Daily Speculations The Web Site of Victor Niederhoffer and Laurel Kenner


to the Editors

February 2006

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Daily Speculations is dedicated to the scientific method, free markets, ballyhoo deflation, value creation and laughter. The material on this Web site is provided free by us and our readers. Because incentives work better than no incentives, each month we reward the best contribution or letter to the editor with $1,000 to encourage good thinking about the market and augment the mutual benefits of participating in the Daily Speculations forum. Prizes are awarded at the end of each month by the Chair and the Collab. 

Past winners

Young Mistakes, from a reader

I attended the wake of my neighbor's 14 yr. old girl. This past Friday she and another 13 yr. old girl and two boys ages 15 and 14 decided to sneak out and take one of their parent's cars. At 1 A.M. they were t-boned by a SUV in an intersection and two of the four died within hours, my neighbor's daughter being the first to pass. The past few days my wife and I have been helping him run his families business and helping our friends in this devastating time. It's hard to watch someone in so much pain and feel so helpless that you can't comfort in anyway. We speculate sometimes in our lives when we shouldn't. It's amazing that you can lead a life of perfection and make one wrong move and life's over. Analogies aside, I am learning that the older I get the more meaningful life, the individual, and what a wonderful thing we have in being in each others lives as humans really means. Give your kids and young friends a hug and tell them of their importance.

Why Do Any Statistical Correlations Matter? from Gary Rogan

A question has been troubling me ever since I've read in one of your books about the principle of ever-changing cycles, and the question is this: why do any purely statistical market phenomena matter at all as predictive devices? You write about the importance of being a classifier, and often come up with interesting ideas about what phenomena should be classified and correlated with positive returns in various markets. Your recent column on market hydraulics is an example of such an attempt, and of course a big part of your career is dedicated to finding and using such correlations. In your opinion, why isn't there are complete contradiction between the principle of ever-changing cycles and relying on any data-mined correlations? Unless one has some non-statistical basis for believing in a phenomenon's predictive value, why is it useful to apply "the lessons of the past" to the future when the lessons can become moot or wrong at any a priori un-knowable point? Would love to hear your thoughts on the subject.

Prevision, by Victor Niederhoffer

One notes 9389 stories over the past 3 years with "law of large numbers" Google growth in them. As the announcement of the latest one filtered across the tape in a second, at approximately 10:30 A.M., the S&P immediately dropped 8 points, the stock itself immediately dropped 50 points, and the following stream of consciousness was engendered:

"Google warned that its revenue growth will probably slow in the fourth quarter and beyond because of increasing competition and the sheer size of the company," (how those who use 'high IQ phrases' like to misuse technical terms such as 'the law of large numbers'), this time at a Merrill Lynch investment conference.

Previously on November 19, 2004, in a regulatory filing they warned "Our revenue growth rate has generally declined, and we expect it will continue to do so as a result of increasing competition and the inevitable decline in growth rates as our revenues increase to higher levels."

No wonder Google declined 4.8 points in that announcement, which it had been making for months prior to Nov 19, 2004. But then the price was $167. I could not help but immediately think that this is the type of language that the Sage must have encouraged them and his surrogate to make in Seattle so that they seemed very dour.

"I think our stock is too high" the Sage said before his discount IPO, and then I got angry to think that they were listening to him, and that they were too smart by half -- I note that, ironically, the Sage's stock hit a 4 month low at 86800 on the same day that his admirers made their Sage like announcement.

But then I realized that I do the same thing, and so did the Palindrome. We've never had a winning trade, or month, or a satisfactory year. And the same was true in my rackets career. I never played a good match, nor did I expect to win one tournament after I turned 22. I also note that one of the things that the market is supposed to do is to react to new news, not old news. I weighed all the stream of consciousness, and yes, I took out the cane for the third time on the company in recent days after the palpitations stopped, on the theory that at the next meeting scheduled for March 2nd, they might wish to take a different tack. Please note this is not a recommendation of Google, I have no idea whether it will go up or down, and as noted, my individual stock trading has been consistently worse than random. It's merely a heads up as to why I indulged.

Steve Leslie adds:

Where did I just read that if something is on a power-point presentation then it is useless information. As I heard Laszlo Birinyi say, "I don't pay attention to what people say I pay attention to what they do."And, I famously remember when at the Seattle Twin Towers, Gates and Balmer gave a dour forecast to analysts and were seen high- fiving afterwards backstage.

In the Kitchen; Plus, an Invitation, from Bo Keely

As usual, it was all you can eat today at the Kitchen, the free food line. Fifty guests walked in and out with distended bellies and smiles, but then a tip at desert about the missing head cook made us drop our forks in surprise. The tremendously obese cook, on failing to show for work a week ago, was investigated at his desert trailer. He was found wedged between his bed and the wall, and cyanotic blue. He later lay in a death coma for one day at the local hospital before being released. Today he showed with quite enough room to spare in the Kitchen doorway and warned patrons not to complain about the food, or else. He was lucky since trailer death wedging is more common than surviving it out here in the desert.

Rick Frey asks:
Do you mean he got stuck between his bed and the wall of the trailer and couldn't get up?

Bo replies:

Exactly. He was stuck for 6 hours, stopped breathing and turned blue -- a possible heart attack. I wrote in the story that he was hospitalized for a day, but actually it was 11 days. He weighed 300 lbs coming out. Further table talk disclosed that trailer wedge is somewhat common in the desert among California fatties. One lady got stuck for 2 days before they uncorked her. typical scenario is the person wakes up, stretches, rolls out of bed, wedges between the bed and wall, thrashes and stuff falls on him, according to an ex-EMT. Most victims die in the trap, so the head cook & we patrons got lucky.

I also have an open invite. On Monday, March 6th at 11am at the Blythe Kitchen is the premiere showing of the Sand Valley Expedition, an amateur video by Kerry Mortel for Los Angeles public TV. The hour documentary of a recent trip to Keeley's rancho includes pauses at Salvation Mt., the Glamis Hot Springs, Billie Bob's barbeque and Sand Valley visits to Alba the Dog Lady, Taylors, the Feral Tuk family, and the Gunnery Range before reaching Rancho Scorpion. We'll eat at the Kitchen and adjourn for the video to either the library or desert North of Blythe granting sunshine for the solar panel on Kerry's truck. Join us for this classic $0-a-plate dinner and show.

A Question on Earnings Re-Statements from Alexi Neocleous

I'm very intrigued by your study showing the correlation between companies that show earnings restatements and the ensuing debacle that often takes place. My question is there are a corporate watchdog, website, publication etc., that reports on companies who restate earnings when they take place?

Thank you for wonderful work.

Bukovsky on EU socialist goals, by Carole Tierney

The idea was very simple. It first came up in 1985-86, when the Italian Communists visited Gorbachev, followed by the German Social-Democrats. They all complained that the changes in the world, particularly after [British Prime Minister Margaret] Thatcher introduced privatisation and economic liberalisation, were threatening to wipe out the achievement (as they called it) of generations of Socialists and Social-Democrats, threatening to reverse it completely. Therefore the only way to withstand this onslaught of wild capitalism (as they called it) was to try to introduce the same socialist goals in all countries at once.

George Zachar on Shoes

"...is 45 pairs of shoes too many?. With sport-specific shoes, snow boots, etc., I estimate that I have about 55 pair of footwear, which I do not find to be excessive. Not really ..."

The above quote from Lynne Kiesling's blog leads me to this: With 6.5 billion humans on earth now, half of them women, and all seeking greater satisfaction as living standards rise, the upside just in the footwear biz alone is mind-boggling.

Economist Disses Government Data Machine!

As an actuary, I have a demographic question about CPI and Fixed versus replaced baskets and growth industries. Lets say you are pricing "hip replacements" and currently 1 in 10000 people have there hip replaced in any given year. But this is clearly a "high tech" growth industry, but also exposed to liability, specialist shortage etc. so price goes through the roof while the still 1/10000 people put this in their basket, say it triples.

This high margin attracts competition and more doctors so prices eventually level off. But once level 1 in 1000 now get this as the boomers get older. The way I understand the CPI does not catch most of this clear inflation because the increase in price occurs before the demographic boom.

