Perhaps three months ago, I met with a Florida insurance company CEO. Like usual, he told me all the advantages of his firm, etc. However, mid way through (in response to my questions–after I thought I spotted an interesting thread to pull) he told me about the aggravating, "opportunistic" element to the Florida Property insurance market. This CEO's firm, like most "real" companies, is "in it for the long haul" to last through the various insurance pricing cycles.

The annoying element he described–after a hurricane or weather event, when premiums are extra nice and his firm (and other conventional Florida insurers) should be set to profit mightily if they were alive, an "opportunistic" element enters the market. A bunch of "rich old guys" set up companies overnight and begin selling the elevated premium. These "opportunists" would then stop writing policies as soon as premiums fell below a generous threshold, and indeed wind down the company(s). The CEO's attitude was, "these lousy operators…. Sure, they make 500% on their capital in 4-5 years, but they never even build out a real IT department!" Then they do it again the next time the pricing is right.

I wanted to ask if he had any particular references on how to meet these shrewd operators. I would much rather invest with those clever folks than the "usuals" who make money only to get caught selling cheap premium at the wrong time in an effort to make the next quarter's earnings expectation.



What are the factors that make so many useful idiots and alluring shibboleths so prevalent and harmful in our field. The desire for publicity and renown must be one of them. So many personages who don't or can't trade achieve prominence and self esteem by becoming pundits or propagandits on the media. Many of them are second handers who can't make a profit on their own, but can only prospect by forming a fan club that carries their positions along once they front run the positions on both the long and the short side. Others achieve prominence by coming up with a very unpopular call that will turn out to be right once in 10 occasions and gives them long lasting fame. Others have recently been fired from their jobs, and join the media as a way of achieving psychic or economic remuneration.

The question arises as to whether a useful idiot has always been a useful idiot or becomes one after he rises to prominence. The same with shibboleths. Have they always been wrongful and harmful or do they become such only after they are bruited to the public. In considering this subject it might be helpful to start with an enumeration of current useful idiots and shibboleths. Certainly those who are consistently bearish on stocks and risk assets like the man of multiple court cases and yoga, or the recently passed Barrons' columnist, or the world stater who always calls for more agrarianism and is always bearish on enterprise must be near the top of the list. But what are the general factors that determine our following a useful idiot or harmful shibboleth? How can this phenomenon be usefully unraveled?

Kim Zussman writes: 

Why would successful traders/ money managers dissipate their advantage by publicizing their methods or thinking? Most or all would want to keep their insights secret. If trying to market to investors, returns sell better than talk.

Depleting the persistently successful from the pool of talkers means more talk from the less skilled, and few meaningful revelations.

anonymous responds: 

There are some strategies that benefit immensely from increasing participation.

Russ Sears writes: 

Of course idiots are useful to those that know they are idiots and take the other side. It's the old dot com hucksters and short sellers secret that promoting a position you already have, once you're holding full position, you want someone to unload it, you need someone left holding the bag. How else could the markets cause maximum losses for the most people.

Might I add that it is easy to find fault and sound profound, but it is difficult to pin-point why someone or some company will succeed and even more difficult to find an audience for ones wisdom. Further, most can't comprehend that volatility is not linear but clearly see the risk tomorrow. Few comprehend the risk premium outweighs the volatility over time, and few are willing to wait, but many want to do something. The law of showbiz meets the internet age: If there is an audience, someone will play for it.

Ed Stewart writes: 

The useful idiots or shibboleths that rise to celebrity circulate and gain steam because they serve an unmentioned interest–they have an unseen fan club. Some times it is increasing the brokerage commission, sometimes it is simply giving the public the "red meat" it needs to get clicks/eyeballs for add revenue, sometimes it is literally as servant to "the idea". At times it seems all three at once. Hat trick. The only known defense is the cane.. to hobble down and buy at puke points, but also to raise over head and smash the media channel that pipes the idiots to restore a more sound state of mind.  I did it 7 years ago. So far, so good.  



I just read this quote supposedly from Jeremy Siegel: "Dividends matter a lot. Reinvesting dividends is the critical factor giving the edge to most winning stocks in the long run…"

Why is this true when there is so much friction in reinvesting dividends vs. the more direct corporate reinvestment. For example, taxation, and the need to buy stock above book value when hypothetically a good company can invest in its business at book value and via earnings and with a decent ROE generate a multiple of that in terms of share price. How can high dividend payout top high ROE or ROIC and a high reinvestment rate.



 The one particular breed of "value" investor I hate most are those who develop vendettas against particular "overvalued" stocks of companies that are changing the world. What bugs me is their attempt at moralizing. It is a crusade to prevent investors from being ripped of by such "charlatans" as Bezos, or the Priceline founder, etc who are among the greatest geniuses of retail and business of all time, perhaps the greatest in Bezos' case. Or it is the "Tesla bears.' Fine. Apologies to those here who hate the company. Yet. It's an awesome product.

If in the process of a leap in technology, better things, a few speculators get burned, so be it. Why not let speculators fund advanced research on business concepts, technologies, etc. Overvaluation is a GOOD thing but for naked fraud, and a tremendous number of those phonies are offset by one Bezos from a "good for society" prospective.

The next great "fraud" of an overvalued company with an amazing product, great customer satisfaction, etc, that the usual bears hate–having studied the "accounting metrics" till their poindexter heads are nearly exploding–I resolve to go long. Reasonable odds they will be crushed given I can only lose 100% yet might gain 20,000%.



Do we want to protect the jobs of those who work in industries where the U.S. is uncompetitive, or do we want to allow U.S. consumers as a whole to minimize their cost of living? [I]t's one or the other. - Howard Marks.

[It is not a question of uncompetitiveness, or the future coming of robots.] A tremendous percent of middle class jobs are already obsolete. Indeed many of the jobs and even entire professions have been obsolete since they came into existence as part of things such as the "great society" program. Regulation, the welfare state, etc, is a huge middle class jobs program. It's not really the supposed beneficiary who truly benefits, it's the overhead, the regulation enforcers, compliance officers, case workers, etc.

The real crisis is that these 'Make work" jobs can now often be done by software of by a communication line to a cubicle farm in India–it kind of killed the idea of it–kind of like offshore manufacturing arbitraged the increased labor protections and union rules, etc. It's not that automation is making more jobs obsolete (though it is), it's that it is making jobs that have always been obsolete more transparently obsolete to more people.

I don't think we will see mass "joblessness" much more likely, we will see a massive expansion of regulatory state in a way that requires "jobs". take the boondoggle of the TSA who mostly just inconvenience the rest of us. If there is not enough crime to hire all the people with social work degrees or who would like to be police officers, etc, we will import criminals to create the need. etc. It's already happening.

Rudolf Hauser writes: 

Or create more crimes so that more people living their ordinary everyday lives become criminals for not being in compliance for some stupid regulation.

Stefan Jovanovich writes: 

To add my worn shilling to what Ed and Rudolph have so beautifully said: so much of the warfare in European history from the Greeks onward can be attributed to the need to find something for the "middle class" males to do. The Great Alexander's initial Macedonian Army - the one that crossed into Asia - was over 75% mercenaries, and their replacements were almost entirely mercenaries. (The good people back home in Macedon who still had farms and pastures wanted and needed no part in his conquests.) Where would the British Empire have been without all the younger gentlemen who were never going to inherit?

Productivity has absolutely nothing to do with the number of hours worked. Part-time workers are no more "marginal" than full-time ones; they just can't put in a full day because they have other responsibilities. (Having owned 7 "small" businesses, I know more than I would like to about this basic fact of economic life. There are only two categories of employees: those who actually want to be told what the job is and then left alone and those who think kissing higher asses is what employment is really about.

Before the labor "reforms" of the Progressive era, coal miners and mill workers and garment workers were paid on the piece rate. This "horror" was complemented by the fact that people could work "odd" shifts - for the women who were garment workers, that could be 8 hours on Sundays (not the Jewish Sabbath), 4 hours on weekdays so there was time for shopping, cooking and childcare. The Progressive reforms were based on the notion that women should not be in the workplace and they most certainly should not be competing with men. A "man" should have a full-time job with wife and children at home. Almost all of the current social legislation - disability, unemployment, welfare - is still premised on this ridiculous presumption. And, of course, payment for piecework is as completely illegal as selling moonshine.

Machines do not have to be "more productive" than people to be a sensible investment. People are a very large liability tail; and they require management by other human beings, which is, of course, the very activity that is least capable of being measured economically. (Try doing a look-up on productivity in government and education, where middle management - mostly gone from manufacturing and distribution - is now the principle job category.) The tax and labor codes also help; you can get a great deal more after-tax profit out of money spent on equipment than the same money spent on labor.



 It is interesting to consider if certain "self-help" people who offer advice on "refraining" and supposed "nlp brain programming" with insistence on "not being your guru" are unintentionally the ultimate hoodoos.

I recall a legendary golfer hanging out with a fellow and I swear he never won again.

I read of a famous entrepreneur consulting with this individual and I believe he lost his business.

I see a legendary hedge fund manager on twitter taking selfies with a fellow and I hear he has not beat the risk free rate in at least 15 years for his clients.

The secret might be that the "self-help" type is actually (and unintentionally) a parasite feeding on the celebrity of these formerly esteemed, perhaps washed up people to better fleece the sheep by borrowing their prestige.

If it is true, the conclusion is very negative for bonds for the lifetime of, say, someone who might be listening to a self-help guru for financial advice.

Jim Lackey writes: 

No. NLP is learned natural by all athletes. The best way to communicate with another person is to figure out their state. It's very good.

Guru? Self help books? There is always something to learn from any human on this earth. A good book has a meal for a life time. A decent book a meal for a day. If we realize a book is bad we have a quick laugh, then a cold shiver of humility.

I assume your point is buying into a guru/system. That is learned right here on the Dailyspec. All fixed systems are doomed for failure. Humans are dynamic and life is not static, unless you stop learning.

I think I know whom the previous post was about. I read those books in my 20s. Here is what I learned:

How to focus

Example: consistent reaction times in my race cars. That requires a pure visual state focus on one light. How? Relax, even though my car was making 950 horse power and I was very excited. Tune out all auditory with out the use of ear plugs as I needed to hear 5 seconds into my run. Eyes see better into dusk and at night learn how to adjust for the tenth of a second reaction time gain or lose to a false start, redlight. My reaction times were always good, under a tenth. However to be great they must be 0.005 to 0.000001 every time. Trading? Why was it when I lost big, my heart rate went to 180? Yet 125 fast walk when I won? A joke. One day I put on my motocross helmet and took a picture of myself at my desk. I was going to send it to a friend that was in the crash with me. My heart rate dropped to 99. That was learned behavior or the state I was always in at the starting line on a dirt bike. With visualization I can put on my helmet in any situation for life, figuratively.

Lastly kinesthetic.

If you can't get into that state, quit. Trading, sales, romance, which I have at this point in my life reversed that order of preference. Point is if you're satisfied with a small profit, if you don't get excited closing deals, if your only interested in a quickie– take time off, a disaster is imminent. Get the joke? Paying for a life coach? It's a percentage of profit on a mutually beneficial exchange. No profits, someone is fired. I've been fired. I like tacos.



One admires the typical high tech earnings report. Made 15 cents excluding certain items. Those items include salaries. With salaries loss of 20 cents. Twitter an example today. Something rotten in the way sale growth of 30% versus estimate 35% is cause for the 15% decline rather than they can't earn money. 

Ed Stewart writes: 

If you think that is bad you should read the "value" stock releases. Every quarter it is "but for" earnings and the analysts play along with the BS to the extent that the fake numbers are the ones that are the default in factset.



 In describing a Hitler oration Shirer in Berlin Diary: "in the sound of the magic words of Hitler, they were merged completely in the German herd." Rosenbaum in his introduction to Rise and Fall of the Third Reich: "was it a unique one-time phenomenon or do humans possess ever present receptivity to the appeal of primal herd like hatred". Galton in his Inquiries into Human Faculties likens the human tendency to gregariousness to the oxen he tried to train to lead without success. We see evidence of this herd like gregariousness all the time in markets, and the only problem is to ascertain the end of its irrationality so as to profit from it.

Anonymous writes:

A CEO told me over the weekend that now that his business is "hot" he has been told the Japanese company that kicked the tires and decided not to buy much lower might now buy at 1.5X to 2X the current price as popularity has created the needed validation for the purchase. Wonder if that matches your observations.

Victor Niederhoffer writes:

Sounds like the gregarious imitative Japanese persona. Do you agree?

Larry Williams writes:

I agree, but disagree. The buying is not based on any unique Japanese Persona, rather most all people buy high and most all people are afraid to buy when prices are falling. Human nature. High prices prove it. Only real speculators look past today for proof.

anonymous writes:

Larry and Vic,

The anecdote and your responses illustrate both of your biases, which are not necessarily any better or worse than the Japanese buyer's bias.

Example 1:

If the company is an early-stage drug company with billions of potential long-term profits, but dependent on Stage 2/3 clinical trial results, it may be demonstrated mathematically that buying the company after it achieves positive results (and after the price has increased 2x) is a better risk-adjusted return for an acquirer who doesn't like portfolio volatility.

Example 2:

If the company is entering a new space and is a first-mover, there are numerous examples where buying the company after it has critical mass is a better bet than speculating on a long shot. Goldman Sachs is a primary example of a company that rarely enters a market early.

I heard a truism on the radio last week: "People love to go shopping when things are on sale. The only exception is the stock market where lower prices scare the buyer." This is both a true and false statement. If a sweater gets marked down 20%, it's the same sweater. However, if an individual stock price goes down 20%, it may OR may not have the same earnings potential prior to the price change. There is a difference between "price" and "value". Great investors understand this difference and even they sometimes get it wrong.

So, while I am not defending the Japanese fellow, generalizations without numbers on the table are no better than snide racial epithets.



I would ask an important question. In the marketplace when are the best times to wait?

Jim Sogi writes: 

Rocky said mean reverters make a little money a lot of the time, like 99% of the time, but on 1% lose big. Its those big big 100 plus point days or weeks that can cause great harm. Those day you wished you waited to the end of the day, until the next day to buy. Those days you wished you stayed in bed. Is there a way to avoid the ax, the falling knife, the big vol trend down weeks? Is there a warning, a canary to tell you, wait? When 99% of the time it's the opposite?

Our friend Seattle Phil used to say, its all about leverage and max expected draw down. Chair says it's about broker margin games. They're all right of course.

On the days when it's 40 plus down, it seems a bit easier, because you know it can't go much further, normally. The other days that are difficult are the low vol creep upwards week after week.

anonymous1 writes:

The Skew Index provider thinks there is an answer in measuring the market implied probability of an extreme tail event in the stock market. It carries the assumption that the market can evaluate the risk in its assignments of implied volatility up or down.

If it can, then you scale risk exposure levels to match the skew risk measurements. High skew means cut back exposure.

That said, I'd rather know the margin call levels available only to the brokers as a composite readig on all their customers. That can work better than skew for capturing the cleanup prints at the end of the day when increasing margins knock out the risk takers.

CBOE SKEW Index Introduction to CBOE SKEW Index ("SKEW") The crash of October 1987 sensitized investors to the potential for stock market crashes and forever changed their view of S&P 500® returns. Investors now realize that S&P 500 tail risk - the risk of outlier returns two or more standard deviations below the mean - is significantly greater than under a lognormal distribution. The CBOE SKEW Index ("SKEW") is an index derived from the price of S&P 500 tail risk. Similar to VIX®, the price of S&P 500 tail risk is calculated from the prices of S&P 500 out-of-the-money options. SKEW typically ranges from 100 to 150. A SKEW value of 100 means that the perceived distribution of S&P 500 log-returns is normal, and the probability of outlier returns is therefore negligible. As SKEW rises above 100, the left tail of the S&P 500 distribution acquires more weight, and the probabilities of outlier returns become more significant. One can estimate these probabilities from the value of SKEW. Since an increase in perceived tail risk increases the relative demand for low strike puts, increases in SKEW also correspond to an overall steepening of the curve of implied volatilities, familiar to option traders as the "skew".

anonymous2 writes: 

Back in 1994, during that memorable Fed tightening cycle, every time the Fed tightened, the market priced in a greater probability of more and faster tightening. Chairman Greenspan referred to the Eurodollar futures market as "A blind man looking into the mirror."

Similarly, I do not think looking at Skew index will help you systematically avoid risk and make money for similar reasons — namely, it is self-referential. At the risk of articulating an Epistemology, any market price that is set by market participants cannot correctly discount the probabilities of something that isn't correctly discounted. I know that sounds like a typo, but it isn't. It's the nature of arbitrage-free pricing.

To say that "high skew means cut back exposure" is way too simplistic and it is what gives rise to the high skew in the first place. It's similar to market participants who adjust exposure based solely on VaR — they take more risk when things "look" safe and reduce risk when things "look" dangerous — with the blessing of academics and statisticians and other wonks. In contrast, many successful investors do the exact opposite: they reduce exposure when things look safe and increase exposure when things look dangerous.

There are many paths to heaven.

Almost no one reading this post has invested a period of protracted 0% CPI or deflation in the USA. I'd suggest that one consider this possibility and its implications — as it is very easy to miss the forest from the trees. The Skew is the trees.

Larry Williams says:

On a different note, seasonality might offer a reason to wait.


Bill Rafter writes: 

If you compare SKEW and VIX you can get some good signals that predict the equities market. But those signals are not necessarily better than signals from other indicators. This coeval of signals is simply evidence that when a market is ready to go [fill in your choice, here], its intention to do so is writ wide across the landscape.

If you compare ratios or differences between SKEW and VIX you find that relative to VIX, SKEW is a pussycat. So essentially the comparisons are merely using SKEW as a benchmark with VIX doing the wild dancing. N.B. the series have different orders of magnitude, which means if you want to take their differences you should cumulatively normalize them.

We have always been suspicious of sausage and indices, as one frequently never knows exactly how they are put together. Those newbies studying VIX would benefit from a good understanding of its construction. Dave Aronson (we believe) had similar concerns, prompting his creation of a less theoretical measure of volatility ("True VIX"). The same can be done for SKEW by taking not prices, but ratios of volume and open interest of equity calls and puts and index calls and puts. We have done that and found profitable results, but again not enough to forsake our current algos. However, we have researched the data with the goal of improving equities trading. Someone with the resources to pursue a full blown options program (e.g. a large investment bank) probably would find further study of additional value.

This is our experience to date. We haven't checked everything as doing so is, to say the least, mildly distracting.

Ed Stewart writes:

Anxiety and waiting sucks. How much of winning is just being willing to wear the opponent down, exhaust them. Play the long game to when when no one else sees it. In markets but also business. It seems easy, but if you play that "long" game, everyone else thinks you are an idiot for along time, asking why, up to the moment you win. Then they get it, see you won, but don't see how. They say, "it was luck". That is why it's difficult. One needs to value results over accolades. 



 GS just launched a smart-beta product which I believe is their first proprietary ETF.

They are charging only 9 basis points for the GSLC <equity> etf!!!

It's a large cap etf, rebalanced quarterly based on their scoring of value, momentum, quality, and volatility. A quick look has them underweight the largest 40 S&P names except for Gild, HD, CVS and WMT. Interestingly, they don't hold any GS — probably due to regulatory issues.

If anyone knows of a backtest of their index, I'd be interested in examining it. Without historical data, it's difficult to understand the attraction versus competitors (except their fees are extremely low and so they've undercut Wisdomtree and other smart beta products). Perhaps their inhouse brokers will sell this as an alternative to the S&P?

Ed Stewart writes: 

Have you continued to look at this product? at 9 basis points it seems like a reasonable core holding. I'm curious what the turnover will be given the rebalancing rules. I assume GS will make the money on servicing the fund such as trading, stock lending, etc vs. the direct fees.

anonymous adds: 


There are a number of similar products out there (so-called "Smart Beta") which charge between 9 and 20 basis points. So the management fees are only slightly more expensive than S&P or Russell Index Funds. I would argue that the Smart Beta products are themselves "index funds" — but they are tracking a different index! I think this discussion is very important and provocative. I'll provide my two cents below:

Rather than focus on a 5 or 10 basis point savings, I would focus on assessing the probability that one (or more) of these smart beta strategies (of whatever flavor) will outperform the S&P over the next 3, 5, 10 years. When you commit to one of these things in a taxable account, you also need to consider the tax effects of selling early/switching to another fund — as the capital gains taxes can really hurt your long term performance. And you need to consider the chance that the ETF is liquidated for some reason, because that will trigger taxes too. You also need to consider the chance of upward fee drift. For example, GS priced their fund at 15 bp in the prospectus, but lowered the fee to 9 BP on the offering. AQR is also cutting their prices. But at some point, there must be consolidation among these many fund complexes, and after that happens, they will surely start to raise prices — since the tax consequences of switching make the assets very sticky.


The academic literature for the anamolies which these smart beta funds exploit is, I believe, compelling. But equally compelling is the fact that their outperformance versus the S&P has been in secular decline. I did some back of the envelope calculations and found that the average annual excess performance for the past 15 years > 10 years > 5 years. That is, the market has woken up to the anamolies and with the advent of these low cost/smart beta funds, it's plausible that you'll see decreasing, if any, outperformance in the future. Cliff Asness at AQR recently wrote an essay on this subject. See:


I think the right way to pick one of these funds is to understand one's own temperament and market beliefs. It's during bear markets and periods of underperformance that one's temperament is revealed and it's critical to be able to stay with these smart beta products during 1, 3 and 5 year periods of underperformance (however you define "underperfomance"). For example, do you love the "hot" stocks? Would you own Facebook/Amazon/Netflix regardless of valuation? Then the momentum strategy is the right choice. But if you like to own "quality" and feel comfortable with less sexy things (Johnson & Johnson, Microsoft, etc) , then you the Quality anamoly is your right choice. Do you like to be a contrarian? Then the "value" portfolios might make more sense. And if you think you are a trading genius, then you want to move around these different things as you predict the next flavor of the month.

