Statistics Question

February 28, 2021 | Leave a Comment

Barry  writes:

Hello Victor,

Hope all is well. I have been enjoying the YouTube videos you have been putting out.

I was wondering if the rules that apply to normal statistical tests should be as constrained when applied for financial data?

For example when comparing the mean returns of weeks following drops greater than 30% in something like bitcoin compared with it's weekly returns excluding those weeks if a tests value of 20% would be consistent with random as one might conclude with most other sciences or is that an indicator there could be something more meaningful to investigate?

Victor Niederhoffer writes:

Thats a very good question  and  related to it is the supposition that a 20% prob of chance occurrence  mite be more p reductive of  a regularity in the future than a 5%  chance  statistics    I'm posting your query to the spec list since it doesn't  contain any meals for a day but is a meal for a life time.



 Hi Victor,

I'm wondering if you have studied bitcoin at all? Or do you only consider a market once its very liquid?

Victor Niederhoffer writes: 

Seems ready to implode.

Barry Gitarts writes: 

Based on what?

Victor Niederhoffer writes: 

Crooks are using it.

Barry Gitarts writes: 

Isn't that the case with all money?

Victor Niederhoffer writes: 

It will be shut down because it competes with things the government like to monopolize.

Barry Gitarts replies:

That was a fear earlier, however the senators, agency heads and Bernanke all seem to think it serves a purpose and are afraid to stifle the innovation:

Ultimately isn't the government just run by short sighted politicians who just want to be reelected? Any politician who stands up against bitcoin or any internet application stands the risk of being "Ubered" (see this article).

Bitcoin does seem to be a disruptor for traditional banking, but so was the internet for the post office, newspapers, tv and retail, that only grew the internet not kill it.

This reminds me of a half joking quote by Russian entrepreneur: "If you create a business that disrupts big business in Russia they will kill you, in America they buy your business."

Victor Niederhoffer writes:

I remember Peter Theil the founder of PayPal
saying that if they knew what he was doing, they would have shut him
down. As it is, only the Lousiana Attorney General was fast enough out
of the box to try to shut Paypal down. 

Richard Owen writes: 

Like all good bubbles, there is a legitimate story at hand. Even with Tulips there was a valid story of rarity that then seemed as psychologically permanent as does now the rarity and desirability of a Van Gogh.

Bitcoin is a bit like the currency of an island entrepot whose domestic economy is tiny and whose export base is mainly composed of criminality and laundering and for which the currency of the island is disproportionately held as wealth of a group of island oligarchs [I suspect he has sold some and someone might correct, but it appeared superficially that the founder's bitcoin may have a billion plus market value?]. Many accidental paper fortunes are held by bitcoin miners: will they stand passive in the face of volatility?

Of the three social gatherings I attended Weds to Sat of last week, all featured discussion of bitcoin and at one - of the type featuring participants who, to listen to their narrative over time, would appear as genius and never to have taken a loss - the non-documented boastage of coups won and utmost sagacity shown in the BTC market. Mr Thiel is smart: he is financing the pick and shovel providers, not running a large position in coin.

So yes, why not $10k BTC, but also, why?

Henrik Andersson writes: 

 Richard, this is clearly the mainstream/consensus view - bubble. The contrarian trade is not always right (far from it), but was is clear is that many commentators don't understand the many faces of bitcoin. What is also clear is that a good investment decision (long term, not trading) can be done on the premise that the highest probability is that the ultimate value is zero. The question is what probability do you put to the USD 10k scenario. "Nothing is more powerful than an idea whose time has come" Victor Hugo.

Richard Owen writes: 

 You make very good points, and I am sure you know all sides of the argument well. If you are long bitcoins I hope very much it is for a large and successful profit. Please manage your risk well. I am not smart enough to assign a probability to $10k. The thoughts are offered without prejudice and are an honest sampling of my experiences as have occurred. I have no position either way and should be distrusted or discredited on that basis. There may be commentary that it is a bubble and my thoughts or analogies may be derivative and unoriginal. The price is possibly also a form of consensus and that is that each BTC is worth a bunch of money, and increasing. As many have gone bankrupt shorting bubbles as being long. 

anonymous writes:

I recall the great Jim Rogers saying that Hysteria is the first thing to look for, but one still needs to pinpoint a reason to go against it. The kind of examples he gives are buying stocks in country's whose stock markets have been closed, buying tea plantations when the price of tea has plummeted etc. Bitcoin? Might just have to let it play its course. I think its a bad joke, but even I must admit it did survive the 50% drop recently before this latest headline grabbing advance. Anyway, this is just my two cents and I have no interest in even attempting to try and speculate with or against it. 

Jan Peter-Jannsen writes: 

Bitcoin as a technology is superb. Bitcoin as a currency is questionable. Bitcoin as an investment is a bad bet.

A great strength of Bitcoin is that it is open source. Any experts can validate the code, and so far there seems to be no flaws. The crypto-curency works!

But cannot open source also be a great weakness? Anyone can copy the code, improve it, and make an even better alternative to Bitcoin. Is there any reason to stick to Bitcoin if and when that happens? Bitcoin is volatile, no prices are quoted in Bitcoins and very few have both their income and expenses in it. Those who use Bitcoin need to exchange to and from other currencies, so why not switch to another digital currency?

In terms of investment I believe it is a bubble. The supply is very low; many coins have been lost and the majority of coins are probably in the hands of the founders. I guess they are selling at the moment, but at a low enough speed to keep the bubble growing. In terms of demand; everyone talks about it these days.

