banditry and local thuggery, and their internal documents speak of reduced levels of financial and military support and, in some cases, of outright despair. Their only hope is to win the battle of CNN.
I can go on, but what would be the point. That the New York Times and Washington Post and CNN remain unaware of what is actually going on in the Middle East and East Asia is hardly surprising, given the fact that their correspondents no longer spent any time in the field but leave that to their native stringers. That members of the list continue to retail the daily "everyone knows" historicisms of the "authoritative press" is disappointing.
Laurence Glazier replies:
More than 20 years ago, I remember reading media assessments that Israel was unlikely to survive more than a few years. I think this is still a good case to be contrarian. Other things being equal, Israel is and will even more so be one of the economic powerhouses of the present century.
There are — as ever — challenges.
Aumann may shine in game theory and bible code analysis but Buffett gets the nod in buy and hold.
J. Klein replies:
It was not only media assessment. 30 years ago I bought land in Israel, and all my friends advised against it, Israel couldnt last, too much risk, what a meshugge thing to do. It turned out to be a hit, by far.
Israel government has announced that it is planning a second wave of settlement erradication. The idea is to cut ourself free from our turbulent, violent, suicidal, no-good neighbors by a good fence. It is only expectable that Prof. Aumann, a believer, would argument against it, since we are giving up land aka Promised Real Estate.Nobel Prize does not make him a prophet, and less so in his hometown.
October 11, 2006 | 1 Comment
Just as books like The Godfather teach us that an individual in his different roles can be very good or bad, like the Don's being so good with the grandchildren, but willing to kill you for a dime without a trial, the rednecks can be very good in one role and very bad in another. I know of a man whose views on things are as bigoted as those of the rednecks — yet he is a very good fisherman, always willing to share his catch with you, and would give you his views on the market without any charge or a hamburger for free if you were hungry and drove to his store. I found the same kind of people as the rednecks on the juries I have had the displeasure of facing. They all have relatives who are policeman or firemen, and you can't ever expect them to decide against the authority of the police. At a more fundamental level, the average person, the average G-d fearing, quarter acre owning, two child parent, high school educated, 40 years old, earning $40,000, has more common sense and compassion than the average prince of Wall Street because he has participated in a series of voluntary mutually beneficial transactions that have taught him that life is benevolent.
Craig Cuyler replies:
Your point reminds me of something I read once that said "the qualities that make you a good businessman are the same that make you a bad human being and vice versa."
Through various friends of mine and work I have come into contact (as am sure most of you have) with quite a few people worth in the hundreds of millions of dollars and the one common trait that they seem to share is their lack of real friends. I've often been to these people's homes for birthdays, New Years, Christmas parties, etc. and they don't seem to have a close circle of friends other than the ones that they have become acquainted with in the last year or two. Most of the so-called average people that I know have large circles of close friends that they have known for years. I don't know if your experiences are the same but is something that my friends and I have often commented on.
Dr. Kim Zussman responds:
To borrow from another scientist, true friendship is an asymptote. The best illustration of this was my friend Mr. Clean (the tarantula), who died without ever issuing a nasty bite with his quarter inch fangs.
Another relation is |F(T)| = 1/$. The absolute value of true friends is inversely proportionate to your net worth (hasten to note this conclusion from too little n, but in that depicted net can be easily conned, you can test the affected sycophancy).
J. T. Holley responds:
My PaPa passed away in 1995 at the age of 98. He lived in a house that he built himself. The only running water was the kitchen sink. The outhouse was conveniently downhill 50 yards from the house and downstream from the creek that ran beside it. He had a Barn that had twelve bear hides on its outside with turkey claws hanging from the tin roof and had every tool known to man inside for survival. There was a cellar underneath the house that had a blacksnake named "Jake" that guarded canned goods and potatoes from rats, mice and men. He didn't have a high school education and never possessed a driver's license in his life. This aside he was probably the closest thing to a true scientist and empiricist that I've met in my life thus far with his handwritten notes, journals, calendars and such. He taught me to trap, hunt, fish and have a love and passion for NASCAR, football, John Deere, Remington, Buck knives and that life wasn't fair and you have to be tough, callous, persistent, and independent in all endeavors to succeed. Knowing my rural upbringing I feel qualified in making a few points about rednecks:
1. There's a lot more of them than you and it's easier for them to become like you than for you to become like them.
2. They really don't care for your opinion or how you do things.
At the same time my PaPa passed away I was ironically knee deep in textbooks teaching me of Plato's "allegory of the cave", Kierkegaard's "stages of life's way", Sartre's "existence precedes essence", Thoreau's "men live lives of quiet desperation", Plato's "mixed metals", and Heidegger's concept of throwness (pure choice except parents and death). Having that deep rooted upbringing and the benefit of a liberal arts education I can tell you the following:
"You are outside the cave, not everyone is. Just because you've chosen to advance your life along the way doesn't mean everyone else has and remain still inside the cave. They like being aesthetes and have not seen the need for logic, ethics, religion, and empiricism at the levels you choose. In their bliss they don't understand that they are suffering just like you are, and realized that they can choose like you choose and decide on a daily basis. For some reason we are all different but yet the same. The fact remains that we are here and that eventually we aren't going to be here anymore at some point. This bothers you more than them and you create value and meaning to cope and deal with your existence just as they strongly hold on to their essence, but this doesn't necessarily make you better than those in the cave when it comes to survival."
One thing that I've learned is the fact that nobody cares about your new found skills of countin' except a handful of people on this List. My wife doesn't care about "normal distributions", my Dad doesn't ever want me to utter the word "heteroskedasticity" in another conversation while playing checkers, while sitting watching football with friends don't ever mention that West Coast offense's edge is being "arb'd away" due to the "law of everchangin' and the adaptation of Defensive Coordinators, "randomness" is something that most people use as a creed, but the most, most, most ever importance is make sure that you and your Mom are on the same page when the words "Fat Tail" come rolling off your lips.
For those wishing to further their understandings on the topic of rednecks, simpletons, the "common man" located predominately in the South or at least having roots traced there, I would strongly suggest reading every single book in the Foxfire trilogy. These books are both educational and give tons of insights into the world of Speculation.
The other important thing is that rednecks or Southerners have a great "dumb act"; Vic conveniently pointed this out to me when I first gave him an "Awe shucks" comment. This is something I can't shake and to even "appear intelligent" is that which makes me feel naked and nauseated. Deception comes in all shapes and sizes.
As Larry remarks, most markets are very different from each other and to take this further so are most time periods. One of the biggest mistakes traders make is that they assume markets are homogenous or they assume that what works well in one market should work well in another.
What works well for one day or for one hour can be completely different for another day or hour in the same market. Daily range can also be deceptive. To assume that a market that has a high daily range is a market that trends is also false. Markets with low volatility often trend better than ones with high volatility. Daily range and its implications also work very differently in certain markets like currencies which trade 24 hours a day. How significant is the range in Asian time of Dollar/Euro? Many commodities like gold for example also trade virtually 24hrs a day but the futures are only open for a few hours. Concepts like average true range take the day open to previous day high and low, and average these, so some specs prefer this measure.
What is a trend exactly and how long must it last to be labeled a trend? A trend is defined as "a general direction" of something. More specifically it is defined by market technicians as the general direction of the market. In the classic book Technical Analysis of the Financial Markets by John J. Murphy he states that a trend has three directions. Herein lies the first contradiction. The three directions are up, down and sideways according to the well respected Mr. Murphy and he states that most people think of trends as either up or down, however the markets spend at least a third of their time in a sideways trend. If a market is moving sideways is it then a trend? How is the word "sideways" compatible with the word "trend"? Most technical analysis uses tools that try and identify a trend, try to identify the breakout of a trend or try and identify the end of a trend. Even if there was a clear cut rule based definition of a trend (a solid testable hypothesis) and one could somehow magically know when a given market w as trending, there still would not be any guarantee that you would make money. This is because a trader needs more information that just the direction of a market even though the choices are really up or down. A lot of the material on the spec list deals with these facts about markets. Speculating involves many aspects like leverage, time frame, risk vs. reward, timing, short term events, stop losses and many other short term factors that could wipe out ones funds very quickly if not taken into account.