If you put a small amount of long term capital into each of these funds, what's the probability of outperforming/underperforming the S&P on a compounded total return basis? I honestly don't know. But I'd guess that at any given moment — with a X month lookback — one of these smart beta funds will look really good — and one of these smart beta funds will look really bad. And therefore, it's no different from picking a stock or a fund manager or a sector. And consistently doing that is very difficult. 



Jack Reacher, from Jim Sogi

September 30, 2015 | 1 Comment

 Jack Reacher is my favorite fiction character by author Lee Child. He's an investigator that suggests thinking like the perp to find him. Use his same thought processes to deduce where he'll end up.

When trading, I try to think how the sellers, especially a panicked seller, might think. Or how the buyers might think, and when they'll start buying. There are tells, there is the statistics of how they reacted in the past. It's helpful to think in the other guy's shoes and be one step ahead, proactive rather than reactive.

Ed Stewart writes: 

I've found that to be one of the most valuable thought processes for trading. Either anticipate the squeeze point or fade after it occurs at an appropriate distance (biased to trade with any drift).



 We often hear that hard work is critical. I agree. But what about the power of waiting? Anxiety can drive one to take an action that is inopportune, not ideal, rushed, or sloppy. Wait and pick the fruit when it is ripe. The idea is related to time preference. I came to the idea when I noticed that much, if not most, work is a salve to cure the desire to "do something" instead of accomplishing something real. So what if one sits back and just waits and by waiting accomplishes in minutes or days or weeks what could not otherwise be accomplished in most of a lifetime. Is it possible? Yes, I think so, as long as one can work hard when needed and on command.

Vince Fulco adds: 

Very hard work is often an avoidance mechanism, and a terrible one, for active or passive significant underdevelopment of the rest of one's life…especially hard relationships which require smoothing out or resolution. I am seeing it with unhappy married friends now who work ridiculous hours because the thought of confronting the elephant in the house is too painful. I think it is a middle eastern saying, "if you wait long enough, your neighbor's body will pass by your doorway."



 On my last haircut before moving, I gave my regular lady a $100 tip on a $17 haircut (applause line here?). That small gesture brought her to tears. She is a very interesting older woman. I've enjoyed talking with the past few years. She knew I worked in investments/trading and asked if I had any ideas for her. I asked about credit card debts and she told me she just cashed in 25K of an IRA to pay down 25K of credit card debt, yet already had accumulated 2K since then and was getting in the hole again. I might invite her down to do some murals in my kids room, and perhaps do some studies on trees (She is an artist who made a living cutting hair for the last 40 years).

The point is (perhaps? At least the relevant one?) is the deadly financial problem of never having working capital that provides the flexibility that keeps one off the spike of usurious interest.

This lady had been sold on long term investments (by her branch XYZ big box bank) in high fee mutual funds with perhaps at best a 5% yr expected value over the long term, while paying off 25% interest rates on credit cards. The scams run on the lower middle class or working class are obscene.

And it is not income. Clearly if these folks can pay these obscene high interest rates, they can afford much more than they have. The problem is that they never understood the idea of having "working capital". I told my friend that her best investment is at least 6 months of living expenses in the bank. As basic as it is, and at such a low margin for error that standard that is, for many it is an alien concept. Her recent issue was a car repair that blew up her budget and started the credit card problem again. With no working capital plus compound interest against, it is like a giant pit metaphorically with wood spikes and lions at the bottom to gobble one up.

So in trading and investing, how can we use this idea? Victor has taught "never get in over ones head" as one of the key tenants of speculation. So how do we manage our cash in our speculations, investments, life's "issues" to have the flexibility to seize opportunities and avoid pit of being bent over a barrel–while still getting a solid return.

Scott Brooks writes: 

The problem is deeper than that.

The people that Ed is referring to don't have the mentality to accumulate wealth and get rich. They are sold on the "here and now" mindset. They go into debt to satisfy the here and now. Something will always come up that will prevent them from succeeding. The only thing they are really good at is coming up with PLE's (Perfectly Legitimate Excuses) to justify their failures.

They are defined by their failures.

anonymous writes: 

Especially with respect to this site, I would wonder the data and testing behind those assertions. Otherwise, one might consider them to be presumptive, elitist, and uncharitable, with mean-spirited implication. But for the grace of god….

Ed Stewart writes: 

"presumptive, elitist, and uncharitable, mean-spirited"

Yes but who cares. I'm guilty of most those things at most times. Is time preference the essence of trading? That might be a more interesting question vs. my original one. Can it be quantified? I think so, as a hypothesis generator. Does it work better than other thought models?

Russ Sears writes: 

Sorry, I disagree Scott. Ed is correct, it's a matter of education and coaching. Have a plan, believe in the plan, stick to the plan.

The average working poor Josie is not a loser. It's the average bank has learned they are more valuable dumb and paying fees than smart with small accounts. The stats say that the fees are several hundred dollars per person in the USA. So some are paying several times that. The banks have the average poor working single parent or mom in a snap trap that they can't figure how to unsnap and lift the door.

The first thing I tell kids is that you need a minimum of $1,000 in emergency cash preferably $2,000. Have a garage sale, stop buying lottery tickets, no gambling, stop buying new clothes, stop cable, and stop smart phones, etc until you have that emergency fund. Also budget, if you can't fix the budget to the pay, downsize housing, get roommates, no car, bus, pay for car pool, whatever it takes to have a workable budget. Then save for the 3 to 6 months expenses in a cash account ready for a big expense. Only then should you invest.

Most people in this problem don't have anyone they can trust to give them the advice and perhaps the tough love they need to stop living in denial. The truth is the banks want the poor.

What does this mean for "investors". Frankly I think most investors have it wrong. It's not so much managing your risk as it is managing your cash flow first, then manage your risk. You can take a lot of equity risk if your investment horizons 20 years out.

Also the lesson to investors is just because someone is in the best position to give you advice and would make some money off you if they gave you that advice, it doesn't mean they will give you the advice that's in your best interest when it conflicts with their best interest. Their best interest is CMA (cover my …) by silence or sin of omission. Then it's to make more money by selling what gives them the most profit to "cover" you like payday loans.

anonymous writes: 

The thing I practice (and I don't know if it adds any edge that can be computed) is to always take some off after a good run. No mater what, be it trading, investing, bonus, etc. Never spend it all–or even most of it. Put it away for when SHTF, because as day follows night, it will…

Andrew Goodwin writes:

A major part of the problem is the thinking that makes the credit limit on credit cards equivalent to ones own money.

For my part, I will never willingly stop at a gas station that has two prices for gasoline with one higher for the credit card user than for one paying cash.

In a world where there are card rebates on gasoline, what is the point of acting responsibly with credit when those who did not act responsibly get subsidized by those who did. The dual pricing also serves to support a cash economy against the public interest.

Peter Grieve writes: 

I feel that I am unique on this site as having been in this hairdresser's situation for most of my life (Hello, Peter). Obviously this is not due to a lack of economic education or upbringing. I feel that the factors include a lack of skepticism regarding my own appetites, a lack of faith in the future, a certain immediacy in response to the world. These are traits associated with immaturity, to which I confess. Of course this leads to tremendous inefficiencies, even when viewed from a purely hedonistic perspective, but it does have its compensations.

I do not regard Scott's comments as elitist, presumptive, uncharitable, or any of that baloney. On the contrary, I find the the use of the word "uncharitable" to be condescending. I do not feel that people in my position are a fit object of charity.

Everyone has their irrationalities, and they are often incomprehensible to those who do not share them. Scott's words are simple, honest truths, which many people (including me) would benefit by internalizing to a greater degree.

Stefan Martinek writes:

It is good to have an emergency cash for at least a decade; locked, untouchable for trading or similar. The rest can be at risk. And after MF Global steal from client accounts (is Corzine still free?), I think it is prudent to keep as little as necessary with FCM. In case of a brokerage failure, the jurisdiction matters (Switzerland is preferred, the UK is too slow but ok, then Canada, and the last option is the US broker).

Ralph Vince writes: 


I entirely disagree; emergency cash has a shelf life which is very short, and our perspective warped as we are speaking in terms of USD. Being the historian you are, you know full well how quickly that cash can be worth nothing. (And again, a many of our personal experiences here would bear out, money is lost far quicker than it can be made).

A bag of air on hand is good for one breath.

People are taught that "saving" is virtuous, borrowing a vice. I would contend that we have crossed to Rubicon in terms of the notion of stored value — no more able to contain that vapor than we can a bottle of lightning. The circulation brought upon by a zirp world, turning all those with savings into the participants at a craps table, the currency being used the product of a confidence game, among the virtues to be taught to tomorrow's youth is that of creating streams of income — things that provide an economic benefit their neighbor is willing to pay for, as opposed to a squirrel's vermiculated nuts.

"Stored value," is a synthetic notion we have accepted and teach as a virtue. It has no place in nature, it is a synthetic construct, one that is not scoffed at in the violent, life-and-death world of fire and ice. Young people need to be taught the fine distinction between the confabulation of "storing value," and that of using today's fruit to generate tomorrow's.

Stefan Jovanovich adds: 

From the other Stefan: I agree Ralph. "Stored Value" is another part of the economist dream that platonic ideals can be found. Money is and always has been one thing: the stuff you could voluntarily give to the tax man that would make the King find another excuse for throwing you into the dungeon. The gold standard did not change that; it simply gave the citizen a chance to make the same kind of unilateral demand on the government. It is hardly surprising that the fans of authority and "government" hate the Constitutional idea of money as Coin. How can you have a permanently elastic official debt if the citizens can ask for payment in something other than a different form of IOU?

However, Stef does have a point. Having a hefty cash balance is a wonderful gift; it gives you the time to figure out your next move. The sacrifice is the absence of leverage; the gain is having literally free time.

Scott Brooks comments: 

There are a lot of companies out there that take advantage of them and the bad advice they were given from their parents. Banks certainly do. Then you've got insurance companies and brokerage firms selling them crap products as well.

But that doesn't hold water in today's society with Suzie Orman and others like her being nearly ubiquitous on the airwaves and net.

These people live beyond their means. Plain and simple.

Yes, they lack education, but even with education available, they don't take advantage of it. They are just doing what they were taught as kids. For far to0 many of these people, as long as they've got enough money for their 1-2 packs of cigarettes/day and their quart of Jack/week, they go and live lives of quiet desperation, hoping that they don't lose their jobs and are lucky enough (i.e. like not spending money on stupid stuff is "luck") to pay off their debts by the time they are in their early/mid-70s so they can live out their remaining few years (if they even make it that long) on social security.

I know. I grew up with these people. I know how they think. But for grace of God (as was mentioned earlier), I might have been one of them. But for some reason, I was blessed with gray matter that works, and I saw the error of those ways, and I was able to get out.

Ken Drees writes: 

I knew a guy–lost touch with him over the years–who exclusively dealt with hairdressers and salonists. He sold variable annuities to them since these people had no retirement plans given to them from the salon owners. I believe in his mind that he was doing them a service–and I really do not know the quality of his products–but at a glance I saw them as mutual fund annuity hybrids that came from heavy fee fund families. He was a tall, dark and handsome gent and he would actually get entire staffs of salon ladies to invite him in after hours for a group meeting/financial planning discussion presentation.

He always said that business was brisk! 

Jim Sogi writes: 

When young friends ask me, how should I invest, I give them a simple asset allocation model based on ETFs or Vanguard and an averaging model. Invest x% of your paycheck off the top each time. Doesn't matter how much really.

Russ Sears writes: 

 Scott, since this is the DailySpec let us bring a little science into the discussion, even if it is social science.

Where we differ is not what is causing the hairdresser's problem. It is in what can be done about it that I differ. I believe you can coach people to delay gratification. I coached kids that never did homework before and got "D's" and "F's" during a summer and by fall the kid was an "A" or "B" student. You probably owe a hardy thanks to the coaches in your life.

Perhaps the greatest social science finding has been the "marshmallow experiment" done at Stanford. They did test on 600 4 year olds telling them if the child did not eat a marshmallow for 15 minutes after they left, they would get a second marshmallow. 1/3rd of them made the whole 15 minutes, a small percentage ate it immediately after the others had waited various amounts of time. They followed up on these kids several time in the last 40 years. Just about every way you can think of to define success was highly correlated with the time the 4 year old delayed gratification: SAT score, college/HS graduation rate, credit scores, long term committed relationships, contentment etc. And almost any way you can define failure was inversely correlated: jail time, high school.

The correlation was stronger than IQ, social economic status at 4 years old. In other words even the dumb poor kid that delayed gratification was happy/content/successful 40 years out. He may not be making much but he is happy with it.

For a humorous view of this experiment reproduced: Joachim de Posada: Don't eat the marshmallow! 



I know Rocky has mentioned the Vanguard star fund (VGSTX) as a good long term investment vehicle. I was looking at the Vanguard site and notice that they also offer what is called the "Vanguard Balanced index fund admiral shares" (VBIAX). The performance is almost identical to the star fund, however the fee is amazingly low vs. very low (9 basis points vs. 35 basis points) so I figured it was worth mentioning.

Alex Castaldo clarifies:

They are very similar. The main difference is that VBIAX is allocated 60% stocks, 40% bonds. The star fund, VGSTX, according to the Vanguard web site, is 62% stocks, 25% bonds and 13% short term reserves. So the latter has some money market instruments and low duration bonds in its fixed income positions that the former does not have.

Another difference is that the stock allocation for VBIAX is entirely domestic (modeled after the CRSP US total market index), while VGSTX includes an international (non US) stock component. The 62% in stocks I mentioned earlier breaks down into 44% domestic stocks plus 18% international stocks.



 I just read a post on the usage of stops when trading Russell 1000 stocks. It seemed to be a fair enough analysis. It concluded that when trading a basket of stocks, stop-loss usage hurt performance.

Has anyone noticed that the "left unsaid" part of the analysis is often the most important? For example. His simulation entry is to buy using a limit order at some volatility measure below the prior close. It seems reasonable and reasonably mirrors some of the things that I like to do in stocks.

The problem is if you use this simple, tested method with any size at all in a great many Russell 1000 stocks, you will not get filled in any shape or form that approaches the simulation results. That trade where in simulation u made a killing? In real life, u got 47 shares. Including a "go beyond" factor on the limit order fill does not help, because your order alters the sequence of prices. If u have a big, dumb limit order, they won't let you in at the best prices (You get the full boat though, when your level will have your buried in no time).

Next is the analysis of stops. The system testing does not factor in that when the "stop" hits the market, a hole emerges - your order is sucked into a pit to be filled much lower than you thought possible. Or if the instruction is to "stop out" on the open the next day, opening price is monstrous and you get filled at some obscene level that ends up being the low of the day, far more than should be expected.

So while some of the principles identified might be reasonable (buying weakness in stocks), the "nuts and bolts" implied from the back-test are going to be mostly dead wrong, and consequently going to ruin a great many trader's starting out with their crafted plan based on simulation results.

It reminds me of 15+ years ago when I believed I had a system to make 7 figures a year trading coffee futures. I did have that system. It worked wonderfully on historical data. in real life I tried 3 trades, all generating significant and unexpected losses, and quit. I actually like trading coffee with small size now, but the initial naivete of having a "sound system for shadow boxing the market" was disastrous. The nuance of the trade makes all the difference. It might be less of an issue in the big markets, but it still comes up.



 More snark from your 19th century correspondent.

1. The world still runs on the Parsons steam turbine.

2. When the New York Times' readers discover the collapse of the obsolete industry that fuels the brand new age, it is finally time to buy.


Stefan Jovanovich adds:

Rhino Energy LLC is a proxy for the Appalachian and Illinois Basin coal industry. The stock symbol is RNO. We do not own it and it offers zero trading opportunities, but it is the closest I have come to finding a public company that publishes numbers about what is happening in the eastern U.S. coal bidness. The news is terrible, as every reader of the New York times knows. RNO has just suspended its distributions, and its $10 stock from 4th quarter 2014 is now under a dollar. But, even as this particular canary continues falls over in its financial cage, operating margins increase slightly year over year and production is sold out for 2016.

The region now has a number of coal "start-ups" that are completely invisible to the public eye. Their registered public addresses are in and around Lexington, KY. They have taken over some coal leases and lands from the bankruptcies and forced sales of the historic companies that have been part of this depression and opened new mines. They have no legacy union contracts and - more important - no "history". None of the miners who work their operations has any thoughts about being owed anything for all the terrible things Mr. Peabody's company did to them or father or grandfather.

So, we have begun buying shares in Joy Global (JOY) on the Howard Hughes theory of investing - i.e. even as the depression in the oil business continued through the 1930s, people needed drill bits; and with the increase in oil consumption from WW II, they needed even more.

Full disclosure: In 2 weeks we are already down 5%; we expect the happy ending, if any, to come years from now.

Stefan Jovanovich further adds:

I am not an engineer and I don't play one either so these comments are even more questionable than my usual rants. But I did get the short course from my uncle, Aunt Mary's husband, along with the cook's tour of the gas and coal fired steam plants around Denver. Uncle Charley loved the prospect of direct use of gas combustion that Carder mentions. Perhaps because he was old and sick, he also saw the limitations of the brave new world he would not live to see.

Uncle Charley's lesson plan for his idiot nephew.

Coal is a poor competitor in HHV values. Where gas on average has 21k HHV BTUs per pound, lignite coal has only 8k and the highest grade coal - anthracite - 14k. On average the bituminous coal used for steam generation has only half the HHV/pound of natural gas. So, coal per pound has to be half as expensive as gas simply to break even on HHV efficiency.

That still leaves the efficiency of the turbines–steam vs. the CCGT. According to thermodynamicist folks at Mankato State steam turbines using coal can do close to 50% at best while CCGTs are, as Carder says, now at 60%. So, coal per pound has to be another 1/3rd cheaper still in order to stay even with gas on efficiencies alone.

Then there are the environmental costs, nephew. Put them all together and coal has to sell for no more than $.25 a pound when gas is at a dollar.

So people will stop building steam generating plants in North America and the rest of the world will keep building them because coal delivered by ship or barge can be had for fixed contracts for a decade @ 1/4th the price of current prices for gas while no one will be willing to bet on natural gas deliveries beyond a year or two at most.

I checked Uncle Charley's numbers before buying JOY.

the U.S. I.E.A. price history for residential natural gas

The current futures price for gas - $2.89 per 1m BTUs which converts to roughly $.09 per pound at the standard prssures and densities - and coal - $43 per ton or slightly more than $.02 per pound.

If Carder is right and Uncle Charley and I are wrong, natural gas suppliers will be willing to offer long-term supply contracts the way people in the oil bidness did before 1973; if Uncle Charley is right, California will have brownouts and demand the right to buy Kentucky coal fired wholesale power before the decade is out. We shall see.



What sub-sectors are traditionally used to benefit from the elections campaigns, or will the campaign be fought on twitter and other social media?

Victor Niederhoffer writes: 

Tim Melvin is the expert on this. Any company that depends on government largesse will benefit as the idea that has world in its grip is that we are victims and the purpose of government is to take from the productive and give to the poor and foster smallness in humans, and strive for inequality so that none stand out as counterweights to the perks and emoluments and mistresses of the governs. 

Tim Melvin writes: 

Oddly enough today's column addressed this big government trade:

While macro stuff is not my strong point I feel like I can identify some segments of the world we live in that are more or less have to happen situations. Obviously small banks fit well into my long term view of the world. Smaller banks are going to have an increasingly difficult time keeping with regulatory and technology costs. The will find that it makes more sense to sell to a larger competitor rather than struggle to remain independent. This simple trend should makes us all a lot of money over the next decade.

The next powerful trend is one that I hate to see but the fact is that without a social and political revolution the Federal government will continue to play a larger role in the lives of its citizens. They are developing programs for medical care, social programs, energy policy and a host to other instructions and instructions that are going to require huge expenditures. A whole bunch of that money will find its way into the hands of consulting companies like Willdan Group (WLDN), Provident Service Group (PRSC), CACI International, FTI Consulting (FCN) and Ameresco (AMRC) that provide specialized consulting services to the various government agencies that will develop and oversee these programs.

And don't forget the print news and radio companies that will see a ton of advertising dollars from local elections–ahc, salm, SBSA–the hispanic vote will be HUGE and much $$$ will be spent there…TV station owners like GTN, MEG, SBGI–ssp owns both local tv stations and newspapers….

And many thanks. I was just sitting here wondering what in the fresh H*** to write about for tomorrow. Problem solved. I will post full column here when done if chair would like.

Ed Stewart writes: 

I think the same thing Tim talks about in banking is going to happen with brokerage firms, though a bit more stealthily. The second tier firms that are primarily marketing firms are going to give up on the technology side, much of the regulatory compliance side, etc, and become something more like introducing brokers. When this occurs most of them, or a great many of them, will consolidate under IBKR's global platform and then focus on sales and service. Apparently scottrade is the first, they have outsourced their options trading platform to IBKR - and the commission will be the exact same (supposedly) that IBKR's clients receive. They do this because ibkr will treat each brokerage relationship as 1 client, give them the volume discount, and then the other firm keeps the spread between the volume discount and what their individual clients are actually doing. Its a neat business model.

It will be invisible from a client perspective as the front-end will be customized or rebranded. One interesting small cap play on the hispanic market and possibly cycle is hemisphere TV, run by an experienced TV executive. I've looked into it just a bit, perhaps if i do more I will write a brief thing on it for the idea list.