In the coming years I predict new payment systems to arise based on technology pioneered by Bitcoin. But Bitcoin itself will soon be forgotten.



 With AAPL down almost 12% because of iphone sales being less then expected sales and gross margins on iPhone coming down one has to wonder if the management will be thrown into a tailspin trying to satisfy expectations.

On a conference call with analysts, CEO Tim Cook was unapologetic about selling less-expensive items. He said *the company's best measure of success is whether customers love Apple products*. Noting that Apple sold 10 iOS devices per second last quarter, Cook said Apple hit the mark.

"You're going to hear a lot of impressive numbers on this call, but that's not the only way we measure success," Cook said. "We're unwilling to cut corners to *deliver the best experience in the world.*"

Its nice to know that management is thinking about the long term and still has the great customer centric culture that made it great, not just trying to satisfy wall st short term expectations, perhaps that is why they keep such a large reserve of cash so they don't need the capital markets when a great opportunity is present.

The traders and analysts are seeing blood on the street because margins and sales are less then expected on a current product, but if stocks are for the long term does it really matter what the current product does in a particular quarter or what is the company vision for creating a customer? Perhaps this dichotomy is the opportunities Henry Clews spoke of when he talked about the old men taking their canes out.



 So the lines for gas around NYC continue. Few stations have gas and those that do quickly run out. However gas is available. People are selling on craigslist for $15 per gallon. A guy near me brings a truck from upstate with gas selling for $9 per gallon. We pay up to avoid the time of searching for stations with gas and then waiting in line.

I imagine this is what life in the Soviet Union was like, where the price at the store was not allowed to rise creating shortages and lines in order to buy something as simple as bread, or you could pay a premium on the black market for a market value created by lack of competition due to lack of incentive.

I'm sure if the politicians removed the price gouging laws, gas would be readily available at the pump. It might cost more in the short term, but at least you can get it if you need it.

Would a politician be more popular with gas at the pump being more expensive and available or low priced with lack of supply?



 With the real estate market improving, stocks up, bonds up and unemployment declining (small but better then increasing), why did the FED decide to go forward with an unprecedented unlimited QE program?

My speculation is it's related to recent animosity of the republicans toward the FED and its future existence. By driving markets higher and driving mortgage rates lower via directly buying 1/3rd of the new issue MBS each month, the FED is helping to ensure Obama stays for a second term, helping to further diminish the threat of the republican party on the FED's autonomy and power. With no fiscal stimulus coming from the democrats they will need the FED more then the republicans. So perhaps the real reason for QE unlimited is self preservation.



 I was thinking that the single most important factor in the success of a company is the management. That is why it seems Buffett does a big disservice to investors when he tells them he looks for companies that any fool can run. A fool can run any great company into the ground, even with the most pristine of balance sheets and great management can turnaround a company with even the ugliest balance sheet, i.e Apple had 30 days of cash left when Steve Jobs took over in the late 90s. If stocks are for the long term, there is nothing more forward looking then management's vision for innovation and creating customers.



 I have recently read Peter Drucker's 5 Most Important Questions You Will Ever Ask About Your Organization, which is based on Drucker's work on helping non profits succeed.

One can't help but think how for profit organizations thrive following similar processes. Would for profit organization be more successful if the mission was not to make money but money was the funding source and market validation of the organizations mission?

In Management Revised Drucker saw companies as organs of society who needed to make a profit because it would do no good to the consumer if the company went out of business and that most executives were failures in pointing this fact out to the public.

Is the only difference between the successful non profit and for profit the funding source for the organization's mission?



I wonder if the top athletes of today would still be the top athletes of today if the rules of sport changed as often as they do in government? The amount of energy needed to adapt to changing rules seem to me would detract from perfecting around set rules.



 Reading through Linchpin by Seth Godin advocates getting away from the quantified.

We measure the quantified because we can. But we should create the unquantified because it's so rare. If you can quantify it, then probably someone before you figured out a why to grind it out. And if you can grind it out, someone can grind it out cheaper than you can. On the other hand, the really valuable stuff, the stuff we pay a lot for, is unquantified. Things like creating joy or security or happiness. No easy measurements for those, thus they are art, and art is always worth more than the predicted.

Henry Gifford comments:

Similar situation with how much energy a boiler takes to heat a buildng. The quantifiable is the least important– the % efficiency while the boiler is operating (% of energy in fuel not going up the chimney, but going into heating the building).

The second most important thing is quantifiable enough to have % numbers on it, but those numbers are hopelessly inaccurate– the annual % of the energy in the fuel not going up the chimney (different from above because of the heat going up the chimney from a boiler that is hot, but not firing). Most of this loss can be avoided, but nobody bothers because the % ratings don't change with improvement.

The most important thing is so hard to quantify there is not even a unit for it– how unevenly the building is heated. The chair helped me put some units on this once, but otherwise, I have never even heard it discussed in my field. Uneven heating means overheating the whole building to satisfy the coldest room, with the overheating costing much more energy than the factors mentioned above.

So, in my field, everyone is running around measuring the least important factor, while the most important factors are not even discussed.

One solution is to focus on solving the problems, (short chimney, thermostat in every room) without being able to predict the resulting saving. But, without prediction, it's a very hard sell. Good for one's own portfolio, harder with other people's portfolios.

