# Market Completeness, from Vinh Tu

January 31, 2008 | 2 Comments

"…Left off the balance sheet is the value of the asset that Gary Becker, Nobel Laureate in Economics, calls human capital. Professor Becker says that the skills and experience of our people are worth more than half a million dollars per person. By this calculation, traditional assets comprise less than 25 percent of the national balance sheet, which means that true U.S. assets exceed \$180 trillion…" Mike Milken

I haven't had my morning coffee yet but here's an attempt at arithmetic along Beckerian lines:

A recent FT article put Japanese assets at 75% of its GDP. Pulling a totally random number out of nowhere, if the return on assets is 5%,

GDP = 5%*(total assets)

GDP = 5%*75%*GDP+5%*humancapital

19.25*GDP = humancapital

Looking at World Bank statistics

World GDP 2006 = 48.2 trillion

World financial assets = 170 trillion

Return on assets = 5% (can someone give me a better number?)

Return on financial assets = 8.5 trillion

Return on human capital = 39.7 trillion

Human capital = 794 trillion

population = 6.6 billion

Average human capital per capita (hheh..) = 120303.3

Anyway, very rough calculations with numbers plucked from the ether, but the order of magnitude at least is in line with Prof. Becker.

(Also, I left out something important - GDP is not just a return on capital (even human capital) because human ingenuity produces excess profits and increases the value of the capital. So you'd have to adjust the calculation of human capital to account for growing return. And risk adjustments. Etc. etc.)

Any real macro economists care to point me in the direction of more accuracy?

## Phil McDonnell replies:

Rather than pulling an imaginary growth rate out of our … armpit, perhaps a better approach can be found. GDP is the goods and services produced by a society. However much of that is consumed as well. The number we are really seeking is the net 'profit' figure that can be carried forward into the next year. It is good to remember that any 'profit' carried over must be held in the form of an asset. Thus a reasonable measure of the rate of return would be the net increase in total assets year over year.

## Yishen Kuik counters:

Maybe I'm too classical, but I've always thought that GDP is a flow measure of all the goods and services we produce, of which one portion is consumed to give us present utility and the remaining portion is invested to enhance our ability to increase GDP in the next period.

Presumably all goods have some aspect of both utility and investment ("school is fun and you learn something" or "bridges are beautiful and enable transportation"), but we can think of the investment portion of GDP as flowing into a stock of accumulated capital.

The stock of capital deteriorates over time, so some of that flow is just running to keep still. Part of the stock is human, part of it is physical plant, and part of it is institutional arrangement of society (courts, laws etc). The dollar figure we attach to capital stock is just a very rough attempt at measurement, and doesn't take into account the importance of having the right arrangement of the 3 kinds of capital stock. The right arrangement catalyzes a \$100mm investment to return 15%, while the wrong arrangement will have no such catalyzing effect. That is why \$100mm produces such different results when invested in America versus Africa.

I think it is this accumulated capital stock (human/physical/institutional) which is the right place to discuss big picture returns on investment. Unfortunately much of it is unquantified and unquantifiable.

## Adi Schnytzer brings up the stock market aspect:

Surely the real issue here is that, however, we define GDP, it's notoriously unpredictable? After all, why has the market been shooting up and down so furiously lately? In part it's because every one has been wondering whether or not the US economy is moving into a recession. Well, if we could agree on a way to to measure and predict GDP, we'd have solved that issue for the market pretty quickly, wouldn't we?

## Derek Gard dissents:

This assumes the market moves based on GDP at all.

From 1950 to 1960 GDP went from 1696.765 to 2517.365 (48%) and the DJIA went from 198.89 to 679.06 (241%)

From 1960 to 1970 GDP went from 2517.365 to 3759.997 (49%) and the DJIA went from 679.06 to 809.2 (19%)

From 1970 to 1980 GDP went from 3759.997 to 5221.253 (39%) and the DJIA went from 809.2 to 824.57 (2%)

From 1980 to 1990 GDP went from 5221.253 to 7112.100 (36%) and the DJIA went from 824.57 to 2810.15 (240%)

From 1990 to 2000 GDP went from 7112.100 to 9695.631 (36%) and the DJIA went from 2810.15 to 11357.01 (304%)

GDP during the 60s was higher than the 50s and yet the market barely budged. And GDP during the 60s and 70s surpassed the growth rates of the 80s and 90s, yet what decades saw the greatest gains in stocks? Stock market moves do not correlate well with actual GDP data over decades or even years, let alone the daily thoughts and musings of financial pundits.

To say stocks move on GDP data, or confusion thereof, is not supported by raw data. This is the same logic that says, "Stocks rose on a drop in oil prices" one day and then the very next day says, "Stocks fall despite a decline in oil prices." It is a fallacy promulgated by the same people who earned 3.5% per year in stocks during the 80s and 90s when the market was earning more than triple that.

My argument was not that the market moves in line with GDP, rather that lately the market has been reacting to news suggesting either an imminent recession or not. To measure the relevance of this assertion you need to check whether or not the market falls some months before a recession (thus anticipating it) and not whether over a long period the market tracks GDP.

## Nigel Davies opines:

As a simple chess player I must admit to being confused by the apparent
implication (seen everywhere right now) that positive GDP is good and
negative GDP is bad. In my own admitedly primitive pursuit one rarely
gets the opportunity to play expansive moves on a continuous basis,
there are periods when one must regroup in order to increase the
potential energy of a position.

So if I were an economist I would not be looking for answers in simple
linear relationships. Instead I'd try to study the interplay between
'potential energy' (one might try to define this in many ways, for
example by defining debt in 'real' terms) and GDP. And I'd hypothesise
that one of the most bullish economic times would be during a recession
in which personal debt was being reduced.

## Vinh Tu tries to sum up and conclude:

Whether more GDP is "good" or "bad" is a normative judgment. To an
economist, however, since GDP by definition refers to the production of
"goods", it has to be good. (It is generally assumed that utility is
monotonically increasing with goods.) Whether the increase in goods
produced corresponds to an increase in share prices is an entirely
different matter. A share represents a claim on assets which, in turn,
yield a stream of goods (or money which can be exchanged for goods.)
Whether an increase in GDP is beneficial for share prices has
everything to do with where that increase comes from. An increase in
efficiency, whereby the return on existing assets increases, would
probably increase share prices, all else being equal. On the other
hand, the creation of new capital assets would not increase the value
of pre-existing assets if it resulted in the assets being less
efficient.

# Wrongly Accused of Sportmanship, by Nigel Davies

January 31, 2008 | 3 Comments

Last Sunday I was accused of 'sportsmanship'. Frankly I felt like a mug. What happened was that in a crucial tournament game in a rapidplay event the minute hand on my opponent's clock stopped moving when he had 5 minutes left. This meant that he effectively had unlimited time and I saw a better position and time advantage evaporate into a loss. Immediately after the game it was established that this had indeed been a defective clock but that my resignation had to stand. I didn't kick up a fuss because then I stood to lose more than just the point. This is why my 'sportsmanship' later got praised.

Naturally I've been thinking about what I should have done, this was the first time I've had this situation. It's difficult to know because calling the arbiter means losing concentration and thinking time, not to mention the fact that you're in the lap of the gods once officials are involved. One could simply ask for a new clock, providing there's someone there to hear this request. But given the potential for argument a better approach may be to knock the clock to the floor, by 'accident' of course. Hopefully the thing will more obviously break and at the very least you can ask for a new clock 'just in case'.

Shouldn't the organisers have ensure that all the clocks were working? In theory, yes of course. But this is the kind of naive attitude that means you always get shafted. It's better to leave 'challenging authority' out of the battle plan.

It is difficult to know what to do. This happens in real trading situations all of the time, and I've been on both sides. There have been many times where I've seen a trader at a Nice Yokel Scum Exchange appear to not honor a posted market. Do I take time out from my trading to call surveillance and have it tracked down, knowing that they are inclined to take the other guy's side?

As a market-maker I've been on the other side too. On the ARCA options exchange, for example, a customer has 30 minutes, I think, to ask for a trade-break on an "obvious" error. The exchange would then look at it, then make a ruling, then call me. So 45 minutes or so after a trade, I get call on something that has already been hedged, on an option that has been up 50% and down 50% in value on the day. I then have to decide do I lose yet more time fighting the ruling, knowing I'm going to lose but that precedent matters, or just eat it? Of course, these customers challenging are never Grandma from Des Moines, but usually a "customer" account at Large Hedge Fund or Mega-Bucks Bank. They buy an option at the market on the open in something that just had earnings. ARCA is electronic, and they take whatever offer I'm sending. Being a good-little liquidity provider, I'm providing liquidity at the moment of the opening in an event-driven stock. 25 minutes later, the initial euphoria is over, volatility is in 50%, and the call they paid \$2.50 for is now offered @\$0.75. They call to bust the trade because the price is "obviously" an error. The cynic would say they are just taking a free look on the open, but I, of course, would never accuse LHF or MBB of such tactics. I did ask ARCA what they would do if I opened Free Look Trading, a division of Customer Capital…

# Thoughts on Bobby Fischer, from John Floyd

January 19, 2008 | 4 Comments

We have read a fair number anecdotes, biographies and controversies, but perhaps another way to look at Bobby Fischer is to think about what we can learn from him in terms of both life and any applications of his life and chess as they apply to the markets.

Independent thinking and willingness and adaptability to live in any number of places: Iceland, Japan, Philippines, and Hungary. Having been to or lived in all of them I can attest to the fact they are all vastly different. Fischer also demonstrated his ability and the longevity of his talents by making a comeback, on his own terms, as in his match with Boris Spassky in 1992. Or, when it seems as victory is improbable to make a dramatic and hard fought comeback as in his 1972 match against Spassky. How many times does the market make us question our own abilities and how needed it is to focus on ones methods and talents while still evolving and improving to achieve success? The need to be aggressive at all times whether it is attacking or using subterfuge as seems to be the case in his match against the grandmaster Robert Byrne.

This is not a suggestion to disregard or ignore his many faults but rather so that we can focus and learn from many of his positive attributes as well. Fischer's almost single-mindedness on Chess and his many transfers and incarnations also seem to have limited the scope of his achievements and therefore what could have been learned from him. As in nature when a tree grows, or is transplanted, it needs the root structure to support a broadening of the branch material and growth above.

Not being an expert on chess or Fischer, or life, I welcome all other suggestions and observations.

An icon of my youth gone, and the same applies for many of us.

It's a big question what to do about great artists who became antisemitic. Most notably in music, Wagner; and there is an open debate in Israel whether to hear his music.

I was never a fan of the recently late Karlheinz Stockhausen, but I listened to him no more after he psychopathically described 9-11 as a great work of art.

We have to take a broader view. Should we deprive ourselves of the works of DH Lawrence and TS Elliot because they were tainted as children with pervasive cultural prejudice? To boycott all literature by antisemitic English authors pre 1950 would leave very few (George Orwell a notable exception).

Bobby Fischer?

Probably not an Icarus, more a Narcissus who, lacking a mentor to grab his shoulder, fell - ever unaware - through the squared pool into muddy waters.

I think there are many things to be learned from Fischer. Here's what comes to my mind:

1) Work rate: Fischer's 'remarkable' comeback becomes more comprehensible when one realises that all he ever did during his 20 year break was to study chess. I heard stories about his time in Hungary, that anyone seeking an audience was well advised to send in some of the latest chess books and magazines as a peace offering.

If you read 'Bobby Fischer goes to War' the comparison with the Russians becomes clear. In their training camps they studied a little chess in the mornings and then got the cards and booze out at midday.

2) Ascetic Lifestyle: Bent Larsen told me a funny story once about how he had to rescue a bottle of cognac from Fischer when the latter was intent on pouring it down the sink. Fischer also took a lot of exercise during his best years, mainly swimming I understand.

3) Learning from history: Fischer had a remarkable breadth of knowledge, studying the old games as well as the new. Amongst the openings Fischer rehabilitated were the Bishop's Gambit, the Evans Gambit and the Exchange Spanish.

4) Will to win: Fischer's disdain for short draws is well documented, one of the most famous examples being to laugh when Geller (who had a big plus score against Fischer at the time) offered him a draw on move 7 in their game at the Sousse Interzonal.

5) Preparation: Fischer took opening preparation to new levels of excellence, a trait which Garry Kasparov was to emulate in later years.

A few more will probably occur to me, Fischer was a truly remarkable player whose play was greatly respected (feared) by his rivals.

# McDonalds and Starbucks, from Alan Millhone

January 9, 2008 | 9 Comments

Just caught on the news that Mc Donalds will add a 'coffee bar' and make more dramatic changes to their drink menu than they have in the past 30 years. I enjoy their Bravo coffee and am sure I will enjoy the drink additions when they reach my area. Mc Donalds is apparently still setting the pace in many areas as it was also announced that Starbucks now plans to make changes.

Although Starbucks gets a different niche of customers, this not good news for Starbucks .

A coffee bar and wi-fi at McDonalds, then Starbucks really has a problem.

I've always believed that the ethos of a corporation pervades, DNA-like, throughout all manifestations of the corporation, however small the "cell." If you want to discover the values of a company, you can look anywhere, from its choice of stationery down to the cleanliness of its floors.

Back to Starbucks. It was telling for me regarding the company's values that, living as I do five blocks from the former World Trade Center, I was shocked that in the days following, when rescue workers, many of them volunteers, flooded the area to begin cleanup, the local Starbucks was selling bottles of water. I'm as much a capitalist as anyone, but the outrage this opportunism occasioned in the local community, and subsequent bad publicity — Starbucks quickly reversed its policy and began handing out bottles for free – rankles to this day. The positive publicity it could have garnered by donating the water to relief workers would have more than paid for the negligible profits "sacrificed."

Ray Kroc was fanatic about cleaning his stores, and making everything perfect. Moreover, McDonald's franchisees are a powerful force for innovation and market research. I doubt that Starbucks has any such credo. And were I a fundamental investor, I'd bet on McDonald's in the race with Starbucks.

A worthy read about McDonald's is Ray Kroc's Grinding It Out. My favorite passage:

The key element in these individual success stories and of McDonald's itself, is not knack or education, it's determination.  This is expressed very well in my favorite homily: 'Press On: Nothing in the world can take the place of persistence. Talent will not; nothing is more common than unsuccessful men with talent. Genius will not; unrewarded genius is almost a proverb. Education will not; the world is full of educated derelicts. Persistence and determination alone are omnipotent.'

## Henry Gifford dissents:

Starbucks and McDonalds offer entirely different products in terms of the cultural experience they sell.

On Broadway in Manhattan, two blocks from me, there is usually a homeless person "working the door" at the McDonald's, opening the door for customers and asking for spare change. Once McDonald's put a guy with a bow tie there to open the door for free, but that didn't last long, and the homeless guy is there every day. Also, the workers in McDonalds don't hesitate to stand around and chat and ignore customers.

At Starbucks a block away I've never seen a homeless person "working the door," (nor at any of the other stores nearby), I don't see homeless people sitting there, and the workers have a spring in their step.

## Jim Rogers counters:

As someone whose first career was in the hospitality industry, I can state that McDonald's moves markets in more ways than one.

The difference in demographics, however, is a present condition and certainly not a necessary condition. McDonald's has always put its eggs in two baskets: families (especially those with small children) and value. In the past, their offerings were weighted more heavily on the family side of the spectrum. Now, thanks to a number of cultural shifts (including those driven by Starbucks), McDonald's has realized that they can capitalize on the public's perception of additional value. Before, it was all about quantity (the Super-size phenomenon). Now, it's about quality (better coffee, more aesthetically pleasing decor, fresher menu items). In the past 24 months, the majority of McDonald's top line revenue growth has been driven by menu items at the top of the price scale, especially new salad offerings. There are a couple of interesting points that McDonald's has embraced: the masses (or at least a historically large percentage of the masses) will pay for quality, and design makes a difference. It made a difference in attracting the kids thirty years ago, and now it's making a difference as it re-attracts adults (with or without children) with Wi-Fi, coffee, and more pleasing decor.

## Marion Dreyfus opines:

Whatever the relative merits or demerits of the individual loci, the Starbucks habituee will not 'descend' to the perceived downmarket of McD's, which is a brand-association drummed into our consciousness by millions of ad messages over decades. The food may be better, the prices definitively so, at McD's, but the smart set will not cotton to the overbright, plastic-dominated perceived lower-ranking environment of kid-friendly McD's.

The escalation of prices for a simple beverage to unheard-of stratospheres is one thing that has, to date, ensured the rarefied perception of Starbuck's as being compatible with the upward-striving status-jumper.

So unless McD's radically alters its branding, the trendoids will find it distasteful to step lively in those swinging doors, even if their coffee tastes more acidic and sets them back more by a factor of twice or thrice the McD's coffee.

Ronald McDonald is five blocks east of me in Seattle, a short walk downhill a ways. Property they have is also just a short walk uphill to Childrens' Hospital. Parents can stay at Ronald's place while visiting kids, many with cancer. Ronald's facility is commendable for its architecture. One can have nothing but praise for Mr. Ronald, whose plastic body is standing out front of the facility, smiling with welcome. Kids love him.

## Vitaliy N. Katsenelson analyzes:

SBUX stock is transitioning from 'growth' to 'value' investors. However, it is not cheap enough for value guys. At least not yet. Also, with current news cycle it will likely see the other extreme of its valuation. In the not so distant future it will probably have to rationalize its store base, close some underperforming stores and slow its growth expansion.

## Jim Rogers notes:

Fast-food restaurants, due to their staffing policies, are much more likely to employ legal immigrants than you might think. The biggest offenders in the food world for using illegal labor: high-end restaurants, because they lack the institutional oversight and back-office support to adequately check a lot of prep cook and porter staff applications (and some are simply dishonest). If you're looking for a trade opportunity in the event of some strict anti-immigration policy, short higher ticket restaurant groups.

## Scott Brooks writes:

McDonalds will have to work hard to overcome their persona. They have cultivated that image for a long time. I have often joked (with an air seriousness to it) that one of the greatest inventions/innovations of the 20th century was the McDonalds Playland!

I absolutely hate the food at McDonalds and will move heaven and earth to not eat there. But my kids like it. So when the wife needs a break and the kids want to go play, I'll take them to McDonalds, buy a few Happy Meals and let the kids play and eat.

Actually, they don't so much eat as graze. They play, come back and grab a few fries and bite or two of their burger/McNuggets and go back to playing.

As much as I don't like the food at McDonalds, they are an incredibly innovative company that I respect immensely. And with their distribution chain and the demographics of America changing, don't underestimate what McDonalds is capable of.

That clown may look stupid, but underneath there is a shrewd businessman!

## Nigel Davies ponders:

I'm just wondering what the real appeal of McDonalds is and what really gets people in the doors.

I often eat at McDonalds during tournaments because there's usually one around, probably they won't poison me and if they do (and I live) I can sue them.

On the other hand my five year old son much prefers the relatively civilised atmosphere of Pizza Hut, so much so that I can use the 'Would you like to go to McDonalds for lunch?' gambit as a threat. Now it turns out he quite likes pubs that do food, but the big thing here was getting him in the door and outside his comfort zone. Now he does miss the balloons but there again he's taken a liking to turkey.

So it seems to me that a lot of this is down to parental choice, the main driver here being cost. Of course most parents are going to be struck by severe pangs of guilt should there be even a whiff of a rumour that the food served up is unhealthy. So with BSE (Mad Cow Disease)/cholesterol etc appearing on the horizon, it was inevitable that McDonalds would take a hit until it overhauled its menus and image.

In this respect I see the coffee/WiFi as being a really clever means of making them look like Starbucks and feeding off the modern, trendy and healthy image of the coffee house chains. But are they a 'competitor'? I really don't see it, and I don't see a Starbucks denizen suddenly switching to McDonalds because of the cost. To me it looks more like an image thing to get the old customers back in the doors.

## Julian Rowberry submits:

Starbucks never really caught on here in Australia. Its brand name and attempt at exporting US culture is a tad brash for the local market. Plus there's already a vibrant cafe scene. The Maccas Cafe has been here for years. It's aiming at the fast and convenient 'healthy eating' market that companies such as Subway feed on. Not branded wanker latte drinkers.

## Alston Mabry recounts:

At Burger King the other day (I'm not a big fan of fast food, but I am a Coke addict, and my dogs love the burgers on the dollar menu), I hit the drive-thru, and when I pulled up to the window, the Latina there said they needed to cook the burgers and would I mind pulling into the parking lot in front for about three minutes (they know their cooking times). No problem. I don't mind waiting in the car because I always have a good book to listen to, this time Adventure Capitalist. I'm listening away, and the pooches are quiet in the back, when I notice it's been almost ten minutes. So I go back through the drive-thru, and there is a young guy at the window this time. I start to explain, and he thinks I'm placing an order. His English is good, but he is obviously from Mexico or Central America. I show him my drink and the ticket and he gets it and starts rattling away in Spanish with the staff. I realize he is the shift manager. He comes back, apologizing profusely, and explains that they accidentally gave my food to somebody else who was also waiting, that they will cook fresh burgers for me and that he will bring them out to me personally. I think he was worried that I would be angry, but I wasn't at all. We park again, and a few minutes later he appears with the food and apologized otra vez.

The point of the story is this young guy. He was a good-looking kid, maybe twenty. He was running the show, working hard on his English, taking reponsibility for the results, apologizing for mistakes and personally delivering the goods. And here was Burger King providing the structure for him to be successful. Not a dead-end job at all, not for this guy. I was very impressed.

I had an funny thing happen in fast food to me in about 1985. I was a manager of a Taco Bell, putting myself through college. We had hired a new girl who had previously worked at Burger King. It was her first day and I had her working the drive-thru.

The drive thru "dings" with her very first customer. She says into the microphone: "Welcome to Burger King, can I help you." I thought it was pretty funny, she thought it was pretty funny, but the guy in the drive-thru began laughing hilariously.

But he placed his order and pulled to the window. The reason he was laughing so hard? It turns out he was the guy who owned the Burger King where she used to work.

# As Many Shades as Joseph’s Coat, from Stefan Jovanovich

January 3, 2008 | 2 Comments

One of the measurable facts about S.A.T.s, I.Q.s and most other standardized tests is that test subjects can have their scores improved by 10% or more if they are allowed to intensively study for 6-10 weeks, take repeated practice tests and be coached on the keys (i.e. the tells) for the test. That is why cram schools have become a multi-billion dollar business.

When I asked Dad why he hadn't invested in cram schools for I.Q. test as he had for the other standardized tests, his answer was that I.Q. testing already had a limited market because people mistrusted the results; if they learned how malleable the results really were, it would ruin what little demand there was. Then he laughed and said that the irony was that the tests were not to be trusted not because study and hard work would change your score but because they diminished the actual range of difference in intelligence; like school itself they pushed people towards the social middle, when the reality was that there was as much distance between a genius and a near-genius as there was between the near-genius and "handicapped" child.

I had far more arguments with my father than I am happy to remember; and he was as capable of folly as any genius, but he knew the reality, practice and even the theory of standardized testing better than anyone. The vast majority of his customers wanted to believe that "intelligence" was a measurable quantity, like height or the atomic weight of copper. Many of them needed that belief to buttress their neo-Darwinian assumptions about the poor being poor solely because they were stupid.

By the end of his life, as the child of an illiterate, Dad felt more than a little disappointment and even shame at the fact that few, if any, curricula were founded on the assumption that intelligence came in as many shades as Joseph's coat and as many forms and rhythms as nature itself. A few months before his death, when the pain had begun to make him more than usually cranky, he gave me his last word on the subject: "There has always been a lot of talk about each child's reaching his potential; but the potential better be something that could be measured in 40 minutes and scored on a Scantron." Some shadows on the wall are produced by the sun shining on rocks that can be kicked; others are the pure projections of the faulty assumptions of social (sic) science.