IBKR is also starting to capture more fund business as smaller funds are kicked off the big platforms.

anonymous writes: 

I took a quick look at HMTV. It's an interesting company. But it seems to have a focus on niche markets within the hispanic community. I don't know how much appeal that may have to political campaign advisors. That's not to say it may not make for a great investment. My father invested in Perkin-Elmer in the 1960s because it launched a product that he thought would be great in the classroom. It flopped. Didn't matter, though. The company flourished because of its position as the leading supplier of electronic manufacturing equipment—a booming industry of the 1960s.



 I was recently referred to the David Stockman's blog, and after reading a few articles was nearly wetting my pants in fear. The fear brought to mind an occasion, a dark, dark memory, of a time I almost blew up my account(s), shorting SP futures just as my son was a few months from being born, one of the darkest periods of my life. And while I had some numbers I was going on, the over leveraging and stubbornness that set in was based subconsciously on the rantings of people like Stockman.

I came to the conclusion that libertarianism, or listening to libertarians is one of the most dangerous investment afflictions around, I disavowed any belief that this perspective that could help me make money, and it seems I have been cured for 6 years. I'm still sympathetic to the position philosophically, but have learned to ignore the market based rantings that I had ignorantly begun to factor into my world view.

I've not done any significantly leveraged short trades since that time. If the crash comes I'm happy to miss the "upside" of that event, play the swings, and hopefully position for the next upside with surplus in high return on invested capital stocks, hopefully be positioned to short some premium, but as for rooting for the crash, "chickens come home to roost" and all that, count me out. I could care less about the opinions, even if on a 100 year time horizon (perhaps) they will be proven true.

Victor Niederhoffer writes: 

Mr. Stockman came to the junta and called for Dow 10,000 a year ago, and said to hide your money in mattress as banks are not safe also. I felt compelled to counter his views with data based on interest rate versus return on capital, and a buy and hold return of 40,000 fold a century. It occurred to me that my approach is somewhat Malthusian. Earnings grow by a compounded rate based on the return on capital. This trumps algebraic opportunity costs and interest rates.

Anatoly Veltman writes: 

Of course what can't be historically tested is next year's stocks profitability following a 35-year fixed income rally. That means that no history is helpful to one's S&P positioning today.

Gary Rogan adds: 

Why does this situation have to be viewed in terms of the trend that led here as opposed to the set of numbers that exist today regardless of the path to the present?



 I'm wondering if others have this experience. Sometimes when I try to reach for something new or novel, I never seem to find it. Other times I look to what I already know. The weird thing is I learn more that is new and novel when I look at something I thought I already knew. The most simple thing that I thought I knew 15 years ago–it turns out I had only the most superficial understanding of it. With luck, in 15 years I will feel the same way about what I know now. Some things are so deep, perhaps it is only just before you die you finally understand half of it, but at each moment you felt you knew everything about it.

Stef Estebiza writes: 

The more you accumulate, and from different angles, points of view, the more your Dbase accumulates nuances, alternatives on which to reason. Reread old books. Concepts overflown and unassimilated, suddenly seem logically obvious. Like trading, the more you experience, the more you realize that they are many faces of the same coin. The problem is that the brain eventually degenerates, loses enamel, and has a hard time tracking down the cluster stored. The hard drive is likely to lose sectors. For this reason you take photographs, directors make movies to store the emotions, a programmer writes a code idea to simplify and recover in a moment the hard work of years of accumulated experience. There is nothing more powerful than the human brain…

anonymous adds: 

Practical trading experience and genuinely new research into live trading applications is asymptotic, i.e there are permutations and combinations of market outcomes that have never happened before. So, in that sense, one never reaches perfect knowledge.

The reaching for something 'new or novel' often comes after observing something new work perfectly and then trying to test it and seeing that it is, like most things, ephemeral.

Intriguingly however, there are things about markets that one can know everything about. I do not believe that 99% of market participants know everything that is publicly available about the quantitative (measurable) securities that they trade, invest or hedge exposures in. Things like: How the Bund and DAX futures open and what goes on in the 60 seconds between the two events.

One can know everything that has happened to a market individually and relatively in the past. The Chair and Ms. Kenner have suggested a periodic table of markets with a bunch of relevant statistics. One suspects this would help prevent much stupidity.

The heterogeneous nature of the FX markets, the uselessness of Value at Risk, the times of day when market making machines are maintained and serviced, the importance of New Zealand and Australia to FX are all knowable.

So, yes, I understand your sentiment.

Also, 'simple' is relative. My first 'upstairs' trade in 1992 was the purchase of an SPI futures contract because it went through a line someone had drawn on a chart. Could there be anything simpler?

Well, on Thursday I sold EURUSD based on an approach I have used more than a score of hundreds of times that looks like rocket science compared to the 1992 stupidity.

As you say, perhaps we will feel the same in another 20 about what we do now.



 As part of an amusing, frustrating, wretched but ultimately uplifting and loss minimising part of my daily routine, I categorize mistakes made, differences observed and yes, things that were done successfully in a timely manner.

The hope is that there are some pedagogical benefits to be had from said classifications. What follows is a hard list (no wisdom or homey style nuggets).

It is regrettable that I do not have much perspective on broader aspects of life outside markets that might allow something approaching the towering lists of a Tom Wiswell. But it is what it is and anyway, I have Messrs. Jovanovich, Watson, Niederhoffer & The Poltergeist that provide one with regular cerebral sustenance.

I entitled this post the things 'we' do wrong. The list is mainly me, but I have had the privilege of observing the best and brightest so there are are few others added. All of their problems are subsidiary to mine:

1. Not enough focus on the stock market. I have missed substantial turns in stocks bearish and bullish because one imagined a speculation in Gold, for example, to have been more important.

2. Ignorance of a certain portion of the trading day (heaven forbid I might rest a while). In my defense, this has been fully rectified.

3. Not focusing enough on trade size. I keep an approximately equal size per speculation as I take some 2500-3000 odd trades a year. My view has been if one trade stands that far ahead of the others in terms of expected return, then why would you bother with the 'sub optimal' trades? Thus the constant position size.

4. Ignoring holding period (I am fortunate to say that this is not a point of worry personally).

5. Never adding to positions.

6. A dislike of hard core programming. I much prefer a simple interface through which questions can be asked. It is notable that the only products in this category that are any good are not available for purchase. It is only in recent times that programming/ hacking skill was valued above picking direction accurately. A reckoning approaches on this but I will not discuss it here.

7. I trade too many markets. My universe has 23 macro instruments in it. 3-5 would suffice.

8. I have never found anything REPEATABLE with a holding period more than a couple of days that satisfies me or any of my backers (who would never allow a 10% + drawdown).

9. This one is a bit controversial. I always assume the other market participants are 'better' than me. That their strategies are better in some way. This has stopped me going for the kill in a few very notable instances.

10. I don't have risk on in the moments before scheduled economic announcements or planned flexionic commentary. This has cost me but has allowed a very very low volatility relative to return down the years.

Ed Stewart writes:

Good list. Particularly the conjunction of size, time horizon, and to add a few of my own - reaction to a destabilizing price shock, endowment effect, prospect-type behavior, distractions such as an in-law asking to participate with you for the day, rationalizing excess conservatism when aggression is warranted which leads to the avoidance of big scores, among other things.

Vince Fulco writes: 

Chutzpah built up over an outsized good run (frequency of wins or profit generation) leads to stepping on a landmine you could have avoided if leverage was kept in check.

anonymous writes:

I've accepted the fact that I will feel like an idiot on a day to day basis. The upside of this is that when I calculate a 6 year compound return as I just did last week, I'm stunned as to how it occurred. How can one climb a mountain (in my case a not so big one) while always feeling one is falling and failing.

Victor Niederhoffer writes:

It is always good for a speculator to be humble. Also I think to follow Irving Redel's rule whenever people ask him how he's doing in market: "Fair". 



I'm not sure how to frame this out yet (perhaps others have ideas) but I am thinking of an accumulation indicator. The basic idea is this. Have you ever seen a market that went from "volatile" to almost a controlled, with a steady rise up. The qualitative thing you see is every single morning dip reverses very quickly. The second thing is that over a period of time there are no sustained pullbacks of any magnitude, an invisible hand guiding the market up. You can imagine how that kind of market feels for a short–every single short covering opportunity is thwarted prematurely.

Regardless, out of these conditions the qualitative hypothesis is that the price needs to accelerate before it can reverse or have a substantial correction. The question is, if defined quantitatively, might such an accumulation pattern show above average expected value. It is perhaps the flip side of the normal swing-type idea of buying a dip. Also, it might be helpful to only look at markets that have a positive drift.

John Bollinger comments: 

Fred Wynia's volume work addresses this concept quite well. The work
is proprietary and quite elegant/sophisticated, but the underlying
concept, that of measuring and comparing volume in swings, has been
around for a long, long time. As usual, the devil is in getting the
details right.

Gary Phillips writes: 

Ed, good luck trying to develop an indicator that is both robust and deterministic. Just a note however, if one only looks at markets that have a positive drift, back-testing results could be affected by said structural bias and rendered useless because they would only reflect the longer-term tendency of the market to go up.

Ed Stewart replies: 

Thanks. The idea as it stands is to complex to begin evaluating. I don't think I have captured the essential nature of the idea yet. I'm going to look if any specific elements of the idea on a stand alone basis. In terms of drift impacting results, that is very true. Drift needs to be incorporated in or it is pure futility. Many years ago when I was a random reader of the site I emailed in and Victor sent me a paper explaining a method that I still utilize, if I recall correctly. That ended up helping me tremendously. 

When I wrote the accumulation post, it was in large part based on watching the climb in IBKR over the prior few months and also similar observations on a short-time horizon. What do you know, IBKR has accelerated quite nicely. Up 5% today and almost 10% in prior 3 days. You can see the qualitative example if you look at a 3 month chart. No luck though, understanding the phenomenon on a systematic basis on the intermediate term. I've had luck with the idea on a shorter time horizon though. 

Gary Phillips adds: 

Most trend following systems have average win rates because of high draw-downs during whipsaw periods. The fundamental problem of most trend-following systems is that in order to deliver a high payoff ratio they must sacrifice a high win rate. If you try to increase the fraction of winning trades, the payoff ratio will suffer. So in effect, you would like to mitigate the negative effects of these problems by by combining a trend following strategy with a short-term trading system that would compensate for the negative trend following performance when markets are range-bound or mean-reverting. I am sure there are those that would argue that volume and volatility are both robust and deterministic indicators, but neither rising volume, nor falling vol, are necessary, nor sufficient, for the market to always trend higher, and even if they are randomly presented they do not necessarily establish timing. 



 I just computed the compound annual return of my IRA for the last six years, which is the period over which I have had it. I made what might be an interesting finding. Perhaps it is just chance, but I doubt it. When I stopped reading libertarian blogs about half-way through the period (3 years ago), my returns from that point forward increased by about 10% yr vs. the average of the prior three years. I was definitely not buying the regular staple of small cap, money losing miners headed towards zero that libertarian sites tend to recommend, but I do think it colored my perceptions in a negative way.

anonymous writes: 

Do libertarian blogs really recommend microcap miners? That sounds like more of a goldbug site. Just want to make sure us libertarian kooks aren't being lumped in unfairly with the goldbugs.

Ed Stewart comments:

There is a lot of overlap, at least on certain sites.



From my limited experience, assessing equity from balance sheet information can be a non-trivial exercise. An issue is the company's assets. Specifically, what are those assets? How were they acquired? What was the accounting treatment?

I've been involved in situations where companies debated the merits of expensing capital costs and capitalizing expenses. Accountants tend to see this question as a black and white issue. Financial officers tend see it as a strategic issue.

The issue frequently arises in project finance. In particular, long-term capital improvement projects tend to finish with complex cost structures. In my experience, capitalized costs can represent half expenses and half assets (bricks and sticks). Some of those expenses include officer salaries, professional fees, corporate allocations and other distributables. In the end, retirement accounts prorate those costs according to the strategic need of the parent company. Once the accountants retire the plant (that is, allocate final costs across company retirement accounts), the asset capex strategy is locked in.

The issue also appears in operations and maintenance. Sometimes replacing expensive equipment is expensed. Sometimes it is capitalized. Often, there is a combination. Again, accountants tend to see this as a black and white issue. Financing, legal and regulatory people understand it as a strategic issue.

The issue pops up in special cases. It is common for utilities to create regulatory assets out of expenses. They do this with the knowledge and approval of their respective state regulators.

I've found the accounting of assets is not consistent within the utility industry. Policies change over time and by geography. They change as economic conditions change. They also change as corporate administrations change.

Finally, there are the subsequent issues of asset depreciation and mark-to-market values. While depreciation appears simple, it is not. How depreciation schedules are developed and used is complex and difficult [impossible] for third parties to analyze. In addition, the depreciated value of the asset is often uncorrelated to the asset's mark-to-market value.

For me, assets can be fuzzy numbers. Any analysis using asset values as a critical component can also be fuzzy.

Ed Stewart writes: 

All good points Carder.

Another issue is when a company clearly has very valuable intangible assets that are almost completely unrepresented on the balance sheet. Consider Nathan's Famous, best known for its flagship hotdog restaurant and sponsorship of the eating contest. They build on top of that brand value to create a licensing business. Last year (ending march 31) they did 18M of this business, which is almost pure pre-tax profit as they just get a % of sales, renting the brand to a manufacturer/distributor. Capitalize that at a reasonable rate (licensing revenue streams usually valued at a premium) u see it is worth quite a bit of money. Yet, on the balance sheet intangible assets is only something like 1.4M, which is absurd from an economic perspective. 

Stefan Jovanovich writes: 

Accounting was developed to catch internal fraud; the whole point of double-entry was that it required two different people to keep track of every transaction. As long as enterprises were family businesses, single-entry worked just fine (as, for example, in the Rothschilds' books well into the 19th century). In that sense, all "book" numbers will be maddeningly disappointing in terms of their economic logic.

Rocky Humbert writes: 

S-man makes an excellent point. To wit, some of my worst investments have been in insurance company stocks that were trading at significant discounts to their stated tangible book value. What seems to happen (with annoying regularity) is that the company "discovers" that they under-reserved for claims and they write-off massive amounts of tangible equity — leaving the stock at a premium to book value. Hence I view a substantial discount to book value as a warning sign of impending bad news rather than a blue plate special. Mr. Market may go through bipolar episodes, but he's quite astute most of the time.

Ed Stewart writes:

Ive seen another situation beyond unforeseen markdowns that can cause trouble for an investor looking at book value to find undervaluation. The issue occurs when an investor marks book value assets "to market" and finds a supposedly huge undervaluation. The first problem I have seen is that it is very easy for a bad or even mediocre business with a good asset to somehow encumber or use that asset in a way that is not helpful to shareholders - feeding a lousy "growth initiative" or simply mortgaging an asset to fund continued operations. It's amazing how many "value bloggers" write about truly crappy, sketchy businesses because they think they spot this type of situation.

In the case where the business is decent, that by no means the business is going to realize the value of the asset over any reasonable time frame, which means that the value must be discounted far off into the future. So far and so uncertain it might be impossible to assign much value to it at all. In this second case, it might add some positive option value to a decent business that is otherwise worth considering, nothing more. My conclusion is that without an activist situation or change of heart by the CEO or some similar circumstance, undervalued assets are not always what they are cracked up to be.

Gary Rogan comments: 

A bet on undervalued assets IS a bet on an activist situation and/or if not "change of heart by he CEO" change of the CEO. Undervalued assets will not of course suddenly start performing by themselves. That's why "undervalued" cash on the books or undervalued assets combined with a substantial cash flow are so much better than an "undervalued" steel plant or similar: cash is easy to understand and reuse and attracts activists, acquirers, and CEO replacement.

Andrew Goodwin writes:

Not sure why the talk on ratios attracted so much interest. In a group that favors scientific modeling, why no thoughts on finding the significance of each industry valuation ratio through regression studies? 

Charles Pennington writes: 

Stefan, what's your definition of "soft jobs"? Do you have an opinion about which companies out there are wasting their money on "soft jobs" and which are acting more wisely?

Stefan Jovanovich replies:

This is a feeble answer to your question, Charles, but it is all I have. Cantillon wrote that nations got into trouble when their tastes for what he called "luxury" outran their capacities to make enough money to pay for them in foreign trade. He was not a mercantilist, but he thought that nations had to accept the verdict of the foreign exchange market when it went against them. They could not use "Chinese paper" (Singleton's phrase for puffed-up securities) when their counter-parties expected coin. As Cantillon put it, nations cannot use use finance as a substitute for commerce and they cannot indefinitely leverage their credit so that rich men's wives could continue buying more lace. For at least some of the time, even the wealthy have to endure being less rich until trade once again comes into something approaching balance.

It seems to me that many, many companies are now like Cantillon's luxurious nation. David's drug companies are one set. Their profits are projected to continue to grow enormously even as the savings and earnings of the hospitals and governments and individual paying customers have stagnated and even begun to fall again. The drug companies' happy futures are based on the assumption that the centrally-banked remedies to the world's savings "glut" can somehow be transmuted into continuing demand without anyone having to endure even temporary insolvency. There is no arguing that the plan has worked up to now (cue John Hussman's explanations of why he has missed the last 5+ years). But, as the Orioles and other clubs regularly demonstrate, the last innings can be very rough even when the guys coming in from the bullpen have had such sterling records.

P.S. Ignore all monetary puns; this is not a recommendation to buy gold.



When the numbers look too good, there is an analogy for when one hires a specialist doctor (based on mortality/morbidity stats) or a lawyer (based on courtroom win/loss stats). If a doctor or lawyer has stats that look too good, it is often because he/she doesn't take the toughest cases.  

Ed Stewart writes: 

I wonder to what extent this applies in trading or evaluating traders. Do extraordinary numbers imply something is not what it seems. Certainly the obvious (fraud). but what about situations where it is not that. Do numbers that are too good at times suggest no real money is being made because no risk is present in the program? Reverse engineered to "look good" by metrics but not actually make any money.   

anonymous writes: 

There is a certain quantitative fund led by a renowned mathematician who has supposedly generated persistent returns in excess of 30% for many years.  That fund is not open to outside investors and is (supposedly) available only to employees and partners of the renowned mathematician.  The principals have a number of other funds which are open to outsiders, which have billions under management, and which have produced unremarkable results.

If one were going to set up a clever marketing scheme  one might use this sort of model. One would use the internal fund (with word of mouth only / no audited returns) as the bait.  And then sell the public fund which is vanilla to gather assets.  I am not a lawyer and have no opinion as to the legality.

Another scheme uses the survivor bias:  A manager sets up a series of funds and then closes the worst performing ones. The surviving ones have stellar track records. The manager then markets new funds using the track record of the surviving one. If the funds are segregated, it also produces large amounts of fee income.  A former Salomon Bros forex trader based in Connecticut got in trouble with regulators when he took this to the extreme by opening separately capitalized hedge funds that ran offsetting positions. When one of the funds blew up, the creditors sought to grab assets in the other fund.

A final scheme is what private equity and VC folks always do.  They segregate each series of fund.  They harvest fees from the winning funds but don't give back fees on the losing funds.  Of course if their track is dismal, the game ends. 

John Netto writes: 

Having spent many years living off of my P and L and working closely with quite a few in the Chicago Prop community who have done the same, there are simply strategies which lend themselves to personal wealth generation b/c they have significant capacity constraints and don't scale well. The reality is if you tried to run these at a higher scale it would decay the returns significantly and potentially alter market behavior around those respective trades.  I can say personally that when I'm trading an event with low liquidity getting out a 25 lot on the euro FX futures has a much different dynamic than getting out of a 1,000 lot. A trade which can make 20-30 ticks on the yen can have it's risk-reward profile altered considerably when factoring in liquidity and the velocity of trades around that liquidity.

Also, by exposing the strategy to the public and allowing for the returns to be analyzed you now open the possibility for the Intellectual Property to be compromised through reverse engineering.
So when I hear stories of funds or traders having return profiles like this I'm not surprised at all, even less surprised when they are not available to the public. Analogous to paying $25 for twitter on it's IPO when it traded in the 40s.

Stefan Jovanovich writes: 

What John wrote (thank you!) made me think about its truth regarding war. The big deployments usually produce terrible returns while the small units win the battles.

In the American part of the D-Day landings the mass bombings of the air forces were utterly useless (except to kill French civilians who, to this day, have been remarkably generous about not mentioning the stupidity and honoring the Americans' graves).

The "plan" was to have amphibious-enabled Shermans breach the fortifications. But only half of them even made it ashore; the rest foundered. Of the 66 tanks, 32 made is ashore (27 on Dog, only 5 on Easy). Against those 75 mm barrels the Germans had a roughly equal number of artillery and anti-tank barrels; the problem was that theirs were in reinforced concrete bunkers and pillboxes. Still worse, the artillery was supplemented by 40 rocket-launchers and 85 machine gun nests; against those the men on the beach had only their M-1 Garands.

For an hour and more after landing (H-Hour was 0630) the 1st and 29th Divisions were literally shredded because the Shermans and the combat engineers could not find a way to get them past the fortifications. What saved them was the fact that some individuals followed John's Rules. Even though all naval gunfire support was supposed to end at H-Hour, the 5 destroyers that were part of the Amphibious Assault Group - the Frankfort, McCook, Doyle, Thompson and Carmick - were ordered to close to the beach. (The order could easily have gotten the Destroyers' commander Sanders and the overall Group commander Hall fired for insubordination; under the assault plan all naval gunfire support was to end at H-hour.)