Peter Grieve adds:

When people are making purchasing decisions in areas in which they are not expert, there is a strong tendency to reduce things to a few numbers. These numbers are easy to compare, but present a grossly simplified picture. The simplest machine has myriad degrees of freedom, and so does the operating environment. The assessment of the interaction of these two cannot be crammed into four of five numbers.

This is especially true in government procurement, for example weapons systems. The M4A1 carbine is supposed to have an effective range of 300m. I have done a lot of shooting with the civilian version of this weapon, and I can assure you that this one number does not capture much of the essence of the range of the machine. On a hot or cold day? Shot by a master or a bumbler? Standing or prone? Against armored or unarmored targets? Shooting from sunlight or shade?

But this number is easy to compare with corresponding single numbers of other weapons.
Or take chess ratings. Chess strength is a very complicated thing, which cannot be reduced to one number. There are cases in top level chess in which A does well against B, B does well against C, and C does well against A (Nigel D. can help with examples here). Single real numbers are linearly ordered, and no three of them can satisfy A>B>C>A. Single real numbers are not adequate to encapsulate chess strength in its entirety.



If one's model is saying that in the short term (next two quarters) the S&P is overvalued but over the next year it's undervalued, what does one do? Is it a matter of one's preference to trading over investing, or should one get long at the risk the market will realize the same thing and ignore the next two quarters of expectations? Although we like to say the market is a discounting mechanism, it seems very often to be discounting the very near future.



The bond move the last three days is down three full handles from 117 3/4 to 114 3/4. That's the greatest three day move down before a FOMC meeting in history, I believe (my data cover only the last 94 FOMC meetings from 1996). The closest contender was March 17, 2003 where a decline of 2 3/4 occurred. The bond market must not like price controls.

Anatoly Veltman writes:

Both the up-swing (to 12/4 118′22 high) and the down-swing (to 12/10 114′12 low) were on reduced Open Interest, allowing me to play reversals with greater impunity. O.I. tipped covering: it meant that fewer stop-loss orders have remained resting; a factor that substantially cushioned risk for the near-term value-picker. More interesting, both reversal trades were obvious to me in real-time; and the slight O.I. data lag was not hindrance.

The top was a double-top in price of the 10-year (and a secondary top in all Treasuries, from 2-30year); while O.I. displayed Bearish Divergence.

The ensuing chart decline was symmetrical to November's chart rally (the chart “symmetry play” piqued Victor’s interest on 12/4), and pointed to low-volume, thin chart space all the way down into the 114 handle. At the minute 114′12 traded, for 10 consecutive futures sessions O.I. cumulatively slid over 100,000 lots (10% of the exchange total)!

So, .25 on Fed Funds and .50 at the discount window — or any other combination, plus “all-important” Paragraph Three FOMC mumbling — the trade here is technically solid. My analysis is performed discretionarily in real-time; I suspect 21-century black boxes execute these trades quite ahead of me, unfortunately!

Carlos Nikros adds:

I suspect that lots of fixed income securities just became substantially longer in duration last week, as well, necessitating the usual hedging and pruning.

Andrea Ravano observes:

I think the fear factor that pushed bond prices to their limit is fading. If we consider yield moves instead of prices we get the following picture :

Mat./1week ago/Yesterday/Difference

2 Yr. 2.87 3.20 +0.33

5 Yr. 3.28 3.60 +0.32

10Yr 3.93 4.18 +0.25

The data along with the collapsing spread between Tips and vanilla Treasuries points to a "normalisation" of the bond market to pre-subprime panic levels.Which, of course, does not mean one should not be worrying about inflation in the long run, but short term wise, the move in bonds might be explained with year end book squaring and the end of the worst in the sell off of the stock autumn bear market move.

Alan Millhone remarks:

I wonder how many other UBS types will fall victim to the subprime debacle before the dust finally settles? May be a long and cold winter for builders/investors/developers. Investors look to the Feds to step in to stabilize. Fed intervention to me looks like a form of price controls, much like price freezes and rationing in the Second World War.

Victor Niederhoffer offers a postscript:

One can now see what the purpose of the four point drop in bonds in the previous three days before the Open Market meeting was: to vigilantly control the Governors from overly inflationary activities.


Barry Gitarts adds:

The equity sell-off today at 2:15 was almost expected to happen as it did when the Fed cut rates last time. What's unexpected was that the market kept going down and did not stage a turnaround at 2:30 - 3:00 pm. Maybe it became too obvious and the daytraders with their one hole located at 4:00 pm got cornered. Maybe the market will resume its upward course tomorrow after feeding the big fish today.



POTUSB!ll Cl!nton popped his head into a meeting with my wife last week. He was in town campaigning for H!llary and had some extra time, so he walked around downtown Iowa City. He popped into a coffee shop and there were a few library employees in there. They told B!ll to come to the library for a tour. Jennie, whose job is to set up job shadows for high school students, needed a room to host a big gathering. I'm a board member at the library, so I got her a room there. B!ll wondered why a bunch of high school students weren't in school, so he stuck his head in. Jennie swooned and ended up talking to him for about 15 minutes. She said the first five were uncomfortable because she was so nervous that she couldn't speak, so he just rambled about the architecture at his Presidential Library. She had her camera in her pocket, but was so rattled that she forgot to get a pic. She had always been a fan of his, and after meeting him in person she said that she understands exactly how he attracts the ladies. Apparently the guy just has "it"!

Barry Gitarts adds:

A few months ago I was sitting in the reception at a midtown law firm which had a photo album on the table of B!ll Cl!nton with the principals of the firm. A lady sitting across from me blurts out “I think he is the sexiest man alive!"