Do they adjust for this?

Russell Sears

A Letter on Emerging Markets, from Arthur Tyde

I think Ayala will be a great potential investment - though, per your observations it should all be handled by a well connected local broker. Ayala owns Globe Telecom - which is the best cell phone operator in the Philippines. I have been happy with the service - and they are poised for growth. Globe is planning $225M USD worth of upgrades to their network - 3g, all sorts of extended coverage improvements. Also, Ayala is the largest property developer in the islands and prices, even with the current instability, are soaring. I'm already starting to track a sample portfolio just to test my theories. BTW - this would be a great time to pick up Philippine currency on the cheap!

The Crossroads of Finance and Physics, by Vince Fulco

Found this collection of articles while doing a cursory review of material for a pilot project. It looks like a decent collection/resource of some of the more classic papers. i.e Peter Carr work, etc. A sampling:

  • Aase, 1997, American derivatives - a review, Working paper
  • Adamchuk, 1997, Collectively Fluctuating Assets in Persence of Arbitrage Opportunities and Option Pricing, Physics of our days
  • Adamchuk, 1998, Arbitrage Relaxation of Instruments with Temporal Constraints , Working paper
  • Adamchuk A.N. and S.E. Esipov, 1997, Collectively fluctuating assets in the presence of arbitrage opportunities and option pricing, Physics Uspekhi.
  • Afaf N., 01/11/97, Going global: how to reduce the number of porfolio sensitivities needed to tabulate foreign exchange exposure, Risk, Market Risk, Vol 10, No 11
  • Agostini G., , Probability and Measurement Uncertainty in Physics - a Bayesian Primer, Preprint hep-phys
  • Ahn C.M., 1992, Option Pricing When Jump Risk is Systematic, Manuscript
  • 22-Feb-2006
    The NAIRU Policy, from Kevin Eilian

    NAIRU is just another device that seeks to empower and maintain the academic and governmental "elite" to the detriment of the masses by propagating the "limits to productivity" meme. Thus, the more certain the "limit" the less of a necessity to create incentives, which alters the balance of power between the elites relative to the masses.

    Luckily, as we have seen with "revolutionaries" like Reagan, this is a relatively short term phenomenon - as, all else being equal, the people will ultimately trade NAIRU for incentives (when given the chance).

    Preaching to the Choir, from Steve Leslie

    Boy, I have got to ask an open ended question for people a lot smarter than me. How can anything be absolutely objective? I just had to read this several times to get the gist of the conversation. There is subjectivity in every thing in life. Doesn't subjectivity mean decision making. Are we to believe, that unless one could quantitatively evaluate a steak it would have no taste? How would you do that any way?

    If there were no subjective decision making at stake in investing then where would value be found. It would seem to me that there is a suggestion that an investment process can be completely objectified. Are we to believe, that if you can not state empirically why you did something that real money can't be made? Does that then imply that there are two worlds a so called real world and a bizzaro world. And if that thesis is true then where does one buy this magic black box to run this formula?  This is in my opinion mere sophistry.

    Name one sport that is completely objective. Lets see, boxing--no, wrestling--no, martial art--no, diving--no, skating--no, ski jumping--no, gymnastics--no, shall I go on!!!!!!! Name a sport that is not over seen by a referee or judge or ruling body.

    With all due respect it appears to me that so much wasted energy is expended on such argumentation. Which reminds me, why did I start this in the first place.

    The UAE Ports Issue, from Pam G.

    Why did the Bush admin. not realize that this would be a hot button and attempt to get congressional support ahead of time by developing a quorum at least within congress?

    They are tone deaf.

    Why did the UAE not realize, no matter what they were told by the US bureaucrats, that they needed congressional and public support in the US?

    They are tyrants. Fairly nice tyrants, but tyrants nonetheless. They kind of don't get the whole democracy thing. And they really don't get Congress.

    Bush's approval ratings trajectory is indicating a decline below that of Carters. How could he have missed this?

    See above re tone deaf.

    That said, on purely trade principles, it seems a perfectly fine, legitimate decision. We should be engaging in trade with whatever company is the best for the job (best services, best cost, etc.) irrespective of their country of origin. The civilizing influence of commerce will do more to prevent hostilities than anything else. It is protectionist, discriminatory policies that undermine our credibility around the world. See today's WSJ George Melloan column on our war on drugs. He makes some interesting points that speak to how waging economic war harms.

    Reader, R.A. comments:

    I think it is indicative of a detachment from reality by this admin. concerning their role as leaders, managers and ELECTED officials. There are decisions politicians must make on their own as leaders and others they must make with their constituents.

    I remember back in the olden days when I was married, I received a phone call while at work one day from 2 car dealers. They informed me that my wife had just purchased 2 new cars, a Nissan Maxima and an Audi 100. I put the kibosh on both deals immediately.

    The dealers were next door to each other on the same street. My wife had gone into the Nissan dealer and bought the maxima and the walked next door and bought the Audi. The Nissan guy thought it was odd that she bought his car and then went next door so he walked over and spoke to the Audi guy after she left and that's when they both called me.

    She never told me she was intending on buying anything.

    When I got home I asked her about it. She said she liked both cars and couldn't decide between them so she bought both of them. When I told her I cancelled both purchases she had the audacity to get upset with me.

    This admin. lives in its own world and views the laws and the people of this country as encumbrances and obstacles.

    George Zachar adds:

    This is the second coming of Harriet Miers: a blatant, hare-brained, unforced error. The earlier characterizations of W's "tin ear" for the ramifications are dead-on.

    The US is now a country where my first grade daughter gets pulled aside in airports for special searches,  while her ports can be controlled by a foreign nation deeply embedded with enemy elements.

    Finally, if appeals to logic and political realities aren't convincing, there's this: America-bashing, Saudi-funded Jimmy Carter thinks the deal is a good idea. That alone should set everyone's alarms off.

    Icelandic Pilot Fish? from Tim Hewson

    The currency was down almost 5% yesterday, and separately Brazil -3% in the rush for the door.

    DJ Fitch Ratings Downgrades Iceland Rating to Negative
        Edited Press Release
        STOCKHOLM (Dow Jones)--Fitch Ratings on Tuesday
    said it has revised the outlooks on Iceland's foreign
    and local currency Issuer Default Ratings (IDRs) to
    negative from stable.
        The long-term foreign and local currency IDRs are
    affirmed at 'AA-' and 'AAA' respectively. The country
    ceiling is also affirmed at 'AA' and the short-term
    foreign currency rating at 'F1+'.
        "The negative outlook has been triggered by a
    material deterioration in Iceland's macro-prudential
    risk indicators, accompanied by an unsustainable
    current account deficit and soaring net external
    indebtedness," said Paul Rawkins, senior director in
    Fitch's sovereign debt team in London.

    Gordon Haave responds:

    I confess to not having spent much time in the study of sovereign debt ratings and the methodology of the ratings systems, however on the face of it, it would appear that Fitch has the same opinion of macro-economics as the New York Times. This reads to me as the beginning of a repeat of the US economy since 1982 or so. Massive capital infusion into a country with newly liberalized tax and regulation policies, accompanied by borrowings in order to tax advantage of the improving business climate. All and all, sounds like a good time to be long Icelandic stocks.

    A Letter on Industrial Logic, from a reader

    Dear Mr. Niederhoffer & Ms. Kenner,

    Since reading your book, I have continued to keep an eye on your website. Counting has certainly helped me figure some trades out and walk away from others.

    The reason for writing today is to point out something to you which if it weren't true, could have been written by Ayn Rand as part of her fictional writings.

    The way the European governments have sought to defend Arcelor from a hostile takeover by Mittal Steel (which I believe is very compelling), is shocking. Short of actually going out and shooting Mr. Mittal, these so called gentlemen of Europe have sought to muddy his character, his business acumen, his brilliance as a corporate visionary, his son's very obvious role as protege, charmer and heir apparent. They have used words such as monkey man / monkey money to show their innate racism and snobbery at a man who is very much not an establishment thinker.