After the battle, James Knight, a Sergeant of the 299th Combat Engineer Battalion, wrote a letter to James Semmes, Captain of the Frankfort: "There is no question, at least in my mind, if you had not come in as close as you did, exposing yourself to God only knows how much, that I would not have survived the night. I truly believe that in the absence of the damage you inflicted on German emplacements, the only way any GI was going to leave Omaha was in a mattress cover or as a prisoner of war." The Chief of Staff of the 1st Division, Colonel S.B. Mason, confirmed as much in the report he wrote after inspecting the German defenses. "I am now firmly convinced that our supporting naval fire got us in; that without that gunfire we positively could not have crossed the beaches."…

Sometimes, good deeds are rewarded. When Hall, the Amphibious Group Commander, retired in 1953 he was still ranked only a Captain, but Eisenhower had him advanced to Admiral "in recognition of his battle honors". To Eisenhower Hall was "the Viking of Assault" (and a fellow football player). Eisenhower undoubtedly knew that, without Hall's, Sanders', Semmes' and the other Navy men's actions, the American part of the landings would have failed.



 "There is no reason why they should not be used by all momentum investors." :"Momentum and Stop Losses"

All traders are invited to the party.

p.s. Don't forget to send a thank-you note.

anonymous writes: 

This guy is making quite a name for himself of late. Book has been well received by Quant community. I had an advisor tell me that he thought Dual Momentum was the most important book ever.

Victor Niederhoffer writes: 

There is hope with useful idiots like this.

Ed Stewart writes: 

My thoughts exactly. More juice for the sprained ankle trades of all kinds, among other things.

anonymous writes: 

If you look in the mirror often enough, you will actually believe you look good for your age, until you see a photograph of yourself, and realize how much you've aged. This perceptual bias may be the result of the repeated exposure phenomenon. I see myself in the mirror everyday while I brush my teeth, and shave. My glances into the mirror are incidental and repeated on a daily basis. On the other hand, I rarely look at photographs of myself. No facebook, no selfies. The resulting effect is a psychological phenomenon by which people tend to develop a preference for things merely because they are familiar with them. Therefore, I have developed a bias due to the frequency of exposures to my image in the mirror. It has been determined that changes in affect that accompany exposures do not depend on subjective factors such as the subjective impression of familiarity, but on the objective history of exposures, and even more interestingly, when exposures are subliminal they are frequently liked better. It's not difficult to become subliminally seduced if one allows themselves to be exposed to a myriad of mumbo-jumbo.



 I have often walked down the moving average street, but I like to look at what number for the average elicits buying so as you get near it, you can hope for a nice change in the distribuion of subsequent changes. I like to stop and stare at the amount that the curent price is above moving averages of different length and look at the expectations that follow various amount above and below. The changes in direction of the moving average have also been of interest. And the first advisory service I ever bought in commodities was called 'the cumulative average'. 60 years ago I bought it.

Ed Stewart writes: 

In 2012 I applied a 10 - 20 moving average cross to VIX trading product as an example showing the propensity to trend downwards in those markets, do mostly to the massive contango effects that were even more severe at that time - I also noted that every single MA combination worked in a wide range. A guy has continued to track that simple MA cross in XIV (inverse VIX etn), and it has continued to work, often much better than "sophisticated" multi-factor systems. I have had a great deal of luck trading the VIX futures with a combination curve slope, moving averages, and my preference for getting a period after a (seemingly) failed breakout of elevated volatility.

My thought based on this is that if one has reason to believe a market has a great deal of trend persistence yet timing might still be an issue, the simple MA approach seems like a good or reasonable tool. It's not the tool or technique itself so much but the features of a market that count and define if an idea or tool might work.

On the distance from MA idea, I like to do a similar thing but use mid-point of an X period range or a point like open, close, or other specific time.

Gary Phillips writes: 

"It's not the tool or technique itself so much but the features of a market that count and define if an idea or tool might work."

Good point. Any technical information and inferences made from using this or related indicators reflect not a primary but a secondary process that involves compliance of the indicators with fundamentals and/or a cognitive bias. However, indicators that are derivatives of price, track price changes; and, if there is persistence (the future is like the past) they inevitably end up contributing to the myth that they are predictive.

Stefan Martinek writes:

I think the best tools/techniques "learn" from the market and use the data features in some way (e.g. market specific level of noise, noise "memory", etc.). This is why I never use MAs or anything that has MAs inside where we arbitrarily via parameter selection force our views on data. Good techniques are usually adaptive and ask data what parameters are preferred now.



 I wonder if the instinct to show off or "peacock" one's wealth is part of a larger social level mean-reversion process. Wealth display might aid in securing mates and other forms of social prominence, yet it also triggers envy which causes others to find ways to drag the individual back lower into the pack or target with new tax findings. In a fictional case, the gangster was identified and targeted because for once we went "flashy" with a vulgar fur coat, and was immediately picked out in the crowd, which triggering his ultimate downfall (also, listening to a woman when he shouldn't have)

Then you have the lists compiled by media of "top earners" that some of the members might prefer not to be on. Every time you see these, you also see the left proposing solutions to level things– "they make more than all the kindergarten teachers in the world", for example. So it seems the list compilers are also playing a part to pull things down–generating the fanfare that triggers envy.

Do markets that "peacock" in an unusual way also undergo this same process. Perhaps the markets that create more "flashy" signals are dragged down sooner vs. those that quietly advance without fanfare. Don't know if any of that is true so I am making assumptions that would need to be defined and tested.

anonymous writes: 

Do you think it an accident that Lifestyles of the Rich and Famous followed a decade thoroughly forgettable from an economic perspective?



 The more accommodating to other drivers I am, the easier it is to get through traffic and avoid potential crashes. Meaning, in those 100 brief moments of interaction between drivers that occur on any city drive, even in a city like Chicago that lacks any notion of community spirit, more than 50% will attempt to return the favor if you yield first are courteous. So you get a positive expected value, perhaps do to the psychological pull of the reciprocity principle.

I am wondering if there is application to this in our trades. One thing I like to do is start with passive orders that are pre-placed, then if/once those fill and the other guy has had his way, I "take my turn" and go active. And it seems many times there is a line of cars that follow along behind me taking their turn as if they were waiting for me to make a move. That observation would need to be tested, as it is based only on my ad-hoc observations. Perhaps this reciprocity or "taking turns" analogy can be extended to broader market action in some way.

anonymous writes: 

A substantial personage in whose employ I was for a few years used something like this,

Using T note futures as an example, he would offer, say, 2000 lots at say 19/32, 'allowing' the market to buy from him (letting them have their way). Once filled he sold 10000-15000 at the market–overwhelming them–taking his turn, as it were!


Ed Stewart writes:

That is exactly what I am referring too, only my experience is not at that size or in that market. My (ad-hoc) observation is it is a useful tactic precisely when it seems most foolish by "normal" logic that does not take into account how it alters other trader behavior (similar to the driver analogy)–creating a shift in tone or sentiment for the rest of ones "drive home". 

Anatoly Veltman writes:

Ed, not sure if anyone finds ANY link to markets further in time of this discussion - but I have a comment re: your initial premise.

I've driven over a quarter million miles, mostly 30-foot vehicles, without an accident. I happen to be a holiday driver (i.e. not driving daily where I live in NY, and not having owned a single car since my distant student years). Unfortunately for myself, I'm yet to own GPS or even use one for the first time - this btw may tie into FB raw that list just went thru. I never opened a FB account to date, either. I think we venerable listers may be too lazy to adopt the basic society's milestones - and no wonder the latest 24y.o. billionaire is way ahead..

What I did found on my dozens drives coast-to-coast and the hundred drives of the entire length of the I-95 was appalling to me, but apparently a norm to what you're participating in daily. Passing thru any urban thru-fare, I see cars obediently lined up for minutes (and possibly adding up to hours), invariably leaving the right lane completely empty and entirely legal to drive on (this is the regular lane on the left of the prohibited shoulder lane). If I once did NOT make use of that legal right lane, giving me substantial edge in traffic, I'd quit long-distance driving summarily. But as it is, it gives me tremendous pleasure to skip hundreds of area regulars in minutes, and leave their daily congestion in rear-view mirror



 Is it possible that many of the market-making strategies that are harmed by "spoofing" are in fact increasing instability by reducing the incentive for large, highly capitalized traders with significant staying power to use limit orders?

They get tired of price crashing to their level, and then literally turning to the tick there, so they switch to other execution approaches that do not absorb energy in the same way–the risk/reward of such activity becomes more and more skewed do to the hft strategies that lean on them. The problem is that when these hft market-makers see one sided order flow, they shut off their computers–yet now, do to their practice of continually leaning on large "real money" orders, the real money traders are mostly gone so no one is there with any capital to absorb or slow the decline.

I am not saying it is good or bad, right or wrong, or even if what I just wrote is completely accurate or even partly accurate, only that there are alternative narratives to events that we never seem to read.

Here is the full email from the fellow. 



The reasons trend following doesn't work are myriad including ever changing cycles transactions costs, and bid asked spreads, the opportunity to game the system against them, and the ease of triggering mechanical rules and the fact that markets are homeostatic, and supply curves change as prices move up or down.

Ed Stewart writes: 

In my opinion, part of it is that people who mostly trade their own money look at IRR or "cash on cash" returns, and thus see issues of gains and losses more clearly vs. those who only look at marketing documents and time-based returns of recently hot funds.

Larry Williams writes: 

Trend following does not work on just one (or 2, 3, or 4) instrument. Trend followers have to have a large basket of 'bets' on the assumption that someplace in the world a market will trend and that one massive trend—think CL this year and last—pays off the other bets.

It's like betting on all the numbers in Roulette one number pays big odds. Trend followers say they cannot predict which number will show or market will trend, but with enough numbers bet, one will win.

Stefan Martinek writes: 

Larry, you make a great point. TF is more risk/exposure management on a basket than trading. Argument that benefits of diversification end after ~20 markets is such a nonsense (my teacher said that too together with other corporate finance theories; they probably never tested anything outside of equities).

Diversification across groups, styles, markets, and time frames improves risk adjusted returns in a long run. Of course in a short run concentration is great - let's bet all on Apple. TF has a nice barrier of entry which is good: First, some money is needed; second, most operators cannot run 2 years without rewards if necessary. They quit. Philosophically it is somewhere between "systematic macro" and "private equity". In PE you expect that most bets will be a crap unless you are in LBOs and other later stage deals. You expect that some areas will be in slumps maybe for years. Patience is such a great thing if one can afford it.

Orson Terrill adds: 

Well if I hadn't unnecessarily deleted all of my old code I would just spit out some examples… I wrote several functions that tested trend following, and mostly what was observed was that the number of intervals (days, weeks, whatever) in which a trade would be open generally follows an exponential distribution.

For those that do not know what that implies: Lets say trend "A" has been going for 5 days, the probability that the next day will be the end of trend "A" is roughly the same as if trend "A" were 1 day old, or 20 days old. The next day the probability of "A" ending is generally the same, regardless of its age (like a Poisson process for the arrival of the end). The general notion that longer trends are more, or less likely to end, due to their age, is not backed up.

Just because a run is multiple days old/young does not mean it was profitable. In many markets nearly half of the period's range is traded through during the next period, on average (I think this is true on almost all scales in the EUR/USD, but its been a while). This means getting in on momentum greatly increases the likelihood that a trade is entered at such a point where near term downside is slightly more likely than near term upside (assuming its a long equity position).

There were marginal improvements through adding responses to measures of volatility(mostly changes in absolute ranges), rates of change of price medians from multiple length of time intervals, and most significantly in the general case: reversing intra-trend can garner a couple tenths of 1%. Specifically applying those while using several time series which switch regimes in the sharing of strength of running correlations in percentage changes like SPY, TLT, and GLD, might have some interesting results (I eat what I kill, so I had to leave it there).



 One of the most frustrating things in trading is when you research a (qualitative, not a systematic) trade, stay up late figuring out how you want to express the idea to maximize gain and minimize loss, and then the next day when you want to put on the trade that stock is up near 3%.   

Considering it has done nothing for months you figure, "I will wait till to buy on a decline a bit lower".  Then the next day you see it is up 8% and the options you had looked at were would be up 60% in a few days had you conceived of the idea just 1 day sooner. 

I think at such times (similar things have happened to me 3 times so far this year) one is very prone to going on tilt, such as finding some other market to chase, or otherwise do something out of frustration that is not logical and end up losing what you would have made had you been one day sooner.   

I am wondering if there is any way this sequence of events can be generalized beyond specific circumstances of one trader, to general market phenomenon, maybe even events that lead to predictable circumstances.

Jeff Watson writes: 

Whenever I go surfing, I miss a lot of good waves. I either am in a wrong position, miss it completely, or just blow it off thinking a better one will be behind. I never feel bad about missing a wave because there will always be another wave sooner or later. I look at trading exactly the same way I look at surfing.

John Floyd writes: 

Agreed, put another way as someone once said to me “there is a bus every 5 minutes”.  Also importantly in terms of the limits of time and energy don’t spend it worrying about missed moves, focus on what is ahead.  

I read a poignant quote recently in The Joyful Athlete: ”Second tier athletes tended to beat themselves up for mistakes, while the champions simply noted their errors and moved on, wasting no energy on self-recrimination.” 

Stefan Jovanovich writes: 

I have the same problem. Sometimes I wait on a trade too. I think it is greed, the desire to seize the least/highest perfect. So I remember: "Luke, trust your instincts!"

Anonymous writes: 

I strenuously disagree with the philosophy that "there is a bus every five minutes." (My late great father used to say, "there's always another street car.")
This is a rationally flawed analysis. Because it treats an opportunity cost as economically different from a realized cost.  The reality is that the P&L from an opportunity cost is real, and it compounds over time. And this is true so long as one is consistent regarding timeframe, methodology and performance benchmarking. The most pernicious thing about this street car delusion is that it can be hidden,  rationalized and forgotten.
By way of example, our fellow Spec Lister and Bitcoin Booster, Henrik Andersson declared on March 12: "Crashing commodity prices, currency war, crashing yields (with a big chunk of European debt trading at negative yield), surely this can't be because everything is so rosy in the world, this cant possibly be 'good' news. Couple this valuations close to ATH  and I have for the first time in 25 years sold everything (I started investing when I was 12). Everything." 

Since this declaration, the SPX, Dax and Nikkei have all risen between 3 and 6% — and the DAX is at an all time high.  If Henrik measures his performance on a daily or weekly basis, this is a bona fide opportunity loss of substantial note. But if Henrik measures his performance on a long term, multi-year basis, it is way too early to render a verdict and this opportunity cost may well morph into an opportunity gain.

John Floyd comments:

Point well taken and a good one. I was afraid my quick comment might garner the need for elaboration.   The point I was trying to make is if you “miss” a trade you should learn from the experience and move on, while trying not to repeat the same error in the future. Juxtaposed against expending energy lamenting the perceived lost opportunity, which also has a cost. Assuming this is done with some degree of improvement I think it is both rational and sound.  In this way the opportunity cost is treated as real and minimized over time. If there is improvement made then returns are compounded in a positive fashion as opposed to a pernicious one.  In anonymous’ example that might even mean Henrik recognizes what may or may not have been an incorrect thesis and “buys” everything the minute he read anonymous’ post.  

Sushil Kedia writes: 

My two cents on the table:

Opportunity costs as well as realized costs are both known and quantifiable only after the market has moved. At the instant of a decision as to whether to decide to take a trade or not, both are unknown.

Since a real P&L is a progression of a series of unknown infinitesimally sized but infinite number of moments, it is likely a flawed debate to undertake whether or not opportunity costs compound, since if those said opportunity costs actually turned out to be realized losses they too would compound.

Transliterating approximately what the Senator has said often in the past, the purpose of a trader is not to be in the market, but to come out of the market, one would like to tune one's mind to focusing on how much could one gain without losing beyond a point. For each this is a unique set of numbers despite the market being same for all. This uniqueness comes not only from different skills, but different restrictions on the types of trade one is allowed to take, the different marketing pitch each has to use for garnering risk capital (oh we keep transaction costs low), the different risk tolerances each must remain within etc. etc.

So each needs to focus on how one will travel from an infinite series of infinitesimally small pockets of time in deciding when to not decide. 

Paolo Pezzutti writes: 

With regards to missed opportunities, I have two observations.

Firstly, I think our mind is biased in focusing on the good trades that one could have made. We tend to forget the bad calls. It is true, however, that if your trading methodology is systematically not "efficient" then your performance will eventually be sub par.

Secondly, if you continue to miss opportunities, you may have an issue in pulling the trigger when it is the right time to do it. I have a long way to go to improve my trading and I think I have to work on both these areas. My trades are inefficient, because I can spot good entry points but my exits too often get only crumbles that the market mistress is willing to leave on the floor after a lavish dinner. Moreover, one tends to be afraid of taking the trade right when the risk/reward is more convenient, that is when fear is the prevalent sentiment in the market, the moment when you should "embrace you fears" as Larry Williams would say.

As a final comment, I have to commend the market mistress for her naughtiness and deceitfulness. The employment report on Good Friday released with markets closed saw prices of stocks plunge seriously (20 pts in 1 hour) to get 30 pts back on Monday.  Many opportunities during the Easter weekend in stocks, bonds, currencies, commodities because of ephemeral end deceptive moves. Who knows if they were orchestrated or simply "random". 

I went short gold on Thursday at the close (1715) at 1202.6. The first price  printed on Monday was 1212.7. I eventually took a loss later that day of about 14 points. After 2 days gold was down at 1994. Focused on my potential loss, I did not exploit the huge opportunities offered. Afraid of even bigger losses, I liquidated my position instead of trying to close the big gap printed at the open. Moreover, I did not buy stocks or bonds to trade the obvious lobagola move. Double damage.

It is a matter of mindset.  There are coincidences, situations; there is the ability of a trader to translate into action tests, statistics related to these conditions created by the market mistress. The more extreme the conditions, the more compressed is the coil, stronger and more powerful it will be the reaction in the opposite direction. Much to learn.

Duncan Coker writes: 

I have always had a hard time reconciling opportunity costs/gains with realized costs/gains, though I know in economics they are comparable. For example, a casual friend offered me a private investment opportunity which didn't smell quite right and I declined and I left the money in cash earning -1% real rates. Shortly thereafter the enterprise went bankrupt and all would have been lost. I suppose on an opportunity basis it was a huge success for me, 100% gainer, and yet my cash account is the same earning -1%. Every day trading is a missed opportunity to be fishing on a nearby river which is easier for me to grasp and adds to the overall cost of the trading endeavor. Being able to forget and move on is a useful thing in trading. A swim or run at the end of the day does it for me.

anonymous writes: 

I do believe one can go broke from taking profits. Maybe if one has very few positions at a time this could take a while to notice (the benefit to marketing a long term strategy of any sort– few observations) but everyone will fail.

Think of football, a defense might determine that if they can hold the other team to 17 points that they have won their part. What if the offense deploys their secondary after 14 points? May your successes be larger than your defeats.

We are playing an unbounded game, we have no idea the amplitude of future gains or losses, let alone their frequency. Taking profit when unwarranted may not give us a chance at tomorrow.

As for opportunity, we all balance the fear of missed opportunity with the fear of loss. The more successful traders I've known are slightly more fearful of leaving money on the table than losing money. Slightly.

But that depends on the difference between the value and utility of the opportunity. Duncan, you bring up the ultimate question about the purpose of life. Way to make this a deep conversation.



Very happy. February 26, 2015: Exactly unchanged to open and from open to close. Anyone who trades loses the bid asked spread and more through stops.

Paolo Pezzutti writes:

There cannot be a forecast at any moment, but there are technical situations in markets that stimulate non random moves. These patterns occur over time. Although cycles are everchanging and all good things eventually end. You have to listen to the inner music of the market, the hidden messages that it sends at certain times of the day, certain days of the week, when it moves from point A to point B in a given time and magnitude. Behaviors are recurring because of regulations, operational technicalities of big players, effects of fear and greed on the herd, impact of margin calls, announcements, rollovers, etc… It is up to your creativty, intuition and ability to scan the markets finding the hidden jems that can provide you with a meal for a lifetime. Unfortunately, this is not enough to be a profitable trader. Similarly to other endeavours in life, I would say that the technical edge is never enough.

anonymous writes: 

Imagine the 1000's of shorts looking for their profit target on a day like today– "missed by a tick or two". Price moves back to breakeven– "Never turn a profit to a loss, time to exit". Price reacts down again– "but I can't afford to miss the overdue correction, It's now been confirmed". Then stopped out once again, to be repeated at the end of the day. If it held it overnight, it will gap up big the next morning for maximum capitulation. 

Gary Rogan writes: 

But is this intentional (teleological to get all philosophical) or just a day out of many days in which this particular relationship between the open and close holds? Almost all the other days are different, so how should one view this particular day: a totally random occurrence, somebody's clever plan, or the market itself deciding through some collective thinking process to play a practical joke on all the short-term trading participants?

Ed Stewart writes: 

Gary, if for a short-term trader there are questions that leads to meals for a lifetime if studied and answered, that is one of the better ones I have seen.

anonymous writes: 

The round number magnet effects must be exacerbated by the fact that many options strikes are at round numbers. Pin risk and gaming risk of options are real. Exotics make the numbers hidden but draw in large capital sometimes.

You can't see the motivations if the options are OTC and not listed. Recall the story of the large macro manager who got into a lawsuit with his exotic option brokerage firm. He was able to get prices to go just one momentary tick beyond his barrier knock-out/knock-in strike and the prospective payout was so large that the breaking of the barrier on the single tick was contested by the parties.