Apparently the earnings yield for the S&P 500 12M forward compared to the 10Y bond interest rate is at a 25 year high at a little less than 350 basis points…

Rob Rice objects:

The Fed model is both overly simplistic and frequently wrong as a basis for accurate valuation of equities versus bonds, except during infrequent, cherry-picked points in time. It’s also inappropriately named. Those sound bites will get you every time.

Victor Niederhoffer replies:

The Fed model Laurel and I developed is completely operational, completely predictive, and accurate to an extraordinary sense. It's based on a I/B/E/S operational earnings forecasts contemporaneously made at the beginning of each year as of the time (the same results from Value Line) and has nothing to do with the accuracy of the earnings prediction. It has to do only with the differential, and when the differential is this high, the average returns is about 20% one year forward, and it's been right 10 of the last 10 years.

Barry Gitarts writes: 

CXO Advisory uses a variation
of the Fed Model. According to them the spread
between the S&P E/P and  total inflation is more significant then
using T-notes as the benchmark for S&P forward yield. A possible
interpretation is that most equity investors do not closely track
T-notes as competing investments, and that they instead focus on the
"real earnings yield" of stocks in deciding whether to buy, hold or
This may be the case, but it seems to me the bond market is more forward
looking than the CPI.



I wonder what the New Fed thinks of the recent market action, following their second rate cut and more liquidity injections.



If the Fed hadn't cut this week, wouldn't the stock market continue its natural long term upward drift anyway? Now that they did cut, what are the longer-term implications for equities given the move in commodity markets?



VitaliyIn the long run, the performance of a stock in isolation (ignoring the external environment, i.e. interest rates, risk, inflation) is the product of fundamentals (i.e. earnings and cash flow growth) and valuation ( i.e. P/E, P/CF).

Google and Apple may have great fundamentals: their innovation has led and may continue to lead to high earnings and cash flow growth. But are they good stocks? They may or may not be. But, more importantly, will they be good stocks at any price? No! If I were to follow the above conclusion, that since Google and Apple are great companies they are great stocks at any price, at any valuation – at 50, 500, 5000 times earnings, then I'd walk into an overvaluation trap.

Take a look at eBay in the late 90s: it was a great company (it still is), but it was grossly overvalued. So, if you bought it in the late 90s and held it until today, despite its earnings going up 100-fold, the stock is roughly at the same level it was then. I'd argue few would have the patience and conviction to hold it through the downturn the stock took in the early '00s. Most investing in the stock in the late 90s lost money on it.

One of the biggest mistakes investors make in investing is failing to separate a good company and a good stock. A great company's (fundamental) performance is wiped out by valuation compression. This is the battle of two winds: the tailwind of earnings growth and the headwind of P/E compression.

Also, with a high growth priced appropriately (even to perfection) there is no room for even a small mistake (no margin of safety) left in the valuation - a small disappointment (it doesn't have to be much) will lead to a substantial decline in price. The latest performance of Starbucks and Whole Foods stocks is a great example of being priced for perfection and delivering slightly less-than-perfect results.

This myopia in differentiating between good companies and good stocks is not just limited to wonderful, exciting, larger-than-life (Google comes to mind here), fast-growing internet companies. The bluest of the blue chip stocks, like GE, Coca Cola, Home Depot, Amgen, Johnson and Johnson (and the list goes on) were all great companies that one "had to own" but were terrible (overvalued) stocks in the late 90s. Their earnings have doubled or tripled since but the stocks have not gone anywhere.

I think it was Benjamin Graham who said that "price is what you pay, value is what you get."

Kim Zussman adds:

What are the parameters which make a good company or stock? Here are some good stock categories from the literature:

1. Large five year decline in price (DeBondt and Thaler)
2. Large one year price gain (-large 1 year price decline.) Momentum (Jegadeesh)
3. Small cap stocks (Lakonishok and others)
4. Valuation: Low P/E, P/B, P/cash flow, high dividend yield, and
various concatenations thereof
5. High (low?) short interest
6. Put/call ratio (especially when options orders are placed by grandmas in Serbia)
7. Value line timliness (used to be more timely)
8. Double tops and wiggle bottoms above and below 10 minute panting average

The problem is that they all work sometimes; actually, just often enough to keep people interested in them.

Vitaliy Katsenelson adds:

I spent a good portion of my soon to be published book called, Active Value Investing: Making Money in Range Bound Markets, discussing what constitutes a good company and a good stock. I created the QVG framework (Quality, Valuation, and Growth).

A good company should get high scores on Quality and Growth dimensions. For instance a high quality company will have high return on capital, strong balance sheet, a sustainable competitive advantage, competent, shareholder friendly management, significant free cash flows. A Growth dimension encompasses predictable (high recurring) revenue growth, multiple sources of growth, a nice dividend, etc.

If a company received high scores on Quality and Growth dimensions, for it to be a good a good stock it should pass get a passing grade on Valuation dimension - be undervalued (have a appropriate margin of safety).

As anything in investing this analysis is very subjective, but I find this framework is very beneficial to maintaining a rational head and helps me to stick to an analytical process. 

Steve Leslie comments: 

On June 28th (post number ?p=1834) I mentioned that one year ago, when Google was $350, Vic and Laurel went all-in on the search engine provider. I also remarked that Apple and Garmin were both $50 then. Today GOOG is $550, AAPL $137, GRMN $80.