    My favorite though is industrial logic. Finance Minister Thierry Breton says the deal defies any industrial logic (repeated today by President Chirac) - this comes from the man who presided over Thomson SA from 1997 to 2002. In which period Thomson touched a high of 80 and then collapsed to 7 again. Sure, there was the old TMT bubble going on at the same, but really, is this the man you want running the finances of one of the largest countries of the world? Are these guys thick or what? They can't show the precise savings they will create, because the management (ie Socialist Managers) at Arcelor won't let them in to do the due diligence !

    At the same time, all of these men are happy for Arcelor to buy Dofasco in Canada. Note Dofasco was initially a hostile deal as well before enough enough Euros were promised.

    In Europe, they have discovered a new word that I believe is just a euphemism for the old socialist interest groups: "Stakeholders". It is under the umbrella of "stakeholders" that Luxemborg is trying to defend Arcelor by pushing a poison pill law through. There are 6000 employees at the steel mill in Luxemborg I believe (could be wrong). In a country of 450,000 people and a coalition government, I guess a group of people who are 1.5% of the population are enough to cause a major protectionist tantrum. I concede however, that Luxemborg is still a shareholder unlike France so are entitled to whine and moan.

    Although not a rags to riches story, Mr. Mittal has over the years exhibited enough business acumen that he should be revered in the same manner as some of his more well established luminaries on the "richest men in the world" list. I would say even more so, as he's done it in an old world /commoditized industry that everyone thought was finished and even now even now every one says is finished because of the cursed Chinese threat. Is there anything you can't blame the Chinese for in the Old or New World?

    Finally, I would suggest to you that these guys with their protectionist, racist, deeply ingrained philosophies are probably worth a place in Atlas Shrugged as the socialist defenders of industry.

    Olympic Hubris, from Nat Stewart

    The lesson of olympic athlete Lindsey Jacobellis seems relevent to speculators. counting the chickens before hatched, thowing in fancy moves when one is "sure" of victory. It reminded me of the skyscraper study in pracspec, and the times I myself have also prematurely pumped my hand in victory.

    Perhaps an obvious lesson here, never let up untill it is truely over.

    A Letter on Estate Planning, from Andrew Haave

    Under current law, when a person dies, all of the person's assets receive a stepped up basis. Suppose you bought your house for $100,000 and suppose you bought stock costing $1 million. Now the market value of the house is $1mm and the market value of the stock is $10 million. Sell it all now and you have capital gain of $9.9 million. But if you die, your heirs get the assets with a new basis of the fair market value at your death. So, as soon as you die, your heirs can sell the assets and have no capital gain tax, whereas you would have paid tax on $9.9 million had you sold while alive. Thus, all else being equal, there is an incentive for an older person to hold on to appreciated assets to increase the after tax value of what they leave their heirs. However, what is not widely known, is that under the estate tax repeal scheduled for 2010, the unlimited basis step up goes away, and it becomes limited. So, to the extent that people believe that estate tax repeal will be made permanent, there will be less incentive for holding appreciated assets, and perhaps an acceleration of sales of stock, real estate and other appreciated assets as compared to what the sales would be under the current unlimited basis step up rules. Perhaps negative for housing and stock markets. But perhaps offset by estate tax repeal, since heirs will have more money to put into housing and stock markets.

    A Letter on Destructive Memes, from Shane James

    Dear Dr. Niederhoffer,

    Steve Ellison's brief post about the catastrophic dollar decline we are witnessing led me to write down the following, in support of his comments. Let us look at one segment of the meme factory and focus on one area of their prodigious production; Investment banks and medium term currency forecasting (let's use EUR USD spot). Having just left the banking side for the Hedge Fund after some years I feel I can say the following with confidence:

  • At any discrete (time zero) moment the EUR USD has a value and there are various banks with various medium term views about the direction of the EUR USD. These views would be espoused in, generally, the institutions monthly publication.
  • As the market moves away from this level (up or down) the initial reaction from the forecasters (communicated through the shorter term weekly 'research' pieces) will be to justify why the medium term view is still correct.
  • Should the market now accelerate further away from the initial status quo then the denial will spread to monthly type publications featuring a variety of non testable and non tradable concepts to further underpin the view.
  • In the meantime any firm whose view was wrong at time zero will start to adjust their view in the direction of the price action. Not, mind you, because the 'fundamentals' have changed but more to be in line with the peer group. This process continues until most forecasters support the meme.
  • It would be nice at this point to say, and now the market stops and reverses back in the other direction. In practice the market will continue in the direction of the meme for a time before some brave souls countenance a trend change.
  • This contrarian call will be the signal for an acceleration in the move -- making the memes sponsors rejoice as their obviously long held views come to fruition!
  • Soon after, qualitatively, we have the conditions for the turn. And then our counting begins......
  • Key points:

    1. The results from following Meme sponsors' views mirror those of the returns to be achieved using a moving average type momentum approach.
    2. Bank research fits all the Delphi like principles put forth in the Chair's books (Ed Spec. and Prac Spec.)

    3. Indeed, and perhaps in a different time, certain banks' research was a short term signal to go against -- immediately -- their views once published. I wonder, Dr., if you remember a certain US bank's research on the AUD USD rate in the early 1990's.

    Yours Sincerely,

    Shane James

    Tom Larsen on Baxter and the Markets

    When you are sitting in front of the screen and you notice that you are really sort of trying to wrangle the market and having troubles in trading, get your dog and go outside! As I see it, this is a great benefit of trading at home. I had a little Amstaff that died last year who was a wonderful athlete. He used to shag flies for me out in the field. I would hit lobs to him with the tennis racket and would always wear out before he would. I should have done some counting to see how much it helped. The funny thing is, maybe it didn't help, but when we came back to my office, Baxter and I both felt a lot better.

    James Lackey on Pressure

    In the Olympic Moguls event, the speed or time of the course was 25%, Jumps where 25% and the Moguls them selves carving and keeping knee and body position was 50% of the scores. To a novice Moguls watcher and MX racer, I was far more interested in Jumping and the degree difficulty of the tricks. A young California kid did 2 tricks never before performed, yet was scored 8th because the most important percentage of the score is the actual Moguls. Therefore, if you take on more risk in the jumps you might suffer on the Moguls from too much speed. Same with the time percentage of the event.

    In your figure skating example it is noted that the scoring system was changed from the French Fraud in the last Olympics. I am only assuming that the degree if difficulty in the jumps is far more heavily weighted than the execution. Therefore a perfect double-double would receive less total points/profits than a botched triple-triple jump.

    The same exact thing dawned on me last night in the markets. We just had a nice down move (which of course I was too early and bobbled) then a nice interlude, a big up and now we are currently on the 3rd day up. The current market event (whatever your time frame is) for us as traders it is 2-weeks like an Olympics. For others it is the entire world championships which they will be skiing again in 8 weeks. For some it is one shot or their last shot to ever get a medal. For a Bode Miller he could seemingly care a less and knows if its his week, it is his time to win and he can hammer out 1st..make a mistake and make 5th or go for 1st with a 5th place skills, crash and destroy his career.

    There is also home track advantage. For MX racers, down hill skiers or long distance runners there is always a track much better suited for their strengths. This may be the Olympics that only come every 4 years, but the next Olympics may be at your home track. Which of course everyone calls "home" where they are most comfortable.

    I stir the pot and make my buddies' blood boil when I call them a "trend follower" "linear man" and they quickly retort well you JUST a daytrader. What I strongly believe is very important is that you pick a system and stick to one. Guys that bounce around between holding periods, patterns rankings, memes and such are often blown around by the markets winds. If there is anything I have learned from racing cars, motorcycles and bikes is there is a time for everything and everyone to peak and profit.

    Its also along the same arguments of improvement I argue with on parenting. If your kid is gifted in Mathematics and science why in the world would you pressure the kid to practice his creative writing to also be "best in class" I think it is much better to focus on improving your strengths and avoiding your obvious weakness.

    It was obvious, judging by my buddies reports, "individual stock day traders" that they were killing it in Dec to Feb. "Lack when are you coming back" My brother that moved on to other business since the halcyon days in 1999-2001 noticed "stocks are back I see our old patterns working again. Where should I open an account"

    I have had serious discussions with stock day traders on the list to see if their gross revenue-net profits were any different now vs. the worst 2003 and the best 1999. The data is useless for predictive value of markets , but I can spot in 5 minutes whether or not the "opportunity or possibility to profit is there" The probability or testing and predicting is always the joke.