Having hung around a lot of high IQ people for most of my life I think your Dad was spot on. Some have evident trouble with things like shoelaces. And they don't necessarily make the best chess players, which at first seems really baffling when one considers that a nice closed environment like chess should be perfect for someone with a high IQ. But when you play against these guys you start to realise the issues they have.

A common trait, for example, is for them to look at chess as a kind of mathematical puzzle in which their brilliant brain will eventually work out a solution The problem with this 'pure' view of the game is that it can make them highly predictable, so all you then need to do is find a problem with one of their lines.

Their solution based view also makes them highly vulnerable to provocation should you play a line which might be considered inferior. They'll want to punish your move (in their paradigm it is incorrect) and start to lose their objectivity. And then the problem is that they won't easily be able to pull themselves back from this state of mind because of a belief that their 'brilliant mind' is not capable of anything but objective, pure analysis.

De Bono also mentions the 'intelligence trap,' which is the tendency for people with high IQs to show off how quickly they can see something. This manifests itself as bad thinking habits, for example a failure to consider alternatives. So in chess someone with a high IQ will often calculate a single variation very quickly, but fail to consider alternatives along the way.

There can of course be advantages to high IQ, but I suspect that other talents also need to be in place to make it work for someone. And the problem may be that these may actually be inhibited during their development.

## Sushil Kedia extends:

I believe a number of Daily Spec readers are members of Mensa.

There is a serious problem with Mensa India. Some who have catapulted themselves to be the managers of Mensa India have not been letting it grow at all. The last several years there have been no examinations done to let in new members. Forget about elections to the management bodies, new people can't get in now.

If you check the Mensa India website and call the phone numbers listed there they tell you for the last two years that the number of Mensa has changed and Ms. Sudha Tendulkar (she is a secretary to an Indian industrialist who has manipulated Mensa) will always tell you that in a few days the new numbers of Mensa India will be put on the website.

Requesting all readers who are also members of Mensa if they will kindly escalate it through their local chapters to the Mensa worldwide management that Mensa India needs their attention.

# Rent vs. Buy, from Gordon Haave

January 1, 2008 | 1 Comment

On the margin, buying to rent should become a marginally more attractive investment going forward. A normal real estate decline, caused by a general slowdown in the economy, should affect buying and renting equally.

But in this case: Take a guy who makes 75k per year. He went in leveraged himself in a subprime to buy a 500k house. He can't afford that now, and he is being foreclosed on. But, he still has his job, and needs a place to live, and he will be entering the rental market to find a roof for his family.

## James Lackey replies:

My sister is in that biz, and its amazing how far prices have to fall to make deals cash flow positive. Florida wasnt since 2001 and it's now near break even for investment rentals. Close, but not there yet. We are talking nice houses near towns, schools, shopping, roads to beaches etc. — a house a guy that makes 75k would rent. And any nice apartment complex was converted in 2005-06, so rentals are scarce.

## Nigel Davies writes:

Professor Haave's point is a good one and I for one will certainly be a real estate buyer when UK rental income rises to decent levels. But I don't think that this necessarily signals a 'bottom' as demand will also be a function of the overall state of the economy and can contract considerably if push comes to shove.

A major argument in favour of a 'strong rental market' is that people need somewhere to live. But there seems to be an assumption that an individual's space requirements cannot possible contract, which is nonsense. It's worth remembering that 100 years ago extended families of 20 or more would live in a houses of the size that are currently occupied by singles, and you still get this in many countries.

# Parenting, a query from Nigel Davies

December 31, 2007 | 2 Comments

Noticing that my son (age 5) was not particularly assertive (e.g. if another kid took a toy he was playing with, he just cried) I decided to embark on argument training. The problem is that in this attempt at rounding I seem to have been rather too successful, and now he argues about everything. And that includes some chess positions, even though he can't play. He's also started memorialising examples of his being assertive in "folk tales," which need to be repeated several times a day. For example there was the time a 2 year old tried to take his plane in Pizza Hut…

I'm starting to wonder if the best someone can really do is to try to improve himself whilst just spending time with his kids, with no particular goal in mind?

## Jim Sogi suggests:

One, no matter what, always let the child know that you love him, even when he fails or is bad.

Second, especially ages 2-8, be consistent with rewards and punishments.  Don't spoil the child, but guide him with firm rules. He will be happier for it in the long run.   I see so many parents unwittingly training their children to be spoiled brats, and they both end up miserable. After that, its almost too late.  Manners and etiquette should be a part of the  program.

See Living with Children by Gerald Patterson for specifics.

## Kim Zussman remarks:

How to raise happy, well rounded kids? That's easy: stay married.

Mom and dad need to transcend herd psycoidology insisting that happiness-entitlement derives from the continuous hunt for new itches to scratch.  If this doesn't resonate, go to church. Then, when your kids grow up happier and well adjusted, mom and dad will be happy as well.

At a Bar Mitzvah yesterday, the rabbi and new man discussed at length the reluctant leadership of Moses on his way to Exodus, as well as themes of peace, forgiveness, avoiding war, etc.  Ironically 80% of the audience had been divorced, and the audience included numerous young people with various parent/step-parent complexes.  So much for Ashkenazi IQ.

## Russ Humbert writes:

Watching a dog raising pups, you will see that the adults are pacifist during the first weeks. The pups can cause all manner of pain and annoyance, and both the male and female dog will take it all without any aggression. Then, once they are old enough to understand, comes the discipline. They are taught to understand hierarchy of the pack. They are also taught to become top dog you must fight. This shows us several things about ourselves that many modern parents ignore.

In a society that is becoming less and less hierarchical in nature and more team oriented, less discipline is needed, but more proper peer pressure. And, governmental attempts to ban corporal punishment by parents is doomed to failure. Like prohibition, the war on drugs, and sexual abstinence. When you go against the brain's natural response, the police lose. Anyone who has been close to the foster care system in this nation, knows first hand how dismal this failure is likely to be all at the expense of the most innocent, the child.

I would suggest that in raising a child one must consider his innate strengths and weaknesses in deciding how much of team player/hierarchical structure he needs. But also one must consider that most parents simple follow the "team" approach because it is popular.

In other words, teach a child to stick up for himself, but draw the line when he disrespects you.

## Scott Brooks follows up:

Unless there is something biologically wrong with a child, there is no reason for that child to become depressed and miserable if he is raised to be happy and find joy in life. Becoming "genius-like" I believe is far more about nurturing than biology. Sure, biology helps, but the right environment is far more important. A good environment can make a kid, whereas a bad environment can break him, even if has the grey matter necessary to become a genius. Training your children how to think is the key. Not just how to think about intellectual endeavours, but how to think about philosophical and emotional endeavours.

Being happy is a choice. Having a good attitude is a choice. Being smart is a choice. I was beaten down in school because they thought I wasn't very smart. They wanted to put me in special school, but my mom wouldn't let them. But I was always raised with a belief system that my life was my choice. When I went away to college, I decided to make a fresh start, since no one knew me. I played the role of the smart guy and — surprise — I was smart and got good grades. I credit all that to my upbringing: being taught to be happy, find joy, to look on the bright side and always believe that good things would happen. I "got smart" as a result of that.

## Jeff Sasmor recounts:

I let my kids (girls, 14 & 16) mostly do what they want as long as they keep up good grades. When they don't I hire tutors. As a result one has an A average and the other B+ with no nagging from me. About the only exception is that I never let them fall behind in math. They have had unfettered and unmonitored Internet access since they were each about 5 or 6.

I let them explore what they want to do and I don't push them in any direction; rather, I think it's more appropriate to encourage them in what they appear to be interested in. One has become a really quite good writer. The other has self-taught herself to become a good artist and is starting a band with some friends.

They should explore while they are able; most adults do not have that luxury once they have to pay rent. They do have friends whose lives are scripted to strict schedules of sport and other activities. I don't understand this sort of parental behaviour, but then I don't understand many things that involve people's minds.

# Standing Like a Tree, from Nigel Davies

December 30, 2007 | 4 Comments

Recently I started to crystalise some, let's say, 'intuitions,' into more conscious thoughts. The bridge between the two was to read quite a few books on Chinese martial arts and the concept of 'Chi' as a kind of life force. Despite a widespread belief in the existance of 'Chi' there is no evidence that such a thing exists. There is, however, some evidence for the health benefits of 'Chi generating exercises'.

To cut a long story short I decided to try it for myself and found classes for Zhan Zhuang. Frankly I was sceptical, as there was no scientific reason for doing so and no means of testing the outcome on my personal sample of one. The only means of judging would be my own senses.

My attendance at these classes naturally caused great hilarity when I told some hard-headed colleages about it. At this point I laid it on thick by explaining that ideally I should stand with my fellow trees in the park and absorb sunlight. Of course I was testing them, sensing their reaction as I built my hypothesis.

What is this hypothesis? Simply stated I suggest that the nature of a scientific education can actually lead to bad thinking, especially if it is pursued to the detriment of non-scientific activities. This is not so much the fault of science as the difficulty humans have in properly applying its methods. The search for a testable hypothesis causes the frustrations that lead to data-mining and failure to falsify hypotheses.

So where do the trees come in? Well, what I've noticed (and I know this is completely untested) since starting Zhan Zhuang is a much greater self-awareness, more energy and a reduction in tension. My chess experience suggests that such effects lead to better thinking, which in turn implies they'd probably lead to better science. The irony here is that many scientists just couldn't bring themselves to do stand like a tree because of the cynicism engendered by their methodology.

Some thoughts:

1) It's better to hire traders who like fresh air.

2) Science has nothing to say on the matter of various ancient practices which 'enhance the senses,' and this is why even really smart guys like Daniel Dennett manage to completely miss the point.

3) If you ever see a tree that tries to stand like a human, get the heck out of there.

Studies of the brains of monks who have meditated for 20+ years show structural changes. Practice of breathing, meditation and other techniques manifest in physical changes, changes in alpha brain waves, change in heart and breathe rates. Practice of Kung Fu and other physical martial arts have beneficial health effects, and application to trading as well.

## Nigel Davies clarifies:

There are two types of learning involved here. One is learning by 'reason', the other is subconscious 'body learning' of the type involved in Zhan Zhuong. The latter develops things like 'awareness.' My hypothesis is that those who rely on learning by reason alone (and this is the main focus of Daily Spec) are prone to a multitude of errors because they have not developed their 'senses' (or rather other parts of their brain that are not directly associated with reason). I have met such people both on the chessboard and in the trading world, and invariably they talk a good game but are unable to function well within it.

'Descarte's Error' is relevant to this way of thinking, with some brain-damaged individuals discussed therein performing well on 'tests' but failing hopelessly when they were let out onto the street. Substituting 'brain undeveloped' for 'brain damaged' and I suggest that we have a similar effect. Not of course the same level of disaster, but certainly an inability to function at the highest levels of difficult professions.

## Marion Dreyfus extends:

The reports of changes recorded in the minds/cerebra of monks are numerous. I wonder if the same can be said of absence of sex? What the monks do is active: They actively calm their minds, and actively bring themselves in concert with their fellow chanters. They breathe synchronously and deeply. They sit in relaxed alignment. These are active conditions.

Is a mere absence of sex in any way equivalent? Not having sex is not a discrete action or series of actions deliberately undertaken. In fact one would argue that a person not enjoying this life-function practice is always on the qui vive to find sex and ameliorate the absence condition. One is always tippy-toeing to locate a prime subject of supply, as it were. But not finding it is not really like co-aligning breathing, balanced postures, deep meditation or efforts at releasing of tensions and earthly concerns. Contrarily, I believe that people who have not had sex for a while still ideate and fantasize and focus on Getting It much of their waking hours, so it is the inverse of monkish contemplation.

Thus I doubt that the two are parallel at all. I therefore doubt that sexlessness alters the brain over time. Except for men. (Who become crazed and completely nuts.) (Or so they would have us distaff siders believe.)

# Najdorf, from Nigel Davies

I like to collect biographical games collections of particular players, when I can get them at a good price. But my negotiations with one particular chess bookstore feature the proprietor trying to give me the book I want and then me beating him up to a higher price.

Last weekend I spyed Najdorf's life and games and it was all I could do to pay for it. "It was remaindered" he told me, "I got it for a pound". "But you've got running costs" was my retort, you need to make a profit. I tried to go higher, he tried to go lower. Eventually we settled on 3 pounds.

I still think I got a bargain, Najdorf (1910-1997) was a wonderful player and interesting personality who argued with just about everyone. I learned that he performed his fabled blindfold exhibitions so that the news might reach his family who were trapped in Poland. He left for the 1939 Buenos Aires Olympiad just prior to Hitler's invasion and found himself unable to return. The news never reached them, Najdorf and his family were Jewish.

When asked about his definition of intelligence Najdorf answered immediately that it was the speed with which someone changed their mind to meet circumstances. Despite becoming very wealthy in insurance, his view of money was to live as a rich man but die as a poor one; he didn't want to be the richest man in the cemetery. And every day he played chess with someone and reviewed some of the latest games.

I met Najdorf once and can't say that I liked him. But such people are often the ones from whom we can learn the most.

# Practice, from Victor Niederhoffer

The importance of practice in music can't be overstated. There are hardly any musicians of great competence who took up their study after the teens, and most have been practicing intensively since the age of seven. The problem is that most people hate practice, stop at an early stage, and waste their time when they do this. Michelle Siteman in her magnificent book, "The Pleasure and Perils of Raising Young Musicians " has a chapter "Practice Makes Perfect " in which she gives 10 techniques for improving the quality and quantity of such practice.I have received completely positive feedback from musicians who have read this book that the techniques she suggests are ingenious and useful. I believe the have universal value, and I will try to apply the lessons from Ms. Siteman's chapter to improve the practice of trading with a few of my own practice techniques from racket sports thrown in. This is a subject that has received much too little attention as practice makes more perfect in every field including our own, And this would apply to any trader despite his natural proclivities and abilities. It is common to think that a quality for greatness in a field is to love to practice it. But Vladimir Horowitz, Glen Gould and many other musicians, including Beethoven, hated practice when they were young, but they were able to conquer their aversion, usually with the aid of a firm parent who applied some of these techniques. Presumably the head of a trading team should insist on practice regardless of the qualms or machismo of some of those whose recent track record is good, or believe they were to the manor born. Emulate Pablo Casals and Yehudi Menuhin, who practiced eight hours a day, every day of their lives.

It's not enough to say: practice trading. Most people don't know how to do it. And most are bored while practicing so there has to be something that makes it interesting. Musicians handle this by mixing in some easy beautiful pieces with the scales, finger exercises and and arpeggios.

1. Group activity. One universal technique for making practice more interesting is to make it part of a group activity. Somehow those who play instruments in orchestras stick with their instruments to a much greater extent than piano, and this is why many impartial observers suggest that orchestral instruments are better for a child to play than piano, because they stick with it. Practice sessions for traders should be in groups.

2. Money rewards. And what follows from this is that monetary rewards are a great motivator for musicians to practice. Some parents make their kids pay part of their lessons with their allowance money. This has a very salubrious impact on the efficacy of practice. Group trading practice should have monetary rewards. It's amazing how many of us will stoop down to pick up a \$5 bill.

3. Record keeping. Record keeping is an important part of a good practice session. A systematic account of what has been learned and what the goals are is always helpful as a foundation. It's also helpful to be able to review the mistakes and winning forays that went into a successful trade.

4. Parental presence. All musicians find it boring to practice alone. Having a parent around to observe reduces boredom. If it's important enough for the parent to insist the child do it, then it's also important enough for a parent to take an interest. The same would apply to a trading manager, who all too often leaves the trading practice to the subordinates without taking an interest in it.

5. Proper logistics. Practice should be at a certain time, and a certain place and there should be good lighting. That way there's no chance that a session can be missed because of a conflict in schedule that arose because the child or trader didnt know that it was scheduled for that day and time. A proper environment without sibling or other traders squawking that they are hungry also improves results.

6. Consistency. Practice every day is essential. The markets are always changing, and after a day or two all the skills begin to detiorate. I once practiced squash every day, 365 days a year, for 10 years. A trader should practice trading each day, or if a hiatus ensues, should practice steadily for a number of days before entering into the fray.

7. Read books about the techniques that other great musicians used to improve their techniques. What worked for them probably would put you on a path that has at least been tested. Eschew the techniques of traders that were not successful, for example the boy trader.

I would be interested in ideas readers have on improving the training and practice of traders.

I have always thought mastery is a largely the function of repetition.

Obviously you have to repeat the right things. Today's great home run hitters all have instant access in the dugout to videos of their last time at bat to review and repeat the right techniques and stop the wrong. Many scoff at paper trading — sure, it is not as emotional, but still provides valuable lessons.

Chris Ledoux won the world bareback riding championship with very few rides in actual rodeos. He was so banged up he practised on a bucking machine (also wrote a good song about it) to prevent further injury and shocked all the bettors who had never heard of him as he accomplished his gold belt-buckle dreams.

## Jim Sogi suggests:

My Karate teacher said, "What is the best practice and training for fighting? Fighting. You can run all day, you can do 1000 sit ups, 1000 push ups, 1000 sprints, and 1000 punches. But the best practice is fighting with an opponent. "My father once said, " The only difference between a small case and a large case is the number of zeros behind the 1."

You can read 1000 books about trading, study data for hours, but the best practice for trading is trading. Even if you do small size, which is best for practice, it keeps your wits sharp and emotions tough and keeps you in the game.

Keep a place set aside for only trading, always ready to go, 24 hours a day without having to clean up, scoot others away. Same with music practice. Have a set aside place or room for music with all the instruments just ready to walk in and pick up and play, even for 10 minutes before dinner. Pretty soon it becomes a habit.

## Allen Gillespie takes it further:

Scales and etudes and pieces played with different bowings, speed, rhythm, etc. Breaking down a passage into shorter component parts. For example, if there is a long passage of quickly played 16th notes, first practice with separate bows for each note, then two on a bow, then three, etc. then change the rhythms from just 16ths notes, then just play the key notes from the scale so the ear hears where the passage is headed as many of the notes are fillers, understand and anticipate the pattern. Learn to play by ear. Finally, Always Play/Practice Musically (i.e. even when practicing the notes do not forget to include the crescendos, etc.)

1) Imagine as many scenarios as possible.

2) The distance between lows or highs or between lows and highs might give an indication as to the key

3) Some notes/days are more important than others

4) Trade smaller during times of practice

5) Test different combinations of variables - first separately then two, etc.

6) Despite all the practice, sometimes the best performances are not straight from the page

7) Finally, trading is an emotional game, so play with passion and remember there is always a low note and a high note and many notes in between.

## Sam Marx reminisces:

Practice is important and in my sport in high school I practiced quite a bit but always felt that I had a limit because of physical limitations. I was 6 ft. tall but my hands were below average for my size. I couldn't get a good grip on a football or palm a basketball.

Once I was seated at a dinner table next to Bart Starr, former Green Bay QB. That man had huge hands. I have no doubt that enabled him to better control the football and made him a star. Another time I was in close proximity to Gil Hodges and I noticed that he also had huge hands. I believe he was a first baseman. I could just picture him with an oversize glove catching balls or scooping up grounders that would be missed by the average infielder.

A friend of mine was an excellent boxer. His arms were extremely long, also, his head was smaller than it should be for his size. He could just move around his opponent and jab him silly while keeping his head tucked behind his shoulders. Standing up with his arms dangling on his side I thought he looked like a chimpanzee. He had no desire to become a professional boxer but I've seen professionals in the ring with those characteristics. Kid Gavilan comes to mind.

On the options trading floor I noticed that some traders could hear trades from across the pit. Their hearing was acute.

Practice is important, but don't dismiss physical and mental ability, especially abilities in the 3 plus sigma range.

Don't tell your kid that he can accomplish anything if he practices enough. Offer this advice only when justified. Tell him he can greatly improve with practice but don't offer false hope of attaining the impossible. It can be frustrating if you're not in the 3 plus sigma range in the field you're practicing in.

## Nigel Davies recalls:

David Bronstein once advised me to prepare for tournaments by studying chess at the exact times the games were scheduled. And I understand that Vladimir Kramnik took this concept one stage further by solving endgame studies (particularly demanding work) during the last hour of such studies. The last hour of a playing session is known to be the most critical, with most games being won or lost at this time. And it does seem that he got the better of Veselin Topalov at this point in the games.

## Easan Katir mentions:

I spent one recent Saturday evening at the Hat and Hare Pub in the basement of the Magic Castle, with two accomplished card men, Aaron Fisher and Tony Picasso, discussing their art. Aaron instructed, "to improve, perform at any opportunity, for anyone." The club was full. He said, "C'mon, let's find you some people." So he rounded up a spontaneous audience comprised of three giggly young things, and gave this amateur the opportunity to perform modestly baffling illusions.

Live performing, live trading. No solo practice or paper trading like it. Mind sharp. Managing audience expectations, unexpected reactions and distractions. The joy of good execution. The thrill of conquest. The glow of accomplishment.

Much theoretical study, counting and practicing correctly precedes such moments. For trading I suppose the advice "perform at any opportunity" could be ambiguous enough to become a way to diminish one's capital, unless one adheres to tested guidelines for what constitutes an 'opportunity'. It works for me to transfer these skills to trading.

## Evan McKeown writes:

Practice is such an important topic. I have always believed that if you do what you love, and love what you do, then success will eventually come your way. Success itself means different things to different people.

I am a 5.0 tennis player, and love playing tennis. No matter how much I played, or practiced, I never was able to reach a level much higher. Notwithstanding my dedication or love for the game, I have enjoyed other success by meeting wonderful people that share my enthusiasm and we enjoy our weekly matches. John McEnroe once said he hated to practice, so, instead, he played in doubles tournaments. John had one of the best net games in tennis which is unusual today thanks to his devotion to being a doubles player as a substitute for practice.

I am a trader. Once again, I love what I do. Trading is not a job, it is a way of life, my passion. I trade every day, and practice every day. Practice for me, comes in many different forms. Just as in tennis, there is on the court, and off the court practice time. Off the court (or ticker screen) I stimulate my mind with financial literature. The best book I ever read, and the only book I ever read for a second time, is "The Education of a Speculator." This work of art should be required reading for any college finance class. Long before this book made me any money, it first saved me thousands. Years ago, when a perfect storm of events had collapsed my portfolio and nearly had me on the verge of ruin, I sent an email to Vic and Laurel for some word of encouragement after the market had crashed through a 200 day moving average, financial condition in the market that is not unlike the one we see today.

To my amazement, Vic and Laurel wrote me back with a few simple words that inspired confidence. Not so much advice, as it was knowledge on how to handle adversity. I not only made back the 50% that my portfolio had declined, I ended the year with a 27% gain. That email changed my life forever. Instead of placing a sell order and taking a loss of half my assets, I took the pearls of wisdom and made the most of the opportunity.

Thank you Vic and Laurel, for sharing your knowledge and experience of the markets, for being an inspiration for common everyday traders such as myself, and for taking a few moments and write such an inspiring email that changed my life forever!

## Pitt Maner III says:

Many years ago I went for 3 days of tennis lessons at Nick Bollettieri's in Brandenton, Florida. An evaluation was done of each player's ability and then we were separated into groups and sent out to practice for about 5 hours each day (with a lunch break at mid-day to watch films of Agassi playing). Thank God it was not in the dead of summer, but at 80 or so degrees it was still quite brutal for moderately trained weekend warriors.

One of my teachers was a former Rhodesian paratrooper named Ian who picked up very quickly on my poor footwork (even for a 3.5 or 4.0 player) and tendency to "float" or not properly set my right foot when hitting a backhand. The school also emphasized the need to follow through on strokes and to keep hitting the ball deep and allowing for sufficient height of trajectory over the net. In other words give yourself a margin of error and don't try to hit winners all the time from the baseline–play it a bit safe and wear your opponent down.

