F GaltonIt's common to say things like today's decline was spurred by a growing concern that a rally of as much as 62% since March 9 had outpaced the prospects. This is like the other canard that the market is not buoyant since 60% of the stocks are down more than 20% from their 12 month high. Or 40% of companies reported earnings that were more than 30% below their previous peak.

Such statements are always true because the extreme is always higher or equal to the current level. With a random ensemble of stocks there will always be a good number that are not at the extreme by a substantial margin. Has to be, because of random numbers and retrospection.

Does such foolishness emerge in other areas, and are there any potentials for profits in such naive utterances?





Speak your mind

4 Comments so far

  1. Dan Costin on October 31, 2009 9:56 am

    I don't know about profit, unless you're playing golf for money, but a recent study found that over 95% of golf putts hit too softly do not reach the hole.

  2. Rajiv Bhutani on November 1, 2009 2:59 am

    These comments come primarily from Journalists who are forced by their profession to comment daily on market movements and find patterns or reasons when they don't really exist. Other group of people who make such comments or feel vindicated by such drops are 'focused bears' with entrenched views that market is overextended and this is a false rally.
    P.S. Till last month I was also concerned that market is overextended (but I was not short the market), but having been proved wrong time and again, I took a re-look at my reasons and looked hard at earnings and economic data and became a bull. I guess most people who have taken the view that this is a bear market rally, have difficulty in accepting that they are wrong. A large psychological and emotional toll is generally involved in accepting that you were wrong! Its astonishing to see (as you write in your book) that many pundits have taken a (bearish) view and have been proven wrong for years, but instead of accepting and taking a re-look at their investment thesis, they persist in their diatribes. I guess they just write and don't back their opinions with their cash, otherwise they will be quick to learn!

  3. Steve Leslie on November 1, 2009 9:19 am

    How does one profit in markets is to tie into the extremes. For example back in 2005-2006 the real estate market was on fire in Florida and across the country. Speculators from across the country were coming to the Sunshine State to buy homes. Developments were springing up like never before. Prices were rising at double digit rates never before seen. People were outbidding each other paying over the asking price just to get in on the deal. The Mantra then was "You better get in you know they don't make real estate anymore." "My neighbor is flipping homes by doing double closings with no money down." "Purchase a home with no money down" "We close in 10 days."Blah Blah Blah

    How short were their memories. 

    My father used to say "Buyers buy something emotionally and justify logically" 

    How do you make money in this?

    Answer When it seems as though everyone is buying something and worse borrowing to do so it is time to sell. On the other hand, when it seems as though everyone is selling and it appears that there is no interest in it, it is time to start to buy. Nothing lasts forever. Good luck and good fighting.

  4. D. R. Dimick on November 3, 2009 9:51 am

    Rules for Frequency and Liquidity: Too Fast, Too Little For Whom?

    Research of order execution protocol for coding purposes – this Sunday morn-aft of “trick or treat” here in Shanghai – bobbed up an article about a recent Greenwich Associates study (http://www.thetradenews.com/trading-execution/regulation/3785) titled, “Investors call for tougher high-frequency regulation.”

    IOIs – The search diverted me to http://en.wikipedia.org/wiki/Mystery_Method (How to Get Beautiful Women into Bed) – didn’t get past that thread.

    However, flash order results (http://seekingalpha.com/article/151385-how-flash-orders-work and http://www.zerohedge.com/article/flash-trading-org-chart) directed me to a schematic with names, including Knight, Citadel, and Goldman Sachs. This trio presents a collective breadth of market exchanges – from first tier to ivory towers to bordellos. Conclusion: gravitas is found here.

    Surmising threads tied to that third of domains so referenced, ponder why the Committee of Ways and Means is coveted among congressmen and senators and state legislators?

    In a word: Rules – right, capital “R.”

    Notably, rules regarding the making of money – or what politicians prefer to label as “raise funds” given the public governance implication, to wit:

    WAYS AND MEANS - In legislative assemblies there is usually appointed a committee whose duties are to inquire into, and propose to the house, the ways and means to be adopted to raise funds for the use of the government. This body is called the committee of ways and means (http://www.lectlaw.com/def2/w046.htm).