    I have a mumbo opinion of how it is best to trade the SNP futures, then the Nazz as it seemingly runs after the initial turn where holding the nazz is worse on a contract basis than the SNP. However the SNP has far more ups and downs at least in magnitude where the nazz is seemingly more "streaky, unpredictable and what people would call trendy" Lastly individual stocks are far more random and there is a time for all things. Call it luck, call it cycles and its all retrospective here, but there is a time for all things.

    Now back to the Olympic analogy, the bang for your buck, is it better for return on invested capital to be in the SNP, NAZZ or Individual stocks? It depends on the event, who is judging, what point you are in the season and what track you are competing on, for a day week month or year.

    May I please make certain that all of this is entirely descriptive and non predictive mumbo. I do that on purpose for two reasons. One is to not give anything away from Vic. However I just do not know, not sure that anyone does know how to predict when and if it is best to switch your focus from Indexing to individual horses. Of course the big fellas play with all three and add options and debt to their game. I do not have that luxury. I need to profit to eat.

    Lastly, "Lack you did stocks for years why not trade both?" That is like skiing a combo, downhill, Slalom and Super G for a total points. That would be like running Motocross, a street bike race, then mountain bike race all in a week. The problem there is I am genetically gifted in one certain aspect and it worked very well in BMX, short track MX races and any attempt to race mountain bikes, road bikes or Road race motorcycles would kill what I am best at. Perfect practice makes perfect racing. Skills are specific, if you add endurance you lose explosive sprint power and jumping ability. Of course there are genetic freaks of nature and genius that can do all things well at all times.

    Regrettably I am not one of them. Thankfully I completely understand this. I was never one of those guys that had "hedged positions" some shorts, some longs or sell a contract to off set this or that. I was always either all in on the gas or flat. I must learn how to improve, but at what costs?

    Mark Goulston responds:

    To me stress is good, distress is not.

    When you're under stress, you can (with difficulty) still maintain your focus on your short and long term goals and steps for getting to them. Stress tests your mettle (a midieval term for testing the armor on knights) and increases your toughness.

    When stress becomes overwhelming and the input overrides all your circuits (i.e. your ability to digest, metabolize it and turn it into something else and/or recycle it back to the outside), it crosses over into "distress." Distress is not good. When you're in distress your focus turnes to relieving it. The greater the distress, the greater your myopia with regards to the consequences of what you do to relieve it (drink, lie, cheat in business and on your relationships).

    The measure of integrity (and fortitude) is what you do when you cross over from stress to distress and nobody's looking and you don't believe you'll get caught.

    To relieve stress you want to find situations that enable you to exhale rather than just vent. Venting exhausts you, but the stress and distress quickly comes back, because you resolve nothing; exhaling relaxes you, enables you to pause and most importantly opens your mind to new data, suggestions, advice, input.

    If you can create a space through accurate and incisive empathy that enables others who are distressed to exhale, they will pause, be grateful and show their gratitude by opening their mind to you. Empathy works this way because when you feel accurately and deeply understood, you feel less alone. Pain is pain, suffering is feeling alone in pain. When you're alone, negative emotions get worse-- fear turns to panic, anger to rage, disappointment to depression to despair. Take away the aloneness and suffering people can't live with becomes pain they can.

    Here's an example of an empathic comment I used recently to create the space described above with a speculator with a huge loss: "When as right as you thought you were is as wrong as you turned out to be, you went in to nose dive, where in your mind all the people who are risk adverse start screaming at you, 'I told you so,' and it's so awful you don't think you'll pull out of it. Isn't that true?"

    He told me, he not only felt understood; he felt understandable. And when he felt understandable to himself, the chaos and loose ends lifted and the result created a clearing in his mind. More importantly, it created "hope."

    The Googie Monster, by Ken Smith

    GOOG has invaded our homes. GOOG is an intruder. GOOG is a monster. Worse than a real live Frankenstein. The whole darn Internet is an albatross slung around the neck of young people who now do not read books. The amazing university libraries of the nation are empty of readers, all the students are hooked into the university provided computers, sitting in rows and rows of desktops and laptops. Cruising for who knows what.

    I walk through the stacks where a million old books with far-reaching wisdom sit on shelves collecting dust. They never move from their place unless I or another "friend of the library" orders a few of them to read. Students go home to a laptop. Come back to the university to a desktop at the library. What the devil is the university doing setting up computers in the library? The library is for books.

    I am ready to disconnect my computer. I can get information daily from Financial Times and other media just by going to the library periodical section, for free. GOOG is an unwanted intruder and should be prosecuted for trespassing.

    A Note from the Inventor of MIG Welding, Richard Bernard

    Aloha Victor, yes things are well with us. In fact, I am answering this from our lanai in Maui. The info from Schroeder is not correct. The MIG welders sold by the big box stores are capable of good results on materials under 1/4" thick. They were never intended for industrial welding but work well for small jobs.

    Hope all is well with you!

    Anatomy of a Trade, from Aaron Koral

    I recently was "shaken out" of a stock I owned by failing to understand the factors affecting the company's products and services. The stock I owned was Agrium, a chemical manufacturer of potash, nitrogen, and phosphate for planting and crop protection. AGU also has a retail arm providing seeds to farmers for planting in North America.

    I bought AGU in 01/2006 at the market price of 23.05 & paid a nominal commission. I mentioned in a previous post that the reasons I bought a stock were as follows:

     A) What is the forward P/E ratio relative to its 5
     year Hi/Lo P/E?
     B) Does the company pay a dividend, and is it growing?
     C) Is this a company whose business I understand?
     D) Is this company generating positive operating cash
     E) What is happening to the company's return on
     invested capital (ROIC)?

    AGU, at the time I bought it, had a forward P/E of 13.7. Compared to its 5 year high and low P/E, the stocked traded at the low end of its range. AGU pays an annual dividend of .11 and the amount of the dividend has grown from previous years. For the trailing 12 months, the company generated positive operating cash flow, and had a similar upward trend in both net income and operating cash flow. Finally, the company had a respectable ROIC for the last 12 months when compared to its industry average.

    My first mistake, post trade, was letting the company's past results influence my reasons for purchasing AGU. I thought the company's strong showing from the quarter prior would continue into the next quarter's results. I think the quote, "Past results are not a guarantee of future returns" would be appropriate here.

    I also failed to realize how important the cost of natural gas is to the manufacturing process of chemicals such as nitrogen. At the time I bought AGU, natural gas prices, as reflected in the futures markets, were quite high, going into the end of 2005. AGU failed to appropriately hedge the increase in natural gas futures prices, leading to an unanticipated decline in quarterly earnings. In addition, excess inventory due to seasonal and planting demands also lead to a decrease for AGU's latest reported quarterly earnings.

    My second mistake was not truly understanding the company's products and services. To be able to read a company's income statements and understand the "story" those numbers are telling you are two types of understanding. A more important understanding, however, is when a speculator can comprehend the factors that affect the profitability of a company's products and/or services. You should not invest in a stock if you only do just enough research to understand what you've bought.

    One should always test what factors will effect a company's future earnings power and, ultimately, its stock price. For example, in AGU's case, I should have tested the relationship between natural gas prices (futures) and AGU's share price (i.e., does the direction of natural gas futures prices have an effect on the quarterly earnings of chemical manufacturers, and if so, to what degree and for how long?).

    When the company's latest quarterly report came out, the stock dropped over 6% in one day. I was tempted at that point to sell AGU, but I remembered that large one day declines in a stock can lead to gains more often than not the following trading day. I sat tight and luckily, the stock rebounded nicely the following trading day. A short time afterward, however, I sold my shares at 25.50 plus commission on a limit order at the bid.

    My third mistake was trading when under a stressful period of time. I recently left my job and the stress from leaving the position has not put me in the right frame of mind for successful speculating. I barely broke even on the trade and I am not completely out of the market. For now, though, I have some cash on the sidelines and no regrets as I contemplate my next move, both from a career standpoint, as well as from a trading perspective.