The tendency of beginning tennis players love to hit winners even at the expense of hitting several poor shots and losing games was discussed. Players were taught to recognize the importance of swing points (ie. 40-30 or deuce or 30 all) and to be more aggressive at 40-0 or 40-15. At the pro level students were shown film of Agassi running Lendl and not finishing off points right away if Andre could get Lendl to "lunge" one more time and thus exert more energy. Tennis warfare by attrition.

Tennis at the highest levels was indeed a different game then what I imagined or had gathered from watching Borg and Conners on TV or reading about in Tennis magazine.

On the adjacent court one could watch the 10 year old Anna Kournikova practice with her coaches under the vigilant eyes of her Russian mother. The tennis school had a quite rigorous schedule for the kids–lots of running in the morning, tutoring–school, weightlifting, and hours and hours of hitting tennis balls. At the time Anna said she loved to play tennis and did not mind the practice. We watched as she played practice games in the afternoon against boys her age or slightly older.

At the end of 3 days my toenails were breaking off from my swollen feet (note to file–never come to a tennis camp with new tennis shoes!) I had experienced my first and only time with tachycardia after running side to side "suicides" on the court. My game had been broken down and I was now playing like a sorry 3.0 player and not able to incorporate or integrate all the intensive things that had been taught. There was a German banker who said he worked 60-70 hours a week at home and came to the camp for "relaxation"–masochism at its finest!

But the lessons were learned and not forgotten and months later my tennis game improved and my appreciation for the game greatly expanded.

## Steve Scoles makes another point:

An important requirement of successful practice is getting proper feedback in a timely manner — touching a hot stove teaches you pretty quickly not to do it again. Markets, because of their probabilistic nature, are really horrible at given this kind of feedback. In investing and risk management, the short-term outcomes are often  unrelated to the quality of your decisions and it may even take years to be proven "right" or "wrong". I don't think this is a new idea to the world of trading, but I have always found playing poker to be a good way of practicing dealing with the probabilistic nature of markets.

Poker has several similarities with investing with some key ones being:
- imperfect information
- probabilistic outcomes
- emotional involvement is in play as money is on the line and your failures and successes can be monitored & commented on by the other players.

The advantage of poker over the markets is that the decision-outcome relationship is usually more analytically simple to learn from and thus the feedback loop is a lot better than what you get from the markets.

Three things that I have found poker helps you develop that can be carried over to the markets are:

1) to learn and internalize how gains and losses are really probabilistic outcomes rather than successes or failures;

2) to improve your ability to evaluate decisions on a basis other than the outcome;

3) to improve your ability to maintain emotional stability through the various ups and downs.

## Jim Sogi makes his second remark:

In Japan the Sumo wrestlers live a strict regimen of diet and training. They avoid emotional upset that might affect their appetite. This is like trading. It has to be approached as a competitive sport. Physical training, proper sleep, good food, avoiding drugs and alcohol are necessary during the trading week to be in top shape when in the fray. If something upsets me or I fall out of training, the trading can be affected.

## Alan Millhone follows up:

I will speculate that the Sumo's do not watch much TV nor hear any negative news while in training ? Mental discipline in Sumo, trading, board games,etc. is critical. When I attend any Checker tournament I get my rest, eat properly, no TV when on the road. Mr. Sogi is correct that being upset is a big deterrent to functioning properly in any endeavor. Staying focused is Job # 1 and critical to proper performance. The avoidance of drugs and alcohol holds true in any event we pursue.

# Boris Gelfand, from Nigel Davies

Very interesting Chessbase interview with Boris Gelfand. Two of his most instructive comments:

"During the tournament I was concentrated solely on my games and was not thinking at all about my chances. It is a very strong tournament and I had to ensure that I'd have maximum concentration in every game and leave aside all the thoughts which could distract me."

"But of course, you have to keep on working hard on chess, keep you motivation and health in order to compete with younger players."

# Josh Waitzkin’s “The Art of Learning” from Nigel Davies

I'm Just back from Germany where I made another 3 DVDs for Chessbase (London System, King's Indian Attack and "Chess for Scoundrels"). It was also a good opportunity to catch up on some reading which included Josh Waitzkin's "The Art of Learning."

I agree with many of the things he says, and strongly recommend getting a copy. It may be of especial benefit to aspiring young players as I believe they will relate to the pressures he had to face. There are also some very deep insights into the process of mastery, and I find myself inspired to resume chess studies.

# Korchnoi’s Coiled Spring, from Nigel Davies

"The readiness with which Korchnoi makes concessions
to his opponent is the readiness of the spring to be
squeezed. While allowing his opponent to take vital
space and handing him the initiative Korchnoi quietly,
little by little, prepares the blow. Korchnoi's real
element, the element in which he has no equal, is the
counter-attack." Vasiliev

Never seen anything quite so reminiscent of the S&P. What's also interesting is that Korchnoi's main weakness arose when his opponents would stay back and get him to make the running. For example against Petrosian in the early days he was likely to overextend, though this changed with their matches in 1977 and 1980.

# Piano Lessons, from Laurel Kenner

October 2, 2007 | 2 Comments

A family member recently asked for my advice on piano lessons for her 3-year-old daughter. I devoted many years to piano studies and teaching, and have performed for most of my life. Specs might find my reply of interest, for children and perhaps even in other matters:

– Right from the start, realize that the most important thing is not what she can play but what sounds are in her mind. The ears are more important than the fingers. You don't "talk down" to her in conversation; don't do it with music, either, by limiting her aural intake to kiddie songs. Let her listen to great music performed by great artists. Have her listen to orchestral music, jazz, opera, choral music -– not just piano. No need to limit the genre of music — have her listen to jazz, classical, rock. But it should be really, really good. James P. Johnson for stride piano, Martha Argerich, Wilhelm Kempf, Vladimir Ashkenazy, Sviatoslav Richter, Arthur Schnabel, Frederick Gulda for classical. Take her to concerts and have her sit close up so she doesn't feel apart from the performers.

– Start by simply letting her experiment on the keyboard. Applaud her efforts. Play with her. Don't let anybody plunk her down on a piano seat and insist that she slog through one of those dreadful kid books. The music in those books is mostly really rotten. Furthermore, it is a very complicated affair to coordinate fingers, brain and ears enough to read a piece of music and perform it.

– The problem with most kiddie books is that they impose a five-finger regimen of "C, D, E, F, G" that is unproductive in building a good technique, as well as physically and mentally constricting. Let her apply the technique outlined in the Leschetizky method. He taught all the great 19th and early 20th-century pianists, and he knew what he was doing. One of his students wrote an excellent book on his technique.

– When she starts learning the system of musical notation, don't let anybody start her off with "C, D, E." No, no, no. Do A, B, C, D, E, F, G — like the alphabet. Then teach her the ledger lines: In treble clef, "Every Good Bird Does Fly" and FACE; in bass clef, "Good Birds Do Fly Always: and "All Cows Eat Grass." Let her discover the black notes. Somewhere in this, show her "middle C" – but if you start there, it could easily end there.

– Don't get just any teacher — attend a recital of students, see if they can play, evaluate their poise and the musicality they're able to project. If you can't sit through the playing without being bored or going crazy, why would your daughter benefit?

– It's crucial to help her learn an excellent piano technique early on so that she can reach a level of accomplishment that will allow her to enjoy music and get as good as her path allows. A poor technique will lead to an inability to express herself, even serious injury.

– Once she starts learning pieces, by all means make sure that her teacher is devoted to performance. She should have an opportunity to perform once a month in a big-deal recital where she can showcase her achievements to her peers and to you. When I was a girl, my teacher had monthly recitals that would include all his students, from the tiniest to the teen-agers. There would be a little musical dictation, a little talk about the pieces, and always be a big cake afterward. Somehow the excitement of competition, the joy of showing an accomplishment, the interest in observing other kids and the sweetness of the ultimate reward combined to make an atmosphere conducive to learning.

– Obtain the best instrument possible. If she is to develop an ear for sound and a fine technique, the piano must be properly responsive. If her technique is good and yet the instrument makes an ugly sound, she'll never be able to express ideas and to find the beauty of the piano.

– Don't let her become a little circus monkey. Make sure that she gets theory and musical coaching. Make time for her to learn about the lives of the composers and the history of music. Lessons should not be run-throughs of pieces while the teacher beatifically nods.

– A good piano teacher will include sight-singing and dictation as part of the training.

– Regular practice is key. It should be in a perfectly quiet environment, without distractions. Use a timer. A good teacher will send her home with a list of things to practice, to keep her moving onward. Don't sit with her — discipline is something that must come from her, not you. The discipline of piano playing will unfold into many beautiful qualities and gifts.

– Send her to music camp. A summer sojourn at a music camp is worth years of regular lessons. The chance to be with other musicians, play music together and learn more than usual is an expansive, life-enhancing experience.

– For heaven's sake do not let her think of piano as a career. It's just not possible these days to make a comfortable living as a pianist, if indeed it ever was. Pursuing a music career will ensure decades of financial weakness that could lead to an envious, malcontented existence. If by some misfortune she actually does make a career of it, she will spend two-thirds of her time on the road. Tell her that music is to be enjoyed, that the goal is to be able to play beautiful music both alone and together with other people, that the better she gets the more people will want to hear her. If, despite everything, she wants to become a great musician, then teach her to invest and trade so that she can support herself!

Recommended:
The Pleasures and Perils of Raising Young Musicians: A Guide for Parents, by Michelle Siteman (Vic's college girlfriend!) Her son, Benny, is now assistant conductor of the San Francisco orchestra. Michelle is a terrific writer and a smart mom.

Leschetizky's Fundamental Principles of Piano Technique by Marie Prentner. The teacher approved this book, written by one of his students.

I concur with Laurel's recommendation to follow Leschetitsky's teaching methods. He studied under Czerny, who was a pupil of Beethoven. There are still in most major cities pupils of pupils of Leschetitsky. That makes them, musically, great-great-grandchildren of Beethoven. They are worth seeking out.

Some of the Leschetitsky exercises I saw are straight out of ki-aikido, but invented long before. He reputedly had a sign on his door stating "There is no Method." Perhaps he was very responsive to each individual pupil's needs, giving rise over the years to differing accounts of the "Leschetitsky Method."

I spent a valuable hour with one elderly pupil of the great man. We looked at how to play a simple scale in great detail. "Listen to the sound," she said.

The pleasures of music can exceed the benefits of a secure income. Van Gogh was prolific though he sold only one painting. There are different kinds of capital.

With the advent of excellent music notation and playback software, there is an argument for piano lessons to be accompanied at an appropriate age by composition lessons. At this stage there are not many pianist-composers but the new technology suggests there will be many more in the future.

## Alston Mabry writes:

I'm reminded me of a favorite anecdote, from Charlotte Joko Beck's book Everyday Zen:

Many years ago I was a piano major at Oberlin Conservatory. I was a very good student; not outstanding, but very good. And I very much wanted to study with one teacher who was undoubtedly the best. He'd take ordinary students and turn them into fabulous pianists. Finally I got my chance to study with the teacher.

When I went in for my lesson I found that he taught with two pianos. He didn't even say hello. He just sat down at his piano and played five notes, and then he said, "You do it." I was supposed to play it just the way he played it. I played it - and he said, "No." He played it again, and I played it again. Again he said, "No." Well, we had an hour of that. And each time he said, "No."

In the next three months I played about three measures, perhaps half a minute of music. Now I had thought I was pretty good: I'd played soloist with little symphony orchestras. Yet we did this for three months, and I cried most of those three months. He had all the marks of a real teacher, that tremendous drive and determination to make the student see. That's why he was so good. And at the end of three months, one day, he said, "Good." What had happened? Finally, I had learned to listen. And as he said, if you can hear it, you can play it.

## Vitaliy N. Katsenelson remarks:

My 6-year old son is taking piano lessons. His heart is not in it. We try not to push him very hard and encourage his progress. I listen to a lot of classical music, some Oscar Peterson and Queen. My son loves listening to Queen, but my wife is concerned that he should not listen to rock music. My argument is that this is a closest crossover from rock to classical/opera music you can find. Well, she doesn't buy it.

## Nigel Davies writes:

I was born into a very musical family and my parents did everything they could to encourage me to play something. They had me on the violin, piano, cornet and clarinet and at school I learned the xylophone and the recorder. They had some early progress as I played the xylophone at one school concert and won a couple of prizes on the recorder at a local music festival. But I would later turn my back on music and turn to chess, which nobody approved of. One day I remember being forced to go out into the sunshine instead of sitting over my board. Of course there was only so much they could do with one small, stubborn boy.

Thinking back, it had something to do with the social dynamics of my family. My sister, a couple of years older than I, was a very good musician, certainly better than I was. On the other hand I was soon beating family members at chess, then family friends and then schoolmates. This had everything to do with early success, this was something in which I could win. I felt special, which provided the encouragement to do it more and be even more special.

Let's fast forward some 35 years. Now I'd really like my 5-year old son to play chess, and it's not because of any frustrated ambitions of my own. There are several compelling reasons: He has the right kind of mind/personality for it, I got a lot from the game myself (education, self-worth and many friends and associates) and it's one of the few things I can teach him with much authority. There's also the thought that if he gets to play chess we can go to tournaments together.

What's my method of encouragement? Well there are lots of chess sets around (both live and on computer screens), not to mention the garden-sized one which adorns my living room floor. And he plays around with it a bit and now knows what the pieces are called. I haven't tried to teach him any moves. The next step is to interest him in a DVD produced by Chessbase called Fritz and Chesster, which is a cartoon that familiarizes kids with chess concepts and moves. I don't have any plans beyond that, my intention being to play it by ear and see if it sparks any interest.

What I would never do is set him up for early competitive failure. Based on my own experience I believe success and self-worth are inextricably linked to the enjoyment of an activity. Music is easier — it's enough to listen to your child play (no matter what level) and pretend to enjoy it. With chess I might have to team with my son against the computer. I'll cross that bridge when we come to it. But I definitely want him to win a few games in his early attempts.

# The Forgotten Art of Adjournment Analysis, from Nigel Davies

September 29, 2007 | 1 Comment

Until quite recently chess games would be stopped after the first time control (40 moves in 2 or 2.5 hours) and resumed after dinner or on a separate day. The player on the move would write down his next move and put it in an envelope. This envelope would then remain in the arbiter's possession until it was time to resume, at which point the 'sealed move' would be played on the board. This apparently complex proceedure meant that both players were looking at the position in which it was his opponent's turn to move.

Naturally a whole culture emerged around the best way to deal with adjournments. At one time players would not seek outside help for the analysis of such positions, and indeed Lasker was appalled by the thought. But little by little adjournments became a team effort, with Mikhail Botvinnik reigning supreme in this now-forgotten art.

Essentially Botvinnik's proceedure was to consult colleagues immediately after adjourning (a kind of brainstorming session) after which he would retire to his room to work out the details alone. A scientist by profession, Botvinnik was very methodical and thorough in his analysis, this particular aspect of his game enabling him to save the 1951 match against Bronstein and his famous game against Bobby Fischer.

I mention this subject because of a conversation I had with a chess student this morning. Just recently I have started studying chess again, after a haitus of more than a decade. I have been looking at a particular type of position, which essentially involved reviewing some games annotated by someone else (familiarisation), searching for any further developments in a database and then trying to form my own view and develop my own ideas. It was the Botvinnik process, but applied to a particular structure rather than a specific position.

This, however, was already at least two steps further than my poor student wanted to go. As a busy person I knew he wanted answers rather than ongoing enquiry. And this in turn made me think about speculative research.

The problem facing most people is that they are goal orientated, ie they want a particular result (wealth, for example) and will logically attempt to achieve it via the simplest and most direct route. Unfortunately this lays them open to the fixed system approach, relying on the untested views of others or hope that cycles will not change. It is, I believe, a psychological vulnerability.

Buddhists believe that our problems stem from first wanting something, and perhaps this is the very point at which the seeds of our downfall are sown. The correct attitude for study may be when we have no goal in mind but do something for its own sake. For it's only then that one is able to swiftly accept things that frustrate us in our goal, such as the flaw in our cogitations or the hidden counterattack.

So why would I waste time studying chess when my best days are obviously behind me? The answer is that it is a pleasure. So did Botvinnik analyze his adjournments for pleasure? No, but he was very disciplined.

# At Last My Trophies I Lay Down, from Alan Millhone

The ACF (American Checker Federation) recently lost one of our Life ACF Members and a top Master player — Gene Lindsay of Tennessee. Gene was 52, never married and no children. He loved the game of checkers, as I and many others do as well. The ACF a couple of years ago hosted an International Match at the Plaza Hotel in Vegas and we paid for rooms and meals for visiting players from England, Scotland and Ireland and received some contributions to defray expenses. Gene told me then he had a dream of putting \$100,000 into a trust account with the interest to be used to fund a tournament every five years — we'd alternate between their coming here or a team of Americans going to Europe to play. We discussed his idea at several tournaments.

The day Gene died of a massive heart attack I received in the mail from him a large packet of papers that he found from when he was ACF Secretary in the mid-1990s. That evening I opened the packet and was pleased at what he had sent and decided to call his cell and thank him. I got no answer so I called his home and Betty, Gene's companion of 20-some years, answered. Betty and I chatted and I told her I'd called to thank Gene for what he sent and Betty replied, "Alan don't you know?" and then told me Gene had died that morning at 10:30. I was shocked and speechless.

Events like this put things into perspective, and there tend to be more of them as we get older. Of the things we leave behind personal wealth may be one of the most transitory, and I suspect there is strong mean reversion amongst the descendents of the wealthy.

This leaves things like 'creative output' and the effect (good or bad) we might have had on friends and family. And all this presupposes that we're not here to just have fun.

### Sep

#### 25

September 25, 2007 | 3 Comments

Someone invited him into the USA and Customs admitted his entry. Now we get him here and he is subjected to ridicule and verbal abuse. Two wrongs don't make a right! Even President Bush got his jabs in. The US should show we are the better people and not lower ourselves with verbal tirades while he is a guest in America. If his mind is ever to be changed (perhaps it cannot be) America and its leaders need to set a pristine example. I totally disagree with Iran's terriorist ties and abuses of human rights — but we did invite him here.

## Nigel Davies writes:

Reminds me of a live televised discussion I once saw between a British and Russian school, back in the days of the USSR. The Brit kids were incredibly obnoxious, using it as an opportunity to lambast the USSR without really knowing what they were talking about. The Soviets kids, on the other hand, were really nice and polite and tried very hard to have a normal civilized conversation. As this was televised live in Russia too, it was quite a coup in demonstrating the superiority of the Soviet child.

This sensitivity might be a games player's thing. In our tournaments and travels we have to get on with a wide range of folk who can be culturally very different. I don't see much sign of it in the Western mainstream.

## Eric Blumenschein responds:

I don’t believe appeasement as a geopolitical strategy works. Neville Chamberlain was very polite to Adolf Hitler and WW2 still came around. If I am correct, Ahmadinejad was invited to the UN, not to the USA. If he thought Columbia University was going to fold over like sheep and give him the podium unchallenged, then he was obviously mistaken. Kudos to that university to call him out in a way that would never happen at the UN.

## Nigel Davies replies:

Chamberlain tends to be dredged up a lot with such issues, but there is middle ground between appeasement and plain rudeness. The way this has been handled the guy will look like a hero back home for sallying forth into a hostile land. And now if they invite Bush to Iran and he declines, it can be portrayed as cowardice back home. You’ve gotta consider the other guy’s moves.

My understanding is he came to visit the UN and as such the US government was forced to let him in. Columbia then decided to invite him and in the spirit of democracy (which was the original excuse for inviting him) they permitted an expression of views contra his own.

## Nigel Davies responds:

The issue as I see it is one of strategy. He will soar in the opinion polls back home because of his 'courage' in going to a hostile land and fighting the infidel.

What about just not giving him quite so much attention? If he can't distract the Iranian population with his slanging matches with external enemies, they're more likely to judge him on his actual leadership qualities.

# Pushy Parents, from Nigel Davies

September 23, 2007 | 1 Comment

I've regularly encountered parents who push their kids too hard. How do I know it's too hard? Because I can see the stress in their game. I stopped coaching one kid many years ago because he got so scared of losing that he kept offering draws. I told his dad that we needed to make the lessons "lower key" so the boy would actually treat them as something more like fun and try to win his games. Instead the father insisted that we double the coaching sessions. So I quit. They got other coaches and then finally the kid stopped playing altogether.

To a greater or lesser extent this is very common in the chess scene. The parents argue that they are doing the kids a good turn by helping develop their skills and besides, little Johnny 'likes' chess. The kid gets parental approval when he does well so he goes along with the process. Everyone is happy. Or are they? Doesn't it depend how one defines happiness?

For some it's achievement. In our culture money is a biggie. People define themselves according to how much of it they have — if they're rich they figure they must be happy, smart, etc. and be more important than those without. This is fine until the cracks begin to show between what they have and who they are. That's when their lives disintegrate, and suddenly all that really matters to them is whether Mum and Dad really loved them. The thought in the back of their minds is that it was really just self-love, with the kids being a shiny reflection of themselves. Amore propre tranferred to parenthood.

What really matters is whether you're patient with your kids, spend time with them and take time to listen. The "education" side may be secondary at best, and, at worst, sow the seeds for the disintegration of their lives.

Any parent this applies to might enjoy my essay Grow Your Company Without Shortchanging Your Kids.

# Chess and Markets, from Nigel Davies

As with chess, there are two different types of thinking in markets — tactical specifics in which specific and concrete calculation is require, and long term strategy which relies on understanding, logic and perhaps a high level synthesis of these, intuition. Jim Rogers recognizes this in his claim that he's the world's worst market timer. Unlike chess there seem to be very few people who are good at both types of thinking.

# Super Crunchers, from Pitt T. Maner III

September 15, 2007 | 4 Comments

… according to a new book by Ian Ayres, an econometrician and law professor at Yale, this is a microcosm of a powerful trend that will shape the economy for years to come: the replacement of expertise and intuition by objective, data-based decision making, made possible by a virtually inexhaustible supply of inexpensive information. Those who control and manipulate this data will be the masters of the new economic universe. Ayres calls them "Super Crunchers," which is also the title of his book, the latest attempt to siphon off a bit of the buzz that surrounds the hugely successful Freakonomics.[Abstract from Newsweek]

Intuition replaced by statistics. Should one therefore learn to ignore one's intuition or at least ascribe less value to it? And what about quick heuristics, rules of thumb, 'blink'-like judgments… and millions of years of instinctual bias?

Are there computer systems that are being designed to handle macro issues as well? I would think that would be highly complex and beyond the scope of computers today.

## Nigel Davies replies:

I can answer that for you - they don't have a hope. And I can tell you exactly why:

Despite huge resources' having been pumped into "solving" a tiny, limited game called chess, computers are just rubbish at the kind of creative synthesis of ideas at which the human brain excels. And it shows. They are totally unable to balance factors such as doubled pawns against the initiative. They just don't "think" like that.

Sure, they've made "progress," they can now beat human chess players by employing huge processing power, crunching a zillion variations a second and never getting tired. The Romans had a much better win when they took Masada.

## Vincent Andres remarks:

You don't have to commit suicide! Computers are our allies — we just have to use them. Of course we have to learn to speak to them.

"I hate computers: they always do what I tell them, never what I want!"

## Nigel Davies explains:

There have been attempts to run tournaments with the players having assistance from computers — they call it "Advanced Chess." But in activities which enhance our experience of life, computers have no part. It's kind of like having computerized yoga.