    Accordingly, algos may be considered no different in their for-profit endeavors to automate program trading and portfolio management systems. Yet as institutional investors and privateers alike seek out how rules-based paradigms of frequency and liquidity relate to market systematics, the exchanges themselves may evolve (or devolve).

    Consider Senator Schumer’s recent letter to Chairwoman Schapiro at the SEC… ”I write out of concern that the proliferation of Alternative Trading Systems (ATSs) and the disparate regulatory treatment between these ATSs and registered exchanges is creating a two-tiered system that undermines the transparency of our national market system and exposes our capital markets to significant additional risks.” (http://www.zerohedge.com/article/full-text-senator-schumer-letter-mary-schapiro-dark-pool-regulation).

    Dark pools, for instance… “The non-displayed alternative trading system (ATS), which is scheduled to open its doors to buy- and sell-side firms in Q1 2010, will allow traders to submit portfolio as well as single-stock orders and assign constraints to the execution of the portfolio. For example, the trader may stipulate that the portfolio does not deviate from a benchmark by more than a specified percentage” (http://www.thetradenews.com/node/3793).

    For regulatory purposes, how and what does “deviate from a benchmark” mean exactly?

    Of the good senator’s six-pack of propositions, the last is perhaps a fashionable (i.e., profitable) costume for debut among those inebriated (with themselves) so trading both along the marbled lines in the senate and in the dirt of the exchange floor…

    “6. Treat Actionable Indications of Interest as Firm Quotes Under Regulation NMS

    I understand that the Commission intends to address so-called “actionable indications of interest” at this week’s open meeting. As you know, I feel that so-called flash orders undermine the fairness and transparency that are hallmarks of our markets, and I strongly support the rule proposed by the Commission at its open meeting last month that would effectively eliminate flash orders. However, I believe that certain “actionable” indications of interest (IOIs) operate similarly to flash orders. These IOIs bear virtually all the indicia of a firm quote, but are not required to be treated as such under Regulation NMS. As a result, very detailed information about potential order flow is exchanged among a small group of market participants, presenting even greater opportunities for abuse as flash orders. This anomaly should be eliminated. While many indications of interest are perfectly legitimate, and contribute to the efficient functioning of the non-lit parts of our markets, I believe that IOIs that walk and talk like firm quotes should be treated as such under Regulation NMS.”

    How do senate staffers (inking such a proposition) envision that benchmarks are constructed and calculated? Actually, a good question, as most (87%) of those surveyed in the Greenwich study indicate being not sure (or know and aren’t talking) given lack of empirical evidence.

    We do know that quantitative systems are formulated from the “walk and talk” (or input) permeated throughout any given system of exchange – sometimes to include the (what may appear to the layperson as) “non-lit” domains of finance and investment.

    Thus where to draw regulatory lines – in statistically granulated sands of mathematics or the bedrock of a given school of financial theory?

    An Exchange
    One example as cited in “Commonalities of the order book” (http://www.springerlink.com/content/t381g74847p52552/fulltext.pdf): “Xetra is an open order book system developed and maintained by the German Stock Exchange. It operates since 1997 as the main trading platform for German blue chip stocks at the Frankfurt Stock Exchange. Between an opening and a closing call auction – and interrupted by another mid-day call auction – trading is based on a continuous double auction mechanism with automatic matching of orders based on rules of price and time priority…

    A feature which makes the Xetra data especially useful for the purpose of our study is that market orders exceeding the volume at the best quote ‘walk up the book’. In other words, the system guarantees market orders immediate full execution, at the cost of a worse price per share than the best quote. The liquidity measures used in the present paper implicitly assume that such a ‘walk up the book’ is possible.”

    A Model
    For purposes of analysis, now consider (http://eco83.econ.unito.it/terna/abm-baf09/abstracts_papers/Ussher(paper)_ABM-BaF09.pdf) a “zero-intelligent (ZI) model of n risk neutral speculators, who have the same initial endowment of money… Since there is no limit order book, the size of each trade is the minimum of the desired amount between the two matching traders, and there is no direct price impact as in markets with limit order books, where large orders ‘walk up the book.’ But large orders can deplete the desire to trade by the market makers, those traders with the best current bid or ask, who drop out…”

    An Effect
    Consider one (see http://www3.interscience.wiley.com/cgi-bin/fulltext/118950641/PDFSTART) “intuitive way to think about the model is in terms of the specialist participating in all trades; however, this does not reflect actual market conditions, nor is it necessary from an empirical modeling perspective. Without loss of generality, but imply as a matter of convenience, in this study the provision of liquidity is thought only to be provided by the specialist.