    I hope others on the board will find some "meals" for a day, maybe a lifetime, from my post. I would also welcome comments on where and how I went wrong on this trade. Additional perspectives are always helpful and appreciated.

    A Letter on John Wooden and Basketball, from Patrick Flanders

    I love Daily Spec, it always generates some great topics that I carry on around the office and at home. I've never understood your criticism of Warren Buffett, but I respect it - and I know that a great deal of it has to do with his sanctimonious nature. Because of that, I think it's odd that you'd highlight John Wooden, who by the accounts of almost all of his peers, is about as sanctimonious as they come.

    Sure, lots of coaches were envious, but far too many people worship at the altar of a person who had a few interesting concepts as a coach, but was certainly not an innovator. And, that's because in basketball, there really isn't a need for innovation, if you stick to the basic rules of offense [ 1) if my man plays off me, I capitalize by shooting, 2) if he plays me too tight, I take advantage by going past him, 3) if there's a mismatch on who is defending me, then there's a mismatch somewhere else on the court and if I have the ball, I need to feed it to the person who can take advantage of the mismatch, etc], and defense [ 1) move your man towards defensive help, 2) if there's an open man who is a threat - and he has the ball - then I drop my man and pick up the man with the ball, 3) I can control the game more on defense by isolating the other teams' strengths and reducing their ability to be a threat, etc] .  He was also much, much too full of himself.  The Wooden pyramid of success is admirable, but it's also just so much piety, and it's my understanding that for a man who was petty, underhanded and could swear up a storm, it certainly wasn't put into practice. Again, there were those who were envious, certainly, but very few coaches have anything nice to say about Wooden.

    You should read a book titled "Foul!", which is the story of Connie Hawkins - in it there's a lot about when Hawkins played for the Suns and Gail Goodrich was a teammate. Goodrich was, from what I've heard from "reliable sources", pretty much an imitation of Wooden put into player form. The comparison is not a flattering one for either man. The person who does come across well (and I think you and your readers would appreciate him) is a very unique gentleman named Scotty Macdonald. He was a lawyer for u.s. borax, but also a basketball genius, and the account of how he helped Hawkins is inspiring.

    Macdonald was also a college teammate and coaching collaborator of Pete Newell's, and it's Newell who is the better example and role model as a coach (more so than Wooden) in the sense of having an understanding of the game, and for having an impact on young players. Newell is captured in a great book titled "A Good Man" (for vic: you might get a sense of the kind of person Newell is by reading the Amazon review that one of his sons did). And, it's worth noting that while very demanding, Newell kept his players loose and encouraged them to have fun. His philosophy of "grub-ahhs" ("grab-ass" for the uninitiated) was a way to keep players fresh and fun - he encouraged some grab-ass playing in practice so that players would feel comfortable in pressure situations. Joe Kapp, the indomitable Cal football coach in the 80's (who also played bball for Newell at Cal) credits "the play" with being the result of that philosophy.

    Anyway, I don't fault Russell Sears because on the surface, Wooden would appear to be quite an accomplished individual, but I feel that his admiration is based on flimsy evidence, something that is not very Daily Spec-like.

    Thanks, sorry for being long-winded.

    Patrick Flanders

    Steve Leslie responds:

    I will be brief, very brief John Wooden: 10 championships in 12 years, 7 in a row, 88 game win streak, 149-2 record at Pauley Pavilion, 4 unbeaten seasons, 6 times coach of the year, 38 straight tournament victories, only one of 3 players inducted into the college basketball hall of fame as a player and a coach (NEVER IMITATED NEVER DUPLICATED) only coach to come close--Coach K', I cant spell his last name but you know who.

    I never met Coach Wooden did the author or is he relying on "reliable sources". Are you really Bob Novak? But please attack the man as such? He is 95 years old. I don't know what hall of fame did you say you were a member of? How many national championship teams did you play on? Did you play with Jabbar, Walton, Wicks, Bibby, Meyers, Allen, Rowe, Washington?

    I refuse to go on any more!!!!!!!!!!!!!!! I have to take my beta-blocker, plus Charlie Brown just came on TV.

    Steve Leslie

    A Suggested Weekend List, from Kim Zussman

    "Liber Acchi." The story of Renaissance mathematician who solved the theorem of profitable cross-dressing.

    Sports Business
    "Ball?" How Armstrong stopped crying and overcame the pain of peddling.

    "Seamen of the Moon." Hagiography of DARPA scientist Justin Case and his billion-dollar company that backs up frozen subscriber DNA off site.

    Population biology
    "Buns of Steal." The biggest heist since the invention of the Y-chromosome (was indie film "In Terms of Herrearment").

    "Barry T. Accelerator." The story of a Darwinistic socialist who collected a team of physicists to model particle behaviour and beat the quarks out of the market

    "Big Stinging Dick." How a vice president was forced to go back to college ROTC and retake Riflery 101.

    "Pelvic Treats." How to incentivize and train your pooch without the invisible hand.

    "God Housekeeping." This month's issue featuring study on birth control in Islamic countries.

    Curious George, by Andrew Moe

    If there is one thing I have learned in my tenure here on the Spec-List, it is that you always download anything recommended by the Voodoo Professor Mark McNabb. Today, I met Curious George.

    Despite the fact that I am already a big Jack Johnson fan, I am stunned by how good the soundtrack is. I mean full-on, slack-jawed amazed by brilliance. This is an artist at the height of his craft. I bought every song.

    Young or old, vetted or new, my friend Jack has words for you:

    "It's always more fun to share with everyone."

    We could use a little curiosity on the list at present.

    PS. I am taking the kids to see the 11:45 tomorrow and have the disc burned for the ride home. I suggest the same for all. You can go blindfolded and will come out giving it 4 stars.

    PPS. 3 is a magic number. NumbeRs posted.

    Jay Pasch on Trading Parasites

    In the spirit of recent discussion concerning parasitic infestation and the ever-present risk of body snatchers, it was interesting to learn that perhaps one-half of the world's human population is infected with Toxoplasma, a parasite that Oxford scientists have discovered alters the minds of infected rats, and subsequently the rat's behavior, to benefit the parasite's longevity and reproductive cycle. A genetically engineered parasite littered about the enemy's decks, inducing him to buy high and sell low, coming soon to a theater or trading floor near you?

    A Letter on 7 Common Roads to Disaster in the Stock Market from Steve Leslie

    I had some thoughts as a follow up to your article on 7 Common Roads to Disaster in the Stock Market. Your top 7 list is excellent and all valuable. Here are a few for a follow up column that I expect will be written after the spec list digests your natural 7.

    1. Insider selling: There are a variety of reasons why people sell stocks but there is but one reason why one buys it.
    2. You never go broke taking a profit. but you never make a big profit either. Plus transaction costs will kill you. Peter Lynch said he made his 7-10 baggers over years. Vance has been one of the best stocks to own over the last 15 years. Plus it takes different mental muscles to buy stocks than to trade futures.
    3. Too much competition. MSFT dominated the 80s with their DOS system. IBM 40s with punch cards, ORCL with data accumulation, the Intel chip, AMGN with Epoiten, Hughes Tools with drill bits and XRX with copiers all dominate their respective markets. Eventually competition can catch up but it can take years, sometimes decades, sometimes never.
    4. Franchise acceptability. McDonalds vs Wendy's vs Burger King in the 1970s, Disney theme parks in 1980s and GE versus anybody.
    5. Barriers to entry. Cost ineffective or massive infusion of capital, such as in the exploration for oil.
    6. Undisciplined work environments with sushi bar, no socks and casual clothes. People are motivated by different things. Sometimes in house day care protects against brain drain. Silicon Valley during the golden years. See AAPL
    7. Entrepreneurs cannot run companies. This is possibly true but you can always hire someone who can, see MSFT or EBAY
    8. There are great companies and there are great stocks but sometimes they are not the same. And sometimes they are.

    If I get motivated I will share reasons why people do not sell stocks too.

    Checker Mentoring to my Grandson, from Alan Millhone

    Hello Mr. Niederhoffer:

    I share with you an article I posted on the ACF Forum to attempt to stimulate some interest in encouraging youth to take up Checkers. The fellow who replied is Ed Bucker, a really nice player from Indiana.