The suicide has been the chess world's insistence on pitting man versus machine, which brought the computer manufacturers their Phyrric victory and allowed claims that computers were now showing "intelligence." But to me this is like claiming a Porsche is an athlete if it can beat a human in a marathon. Computers are still just number crunchers as far as I'm concerned.

I like computers; they are nice obedient slaves. But the claims they are showing any kind of intelligence is just bunk. All that has happened is that they're crunching faster.

Does fast crunching lead to consciousness and the human ability to reason? I don't think so. Humans crunch very slowly but are nonetheless able to deal with problems in which crunching is less effective. One demonstration is the miserable failure of computers in Go, which is still a closed game but "bigger" than chess. As for non-closed systems they will, therefore, be utterly hopeless.

There is another issues arising from the way that many humans are now assuming that computers have intelligence and assuming that computerized models are going to work. This viewpoint is not only wrong, the reliance on computerized models can lead to people's suspending their own intelligence or subjugating it to the computer's ideas. This is one of the main problems when human Grandmasters try to look at a chess position with a computer running in the background — they end up letting the computer take the lead.

These are very complex issues which the world will be addressing over the coming decades. But there are great dangers here, and I believe this effect was behind both LTCM and the current banking crisis.

## Vincent Andres responds:

Brute force algorithms are used in chess. But they are so many other ways! Computers are doing many other things in so many and so far different ways than brute force. Chess was a challenge for number-crunching, but please don't reduce computer science to that.

Do not confound newspapers and computer scientists. We knew for years what the end of the chess story had to be. Nobody is surprised, nobody is overproud. It was a tedious job — but it had to be done. 10^30 computations had to be done, 10^31 were achieved.

In the computer science community there were few remaining people interested by the human/machine chess battle. Even the finances for the projects were questioned. A complete battle of the past, as far back as 1995 for many of us.

### Sep

#### 14

What theory exactly do I test, and how is it put together on the basis of history? In the physical sciences, the answer is, ironically enough, often gut feeling and intuition. Bohr's "crazy" ideas about atoms are an example. That is what makes counting so difficult: What the heck do I count? Statistics and econometrics are fabulous tools, but applying them to forecasting is tough!

I agree that is the crux of the issue. The inductive leap that all scientists must make is a mystery that is not itself explained by science. Francis Bacon, who convinced me to ditch philosophy and take up engineering, hand-waved it away by putting a philosopher-king at the head of the rational, scientific state, with all the other citizens scurrying about gathering data to test the hypotheses that he came up with.

## Nigel Davies remarks:

The reason a chess player should practice analysing positions is in order to cultivate intuition. Many players wrongly believe that the idea is to find specific improvements from specific positions, but they rarely get the opportunity to spring their cooks.

I have come to believe that the same role is played by counting for traders, that the main goal should be to cultivate understanding and awareness rather than devise specific trades. And one can find many other examples in difficult human endeavours, such as the importance of kata to the martial artist.

## Bill Rafter explains:

The answer to "what to test?" is "everything."  You try to break everything down to its smallest components and test each.  You keep records and their summaries on everything.  If you learn of something new, you have to go back and test everything again using that new method.

Suppose you know with certainty that the market is headed up in the near future.  A simple and intuitive strategy would be to buy the high beta stocks.  But testing that strategy would prove you wrong.  You cannot know that unless you test.  Okay, now let's consider the reverse:  you know with certainty that the market is headed down.  What about selling the highest beta stocks?  Test and you will find out.

One of the big topics now is volatility.  How do most people define volatility?  Are there any other ways to define volatility?  Is there any symmetry to the various definitions of volatility?  That is, does it work the same way in up days/weeks as it does in down days/weeks?  If you define volatility as one-day rates of change, the answer is affirmative.  But not so with other definitions.

Most researchers make the mistake of testing their ideas against "the market".  Well, the market is just the average.  You are not going to find any leading indicators by looking at the average.  So let's say that instead of looking at the S&P 500, you do your research on the 10 Sectors.  The results are different.  So then you drill down a little more to the 24 Industry Groups, and then to the 60+ Industries. If you are "on to something" you will find that the results get better with additional focus.  Your universe is the same 500 stocks, but you are no longer averaging to mediocrity.  Note that I didn't say this was technical or fundamental research; it's just research rather than intuition.

Most people do research badly.   Let me give some examples. (1) One of the major data suppliers (50,000 subscribers) gives its users the ability to construct their own portfolios.  That's important, as you may just want to work with stocks of companies with positive cash flow.  However a call to the support department of that data supplier will inform you that virtually none of their subscribers make their own portfolios. (2) The research software platform with the highest number of users does not even allow users to construct their own portfolios.  They give them pre-constructed portfolios of the S&P, Russell, Dow, etc. Take it or leave it.  (3) One of the leading (at least by reputation) institutional and retail providers of fundamental research allows its users to screen stocks on the basis of certain factors.  Their screening tool does not work correctly; giving the wrong results.  It's been that way for the two years that we have had a comp account.  No one has fixed it, most likely because no one has noticed.  We noticed, but of course we're not going to tell them.

So if flocks of "counters" or "quants" did poorly in the recent selloff, it may not be because counting or quant research is a flawed concept. It may because the researchers are not giving an honest day's work for their pay.  They are pretending to do research.  Their version of the scientific method is shoddy at best.  But that's okay.  To be a consistent winner, you need a supply of losers.

## David Lamb writes:

"What to test" brings to mind the passages on counting in Vic and Laurel's books. In one, Artie, Vic's father, was writing on a yellow pad of paper while he was watching handball players. Upon a completion of a point Artie would notate: OTWK (off the wall killer); KW (killer, winner); DW (drive killer); A (ace); AW (angle winner). He was trying to calculate "the chances of winning the next point after runs of winning and losing points of different magnitudes."

And Dr. Rafter's comments on not testing ideas against the market, due to the market's being average, if further demonstrated by Artie's note taking during handball matches. He wasn't watching average players, he was watching a particular "sector" of players. In this case it was the best players.

# The Martial Way, from Nigel Davies

I'm in the midst of reading Living the Martial Way: A Manual for the Way a Modern Warrior Should Think by Forrest E. Morgan. It's given me new respect for the warrior classes and provides a model for both traders and chessplayers. Of course we don't face any risk to our lives, but the discipline and thinking needed for life and death combat can be transfered to our modest pursuits.

# Those Five-Star internet Retailers, from Nigel Davies

September 10, 2007 | 1 Comment

I learned a new trick that can be used by retailers on eBay this week. They ask you for feedback on the transaction, including in their note that 'we will do the same for you.' So you may not like how the transaction went but may avoid commenting because of the possibility of getting vengeful comments back from them. Another issue is in whether it's worth returning items which cost very little. It's really not worth the postage, packaging and hassle of returning low cost items.

So I figure that with more expensive items people are more likely to return them and complain. What this probably means is that the ratings for retailers who sell only low cost items may be positively biased. So it's probably worth checking the average price of their entire shop before buying anything.

## Sam Humbert replies:

There's a time-limit (90 days, last I checked) after which eBay won't accept feedback. So if you're eager to flame a seller, send the negative feedback (90 days - 5 seconds) after the transaction. The seller won't be able to retaliate.

Also, you can use the Toolhaus site, or a browser plug-in, to quickly display only the seller's negative/neutral feedback. That's all you really care about anyway.

## East Sider notices:

Speaking of eBay: Two on the aisle, \$1.8m to open!

## Mike Desaulniers explains:

Don't laugh! That parking is two blocks from the Delano. Vintage BMW drivers take note!

# Is Chi Just Mumbo? from Nigel Davies

September 3, 2007 | 7 Comments

The concept of Chi (Qi, Ki) as a 'life force' lies at the heart of Chinese (and indeed Japanese) culture, yet it is something quite alien to the West. The UK's National Health Service started offering acupuncture, though apparently not so much for Chi reasons as the effect it has on nerve cells in promoting the release of endomorphins.

So is 'Chi' just mumbo, a false belief of a quarter of the world's population: Or is just difficult to grasp through the prism of Western culture and science?

# One Trick Ponies, from Nigel Davies

The process of chess mastery involves continual broadening of one's style and developing objectivity. One of the things I most often recommend to students is that they study what their opponents might do to them. All too often they consider only happy outcomes, which works some of the time but all too often ends in tears.

Some players, knowing that White wins around 55% of games at IM/GM level, expand on this belief to adopt the sharpest possible style with White and indeed score heavily against weak opponents. But against stronger ones, in poor positions and with Black their one trick ponyism will result in many disasters and highly inconsistent results.

Fixed beliefs are every bit as vulnerable as fixed systems, the belief leading to a selected use of examples (i.e. favorable ones) and a lack of enthusiasm in finding the refutations. Of course cunning opponents will use these things against the believers with highly destructive effect.

# Travel Tips for Europe, from GM Nigel Davies

August 28, 2007 | 1 Comment

What I've found with most cities is that there's an unspoken two-tier system of cost — one for the locals and one for foreigners. Which tier someone chooses is entirely voluntary but preys on feelings of insecurity and ignorance about his destination.

Here are some travel tips for visiting any city inexpensively, and getting to know it much better too:

a) Dress down, and that doesn't mean new/garish casual clothes. By blending in with the locals you'll feel more comfortable living as they live.

b) Use inexpensive luggage - less chance of its being stolen and you don't present yourself as a turkey waiting to be plucked.

c) Make an effort to learn local customs and language, and that includes English. Blending in gives you better access to less expensive services and makes the locals more willing to help you.

d) Don't assume that everywhere has areas that are as bad as your home town or that muggers are waiting round every street corner. In the UK, for example, very few criminals have guns so the very worst they'll do is pull a knife. If you're really nervous about this, carry a personal alarm, or big stick, or be prepared to hand your wallet over. This helps give you access to less expensive areas.

e) Don't take taxis as a reflex. Get the appropriate maps (which are usually free) and investigate the local underground and buses. With trains, check if there are expensive times to travel and find out what deals are offered with travel cards and contracts.

f) If you're visiting the capital consider staying in a nice suburb (where the locals live) and commuting in. This guarantees much better value on hotel rates and just about everything else. Traveling light helps.

g) Consider visiting places outside the capital, even if they reduce bragging rights (I 'did' London/Paris/Rome). I personally have no idea why anyone would want to visit London when there are cities like Chester and Durham available.

h) Get as much inside knowledge as you can about your destination. With London, for example, Southall is a dirt cheap but great place to go for a curry and offers the best value outside of McDonalds.

i) Find out what level gratuities are appropriate. In London 10% is plenty and if you stay in a place without a bellboy you don't need to tip.

Paying more than you want to is a simple product of laziness.

# The Real Value of UK Homes?, from Nigel Davies

August 5, 2007 | 1 Comment

I have found recently that whilst property prices have not declined at all in the UK, REITs are down 25-30% from their peak. Relative strength of REITS against the FTSE also seems to be turning.

Hypotheses:

a) The illiquidity of the UK housing market plus things like 'fixed rate mortgages' has led to an imbalance between property stocks and property, and this will gradually close over the coming years. b) The squeeze on the consumer (government, housing stagnation etc) plus the crisis in exotic debt will lead by force to a considerable rise in defensive stocks (drug/food producers etc) and quality bonds, certainly relative to UK housing. c) UK interest rates will fall just as they've been doing in the US. GBP/\$ rate? Who knows, but I wouldn't bet strongly on the current 'trend' continuing.

I have no idea how to test this (for example REITS are new here) and no doubt I'm as bad as most other people at macro analysis. But comments are welcome.

As a disclaimer, I am increasingly long defensive stocks and corporate bonds for no concrete reason. So confirmation bias is no doubt present in the above.

The bottom line is that I would say I am somewhat bullish REITS vs property itself, not much idea about anything else.

# Advice on Torture, from Nigel Davies

Sometimes the market reminds me of playing a worse endgame against someone like Mikhail Gurevich. They move you back and forth, slowly improving their position whilst testing your nerves and patience. The advantage may not be much at first, but when compounded by some small mistakes it becomes much more serious. Strange things start happening when you're put on the rack, opportunities are missed and the mind starts playing tricks.

The following quote from Belavenets appears in the endgame section of Kotov's 'Think Like a Grandmaster', which is good advice for a would-be torturer and well worth being aware of if you're the victim. And I start to see where the chair is coming from with his interest in point and figure.

The basic rule of ending is not to hurry. If you have the chance to advance a pawn one square or two, have a good look round, and only then play it forward one more square. Repeating moves in an ending can be very useful. Apart from the obvious gain of time on the clock one notices that the side with the advantage gains psychological benefit. The defender who has the inferior position often cannot stand the strain and makes new concessions so easing his opponent's task. Apart from this, repetitions clarify the position in your mind to the greatest possible extent.

# Anatoly Karpov, from Nigel Davies

I've heard that Karpov is a natural at other games besides chess, figuring out the odds and efficient strategies very quickly. He shares this with a lot of chess pros, for example Grischuk doubles as a professional poker player.

A lot of the criticism leveled at Karpov by Kasparov, Korchnoi, Bronstein and others boils down to his open rejection of risk and brilliance in chess together with his efficient adaptation to life in the Soviet Union. Karpov figured that his own best interests were served by not rocking the boat, whilst others suffered varying degrees of personal hardship for taking a more 'principled' stance, both on and off the chess board.

One of the ironies of this is that Karpov might actually have been more in tune with Western individuality and efficiency than those less favored by the Soviet state.

# Yojimbo, from Nigel Davies

July 21, 2007 | 2 Comments

I'm becoming a big fan of Akira Kurosawa's movies, despite only having watched two so far (Dersu Uzala and Yojimbo). I commented earlier on Dersu Uzala.

The storyline and elements of Yojimbo can be seen in many Westerns. But there's much more to Yojimbo, mainly because of the insights we gain into the mind of the enigmatic lead character, a masterless Samurai (we never learn his real name).

The film starts with the Samurai throwing a branch in the air to determine which road he will take. Arriving in a town he discovers there is a conflict between two warring clans and soon has them competing for his services.

Yet as the film continues we start to discover that his true motive is not money — he later gives his entire fee to a family he saves (simultaneously describing them as 'pathetic'), and apparently leaves without making a penny. So what is it that makes the Samurai tick?

I believe that much of the answer can be found in Japanese history. With the outbreak of peace that came with the Tokugawa shogunate, many Samurai found themselves with nothing to do. Yet generations of Samurai had devoted themselves to warfare and the perfection of their skills, with warfare and honor being in their blood. Could they simply forget about this and do something else?

Apparently not, as the Satsuma Rebellion (very roughly portrayed in 'The Last Samurai') was to demonstrate. History ascribes this rebellion to the loss of status the Samurai had to suffer, but in Yojimbo there is a clue to another element. When a man has lived for an appointed task (whether it be warfare, chess or trading), he is only truly alive when given the opportunity to ply this trade. Take the trade away and he becomes a kind of anachronism, but one which will search for pockets of meaning.

This, I believe, is the dark secret in Yojimbo which Kurasawa was no doubt aware of (he was born into a Samurai family) but which I don't think will be widely understood. When one compares the Samurai with, for example, the character William Munny in 'The Unforgiven' , Munny is given a financial reason for embarking on his killing spree (failing farm, kids to feed and then subsequently the murder of his friend) with his darker side being something akin to Dr. Jeckyl's Master Hyde.

The Samurai, on the other hand, kills because of what he is, the gradual emergence of his humanity being an endearing weakness that almost costs him his life. The brusqueness of his final goodbye shows that he doesn't intend to let it happen again, and not because he fears death. It's more a question of professional pride.

I am reminded of the busted traders of yore hanging around Wall St. If markets evolve, there must be extinctions as well as successful mutations. Is it possible that new and profitable traders must defeat the old lions, and have the advantage of not yet holding a deep identity as market maven? Once deemed a master it will be difficult to accept the possibility that old market understanding has become obsolete, and what should be a logical inflection becomes instead a battle to the death.

Similarly, success at trading begs to be made a continuous career; though there is pretty good evidence that tradable periods are ordered irregularly in time.

The best lady’s-men are truly indifferent.

# Computers Crack Famous Board Game, noticed by Gordon Haave

July 20, 2007 | 2 Comments

Draughts has about 500 billion billion potential positions. It could be a case of game over for draughts - scientists say the ancient board game has finally been solved.

A Canadian team has created a computer program that can win or draw any game, no matter who the opponent is.

It took an average of 50 computers nearly two decades to sift through the 500 billion billion possible draughts positions to come up with the solution. Writing in the journal Science, the team said it was the most challenging game solved to date….

## Nigel Davies writes:

During my last visit to Chessbase I learned that they're working on a 'universal game program', by which the computer is told the rules of the game and then figures out the best strategy. Naturally I started wondering about market applications.

# Depth and Uncertainty, from Nigel Davies

Despite chess being a game of 'perfect knowledge' (game theorists’ term, not mine) we are nonetheless beset by uncertainty. Even in relatively benign, 'typical' positions, it can be difficult if not impossible to assess outcomes with any accuracy.

But does one need to know, to have deep insights? Here the answer is much more clear, in fact it's a definite 'no'. The players who win tournaments are those who play good moves, not the ones who see very deeply. And as evidence I cite the example of Friedrich Saemisch, inventor of several important opening systems but famous for losing on time.

Interestingly Saemisch's impracticality went beyond the bounds of the chessboard, as illustrated by these stories related by Ludek Pachman:

'Isn't Hitler a fool? He thinks he can win the war with Russians!' Samish said completely aloud. Prague of those days was full of Gestapo and Samisch had to be overheard at least at the next few tables. I asked him to speak quietly. 'You don't agree that Hitler is a fool?' was Samisch unconcerned retort.

"Samish stayed 'afloat' untill the Summer of 1944. Then he let his mouth run off at the closing banquette after the Madrid tournament. Upon his return, Samisch was arrested right at the German border and shipped to a concentration camp. In Apr, 1946 I asked Samish in Switzerland what was his internment like. 'Unglaublich, uberhaupt nichts zu Rauchen!' Samish replied; and immediately added: 'Noch schlimmer ist es, dass ich jetzt volkommen frankelos bin!'…" (Unreliable GM translation: 'Unbelievable, above all nothing to smoke. Even worse is that now I'm completely broke.')

## Gabe Ivan remarks:

Bruce Pandolfini says:

Most people believe that great players strategize by thinking far into the future, by thinking 10 or 15 moves ahead. That's just not true. Chess players look only as far into the future as they need to, and that usually means thinking just a few moves ahead. Thinking too far ahead is a waste of time; the information is uncertain. The situation is ambiguous. Chess is about controlling the situation at hand. You want to determine your own future. You certainly don't want your opponent to determine it for you. For that, you need clarity, not clairvoyance.

# Vodka and the Russian Bear, from Tony Corso

July 7, 2007 | 2 Comments

About a year after the Berlin wall fell, I found myself in Bucharest screwing around with the flying hydraulic knife of a continuous casting steel mill my dad had designed a dozen years before. I ran across an old buddy that had switched jobs and was tasked with finding investment opportunities for a FBC fund run by Mike Holland.

We meet in the lobby of the hotel he was staying at and he asks me if I want to go to Warsaw the next day. So we catch a morning Aeroflot flight to Warsaw. I ask the stewardess for OJ and my buddy asks for tomato juice. She pours out half a glass of orange juice and half a glass of tomato juice and then grabs a bottle of vodka that and poured a shot into both.

My buddy says, ''if the default on the breakfast flight is vodka, maybe eastern Europe isn't the next Singapore or Taiwan, maybe eastern Europe is the next Brazil or Uruguay.''

With the death of Maxim Sorkin (after being discharged from hospital) it's difficult not to notice the number of Russian Grandmasters who've died either during or after medical treatment, the two most notable ones being Leonid Stein and Paul Keres.

It's also difficult not to have noticed the number of domestic Russian plane crashes or the fact that my brief visit to a Russian dentist (whilst residing in Israel) came to a sudden end when I realized he'd been partaking in a few glasses of vodka that lunchtime (I ran like the wind). And this guy had been recommended.

Now does anyone want to speculate why India and China are emerging as powerhouse economies whilst the Russian bear seems to be somewhat confused, and at every level? Well here's a big clue, even according to the Kremlin's figures, 12% of deaths in Russia last year were directly attributable to alcohol.

# Threats, from Nigel Davies

One of the major differences between master and amateur chess players is in the way they perceive threats. Amateurs have a tendency to defend against everything and anything, largely due to their inability to calculate to the end and distinguish the real from the imaginary.

So the bluff carries great weight at lower levels, often resulting in both sides defending against imaginary threats as if both were participant in a game of blind man's bluff.

On the other hand, the intrinsic worsening of their positions by small mistakes and inefficiencies is often not noticed at all, usually resulting in quite the wrong diagnosis as to why they lost. Often it's put down to a single move when in fact they were on the wrong course for some time. They then eventually find one of the blunders which becomes ever more common in dodgy positions.

# Note to a Bloomberg Columnist, from Sam Humbert

I see your colleagues are trying out a new verb this morning –"quicken"

BN 8:30 *TREASURIES DROP AS PRODUCER PRICES QUICKEN

It has a nice Elizabethan feel to it, as if the newswire were running in 1580 — "Horseshoe prices quicken in early London trading."

## Nigel Davies remarks:

Nothing could have prepared them for…the quickening.

## George Zachar extends:

Headline composition is the only widely used form of constrained writing I'm aware of. You specifically write to space, not word count, syllables, etc.

In the days of hot type you had to remember arcane counts corresponding to the width of each character, both upper and lower case. The mark of a great headwriter was the ability to hit the exact length needed, with something catchy and relevant.

Writing headlines on deadline at newspapers trained me to cycle through my mental thesaurus efficiently. This makes composing ordinary prose a relatively easy task.

Headline writing as a vocabulary drill for kids? I may try this at home.

# Some Thoughts on Forecasting, by Victor Niederhoffer

I often wonder why the public can be repeatedly misled by forecasts that are consistently wrong, and by forecasters that have no raison d'etre. I believe the underlying reason is that we are brought up to be insecure, and we look to others for the sources and solutions to our problems, rather than looking to ourselves.

Such forecasters as the weekly financial columnist, can be consistently wrong, (he has been bearish every week since the Dow was at 800), and yet be among the most revered and respected forecasters of all. For an answer to this, I turned to Harry Browne's book, Why the Best Laid Investment Plans Go Wrong.

I always start with the Humble Pie with Whipped Cream, on p.43, where Browne points out that the archetypal forecaster looks for anything in his forecast that happens to have the vaguest resemblance to the ultimate outcome, and then tells you in subtle ways that "he told you so" or "it was so clear from this or that indicia."

Browne reviews the yearly self-evaluation of an investment adviser, who might be prone to using levels and ranges as his weapon for misdirection:

He almost always seems to have been around 87% right … He usually cites some examples that turned out to be wrong – "I was a bit too optimistic about the high in gold, I said 450 when it was actually 406." You can see that he's being more than open and honest, and he demonstrates that his talent and even his standards tower far above yours and mine … Any man who's wrong 13% of the time, and who's that close when he's wrong must be a genius … When I check, however, I find that his original forecast was "Gold's high will be between 450 and 500," and this was made when gold was already at 406. So he missed the high by 15% and failed to note that gold actually ended the year at 350, down 15% from his forecast.

For many years, I have believed that there is little correlation between the past record of an adviser or manager and his future success. Too often, adviser get good results with small amounts of money, but the market loves to let you make a small amount of money, just to encourage you to then raise a larger investment to lose.

I believe that the period of 2000-2002, where advisers and managers made money by being hedged or net short, was a period that was particularly detrimental to investors, in that it has led so many of them to stay with those who were relatively successful in this period. These managers and advisors have lost their investors so much more money in the subsequent period, when the markets have doubled, than the amounts they made their investors when they initially began investing.