    In cases where the best bid-offer prices reflect limit orders, and a trade removes all liquidity at these prices, or in cases where orders “walk up the book,” it could seem that spurious effects are induced. However, this is only true if the specialist chooses not to provide the extra liquidity required, for reasons other than informationally related. If provision of liquidity is short because of informational considerations, the inference is valid.

    Furthermore, empirical investigations of the posted liquidity at the quotes minus the volume of trades, conditional on the estimated regime classification of trades, yield results in favor of the model. The percentage of trades removing all liquidity at the best bid-offer prices is the same across the two regimes. If spurious effects existed, more informational-classified trades would dry up liquidity than the non-informational classified trades. Because this is not the case, spurious effects are not prevalent.”

    Would our senatorial bastion of transparency – particularly if "vogue-not" for protecting New York’s financial markets franchise(s) — so agree as to what is and is not “spurious” here?

    A Result
    Consider “The Informational Content of Broker Identifiers” (http://www.firn.net.au/pdfs/USyd_Tang_07.pdf): note the pattern inversions of cumulative abnormal returns when distinguishing between client and non-client trades at Page 32.

    “Our results show that, for the most active stocks, anonymously-initiated trades are typically executed at lower proportional and effective spreads compared to non-anonymously-initiated trades… Finally, we find that anonymity depends on a very limited set of factors: the order location (i.e. whether an aggressive market order or passive limit order), the order size and order source (i.e. client, inventory, non-client or specialist). Traders tend to be more likely to trade anonymously for either large market orders that “walk up the book”, or large behind-the quote limit orders where the submitting traders are specialists, non-clients or clients. Anonymous traders are least likely to set the inside quote…

    These implications will also be of relevance to regulators interested in assessing traders’ best execution obligations, and to exchanges interested in evaluating the impact of the level of anonymity in their trading systems on market integrity and price discovery, liquidity, execution costs.”

    The Indication
    Market microstructures are devolving to the point where rules-based approaches such as The Schu’s (NY) self-serving proposals are DOA for two, rather uncomplicated reasons. First, his two political predicates for reform are false: (a) his “national market system” has become “international” due to SEC and GAAP (non)influences, and (b) “our capital markets” are no longer ours (as Americans) due to undisciplined, corruptive government debt accumulation combined with social and corporate de-leveraging caused by legitimization (via non/substandard-enforcement) of (MNC) corporate malfeasance. All of which he and his colleagues should have thought about before voting, for instance, on the repeal of Glass-Steagall.

    Second, certainly more to the point for daily speculation, is what any student of the subject (see “High frequency financial econometrics: recent developments”) learns at the opening of the book… “Experience has shown that each of these three view-points, that of statistics, financial theory, and mathematics, is a necessary, but not sufficient, condition for a real understanding of the quantitative relations of modern financial life. It is the unification of all the three that is powerful. And it is the unification that constitutes financial econometrics.”

    Therefore, perhaps, be it when either designing program trading and portfolio management systematics or drafting rules and regulations for SEC enforcement, we as any jurist may consider the issue of standing, being a question about who (or whom) – see http://en.wikipedia.org/wiki/Legal_standing.

    Application of this approach, whereby we promulgate rules-based trader activity correlative to market liquidity (and frequency), is evident from a review of trader profit/cost structuring with book monitoring systems. See “Liquidity Supply and Demand: Empirical Evidence from the Vancouver Stock Exchange” (http://finance.wharton.upenn.edu/~rlwctr/papers/0108.pdf). “Our results provide evidence that greater book depth and higher trading volume each shift the conditional probability of a limit order submission more than predicted by the change in profitability alone. This leads to an increase in the supply of liquidity. Furthermore, our estimate of order submission cost is significantly negative under all specifications. This implies that traders are not able to exploit all profit opportunities available on the book, perhaps because the cost of continuously monitoring the book is high.”

    Therefore, by defining trader capacity based on risk/reward assimilation of the book, resulting complexity of regulatory applications may be reduced to (horizontal and vertical) categorization of participants rather than codification of market schematics derived from analyzing and distinguishing institutional and exchange activities.


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