One of the parties offered unlimited supply on the offer to stop the breach of the strike. –Can't recall seeing who won that lawsuit. Still the fact that large players often think in terms of hidden strikes, could lead to defending and attacking of certain price levels on a given day. The exotic expirations are customized as well.

anonymous writes: 

A word about round numbers & option strikes in the OTC markets.

It is interesting to consider, study & think about the following;

1. What is the 'real' round number. Consider the currency markets. As I type, the AUD USD spot FX rate is 0.78244. The June 2015 AUD futures contract is at 0.7773. The forward FX points that one adjusts the spot rate by the get the outright forward are merely interest rate differentials expressed as FX points. So, if the futures price rallies UP through the 0.7800 round then the spot market will likely be around 0.7845/50 - arguably a 'nowhere' price.. So, because the futures price incorporates the forward does that 'round' have any significance at all. Arguably, the important 'rounds' are only relevant to the core market. It is an interesting null hypothesis that currency futures rounds of a given expiry are 'artificial'… Something to chew on there.

2. Another point about the 'Strike Price Heat Maps' that our magnanimous friends in various market making institutions provide in 'research' pieces/ updates. Be aware that many, many flows are NOT included in these due to wording in various Prime Brokerage agreements, other legal documents and sometimes courtesies given to, for example, institutions in mercantilist high growth non English speaking parts of the world. So you end up just looking at poor quality partial information infected by contractual, confidentiality & 'cover my posterior' bias.

For the avoidance of doubt and to pre-empt the snipers on the list who pop their heads up when a sacred Taboo of theirs is breached, I am specifically referring to OTC markets, incomplete information provided by market makers & bias that anyone who has tested the information will have seen in out of sample results.



One of the biggest sources of undue loss I have seen with active traders (decent ones, not the chronically hopeless) is managing day-based strategies on an intra-day basis, using untested assumptions about how this shorter time horizon operates based on the day time horizon idea(s).

Another is having a day-based system, and then managing it intraday based on ones P&L since entry. I have found that these two things are very good at turning a profit into a loss more often than should occur.

On the other hand if you have a day-based system and then do the opposite intraday of what people managing their equity tend to do, and test it, it is abnormally likely to be a decent entry point for a fast profit.

anonymous writes: 

As usual sir you have identified an excellent discussion point.

Within the HF community, the mismatch you mention is called being '5 minute macro'. What this means is trading substantial macroeconomic themes with day trader stop losses.

It is a dead giveaway when a Portfolio Manager of a discretionary bent ( managing say 150 million) sells 200 EURUSD because the U.S. is going to raise interest rates in the third quarter and puts a 30 pip SL in.

Genuine macro trading barely exists anymore. The names that come to mind are Bruce Kovner, Nick Roditi & Stanley Druckenmiller. This is probably a combination of conditions not being conductive in recent years (overall and with exceptions) but it is more to with investor preference for not wanting to lose any money.

Stanley Druckenmiller has an interview somewhere on You Tube in which he talks about how investors used to say that he wasn't trying if his years result was within +\- 25% and 'risk adjusted' returns be damned.

If one's method is genuine macro then one must have a reasonable degree of volatility in performance and long flat periods.

Consider this: The underlying assets that macro traders speculate in have volatilities generally in the range of 10% (currencies) to 60+ percent (energy complex). How then is a genuine trader of macro themes to keep his stop loss to 3% peak to trough (a common number in brand name macro establishments) with a Sharpe Ratio of 1.0 when the underlying all correlate and have huge volatilities… The only answer for these poor souls is tiny position sizes or perfection in entry and exit.

Interestingly, the Principals at the brand name shops do not have these same restraints…. Some allowing themselves 20% hard stops and 3+ consecutive losing years….. It's almost as if the 50-100 PM's at a large macro shop whose names are not above the door have the game tilted against them by their own sponsors… Almost as if they are all window dressing to make the firm seem more deep and substantial to conservative high fee paying 'investors'.

anonymous writes: 

"A perfectly timed trade" the macro trader thinks to himself. His well timed entry has lead to a very quick 30 ticks of open profit. Utilizing his trusty 5 minute chart, he sets a stop-loss just beyond the recent resistance zone. "It's time to sit back, be patient, and let the market do the heavy lifting," he thinks.

Yet the market throws a curve ball, as usual, and now the position is back to breakeven, leaving the trader biting fingernails as the P&L window flickers between red and green. "Perhaps I was early going in with my maximum position size" he contemplates. Clearly, the position will now get stopped out. Within minutes, he has exited with a few ticks of profit."… At least I covered the transaction costs, and green is always better than red".

Only now the market reverses big in what would have been his favor, dwarfing the prior move. "Four times my initial risk… and I missed it!" he observes in anguish. Price breaks a recent low, so the trader shorts again. "Price has now confirming my macro analysis - and a teeny risk is always worth the 20X reward" he rationalizes. The market reverses again, furiously, and stops him out again. Yet within seconds, price has rebounded 20 ticks from the exit point, which restarts the cycle. This train wreck of logic continues until the trader decides to take a break in order to "reset the bearings" and focus on the big picture.

At this point the directional move the trader has anticipated blasts off. He waits for a low risk pullback "I can't afford a stop loss that far from resistance, after all" but it never occurs. Having missed the original move and now seeing the market overextended, the contrarian side looks very promising - "clearly, this has become a reversal market". Yet when his resting limit buy order is filled, there is no rebound - indeed it is instantly underwater by 10 ticks, and within the hour he is down 100 ticks. He adds, and adds again…

At this point if he is with a big fund, (if Anonymous is correct, and I'm sure he is), the manager calls– the trader's call option value with the firm is now zero. "How could my correct analysis have lead to this point?" He thinks to himself as he cleans his desk and is escorted from the premises.



When you put a limit in, can the market smell a man like a duck, and come in very close, and then veer away at the last minute saying "whew, am I lucky, that man almost got me with his gun (limit)".

anonymous writes: 

It might be like recent tests show of cancer cells. They give off their own vapour /smell, to the HFT guys at a minimum.

Ed Stewart writes:

I think so. If the short-term edge is too great, they don't want to give you a fill. You have to let out some line first. And if you try to counteract what occurs you will independently discover the banned trading techniques.



Technical Analysis is not the only area where charlatanism seems to rampant. In my view, there is more than a little bit of charlatanism in the more reputable field of "asset allocation". Much of the problem stems from the fact that many of the well regarded practitioners don't seem to understand practical aspects of the market, such as capacity constraints, or that they are using hindsight to pick the winners within an "asset class" to represent the field. Also, their mostly flimsy simulation is exactly the kind of thing they would criticize if done by a technical trader. Calling what is effectively a speculative strategy an "allocation" seems to subject such things to a much lower level of criticism. I understand that all the people selling commodity-like products need a secret sauce for marketing purposes, but at times the useless tinkering gets ridiculous.

Gibbons Burke writes: 

Trust, faith and confidence are everything in this game, as in life. Men who can elicit confidence from others have a skill which may or may not correlate well with their ability to make money in the markets. The name "con man" is short for a "confidence man" because creating and maintaining confidence until the play is over is the essential skill of a huckster.

Rishi Singh writes: 

The biggest culprit I found in this "charlatanism" were those who did not have skin in the game but sold products that allowed people to put their skin in the game: banks. Asset allocation of "smart-beta" type strategies are being commoditized and packaged to be sold to clients, but if you look at the research it is ridiculous. They post strategies of sharpes between 3-6 and some of them are long/short commodities which significantly ignore capacity constraints. When you try to replicate their strategies, you cannot get close to those numbers. Our backtests found sharpes of about ~2, which we still discounted and when we ran our own strategies, we realized just a sharpe just under that (before fees). One disclaimer was our fund would never be the next Bwater given capacity constraints of these strategies.

The academics were not much better. I remember reading a paper that used cattle spot prices (not futures) in their backtest. I could probably only replicate the results of 15-20% of academic papers.

I am hesitant to blame anybody for this, as I think it is the current pervading culture of banks that promote quantity of research vs. quality. People need to feed their families and were taught these methods were okay. How you break the cycle, I'm not certain.

We did find the papers were fantastic for idea generation though and to reveal general trends in the marketplace. It did give us inspiration that helped improve upon our current strategies…unfortunately though it looked like they were planning to sell their strategies to clients as-is.

anonymous writes: 

Central Banking, and specifically the Federal Reserve, must be counted as one of the greatest confidence games ever pulled off.



 The Disney intellectual property focused economic model seems like an extraordinarily good one which I think can teach allot about money making in today's consumer economy. I am only scratching the surface and have little real insight, however I think it is still worth taking the time to consider, to better identify good investments and also to monetize our own ideas.

The movies and other entertainment programs are intense emotional experiences where kids bond with certain characters as heroes or loved villains. The fact that the huge investment in infusing new "magic" into IP assets (movies and their characters) called can in itself turn a healthy profit is extraordinary. In most industries that would be a huge cost that had to be recouped over years, vs Disney where it seems to be a profit or annuity on top of healthy profits. The smash hit and profit of a movie (and of course offsetting some of the losers), there is the ability to monetize the characters and songs far into the future through products that must have at least a 97% gross margin, and most parents have no problem buying armloads of the stuff.

Another great economic feature of the Parks is the complete integration of product sales with the various amusements. I was continuously surprised with the 1001 creative ways that rides and amusements were used to create a sales funnel for high margin toys, clothing, and accessories. One of the best was after the Star Wars 3d ride (very impressive!), where we exited our space craft and suddenly found ourselves in a bazaar-like selling space where we had the ability to buy all the characters, space crafts and light sabers - it was impossible to exit to outdoors without at least 100 sales pitches at the children's eye-level, and It seamed to me that at least 50% of riders were looking for stuff to purchase.

While exiting an accidental excursion into one of these selling spaces, I overhead a lower-middle-class looking woman telling her kids, "We have already spent $600 today, sorry we are broke" and I noticed her kids were decked out in Disney gear from head to toe.

Indeed, one of the benefits of visiting Disney is that it seems a window into the hopes and economic prospects of what might be called the dead-center middle class, and even the lower middle class. Tim Melvin (Who was kind enough to meet me for breakfast one morning) told me that many families save up for months, even years, for their perfect Disney vacation - including those who might otherwise be 4 months worth of paychecks away from losing their rent or mortgage money. It brings to mind the powerful role that time preference has in determining who rises economically, and who is stationary or falling. It seems that much of the consumer economy is an amusement designed to facilitate income shifting up the pyramid.

 Based on the promotional videos I watched, 70% families of color (all wearing polo shirts) might have been expected at all Disney Properties. In reality, over the 4 full days of our trip (and not including a few school groups) I saw no more than a handful of persons of color among the many thousands of guests. The only "complete" family of color (mom, dad, kids) I saw was in our hotel lobby, where they were filming a promo video for Disney Resorts! The other PC amusement in this area was seen in the Disney educational rides, where 90% of 20th century achievements were persons of color, including the female wearing thigh-high gogo boots sporting an enormous Afro, leading the NASA control room for the moon landing. As an aside an ugly-looking white male was seen inventing the computer revolution, but his back was to us and he seemed to lack significance and stature vs. the others, almost troll-like in his disposition.

Overall it was a very fun and worthwhile trip. The kids had a blast. It was a new experience for me, as my parents much preferred a place similar to Victor's "worst place in the world" with zero crowds or commercial interest of any kind, a fusty attitude I had maintained until this trip (And might now return to). One surprise was that the food at the restaurants was mostly very good, the primary difference relative to decent city dining was the larger portion sizes. It is a great relief for parents to be at a pleasant place for dinner that is 100% kid friendly, without receiving dirty looks even when kids are 100% well behaved. That plus the night-time ride on the lake to one of our dinner destinations was my favorite Disney experience. My son's favorite was the "Design a car" ride and the Star wars 3d, plus playing in the pool.

Tim Melvin comments: 

We have annual passes and go to the parks often. My observation has been that the demographics are right in line with the general population. There is always a large international attendance as well with Brazil and England be the source of most out of country visitor.

Disney is ruthlessly efficient about the quality of the guests' experience and squeezing every dime possible out of its guests. At times I will just get a coffee and watch a particular attraction for a period of time and the amounts of money spent in each and every little shop (says the man with two Grumpy sweatshirts and 4 coffee mugs that also have my namesake character on them). B-school students would do well to spend some time in the parks to see the sale power of customer service, marketing, branding and capitalism at its finest.

You do indeed see many folks their for their dream vacation of a lifetime with months and years involved in saving for the trip. These visitors seem almost desperate to experience in every park. There is a statement in there about our society but it's too nice a day down here to spend time on such serious matters.



 1. The January barometer has become a Judas goat for the weak to be slaughtered having failed big when down the last 3 times, in 2009, 2010, and 2014 with average subsequent rises in double digits each time (after holding in 2008) but failing in 2005 and 2003.

The stock markets swoon in last few hours on Friday, Jan 30 was 10th worst in last 15 years.

3. Some constructal numbers of the week: gold below 1300, SPU below 2000, and wheat below 5.00, and vix above 20.

4. The best book on science I have read is Michael Munowitz Principles of Chemistry. Some other great books I am reading is Paco Underhill Why We Buy (does for buying what we should do for the market in terms of scientific analysis), Russ Roberts How Adam Smith Can Change Your Life (applies the theory of moral sentiments to how to live happily in current days), Paul Moskowitz and Jon Wertheim Scorecasting (applies sabermetrics and counting to our favorite sports shibboleths), Michael Begon, Townsend, and Harper Ecology 4th edition (the best selling standard ecology book these days) and William Esterly The Tyranny of Experts (how planning leads to poverty compared to the invisible hand), Chris Lewit The Secrets of Spanish Tennis (gives some great footwork drills the Spanish use to rise to top), Lamar Underhood The Duck Hunter's Book (the most beautiful writing about fauna I have ever read and reread that makes you long for the beauty and poetry of bygone pastimes) Uri Gneezy and John List The Why Axis (uses pseudo experiments in real life and contrived anthropogical settings to attempt to prove liberal shibboleths like why genetics and incentives don't matter), David Hand The Improbability Principle (why miracles are likely by chance). That's enough.

5. The service rate paid by the world's most sanctimonious billionaire has risen from 2.5% to 9.5% on quarterly ebit this last reported quarter.

6. The ratio of stocks to bonds is at a 1 year low.

7. Gold is playing footsie with 1300 and SPU with 2000

8. Crude broke a string of 15 consecutive weekly declines with a 7.5% rise this week finally showing that futures moves to telescope reductions in supply the way Heyne elegantly shows they do.

9. The pythagorean theory of baseball runs scored for and against is a statistical due to random numbers, completely consistent with chance and has nothing to do with any recurring tendencies or baseball tendencies.

10. When my kids and relations start calling me worrying about how far the stock market is likely to fall, it's bullish. Conversely when they all start apps, it's time to wonder whether that goose has been plucked.

anonymous writes:

As to point 1.

I posit that all 'indicators', techniques and strategies in the public domain are worse than useless as presented. Within this I include everything preprogrammed into trading software like Bloomberg or Tradestation, the 'January effect', every indicator written about in Futures magazine etc… There are a few public strategies that some firms have made money from but the volatility is enormous and no note is made of survivor bias of others who used the strategy. There are then the preprogrammed techniques available that can be very useful but only as part of a bigger trading process. These last are probably less pernicious than claptrap like the RSI.

It belittles us all to discuss these things.

Consider it this way– everything that makes its way into a magazine or gets programmed into trading software is detritus from the core of truly predictive strategies.

If there is anything to be gained from this it is that you have to do your own homework. 

Larry Williams writes: 

With all due respect you are way off base on this issue; you mean to say OBV is useless, that seasonals have no value that volatility breakouts are worthless, that Bollinger bands are junk and select price patterns have no value? COT is just a joke, that watching spreads and premiums is the same as an Ouija board? Delivery intentions tell us nothing and advancing stocks, volume and Open Interest reflect nothing?

There are lots of great tools in public domain, just as there are good saws and hammers but it takes a good carpenter to make them work.

Anatoly Veltman writes:

Paragraph 1 falls apart on many levels: so what that "it" failed in 2009 and 2010 at price levels triple and double the 2015 level? So what that "it" failed in 2014 - then via principle of alternating years, "it" better work in 2015! But most of all: in day and age of still ZIRP manipulation, what historical market stats? The 2009-2010 were onset of QE, and 2015 is sunset!

Ed Stewart writes:

Taking into account changing cycles, I tend to disagree. I think there is quite a bit of stuff in the public domain that is very worthwhile.

For starters, a careful reading of Victor's book revealed many more specific ideas than it seemed on a casual reading, which I'm sure many/most here know. I have actually made more than decent money with a few ideas (gasp!) I found in the first market wizards book. Larry's book is a bit of a brain dump (which I always like, no offense there), but once again I found some good ideas in it.

I made (for me, not relative to a big fund manager) very significant profits in 2012-2013 using concepts that I first learned about (If I recall) on Falkenstien's blog, and for a time I tried to get a fund started to trade that market. My thought is that sometimes the market is rich for a particular approach do to a counterparty paying a massive premium, consequently sometimes these things go on even when everyone doubts them (which is why they might keep working).

I think the key to public domain stuff is that if one gets the concept behind a good rule-set there might be 1000 other rules related, waiting to be discovered that might be more attuned to the current cycle of market behavior.

Another is in combining ideas. For example in my way of seeing things there are environments were "naive" strategies are very effective - it is a matter of if u can catagolize that environment and then if there is some persistence to it in the next period (My finding is that there often is), though never perfect.

One last thing I learned is (perhaps contradicting the above) Don't ever write anything and assume that no one will reverse engineer and map out every qualitative thing you write. I had a trading blog that admittedly was mostly goofy stuff i wrote to draw free traffic from google, but also some pretty good core ideas I have made good hay with. Then one week I got emails from two different guys (one a big algo firm, the other an execution algo guy at MS) basically saying, "hey, I mapped out these ideas ideas, they really work - thanks!". The next week I took the blog down. So my conclusion is while some good stuff is in the public domain, don't put anything of value in the public domain yourself, even in vague terms not intended to attract a sophisticated audience. 

Stefan Martinek writes:

From whatever I tested, +90% does not hold or does not improve the base case. Few areas are fine despite being in public domain. They can be further developed. It also helps to start PC at least 250-350 times per year, and make tests before forming opinions. There are so many people with beliefs but when you ask them "show me the codes", there is nothing to show. Sometimes an argument goes that you can take anything and make it working, making the dog fly; I agree but I do not think it is a good use of time.



 Something today reminded me of a mentor (English teacher, older guy retired a few years later) that I had in high school. One of the key things he told me was, "Never get serious with a girl whose mother you would not want to have relations with, if given the chance". I think more than a few times that thought flashed before my eyes and it saved me from serious error, partly because it was memorable. I'm trying to think of any similar rules of thumb that might help us to avoid those trades or strategies that can severely set back profits, create anguish, and otherwise make things worse than they should be. Any ideas?

Leo Jia writes: 

Hi Ed,

"Never get serious with a girl whose mother you would not want to have relations with, if given the chance"– I thought that was only my words!

There can be many similar things for trading. Here are some for critique.

1. If you don't like someone's way of life, don't trade like him.

2. If you don't like the dominant players of a market, don't trade that market.

3. If you don't like the rule makers of a market, don't trade that market.

4. (I learned this one from Scott Brooks) If there is already a professional at the table, go somewhere else.

5. If you don't like a country's tax code, don't trade in that country.

6. If a market hasn't shown a lot of opportunities in the past, don't trade that market.



"World’s Largest Traders Use Offshore Supertankers to Store Oil"

This article is a beautiful example of how futures markets coordinate production/consumption/storage of commodities over time– creating the price structure and consequential incentives for entrepreneurial action.



 I was shocked to read that the default choice for premium pension savers in Sweden (not sure what a premium saver is) who are under 55 is a 1.5X levered global equity fund. My thought is that for an individual actor such a move might make sense, but I question if the market is giving enough to allow massive numbers of people to profit from such a technique at the same time - without in some way shaking most out with a disastrous IRR. It might be a sign that people are over-reliant on market returns to provide for their future relative to increasing savings rate and similar conservative measures. The same is true of the very popular "all weather" strategies that appear to get most of their juice by leveraging fixed income– which was shown in Roy's paper to the the source of over half of CTA profits as well. How can the market allow for great multitudes of people in "leveraged" products to simultaneously get above average returns over the long run do to a simple factor, leverage.

Based on the following article it appears that the managers are looking for tactical timing techniques to help them escape "popping bubbles".



 The rise and fall of the mortgage servicing tycoon might contain lessons. In every interview or article I read about him, I felt in not-so-subtle ways he was poking at the flexions– celebrating his triumph in the highly flexion-centric industry in a way certain to create animosity. For example, his public gloating about his firms 90% tax savings vs. the competition.

"The New Subprime Bet: How Bill Erbey Built A $2.8 Billion Fortune By Getting Inside Homeowners' Heads"

he moved his principal office from Atlanta to St. Croix, in the U.S. Virgin Islands, which happen to be an economic development zone. As a result Ocwen now saves 90% on its corporate income tax. It's also the reason Erbey is now worth $2.8 billion and may be the most innovative man in the mortgage business.

In the meantime, as he avoids the sun in St. Croix, Erbey relishes the attention his financial empire has gotten on Wall Street and on Main Street thanks to his "socially responsible" mortgage innovations. But he makes no pretense: "I am in the business of making money, but I try to do it in a way that I can go home and say that people benefited from what I did today." Even better when his new home saves his shareholders millions in U.S. taxes and happens to be a stone's throw from a Caribbean beach.

People laughed at us for the first 15 or 20 years. Today it's something that has been adopted by the industry.