I try to eschew from forecasts on this self improvement, mutual education, deflation of ballyhoo, forum. For one, I know how fallible I am, and second, I am cognizant of the principles of ever changing cycles, (Robert Bacon.) If we did forecast, many very potent readers might mistakenly believe that what we have to forecast is better or worse than average, and in either case it would be detrimental to all concerned. Also, I would find it hard to make a forecast where I didn't have a position, because I trade often … and if I did have a position, my position could be helped along by my communiqué. Furthermore, when I got out of the position, I would be hard pressed to be so fair and honorable that I would let all of my readers extricate themselves before I did, to my disadvantage.

Of course, if I were an innocuous type, and was prone to forecast without having a position, then I would be subject to making absurd calls, without possible economic feedback, and could possibly be wrong as consistently as the weekly financial columnist, or others of his ilk. I would never know how much damage and harm and loss my forecasts might cause to those poor souls who actually placed any reliance on them.

Harry Browne's book is a treasure trove of insights as to how one can watch out for being misled, and I recommend it highly. I also encourage all of you not to rely unduly on forecasts in the future.

As an afterthought, while considering this question, I couldn't help but notice that the Fake Doctor might do well to refrain from making so many forecasts in future. His former economics forecasting company was not well known for its accuracy, and recently he has been involved in an orgy of forecasts on such things as interest rates, the extent of reserves in the earth, and the likelihood of gains in the Chinese markets.

Browne lists several criteria for evaluating the likelihood of a forecaster to stand out from the crowd, such as talent in the field, and expertise. Other caveats, like the self interest they might have in their forecasts, the ability of those who follow them to extricate safely, and the likelihood that their own expertise in areas like geology, or Asian activities, might not be greater than average, should be considered also.

## Riz Din writes:

Judging by the content in much of the media, there certainly seems to be an education of insecurity taking place, well beyond the realms of the financial forecaster. Combined with the tendency to focus on the shorter-term and not to cultivate the big, broad outlook, these are good conditions in which the pessimistic forecaster can flourish. I also wonder whether their is an evolutionary component that plays a role in this game, since the average human is a risk-averse individual.

Regarding the Fake Doctor, in March of 2004, he commented on exchange rate forecasting that,

…despite extensive efforts on the part of analysts, to my knowledge, no model projecting directional movements in exchange rates is significantly superior to tossing a coin. I am aware that of the thousands who try, some are quite successful. So are winners of coin-tossing contests.

He is obviously now paid to have a view, but I wonder whether he really believes it.

To all the good arguments for abstention from forecasting, I'd like to add: publicly touting one's views leads to psychological lock-in ('getting married to a position'), because changing one's mind and dumping a losing position will result in a loss of face, in addition to the (perhaps less costly and painful) loss of dollars.

Adding to Steve's point, the problem of 'lock-in' of public forecasts may be exacerbated by the fact that much time and money is often spent generating a forecast and thesis. From the sell-side, creating a unified thesis across research departments is no small feat, and new data that are coming days and weeks may be judged less on their own merits than on how they can be interpreted to fit with this thesis, i.e., going about things backwards. I'm guessing the ability to turn on a dime is a valuable advantage to the likes of Soros and other nimble macro players.

On a separate note, I recall when I was working in the prediction business. It would be about a month or so before the start of a new financial year when clients would call asking for various forecasts for the year ahead, sometimes even further out. I'm sure many of these folk knew better, but they did it any way. They had spreadsheets to fill in.

It reminds me of story about the general who told his team of weather forecasters, "I appreciate being informed that your forecasts are no better than random, but please keep sending them on, as the army needs your predictions for planning purposes."

## Charles Humbert extends:

There are three classes of money managers:

1) If your edge is unreliable, or modest to nonexistent, then your best approach is maximum publicity. If you're good at promotion this may lead to much greater benefits than you will derive purely from money management.

2) If your edge is positive but not spectacular, you should try to manage OPM. In this case a little bragging is part of the game; but it must be done with discretion. The goal is to be credible thus attracting investors and increasing your earnings in direct proportion.

3) In the rare case where your edge is outstanding, shut up and trade. If at all possible trade only your own money. Resist the temptation to make your brilliance visible to all. Always keep in mind the goal, which is to last as long as possible before the competition catches up.

Trading is a cutthroat business. If you make it easier for your opponents you eventually make it harder for yourself. The only reason for making public forecasts is to feed your ego. But those who deserve it most are the least well-served by such promotion.

## Nigel Davies writes:

One of the tactics that can be used for nobbling a tournament leader is to congratulate him on his fine performance and asking what the secret is. The self-consciousness and commitment induced by a reply can take them out of 'the zone' with a bump. Not that I'd use anything like this myself, it's just something to watch out for if one is in the lead.

I think a similar effect can be at work when players write books. Besides making them a target should they publish anything too valuable, there's a certain inflexibility that can be induced by the 'lock-in' affect of going to print.

## J T Holley contributes:

There needs to be if not already a study of the "Power of Anonymity".

It is the spirit of the AA program and one that Mr. Bill must have suggested or he saw this same powerful principle in its possession.

Having quit smoking numerous times, I know that I tried I didn't lick it until I remained anonymous about my intentions. The minute you tell people they will ask you when you bump into them, "still cravin'?" "want to smoke?" "how you doin'?" Even with their good intentions the first thing you do is start thinking about smoking and it simply fuels the fire. Maybe this is why you shouldn't share speculation positions as well.

Doing a quick count I can think of very few times where I've gone out and said something in the touting category and come across a winner. Yet being the anonymous I have risen to the occasion and accomplished magnificent goals. Card games and betting are the horrible exception because one must always be vocal with intentions and can never be silent.

If you look at the risk/reward of touting vs. non-touting it seems so unaligned to me. Even if you tout and succeed then you still lose it seems. You are disliked, set up to be the "one" to knock down and most of the time left doubting the outcome or feeling a Nietzschean withdrawal. Does touting burn unwarranted energy and power as well?

The anonymous one walks freely and has the power. Think of sports when something great happens and the comment is "who was that guy?" This years Masters is a good example.

I think anonymity has got to be the most powerful principle next to compounding.

It seems that forecasters and others with the most bearish and pessimistic outlooks don't actually own any stocks and generally never have.

## Steve Wisdom replies:

I especially like these standard tropes from bear newsletters: "We advise you to liquidate all stocks," and "We advise you to take profits on stocks now,"… Begging the question: ‘What stocks? If I believed your newsletter, I'd have sold all my stocks years ago.’

# New Twist for Donchians? from Nigel Davies

In an idle moment I checked the classic Donchian moving average cross (5/20) over the last 3,000 days and gave it the advantage of only trading the long side. Even so the whipsaws were so many that it produced a loss, and that before commissions and slippage.

But it was interesting to see that this system produces a profit when applied to a stock/bond ratio over the same period, on both the long and short side and in both stocks and bonds. It even beats buy and hold, though I didn't include commissions and slippage.

I mention this because the first just gave a short signal after a long run on the long side. But the second has not.

I don't actually think this is a good system or I wouldn't be posting it. But the result seems kind of interesting and may be food for thought.

Having read and heard numerous presentations from well known and lesser known Donch's over the last five years it is always amazing to hear them down-speak equities. and if you look, their "diversified approach" index futures tend to be a smaller allocation. Their answers to questioning tends to be:

"Equities tend not to trend."

"The whipsaws don't justify a bigger allocation."

"This is the last frontier in trend following."

Nigel's study shows why they make those replies, but they still try. I often asked them "why not just take them out of your allocations?" with no good answer. I guess it is some Edisonian effort to persist or maybe Vic's often quoted "lose more than they should."

Once the Donch's deviate from the fixed system and try to screen, filter, and curve-fit a new fixed I have often wondered why in their attempt at scientific discovery don't they realize the "Law of Ever Changing," and abort the 5/20 or any variation or breakout in same fashion for another method?

One is only left with the assumption that they too have been Bodysnatched!

# To Learn or To Win? from Scott Brooks

June 11, 2007 | 3 Comments

This evening, I watched my ten year old daughter's softball game. She played a very good game and her team won 22 - 16 (yes, that's softball, not football).

As I watched them play I figured out how to easily win the game. All the players had to do was stand there and never swing the bat under any circumstances. You see, the pitchers at this level are simply not able to throw three strikes in seven pitches. They would have walked every one. Of course the league only allows a maximum of seven runs per inning, so we would have had to play defense some of the time.

So, when our team went out to pitch, I would have told them to forego the windmill pitching action and just do a slow underhand lob over the plate for strikes or close enough to force the other team to swing. The other players would have struck out some of the time, but otherwise, the only way to get outs was to get them in the field. Still the other team would have been limited to seven runs in an inning. Therefore, in order to win, all our team would have to do is limit the other team to fewer than seven runs per inning.

You don't think they missed out on a great lesson in flexibility and adaptability, rather than going through the motions of what they thought they should be doing? As Sun Tzu stated, "To subdue the enemy without fighting is the acme of skill."

In my experience playing-strength is fostered first and foremost by the pursuit of victory, with mentality and technique improving to meet new challenges. Those who focus on appearance and style usually turn out to be weak posers with no real substance behind their moves, just shadows of what a good player should be.

## Rodger Bastien writes:

I am sure this piece was all written tongue in cheek. As a little league coach I am on a personal crusade to de-emphasize winning vs. learning to play baseball in K-6th grade. Granted, you could "win" using the methods you describe but my team "lost" a game last week by taking the exact opposite approach.

After witnessing a couple of innings of a an endless walks I could see a palpable lack of interest amongst all of the players. I instructed my players to go up there hacking and I’ll be darned if we didn’t rattle off 9 straight hits before the ump declared the "6 run maximum per inning" rule with no outs. In the bottom half of the inning our opponents maxed out on runs without taking the bat from their shoulders.

We lost the game but afterwards you would never tell that my guys were the losers from the pie-eating grins on each of their faces. In baseball, as in life, there is much more to be gained by taking your hacks than standing there with the bat on your shoulder.

# UK Stock Picking, from Nigel Davies

June 10, 2007 | 1 Comment

Does anyone know of a good service/methodology for selecting UK stocks? I only know of the 'OCD' (Outstanding Companies Digest), which despite some apparently good picks has the Sage of Omaha as one of its heroes.

I find this slightly off-putting, leaving me to wonder if Sage is just a marketing ploy or whether they manage to bury their mistakes. I remember Marconi being covered in their previous incarnation as 'The Analyst' (this is a lousy name because of too much competition with search engines), but then it was dropped without trace when the company went bankrupt.

OK, I have a methodology based on reading Clews plus my view that the UK is heading for stagnation (the idea that the gold trader, Chance Brown, was good at his job will shortly be exposed as being nothing more than being in the right place at the right time). But it would be nice to get some science into such decisions.

# Bond Movement, from Nigel Davies

I found myself really confused by the move in bonds this week, not to mention the apparent expectation of higher interest rates 'globally'.

My novice reading of this is that maybe things aren't so global; the US economy is continuing at a fair clip (low taxes etc) whilst the green, leftist UK looks like it's heading towards stagnation. And we haven't even had our housing slump yet.

Carrying my thoughts a few steps further (way too far probably) then the dollar will strengthen against the pound and Brits should turn to defensive stocks and grade A corporate bonds, if they don't want to buy US stocks that is.

## George Zachar writes:

There have been reports of an enormous multi-week liquidation of cash bunds dragging all debt markets lower, which in turn triggered rebalancing of positions embedded in structured notes, which were synthetic short straddle positions.

The economic fundamentals have been bond-bearish IMHO for a long time. This rout, though notionally validating my view, was triggered not by repricing the Fed, but by judo in the hand-to-hand combat of the capital markets.

# Markets as Scary Movies, from Nigel Davies

The psychology of scary movies might explain some market behaviours. People appear to enjoy this genre of film because they provide excitement without genuine danger. This differentiates them from, say, almost being run over, which isn't enjoyable at all.

Apparently movies are much more scary when the audience can identify with one of the characters. Thus Alien was so scary because Sigourney Weaver's character (Ripley) looked after the cat. On the other hand, Alien Resurrection wasn't scary at all as people couldn't identify with Ripley's character once she had been reborn with alien genetic material herself.

So in markets, the identification is created by having some stocks, and the scary part is provided by reading bearish columnists. So one should probably not be too hard on some of the bears, their job is not prediction, but rather entertainment.

# Rebirth, from Nigel Davies

A theme which I believe should be of interest to readers is that of rebirth. It happens in many aspects of life. I'd apply it for example to insects that shed their exoskeleton. I've seen this concept described within Judaism as one way of interpreting 'the breaking of vessels'. The movies are replete with examples of this theme, just one memorable example is the opening scene of 'Dances with Wolves'.

I can say for myself that I have been checkmated many times, both on the chessboard and in life, and I know this has happened to people here as well. But what I have learned is that this is not a bad thing as great growth can follow the apparent destruction of all that one holds important. In the subsequent rebirth a better one can replace the failed paradigm.

As with birth, rebirth is a time of great danger, not least because the 'breaking of vessels' can be misinterpreted as the end of someone's usefulness on this earth, and they can take their own lives before the process is complete. Yet rebirth is essential to growth. Someone who has never experienced real despair, in my opinion, has never experienced real growth, whatever the self-help books tell us.

I post this subject only because it is so applicable to markets. The market experienced a death and rebirth around the Feb 27th pivot, and I leave it up to my fellow readers to consider how the paradigm then shifted.

# Wiggling Mistress Confounds Bloggers, from Nigel Davies

Here is an interesting analysis of the Ticker Sense blogger sentiment poll suggesting that switching might do even worse than permabearism. The wiggling mistress seems to be very effective at confounding her suitors.

# Privacy in the 21st Century, from Nigel Davies

For some time now I've been considering the issue of privacy in the 21st century. We are in a situation in which there is so much information available on people and so much computer power available for its processing that even the apparent anonymity of city life might assume aspects of living in a small Welsh village, or the Soviet Union where something like 30% of the population were KGB informants.

What happens when everyone knows your business? I think it fosters conformity. And Jung pointed out that such situations could also give rise to a temptation to lie.

So how does someone regain their privacy? Well it only seems possible by systematically abandoning modern conventions like credit cards. And then you've got to be careful using cash at airports. That will put you under suspicion of being a drug smuggler or terrorist.

I suspect this is going to be a big issue in the future, part of our brave new world.

# Singapore, from Yishen Kuik

May 31, 2007 | 2 Comments

The local Singapore business paper had an article breaking down performance of local equities in various sectors. There is triple-digit performance in the construction sector, 40 to 50 percent performance in the finance sector and healthy rises across the board.

Swanky new nightspots are mushrooming and expensive cars are seen in greater numbers. Property sells for record prices with each new development. Recently there was a story of professional speculators who purchased condos to get on their boards in order to urge residents to agree to flip the entire building to a developer, essentially merger arbitrage in real estate.

## From Ryan Carlson:

Yesterday, I just returned from a week in Singapore and am wildly bullish on it as well. So bullish that I'm planning on moving there in about six months and this trip was to help lay the groundwork for it.

Apparently, I'm one of many. The current cover of Time's Asia edition is on Singapore and the lead story is Singapore Soars.

In regards to construction stocks, besides riding along for the sharp upturn in local real estate values, I think it's a great way to play region growth as many have projects in China, Vietnam, Indonesia, and other countries where I wouldn't/couldn't invest directly.

The mention of expensive cars really is a great wealth indicator judging on how expensive it is to have a car in Singapore. I certainly won't have one once I move. An easy estimate is that whatever a car costs in the US, double it for there.

I strongly believe Singapore is the most dynamic place to live in the world today, and if I had to choose what investment I would buy and hold for the distant future, Singaporean equities, real estate, and the currency would be my choice.

Geographically, it's at the hub of three of the four most populous countries in the world (Indonesia is the 4th), which makes it an excellent place to watch developments in those other countries. No other place in the region can even remotely offer the quality of life or cleanliness and I firmly believe that wealthy citizens of India, China, Vietnam, Indonesia, etc, will all aspire to live in Singapore's cleaner, safer and more orderly society. If not full-time, then perhaps a pied-a-terre as a hedge against trouble in their homeland.

Regardless, the most important thing that will find a home in Singapore is capital. Private banking in the country has been a particular highlight as bank secrecy laws are in some instances stricter than in Switzerland. As the saying goes, "when it comes to large amounts of money, it's advisable to trust no one." And I certainly wouldn't trust the banks in other regional countries to hold a large amount of my money.

To help with inviting capital, Singapore offers favorable low tax rates, doesn't tax capital gains, and also provides numerous incentive programs including one aimed at attracting derivatives traders. I agree with the method of taxing consumption rather than income, which is generally how the system allows for a lower direct tax.

A reason why so many policies are correct in my view is that almost every Singaporean I've ever met was educated at a university overseas in the UK, US, Canada, or Australia. In turn, they take back home the best policies but also get a firsthand view of damaging policies elsewhere to avoid.

Those civil servants who enact and draw up policies in Singapore are some of the highest paid in the world. Although there is understandably some backlash to government officials paid so highly, I like how it retains those who would be bid away to the private sector. It's hard to take care of others if you can't take care of yourself first and the policy discourages corruption.

Quite often the mentality of Singapore is summed up simply with the word 'kaisu' which translates from Chinese into 'afraid to lose.' The small island has to compete globally in almost every facet and most notably with Malaysia in terms of many regional competitions. Because of the mindset and no shortage of competitors, Singapore will always have to continue the pace of development to drive the economy. Those in Singapore have built a tremendous global city through their ingenuity, and I hope that I can make my contribution by moving there myself soon.

Why is Singapore considered to be a good place to live? Is it really freedom, or is there an unspoken 'biggy-like' respect for property rights? Here are some sample laws in Singapore:

1. Bungee jumping is illegal.
2. The sale of gum is prohibited.
3. Homosexuals are not allowed to live in the country.
4. Pornography is illegal.
5. As it is considered pornographic, you may not walk around your home nude.
6. Failure to flush a public toilet after use may result in very hefty fines.
7. It is considered an offense to enter the country with cigarettes.
8. Cigarettes are illegal at all public places.
9. It is illegal to come within 50 meters of a pedestrian crossing marker on any street.
10. If you are convicted of littering three times, you will have to clean the streets on Sundays with a bib on saying, "I am a litterer."

# The Golden Man, from Nigel Davies

The Soros piece about the Palindrome's predictions over six months got me thinking about the talents really required for short-term trading. This brought to mind a Philip K. Dick short story entitled The Golden Man.

The golden man of the story is really nothing more than an instinctive hunter-gatherer. But he has three unusual abilities that mean that he will not only be invulnerable but that the existing species of mankind will inevitably be wiped out and replaced by his kind. These are short term clairvoyance, speed, he is irresistible to women.

Now what better qualities could a day trader have? Within a few years he could accumulate huge wealth and ensure that his genetic tendrils dominate the world's gene pool for millennia.

Who needs economics?

# Waking Up In an Orwellian Nightmare, from Nigel Davies

At first you might think it's a joke, but apparently they're deadly serious. The latest proposals by the UK's education secretary are that private schools may be forced to 'loan' teachers in order to maintain their 'charitable status'.

Evidently it counts for nothing that they already take the burden off the education system and parents who send their kids there without taking up their 'entitlement' to free education.

# A Bias Against Brains? From Nigel Davies

May 23, 2007 | 2 Comments

The latest report from Amnesty International (see the FT report below) provides more grist for my foot-shot theory of human affairs. Can anyone ever make a profit without it being 'exploitiation'?

I thought I'd try to learn more about the field of economic inequality and discovered that Amnesty International evidently subscribes to the 'dependency theory'. But there are three other major types of theory about variations in nations' wealth, plus Richard Lynn's deeply unpopular thesis, which claims it has more to do with national IQs than anything else:

1) Dependency theory: Proposes that the economically developed capitalist nations are responsible for the poverty of the underdeveloped nations because they dominate the world economy, force the rest of the world into economic dependency, and pay low prices for Third World agricultural products and natural resources. This is why we get products labeled 'fair trade' in supermarkets.

2) Climatic theories: These propose that different climates naturally lend themselves to different levels of economic activity.

3) Neoliberal theory: Proposes that the major factor responsible for national differences in economic development is the presence of free markets as opposed to command, socialist, and communist economies.

4) Various psychological theories about motivational factors, such as the Protestant work ethic, have helped northern Europe.

Perhaps several of these theories have an element of truth, but I do find Lynn's hypothesis quite compelling, especially if his IQ/GDP correlation (0.82) is correct. And I can see why it might be rejected without study.

Given the taboo surrounding Lynn's ideas, could they be used for investment purposes? Well maybe. Just go long on a high IQ country that has been held back for reasons that are being reversed. Conversely one might short the hell out of a wealthy country in which the average IQ takes a sudden nosedive.

I started wondering about how someone should set about investing in Mongolia. To my dismay, I discovered that Lynn had already investigated the IQs of Mongolian kids and found them to be 5 lower than Han Chinese living in the same community. I guess it's back to the drawing board.

So it looks like genes are not enough, IQ is probably dependent on factors other than genetic material alone. But perhaps there's still an angle here for investment in companies.

Now I've seen lots of theories about how buying into companies with a good ethic works well (without quantification), but nothing based on IQ. And there are a couple of companies I can think of whose ethics have been criticized but not the brains of their leadership; Google and Microsoft.

Could there be a bias against brains that might be profitably exploited? I suspect that most people would much prefer to invest in dull honesty rather than the too clever by half. But maybe they are wrong.

From the FT's website:

The United Nations must develop international standards that hold big business accountable for its impact on human rights, Amnesty International says in its annual report published on Wednesday.

There is evidence in many parts of the world that people are being tipped into poverty and trapped there by corrupt governments and greedy businesses, Irene Khan, Amnestys secretary general, says in her foreword to the report.

According to Ms. Khan, a growing demand for mining, urban development and tourism projects is putting pressure on land, across Africa, Asia, and Latin America, with entire communities evicted from their homes without compensation or alternative shelter.

She says that weak, impoverished, and often profoundly corrupt states have created a power vacuum into which corporations and the economic actors are moving.

In some of the most resource-rich countries with the poorest populations, big business has used its unbridled power to gain concessions from governments that deprive local people of the benefits of the resources, destroy their livelihoods, displace them from their homes and expose them to environmental degradation.

Africa has long been a victim of the greed of western governments and companies, says Ms Khan, but she singles out China and Chinese businesses for showing little regard for human rights on the continent.

# Some Colorful New Terminology from China, from Nigel Davies

From the Financial Times’s site. I do wonder about the name “rat investors,” given the high regard in which rats are held. Is it a compliment?

Chinas Day-Traders Look for Black Horses, By Geoff Dyer in Shanghai

Published: May 22 2007

The thousands of ordinary Chinese who are signing up each day to trade shares are not too concerned about the conventional ways of valuing a stock, but they need to know the difference between a ghost and a black horse.

Chinese have combined a traditional delight in word-play with their new-found passion for stocks to create a rich supply of colloquial jargon for investing that is bandied around brokerage offices.

Ghost shares are highly risky, but black horses have beaten expectations. Buying cheap to sell high later is known as fighting for the hat, while selling at a loss to avoid further losses is meat slicing. Investors who think a piece of news will boost prices claim to be lifting the sedan chair.

When a fund manager was sacked last week for allegedly manipulating share prices, websites hummed with talk of rat investors, the term for insider traders.

There is even a Chinese phrase that could define the current boom. On top of bulls and bears there is the deer market, when large groups of amateur, short-term speculators cause markets to move in erratic jolts.

