We have all read Education of a Speculator, but how long has it been since you have picked it up? I have recently been re-reading it again for the fifth time, and having had the privilege of meeting Dr. Niederhoffer, studied his ideas in depth and meeting many who are mentioned in the book, it all takes on a completely new meaning. I highly recommend a re-visit as there are many hidden gems.On page 136, Sir Francis Galton says, “An incapability of relying on oneself, and having faith in others, are precisely the conditions that compel brutes to live in herds.” The necessity of self reliance is self evident, but faith in others is an easily overlooked and important idea that brutes miss. It is part of what makes them brutish and causes them to be many time losers.

Dr. Niederhoffer says, “Trading from the middle is a sure recipe for disaster.” Where is the middle? A price volume chart shows where the greatest number of trades are, and typically it is in the middle of the daily range. The trades on the edges are the hardest to take, but will definitely not be with the public, and may present and overlay. A lesson learned from the visit to the racetrack was that in handicapping, the public favorite is almost immediately tossed out in the initial screen or process of elimination, which increases the odds of an overlay due to the parimutuel system of decreasing the layout to the odds on favorite. The basic process appeared to be a binomial system of eliminating the worst half, and by doing so increasing the probabilities in the remaining. Dr. Niederhoffer discusses a similar system in analyzing test questions. In the markets, elimination of even 40% of the sure losers with negative bias, and eliminating over 50% of all the losers will give some sort of edge. Add that to a good execution system which executes in the correct 50% of the range and there is a recipe for some success.

“A good speculator builds his position from a single base linked to a long, flexible chain of trades. …The dollar’s going to be weak because the government’s going to keep the interest rates down so jobs will be good when the election comes.” (Sound familiar?) But caveat! “Mix it up! The patterns are reshuffling and realigning.” p. 139

On the endowment effect Dr. Niederhoffer reflects on his 90s fund’s investors’ complaints about their 150% gains being eroded by a 30% drop in one day. They felt entitled to that money under the endowment effect. I speak authoritatively about the endowment effect because I am an expert. The key to greater gains, Dr. Niederhoffer advises, is to hold on to trades longer, and this past two weeks is a perfect example. In order to makes the large gains, drawdowns are part of the process. The endowment effects makes unrealized capital gains too dear to part with, and so they are realized prematurely. The thinking goes like this, ‘I can buy them back at a lower price.’ Jump forward to 12 points lower. Now the buy back is obvious but the thinking goes like this, ‘what if it keeps going down and I lose my hard earned gains to which I am eternally entitled to as mine?’ Whereupon the market jumps back to new highs. A big joke in our family is the observation, and now the recollection, of young children playing with each other, and the ever present dialogue is, “MINE!” It seems to be an ingrained part of the psyche.





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