Mar

5

A LoBagola, as described in The Education of A Speculator by Dr. Niederhoffer, is a phenomenon whereby a market makes an historically large run in one direction, usually up, and then at some unpredictable point begins an equally extreme run back to where it started.

Some recent cases in point would include virtually every asset class there is. Most certainly oil and other commodities have retraced much of their spectacular run ups. Stocks have now retraced the last 12 years of gains with no bottom in sight. Real estate is another prominent example.

To understand LoBagolas we need to understand how they start. They start with some early optimism. Things start improving for a certain stock or asset class. Some early profits are made as more investment dollars chase the emerging bull market. These profits add to account equity and can be used to compound returns through increase margin borrowing. In futures there is not really borrowing but the effect is the same - investors can take larger positions as prices rise. In effect there is a feedback mechanism. Higher prices result in even higher prices as more leverage is added.

But when the price finally cracks the effect is reversed. The first selling causes some short term holders to exit resulting in a further decline. At some point the decline reaches the level where the latest thin margin players are forced out. This results in another round of feedback selling. As prices come down it almost seems like they break in waves. Each successive wave forces another round of margin calls and forced selling. Finally the entire bull run is retraced. All the new holders who were enticed in by the lure of quick profits have been forced out as the whole bubble unravels. That is a LoBagola.

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

Victor Niederhoffer writes:

The question about LoBagola, especially since he was a charlatan, is whether the migrations that he described with an exact retracing of the path but variable in time exist to a non-random extent. How can this be tested, and what predictive value does it have? The picture of me in the WSJ with Lobogola overlaid did give James Lorie the biggest belly laugh of his life and for that it is undeniably valuable.


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5 Comments so far

  1. Matt Johnson on March 5, 2009 10:40 pm

    Why they happen is easy, like PhD easy.
    When and where, now that’s tough.

  2. Chris Monoki on March 5, 2009 11:16 pm

    I understand and have read Dr. Niederhoffer's LoBagola. I'm appreciative of the thoughts and what it provokes. I find the analogy helpful. Thank you.

    But are markets predictable like LoBagola's elephants, taking the same, predictable path as yesteryear? If they did, was is also predictably of the same magnitude as the previous years — did 50 elephants come each year or did 6,000 elephants run rampant other years? Did the elephants attack the same village over and over, or was the same village, along with other villages attacked? Was it only one herd that attacked one village or could it have been several herds attacking several villages, but to the eyes of the beholders, it is only his village that was attacked?

    In this market, this is what I find amusing: a) those that thought intrinsic value was X have been proven incorrect; b) those that have sought any kind of typical chart pattern — the bottom, resistance, stochs, moving averages, charts a la O'Neal, et. al. — have been proven incorrect. Those trying to find something, anything, in Elliott Wave or Fibonacci haven't seen any pattern. And elephants aren't herding to attack a specific village, they are disparate, acting independently and attacking anything. Efficient market hypothesis, you can throw that out. Behavioral economics has failed to project.

    Perhaps Nassim Taleb is correct: we simply do not have the capacity yet to gauge or predict market reaction. But if there's one thing I have experienced that might be a pattern is that things come in groups, however unpredictable they might. And I always listen to that one prick that is the outlier from the bunch. Some how, they have something more important to point out. Perhaps they are the Paul Reveres, warning of that herd of elephants coming your way.

    Keep pressing,
    Chris Monoki

  3. Craig Bowles on March 6, 2009 5:40 am

    Prechter has been great in his Elliot Wave analysis. His most interesting view may be how education would change similar to communications if we'd break up the government monopoly. We had a few rough years after AT&T but the rest is unbelievable.

  4. Gary Rogan on March 6, 2009 6:29 pm

    I have always found it hard to believe that any repetitive pattern can survive millions of people and thousands of computer programs looking for patterns indefinitely. As new patterns appear, those who recognize them first benefit, but of course a similar number of people who falsely recognize non-existing patterns fail. Are the only repetitive patterns that have survived for years those that are inherently difficult to analyze?

    If I were to summarize the essence of Taleb’s life’s work, it is that most pattern watching algorithms blow up at an unpredictable time, and more spectacularly than most people imagine. You can make money by betting on various known pattern blowing up spectacularly if you’re willing to pay for the privilege indefinitely with no positive reinforcement along the way. Of course every time patterns watched by many people blow up spectacularly, the implied risk of various other spectacular blow ups goes up, so at some point even Taleb won’t be able to make money. Could it be that the only way to make money reliably in the markets is to be young Taleb?

  5. Steve Leslie on March 7, 2009 3:22 pm

    The significance of an observation such as a retracement of a path by elephants, birds returning to Capistrano, salmon returning to their breeding grounds, Canadian Geese flying along the Eastern corridor, is the predictability of such an event. Therefore I suggest it is qualitative rather than quantitative. In some animals it is seasonal, in others it is event driven.

    I am not sure what caused the elephants to stop advancing and assuming a retreat. This is a real question. I suspect that in their minds they came to the conclusion that they have traveled as far as they cared to and decided to retrace.

    In humans this is entirely predictable. I am a Cancer and as such I find comfort in the home. Thus when I venture out be it to work or a vacation, I long for the opportunity to return home in short stead. I am also a creature of habit. For example if I drive to Ohio, I take the exact same route that I always take. 95N to 27 West to 77N to Cleveland. When I drive back, I come back the exact same way. That would be a Lobagola by definition. Now when I return on the same path is contingent on certain variables. How pleasant was my stay in Cleveland, did I get into a fight with my family, what was I there for i.e. a family reunion, high school get together, wedding, funeral, vacation.

    When one includes the law of large numbers such as how Insurance Companies calculate the M&E quants become more exact. Example Girls age 16-21 are the most reckless drivers by demographics. We all know that. However, the Insurance company cannot tell you which girl will become involved in an accident versus another. The same with white males age 70. The average white male who reaches 70 will live 13 years longer. Which one lives 13 years again is subject to variables.

    This may be senseless ramblings or not. I hope it furthers the thought process and the discussion.

    sl.

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