# On Emotions and Thinking, from Nigel Davies

May 19, 2007 | 1 Comment

The point of having 'will to win' is not to intimidate the opponent but rather heighten one's own motivation, awareness, speed of thought (pattern synthesis) and be able to withstand the pain. I don't think someone can do this well when they're a cold fish. You've got to be 'on fire' to achieve these higher levels of brain function. This is very clear to the fraternity of chess Grandmasters, who tend to discover all sorts of errors in their homework when they're actually sitting at the board in combat.

What enables people to achieve such levels of concentration will vary from person to person; Korchnoi found it was good to hate his opponents. For Fischer I believe it was some kind of sadistic impulse ('I like to crush the other guy's ego').

Not everyone accepts the idea of day trading being a cold intellectual exercise, and quite rightly in my view. Maybe long-term traders and investors can afford to be more aloof. But for good day traders (and chess players) I believe 'aloofness' will be much more the exception than the rule. This is certainly the case amongst people from both fields that I know. The whole brain is needed for tough challenges like day trading, not some lobotomized part of it.

I couldn't agree more with Nigel's point.

That heightened emotions can enhance one's cognitive awareness and "power" is well known. As organisms, we are Darwinian beneficiaries whose higher functioning is galvanized by the presence of danger, when adrenaline kicks off a cascade of cognitive and physiological responses.

Moreover, the pure absence of emotion in thinking, as in the complete detachment epitomized by Spock in the original Star Trek series, is demonstrated to be a mistaken ideal by Damasio in his book "Descartes Error" (highly recommended). But. . .

1. Although a mammal's (trader's) neural and synaptic functioning are accelerated by adrenaline, the field of cognitive awareness is narrowed, leading to potential errors. (In the presence of a potential danger, a mammal focuses on the perceived threat, to the practical exclusion of everything else.)
2. Emotions may better serve a trader in the discovery of a trading system than in its application. Is it not a goal to trade by a system?
3. It is well-documented in the history of science that, while heightened emotions are necessary in the "incubation" stage of scientific discovery, that the actual discoveries come when one is relaxed, usually out of the blue (the famous BBB phenomenon is bed, bath, bus — the last being an alliterative proxy for walking or travel).
4. In my former field, in which I dedicated several decades to pondering optimal brain functioning, I have yet to work out the extent to which intelligence tests measure intelligence versus measure "the will to win" (i.e., solve a problem or answer a question).

## From Henry Carstens:

Hmmm….

Trading Firm 1 is filled with discretionary traders. They have back-tested their ideas and have a defined edge which they trade each day with discretion. Traders do additional research on nights and weekends.

Trading Firm 2 is filled with discretionary traders and mechanical systems derived from each trader. Each trader's ideas have been back-tested and their edges defined. Firm 2 uses each trader's mechanical edge as a baseline to monitor their performance, to forecast the performance of the firm, and to create realistic risk and capital allocation controls. When a trader goes on vacation, has a new idea to test, or retires, that trader's mechanical system is substituted for the trader so the firm suffers no downtime.

Trading Firm 3 is filled with computers and researchers. Each researcher builds out all the viable trades in a time frame, mechanizes the rules, and moves onto a new time frame in the same or a new market. Incoming researchers are handed existing systems to maintain and improve before getting their own timeframes to build out. Each system has built in monitoring code that alerts the risk department when it has moved outside normal parameters.

Then,

Which trading firm has the least overall risk?

Which trading firm is most likely to evolve with the markets?

Which trading firm is least subject to ever-changing cycles?

What is the growth curve likely to look like for each of these firms?

In my mid 20s I learned some methods for systematically relaxing during a chess game because my 'nerves' were often getting the better of me and leading to errors during the later stages of a game. This became more or less automatic over time.

Whilst trading I find that a similar 'controlled intensity' works best, though usually at lower levels than in chess, depending on the state of the market. I think that in both fields the focus may well be on 'perceived threats', but I think that one can learn what to look for via research or experience.

It may be just me but I find any attempt to conduct research whilst trading to be an exercise in futility, not to mention very distracting. It is much better to do it beforehand and have an armory of trading patterns ready prepared.

Research during a chess game would of course be illegal, but I think the effect would be the same - no benefit and plenty of distraction. I even found the Blumenfeld rule (writing down the move before playing it) to be very distracting, though now I've been saved from the temptation because they've made that illegal too (relying on 'notes' apparently).

So this paragraph kind of tallies with my own experience. But my take on it is that adrenaline levels can be controlled by the combat veteran and that any narrowing of cognitive awareness isn't a problem as long as someone has the most important things 'hard wired' via training.

## George Zachar writes:

Did Einstein have the will to win? Feynman? What about Mises and Hayek? Palindrome? Chair?

My barstool analysis is that humans have too many personality facets, too many parameters of success, and too many life tracks to allow for broad, empirical rules in this sphere.

Looking in the mirror, I see aspects of my life where I am a complete failure and aspects where I have succeeded beyond my wildest dreams, having marshaled the same intellect and will throughout.

## From Stefan Jovanovich:

Ian Deary's book Intelligence is the best thing I have read on a subject. Deary's position is that (1) yes, there are measurable qualities in human beings that relate to the brain's ability to calculate, (2) the word "intelligence" is the shorthand description people have decided to use to describe this trait (hence I.Q. tests), and (3) as a measure of human capacity I.Q. tests alone are relatively feeble because living is far more complex than calculation.

I continue to trust my Dad's opinion about this. He was shrewd enough to foresee that standardized testing (MCAT, SAT, etc.) and test cramming (Princeton Review, etc.) would be growth businesses well before any other American or European publisher did. He was also someone who understood the limitations of what he did to make money. He thought there were two problems with intelligence testing. The first was that everyone who fell below the 95th percentile - and their parents - ended up hating the test. The second problem was that neither schools nor teachers nor publishers were honest about telling the students and teachers the truth about how limited standardized tests were.

His solution to both problems was to expand testing so that it measured the entire range of human capabilities - spatial orientation, dexterity, honesty (yes, honesty), mechanical aptitude, and all the other skills and abilities for which actual quantitative testing had been developed. That would confirm what people intuitively knew - that straight A students did not automatically rule the world; and allow schooling to be of value to all students.

It would identify each student's strengths and weaknesses so that - ideally - the student, his or her parents, and teachers, could all work towards diminishing the weaknesses and improving on the strengths. Dad believed that everyone could learn to do better. It was not just a matter of faith. He knew that, even in the area of I.Q. testing, repeated drill and practice worked. Students could improve their scores by almost an entire standard deviation simply by taking an I.Q. test every 3 months instead of only once or twice in their entire schooling. Drill and practice worked. The reason it fell out of disfavor was simple; it was hard work for both the teachers and the students.

I'm sure discretionary traders would do badly. But a key factor here is the state of the human material the firms start out with, and even the ancient Hagakure notes falling standards in manhood:

"… [W]hen one comes to speak of kaishaku, it has become and age of men who are prudent and clever at making excuses. Forty or fifty years ago, when such things as matanuki were mainly considered manly, a man wouldn't show an unscarred thigh to his fellows, so he would pierce it himself.

"All of man's work is a bloody business. That fact, today, is considered foolish, affairs are finished cleverly with words alone, and jobs that require effort are avoided. I would like young men to have some understanding of this."

# Crisis, from Victor Niederhoffer

I have been thinking about the performance of companies in crisis. Often crisis is a time of great growth, as often companies in crisis are tarred by the unethical activities of some executive but the basis capital structure and earning power of the business is not affected. Some examples of this are AIG and Tyco, and many of the companies tarred by the back-stating of options, as well as the few companies on the NYSE, where an executive seems to have been too greedy.

There are some million cites on Google for "Crisis" NYSE, and it would be hard to test the overall systematic tendencies and performance of these companies. There is a Delahave index of corporate reputation, which publishes a list of the reputations of the 100 largest NYSE companies. Companies with very bad reputations as of year-end 2006 (with their 2007 performance in parenthesis) include Fannie MAE (+10%), Allstate (-3%), and FORD (+15%).

It would stand to reason that the companies with the worst reputations should have the highest risk premia, and the best should have the lowest.

Another aspect would be the regression bias factor of bad and good reputations being inordinately due to ephemeral factors.

The whole subject calls for a systematic meal for a life time study. See this article on the Delahave Reputation Index is a must read.

But reversalists can take heart in the CS/Tremont Hedge Index, which shows that the most successful category in the long run has been Event Driven/Distressed. Optimists can also derive intense pleasure from the worst performer on the list: Dedicated Short Bias.

There is a phenomenon in competitive games whereby under-performing participants will outperform in order to reach the standing that accords with their belief about their 'status'. Alternatively, over-performers often find ways to scuttle their own performance in order to reach the comfort of what everyone expects of them. For older players this is the main problem on the road to improvement. The young tend to be immune from such effects as they have yet to 'discover their place'.

I wonder if this same effect is seen in the corporate world, with companies that slip from grace fighting like tigers to recover the status that they believe they deserve. On the other hand, young upstart operations (Google comes to mind) will not know their limits and can leave more respectable rivals in the dust.

# Ken Fisher’s Reply to Bearish Propaganda, from Martin Lindkvist

May 17, 2007 | 4 Comments

As bearishness is surfacing in our midst, I thought I better refer to Ken Fisher's latest column in Forbes.

There is no doubt that over a long period of time stocks go up. This is not the issue. The problem is that 20% of the time the market is lower five years hence, and 26% of the time two years hence. I also believe that serious housing declines hit stocks.

This has nothing to do with bearish propaganda; these are hard facts. Now there may well be reasons why this is not the case, not least of which is the GaveKal thinking. But I should point out that the GaveKal approach has not been quantified and therefore, unless I'm mistaken, qualifies as 'mumbo'.

But the real issue here is in why any counter-arguments are ignored or shouted down as 'bearish propaganda', even when they are reasonable. Now there is no doubt that bearish propaganda exists, but delusion is not a one-way street.

Ken Fisher's view is untested mumbo, as one can see from the title 'Never Before'. And as I'm quite enjoying playing a bear (albeit one who only ever takes the long side), the obvious answer to this is that if the consumer spending spree comes to an end (because they can no longer use their new found housing wealth as a checking account), earnings yields will shortly be heading south.

## Vic mentions:

During the last several years, many chronic bears have submitted original pieces to our site, and if they have a strong point, and argue it well, we are always happy to publish it.

I can't agree with Nigel’s point about some of the two and x year changes being down, as the studies of Fisher and Lorie show that when you look at the distribution of returns by holding periods, that almost all of the seven year returns are up, and an extraordinarily high percentage of them yield returns of more than 15% a year compounded.

These results are completely consistent with those that would be expected from a 10% a year drift with a standard deviation between years of about that much. Many people try to grind against the house in Vegas and we know they all end up broke. To try to grind against a drift like this is sure to end up in the 97% yearly loss that one of the chronic bears (who claims he caught the Feb. 27th debacle) actually experiences. Imagine what the fate of those who actually followed the advice and views of the weekly financial columnist have been — how many times would they have lost 97% in a year while they waited for events like the Oct. 19th, 1987 landslide to occur. How terrible it was that rather than receiving a heads up to cover their shorts and get back in the market, the weekly financial columnist told them that the Oct. 19th, 1987 decline of 25% was just a beginning.

The same is true of the key level boys who state that this or that level, down 5% from the current, is what the pros are watching closely. Are they bullish then or bearish, and what happens to the 10% a year drift against them as they wait for that 'level the pros are watching' to actually occur in the fullness of time?

They will all end up ghosts in Trinity Church, whilst they wait for their key levels, and as it has so often been in the past, my pocket book will always be open to them, whether for a lunch or otherwise.

I am one who writes naked puts very frequently and find them very profitable. I am aware of the dangers (or some of the dangers) associated with this practice including specialists gunning for certain active strikes the same way the do with stops, etc., and I sometimes modify the pos. to credit spreads. I even use them instead of limit orders in some cases when I am more aggressive and look for assignment.

Could Vic and Laurel kindly clarify the dangers of this? I am under the impression that writing puts is consistent with the 10%drift and is generally taking a bullish stance to the markets. I am particularly interested in this as I am very active with this strategy and it has been very rewarding in the past, but I hope that the mistress is not hiding behind the curtain to take it all back in one blow.

There was one particularly gifted option trader on the Sydney futures exchange trading floor, who regularly, generated considerable monthly returns trading options, (selling puts, just one of his many strategies) — however each year for many years he would blow up and blow up big, only for a new underwriter to get him back in to trading, (maybe lulled in by his solid monthly record, up until the time it took him out of the game).

Maybe his risk management left a lot to be desired, but as one trader said me after Sept. 11th, for every dollar in the market, you need 10 in the bank (to cover not getting squeezed out of positions and to cover extended and added margin requirements by the clearing houses when volatility goes through the roof).

That one little black swan can kick up some dust.

Selling naked puts is not the only strategy where, in essence, you are receiving income in exchange for assuming the risk of very unlikely events. What is great about them is that these events are so rare, that when they happen you (the manager) can shrug them off as a one time event that you have now learned from … and get back in business with new capital.

## Chris Cooper responds:

Prof. Haave's words strike me as true. On the other hand, it seems likely that in a market subject to a 10% drift, where that drift is not modeled in the option pricing formulas, there may very well be some positive expectation in selling naked (or semi-naked) puts. Since I have assiduously avoided options in the past because of concerns about liquidity and execution costs, perhaps it is time to reevaluate, but I have several concerns.

A skewed distribution of gains, such as one receives by selling OTM puts, is undesirable for one trading his own money. The market crashes are so rare that it will take many years to see enough of them to trust that you can model their frequency/amplitude. It is thus easy to fool yourself about the expectation of your model, and it is also easy to get wiped out. By hedging you can transform the fat left-side tail into a better-behaved distribution function. Is this what people do in practice, or do they very often run mostly unhedged, since any hedge costs money?I can imagine various ways to hedge, such as: stop-loss on the naked puts; sell futures; buy further OTM puts; and probably many more creative strategies. These can be dynamic or static. What is the best practice, assuming that you need to have good liquidity and keep your hedging costs at a minimum?

Isn't selling a put a combination of a directional bet on the market plus a bet that volatility will not be rising? If so, then does it make sense to separate the two? Buying futures would be the directional component, and one could sell volatility by selling both calls and puts. Am I seeing this correctly, or is there a better way?Is it better to let your OTM puts expire worthless, or does it make sense to sell them before expiration to free up capital?

What about execution costs? The spreads in options always seem high compared to futures or stocks. Am I looking at this in the wrong way? Does it help to sell puts by entering a limit order on the ask, and adjust it based on delta and the underlying? How is liquidity in these markets, compared to futures?

It has always seemed to me that the derivatives markets are obfuscated by jargon.

The bears' argument is built on the relatively recent housing boom and its extraordinary recent returns, 2000-2005. It is as if the "old economy" insisted its importance in a post dotcom bubble. The bears' argument boils down to: stock market returns are dependent on housing market returns. This may very well have been case recently. But should we be shocked to find a regime change, just as the housing market slumps? Obviously the 100 year drift in the stock market, cannot always be dependent on a 10% drift in the housing market. This is because the housing market is limited by the income level of the typical buyer.

# Static Vs Dynamic Pattern Thinking, from Nigel Davies

Here are some elements of chess thinking that may be relevant to trading:

a) In considering patterns on the chessboard one does not select a single element (e.g. a doubled pawn) and then assess a position purely on the basis of previous examples (e.g. outcomes after x moves since the doubled pawn arose). It may indeed be the fulcrum for one's considerations, but one should also be on the lookout for patterns that might arise as a consequence.

At this point we start to get beyond static testing of patterns into the realm of simulation. Now I'm aware that there may be some advanced simulation programs around, but on the basis of what I've seen of chess programs they're going to be way too primitive. For day trading at least it needs a flexible organic mind to look ahead, synthesize patterns, adjust one's perspective along the way and work within available margin.

b) Even more important than considering one's own happy outcomes is to bear in mind what the opponent would like to do to us. Many beginners make the mistake of only considering ways the game will be won for them without bearing in mind the myriad ways in which they can lose. As a result they can play very badly in adversity, or build their positions so that they fall apart when things go wrong.

I have an example of this second point in that I've seen it mentioned numerous times that everyone is afraid of another decline like Feb 27th. But not once have I seen it mentioned that people may also be afraid of missing the kind of rally we saw out of last year's panic. This seems like an equally viable proposition and yet it hasn't been mentioned. Why not? Because it would raise the possibility that bulls can act irrationally.

Now we all know that stocks tend to go up, but this does not immunize bulls against irrational behaviour. A bull can go every bit as bankrupt as a bear if he's highly leveraged, operating on a short time frame and doesn't have some very fancy footwork. And he can turn round and say he was 'right' when the market goes back to new highs, but this is just another form of denial if meanwhile he went broke or didn't have the margin to exploit it.

# Cheap No Longer? From Larry Williams

I was looking for bids to print some DVDs for my commodity trading course; tried the USA first, India second. They're cheaper in the USA, even before shipping! I would try China, but I'm concerned about quality control.

I'd also be concerned about their making extra copies and selling them off on the cheap. This happened with one very nice Italian-Russian chess production which found its way into the suitcases of Russian chess players when they went to tournaments. You couldn't tell it from the real thing because it was the real thing — just half price or less. And when the Italian partner realised they couldn't sell many of the official copies they finally twigged what was happening. And not much chance of joy in the Russian courts…

## Barry Quigley remarks:

A friend of mine outside the US has a very successful little business duplicating and printing CDs and DVDs. I tried the exact same business model in the US and could not compete. Competition was unbelievable. Only the biggest mass-producing companies can pay for advertising, charge the lowest prices, and still make a profit. I also suspect quality control in the US is the best.

# The Stockdale Paradox, by Nigel Davies

May 9, 2007 | 2 Comments

This paradox is named after Admiral Jim Stockdale who was the highest ranking US military officer imprisoned in Vietnam. He was held in the Hanoi Hilton and repeatedly tortured over eight years. The "paradox" lies in the way that he managed to survive where others perished.

"I never lost faith in the end of the story. I never doubted not only that I would get out, but also that I would prevail in the end and turn the experience into the defining event of my life, which, in retrospect, I would not trade."

Asked: "Who didn't make it out?"

"The optimists. They were the ones who said we're going to be out by Christmas. And, Christmas would come and Christmas would go. Then they'd say, We're going to be out by Easter. And Easter would come, and Easter would go. And then Thanksgiving, and then it would be Christmas again. Then they died of a broken heart.

"You must never confuse faith that you will prevail in the end - which you can never afford to lose - with the discipline to confront the most brutal facts of your current reality, whatever they might be."

This recalls Viktor Frankl's "Man's Search for Meaning", in which he describes Nazi concentration camp survivors and those who didn't. He was surprised that big, tough guys were usually among the first to go. The psychiatrist learned to function as a physician at the camp, and managed to avoid despair by remaining mentally active. The book he wrote had been destroyed, so he re-wrote it mentally and memorized it giving him an important goal to publish when it was all over.

How much does mental toughness correlates with volition and how much with genes, and to what extent you can improve it? Suffice it to say you can't choose your parents.

## From Stefan Jovanovich:

To equate survival in a prison camp with "mental toughness" is to indulge in what the surviving Japanese military leaders of WW II came to describe as "victory disease". You assume that a happy result says something about your intrinsic superiority as a human being when it doesn't. Neither Lance Sijan nor Eric Liddell survived their imprisonments, yet dozens of the survivors from their camps have said that they owe their lives to the help and example of the bravest men they ever knew.

I know Frankl's book was immensely popular when it was published and still remains one of the bibles of secular humanism; but I find it chilling in its narcissism. When I did some minimal research on Frankl's own life, I found it odd that that there was no one from the camps who praised Frankl for what he had done for the other survivors. I would have expected that from Theresienstadt, of all places, there would have been at least one testimonial - given its importance as the Nazi's show camp.

Joseph Fabry, the person best known in America as a "fellow survivor" with Frankl, was held briefly in a detention camp in Belgium, but was never in Austria or Germany with Frankl himself. (If anyone on the List knows of any testimony from others who were in Auschwitz and Turkheim with Frankl, I would appreciate the reference or link.) The only survivor commentaries I have found that could relate to Frankl are the comments made about the Jewish camp doctors. Sadly, those affirm that most of the doctors, like the Sonderkommando, put their energies into working the system for their own survival, not into the care of their patients.

I don't imply that those general comments apply to Frankl, and I lack the necessary chutzpah to judge anyone who was ever imprisoned for more than an evening in the drunk tank. What I can say, without embarrassment, is that I wish that Frankl's desire to find profound meaning in his own random survival had not encouraged the temptation to rank others as somehow inferior just because, like Frankl's own wife, father and mother, they were given different numbers in the Nazi's insane lottery.

What Kim Zussman did not quote were Admiral Stockdale's many remarks about those - like Admiral Alvarez - who never gave up. They, like Stockdale himself, were the ones who always did their best to help and encourage others.

I don't know anything about surviving prison camps but this did strike a chord with me vis-à-vis chess players. I've met lots of players who are perpetually optimistic and this shows in every decision that they make. One very noticeable facet is that they tend to be very poor at defending inferior positions, showing a tendency to lash out. In one case I've known the parents too, and they weren't optimistic at all.

This made me wonder about the value of 'state of mind' in survival. A direct application would be to draw up a matrix of returns during the last 100 years applying 1-10 times leverage in stocks. I hypothesize that mild optimism may be an advantage, but with a rapid falling off of efficacy in higher doses.

Admittedly this would be very tricky to do 'realistically', for one thing there are not many 100+-year-old stock investors around and for another margin requirements will have varied considerably. But it might nonetheless be interesting to know that just how optimistic one might be in order to still triumph.

## Kim Zussman remarks:

Martin Seligman wrote about "learned optimism" (as opposed to the inherited kind, which is much easier to acquire). In scientific trading, there is "optimistic learning" (OL).

OL is a variation of the scientific method whereby you open trades during the day's churn based on gut, then go back at night and do enough statistical studies to find at least two in support your position. Then you share these studies with at least two friends, who for social reasons don't debate your conclusion, and you are fully prepared for tomorrow's shellacking.

# No Fun at All, from Victor Niederhoffer

May 8, 2007 | 8 Comments

There is a point of view out there that the best performance comes when you're having fun. In my lifetime I have played in more than 10,000 refereed squash matches, and won at least 50 national tournaments, and I never had fun in any of my matches. When I tried to have fun, it was disastrous, and I shudder at what a horse's ass I was on those occasions.

To someone who's a serious competitor, the idea of having fun in a tournament is ridiculous. There's so much work, and so many better athletes that you have to beat. So many officials working to do you in, and so much equipment to properly deploy. So much practice and preparation before and during the event. You might think that this is a matter of individual differences or different sports, and I grant that there are some so great that they can soar so high and so much better that it's possible for them to have fun.

I believe that Sharif Khan and Hashim Khan had fun when they beat me, but they didn't have that much fun when I beat them, on those much too rare occasions.

I do know it's totally wrong to try to have fun in the market — it's much too hard, and there are no naturals. The cycles are always changing.

One of the best things I've done in my operation is to make sure that no one has fun in my office. Every now and then, I catch someone who doesn't get the joke, and I upbraid them.

I try to suppress all exuberance, and when I hear of some former trader who loves to have fun by trading I know he's a straw man waiting to be exposed, and I only wish I could short his fund. Normally I wouldn't comment on a subject like this but I am sure that all frivolity should forever be knoced out of the speculative arena, especially when even an iota of other people's money is involved. They should have their own fun with money you make for them through serious and scholarly discipline and improvement, with no fun whatsover.

I don't know whether he considered himself to be having fun, but I remember a quote from Rod Laver in which he said that he would just swing for his big shots until they started landing in. If they didn't, then he would lose. I guess he knew that losing when you're having a bad day was inevitable when you're playing at the top of the game.