All these factors need cognizance if one is to successfully trade a trend, because as Mr. Murphy has stated they (trends) are not always present. It is precisely the times when they are not that trend followers lose severely because it is at these times that inevitably their positions will be the largest.
Most people assume that a daytrader is a guy losing his $10,000 account in CMGI, who will have to go back to moving refrigerators for a living. Sadly, that is not too far from the truth for a guy running his own money, given time, using any investment approach.Another reason for the negative reaction is jealousy. It makes people green with envy to imagine a guy taking down mid six figures while working four hours a day in his pajamas from home.
But the reaction that I respect, is the more experienced traders who recognize that there are size limits to daytrading and that if one wants to play in the big leagues one has to develop a higher level of sophistication, no matter how successful one may be as a daytrader. These same experienced souls recognize how easy it is for a guy running his own money to destabilize when the market changes and crash and burn.
My professor, who was at Solly when it was Solly and was the fourth guy at LTCM, looked at my resume and my sheets and told me that I had the worst resume he had ever seen (after 10 years of daytrading) and that I needed to get beyond daytrading because if I was not careful I would be 40 when cash equities went away and then I would be a greeter at Wal-Mart.
Of course the flip side is that for many of the investment/trading guys out there who are not doing something as 'easy' as daytrading to make a living, their 'sophistication' is just a crutch to hide behind as they will under perform indexing year after year.
The bottom line is that dollars are green and if you have got the nerve to do it on your own and can do it, then you can write your own ticket and live the way you want to live. As has been well discussed on the list, money doesn't buy happiness once one can pay the bills, so it is mostly the intellectual challenge that should push any successful daytrader into the 'big leagues.'
Nat Stewart comments:
In the 1990s and 2000s some on the sidelines missed opportunities and were afraid to take a chance. They often now manifest their impotence in hatred for those who shoot for a dream and are willing to assume risk. The day trader phenomenon of the late nineties created a mass mob of little Abelsons, waiting for the fall and relishing the reports of young upstarts getting their comeuppance.
Yishen Kuik adds:
In the late 1990s thousands of otherwise unremarkable young people were making a great deal of money as day traders. Public knowledge of this was fairly widespread — perhaps you recall the television ad where stock trading Junior lands his helicopter on the front lawn of the family home, as Dad looks on bewildered.
It was about upsetting the perceived status quo, young upstarts making fortunes doing apparently nothing too strenuous while 'the rest of us' were left behind, looking stodgy and foolish. When the NASDAQ collapse came and a lot of these mo-mo fortunes were destroyed, the moment of schadenfreude was too delicious for the general public to resist. The public's smug satisfaction that "we were right after all" led to the comforting notion that those who day trade are indeed fools who will soon lose all their money.
I think therefore that the public's enmity towards daytrading is partially explained by the need to protect its own fragile ego — it hurts too much to believe that someone sitting at home in his pajamas can draw down 7 or 8 times the median wage while Joe Public sits in his cubicle cursing out the boss.
Craig Cuyler mentions:
I came across some guys that had a fund in Switzerland about a year ago they were posting plus ten percent returns per month scalping the Dax and Dax options. They developed some software for the Deutsche bourse and had a data pipe line that was a few seconds faster than the rest of the market. The were buying or selling bullets and making five to ten ticks all day on many many trades. It lasted about six months until their method was discovered. Articles on the Flipper have also appeared over the past year, and it is the same story, they have a very short lifespan. There are some other very short term strategies that I have seen for trading futures based on NYSE tick, that work quite well. I just think that, for the reasons I have given, the equities are very risky, and perhaps you bleed to death slowly until rampant markets like pre 2000 come along again.
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