When one finds a great company with a great product line and great prospects, selling at a reasonable price, it is time to buy. Strike when the iron is hot! And eschew the short-term gain for the much larger pot o' gold that lies at the end of the rainbow.

Charles Pennington responds:

I can find nothing in the original post of Mr. Leslie stating any requirement that the stock be bought at a reasonable price (let alone any definition of what a "reasonable price" would be). The concluding quote was:

".. most importantly the speculator should be willing to hold onto the companies eschewing the quick buck in search of the really big gains that can be achieved through diligence and patience."

I'm sure it was an oversight not to have included some kind of requirement of "reasonable price" in the original message. The vehemence of the reaction is because, I think, the post's assertions were untested, apart from anecdote, and Daily Speculations is supposed to be reserved for ideas that are tested.

An example among many of the way the assertions could be tested is to go back to old issues of magazines, newspapers, etc., and find the companies that were rated at the time as highly admired, and then look at their performance afterwards. If you do this exercise, you might find that highly admired companies do well.

However, it is not at all obvious. Many companies which were once highly admired are not so highly admired now, and their stocks have not done well. Enron, for example, was once highly admired.

Barry Gitarts comments:

Haven’t many value experts said Google has been overvalued since its IPO, and Apple for several years now, however both stocks have significantly outperformed the market.

Driving looking out the rearview vs. the windshield could also be the difference between over and under valued perception.



 I take the subway to work daily. While not the most prestigious means of transportation, it is definitely in my case the most practical, economical, and time saving. I happen to live three subway stops from the beginning of the line.

By the time I catch the subway, it is usually full with no seats available. Sometimes, I am in dire need for a seat to get a little nap, especially if I am caught trading overnight. An hour nap can do wonders in my case.

Out of this need I become more creative about finding this precious vacant seat. Knowing that the previous two subway stops to my own have only two sets of stairs closer to the front end of the train, I started walking all the way to the opposite end in hope that most people will go for the closer compartments. This is in fact the case except oddly enough that the farthest compartment is always packed.

My reasoning in this case is that most people play the same game I do hoping for the precious nap and seat. However, three cars away from the far end seems to be day after day the optimum solution to this game. Now that I choose the optimum car successfully, sometimes I still am not lucky enough to get a seat unless one of the passengers gets off the train.

I start analyzing the passengers’ profiles trying to figure out which ones are likely to get off the train first to sit in his or her place. This is not an easy task but some knowledge of the city and behavior can do the trick. For instance, I stay away from all people over 30 in business suits as chances are that they are headed to my same destination. Once this category is eliminated, I try to eliminate all university students by guesstimating their ages simply because four out of five universities are located downtown (at the end of the line) so the odds are clearly not in my favor there either. I try to spot two age groups. High school students and under since parents most likely prefer to send their kids to nearby schools so it is unlikely that this group will travel all the way downtown for schools. Also, the elderly group is most likely not traveling far either. This whole process usually takes few seconds since I usually get lucky enough to get a seat before we reach the next stop.

This process is very similar to gaming the mistress although I admit it's never this straight forward with her. Incentive, incentive and incentive. I play the market for monetary profits and only profits. I don't care what philosophical reasoning a speculator would give you a la George Soros; the bottom line is that it is all about the monetary reward. It is all about the nap in the case of my subway trip.

I always try to figure the line of least resistance in speculation, the car with the fewest passengers. This is usually the road least followed by the public. In search for prosperity, I have to copper the public play at all times (by going to the opposite end in the case of the subway), but sometimes the simple contrary play is not good enough to win the game. A little tweaking is often needed. In the subway example I had to go to the third car from the opposite end and not the last since some smart passengers figured out the "simple" contrary play by going straight to the last car.

Timing is also a very critical factor and can make all the difference between a win and a loss. In the case of the subway one has to process some information and position oneself accordingly in a few seconds before reaching the following stop. Flexibility is also a key to successful speculation as no fixed system will beat the market forever. In the subway example, my game plan is different on the way back home since a different crowd is taking the subway at that time.

Ever-changing cycles also plays a great role in this game. The last car was full as the public got wiser and I am sure the third will be one day and a new game plan and system will have to be developed.

Knowing who you are playing against is critical to any speculative game as is the case of the passengers' profiles of this subway. An extensive knowledge of the markets you participate in is essential to your success as is a knowledge of the different subway stops and what they represent to different passengers.

I will end this post here as I reached my subway stop and have to vacate my seat for the next player.

Sam Humbert comments:

In my Manhattan years, I'd often give up my seat to a person of gender or age. For me, the psychic pain of sitting whilst a pregnant woman or pensioner is standing outweighs the benefit of sitting down. Often I'd get the fish-eye from my fellow New Yorkers — they were silently thinking "he must be mentally ill." I'd sometimes make eye contact and explain "I'm not originally from New York," and this would calm them.

Craig Mee adds:

Watching commuters pile into the tubes in London, there is sheer brawn! Doors open at the station and boom, some people are fixed on the destination, i.e., empty seats and God help anyone getting in there road. Funnily enough this is usually concentrated to a certain gender. Some people like to try and muscle markets around too!

Chad Humbert adds:

 1. Watch for mothers with small children. Sometimes a child will scurry, and the mother will have to leave her seat to retrieve him. Voila! Open seat!

2. The elderly are often slow. I've found I can often simply beat them to the open seat by walking somewhat faster. If I'm careful, I can make it appear that I passed them inadvertently. "Oh, were you going to sit here? I'm sorry! Do I need to move?" Most of them want to be polite, and they insist that I keep the seat. Copper the elderly.