Regardless, I remember that he was my favorite player to watch when I was a kid. It's difficult to find footage of those old matches now, except for a few minutes of a match with Borg in 1977. Laver is past his prime, but he's definitely holding his own with Borg. His modest height of 5'8'' makes the court look like a football field. Notice the beautiful drop shots he makes, even from near the baseline, which are so startling when mixed among his blasting drives.

## From Alan Millhone:

Your remarks carry over into competitive checkers with ease and are sound advice. When you play in a competitive tournament you had better be focused 100% or get crushed by your opponent. I have not had the proper time to devote to serious study for some time and my game has suffered accordingly. You have to spend time preparing for any tournament. The better players have obviously prepared with diligence.

Our World's 3-Move Champion, Mr. Alexander Moiseyev has often said that he is wary when making a move as his opponent (regardless of their strength) can make any reply move, and their reply may be a very good move. He is watchful in every game regardless if he is playing one of the top players or an average player as myself. You might play 'skittle' checkers at a party for fun on occasion, but in a tournament leave the fun outside of the playing room or suffer the consequences .

" Knowledge is power" in the market, checkers, chess, or any athletic event.

## From Russell Sears:

At least in marathoning nobody comes to the line and expects to "have fun." The fans don't say, "look at how much fun he is having out there." The best they used to say of me was "he doesn't even look like he is trying." But believe me I was "trying." It's funny now that I am older, and much slower, they don't say that any more.

It's good to hear from Vic, that it's only the weekend warriors that think it's all about fun even for the serious competitor. The fun is left for after the finish. Or as the old country song goes, "time enough for counting, when the dealings done."

## Nigel Davies writes:

I think there must be a difference between how a games player or sportsman defines 'fun' and how the average person on the street does so.

Here is a profound clarification of fun that is so on the mark from my perspective.

I heard tournament poker pro Amir Fahidi say "If you are not willing to die you cannot live."

George Patton said, "Compared to war, all acts of human endeavor pale in comparison." In the movie Patton there is a dialogue between Omar Bradley played by Karl Malden and George C. Scott as Patton.

Bradley: "You know the difference between you and me George? I do this because it is my job. You do it because you love it."

Upon reflection Patton remarks: "God help me I do love it so."

## From Alfonso Sammassimo:

Playing a tournament match with the aim of having fun has only occasionally entered my mind since junior days, simply because it has always been such a costly attitude to take onto the court. In particular I recall matches where I subtly tried to imitate players whose styles I admired and envied, especially when I had only recently watched them, and how badly it affected the score for me, cost me more matches than I can count.

I recently had my first competitive match (our annual club championships) in a while after a shoulder injury, meeting up in the second round against an older fellow who used to tour our satellite circuit and played a for a few years as a pro. He had been playing club matches for months and was in sharp form, typical Australian grass style player. I was very fit going into the match but hadn't played much, and my plan was to just enjoy myself. But after realizing my range was way out and seeing that the guy couldn't hit three high forehands in a row I decided to turn the match into a hack-fest, the only game plan I was capable of executing well on the day.

Fortunately fitness and concentration won the day for me, and as ugly as the game was it satisfying to win knowing that I managed to change plan, use my available strengths to make him push himself to hurt me - no fun involved until shaking hands.

The tournament player walks onto the court to win, and it's no fun losing no matter how fancy you looked - the fun is in the prize. With so many things that need to be done in consecutive matches to win a tournament and the concentration that is required, there is no room to think of enjoying it. My P&L tends to suffer the same fate when I trade for fun or try to get fancy, not playing the game that feels most natural to me. And I have more recently been prone to some imitation of market players, but that hasn't hurt me much.

## From Stefan Jovanovich:

What poker has to do with either running or baseball, I have no idea. I do know that Don Schlitz wrote "The Gambler" in 1976, and Kenny Rogers' recording of it was a hit in 1978. As "old" wisdom, that is bit on the short side even for the more synthetic products of Nashville. I will defer to one of the many poker experts like SL to comment on whether players at the table count. My amateur observation tells me that they can tell you the history of every chip they have in the stacks in front of them.

Those of us whose sporting careers were limited to the John Kruk school of athletics ("M'am, I'm not an athlete; I am a ball player") have no way of understanding what Russell Sears knows as a marathon runner. We are even more puzzled by why he is so moved to anger when told that fun is a necessary part of baseball. Baseball is a game that you can only play well after 10 years of daily practice, study and good teaching. The first time a player gets to the major leagues he fails - either mostly or completely. (Tim Lincecum's debut yesterday with the Giants was a "mostly" so he may, in fact, be the next "pheenom".)

If, thereafter, you are hard working and talented and lucky enough to stick at the major league level, you get to fail only 3 out of every 4 tries. If you are that 1 in a million player whom God has truly blessed, you fail only 2 out of 3 tries instead. Precisely because it mostly about failure, baseball has one cardinal rule: you never "show the other guy up". If you do, the guy standing 60 feet 6 inches away holding a rock-hard ball has the right to aim it for your ribs instead of the inside corner; and even the players on your own team will think you had it coming. What almost all baseball players share, whatever their degree of success, is the capacity to find joy in its daily grind of failure and humor even in its worst moments of humiliation.

## Rodger Bastien writes:

Have fun all of the time? Ha!! I think the struggle to excel is universal, in any sport. The idea that it's more "fun" in baseball or that the struggle is less is to me absurd. However, I would give anything to be able to enjoy that struggle again!

Perhaps there is an element of frustration, in what I wrote. The original reply was not meant in anger, but from a Spartan spirit. Nigel said it much better.

Age has forced me to run marathons for "fun" and feel many of the same sentiments Nigel expressed. However, unlike Nigel, my game suffers no matter the discipline I bring to it. But discipline can be exhilarating, even in defeat. Discipline can make the game fun.

After some further thought I think I know exactly what the fun is in competitive sports (and trading) if you play for blood. It's the intensity of the experience which is completely off the spectrum of those we have in 'normal life'.

A chess game in which one puts everything in can lead one to feel either great highs or great lows, but always the feeling that one is more intensely alive because of the rich tapestry of emotions. Strong players will also tend to have feelings of pride and self-worth linked to good performance, and not necessarily to favorable outcomes, though the two tend to run side by side.

Those who can't bring themselves to play with much intensity are those I'd describe as dabblers. And they'll never be much good because they won't be able to fire on all cylinders.

My intent wasn't to diminish Mr. Jovanovich's knowledge or opinion pertaining to baseball as much as to respectfully disagree with the idea there are absolutes unique to baseball, especially regarding that difficult period at the beginning of a major league career.

I suspect that the first year in any sport at the major league level is especially daunting. The NBA is a prime example where the first or second year is often a year of learning. I'm convinced that these elite athletes do such a good job of making it look easy that we mere mortals can't begin to understand how gifted they are. When we relate our experience playing the game to the game they play at that level it is truly comparing apples to oranges, their game being that much more difficult.

That all said, I have always enjoyed Mr. J.'s musings and am partial to anyone who loves baseball and respectful to their opinions of it as it certainly is expressed from the viewpoint of greatest affection. Now Vic, I am still trying to figure out how you achieved such great success in the racquet sports without indulging yourself in a modicum of fun! Is it that to label it as fun is to infer a lack of seriousness? I know that at the moment of my most outstanding athletic achievement the almost orgiastic release would be defined in many ways, fun being nearing the top of the list.

## Stefan Jovanovich replies:

Rodger: I think you are right. I was going to offer pitcher's WHIP stats as an example of baseball's uniquely absolute level of failure and compare that to the number of unforced errors in a tennis match. But, when I looked at the statistics for matches between professional players at the same level of excellence as the best major league hitters and pitchers (the top 25), their ratios of points won on service games vs. double-faults, unforced errors and winners by their opponents were roughly the same - 1 in 3 or 4. I am afraid that I got mesmerized by my memories of looking at the game through a mask and the joys of doing something well, at least at the orange level.

# Causation and Koch’s Postulates, from Peter Grieve

May 3, 2007 | 1 Comment

I have been thinking a lot about the important problem of establishing cause and effect, since Nigel Davies brought up the topic earlier in the week.

It seems like the more complicated systems become, the more difficult it is to establish cause and effect relationships between different phenomena. Physicists often say that two phenomena are "associated", when they don't dare establish a cause and effect relationship.

But the science that really has a problem with this is biology, which studies extremely complicated systems (remember that there are more cells in your body than there are stars in the Galaxy, and each cell is quite complex). Perhaps more biological thinking would do us good, rather than the physics-like thinking often used in market modeling.

In the germ theory of disease, for example, it is very difficult to establish the mechanism by which the germ actually causes the disease. And the mere presence of the germ in large numbers is not enough to establish cause and effect. The germ may be an opportunist, taking advantage of the diseased state to increase its numbers.

Anyway, around the turn of the last century an attempt was made to make criteria for establishing this kind of cause and effect. One scheme was called Koch's postulates. Here they are in their original form:

Koch's postulates are:

1. The microorganism must be found in all organisms suffering from the disease, but not in healthy organisms.

2. The microorganism must be isolated from a diseased organism and grown in pure culture.

3. The cultured microorganism should cause disease when introduced into a healthy organism.

4. The microorganism must be reisolated from the inoculated, diseased experimental host and identified as being identical to the original specific causative agent.

I'm sure my fellow Specs can find holes in this scheme. But can we establish our own postulates for cause and effect in markets? Of course we can't "introduce" and "culture" market phenomena (much as we would like to). But maybe some other kind of formal scheme would provide food for thought.

This seems like such a good analogy. For example there are recurrent conditions in which the sufferer has occasional outbreaks of the disease.

In considering outbreaks of a market disease there might need to be the presence of germs plus some trigger factor such as 'stress'. Even then there are no guarantees.

## Bill Egan writes:

Tylenol (acetaminophen or paracetamol) is the #1 cause of fatal liver failure. It produces minor effects on the liver at the recommended dosage levels (4 grams per day in adults). Fatal liver damage (zone 3 necrosis) can happen with as little as 10 grams per day. The safety margin is a mere 2.5x between pain relief and death.

Most drugs are metabolized by enzymes in your liver, so that they can be excreted more easily. Acetaminophen is not an exception. Five percent of acetaminophen is converted to a reactive metabolite that will bind to liver cells and kill them. This is normally prevented by the body's anti-oxidant defense system, a molecule called glutathione, which binds to reactive molecules and thus prevents them from causing damage. Should your glutathione levels be low (not eating right, alcoholic, sick, etc.) you will be more susceptable to damage caused by the reactive metabolite of acetaminophen because your glutathion levels will be lower than normal. Should you ingest a bit too much acetaminophen, you rapidly exceed even the capacity of the normal levels of glutathione to prevent its damage. It is like a step function.

What market mechanisms act to prevent routine damage? What is the tolerance limit beyond which they are overwhelmed? (This is a violation of Koch's postulate #1 but it is chemical not biological.)

# Traffic, from Nigel Davies

The route by which I take my son to school got me thinking about the distances between two points.

If I take the most direct route it means negotiating a road packed with cars and little likelihood of a 100% legal parking opportunity. Unpleasant and stressful to say the least.

On the other hand, there's another road running parallel which is connected by a footpath; only a few parents park there. Now getting to this other road is not quite as straightforward either. By the most direct path it means crossing a busy road. So the most efficient route once again means taking a slight detour so I can join the busy road with an easy left turn (bear in mind that Americans, Frenchmen and Germans drive on the wrong side) and then leave the main road with a right.

Thus we have left, left, 2nd right, left, left, 1st right, park, walk left through an alleyway and right out of the alleyway rather than left, left, 2nd left, right, 1st right. Route 2 is more direct but is ultimately less efficient and more costly.

This conclusion got me thinking about the wiggles in markets; why does the market move in such an indirect and apparently inefficient way? It seems that it could be because of the traffic, which makes me realize that passengers might find it as difficult to guess the S&P's eventual destination as any of my passengers might guess mine. Unless I tell them of course.

# Reversing Cause and Effect, by Nigel Davies

May 1, 2007 | 1 Comment

Some recent events have had me thinking about cause and effect, and the logic which surrounds their application. Let me explain:

Just over a year ago a family member was diagnosed with Asperger's Syndrome. Now whilst there is plenty of denial around about the causes (people seem to go out of their way to blame vaccines etc.) it seems that the most likely one is inheritance. And since I am related and happen to be a chess grandmaster with some social 'eccentricities', fingers quite naturally get pointed.

After reading up on the condition I noticed that I had a number of traits. So I figured it might be good to get tested, which in older people is done via an interview of the suspect together with one of a close family member, in this case my sister. The upshot was a 'not guilty' verdict, it was simply impossible for the psychiatrist to establish a positive diagnosis (too much eye contact, apparent sense of humour etc.). On the other hand he thought it possible that I was somewhere on the spectrum and that had he seen me 30 years ago then I might well have tested positive.

This was quite thought provoking. Can a still existing physical condition (in this case the small matter of dodgy brain wiring) be regarded a 'cured' if the person who has it finds 'work arounds' so that any symptoms effectively disappear? The prevalent view seems to be that those who are on the spectrum are somehow 'incurable', but I do wonder about the evidence for this. First of all the hypothesis that Asperger's Syndrome means xyz traits relies on testing a sample of people who show xyz traits in the first place. This ignores the possibility that many people might have overcome the same condition so as to be undetectable. An excel spreadsheet would call this a 'circular reference', demonstrating how smart it is compared to the average humanoid.

Then we come to the confusion of cause and effect. The process through which one finds effects have particular causes may be a good way to study many things, but flaws may appear when the reverse argument is applied (ie that a cause will necessarily result in a particular effect). So if someone breaks their back and therefore cannot walk, this might prove to some that they could not possibly become, say, one of the world's strongest men. Yet Valentin Dikul did exactly that, breaking his back and then curing himself with a set of unique exercises that developed other muscle groups.

Similarly one of the word's greatest composers was in fact deaf when he wrote much of his best music. Beethoven certainly 'worked around' his deafness and possibly his Asperger's Syndrome as well (see Fitzgerald for evidence of Beethoven's Asperger's Syndrome).

I can see the very early stages of a similar process at work in my son. His difficulty with the standard way of acquiring language is being offset by an ability (not to mention determination) to remember a large number of phrases (mainly from Thomas the Tank Engine DVDs and software) and then recombine them in situations he recognises as being appropriate. The results are slightly odd at times (not to mention comical) but this work around is doing its job, he's learning to talk. I further speculate that he will learn to work around the other 'disabilities' associated with Asperger's Syndrome, including sacred cows like 'empathy' and 'humour'.

Is his method of 'working around' approved of? Apparently not. Whenever I've had to discuss his case with any 'authorities' who have been involved, they try to say that his 'understanding' needs to be developed rather than him using memory. I get the impression they'd say that Dikul had no right to cure himself either, at least not by methods that weren't approved of.

What's their problem? I think their understanding of cause and effect is flawed in that the assume the causes they know of are inseparably linked to the effect being observed. And I further suggest that one can find similarly poor linkage in things like 'climate change' in which a series of plausible relationships is being presented as proof of impending doom. It's there in markets too, lying at the heart of failed and failing models.

Why are cause and effect leading to such problems? I think it may be down to a lack of creativity, the ability to come up with alternatives. Normally creativity seems to be sidelined as nothing more than an adjunct to the analytical process (come up with an idea and then analyse it). But what if analysis is necessarily flawed if it lacks a creative element at every stage, the reason being that without the ongoing generation of alternatives, cause and effect will be assumed to be fully reversible?

Chess players here may note that Kotov's famed 'tree of analysis', in which the player first comes up with 'candidate moves' and then analyses them afterwards, may be similarly flawed. For years Grandmasters have felt guilty for being 'undisciplined' by generating new candidate moves during the analytical bit and then going back to square one. But perhaps they weren't so wrong after all.

I'm not sure if my thoughts on this are 'new' or not, at least they're new to me. Sharpening, clarification and criticism appreciated as always.

On 5/1/07, Stefan Jovanovich wrote:

One group was identified to each of their new teachers as having exceptional potential and the other as being what my recently released from high school daughter assures me is still the term for dummies -"retards".

There is also correlation between intelligence and good looks; some of which may stem from teachers and mentors affinity for cute kids and interns.

(Those hoping for something here about priests will have to settle for this)

You can see this with income/net worth also. For example we have Whole Foods and Trader Joe's markets here, which sell similar "healthy/organic" (what food isn't carbon-based?) TJ's is quite inexpensive, but WF is very high. If you enjoy retailing adventures, shop them both and you will see a clear difference between clienteles. The TJ housewives are trying, but saggy and kind of hungry-in-the-soul looking in the eyes wishing it weren't so. A lot of the WF crowd looks machina ex-Berkeley, with things still holding up well by dint of good jeans toting a perky-in-the-credit-card eager to check out.

All of which evidences that Asperger's and volitional Tourette's may still have funny jeans, especially large ones they wore as a child impersonating Jonathan Winters.

## Stefan Jovanovich says:

The women in my household (one 58, one 22) disagree with Dr. Zussman. They attribute the WF phenomenon to the trophy wife syndrome, and they remain skeptical about the correlation between brains and good looks, given what the older one knows from three decades of working in show business and what the younger concludes from having survived both high school and college. They offer the Drive Through ATM joke by way of confirmation.

# The Demonization of Private Equity in Germany, from Nigel Davies

Germany | 20.05.2005 The Year of the Locust

The insect metaphor is finding plenty of resonance in German media.

A senior politician sparked the current debate on capitalism in Germany by comparing foreign investors to a plague of locusts. But some say the use of such populist rhetoric masks a deep-seated aversion to capitalism.

The hum started in April, when SPD party secretary Franz Muntefering unleashed a stream of rhetoric likening foreign investors to a swarm of insects.

I must admit to being quite shocked at the similarity between the language and images used to describe private equity, and propaganda about Jews from the 1930s. What's going on here? Seems like a thinly veiled form of an ancient hatred.

## Gordon Haave explains:

In Europe, at least relative to the US, there are a lot more stakeholders in public companies. First are the politicians, who get cash subsidies from the large corporations. See Societe Generale.

Then there are the workers who through various workers' committees try to influence corporate policy. Add to that journalists, Greens, and other sorts who, in essence, shake down the large public companies.

Companies run with ruthless efficiency by owners in London and NY threaten all of that.

# Multiple Hypotheses, from Philip J. McDonnell

April 20, 2007 | 3 Comments

When we do a study based on historical data and find a statistically significant result at the 5% level, we really are saying that there is less than a 5% chance that this study is completely attributable to chance. But if we observe some pattern in recent market action and then study it, that can be a problem: the multiple hypotheses problem.

One might think that if only one test is done that only one hypothesis was tested. Sometimes this is true. Other times traders will be intense students of the markets and notice a recurrent pattern. The trader then forms a hypothesis based on this pattern. It is properly tested on the most recent data and shows itself to be statistically significant.

There are two problems with this approach. First, if "the most recent data" include the same patterns that were observed and used to form the hypothesis then we are subject to the multiple hypothesis issue. This is true because that exquisite pattern-matching machine called the human mind continually looks for non-randomness and meaning in everything it sees. The mind tries out incredibly many hypotheses all the time. Most of us cannot even guess how many hypotheses our mind tries out before we identify one as interesting. So including the data, which formed the hypothesis, implicitly includes an element of multiple hypothesis testing.

The other problem is that we already know that the data will validate our study because it was used to help form the hypothesis. So it is not independent data but inherently biased. Thus our significance tests will be biased toward acceptance.

The best way to do these kinds of studies is to form the hypothesis on one data set and to test it on another completely different data set from another period.

Or consider the same period but another market. For instance, if some phenomenon shows up in US stocks, test it on French and German stocks, too. There must be a reason for the putative phenomenon, either microstructural, behavioral, or economic. If so, it should show up in several markets. This extends the amount of testable data. One must be cautious with microstructure however, because it can differ.

## Philip J. McDonnell responds:

I do not agree with the idea of testing on data from different markets during the same time period, because many markets are highly correlated on a coterminal basis, sometimes as much as 90%. So it is really not an independent test on independent data.

But when one uses different time periods the correlations drop to near zero. So we can conclude that the data are truly out of sample.

## Bruno Ombreux replies:

Dr. McDonnell is 100% right, but I still think it is not completely worthless to extend the sample to other markets. If you test a hypothesis on the US market, you'll be interested in the cases when you reject the null. Now, you test the German market and you still reject the null. You're right — not very useful. But if you fail to reject it on the German market, you need to come up with a very good explanation why it would work in the USA and not in Germany.

This is not nearly as good as different time periods, but it can be useful and increase understanding.

I like to take an idea that has demonstrated its worthiness in actual trading in the US, then port it to other countries to see whether it works or not. If one has a group of countries for which the idea works and another for which it does not, it becomes interesting to try to figure out what members of each group have in common.

## Nigel Davies remarks:

Presumably you're also taking account of time zones here. I've noticed that other markets tend to be led by the US during the day session (and even a couple of hours before its open) and have their measure of independence at other times. China is probably leading the overnight action now and Europe dominates during its morning. So perhaps it's not so much cultural as different time snapshots showing a certain similarity.

## Martin Lindkvist extends:

Like the human flus that originate in Asia, many market ones seem to come from there too. Now, last night's Chinese flu seems to be of the same strain as that of late February. And as such, the market's immune system should be better prepared now. Perhaps a bit of coughing, and some sneezing for a little while, but not much of a fever this time?

From a book recently recommended to me: "Routine design involves solving familiar problems, reusing large portions of prior solutions. Innovative design, on the other hand, involves finding novel solutions to unfamiliar problems." To borrow a quote from a friend, "Better necessarily means different."

# Proof That Chess Is Much Harder Than Economics, from Nigel Davies

It's interesting that the UK's high CPI numbers require a letter of explanation from the Bank of England to Gordon Brown as to what will be done. Evidently this can't have much to do with matters under the future Prime Minister's control, such as taxes etc. As the Bank is obliged to provide the 'explanation' it seems that inflation must have a one-dimensional relationship with interest rates.

This just goes to show how much more difficult and subtle the game of chess is as opposed to managing an economy. As every chess player knows even a small pawn move on the side of the board can have serious implications for the position as a whole, even if it doesn't seem relevant immediately.

So given the simplicity of their task the bank better get its act together and start playing those interest rate moves with far more subtlety. And I'm not sure how they've managed to make such a mess of it so far, with US CPI signaling lower inflation than the UK even though interest rates are lower.

From the FT website today:

Consumer price inflation in March hit its highest level since comparable records began, sending sterling through the \$2 barrier and resulting in Mervyn King, governor of the Bank of England, having to write a letter of explanation to Gordon Brown…..Any reading that is more than 1 percentage point above or below the 2 per cent target requires the Bank governor to write a letter saying why the target is being missed and explaining what will be done to bring inflation in line.

# Climate Change Comments, from Nigel Davies

April 17, 2007 | 2 Comments

Discussion here has previously focused on whether or not there's any basis to 'manmade climate change'. Well actually it doesn't matter. The idea is well established and they're going to start legislating for it anyway. The UK's draft climate change bill is proof that its manmade causes are being presented as a fait accompli.

It's difficult to assess the economic implications of where the greens are leading us but I suspect they're being underplayed just as much as the catastrophic effects of not doing something are being overplayed. In my mind it's not inconceivable that after the local witch hunt for co2 emissions there will be an even greater commitment to planet saving (normal psychological reaction). My guess is that we're going to have issues with free international trade. After imposing expensive regulation on your own industry who's going to want to take cheap imports from planet destroyers?