I wonder what observations might have been made to predict the unraveling. On the other side I received quite a few emails and read quite a few articles suggesting his stocks (ASPS, OCN, both down 30% today, ASPS down from 150+ to 17 in last year) were great values mid-2014, and that the pending legal issues and lawsuits would all blow over.



 "Millennials regard McDonald's as unhealthy, outdated and downmarket"

I Noticed the dismal quality and service on a road trip in 2013, were I tried all the "new" menu items and found them worse than sub-par.

Ive noticed that many of the Downtown McDonalds (Chicago) are underclass hangouts nearly 24/7, to the extent I would not take my kids to one, period. Even the neat "Rock n Roll McDonalds" was recently hit by a flash mob, as you can see here.

I was happy to see the rumor that the Ackman might be targeting the stock, would love to see a shake-up including (first thing) removal of the failed CEO before things get worse. And I'd bet that there is a mountain of bureaucracy to cut.

Gary Rogan writes: 

The first article seems like a not-too-subtle Shake Shack PR piece. The Shake Shack propaganda is suddenly everywhere, helped by the slow news period when the IPO was announced and its NYC roots. The hamburger marketplace is just crap, pure and simple. It's saturated (with fat and otherwise) and a lot of exploration of alternatives has occurred due to the age and low barriers to entry of the basic concept. There is not that much to be done about McDonalds unless someone serendipitously hits some goldmine with some random menu item or trend. It may make sense for them to be associated with the urban delinquents if a lot of them congregate and eat there. Or maybe go full Angus and get the upscale clientele. Probably six of one, half a dozen of the other. There are better places to fish for both growth and value.

Ed Stewart writes: 

I agree, it was definitely a Shake shack PR placement. However I also agreed with most of the criticism it offered of McD, including the notion that niche, more targeted business models are more workable given the transformation from a relatively homogeneous population.

At this point I don't think the underclass is big enough to sustain a chain as big as McDonalds in the USA. The issue is that when they become a critical mass, they start to lose everyone else. Plus, the antics increase operating costs — stores with that situation become tainted very quickly.

Chipotle has been a great success for investors, but it is a health disaster. It's amazing that it is mentioned as one of the new "healthier" options.

Gary Rogan writes: 

I guess I'm simply looking at the present situation and not seeing much of a nationwide opening, either in terms of "fixing" McD or some deterministic success for a wide-footprint competitor.

McD and pre-existing large competitors have penetrated every nook and cranny of the US market (and quite a bit of the world's). This is not new. McD historically has been somewhat experimental as replicating local menu item additions and any other gimmicks on a wider scale.

There are "upstarts" like In-N-Out that are actually more than half-century old that have expanded greatly in the west and are still rapidly expanding. Should any gimmick like serving wine with your burger work anywhere they will copy it in a nanosecond or someone else will. Yes, it's possible that there is some solution either for an existing player like McD or a new entrant that will produce a Chipotle-like effect nationwide, but knowing in advance that anything in particular will work in the nationwide, and more so in the world-wide market seems like a risky bet.

As a rule, restaurants fail. Fast restaurant expansion plans usually fail. Once in a blue moon something succeeds and your availability bias will always move you in the direction of pointing at it and saying "See!", but it's still risky to predict a great success no matter what they do.



 The CME and the CFTC are doing a great job at destroying the market ecology by exterminating the 'spoofers' out of the futures markets. This clever species helps maintain the equilibrium of order flow by gaming liquidity asymmetries and thus keeping the population of naive momentum front-running strategies in check. It reminds me of the extinction and later reintroduction of the wolves in Yellowstone.

Ed Stewart writes: 

I can't see how spoofers are bad for anyone but the momentum front runners, as you suggest. There must be a "god given" right to jump in front of slower moving participants that we are not aware of. I'd love to know how the spoofing practice developed. My guess is it started as a counter-strategy to neutralize front-running before it became a source of profit?

anonymous writes: 

And "they" destroyed limit orders when they busted the trades during the flash crash. I guess front-running is the only virtuous and god-favoured strategy?



 To what extent are companies that have a high cost of search for an initial order from customers and then have recurring repeat business from profitable subsequent sales better values in the market than others. Such companies in my day were called mail order or data base companies. Companies like Keurig and LinkedIn and Gillette come to mind. Would searches under "repeat business" NYSE enumerate a subsection of companies with superior performance?

Richard Owen writes: 

At the other end, also a great source of accounting pyramids/shorts, as such long term customer strategies provide opportunity to diddle with customer acquisition costs, etc.

Ed Stewart writes: 

One good example of that type of business is the alarm business. U sell the equipment/sensors then sign the user up for a service contract. The service contracts are valued (and trade) at multiples of RMR (Recurring Monthly Revenue). The RMR multiple you can get is based in large part on the credit quality of your customer base - so if you ask for a credit check up front u get a higher RMR but might lose some sales of the basic system install or service up front.

It has been a terrific business for a long time and banks lend very willingly against the cash flow. On of my best friend's father took their relatively small business to a very large private company I estimate well over 1B private market value by pyramiding these cash flows with the aid of leverage, buying something like 70 companies over the years. One of the features of the cash flow is that the customer relationship is ammoritized quite aggressively. Basically so long as you grow u don't pay much in the way of income taxes on all the cash flow. Presently, they are considering keeping the highly valued (by investors) alarm business and sell their physical security (providing security guards to companies) business, which employs thousands of people. It is profitable yet not a great ROI, plus a major headache to operate do to employee count, potential liability, etc.

With employee problems growing including the new O care costs, It makes logical sense at the moment. Yet I can't help but think that in the next 15 years the Alarm business will face more extreme and innovative competition from tech companies (potentially from things like google nest?) as high ROI's must eventually draw in competition. At the same time the "crappy" business might go up in value as there is an increasing need for private physical security, even for residential areas. I could be dead wrong - perhaps Im rationalizing sellling the winner and keeping the loser? Perhaps the formula would be to sell the physical security, use the proceeds to expand alarms, then sell a few years beyond that? 



 American Exceptionalism. I have always hated that phrase and the perverse doctrines that accompany it. The American Constitution is remarkably exceptional; one wishes it were still followed. But the idea that we Americans were born or (equally bad) become endowed with some special grace is one that makes me look for the Exit sign in the hall every time I hear it.

It also reminds me of the disastrous presumption that infected so much of the period that Stern writes about and led to WW I.

Ed Stewart writes:

I notice that every time I start believing that I am an exceptional trader (like I did a few weeks ago), a large loss is near at hand. Best to curtail commitments at the hint of that feeling– the opposite of what the feeling suggests to do.

Gary Phillips writes: 

Success is more destabilizing emotionally than failure.

Ralph Vince writes: 

Failure is absolutely necessary–in fact, nothing is more necessary, in all aspects of life.

For one, it teaches the individual not so much not to do what caused the failure, but how to regroup, reassess and recover from failure. The lesson of failure is about what you do afterwards.

Many things in life require failure. No one learns, say, to lift a lot of weight, to solve a differential equation, or do a backflip on pavement, without failing many, many times. There is no may to accomplish many things in life without enduring the requisite and many failures required.

Jeff Watson writes: 

Failures teach you much more than successes which can lull you into complacency and hubris (like when you have 10 successes in a row). But you must attention pay attention to and analyze the failures inside and out. You have to ask yourself "why?". Ralph hit the nail on the head with his post.

Ralph Vince replies: 

The 13-year-old boy looks around the gym, struggling to lift pipsqueak weight. Failing.

I point to all the old smellies, putting up ungodly amounts of weight.

"You see those guys - every one? Every one of them failed at every increment, every 5 pound increment between what you are failing at and lifting what they lift and they failed at every increment over and over. That had to keep trying, eventually, sneaking up on it. Failure, repeated failure, is part of the process."



 Will the increasing popularity of securities-based lending create the next opportunity for "strong hands"? Lots of "potential energy" if certain pain points are breached, I would think.

On a related note, I've read that the super high short-term rates encouraged people to invest short-term in the early 80s, when with hindsight they should have been invested long term and locked in those 10% rates. Are super low short rates (opposite condition of early 80s) creating a mirror distortion reflected in things like securities-based lending - causing the public to lean the wrong way at the wrong time?

"The rise of rich man’s subprime"



 Monkeys trained to use a fiat currency make the same mistakes as humans: they are loss-averse.

There are few ways how traders manage loss-aversion: (a) Deleveraging. In other words, everyone has a breaking point and can operate below this "gambling" threshold; (b) Diversification. By spreading a total exposure over wider group of instruments our anchor to individual outcomes is weakened [focusing illusion]; (c) Operational controls to enforce trade exits in case that all the other things fail [Paul Willman's research of traders in the City of London].

But how to design a trading strategy which is built to directly profit from loss-aversion of others?

Leo Jia comments: 

If this means one decides to totally abandon the nature of loss-aversion, then one can go do against all he recognizes as loss-aversion behaviors. This brings a question about its true benefit. If on the other hand, one only wants to take advantage of others' loss-aversion behaviors but maintain his own loss-aversion nature, then what he can do perhaps is limited.

The question is what really counts as loss-aversion.

If what we mean by loss-aversion is losing 1% of assets, then clearly it makes great sense to abandon it. But as one is willing to lose no more than 50% of assets, is he still considered loss-averse? If yes, then how much benefit would he gain by relinquishing this 50% limit?

So if God enforced us a loss limit within which we humans operate, perhaps he gave us a limit that is too small. Is it truly limitless in His mind? Perhaps there is also a limit with Him which just happens to be somewhat larger than ours. This latter may seem reasonable.

anonymous comments:

For those who believe loss aversion is an evolved behavior, it makes sense in the world of extreme scarcity: if you are on the edge of starvation and have a little bit of food, losing all the food could be significantly more detrimental than doubling it is beneficial. This does have some parallels in today's world, as for an average person near retirement age losing all of their savings is significantly more detrimental than doubling them is beneficial.

In terms of the markets, taking advantage of this asymmetry would be something like this, I imagine: let's say the average market participant hates to have their holdings go down by 1% (or any other number) twice as much as they would like them to go up by the same percentage. Let's also say that on the average everybody's holdings have an equal probability to go up and down. If you can figure out how to bet a small enough amount of your capital not to go bust multiple times in such a way as to counteract that tendency than on the average you'll make good winnings. The big question is of course how to bet against this tendency. Should you always bet when others are fearful against their fear regardless of any other evaluations of the situation?

Ed Stewart writes: 

"But how to design a trading strategy which is built to directly profit from loss-aversion of others?"

I think you can open up the concept far more broadly. I see it as the fundamental concept for a near unlimited number of strategies — an idea close to the core of the trading game, regardless of the market.

I told a spec-lister I met with a few weeks ago that the concept (described differently) is 80% of my short-term trading focus — meaning if I don't see it at work I don't trust the idea much at all — to such an extent I've mostly given up on other things. It is very similar to the Bacon cycle idea, but on a specific duration or circumstance (which itself is subject to the larger bacon-cycle effect). Loss-aversion creates urgency, price-insensitivity, and enough order flow to at times scare market makers — all things which open the door to speculative profits.


-Times of day that loss aversion is most impactful or loss averse traders are prone to being active
-Price movements that signify loss aversion - quantitative definition
-Events that will trigger loss aversion
-If you know the basic "plays" or trades used by speculators on different time horizons, u look to anticipate who is about to be squeezed. If u define the setup condition (basic play) and a trigger event (of loss aversion) and combine them, you can find interesting ideas both on a discretionary and systematic basis that are highly counter-intuitive to most traders.



 Foxcatcher for me was highly thought provoking and educational on many levels.

1. It records the decadence of one man John Du Pont who was born to wealth, once his interests in ornithology, philately, and conchology receded.

2. It shows once again the violence that people without opposite sex partners are prone to. (apparently he killed Dave as a birthday present to a rival wrestler).

3. It shows the great composure, and consciousness, as Brett would call it, of Dave Schultze who never lost his cool during all his aggressive bouts winning the Olympic gold and world gold while maintaining a truly benevolent attitude towards his life and students.

4. It shows the athleticism and sports genes of a truly great athlete in Mark Schultze who was always in the brother's shadow even though amassing the same golds, and adding an ultimate world to his laurels.

5. Once again the seed of the problem was the the Wrestling association like all official bodies tends to impoverish it's customers while enriching themselves thereby leading to the poverty of Mark that made him bend to the will of a crazy man as the only way to make a living while training to compete with the state sponsored athletes.

6. It reminds me of what the USSRA was like when I was in a similar situation to Mark, the best with no money and the USSRA watching me like a hawk to see that no prize with the rise in the price of gold amounted to more than $150.

7. It shows what good actors can do under the stewardship of a good director, the actors being Steve Carell, Channing Tatum, and Mark Ruffalo. They had to work out strenuously for 7 months to perform all the wrestling scenes in verisimilitude and live action.

8. It shows the subtlety of Bennett Miller who directed Moneyball and is obviously a fellow traveler in leaving the output of the movie to the viewer without knocking him on the head with hateful depictions of the rich, albeit to insure good reviews he had to make Du Pont look like an idiot for his patriotism.

9. It has real wrestlers and real footage to carry the story along.

10. the one thing left out to me was the strange case of why the security head who accompanied John on his fatal shooting didn't try to stop the shooting. Also, why Dave stayed with John for 7 years after the brother was ostracized. The humiliating spectacle of Mark staying on living rent free after being fired but being paid shows how money is so important in shaping a destiny. It's a highly recommended sports film.

Victor Niederhoffer adds: 

Here is some good skinny on the deranged man with money who was able to buy the wrestler's loyalty. There are many Jewish proverbs about this: a rich mans jokes are always funny; if you have money, men think you are wise, and handsome and sing like a bird.

Ed Stewart writes: 

The idea that the "amateur" restrictions on money making opens a window for freaks and weirdos to get leverage that they don't deserve is a good one. I have though that to some extent the same process occurs in political funding. The amount of leverage that, say, $25m can get is astonishingly out of proportion to what seems logical.

Another thought: can accommodating nutty behaviors or antics actually accelerate or provoke the insanity? I think so, I think I have seen it. And there is a clear line between expressions of individuality and self-destructive antics of a pending madman.

Some behaviors cry out so loudly to be corrected, it is almost as if the person in the downward spiral is dying for someone to set a limit for their antics. If there is no pain or reaction, (the real world) the aberrant behavior grows unchecked. In that sense humoring such a person might ultimately be a very cruel act. 

Hernan Avella writes: 

One aspect of the movie that is touched only tangentially is the decline of the sport of wrestling. These great athletes compete at the highest levels in their twenties and then it's all over and the best thing they can aspire is to be a coach in a reputable college wrestling program. The final scene shows Mark in a cage fight. He participated in the Ultimate Fighting Championship #6 and won his fight and $50K. Capitalism has open a window for wrestlers to transition into a profitable business or continue their careers through Mixed Martial Arts. It's a truly barbaric sport, but the consumer likes it. I have the utmost respect for cage fighters, who not only have to be highly proficient in wrestling, but also Brazilian jiu jitsu, boxing, Muay Thai, and many more arts. Thanks for the recommendation. Great movie.



 Car Talk was a really fun radio show to listen to on long highway trips. Both of the brothers who did the show were very smart MIT grads with a great sense of humor and a penchant for fun practical jokes on each other. Here is an obituary for the older brother who recently died.

"Tom Magliozzi, One Half of the Jovial Brothers on ‘Car Talk,’ Dies at 77":

By his own account, after graduating from college, Mr. Magliozzi took a conventional path as an engineer until experiencing his "defining moment" after being involved in a close call on the highway. He described the incident in 1999, when the brothers shared a commencement speech at their alma mater. Tom described driving on Route 128 to his job in Foxboro, Mass., in a little MG that "weighed about 50 pounds" when a semi-truck cut him off. Afterward, he thought about how pathetic it would have been if he had died having "spent all my life, that I can remember at least, going to this job, living a life of quiet desperation." "So I pulled up into the parking lot, walked to my boss's office and quit on the spot." His brother chimed in, "Most people would have bought a bigger car."

Ed Stewart writes:

What is interesting is that they made an entire franchise out of something that seems so mundane and unworkable. No planner would have guessed, "this concept will be a hit." It entirely revolved around the talent and humor of the Magliozzi brothers. Isn't that the way most of the best things are? Talented people surprise us with things we enjoy or end up needing that we never would have anticipated. A great functional argument for an open system and individual choice vs. bureaucratic control, excessive tracking and credentialism.



 For at least the time I have followed to both the libertarian "movement" and markets, there has been a broken-record band of promoters selling the same defective message.

The thematic predictions are only a part of the damage. The hidden damage is that so many of the gurus promote sectors with terrible track-records of returning value to investors. Not only do you miss the drift, you are very likely to suffer continual dilution and large losses in a micro-cap mining stock or highly speculative energy development project.

I had the good fortune of seeing a "Libertarian Guru" portfolio - 100% in foreign, illiquid, micro-cap energy and mining plays. Completely off the wall, opaque stuff, all marked down about 70% from cost. My guess at the time was that liquidating the portfolio and converting back to USD would cost an additional 15%, perhaps more.

If the Sch—s of the world turned out to be agents (sent by those who propogate "the idea") to destroy the financial base of the budding libertarian movement, wreck its members fortunes, etc, they could hardly have done a better job.



 "Running out Red Tape is a Growing Industry":

What industry sector employs more Australians than construction, education or manufacturing, and three times as many as mining? What function costs private industry and government a combined $250 billion a year? Few would have guessed compliance – the red tape industry. And it's booming."However, a frightening report released this week by Deloitte Access Economics fingers the real red tape culprits – the private sector business community whose compliance costs leave the government looking like rank amateurs when it comes to creating and paying for what, in many cases, are unnecessary and unproductive self-imposed rules.The total private sector workforce grew by 10.4 per cent over that same five-year period; its compliance workers grew by 17.4 per cent.Ironically, the group that represents our very large companies, the Business Council of Australia, has been a flag-waver for the government's attempts to tackle red tape. The embarrassing reality is that it should be focusing on its own backyard.

Ed Stewart writes: 

The missing factor is that "private" compliance rules are motivated by government mandate. They are required in order to avoid fines, bad pr, or lawuits. For example in the USA we have EEOC and OSHA, which both create enormous private bureaucracies and consulting practices. The "private" workplace rules are most often attempts to fulfill the requirements of these mandates.

Consider the headache a company must go through to fire an employee, particularly if they are "of color". It is a long drawn out process of documenting "evidence" that is fraught with risk if done wrong. Then you have the seminars on avoiding offending others, how not to think with the little head and accidentally cost the company 10m, the lengthy questionnaires with many imbedded "tricks" to weed out those not "with the program". It all works to create an environment that actively stifles common sense and rewards bureaucracy-enforced sensitivity.

Mandated dead-weight employees who can't be fired have a compounding effect of non-productive complexity. Everyone is a "stake-holder" and all ideas must be treated equally - or else. This leads to three hour meetings with no defined objective, the purpose of which is to provide ample room for people with no task related to the corporations primary purpose to feel important.

In my opinion we would see allot less "offshoring" of jobs if large US corporations were allowed to operate, hire, and fire efficiently.



 Since Rocky's unfortunate demise (though I still hold out hope he will yet be found alive), it seems like there hasn't been much talk of the muni market and the impact of various factors on rates. So when this piece on Chicago came out (albeit on Chicago as the new "Detroit"), I thought it might invigorate a discussion which seems to have disappeared from the list. At some point, there's going to be more than Chicago and Detroit in trouble, but I don't sense that anyone else shares that view.

Ed Stewart writes: 

I know the finances look dire but on the ground level much of the City (loop, west loop, near north) appear to be doing great. It is a "tale of two cities" - at least. Google just finished rebuilding an old meat freezer building into its new midwest headquarters about 4 blocks from my apt. New hotels, new restaurants everywhere, seem to be plenty of wealthy people with jobs or starting businesses. Plenty of street-level entrepreneurship. So far taxpayers don't seem to be fleeing the city. The banana republic element is mostly out of site to the extent that one can forget there is a serious problem. I think they realize they can't afford to trigger capital/talent flight.

My guess is that the Chicago bail-out will be the same one that saves all the other failed systems, if inflation does not pick up enough to get the job done. 



 The wrongness of the sage's idea that you can just buy a company, a brand, and keep it forever is shown by these examples. A study in Soccernomics shows that of the 50 biggest companies in 1970 or some such, almost half of them were no longer in existence by 2010. Of course all these studies fail to consider being acquired. But the return of these 50 biggest companies have to be tremendously lower than the average. Mr. Jovanovich has the one major secret to the Sage's high returns, and it has to do with a service strategy that I don't understand. But next to the service strategy, and the affair with the owner of the paper, he is the consummate mooch always creating the public face of saying that everyone else should give more to the government, and service payments from everyone else should be higher, thereby defusing attention from all the handouts he gets from the government for being the public face of the idea that has the world in its grip, i.e. sacrifice is what we were all born for.

Ed Stewart writes: 

All of Buffetts's cash cows that have stumbled are big on buyback plans, particularly IBM. With interest rates so low the share buyback plans seems like a no-brainer. The problem is competition. A relatively free market does not want to allow competitors to have copious cash flow and return on investment. Right when these companies think it is time to "milk the cow" the reality is it might be time to reinvent the business model. I have read for example, that Kodak was very good with its alternative investments while its cash cow was killed by the market. The extreme buyback formula might work best in highly regulated industries where competition is restricted.

Rocky's Heir writes:

The title of Mr. Niederhoffer’s piece is “The Wrongness” but this noun could better be applied to Mr. Niederhoffer’s characterization that Mr. Buffett keeps his investments “forever.”