3. I've found that the handicapped seating rules are rarely enforced, and when they are, it's just a small fine. I pay that fine many times over with the extra trading profits I generate from feeling refreshed after a nice nap.

Yishen Kuik offers:

Mr Saad's comment on how the farthest caboose is not the optimal choice because of gamesmanship, but rather some not so inconvenient caboose reminds me of a well known behavioral finance game.

Ask 100 people in the audience to pick a number between zero and 100. The winner is the one whose number is closest to two thirds of the average.

Eggheads will zero in on zero, but that answer merely demonstrates deductive abilities without canniness.

People with a more limited appreciation of convergent series might pick 33 instead, based on the assumption that the average will be 50. People able to think one more step ahead might pick eleven. People able to think one more step in the convergence series might pick nine, and so on.

The real challenge of the game is to guess the distribution of this gradient of deductive powers among the audience and weight one's answer accordingly.

e.g. If you think half the people in the room will guess 33 and the other half are extremely bright but guileless and will guess zero, you should guess eleven.

So perhaps if the challenge is given in a lecture room at MIT, guess one (zero is pointless because of the likely pot split). If the challenge is given to the general public, guess between ten and fifteen.

Philip Tetlock, whom I'm reading currently, reports that the most common winning answer is thirteen.

Barry Gitarts contributes: 

 Here are a few of my subway gaming experiences as they relate to the market.

Gain an edge by counting - I use the grip mats markers to note where the train doors open when the train stops, so next time I will be standing there well in advance of the train arriving. This prevents others from being the first in the door. This takes several observations, because the train never stops in exactly the same spot, but it’s remarkable how close to the doors you can be. Standing on different parts of the platform to observe which cars are the emptiest helps in figuring out which car you would want to focus on.

Work harder then the next guy and be prepared in advance - Even if you are the first in at your door, there will be others coming into the same car through other doors, competing for the same seats as you, this is why you must start looking for empty seats through the windows as the train is still pulling in so you know exactly which seat you need to go for, instead of walking in, looking around and then going for a seat. Those two seconds are the difference between sitting and standing.

Know the relationships between markets - I find that sometimes, especially during rush hour, it makes sense to take a different train one stop away from your destination so one can catch the transfer one stop before the mob boards.

Capitalize on the public fears long after the threat is gone - Unlike Mr. Saad, in my case the last two cars are the emptiest, because the train I take starts in a more unfriendly part of the city where people wouldn't want to be caught sleeping in the last car, so when the train gets to midtown, every car is packed like sardines except the last two which are near empty.

George Zachar strategizes:  

As someone who sits most of the day in front of screens, my subway priority is not getting a seat but minimizing total transit time. I have a mental map of where the stairs are at my destination, and maneuver to get closest to the doors that will open nearest to my exit route.

Market lesson? Different players have different goals. Absolute or relative return? Style box restriction? etc. 

John Floyd adds: 

 I spent one of my school day summers as a messenger in Manhattan. To increase efficiency I learned the exact subways, waiting positions on platforms for door openings, and the correct cars to place me near an exit that would easiest to get me to my destination. I did this for as many of the routes I traveled as possible.

The numbers of possible routes in terms of subways, exits, etc. are myriad. The proper choice allowed me to be the first off the car and up the stairs, oftentimes placing me right inside the building I needed to reach. This was an added benefit as I avoided the often hot, humid, and crowded streets. I would estimate that this on average increased my efficiency by 20-30% at least. Conversely when I rode my motorcycle across the country I looked at the map once in the morning to get a general idea on the direction I wanted to head and roads I might want to take and then just drove. My efficiency of time probably dropped by 50% but my efficiency of pleasure went up by equal.

When traveling now I try to use the time to read, listen to books on tape, or use the time as a period of thoughtful reflection. I do this mostly because I find it most productive for me given I do not find the sleep comfortable or useful to me in modes of transport. I can understand others find it as a useful battery charger that allows them to be productive later.

So I would extend the logic and say that while the goals –profits, learning, etc., may be the same, the path and methods to getting there may be very different. I think another important point is that one needs to decide and focus on what works best for them, as it may not be the same as what works best for others. 

James Sogi comments:

 We don't have subways here in Hawaii, but I try to find the best time to find uncrowded waves for surfing. The best bet is to take my boat to spots such as the nearby national park that has nice waves, but only with a long walk and even longer paddle which weeds most out. The boat takes me to the front row spot and a short paddle, with refreshments waiting.

The other method is to go right after lunch, but before school is out and before workers get out. That seems to be the old guys’ slot, and usually only one or two old guys like me are left still surfing.

The other odd thing, is that even if its crowded, many in water can't see where and when the wave will form and break. If you calmly paddle to the spot where the wave will form as you see it coming over the horizon before anyone else realizes where or when it will come, you will be right at the right spot as it breaks without paddling and catch the perfect wave with a single stroke without effort at the perfect spot while all the crowd is scrambling around trying to catch the wave in the wrong spot.

This of course takes about 40 years water experience and have obvious market application as well. Study of the bottom, which many in water don't bother looking at, triangulation of shore navigation aids, like palm tree lined up with volcano peak and far point, and timing of the waves and sets all help find the ideal entry point. I guess it’s like standing at the right spot on the subway platform.