From a January 31st Financial Times column:

Climate change is no longer a fringe issue; even investment bankers are worried about it. Lehman Brothers and UBS both published bumper reports on the subject on Wednesday. This sudden burst of activity illustrates a central point of the Lehman report: the progress of climate change may be slow and hard to quantify but the impact on business can be sharp and sudden. Already, some houses on low-lying land have become uninsurable and unsellable owing to the increased risk of flooding.

Even if skeptics aren't convinced by the science, carbon dioxide is already having a big effect on the political climate. In the short term, the greatest impact on business is likely to come from more stringent regulation….

# An Amazing Consilience, by Victor Niederhoffer

April 16, 2007 | 1 Comment

The Collaborator and I recently had dinner with Louis Gave, one of the three principals of GaveKal, and found ourselves in agreement about almost everything in the world of markets, even though we had reached our conclusions by completely different means. The amazing thing was to find Louis talking about the weaknesses of such things as the Shiller predictive work on returns based upon 10 year averages, the importance of the February 27th decline as the key to a bullish future, the differential between bond yields and earnings price ratios as an upward driver, and the coming under performance in commodity prices.

After we left the meeting, Louis and I crossed emails, with me telling him that the Collab. and I agreed that the smartest thing that kids could do was wait for a big decline in the market and then buy a distant futures contract, or spider, and roll and hold forever. Louis wrote that he planned to buy some long term calls on the Hang Seng next time there was a big decline and invest the billions of ultimate profits in land for the kids.

I wish to say up front that it is embarrassing in a sense to trumpet the agreement of someone widely respected like Louis, who runs a big and important business that has put clients with many hundreds of billions under management with the weather gauge, and myself who is a poster boy for how to take undue risks. And yet, because I like to fan that image I thought I'd take a crack at memorializing some of the things that I know something about, on which our consilience was based. I immediately point out however, that there is no reason to believe that anything I say about macroeconomic policy or Asian markets or the dollar has any positive or predictive information content, and I am truly embarrassed to find myself in agreement with Louis based on my views on those specific matters (as opposed to the one or two things I do know about) since as far as I can tell Louis and his team have done about as much good as the weekly financial columnist has done harm.

Gavekal produced an ad hoc comment dated April 4th named 'Why we remain bullish', in which Louis points to five trends as the cornerstone of his belief. In a previous back and forth on this site with Louis he kindly offered limited availability to our readers for his reports, but I will summarize this particular one here. The backdrop is that he finds that the wisest people he knows agree that they should all have been more bullish during the last 5 years, but now they are worried that prices are too high. He believes however that the trends in the world economy are better than ever now because of globalization, emerging markets finally emerging, a financial revolution becoming established, and montetary policy is now on the right track. As for gloablization he has some nice quantitative work showing that volatility of output in the US has decreased markedly in the past 25 years,and as a consequence corporate profit margins have gone from the lower left to the top right of the chart. He elicits a host of factors ranging from increased trade with Asia, to the movement towards a knowledge based economy.

While I am not knowledgeable enough to appreciate fully the implications of his platform company model, or monetary base adjusted for volatility, we found ourselves toasting each other on the idea that rational expectations is such that there is no reason to believe that bankers and consumers always do the wrong thing. Quite the contrary, they are behaving very rationally considering the enormous increase in wealth that has been generated from increases in asset prices like bonds, stocks, and real estate.Louis has an infinite amount of what seem to me insightful ideas about how interest payments and corporate taxes are much less, and therefore profits have much more mojo in the future. However, as he puts it "most importantly our economy has evolved to a knowledge based economy where one only needs ideas and good people, and from these the returns can be enormous."

Next they cover the emergence of emerging markets with many beautiful charts about industry, agriculture, education, investments, expressways, and productivity in China. For obvious reasons I am not competent to comment on the predictive accuracy of such charts.

Next, the financial revolution. He has a startling chart showing that mortgages as a % of real estate values are very low all over the world except in the U.S. and the Netherlands, and he points out that if the trends to increased mortgage in various countries continues, unfathomable spending and better deployment of assets will be released. It is in the area of the financial revolution that Louis comes up with the shocking statement that the February 27th decline is a key to his bullishness. He believes that when huge declines like this are quickly reversed it shows the resilience of the financial system. My contribution to this is the tested assertion that after startling declines, anything that looks like it has the slightest similarity to the preconditions of the past decline is a high expectation relative to risk buy.

I believe that in one day, the February 27th decline duplicated the whole pusillanimity of the spring of 2006, the summer of 2002, and yes, the aftermath of October 19th, 1987 after which all big Friday declines led to to so much more gain on the subsequent Monday than the decline of the terrible day itself.

Louis has a nice table of the kinds of things that chronic bears have predicted during the last five years, and shows that they have happened and the market has withstood them with aplomb. I would point out what we have shown in our bear corner often that what has happened negatively in the past 10 years, has happened in the previous 100, in each of the years, and that conditions are not any more negative now than during the Dimson 10,000 fold return century.

Amazingly Louis had come to his conclusions about the resilience of returns and the case for long term bullishness without reading the Dimson work, which probably is a plus since the great triumvirate in my opinion suffers from a certain belief system all too common in France as opposed to the entrepreneurial ethos in Siliconia.

Another plank in the Louis case for bullishness is that we are going to have lower inflation in the future. He has many simple facts and tables about the trade balance and the hypotenuse of, to me a G and S, nature that support his point. I always find it amazing that with all the brain power devoted to fixed income  anyone could believe that they could come up with a better forecast of where inflation could be than the long term bond rate, which gives a 3% or so expected real return and at 4.7 % is consistent with 2% a year inflation.

A final trend that follows from this in the Gavekal analysis is that because bond yields are so much lower than earnings yield, that all sorts of liquidity will come in to buy stocks from such sorts as private equity funds, and pension funds. Our own work on the differential which is posted in our quantification of the Fed model with actual prospective forecasts of e/p as the basis, shows that during times like these when the forecasted earnings yield (without regard to its accuracy) is a few % over the bond yield, the expected rate of return on stocks is some 20% a year, with an incredibly high accuracy. Amazingly again, Louis had come to the same conclusion based on qualitative analysis of such things as the actual level of savings in the US ("Why do we have all the big mutual funds, the Fidelities, the Alliance capitals, and the Vanguards in the US if the US isn't saving").

I cannot begin to do justice to the Gavekal case for bullishness except to say that I would consider his book "The End is not nigh" one of the 6 most important and helpful books for the investor to own, and that in the course of a rather encompassing career of over 50 years on Wall Street, and in the groves of academia, I have not come across any individual, (except for my friend from Mount Lucas), with sounder insights into the forces that shape investment returns.

Long bonds are not the only markets with implicit inflation forecast. The currency markets clearly have a relative inflation expectation as do the gold market. I would posit that gold, which has risen \$140 since helicopter Ben became chair (that would be up at a 13% annual rate), or the dollar index which has fallen at a 7% rate, are telling us something about long term inflation expectations that are in opposition to long bonds.

This is not to say that higher inflation rates are clearly bearish, or that bonds are necessarily wrong, but to point out that the long bond's 2% expectation, which is consistent with the Fed's expectation, may be standing in opposition to other forecasts which may prove more accurate. In fact gold at \$680 up from \$20.67 in 1900 computes to a 3.3% compounded inflation rate. At the peak in 1980, gold implied a compounded rate closer to 5%. Gold has been rising at a 13% rate since the new chair, and I do not believe this should be ignored. I posit that a new high in gold would complicate the Fed's calculations.

In addition, momentum screens currently are being dominated by inflationary and recessionary sectors, and arbs (which tend to rise during market stress, because of their fixed income, like return profiles).

## George Zachar remarks:

The Dallas Fed agrees with the Specs and GaveKal,

As knowledge spreads in our globalizing economy, it unleashes powerful forces that redefine fundamental economic relationships.

In one industry after another, lower transportation and communication costs have knit together far-flung companies and workers, expanding local markets into worldwide ones.

A more integrated global economy generates new competition, identified since the days of Adam Smith as a key to delivering more output at lower prices.

Larger markets bolster incentives for innovation, the wellspring of economic progress. They open new possibilities for specialization, which channels factors of production to their most efficient uses.

Globalization boosts foreign investment by freeing scarce capital to seek its highest return anywhere in the world. Companies can find and manage a broader range of inputs, the raw materials for more efficient production methods.

Where fixed costs are high and marginal costs low, globalization extends economies of scale to output levels beyond the scope of national markets. The connection of competitors and capital from all parts of the world reduces entry barriers in high fixed-cost industries, eroding the monopoly power that keeps prices high.

Knowledge and technology spread more readily, loosening the restraints that shackle progress. Production becomes more efficient…

## From Russell Sears:

This may be blasphemous for the gold bugs, but:

Gold is a physical commodity, which historically has implied wealth. When my maternal forefathers fled Russia, invading northern Finland, with as much gold as they could carry, it was due to inflation expectations of currency. Now when gold is hoarded, it is more likely due to the bling factor, not that US currency can't be trusted due to the inflation expectations.

In fact I would argue the opposite. The last 25 years have trained most to think the feds will always be pushing inflation down on the whole. But this causes pockets of inflation and deflation to spring up. Gold, like most items purchased to advertise your wealth, is experiencing high inflation, as the pool of wealth has spread. Gold is still a hedge for the wealthiest against inflation expectations, but not the economy as a whole.

Rather than a sign of coming Armageddon, it's a sign of spreading capitalism.

One minor point after a mere six weeks cogitation, is that it seems like quite a contradiction to believe that consumers act rationally here but that the public always acts wrong where stock purchases and sales are concerned. Especially when one considers that stock buyers are likely to be relatively sophisticated individuals compared to the man on the street with a credit card.

I suggest that they will act more or less like sheep in both cases. Perhaps the difference with stocks is that someone may try to deliberately mislead them rather than participate in the shared risk of them overspending.

# Spanish Sub Prime, from Nigel Davies

The situation in Spain puts the US housing market into perspective. There is plenty of sub-prime lending plus steep sales taxes (6% plus) which would exacerbate any problems if they have an economic downturn.

"The chill winds of the home loan crisis in the US are having a sobering effect in Spain, where mortgage lending and house prices have risen faster than anywhere else in continental Europe.

"As with the US, low interest rates and a buoyant job market have made home ownership affordable to lower income groups in Spain. Fierce competition has driven some Spanish banks into the riskier segments of the market. In particular, Spain's 4m-strong immigrant population - young, low-skilled and with no credit history in Spain - have proved to be too large and tempting a group to ignore. Mortgage brokers who specialise in arranging loans for immigrants are doing a roaring trade."

## John Floyd writes:

Spain has gotten itself in a difficult situation now that requires a lot to maintain current stability. The Spanish economy is roughly \$1 trillion versus Germany at roughly \$ 2.7 trillion. Spain's current account deficit is running around 8% of GDP and the country has lost about 35% in competitiveness to Germany over the past few years. The funding on the capital account side has come in part from direct investments and debt as the sovereign and corporate are in many cases highly rated and bought by pension funds despite tight spreads. The government fiscal accounts are in good shape with a surplus of 2%.

The fact the Spain is somewhat pinned by monetary, fiscal, and currency policy constraints makes this a difficult predicament.

The market currently has a very benign scenario priced with Spanish sovereign credit in the 5 and 10 year trading about 5 basis points over Germany. The heavily bank weighted stock index has also been doing well.

It is unclear what the trigger is but the sustainability of the situation seems tenuous at best. The likely sequence of events may be a weakening economy leads to strains on the fiscal accounts that lead to downgrades of the debt and political noise.

Opportunities to investigate seem to be the stocks that may be heavily levered to the housing market and credit spread widening.

# Time and Money, from Nigel Davies

In the days of non-convertible rubles, Western chess players visiting the former Soviet Union were given a fistful of rubles as 'pocket money' and maybe a lot more in prize money if they did well in the tournament. This presented a unique problem: you had a lot of money, not much to spend it on and very limited time in which to spend it.

The electric samovar which adorns one of my shelves is from this time. I didn't particular want it and it has never been plugged in. But what else can one do when the tennis racquets were a bit on the heavy side and several tonnes of cheese would never make it through customs. Perhaps Larry Christiansen had the best idea, after a great result in the Moscow Interzonal he went to one of the best restaurants in town and bought dinner for everyone in the place.

This experience may seem surreal but I think there's a clear analogy. In life itself any prize money has a time limit of when you can spend it, and as far as we know there's nothing we can buy which will be allowed in by the customs officials at the pearly gates. Give it to the kids? It seems that kids who get their parents' money but not their time, don't seem to lead productive and happy lives. So how should we play it?

Money is a kind of energy which needs to be transmuted, the two main limitations being the extent of our personal freedom and the time we have to do it. Money can also be converted into time, say with labor saving devices and good health care. But it is not in itself a thing of permanent value; it has to be traded.

Thus everyone is a trader whether they like it or not. Refuse to trade and your life and any money you have withers away and will be wasted. And this is why I keep the electric samovar, it reminds that there's limited time in which to trade, exchange and transmute.

# Deception in the Market/Games, from Dean Davis

I spent some time reviewing the DS site and the discussions of deception. I did this after noting that the upcoming featured article on Wikipedia is a piece on one of the most amazing deceptions in the history of chess, "The Turk." Apparently many of its age were drawn in by the fake computer/machine, including Charles Babbage, Fredrick the Great, Catherine the Great, Edgar Allan Poe, Benjamin Franklin, and Napoleon Bonaparte. The ruse was made all the more credible by the construction that allowed the cynic to look through the cabinet and the fact that a Hungarian grandee, Wolfgang von Kempelen, was its creator and sponsor. There were vocal critics, however, the machine continued to attract attention as long as it remained on display in Europe.

The Turk was purchased by Maelzel and brought to America, which allowed Poe to create an account. It is interesting to note the skepticism and fascination in the following passage by Poe:

"What shall we think of a machine which can not only accomplish all this, but actually print off its elaborate results, when obtained, without the slightest intervention of the intellect of man? It will, perhaps, be said, in reply, that a machine such as we have described is altogether above comparison with the Chess-Player of Maelzel. By no means–it is altogether beneath it–that is to say provided we assume (what should never for a moment be assumed) that the Chess-Player is a pure machine, and performs its operations without any immediate human agency. Arithmetical or algebraical calculations are, from their very nature, fixed and determinate. Certain data being given, certain results necessarily and inevitably follow. These results have dependence upon nothing, and are influenced by nothing but the data originally given. And the question to be solved proceeds, or should proceed, to its final determination, by a succession of unerring steps liable to no change, and subject to no modification."

How many times do market operators take for granted that some function of the market is beyond being gamed, a mere logical extension arising from "certain data" and the ensuing calculation? Might the artifice we see be constructed to allow for examination, but concealing the kernel of deception? Might sponsorship of the esteemed be the final cog that turns the deception to its highest degree?

I saw many of the items at work in the late 90s in the OTC market as large bids or offers were flashed by proprietary traders on Instinet creating the perception that a natural buyer/seller was available in size. The ensuing stampede would generate the desired profit courtesy of the deception.

A book has been written about the history of the Turk. The idea of human intervention in 'machine' decisions was echoed by Kasparov's 'hand of god' accusations during his match with Deep Blue. But now the focus is on humans receiving machine help, signifying that there's been a turning point during the last decade.

Turk in its modern incarnation is somewhere on 42nd street with Pillsbury playing inside it and another checker midget champion. I believe I may have played against it in the 42nd street freak shop that Larry Ritter wrote about in some of his NY stories, next to a great former pitcher.

## From Alan Millhone:

Was this the checker playing automaton that was at Eden's old Musee? 'Ajeeb' was another one that appeared for some years at Coney Island and you played against it for a dime a game. Samuel Gonotsky reportedly played inside of 'Ajeeb' for some time as well as other checker players. Pillsbury was a terrific 'blindfold' chess & checker player. Branch Rickey loved checkers as well as Christy Matthewson. You can find a little information on 'Ajeeb' in William T. Call's long out of print Vocabulary of Checkers. The art of playing both games 'blindfolded' is another interesting story.

I quote Mr. Call on page 12 of Vocabulary of Checkers. He describes "automaton" as follows:

A lay figure that apparently plays the game mechanically, the moving arm being operated by- but the ethics of the pastime forbid details, because of the harmless pleasure the public finds in telling how it is probably done. The impassive attendant, when pressed for an explanation, gives rapid vent to something like the following: 'The board is sensitized by that the move you make operates a corresponding change in the power of the piece controlling the square reflecting the correct reply.' Ajeeb, Mazam, Ali, and Akimo are the names of some famous automatons.

Recently Durgin's Single Corner, by E.A. Durgin 1894 was sold on eBay for \$13,000.00 becaue this little book belonged to Baseball great Christy Matthewson and he signed his name inside of the book showing that it was his.

Checker's is deep in history and dates back to the Egyptians.

# The Costanza Doctrine, from Nigel Davies

This has been used of late in a political context, but the Costanza Doctrine (taken from a Seinfeld episode in which George Constanza temporarily improved his fortunes by doing the opposite of what his instincts told him) would seem to offer hope to thousands of losing traders. The trick would seem to be to buy when you feel that knot of fear in the pit of your stomach, or sell when you feel the joy and excitement of a trade going your way.

George:

"Why did it all turn out like this for me? I had so much promise. I was personable. I was bright. Oh, maybe not academically speaking, but I was perceptive. I always know when someone's uncomfortable at a party. It all became very clear to me sitting out there today, that every decision I've ever made in my entire life has been wrong. My life is the complete opposite of everything I want it to be. Every instinct I have in every aspect of life, be it something to wear, something to eat… It's always wrong."

Jerry:

"If every instinct you have is wrong, then the opposite would have to be right."

There is a twist to this. In the markets, and in life, there is an asymmetry of some sort that throws this equation off. How it works in life will take some thought. But in markets, long is not the exact opposite of short.

## From Kevin Depew:

A funny application of the Costanza Doctrine (pre-Seinfeld) appeared in the movie "Let It Ride," which may be the closest the movies have come to real-life racetrack bettors in action. The main character, played by Richard Dreyfuss, is a degenerate gambler/loser who one afternoon mysteriously begins winning. (That the notion of winning at the track would be considered a) mysterious, and/or b) noteworthy enough for a film or book, is itself a pretty hilarious inside joke.) Anyway, in the middle of his winning streak he decides he's not even going to handicap the next race and instead walks around the track asking various degenerate gambler acquaintances of his who they like. Whichever horse they name, he scratches off the program and eliminates from contention.

When he gets to the one horse that hasn't been named, he lets his winnings ride on the unwanted horse with predictable winning results. As an aside, Robbie Coltrane has a nice turn as a dour teller. Also worth noting, the hatred emanating from his fellow degenerate gambler "friends" as his winning streak grows; everyone hates a winner; everyone loves a loser.

Interestingly, last night on the Black Donnellys (clearly, I'm watching way too much television these days), two of the Donnelly brothers are at the OTB to place a bet and hopefully recapture some money they owe to a crime boss. The "expert," Kevin, (a fictional character who nevertheless I am convinced is a direct blood relative of mine) can't decide between two horses. After much prodding from his brother, Tommy, he chooses one rather indecisively. Naturally, Tommy bets the one Kevin didn't choose, with predictable winning results.

By the way, the Black Donnellys is not a good show. The main character, Tommy, seems to have modeled his mannerisms on Tony Soprano, and the Irish stereotypes run for a full 47 minutes, laddie; may misfortune follow you the rest of your life, and never catch up. This may sounds strange, but I think I watch the show because Eisenberg's Sandwich Shop is one of the locations for filming.

One of the first things taught in a first-semester computer class is that the opposite of > is not < , but rather < or = . This applies to markets as well. The opposite of "long" is not "short," but rather "short" or "flat."

# The Rise and Rise, from Nigel Davies

Visiting the Financial Times site today a pop up poll appeared asking me whether I thought a preemptive nuclear strike against Iran was a good idea. I decided to mull it over whilst I finished my pizza and meanwhile recalled the Peter Cook film, The Rise and Rise of Michael Rimmer.

This 1970 movie fairly accurately predicted the rise of a new style of prime minister (Tony Blair for example). In fact Rimmer became absolute dictator of the UK. The ploy he used to gain absolute power was to give people a choice on everything. They could vote on all the major issues of the day by pushing a button. Eventually they got so tired of this that everyone was happy just to let Rimmer take care of it.

In the case of these online polls I wonder if the movie was equally predictive, the danger not being that people will hand over their democratic rights, but rather they will vote the way they think they should on matters of such importance, and this in turn will influence ever more populist politicians.

There also seems to be an interesting paradox at work here. Increasing the amount of information and choice may actually reduce thinking and cause a greater reliance on memes and heuristics. There seems to be a clear application to trading here: information overload.

# Note Taking by Movie Assassins, from Nigel Davies

I couldn’t help but notice a striking similarity between the note taking of assassins from two different moves, Harlen Maguire (Road to Perdition) and Elle Driver (Kill Bill). They liked to get their facts straight. Winston Wolf (Pulp Fiction) was similar, but he was a ‘problem solver’ rather than an assassin.

Taking notes during the post mortems of my chess games is something I learned from International Master Danny Kopec. No matter how smart you think you are, important lines get forgotten if you don’t write them down immediately after the game. And there was a time when I kept a diary too.

Of course these excellent habits are difficult to keep up over a long period of time, there tends to be a gradual erosion of the habits that got us there when comfort sets in. And this is the beginning of the end.

# Talking Whilst Playing, from Nigel Davies

A lot of players get nervous when they play and like to defuse the tension by talking. I tend to sit at the board just to avoid this; it's very distracting.

This reminds me of a story about a somewhat insecure Romanian GM I'll just call George. He used to get up all the time and ask colleagues what they thought about his position.

What do you do if you're asked? One colleague wondered: "You're completely lost! Haven't you seen the latest Informator?" I'm not sure whether or not he actually used this on George.

Trading also needs focus, but in my experience it's not quite as intense as a chess game. There is lots of watching and waiting. Even so, I don't like to talk, but I found that email isn't a problem.

# If the Water is Clear, No Fish Will Live There, from Nigel Davies

More from the Hagakore. It's an idea that has been echoed by the chair, and also in Saveilly Tartakover's "obvious therefore dubious, dubious therefore playable." If moves and trades look too good to be true they probably are. The reason being that an unskilled player can also find them.

So the water should be at least a little murky, but then where does this leave our z-scores?

"I hear that some samurai is preaching thrift. He is fussy and fastidious and feminine with his preaching. This is not desirable.

"It sometimes happens that, if the water is too clear, then the fish will no longer dwell there. When there are algae and water plants, fish can safely grow by hiding behind the plants. As long as people overlook matters, then inferiors can, without any fear, lead an easy and pleasant life. You must know this as far as your personal conduct is concerned.

# A Trading Query, from Kevin Bryant

March 29, 2007 | 1 Comment

I live in the UK. I am looking to do a bit of intraday trading and would like recommendations on the best online trading systems — execution speed and accuracy, charting software, price. I am looking to deal primarily in commodities but may also trade equities and currencies.

## Nigel Davies responds:

If you want pictures then one possibility is the software that comes with a Deal4Free account. You can even have live Point & Figure charts there now. It can also do backtesting.

Many UK futures brokerages use J-Trader, which has an intuitive interface and works just fine. I tend to put the resizeable 'Dome' from J-Trader on top of the Deal4Free window, like the way Tuco constructed his gun in The Good, the Bad and the Ugly.

## Vince Andres remarks:

Instead of a product name, I propose a few criteria:

- Controllable, easy to master
- Complete, full-featured
- Proprietary, or open-source
- Cost
- Technical support
- Safety/respectability: tool developed by one person or 100?
- Number of users: 500 or 50,000?
- Independent and objective, or a broker tool
- Customizable
- Confidentiality: can the provider access your algorithms?

This list is far from complete.