    Hany Saad on Risk and Exit Strategies

    Here is what I qualitatively tend to do in simple layman terms:

    Whenever I feel that I am walking on water after/ during a good trade, I pull the plug and stop trading altogether. I have a tendency to blow up big after good trades. I happened to buy a certain stock at the low tick and sold it close to the high. This trade comes to mind as it was contrarian to the death watch posts of some esteemed personage that I have tremendous respect for. After exiting, I took a few days off trading to put my ego back in place. When I am losing I do the opposite,  I push my luck and double up as this is the time I am most alert.

    Of course, I use some para-scientific techniques to fine tune this very general idea. But, it is interesting in the sense that it is the exact opposite of what all market wizards advise you to do. Namely, get out if you're losing and push your luck when things are going your way and what legends like Paul Tudor Jones put so eloquently as "losers average losers". Far be it for me to compare my meager abilities with these legends, but my system has stood the test of time and kept me in good shape (so far).

    Ringers and Rascals, from Mr. Ckin

    This may be a well-known story for the racing aficionados in our midst, but I had never before heard of the story depicted in a book that I recently acquired entitled "Ringers and Rascals - A Taste of Skulduggery," by David Ashworth.

    From the inside of the dust jacket:

    "Peter Christian Barrie had a strange skill; he painted horses. Not with oils, on canvas, but on the horses themselves. The King of the Ringers disguised good horses as bad ones, and tricked bookmakers out of millions of dollars."

    Apparently, Barrie used a variety of henna tattoo techniques to give the impression of an injured horse. The implications (obviously) are reminiscent of list members' writings on deception in the marketplace.

    It also reminded me of a quick survey I had done late last year, of what I thought to be cases of deception within the stock market, namely among the companies that have nominal share prices far into the triple digits. Many such firms (there are about 80 or so of them) are dominated by a small number of large shareholders. For various reasons, I suspect that they don't care all that much about minority investors, and so choose to avoid stock splits, and even financial disclosures (if they can keep the number of registered shareholders below a certain threshold.) The deception arises from the fact that the controlling stockholders would presumably like to accumulate the thinly traded shares of their company at a relatively low valuation, and thus have a vested interest in reporting the lowest earnings possible, and understating assets on the balance sheet. If this is in fact the case (I am making some suppositions), it would indicate that such firms with very high share prices (in dollar terms) may provide excess returns. They seem to have done so over the past several years.

    I have seen a number of firms over the past few years, probably in response to SarbOx, choose to deregister their shares in order to eliminate their disclosure obligations. One technique used to eliminate the number of shareholders is the reverse split/forward split scheme, in which the fractional shares that exist for a brief instant following the reverse split are exchanged for cash. Cash self-tender offers have been occurring as well. I'm not sure how much use such a study would be to larger investors, however, as many of the high-price companies in the stock screen are highly illiquid, and some don't always have two-way markets. Nevertheless, I would think the concept deserves further study.

    Victor Niederhoffer responds:

    Ben K. Green's  Horse Tradin' is recommended by Professor Martin Shubik of Yale as the best book for aspiring stock traders, and by collab and me as one of top five on deceptive techniques used in markets. It is replete with stories of sellers painting horses to disguise their worth. Such activities are very common in markets

    An In Depth Look at January Barometers, from Vince Fulco

    Spearmanís Rank Order Correlation of Dow Jones Index Members:

    1st Month Performance vs. Subsequent 11 Months Performance

    February 3, 2006

    Extending the previously mentioned work on the January barometer, we chose to look at the data from a second vantage point. Spearmanís rank order correlation is a technique for determining the correlation between ordinal variables. In our application, the correlationís inputs take into account the ďstandingĒ of each member in the performance table vs. its actual return results. For example, looking at the top five best performers in the Dow Jones Industrial index for two periods; January 2005 and the subsequent 11 months, we find:

                                     Starting     Starting               Next 11       Next 11 
    Company                          Month        Month                  Months        Months 
    Name                             Rank         Performance            Rank          Performance 
    Altria Group                     1               4.42%                 4              17.06% 
    Disney                           2               2.69%                29             -16.28% 
    Citigroup                        3               2.12%                18              -1.06% 
    3M Co.                           4               1.95%                24              -8.13% 
    Johnson & Johnson                5               1.81%                23              -7.11% 

    Using only the ranks of these companies (and the other index members), we perform a correlation calculation with R projectís cor.test() function. Due to the nature of the inputs, the significance measures in a typical Pearsonís correlation is not appropriate for this type of analysis. Instead, studying the p-values gives us an idea as to whether there is statistical significance between the two time periods in question.

    For the full set of data, 2000-2005, the results of the study were:

    Ranked Returns Study- 1st Month vs. Subsequent 11 Months

    Dow Jones Index Members 
    Starting Period: 12/31/1999 
    Ending Period: 12/31/2005 

    Results of Spearman's Rank Order Test

           Spearman's         P 
    Year       Rho             Value 
    2000     -0.060           0.751 
    2001     -0.012           0.9494 
    2002     -0.022           0.9084 
    2003     -0.083           0.6618 
    2004     -0.019           0.9195 
    2005     -0.118           0.5326 

    In this exercise, the null hypothesis is that the time periods in question are not correlated with regards to performance. That is to say, what happens in January is not indicative of what will occur the rest of the year. P values >.05 indicate that the null can not be rejected which is what we found in our calculations using a .95 confidence interval on a two tailed test.

    A Letter on Checkers from Alan Millhone

    Hello Mr. Niederhoffer:

    I share with you an article I posted on the ACF Forum to attempt to stimulate some interest in encouraging youth to take up Checkers. The fellow who replied is Ed Bucker, a really nice player from Indiana.

    Intel or AMD (Heads or Tails), from Yuri

    With there really only being two players competing in that industry, is picking the one beaten down most the best way to gain exposure to that industry? It seems that AMD is the growth player that has been hoisted up and INTC has been beaten down for not keeping up. Which is a better predictor of future returns, the company which beats earnings estimates or the one beaten down?

    Good Surfing, by Tom Larsen

    For surfers and surf spectators, yesterday was the Maverick's Big Wave Surfing Contest here in Northern California at Half Moon Bay. I didn't go because they are really hard to see out there, but it was a beautiful day and the waves were said to approach 50 ft. Also, don't miss Maverick's website containing good video.

    Incentives and Greenspan Memorabilia, from Tim Hewson

    Chair often talks about the importance of incentives, and today while snooping around Ebay I found a nice little, if offbeat, example of this market phenomenon at work. Greenspan's retirement, the ceaseless CNBC coverage of it and the accompanying auction of the Erin Crowe portraits has spurred a number of budding artists to put brush to canvas and cash in on the bandwagon.

    The remaining Crowe painting is currently at $15k, with two days left to go, but approx. 10 others are up for auction on the website including a piece of toast in the image of the former Fed Chairman [currently being offered at $2.05]. the median price of these lots is about $40.

    Even though some of the paintings are not very good likenesses, and actually could be paintings of any septuagenarian with large glasses done by anyone with opposable thumbs, it does seem to show incentives are at work and markets can be made in the unlikeliest of instrument, however worthless they may seem to some.

    A Letter on Stress, from Dr. Mark Goulston

    Three years ago I had emergency surgery after I almost died. My doctors said my colon had perforated from diverticulitis. But I knew better. It was because I thought I was able to stay safely ahead of all the crappy people I had to deal with, and they overtook me and when I could no longer off load what they put into me, I imploded.

    When I woke up from surgery with a handy little accessory attached to my side (a.k.a. colostomy, which fortunately was reversed 5 months later), I realized who those crappy people were and are and vowed to not let any new ones into my life. Here are 7 attitudes YOU won't want to work around. A year ago I extended it to "crappy" companies and since taking a stand in both places, my stress has gone way down.

    My Significant Other, from J.P. Highland

    While trading I refuse to take telephone calls, the only person who is allowed to call me is my wife but only for something of extreme importance. Maybe I'm exaggerating, but Scalping requires full attention and any distraction can be the difference between a profitable trade and disaster.