Another method if the waves are small, or really big, is to use a big board. All the kids ride short boards and only have one board, so if the waves are mushy they can't catch rides, or if the waves are big, they can't catch rides, and with 12 different boards for each micro category of waves it’s easier to catch the nice ones. So really good equipment helps.

Another method is to exercise and train even when the waves suck, so when the waves come, you are in great shape and can charge while the kooks are gasping for breath. Of course pros like Shane Dorian exercise all day long lifting weights, and after surfing five hours, swim around Tavarua Island twice. Geeze.

There are a million ways to beat the crowd. The last one is move a million miles away. The market still reaches here in about 89 milliseconds. 

Victor Niederhoffer extends:

These posts on how to get a good subway seat are a fine pyrotechnic display of native ingenuity. Presumably many of our readers, in their days as poor shavers, also had to apply these techniques to finding parking spaces, especially if they lived in urban areas and didn't want to pay $50 a day for a garage. What I'd like to ask, however, is how these ingenious delectations could be applied to getting a seat in the market. When someone is forced to get out at an unfavorable price, how do you know it's coming, like on the subway, and how can you take his place at a very favorable position to you? One hint is to study Michael Covel and his gurus.

Allen Gillespie replies:

In my experience, a sign of an open seat in the markets frequently presents itself when everyone sells a stock from news on a single company. A recent example is the retail selloff following SHLD's news — only to have WMT, HD, and retails sales numbers lead the market higher a few days later.

Questions I always try to ask myself in those situations:

1) Is the news company-specific or general?
2) Is the bad news the result of good play by a competitor?
3) Did the valuation make the news appear more important than it really is?
4) Which companies have future catalysts? 

Hany Saad contributes:

A fund manager using a trading system that has been losing for more than three consecutive reporting periods is usually a good bet, especially if the majority of fund managers trading the system fall into the switch trap by moving to a different system (usually a very thorough read of the fund prospectus is necessary in this case). They usually give up on the first system at the exact wrong time when it is on the verge of a big win, falling into what Rob Bacon warned against in his wise words "beware of the switches", leaving a seat wide open for the wise observant player.

The same reason I wager that trend following will make a killing next year with the only reservation being that it should be on the long side. 

Barry Gitarts adds:

I have tried to predict who would get up on the train, but such efforts have usually been futile. Instead I stand ready, knowing that anyone could be the next person to get up and I'll be ready to run for the seat. Of course this works better standing in the part of the car where there are fewer people, since there will be less competition for that seat when someone does get up.

In the market, this is like predicting the next big selloff. I can't predict when it will come, but I can be sure I have sufficient reserves for when the opportunity presents itself. As in the subway, this may work better where it is less crowded, and in stocks/markets with less media/analyst coverage. 



 The Wimbledon Final between Federer and Nadal illustrates the importance of ever changing cycles in sport and the markets. Not only did each set alternate, but the break between the sets was key to a change of fortunes for the players. The first three games of the first set, which Federer won, were fatal for Nadal, as was his inferior stroke production, and how this tired him out in the end. I predict that Nadal will drop out of the top ten within the next two years as his athleticism regresses with old age.

The lessons from this match would all seem to have direct applicability to the markets:

Gravitation: If you looked through every world market as to its performance this year, you'd find the US below about 90% of them. This has been the case for the past three years, and could perhaps indicate that the hatred of the US that permeates the rest of the world carries over to investments, and leaves the US cheap relative to other countries. I hypothesize that there is a gravitational pull from all these other markets to the US.

Palindromic Lesson: People often ask me what I learned from the Palindrome during my 10 years of intimate association, aside from the value of using two cans of tennis balls in a match, being humble about your performance next year, and never admitting to a profit in the past. I would say that his idea that refuted hypotheses are the key to major market moves has much explanatory and predictive power. The most recent refuted hypothesis was that stocks couldn't go up when bonds are down. Last week bonds were down two points and stocks up 2%. Stocks are back to near their all time high, but are not there yet. I hypothesize that they need a refuted hypothesis to climb the last leg.

Death in the Woods: Much too little attention is paid to the death of companies and markets, as a prerequisite to renewed and bounteous growth in the future. A visit to Muir Woods, where fire and wind toppling a tree, leads to a profusion of new growth, from burls, roots, and stragglers, confirms the importance of this theory.

James Tar adds:

During yesterday's match coverage on NBC, there was a videotape comparison of the forehands of Borg and Federer. The strokes are frighteningly similar — the controlled loop backswing, the length and arc of the stroke, the extremely forward contact point, the angle of the racket at contact, and the follow-through just under the left shoulder. Their physiques, too, are almost identical. If you changed the hair and apparel of these players, you might have trouble identifying who was who. The real difference was the racket in each hand.

Borg's forehand was the most feared shot of its day, as is Federer's now. The point is that as technology changes, the foundations of competitive success remain constant. Nadal's strokes are completely different, even inferior. The power he generates is enhanced by the racket he uses. I recently tested the same racket. It does not favor smooth, traditional strokes. The balls flies — everywhere but into the court. Abbreviated, quick, jerky strokes, designed to create spin, must be used to harness the advanced technology in your hand. When the ability to make these incredibly timely movements diminish, so will the end result.

Barry Gitarts mentions:

One thing we can learn from Nadal is how far working harder then the next guy can take you.

