Jan

18

LemurBurton Fabricand wrote two interesting books: The Science of Winning and Non-Brownian Movement in the Stock Market. One of the major principles of the books, highly recommended as a supplement to Bacon, is that when a horse goes off at odds that are unusually unappealing, it's good to bet on it. He applies the method to a small sample of horse races, and finds that for specific applications of the principle, a slightly winning system can be developed.

I was reminded of this principle by the very unusual action of the stock market the last two overnights. Thursday evening and Friday morning, New York time, the market moved up about 1% overnight after yet another 40 day low on Monday. The optimism was broken by the Merrill announcement and the disappointing Fed testimony, as well as the credit downgrades. One of the worst declines in history occurred, 47 points from the open to close, exceeded only by the 66 point decline on 4/17/2000.

You would think that after such a decline, especially after an up opening, with fear in the air as never before, there would be a terrible fear about opening the market up again overnight. But no, it's up 2/3% overnight and Japan during the last two days, when the US market has been down 4%, is up some 1% from 13505 at Wednesday's close to 13650 as I write at 11:00 pm EST.

The insight of Fabricand is relevant, that this seeming underlay, this amazing courage in the light of the pessimism is not quite as amateurish , "boy, don't try too hard in the stretch unless you really are going to take it because I want the odds to be up next time" as it might seem.

Parrot

I have been studying the intake of clay by lemurs and parrots so as to neutralize the alkaloids and other poisons in seeds that they eat and disperse. What are the comparable foods that the market must eat to neutralize bad events? What does the speculator have to do to neutralize the many uses of specialized information and unlimited capital that the trading houses can apply when they are not acting over and above the various Chinese Walls that they can climb whenever there is a merger or downgrade?

I found 38,000 articles on "underestimation of change" on Google and have not read them all yet. Victor Zarnowitz found that underestimation of change was a persistent aspect of his data on GNP forecasts although the rarity of predictions of declines made his data consistent with algebraic underestimates as well. I thought a realistic way to test this was to look at all the moves from close to 2:00 am EST to see if the big ones are underestimates. I found there were 18 big ups of more than 10 points as of 2:00 am, and 18 big declines of more than 10 points. Of these 36 big moves, 18 had reversed by 10:00 am and 18 had continued. Thus, there was no evidence in a real data set without revisions or biases or contrivances, that there was an underestimate of change. 

Martin Lindkvist adds:

Fabricand also wrote the books "Horse Sense" and "Beating the Street".
In both he explains the principle behind his systems: The principle of
maximum confusion. Writes Fabricand in "Horse Sense":

"The betting public is most likely to err in determining the winning
probability of the favorite in those races where the past performance
record of the favorite is very similar to that of one or more horses
in the race."

in "Beating the Street" he continues on the topic:

"For the races, the intuitive idea behind the principle is that
although the favorite appears very much like the other horses in
ability, there must be some reason or reasons not immediately obvious
for the betting public to make that horse favored. Yet, because the
two horses seem alike on the surface, the public may be confused
enough to bet too heavily on the other horse, making the favorite
underbet."

In "Beating the Street" Fabricand also lays out a stock trading system
based on the principle. 

Yishen Kuik reports:

A new word for today, Geophagy.  Wikipedia says:

Geophagy is the human practice of eating earthy or soil-like substances such as clay, and chalk, in order to obtain essential nutrients such as sulfur and phosphorus from the soil. It is closely related to pica, a classified eating disorder in the DSM-IV characterized by abnormal cravings for nonfood items.

Geophagy is most often seen in rural or preindustrial societies among pregnant women and children. However, it is practiced by members of all races, social classes, ages, and sexes. In other parts of the world the practice is less stigmatized, and geophagy is not studied as a pathology but rather as an "adaptive behavior" that supplements the diet with essential nutrients or treats a disorder such as diarrhea.

In some parts of the world, geophagia is a culturally sanctioned practice. In many parts of the developing world, earth intended for consumption is available for purchase.