    My beloved wife came to the City due to the visit of some relatives from Argentina, she called me around 13.00 to say that she arrived earlier than expected and that she had time to visit me at my office. "NO WAY", I thought.

    I always keep in mind a phrase contained in "The Education of a Speculator", written by a well known author that says, "When trading, bring your favorite significant other by to see you in action. Hey, if you're good flaunt it!

    I'm not even good at it so what am I going to show, my churning? The tons of curses I shout at the Specialist or at the buyers that don't move up and the stubborn sellers that keep trying to fade a nice trend or vice versa?

    "I have nothing to you show here, Fridays afternoons are very quiet, most of the Jewish traders don't come back after lunch... why don't we go to the Barnes and Noble on Union Square to have my tenth cup of coffee of the day, or maybe we better take a walk around Washington Square". That was the better answer I found. She was not very satisfied but I'll follow the author's advice, I won't bring my significant other to see me trading, not in a million years.

    Beethoven Meets Mozart, from Stefan Jovanovich


    The story of Beethoven meeting Mozart is great theater but it is undoubtedly one of his devoted biographer Jahn's inventions. For Beethoven not to have been recognized as a genius equal to Mozart would have been intolerable. It was what everyone expected, included Waldstein, who sent Beethoven off to Vienna with a purse and a letter that read: 'You are now going to Vienna in fulfillment of a wish that has so long been thwarted. The genius of Mozart still mourns and weeps for the death of its pupil. It has found a refuge in the inexhaustible Haydn, but no occupation; through him it desires once more to find a union with someone. Through your unceasing diligence, receive Mozart's spirit from the hands of Haydn' (Hans Gerstinger, Ludwig van Beethoven's Stammbuch, Leipzig, 1927).

    I imagine the letter must have felt a thousand times heavier than the purse. How else can one explain Beethoven claiming that he had never heard Mozart's music before he came to Vienna when, in fact, he had played Mozart's operas while a viola player in the Bonn court orchestra?

    A Letter on Music and Poker, from Steven Leslie

    I was talking with an expert in music theory last evening. I happened to have your auto bio with me and asked him to explain what a major 3rd, minor 3rd and diminished 3rd was. This led to a detailed and exhaustive discussion on classical music. I will not bore you with the details. He did explain to me how Beethoven crafted his symphonies and the relationships of the various movements within. Please keep in mind that I am void of music theory or knowledge. All I can say is that I don't know if it is art but I like it.

    Anyway, this got me to thinking. You discussed in a column last week of the relation of a symphony to the trading of markets. Well, I played in a hold'em tournament this weekend and placed 2nd after 4 grueling hours of competition. Here is what I noticed. As in chess where you have an opening, a middle game, and an end game you have remarkable similarities in a hold'em tournament. Note I know little more about chess than I do about music.

    As any tournament player will tell you poker players wage battles with chips. I call them bullets and they are critical. If you want to fight you need to have the appropriate weapons. Early in a tournament the objective is to build your stack. For me that means selectivity and carefully playing premium hands. I only want to position myself for the middle game. Similar to the early stages of chess. The middle game is where the fun is. This is when the superior stacks and players go after the weak. They attack and attack the weak absorbing their stacks in the process. Similar to the Soviet Union's annexing of Eastern Europe post WWII or The Highlander after he has severed the head of another immortal. Conan the Barbarian was asked What is best in life? His response "To crush the enemy, see him driven before you and hear the lamentation of the women!"

    These mini battles lead to the end game. A mano-a-mano fully blown toe to toe slugfest. Tension is high and one wrong move one incorrect read ends your day and your life as you know it (a bit theatrical I know). Once again there is an ebb and flow depending on the variables. Finally in one major cataclysmic event the tympani rolls, the moment builds and the final showdown comes. An explosion of sight and sound and One is left standing to savor the victory and stand victorious over his conquest. A brutal gladiatorial like finish.

    The crowd applauds and slowly disperses into the night. The victor rises from the table while the loser exhausted, stares aimlessly in a fog like trance dreaming of what might have been.

    An anonymous contribution from Brazil

    Hi Victor.

    I trade Brazilian sovereign bonds (was trading brl fx options before), and I read your article about why you don't believe in trends, some weeks ago. I decided then to write a c program and run some tests using simple MA cross-over system. Final results showed me that although some prices series could show me a net profit, statistically the significance was not relevant. The results came from just a few trades. And the back-test was really sensitive to the time window. I also tried to use some money management rules, like increasing or decreasing the position depending on the accumulated P&L, and that made some changes in the final results, but again based on just a few trades. Have you ever made a study about money management rules?

    Put a Little Spice In Your Life, from Sushil Kedia

    This web-link which provides a brief yet holistic story of the rise and maturing of the global spice trade, uses, sources, properties etc. of spices. You might find it interesting reading both as one who studies trade history and gastronomy.

    Alan Millhone on the Roulette Wheel

    Hello Mr. Niederhoffer,

    I have just now read your article on Roulette and found it interesting and thought provoking. Have you ever noticed that 26 & 29 black seem to come up a lot on the wheel?

    A few years back I was in Alice Springs and one evening visited Lassiter's Casino there. The wheel there only had a "0" and lacked a "00". Anyway I played a few rolls and was doing okay and finally decided to place a hefty bet on zero and it hit! On that one roll I was paid around $1,400.00 and I left the casino.

    Over the years on my trips to Vegas, like most gamblers I began with the slots then to Blackjack then to Roulette. Over the past few years all I play is Craps. Craps has the best odds for the player of any game that Vegas has to offer. We stayed in the Venetian on a recent trip, but I never gamble there. I prefer hotel/casinos like the Stardust. You find the table bets lower (more gambling time for your buck) and the dealers much more friendly.

    Sincerely, Alan Millhone
    Belpre, Ohio

    A Biography, from Michel Olagnon

    For Michel Olagnon's Post on Rogue Waves.

    I got an engineering education at Ecole Polytechnique in Paris (72-75) supplemented with ocean engineering at Ensta (75-77). Ever since, I have been working as a researcher at the French Institute for Marine Research, mainly on extreme environmental conditions and reliability of offshore structures. I participate in various international committees, and I organized the Rogue Waves 2000 and 2004 workshops with worldwide attendance. I like to keep my mind open to other topics, I came to friendship with a few good statisticians when working on fatigue of materials, and was lucky enough to attract their attention to ocean waves and sea state processes. I wrote only one book, in French, about the Fortran 90 programming language. By the way, I also maintained for many years the internet FAQ for Fortran. My programming skills (I read that you are interested in people with programming skills!) led me to help colleagues, especially those working on seismic surveys, and to enjoy applying new ideas with them in their work, for instance when they try to show that an actual flooding of the Black Sea by an opening of the Bosphor was at the source of many a myth.

    As for stocks, I am not a trader, but thanks to my personal investments, I can afford to remain in a poorly paid research position working on things that I like, instead of polishing my boss for a raise. I started early: in 74, with 2 other friends, we climbed the fence of Ecole Polytechnique (it has the status of a military academy) while the watchman was looking the other way to buy a small flat at a ski resort in the Alps with the money of our student loans. About 10 years later, when I had bought back the others' shares of the flat, I started to invest about 1 month salary per year into stocks. Though I ceased to put in fresh money after 10 more years, I now own about 12-15 years of salary in equity and I can relax about my standard of living when I retire.

    Most of my best ideas came to me when I was jogging on the footpath overhanging the sea, and when I was younger I ran about every distance from 110m hurdles (18s) to marathon (3:20). I am much slower now, but I hope that my mind is still quick enough for most purposes.

    End of Bull Market? from Steve Leslie

    Obviously my last email was tongue-in-cheek but on a serious note:

    I keep hearing from the ubiquitous financial pundits that we are in the late innings of a 3 year bull market that began in 2003. Granted 2003 was a good year to be in stocks, however, I would argue that the last 3 years would hardly be characterized as a bull, more like a calf and 2005 would hardly be seen as a much of anything.

    However not to become argumentative, my question is: How likely is it that the market will be negative this year bearing in mind the fact that this would mean the market would technically be down 4 out of the last 7 years? Is there precedent for this, let's say for the last 40 or 50 years?