Alfonso Sammassimo writes: 

Some points on the Wimbledon final:

1. Changing cycles. Just under thirty years ago one of the greatest ever baseliners won the title for the fifth consecutive occasion. Last Sunday one of the best ever all-court players in history did the same, playing predominantly baseline tennis. In between these two heroic feats, serve and volleyers have taken most of the spoils. Tennis, like markets, is a dynamic game where players discover new ways to counter present styles and tactics. It is a simple but perfect example of ever changing cycles. Greg Rusedski said it so well, "Tennis changes. If you look back in the past, they say it's too slow, then you have eras they say it's too quick. It always balances out."

2. Equipment best benefits those who best use it. While baseliners have benefited greatly from the power that comes with new racquets and strings, so too have the big servers. Nadal does indeed use a racquet that is very hard to control - the fact that he does so well is a testament to his talent, not the racquet. Roger Federer has his racquet strung at 50 pounds which is also extremely difficult to control and provides much power. They both have strings which can help generate a lot of spin. These are two superbly talented tennis players who maximize the benefits of available equipment. 'R' or a Bloomberg terminal doesn't help me trade any better unless I have the ability to utilize them expertly.

3. Speed and agility are often overlooked and under trained. From the first point the most obvious difference between this match and the lead up matches of the tournament was the speed of both players. They are in the right spot at the right time more than the other players. Not only better foot speed, but also better anticipation. Market analogy…

4. Never give up. Federer looked on the back foot for much of the match. Only one break point opportunity during the middle three sets, and down break points in two service games in the fifth. He hung in, and the opportunity came as nerves and possibly fatigue got to his opponent. He took it swiftly as a champion does.

5. Efficiency nurtures longevity. A style of compact strokes and taking the ball on the rise requires less physical effort, expends less energy, is less likely to lead to injury, and most of all can be continued for longer in a career. Agassi and Connors are examples. Fewer trades and less commission, and coming straight in after a decline might prolong my trading account. I would agree that Nadal will suffer as his athleticism regresses with age.

6. Have outs. Much advantage having an all-court game to fall back on, having something else available when you're in trouble. When he was down break points in the fifth Federer cranked out three aces in a row, so discouraging to an opponent who has to earn nearly all his points with longer rallies. It’s good to have mouse holes when in the market.

7. You have to work harder than anyone. Nadal's was an incredible effort, coming so close to winning the running double which has eluded previous champions who aspired for the Grand Slam. He is possibly the hardest worker on the tour and his obsessive and methodical approach to everything from training and practice to the placement of his water bottles might just help him maintain his place in the food chain for longer than might be expected. 



 I've found in my 45 years of business experience, as a rule, starting with Tyco's toy racecars (by far the fastest) was that the company with the superior speed or design or popular fancy was always overtaken by a competitor who came up with a comparable or better product. As a complete layman, I wonder how long it will be before someone comes out with a better phone than Apple, and whether this makes the profits form the iPhone ephemeral. Please excuse my ignorance in this field.

George Zachar comments:

Technology acceptance is heavily influenced by network effects and compatibility issues that make the diffusion of digital products take a different trajectory from their non-digital predecessors. 

John Floyd adds:

"Leapfrogging" is a real danger. It is also evident in the way Japan evolved in car manufacturing in the 1960s and 1970s. I can remember driving in my uncle's "nouveau Datsun" as a five-year-old and hearing him tell me about the benefits in terms of cost, fuel efficiency, luxury, etc.

From a stock performance perspective I would imagine tests exist and can be done to look at stock performance post introduction of a new product for a variety of markets and products, Apple obviously included. What seems likely difficult to quantify is the "wow" factor: the market's potential to extrapolate huge multiples going forward based on various forms of growth, as happened in cases like the Internet stocks. 

Henrik Andersson writes:

It seems like Apple is holding on to their market share for portable music players even though it might not have a superior technology. I can envision the same happening for the phone, which I think would be very suitable for WiMax in the US rather than 3G. 

James Lackey writes:

There are so many elegant angles to the iPhone. When you look at the products vs. cycles, prices and innovation, many examples of car production vs. tech can be used. Examples include the furious competition, lower prices, and leaps of innovation.

The iPhone may be a leap of innovation. Of course others will adapt and prices will fall. What is uncertain is how much innovation and cost will trickle down to the sedan market of cell phones. Perhaps that equation, how the mass market accepts it and is willing to pay for the new bells and whistles, will set the pricing and production of future iPhones. Will the iPhone be a sporty two-seater high performance vehicle or just another used sedan at 50% off current retail in five years? 

Barry Gitarts writes: 

I think your questions apply to the smart phones which have been on the market for years from companies like RIMM or PALM and the iPhone is the answer.

To paraphrase Steve Jobs, people are used to thinking that something is wrong with them, when the real problem is the phone they are using. But Apple is not an iPod or iPhone story, it is a Steve Jobs story. Just look at how Apple did when Jobs was at the helm and then when he left and then when he came back. Is there any doubt he is the man responsible for the value creation reflected in Apple stock?

When I watch Jobs talk about his products, his passion and dedication reminds me of Howard Hughes and Airliners as portrayed in The Aviator. While there is no doubt that new technology will come out that will give the old technology a run for its money, how does one know the new technology will not be developed by those who developed the old one? 

J.P. Highland writes:

It won't be about someone producing a better phone, but someone being capable of delivering a cooler phone. The IPod might not be the best mp3 player in the market, but there's something irrational about it. People love it and will keep buying unless the meme fades. But so far people are in love with Apple and the success of the IPod has permeated to the iPhone and the PowerBooks are doing well. 



Today is one of those days where there was much movement in market, only to end the day practically unchanged. Makes me wonder: what's the purpose of such energy expenditure?


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