Admittedly, Mr. Buffett’s stated favorite holding period is “forever.” One can demonstrate that this is the analytically optimal strategy for both deferring capital gains taxes and harvesting the implicit call option in all companies that grow earnings at a faster rate than the index. However, there are numerous examples of Mr. Buffett and Berkshire Hathaway selling the stocks of companies whose characteristics, he believes have deteriorated. The current headline example is Tesco, which he acknowledges as a huge mistake . Less recently, he substantially reduced his position in Moody’s (MCO) after the financial crisis, which in hindsight was a mistake, since Moody’s stock is now trading at an all-time high. Whether IBM joins the list of his winners or losers remains to be seen, but if it turns out to be the latter, then expect Mr. Buffett to eventually sell, harvest the capital loss, and not ride the stock to zero.

Notably also, during 2014, BRK sold holdings in NOV, PSX, DTV, LMCA, COP, GHC, STRZA — although these were comparatively small holdings.

If one finds the methodology of Soccernomics to be laudable, then the same analytical rigor should be used to examine the portfolio strategies of someone who will surely be remembered as among the greatest stock investors of the past 100 years. Confusing political biases with incorrect generalizations is just plain “wrong”.

Stefan Jovanovich adds: 

There are 3 events in American financial history that changed everything that went before them: (1) the Constitutional Amendment that enabled both Federal and State income taxes, (2) the rise of 50%+ estate taxation on great wealth, and (3) the abandonment of the gold standard. It is no coincidence that all 3 came in the same decade - the 1910s - that also brought government absolutism (of course, we can conscript you into the Army even though the Declaration of Independence promises "life" and "liberty"). The Oregano has been the master of working all 3 of the wrinkles and the government absolutism that came with them (of course ownership of liability insurance should be compulsory).

His avoidance of paying dividends is a direct lift from Henry Singleton. It is now obvious but in the 1950s it was not; if you pay out cash under (1), it gets taxed twice at the highest possible rates when the same flow could be taxed only once. The reason the Oregano's pilot fish (mixed vegetable/aquatic metaphor) is so consistently dismissive of HS is that it pains him that they had to copy the idea from someone.

His acquisitions of private companies - Marmon being the latest American example - are all enabled by (2). Since he works the tax system and knows it in a way that is absolutely foreign to CEOs, he is the acquirer of choice for any holders like the Pritzkers who are facing enormous potential tax bills if the sale is "normally" structured.

The "moat" around his successful companies - Coke, insurance - is the one built by (3); in an age of steady inflation unmoderated by any shortages of legal tender - prices can be ratcheted above costs for generations.

There is a fourth advantage that BH has for which I think the Oregano himself deserves the credit; he figured out how, as Ed Stewart and the paper he cited both note, insurance companies can provide an investment leverage that is "safe" from any call risk. In this area other people copied him - specifically, John Templeton and the Lazard folks with their bets on Japanese insurance companies in the late 50s, early 60



 If this is as good as he says the prediction that most jobs will be functionally obsolete is even closer than I realized: Tesla Unveils Dual Motor and Autopilot.

3.5 million truck drivers in the USA, for example, will be out of a job. I imagine that there will need to be an extended period where increasing numbers of people are doing mandated pretend work until the conception of what people should be doing with their time changes. When work was hard people wanted idle time, now that for many it is easy, people wonder what they would do with that idle time. They are afraid of it.

Pre-divison of labor economy if you had food and shelter and secured the ability to reproduce, your existence (I would think) was justified. You didn't need to rationalize anything or explain yourself. Today, people view their self-worth as part of a large, complex system– "how do I fit in, am I needed, how do I justify myself". Note: most people don't say, "We want high productivity and wealth" they say "we want a job".

I'm wondering how technological change will once again impact common value systems and ideals over, say, my son's lifetime. Many believe that work will be made that "filling the gap." I used to believe that, but don't anymore. Look around. Most organizations are already highly overstaffed to an efficiency-minded person, and that is just the private sector. In the public sector, at this point, the post office is a giant jobs program that also delivers mail. Same with public school systems. They are obsolete relics.



An Interview with Mark Andreesen

"I can tell you, at least from the last 20 years, if you bet on the side of the optimists, generally you're right."

He also does a nice job fancy-dancing around "world in it's grip" type of questions that have dangerously career ruining non-pc implications if answered incorrectly.



It would be good to have the distribution of swings up and down after moves of x % from a "previous" low or high in markets the same way they now do in rebounds in basketball.

Ed Stewart writes: 

One thing I wonder about measuring swings is if static points in time (such as the close x days later) are best to measure swings. Measuring static points seem to miss allot of the intra-period variability that might be useful to know about and understand. I sometimes look at the expected value to a point and then the max and min excursion within the period. I'm wondering what better ways there might be to measure a swing that takes into account the variability within the measurement period.



 Perhaps one for the Department of Deception. Is the following not somewhat akin to moving the line in Las Vegas? Are there not examples of similar activities in other cases? A potential new crime at the millisecond level:

"'Spoofing,' a New Crime With a Catchy Name 'Spoofing,'":

A big hurdle in the "spoofing" case against a high-frequency trading firm is that a jury must decide whether one computer fooling another is a crime, Peter J. Henni…

"The indictment seeks to hold Mr. Coscia liable for trades executed in milliseconds by a computer, including one trade at 4:54 a.m. when he was probably asleep. The spoofing charges may send a chill through the high-frequency trading world because the evidence of fraudulent intent will come from a program that uses rapid-fire orders and does not depend on humans for its execution. So finding that Mr. Coscia engaged in spoofing may come down to a jury deciding whether one computer fooling another is a crime."

Ed Stewart writes: 

The indictment describes how Mr. Coscia's programs would enter small buy or sell orders for future contracts that he wanted to have filled. He then placed large orders on the other side of that trade at a higher or lower price to entice others to enter the market on the belief that the larger order would affect the price. Once the price moved so that his small order was filled, the program canceled the large orders. The program would then do the same transaction in reverse by entering another round of large orders that would move the price up or down to allow for Mr. Coscia to exit the position at a profit.

In other words he gamed other HFT traders who were using order book info to step in front of his large limit orders. As if jumping in front of a large limit order should be a protected activity? I would think non-HFT traders would applaud strategy, as it would increase the cost of stepping in front of orders, as the HFT would never know if it was a "spoof" or not. I see nothing inherently wrong with the strategy indeed it might be correcting a distortion itself.

The fact that this is a crime suggests to me that what is "level" to most is simply what tilts the odds in their favor.



 I liked the conclusion of this article:

"I predict that if we continue implementing Common Core, average students will drop out of math as early as they are allowed. Even math-bright students will hate math. Tutoring companies will proliferate to serve wealthy families. The educational gap between rich and poor will widen. If we want to destroy math and science education in this country, keep Common Core."

Ed Stewart writes: 

In my opinion a lot of the need for "change" is very likely driven by PC motives, which is why when it is looked at logically from a mathematics perspective it makes no sense. My guess is (using an example from article) it was hoped that allowing calculators for everything and allowing an increased use of "cheat sheets" would open up math for more equal distribution of supposed talent.

In terms of pace when I was in school we did have an accelerated math program but one had to test into it with an IQ test. The notion that a curriculum can be designed that can shuffle through all kids to be "above average" is part of the problem. It is a lack of realism.

I strongly disagree with the author that non-college kids are necessarily sent to dead-end jobs while college kids are not. Reality is working in a cube with a degree is just as much a dead in job as others, particularly in the outsourcing era where such work has been massively devalued. The notion that keeping ones hands clean is always better is just a bias. Guys who get involved in a field that actually builds something or is otherwise productive such as Natural resources will be better off vs. a twin of equal ability shuffled through the "college" program. And clearly many who see that opportunity follow this different track. Charles Murray is right we'd be better off admitting college is useless for all but the relative few - making it more accepted for people of even moderate above-average ability to go right into a job for training.

Stefan Jovanovich writes:

The need for "change" in education is driven by nothing more than the same financial incentives that operate in all markets where the customers are not the actual users of the product. Even military contractors have to deal with the fact that at some point the soldiers, sailors, airmen and marines have to use the weapons; and, if they don't work or work well, people get hurt, and then the survivors get mad and resolve to get even. Elementary and secondary public education in America has no such feedback mechanism. No school keeps data on the future trades and incomes of their students; in fact, in the name of "privacy" (that Federal Constitutional right that first trimester unborn children lack but the rest of us have), schools are prohibited from collecting and keeping such data. So, in education, "change" happens not because of any customer demand but because of the incentives it offers to the people who manage and create the changes. Every curriculum change means more money for the creators of the curriculum and, far more important, more paid time on and off time for research studies, training and conferences - all of which guarantee time away from the nasty children.

It does not matter whether or not the change works for the customers; indeed, there is a real incentive for the change to fail because that has invariably meant that more money, not less, should be spent on schooling. (Er, sorry, not "spent", "invested")

P.S. There is no evidence that public "job training" works any better than classroom education in the academic subjects; "job training" is another field where the government pays the money and the customers' feedback is completely ignored. The roughnecks who are getting semi-rich in North Dakota right now learned their trade from the informal apprenticing that comes from having an uncle in the oil bidness.



I have been spending a lot of time researching GDP construction and it's history and this will be a part of my book that will be out in about 6-9 months. The basic issue is that "how" to measure an economy is a difficult thing. Very difficult. There were many competing theories on it in the first 1/3d of the 20th century. Modern GDP was constructed to serve the purpose of measuring the potential output of the economy for the purposes of conducting WW2. It has since become standard around the world as the only way to measure the economy.

The issue is that it does a very good job of measuring things in the short run. However, it can't take into account the "quality" of economic activity in the long run.

For example, under GDP 100 guys digging ditches and filling them in again are seen as better for the economy then 75 guys doing productive work and 25 guys staying home and taking care of their kids.

Likewise, 100 guys getting paid to destroy productive capital and kill people are seen as better for the economy then 50 guys working in 7-11 and 50 guys taking care of kids, painting, and playing the guitar.

GDP assumes in essence that people are rational actors and that if someone is being paid to do a job that it is by definition productive activity. However, with government that is not always the case, and with zero interest loans for wall street that is not always the case either.

There is a lot of chatter in public about why wages are stagnant and the average person isn't better off than they were 20 years ago despite the rise in GDP. The answer lies in GDP's accounting for War and other government expenditures, as well as the much more complex issue of how the banking/finance industries are reflected in GDP (you would be shocked at the answer to this most likely, but it is so complex I still don't fully understand it myself).

Stefan Jovanovich writes:

I remain amazed at how easily our political economy dismisses the pure waste of warfare and its effects.

Ed Stewart writes: 

Interesting points anonymous and Stephan. Anonymous, I look forward to reading your book.

Your ditch digging example is an easy one to see but when you start using that logic - what about the tax preparation industry that exists do to an ultra-complex tax code? There are many other examples. Many aspects of the regulatory state might be best considered a jobs program for the reasonably intelligent in the way that ditch-digging is a jobs program for physical laborers.

I had a realization a while back. We might be better off if we could shut down all of the fake work and specific social programs that actively harm productivity, that provide bad incentives (more kids = more $$$), and then just pay a basic annuity to all adults (privatized as a property right) to set a floor on living standards. Make it tradeable and you have an easy mechanism to transfer citizenship, etc. Citizenship is worth something why can't be buy and sell it, and why don't we earn anything directly from it like a dividend stock or bond.

Stefan Jovanovich writes:

Ed (and anonymous also) may be going down the path that my grandfather first set me on back in 1950s. He said that the Wobbly idea about "one big union" was hopelessly naive (he had been in his early 20s when he and grandma joined the IWW), but there was at the heart of it one very good idea - markets work brilliantly for consumers aka people who have the ready but they don't work nearly as well for "jobs". He had started mining when hand drills and sledgehammers were used to create the holes for the dynamite. (He told me that he even worked on one old and stupid mine in Southern Illinois where the owner still used black powder; he said he was young and stupid about politics but not about mining. He worked that job until he got his wages and then took the train to Chicago where he found a job working on what became the Navy Pier.)

He thought the Marxists had it backwards; the last thing you wanted was for the government to own anything and have permanent workers. They would inevitably become worse than even the most naked capitalists because they would never, ever have to stand the test of the market. You wanted competition and prices in everything; BUT you had to have everyone who accepted those rules be able to share in the prosperity they created. In his day miners did that sharing by literally passing the hat for sick and disabled workers and for burial expenses (for the children as much as for the miners and their wives). The idea of a "one big union" was that the hate would be passed for every person who was in the United States legally (which was everyone back in the day when people were freely allowed to come here if they passed the entry test for communicable diseases).

When he asked him about Bismarck's "social" programs, which were the model the American Progressives used for their "reforms" (sic), he just laughed. "You mean the laws that guarantee that every gymnasium graduate has a job telling everyone else how to behave?"

He would have agreed with Ed that even citizenship was a property right that people should be free to buy and sell. What he wanted attached to that right was the annuity claim to have the hat passed. And, he thought everyone - Rockefeller included - should have an account. "It is the only way to prevent people from thinking they need to make distinctions between the people who "deserve" to have the hat passed and those who don't." Sooner or later, he told me, the preachers will want to get their hands on the money and say it came from God. "But what about the communists and the socialists?" "Same thing, only they will say it came from Darwin."

The man has been dead for more than half a century, and I still miss him nearly every day.

Ed Stewart writes:

Very interesting, Stefan. It makes a heck of a lot of sense to me. I would love to read more if your grandfather or anyone else ever mapped out the idea further.

Stefan Jovanovich responds:

Ed asked if anyone had ever mapped out the Wobbly idea of one big union. The answer is "yes" - every time someone sits down and calculates what is spent on "poverty" and the parts of public health that do not deal directly with quarantines, innoculations and other direct measures against communicable diseases (in other words, almost all of the "wellness" spending). The most recent effort was this one:

"This week, the U.S. Census Bureau is scheduled to release its annual poverty report. The report will be notable because this year marks the 50th anniversary of the launch of President Lyndon Johnson's War on Poverty. In his January 1964 State of the Union address, Johnson proclaimed, "This administration today, here and now, declares unconditional war on poverty in America." Since that time, U.S. taxpayers have spent over $22 trillion on anti-poverty programs (in constant 2012 dollars). Adjusted for inflation, this spending (which does not include Social Security or Medicare) is three times the cost of all military wars in U.S. history since the American Revolution."

"Federal and state governments spent $943 billion in 2013 on these programs at an average cost of $9,000 per recipient. (Again, Social Security and Medicare are not included in the totals.) Today, government spends 16 times more, adjusting for inflation, on means-tested welfare or anti-poverty programs than it did when the War on Poverty started. But as welfare spending soared, the decline in poverty came to a grinding halt. How can this paradox be explained? How can government spend $9,000 per recipient and have no apparent impact on poverty? The answer is that it can't. The conundrum of massive anti-poverty spending and unchanging poverty rates has a simple explanation. The Census Bureau counts a family as "poor" if its income falls below specific thresholds, but in counting "income," the Census omits nearly all of government means-tested spending on the poor. In effect, it ignores almost the entire welfare state when it calculates poverty. This neat bureaucratic ploy ensured that welfare programs could grow infinitely while "poverty" remained unchanged."

Grandfather, being clear-sighted, knew that you could take all the money spent on the officially poor and divide it up among everyone - Rockefeller included - and eliminate poverty tomorrow; but, that would offend everyone who wants vices to be illegal and everyone (usually the same person) who wants official helping to be a sinecure that can be passed down from generation to generation just as parsonage livings once were. These are my words but his thoughts: "The snobbery of the caring classes will always win."



 Shades of Galton….


In his fourth-floor lab at Harvard University, Michael Desai has created hundreds of identical worlds in order to watch evolution at work. Each of his meticulously controlled environments is home to a separate strain of baker's yeast. Every 12 hours, Desai's robot assistants pluck out the fastest-growing yeast in each world, selecting the fittest to live on, and discard the rest. Desai then monitors the strains as they evolve over the course of 500 generations. His experiment, which other scientists say is unprecedented in scale, seeks to gain insight into a question that has long bedeviled biologists: If we could start the world over again, would life evolve the same way?

Stefan Jovanovich writes: 

The absence of time's arrow is fascinating. The "fittest" compete in a world where the rules are constant and invariable - "meticulously controlled" - while everything we know says that the rules are always changing in ways that even we brilliant humans fail to predict. Still worse for the purposes of experiment, the rules sometimes instantly and violently, even as they obey all of our entirely predictable laws of physics.

Ralph Vince comments: 

This has nothing to do with "fitness," and everything to do with randomness.

Take X scenarios. At each discrete point in time, they branch into one of these X scenarios, such that after Q discrete periods, you have X^Q branches.

Your "expectation," (not in the classic sense) is the sorted median outcome (whereas the classic sense expectation is the probability weighted mean outcome, and I contend that in the limit, i.e. as Q->infinity, they converge *).

About this sorted mean outcome (at QP0, in the paper this thread pertains to) there is a vast region of similar-outcome branches. It sounds to me as though this experiment has lass to do with evolutionary "fitness" and more to do with artifacts of expectation in finite time.

I am working on a proof of *, but working on it with respect to continuously-distributed outcomes (as opposed to discrete "scenarios") as well as continuous(though fininte) time, rather an discrete increments of time to Q.

It is a struggle.

Mr. Isomorphisms adds: 

This may not be what you're looking for in proving *. But the other day I worked out that you can exploit the "soft max" identity (seen in tropical geometry and elsewhere) to get analytic formulae for the median, third-from-top, etc. (only with log base âˆΕΎ) which might get you where you need to go.

max = log_t ( t^a + t^b + t^c ), t going to infinity

min = log_t 1/( t^-a + t^-b + t^-c ), t going to infinity

second_max = max( {a,b,c} - max({a,b,c}) )

With recursion you can get all the way to the middle. (Now since we've turned the median into a continuous function we can take derivatives, which I haven't simplified or played around with since I realized one can do this. But I don't think that relates to your * — just hoping the method would.)

Steve Ellison comments: 

Regarding Shane's original question, yes, there is a phenomenon known as evolutionary convergence. Isolated areas with similar conditions often have similar life forms that developed independently. For example, cacti originated in the Western Hemisphere, but there are plants that originated in Eastern Hemisphere deserts that also store water and have spiky exteriors.

Gary Rogan writes: 

Clearly there are niches in the environment, just like there are in the economy, the market, the arts, sports, etc. It seems self-evident that a species that thrives on a Pacific island is likely to be different from a species being able to survive in the Arctic or at the bottom of the ocean. Not having "a single, cannibalizing species inhabiting the planet" only speaks to the niches in the environment not some complicated problem with evolution.

Ralph Vince adds: 

Perhaps we DO, in effect, have one, cannibalizing species, depending on how broad the field of view of our lens of examination.. How many animal life forms on the planet have but one eye? "Evolution" having eliminated that not-so-robust construction in all earthly environments. Is our notion of "species," which we believe to exhibit a vast array of life forms, only show us carbon-bases life forms with, at most, five senses. In that sense, is a penguin so much different from a scorpion from a human being? The notion itself of "food chain," with such biochemically similar life forms, is, in effect, an exercise in cannibalism. 

Gary Rogan writes: 

Since the evidence points to life arising or being successfully introduced to Earth just once, it's not surprising that we only have carbon-based life forms. And just because a scorpion shares a lot of genes and proteins with penguins doesn't mean they are of the same species, simply based on the definition of the word: to be so classified they'd have to be able to interbreed. I'm now no longer sure what the point is, but hopefully "descent with modifications" is not in question.

Ralph Vince clarifies: 

My point simply put, is that I don't find "evolution," or "Survival of the Fittest," an adequate model, i.e. a panacea for how life arose and differentiated (to the restricted sense that it has) on earth. I find it too simplistic of a solution, believe there are likely many other explanations (all of which are, in a limited sense, true, similar to the wave/particle properties of light) and am interested in any other explanations (there is not a debate here, aside from one which I don't believe you ascribe to of "Fitness" being an explanation for all life on earth).

For example, (to the best of my knowledge) every living thing seems to fit somewhere into the food chain. Perhaps there is an overriding-yet-undiscovered mechanism requiring this as a license for life on earth? (And if not, why not? A stupid question, unanswered, is still an unanswered question. I believe evolution seems to explain so much that we use it to explain where a different mechanism may be the driving one, yet, occluded by the seemingly-obvious-to-us explanation of "fitness"). Evolution is a powerful explanation, but it does not explain everything.Not that I have a problem with "fitness" as a driver here — clearly it is, so I am not at odds with you there (though I am not so sure life was introduced on earth only once, again, viral and fungal life is a difficult leap from living cells). So I simply wonder of what other driving mechanisms are at work here that we are unaware of.

Gary Rogan writes: 

Ralph, as it's generally hard to prove a negative, especially in open-ended complicated situation, I can't argue that there are other forces at work. As for fitting somewhere on the food chain, all carbon-based life forms eventually get weak and if not eaten at that point die. Weak or dead concentrated proteins and other valuable chemicals present too rich and too easy a food source not to be consumed by something, so this particular point doesn't instill a sense of wonder in me, but perhaps there is more to it than meets my eye.

We should keep in mind that on the average over any appreciable number of generations every existing species or otherwise categorized collection of biological creatures has almost exactly one descendent per individual, otherwise within a short span of time the group's mass would exceed that of the planet or conversely disappear. Therefore available resources present arguably the highest hurdle on the success of species, but as Hamlet said, "There are more things in heaven and earth, Horatio, than are dreamt of in you philosophy."