    As an addendum: When was the last time that the federal reserve raised rates 14 or 15 times (actually I have lost count.) in a row?

    And, finally, would it not bear witness that the Fed is committed to take rates to at least 5 per cent as futures are pricing in, thus driving the economy on a collision course to a recession. Note: has anyone noticed that oil and hurricanes are now the Siamese twins of excuses to explain earnings shortfalls during this earning season?

    In this grim view, won't 2006 be one of those rare times when cash and short term instruments have the best performance for the year and that stocks might not be able to be revisited until late 2006 as long candidates. I submit these questions for an open review by the esteemed who visit this wonderful website.

    Steve Ellison adds:

    To determine whether a bull market is likely to end in its fourth year, we must first define a bull market. A commonly used definition is that a bull market is an increase of at least 20%, while a bear market is a decrease of at least 20%.

    Using these definitions, bull and bear markets in the S&P 500 index have been recognizable on the following dates:

    Market type  recognized on  from last extreme on
    Bull         09/03/1982     08/12/1982
    Bear         10/19/1987     08/25/1987
    Bull         01/05/1988     10/20/1987
    Bear         10/11/1990     07/16/1990
    Bull         02/06/1991     10/11/1990
    Bear         09/01/1998     07/20/1998
    Bull         11/02/1998     10/08/1998
    Bear         02/22/2001     03/24/2000
    Bull         05/21/2001     03/22/2001
    Bear         09/17/2001     05/22/2001
    Bull         11/08/2001     09/21/2001
    Bear         07/03/2002     01/07/2002
    Bull         08/15/2002     07/24/2002
    Bear         10/10/2002     08/22/2002
    Bull         11/04/2002     10/10/2002

    Because bull markets can only be recognized retrospectively, I defined first-year returns as the change in the S&P 500 index from the date on which the bull market became recognizable to the one-year anniversary of the bear market low. For example, the first year return of the 1982 bull market is the price change from September 3, 1982 to August 12, 1983. Subsequent years' returns are the change in the index between consecutive anniversaries of the bear market low (including part of a subsequent bear market if the bull market ended that year).

    Bull market returns by year were as follows:

    bull       1    2    3    4    5    6    7    8
    1982     33%   2%  13%  30%  37% -21%
    1988      9%  23% -12%
    1991      8%   6%  14%   1%  24%  21%  38%   2%
    1998     21%   5% -25%
    2001a   -11%
    2001b   -25%
    2002a     5%
    2002b    13%   8%   6%   6% (through 2/3/06)

    I see nothing in these returns to indicate that the longevity of bull markets is anything but random. I would guess that the probability of a bull market ending in the fourth year is approximately the same as the probability of the bull market ending in the third year or fifth year.

    Kim Zussman comments:

    I looked back even further using DOW annual returns starting 1929 (Dec/Dec). Checked for yearly closes which were lower than 5-years prior (which includes 2005 and 2004), and looking at the following year's return:

    t-Test: Two-Sample Assuming Equal Variances

    Mean 1.08556 (8.5%) 1.0668 (6.7%)
    Variance 0.031131668 0.038422057
    Observations 15 77
    Pooled Variance 0.037287997
    Hypothesized Mean Difference 0
    df 90
    t Stat 0.343473597
    P(T<=t) one-tail 0.366021639
    t Critical one-tail 1.661961085
    P(T<=t) two-tail 0.732043278
    t Critical two-tail 1.986674497

    After 5-years without gains, the following 11/15 gained (avg 8.5%), which was more than mean of all years but not significantly different. 2005 return was negative, and followed a 5-year down period ending Dec 2004. This was the first 5-year down since Dec 1981. Here is a list of the year end following years lower than 5-years prior, and the return for the next year:

    2005   ?
    2004   -0.61
    1981   19.60
    1978    4.19
    1977   -3.15
    1974   38.32
    1973   -27.57
    1970   6.11
    1969   4.82
    1943   11.80
    1942   13.81
    1941    7.61
    1940   -15.38
    1935   24.82
    1934   38.53
    1933    5.44

    Big Days, from Big Al

    I counted larger moves in the S&P relative to volatility, by month, from 1951-present. October strikes again, and other end-of-year patterns are here.

    A Letter on Groundhog Day, from Steve Leslie

    Trivial point: Did you know that James Stewart the great actor and star of such classics as Rear Window and Its a Wonderful Life was born on May 20th, 1908 in Indiana Pa. Now as anyone from the Keystone State will tell you Indiana Pa. is but a stone's throw from Punxsutawney Pa.

    Any true American and especially a mid-eastern American will inform you that Punxsutawney is the home to the irrepressible and dependable Punxsutawney Phil. The most famous rodent and weather prognosticator of all time. Each year on February 2nd Punxsutawney Phil is wakened from his winter slumber to have a prepared speech read on his behalf ( probably because Phil does not speak human) from Gobblers Knob in the center of town. Even the famous actor Bill Murray forever memorialized Phil in his greatest work Groundhog Day! This famous speech is captured by news media and broadcast around the world for its profound implications for countless millions who will be affected by his call as to the likelihood of the continuance of winter.

    I have enclosed his speech read this morning at sunrise from the most famous weather station in the world:

    Phil's official forecast as read 2/2/06 at sunrise at Gobbler's Knob:

    It is said that imitation is the sincerest form of flattery.
    Around the country there are many imitators of me.
    In Harrisburg there is Gus who appears on TV working for the lottery.

    Then all around town,
    Cute groundhog statues abound.
    They all look like me, I found.

    Today on the Knob as I'm doing my job,
    I don't like this likeness of me.
    It's my shadow I see. Six more weeks of mild winter there will be.

    Perhaps Dr. Vic, the great statistician and luminary that he is, would care to comment on any correlation to Phil's prediction and the concomitant effects on the markets today. Is there further precedent for successive declines in the NYSE and Nasdaq on this one event in history for the balance of the year.? And finally, can we use Phil's predictive skills to handicap the upcoming winner of the Super Bowl this Sunday?

    A Letter from an Interested Observer, Dr. Mark Goulston


    One of my closest friends, Mark Silverman, who brother is Barry Wine, said he met you recently and suggested I check out your website and writing. I did and I am suffering from case of "envy"-- not of how well you write, because I am no slouch. What I envy is your humility.

    Because of not feeling particularly impressive to my dad (more his problem with not being impressed by anyone than mine), I still suffer with the need to sound "interesting." Fortunately in my day job as a psychiatrist, I have disciplined myself to be interested in others, but the other side leaks out in my writing.

    What I like about your writing is how clearly you are interested in others. Apparently I am not alone in this conflict. In an upcoming Usable Insight I talk about Jim Collins' advice from a mentor, John Gardner:

    If you really want to win friends and influence people, concentrate more on being interested instead of interesting. - Jim Collins, author of Good to Great and Built to Last

    Jim Collins explains in the December issue of Business 2.0 how learning this changed his life in 30 seconds:

    John Gardner, founder of Common Cause, secretary of health, education, and welfare in the Johnson administration, and author of such classic books as Self-Renewal, spent the last few years of his life as a professor and mentor-at-large at Stanford University. One day early in my faculty teaching career -- I think it was 1988 or 1989 -- Gardner sat me down. 'It occurs to me, Jim, that you spend too much time trying to be interesting,' he said. 'Why don't you invest more time being interested?'

    "If you want to have an interesting dinner conversation, be interested. If you want to have interesting things to write, be interested. If you want to meet interesting people, be interested in the people you meet -- their lives, their history, their story. Where are they from? How did they get here? What have they learned? By practicing the art of being interested, the majority of people can become fascinating teachers; nearly everyone has an interesting story to tell.

    "I can't say that I live this rule perfectly. When tired, I find that I spend more time trying to be interesting than exercising the discipline of asking genuine questions. But whenever I remember Gardner's golden rule -- whenever I come at any situation with an interested and curious mind -- life becomes much more interesting for everyone at the table.

    I hope this is as "usable" for you as it is for me. I also hope that if you find these Usable Insights helpful that you'll share them with your co-workers, family and friends.

    Best regards,



    Letters to the Editors: Archive