Bill Craft relates:

In the rural Southeastern US there exist deposits of Kaolin along the Oconee Group (formerly called the Tuscaloosa Formation). The locals and miners call it 'chalk' because of the white look and ability to stick when wet and permeate when dry any supposedly closed space.

Some of the residents have consumed the 'chalk' for centuries as it was a cure-all. Even the Creek Indians used it with Yaupon Holly (Ilex Vomitoria) for ritual 'cleansing.'

Mix some Washington State Apples with it and you get:

Kaopectin!

Ahh! Ritual Cleansing! Just what the mistress ordered!

Phil McDonnell explains:

Ketchup/MustardMost toxins are alkaloids, which in turn are bases. These toxins can usually be neutralized by ingesting acids. This is a practice which is not unique to backward civilizations. Check common condiment ingredient lists for vinegar. It is in ketchup, mustard and many other items. Chemically it is an acid. Oil and vinegar salad dressing is another example. When an acid and a base combine they neutralize each other and form a salt. Many salts are water soluble and can be readily flushed from the body.Even in modern society we have many minerals that are important to nutrition and are routinely used as remedies. Antacids such as Tums and Rolaids are simply calcium carbonate — chalk. Products such as Milk of Magnesia and Pepto Bismol are long-time mineral based remedies as well. Most so-called vitamin pills also contain a long list of minerals that are essential to our daily well being.

In the markets the toxins are the bad stocks at any given time. Recently the toxic stocks have been the big banks, most are down something like 50% over the last year. They continue to feel the worst effects of the current financial meltdown. Money usually goes somewhere. So when the banks are sold the good stocks are the beneficiaries. Google is a prime example. The high growth of earnings continue on track. So for a while GOOG continued to surge ahead. But toward the end of a panic the market acts more like the police when they raid a house of ill repute. They take the good girls with the bad. So even the formerly strong GOOG has seen a come down from well above 700 to a touch below 600. But there is nothing wrong with Google as a company. It is only that the big G has to act as an acid to neutralize the toxic base which is the subprime dependent stocks. So that salty taste in your mouth may not be just blood. It may be the act of a market neutralizing its toxins in order to return to good health.

George Parkanyi writes: 

To answer Victor's question about ingesting antidotes to poisonous markets, I eat 2x leveraged short ETFs, and I'll tell you why.

I live in Canada. Our family assets are tied up in tax-deferred registered retirement savings plans and registered education plans denominated in Canadian dollars. Although we can buy U.S. equities (and have to convert currency back and forth every trade), we can't buy options (we can write covered calls), we can't use margin, and we can't use futures. So there was a time when you had two choices in these conditions, sell or hold.

One morning last year I'm making my kids' school lunches, watching the Business News Network, when a commercial comes on proudly trumpeting three new pairs of long/short 2x leveraged ETFs. I remember thinking "Finally, something useful!". Later that day I researched those same Canadian ones, and found the U.S. ones. There was a wide range of available pairings, not only by indices, but by industry sectors as well. Some even paid dividends.

I use a specific strategy that requires full investment. By embedding (OK, eating) just a few of these ETFs on Jan 2, I was able to maintain my holdings, and keep my drawdown to only 3% as of today's close (despite all those NASDAQ stocks — ahem). It didn't take many; at most, 1/6 of the portfolio was in short ETFs, and I even scaled these back as the down-leg progressed.

Bottom line — your garage mechanic or plumber now has the ability to turn his retirement savings into a hedge fund.

If you can now so easily buy what is essentially market-catastrophe or profit-protection insurance, could this be changing the fearscape when markets fall? It makes being a contrarian more complicated. Reminds me of the Monty Python sketch where the people's bandit Dennis Moore is so successful stealing from the rich and giving to the poor that the poor become rich and lazy, leaving him confused and conflicted. Eventually he ends up holding up stage coaches and just re-distributing the wealth amongst the passengers.


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