Ed Stewart writes: 

Speaking of the food chain, I think the concept of the tropic level has some serious application to the markets, as I the chair documented in his first book. Might be particularly good model to analyze the impact of various stimulus measures - what level the stimulus directly stimulates, then who feeds on that level directly and indirectly for investments opportunity.

anonymous writes: 

There are no marsupials above the Wallace Line above Australia. Below there are the myriad odd and strange life forms in Australia. It was a function of geology creating distinct eco zones and separate paths of development of life forms.



 Just about a year ago I sold all of my McDonald's stock after dining at multiple locations in the course of a 2000 mile road trip. Basically I tried most of their new menu items and found them to be disgusting and out of touch. I note today they reported terrible same store sales and the stock has done poorly since I sold.

It might be just one example, but I think Lynch was on to something when he suggested that it is a good idea to sample the companies products that you invest in. In my opinion, McDonald's badly needs a new CEO and strategic direction. Regardless, I will be sampling the food on this year's road trip, and hoping for improvement.



 What can be learned from the ice bucket challenge–the challenge task itself, how it has spread, why people enjoy watching it, and how when you search for "ice bucket challenge" on YouTube the next suggestion is "ice bucket challenge fail". The ice bucket challenge fail video reminded me of a stop-stop order that has skidded out of control and exits much worse than expected.

Jeff Watson writes: 

Patrick Stewart has a most elegant way of handling the ice bucket challenge. This meme is transferred similar to a way the Chair described years ago.



 I was at the Whole Foods this weekend and spotted a very attractive woman giving out samples of a new, "Small Batch" whiskey made by a new "craft" manufacturer. Naturally, I stepped up and requested a sample. While I sipped (slowly, as I am not a regular whiskey drinker) she rambled incessantly, providing the charming "back-story" of this "craft manufacturer." It was a "secret recipe" passed down for generations, etc.

I pulled out my phone and took a picture so I could easily research the brand further when I got home. It turns out this "craft" brewer was featured in the following article.

The "secret recipe" of this "brand" is the unaltered factory product from the standard, generic producer of this Whiskey variety. The entire "charming story" is a work of fiction. I am not naive enough to think that this not often the case, but at some point it gets ridiculous. I think it was that this woman wasted three minutes of breath telling me the ludicrously bogus story that put it in a different perspective. Perhaps if she was not busy telling the fraudulent story, we could have had a decent conversation — which would have made my time sipping the mass-industrially produced whiskey far more enjoyable.

Victor Niederhoffer writes: 

As the Senator would say, where's the picture of the con artist?

David Lillienfeld writes: 

My wife is a pathologist who also completed post-doctoral training in epidemiology/outcomes research. Her thesis was on reasons physicians adopt new laboratory tests. It turned out it was the first time the question had been posited, at least in the academic sphere. It blew her thesis advisor's mind. I was in my Marketing 201 class at the time, and both she and her advisor were surprised with my response to her finding-"Don't you think that the marketing departments earn their keep? If they didn't, that cost would have been cut already." I've been told that mine is a naive view, that no one in a business would dream of cutting marketing back do the degree I suggested if the exercise had little ROI.

Same thing here. Someone in marketing had some rich ideas, and it sounds like the sales department was executing nicely.

John Floyd writes:

What are the usual tells and ways to decipher such marketing? I wonder about market parallels such as market reversals shortly after events that were fully priced, i.e. the market reaction after the first shots in Gulf War, etc….also makes one think of the famous Schlitz live beer taste during NFL games.

Chris Cooper writes: 

It has always been hard for me to understand the appeal of small-batch, "artisanal" marketing stories. Nevertheless, we sometimes use it ourselves in marketing our bottled iced coffee. But the sooner I can scale to big-batch brewing the happier I'll be. I designed the process so that it would scale…now I just need the sales.

Better than any marketing story is simply letting people sample the product. Even better is blind tasting against the competition. When people try it, they know it is the best. But that marketing approach does not scale.



Here is an easy read. The paper is courtesy of the Kansas City Fed, on the history of agriculture, the booms and busts, other cycle changes, and agriculture's role in the economy, past, present, and future. For a layman, this represents and provides great value.

"Agriculture's Boom Bust Cycles: Is This Time Different?"

Ed Stewart writes:

Thank you for sharing. I wonder to what extent REIT and other capital markets investors will be adding fuel to this cycles' boom and bust experience.




Within the "dark pool" of the market's ecosystem, there exist top feeders who like to provide bottom dwellers with 'insurance' policies. This "magnanimous" activity manifests itself in the provision of such products as options and more 'complex' structured products.

Clearly, as with all insurance policies, the seller of the policy has no intention to pay out upon the risk if it eventuates.

One noticeable element of these structures is the inability to get out of them in a timely fashion.

An examples should suffice:

In 2008 one was fortunate enough to have bought an AUD Put / JPY Call. As the AUD/JPY cross rate declined (and, for those who remember, Armageddon approached) not only was the 'delta' of the position increasing but the 'Vega' was too! A rare occurrence in option-land for TWO of the 'Greeks' to be in one's favour. At a time when I wanted to cut the position with a reasonable gain, the counter parties in the options market made a volatility spread so wide, that to have sold the structure back would have entailed losing money even though I had bought a low volatility and the spot had moved massively my way. To have simply bought back the delta and ridden it to expiry would have led to massive illusory PL swings because of the way options are revalued by the seller. The upshot is that I was unable to collect on the 'insurance policy'

Even in today's 'it can only go up/ prosaic times', market insurance policies are a scam.

Some things for speculators to consider:

1. Is there a level of volatility at which markets become 'untradable'? On the upside, I believe there is a level - or put differently, there is a quantifiable rate of change in the cost of insurance after which the spreads are impossible to deal at (In the above AUD/JPY example the volatility spread was 30% / 130% !!!!)

2. Is there a certain minimum level of volatility that the ecosystem requires? The answer might be different for different markets but overnight implied volatility in the major currencies hit the lowest in more than 20 years yesterday at circa. 5.5% annualised so who knows.

3. As alluded to above, should one watch the bid/offer spread on insurance as a predictor of bad/good times ahead. The magnitude of the spread in At The Money options markets certainly widens as the underlying approaches the point at which the big sellers might have to pay out thus making it hard or impossible to exit.

4. The amount of inbuilt spread in structured product in the street at the moment is genuinely appalling. But it is selling VERY WELL because large over regulated investors are being required by their 'consultants' to deliver 'stability' at all costs….. Not a single one of these structures is fit for purpose.

Lifting a line from EdSpec - '…..are there any words in the English language that mean 10000 times less than zero..' is a good way to explain the probability of the buyers of these products being made whole if the worst happens.

Jordan Neuman writes: 

It is a fear I share when I buy out of the money puts. I recently corresponded with OCC about their "Doomsday" procedures and found out they don't really have anything concrete. How do you plan for option settlements under total chaos? And I do remember the 30%+ spreads on plain vanilla S&P options in the fall of '08.

I recall in the original Market Wizards Jim Rogers advised shorting Japan but said that while you might be able to get some money out on the initial decline, if you wait until the ultimate collapse you won't.

Ed Stewart writes: 

Awesome post with much food for thought.

For the health of the market I would think that two environments are critical -environments that best feed market makers, and environments that most encourage commercial participation. If a market becomes too stable there is less need for commercial hedging, less transactions for market makers, and the range for speculative profit to profit dries up. I see it as speculators "crossing the bridge" between commercial buyers and sellers - the profit incentives motivate us to find ways of doing this. If the path is too short we can't make any money to cover costs.

A notion that I like is that the best speculative markets are where commercial interests have just been pushed to their uncle point in terms of pricing - at that point there is a very strong need for speculators and certain premiums develop - one can see this dynamic if you read the reports of (for example) commodity processors after a large price move.

Also which side of the trade is weak (buyer or seller) might depend upon who is on which side is the speculator vs. the house, or alternatively which side can take delivery vs. the side that needs to offset over a certain time horizon. The edge to the first party grows as (say) first notice approaches.



 All due respect, the slam against female CEOs is only because there are so few of them in the CEO biz that men can still poke fun and smear. Once there is a substantial percentage of progesteronic/estrogenic CEOs around, the model will magically "get better".

Or so I feel.

Ed Stewart comments: 

M, it is not necessarily that the lady CEO's were not up to task, but rather that desperate companies looked to "pass the buck" to a female CEO at just the wrong time. And the reason i think is that it is still a "newsworthy" or "progressive" thing to do, so the company can get good press about it (particularly in the tech industry) and appear to be innovative without actually accomplishing anything of substance. As very few women, even highly intelligent women, are truly tech oriented, they tend to bring in "Jargon-filled, MBA dialect" solutions which tick off companies that have an engineering culture, etc.

A counterpoint (with regards to performance) is TJX CEO C. Meryowitz who came in in 2007, who many credit with an outstanding performance that has vastly rewarded shareholders. She also worked up the ranks and was not "cherry picked" and placed on top at the last minute.

On a related note I firmly believe all men should consult as many women as possible in order to understand the modern consumer economy. So much of the spending makes such little sense to so many of us (men) we are completely lost. For example my wife was shopping at Lululemon early on, (a store I laughed at as ridiculous), I didn't think whole foods would catch on and continue to grow, TJX seemed like a bunch of junk no one needs - but to Meryowitz's (and my wife's) credit it is now one of the stocks that I own with the largest unrealized gains, in spite of not doing well this year. 



Did Bacon's invisible hand guide these institutions investing in the "alternatives model" at just the wrong time? Darn cycles changed again…

At what point do they at least partially
throw in the towel and barrel back towards a higher % in US stocks?
Perhaps a new guru will rise up to replace the old Yale one, the with a
record of superior returns based on an unconventional and innovative
approach - holding an over-allocation to US equities.

From this WSJ article "Big Investors Missed Stock Rally":

Corporate pension funds and university endowments in the U.S. have missed out on much of the rally for stocks since 2009, following a push to diversify into other investments that have had disappointing performances.

Some argue that the shift stems at least partly from an effort to ape the strategy of David Swensen, who has long led the endowment of Yale University.

A 2012 paper written by Mr. Goetzmann and another professor at the Yale School of Management, Sharon Oster, argues that university endowments often invest in hedge funds simply to catch up with their closest competitors, rather than to achieve top returns, a shift the professors call "herding behavior" and "trend chasing."



 Do the markets engage in old skool breakdancing?

"Breakdancing" appears to be a variant of "peacocking", or behaving in an over the top or flashy manner for the purpose of attracting women.

Is the market is breakdancing for this purpose?

The key to breakdancing from an observer's point of view seems to be the center of mass.

If you watch a head spin you see some interesting properties with the diameter created by legs and arms vs. rotational speed (as also seen in figure skating). You also see that increasing speed is used as momentum that carries the dancer into a quick transition.

Is this also true in for the SPU, bonds, currencies, and crude oil, and agriculture.



 The focus on debt and "paying for stuff" is a distraction from the real issue of the future - The coming explosion in productivity growth.

We are on the verge of a massive increase in productivity that will result in (among other things) the replacement of most workers with automated processes and artificial intelligence.

Just consider transportation. We will not need bus drivers, cab drivers, truck drivers, airline pilots, railroad people, etc. For example, "Rolls Royce Envisions Crewless Drone Freight Ships".

The need to "offshore" work to low wage countries will go away because wages are not paid to automated processes and devices with artificial intelligence.

The entire notion of a division of labor economy will change. The identity of "I, worker" will increasingly lose relevance.

Thinking about "paying for stuff" using the old model that needs "new workers" to fund "retirement benefits" might be (close to) reasonable for a few more years, but it will soon be 100% obsolete. It is already extremely short-sighted. Note, by "soon" I mean within my lifetime, not within the next few years.



 I have been considering the many symbiotic relationships that exist between capitalist enterprises and the welfare state. A common theme of many of these relationships is that their foundation is in encouraging consumers to pull their time preferences as far forward as possible, which of course creates room for others to capture as much of that person's income (from whatever source, including government subsidy) as possible.

What is interesting is that when this is done, it seems to create an entire mini-economy that in my mind represents a distortion. I say distortion because the ill effects are often subsidized, which further fuels the mini-economy's growth and turns off the self-correcting mechanism.

For example, we know that eating large quantities of junk food and processed food is bad for health. The consumer is satisfying a short term desire at the expense of long term health, which I consider a form of time preference shifting. And of course this is heavily encouraged by the system, to the extent that the a large % of the population considers a very unhealthy diet to be normal. This has become so normalized that many do not see why they are so fat, because everything they have known tells them that their choices are normal.

This creates health problems and obesity. What do you know? The treatment of all of these largely self-inflicted illnesses is a huge business. Now if costs for these diseases were borne by individual consumers in some way, the system would not become "supercharged" because there would be a self-correcting mechanism– the ability to pay for treatment.

However, with the shifting of medical bills to the state or to various insurance schemes that do not allow for risk-based pooling of similar risks, the system does become supercharged. The medical system can treat the self-inflicted medical problems at great cost, indeed that cost to the "system" is often privatized and converted into various profit streams. The self-correcting mechanism is now gone and has been replaced by an incentive to perpetuate the system, and even enhance it.

Every step of the way the unthinking person is pushed through the system and as a result feeds the system. For example, there is a massive interest in promoting large portion sizes. It is a business that wants to increase sales. Cereal bowls are 2X what they used to be but most people hardly notice, etc. Middle income shoppers feel size = value so portions have been super-sized.

The smart people continue to make real choices, but if you look around it is clear that many people don't actively make choices, they just respond to the environment and what is in front of them uncritically. When they develop medical problems the costs are then distributed and the profit is targeted.

At the extreme, the system seems to be creating an entire class of citizens who basically have zero control over their lives. They are steered the great majority of the time for the benefit of other people's profit, with zero awareness of this fact. It is an odd system. Since it will not be changing any time soon and indeed appears to be durable, the best thing for ones well being might be to accept it and profit from it, without undue moralizing. It could be that crony capitalism is not the distortion of capitalism that libertarians think it is, but is in fact the real capitalism– the version that has staying power vs. the one that is just transitory and dependent upon a liberty minded population.



 One notices that crude has been building a nest around the level of 10250. One wonders whether nest building has anything to teach us about markets. Apparently its a biological imperative for birds and others.

Ed Stewart writes: 

How could the nest be defined. I noticed (including today) a sequence of 4 CL closes within the day's range that was prior to that. Is closing price proximity a good measure of nest building– if defined relative to the recent past. Gold seemed to be a very well built nest– just before the break.

Hernan Avella writes: 

I found this article about ant nests very interesting.

Despite some "agents" beliefs that the numbers themselves have any significance, volume/time/activity clusters are all results from local interactions, . In the ever-changing cycle of consolidation-expansion, the consolidation phase is like a living architecture building process (nests). Researches have discovered three main rules of nest building in ants: "The ants picked up grains at a constant rate, approximately 2 grains per minute; they preferred to drop them near other grains, forming a pillar; and they tended to choose grains previously handled by other ants, probably because of marking by a chemical pheromone". One often sees the liquidity asymmetry games (big bid, small offer) as the building blocks of this structures. Traders (algos), like the ants, follow the patterns of the bid/offer and consolidation begins. This process has moments of high predictability and increase competition.



 In my opinion the worst thing about [Mr. X's bearish, stubborn approach] with regards to trading is that it takes one out of the market's rhythm or one's system with unhelpful thoughts. For example, if one shorts as part of a swing trading or short term program, what works is some variation of, "short and cover" but if you miss the "cover" part because you think, "this is it, the End of The World prophecy is coming true", you don't cover, you get run over, you lose positive focus, become stubborn, miss your next long trade, basically are completely thrown off of your game. That type of scenario is all too easy to fall into and must be guarded against.

Victor Niederhoffer adds:

I believe the worst part of it is the cognitive dissonance that comes from being wrong, which makes you double down on your reasons in an effort to find new straws in the wind that support your view, the carry over impact on your other views that makes you a confirmed pessimist, the related problem of being wrong so often that the only way to maintain your mojo is to become a promoter, the inability to realize that there is always something bearish as Mr. Ellison has helpfully pointed out, the refusal to pay heed to the fed model as developed by Mr. Downing and myself, the refusal to take account of the power of compounding with a return on capital of 15% versus an interest rate of 3%, and the lack of consideration of the evolution of how big companies have learned to be flexionic to grab higher rents from their cronies, et al. That said, the great Jim Lorie agreed with Mr. Stewart that the worst thing was when you get out of the market, you never know when to get back in, so you miss the drift.



 There is something like the keech cult in many academic papers about systems. Many of them don't work in the real world. The more they don't work in the real world, the more the academic papers with titles like "is momentum really momentum?" or "the disposition to ride winners too long—" or "investing with style" or "value and momentum everywhere" or "dissecting anomalies" or "251 years of price momentum" or "the world's longest back test" exist. There seems to be no awareness of the principle of ever changing cycles to explain why things like fama french discovered in 1992 with retrospective compustat data, don't work in practice. Similarly why momentum strategies will reach a peak before a year like 2008 when they lose 85 percentage points relative to neutral.

Ed Stewart writes: 

I believe the failure to account for changing cycles and how the profit incentive inevitably leads to a reduction or removal of a static profit opportunity to cost or worse has to do with the academic's need to create an aura of prestige and permanence in their work. You don't see academics studying supposed profit opportunities in retail or other mundane businesses that lack (what often is) the veneer of intellectualism that finance offers. Reducing things to this reality would kill the profession.

anonymous writes: 

I'm glad the Chair brought up again the subject of Ever-Changing Cycles, a.k.a. "regime switch". Where could one find literature about it, aside from Bacon?

There's an entire industry of publishing about "alpha-generating signals", but I can't find one reliable source of how to treat data in order to be aware of the regime shift as soon as possible.

It seems this is the "Great Arcanum" of speculating, and even the liberated Adepts are not allowed to mention it.

PS: We just suffer the effects of regime switch recently, in a very frustrating way: after 3 months of incredible hard work to put together a portfolio of futures strategies (in order to go "full f" with it), we noticed that something wasn't ok with the distribution of outcomes. We then realized that PBR (Petrobras) which is "the" political brazilian stock, was being traded very differently than the previous years, due to this election year of 2014. It seems that the whole communist party (which PT - Partido dos Trabalhadores really is) is buying the stock, pricing it higher with great urgency, in order to make up the immense dammage they (the government) did with the company. (They could make an oil company to go broke).

But, that's post mortem reasoning: our portfolio remain useles, since PBR (Petrobras) has a great deal of impact in the stock futures contract (our primary trading vehicle).

The question that arises is:

What length of testing should be used as metrics for regime switch awareness?

What is the testing one should do to put aside a strategy that is performing badly?

In other words, what would be the procedures a spec should be doing to prevent being caught in the changing cycles?

We would appreciate very much any guidance.



 We need to analyze this. She is unconventional, chatty, attractive. Does she throw the competitors off?

"Victoria Coren Mitchell makes poker history with San Remo victory"

Now Victoria Coren Mitchell has made history by becoming the first two-time winner of one of poker's most prestigious tournaments.

"I think I'm quite quirky in poker because there still aren't many women playing big tournaments," she said.

"I have another job and I sit at the table drinking wine and chatting. Poker's a strange game because it's face-to-face combat and we're trying to knock each other out and take each other's money but at the same time we're all friends."

Ross Jarvis, editor of PokerPlayer magazine, said Coren Mitchell's win came at a time when professional poker veterans are fighting it out with a new generation of online whizzkids, many of whom have won millions before they turn 20.

"You have players who are the best in the world who are well-known in poker, then there are so many young players who you won't have heard of until they burst on the scene. Within the hardcore, there are people as famous as Victoria but when it comes to the mainstream she's in a league of her own," Jarvis said.

Jeff Watson opines:

In my opinion, a good poker player that happens to be a woman will beat up most men. Women scare me at the table and I generally play around them. If they're semi hot, flirty, and charming, they have an significant edge provided they have solid poker chops. Their edge exists because they are in control just because of what and who they are and by virtue of this, can manipulate the opposite sex. It's a spectacle to see a solid woman poker player slice, dice, and chop up her victim. And many men believe that these women are just lucky since there's still that core belief out there that women aren't as good as men in poker. 

Ed Stewart writes: 

 A man's competitive instincts start to shut down around a beautiful woman. Competition goes against the natural order that furthers the species in a beneficial direction. Chivalrous notions emerge, good business sense quickly erodes. One can't fight that instinct for long, in my opinion. It is a lost cause.

In the old days when the workday was more segregated men were protected from this weakness. Now it is open season on us and the other side knows it. If a brokerage salesperson with a very sensual and attractive voice asks to make a face-to-face presentation, just say no, as difficult as it is to do, summon the will to do it and you will be thankful.

It could be that this is why men practiced some forms of workplace sexism. It kept us from becoming fools on a consistent basis. When our main work conflicts are with men we are energized. It feels natural. Not so much the other way. A women might read this and be extremely disturbed and think, "think with the big head" but it is easier said then done. Modern mores are constructs, conditioning, overwhelmed by the most simple flirtation, and every good looking professional woman knows this.

If we try to avoid the attractive woman we might be in violation of laws, so self-preservation is now illegal too. 



 I applaud the tradeworx fellow Manoj for standing up.

"A Much Needed HFT Primer for 'Flash Boys' Author Michael Lewis"
by Manoj Narang

From the first time I read Liars Poker as a teenager, I have felt Lewis was a snake. Making satire of former colleagues one worked elbow to elbow with and painting them in the worst possible light rubbed me the wrong way. He is an entertaining writer, but a tabloid writer, the type one is lucky to avoid in life.

Moneyball was a decent read but his missteps with his HFT book makes me wonder how badly he got the baseball story wrong.

One thing I have considered after reading about the HFT approach is the benefit of operational leverage and scale/turnover. These are factors I would like to take better advantage of.

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