sorosI'm still waking up in the morning trying to decipher this statement as I look at Cotton, Soybeans, Sugar…what time frame…what context, what… whatever else?

For someone as "learned as Soros", besides talking about his book, who is missing what? :

Billionaire financier and political activist George Soros shared his thoughts on topics ranging from Japan's yen intervention to the European debt crisis at the Reuters Newsmaker event on Wednesday. According to the host's coverage, Soros remains bearish on the U.S. economy, noting, "If I had to sum it up in one word, I would say 'blah,'" and there may or may not be a double-dip recession.While Soros is never shy about voicing his opinion on the global economy, the billionaire made particularly interesting remarks on gold prices, where his namesake hedge fund, now actively managed by his two sons, is invested. "Gold is the only actual bull market currently," Soros explained, adding "It will be very interesting to see if there is a decline in the next few weeks," and, "It's certainly not safe and it's not going to last forever.

"Recall that earlier this year, Soros called gold the "ultimate asset bubble," as his hedge fund was more than doubling down on its position in the SPDR Gold Trust (GLD). At the end of the second quarter, the ETF was still the largest position among Soros Fund Management's top-15 U.S.-listed equity holdings, as disclosed in 13F regulatory filings. The firm was reducing its position in the gold trust and miner NovaGold Resources (NG) during Q2, but it left the Kinross Gold (KGC) position largely unchanged.

article here 

Anatoly Veltman comments:

An 80-year-old trying to keep $20b working can't possibly mind some of the frisky markets you and I both love.

Hany Saad comments: 

Soros sports the nasty habit of actually riding a bubble knowing it's a bubble. This seems to have paid off handsomely over the years. Gold is a metal of no industrial use that keeps going up largely due to a universal psychological flaw that it is the only hedge against recession. A lot of similarity between the behavior of Gold and the tulip mania may be, yet fighting it might not be a winning proposition right now.



Resistance/SupportThe concepts of support, resistance and pivot points became such widely accepted market concepts that one is amazed how every market book mentions them freely as if the reader is supposed to know what they mean and how they should be traded.

In Alchemy of Finance, even the philosophic palindrome mentions them in his real time experiment and how he trades them. Same with, dare I say all the immortals including Paul Tudor Jones among others.

Now, I will not debate the validity of these concepts nor will I question the wisdom of the immortals here but I have a very genuine question about applying these ideas to indices.

You hear all the time that the (pick your index), let's say S&P500 hit a major support (pivot) point that should be watched very closely and if broken will signal the beginning of the bear market. A statement one hears frequently nowadays.

Now, if you consider that the S&P is made up of 500 companies, these 500 companies have each their own support and resistance levels that are tradeable in the same manner as the index, doesn't that mean that the S&P500 index resistance and support levels really reflect nothing and only represent arbitrary numbers that reflect where its components are at, and that the main premise of pivots, support and resistance levels on the index is a faulty concept?

In other words, if we take the extreme case where all the 500 companies are trading at a support level, this doesn't necessarily mean by definition that the representative index is trading at a support level on the chart. It can be trading at one arbitrary point on the chart with no significance to a chartist. Yet, this point is indirectly significant since it represents a colllective support (all the 500 companies are at a support level).

The other extreme case is where none of the companies is trading at a support level but the S&P is trading at what chartists call a support. In this case, what is the significance of the support level of the index (or the pivot point), if all the components of the index are trading in the more fluid level of no support.

For the sake of public disclosure I do not believe in support or resistance levels but am trying to get educated on how the other side thinks so one is well prepared to react or even change one's mind in extreme situations.

Larry Williams chimes in:

I am a doubter of support and resistance, but I am a user or short term highs and lows as they can be mechanically constructed and tested.

And, furthermore, even something that does not work (in my book that would be Support/Resistance, Fibonacci, etc.) may be of value if it forces a trader to use those points as stops or targets. At least you have an approach and something that says get out; limit your losses, or well enough; take profits. Yes, even if they are meaningless they can be of value if they add some form of discipline.

Steve Leslie offers:

I agree that the indices are fluid and not static. Individual stocks are added and subtracted all the time. Therefore it is quite difficult to draw conclusions based exclusively on this and across time. This is akin to comparing athletes across different generations. However two points can be made. First, they can be a good indicator of the general mood or tenor of the particular market that one is studying. The psychology if you will. And the psychology of the market is very critical to performance. Second, If one studies the overall market, one should study the various submarkets as well. The S&P 500, S&P 400, Transports, Utilities, Russell 1000, Russell 2000, NASDAQ, Value Line, Wilshire, etc. A composite can develop. A pastiche. Remember that as in all things, trading is a business of imperfect knowledge and imperfect information. Therefore nothing is absolute. Better to err on the side of caution at times and try not to extract too much from something that can not provide it. As we know, even the very exceptional traders have tough times and lose money. The key to trading is money management.

Eric Blumenschein writes:

The S&P financial contracts are traded for different reasons then the component companies that make up the S&P Index. I know it is obvious but it has not been stated yet. Certainly there are correlating movements some of the time and with some companies and often a lot of the time with a lot of the companies, but in the absence of a definable edge which may already be in use in some blackbox algorithm, it's all just noise. I suppose an edge worthy to explore for me as a daytrader is to know what percentage of the 500 companies currently register on some intraday interval, either above or below their previous day close. That may or may not be relevant to a trade I would take on the S&P eminis. It may make a difference to equally weight each of the 500 companies or slant the weighting to the largest ones or perhaps the smallest ones. If I was a position trader then perhaps there should be separate percentages to defensive issues vs speculative ones. That may or may not be valuable. 



In honour of Vic and Laurel, I suggest we start a new department called "Needs to be Tested," where refutable observations make it, while others bite the dust. I would invite readers to join with some testable hypotheses.

I will start with few of my own that I find to have some value for a meal for a day.

a) A market that goes down very hard suddenly in a free fall, then recovers immediately, will often revisit the low point as the original move was just the Mistress checking how many victims she can take with her. She then recoups and re-attacks and the low is often revisited in time after the big recovery that most green specs take as a bullish sign

b) When a big offer shows in a dull stock all of a sudden, expect the stock to move through the offer and well above it in the short term. This serves two functions. One is to grease the wheels of commerce from the fees generated from the execution of the big order and also a deception function is satisfied with the seller that is in a rush to sell while he is scooping the stock on the other side.

c) Markets sometimes have a delayed reaction to good earning reports and news. A stock that doesn't move immediately on good news often has a delayed explosion in the direction of the news. While the green observer would take the stock action as bearish, since the news must be priced in, it is often the wrong assessment and the stock moves in the direction of the news the following day.



Henri Cartier-Bresson, arguably the most powerful street photographer in history, used only a Leica 3 with a 50mm f3.5. I enjoy his photo book very much.

Bruno Ombreux adds:

Robert Doisneau is great too.

Janet Murphy writes:

Eugene Atget photographed Paris years before Cartier-Bresson was even born. Both had a keen eye, and their photographs of Paris embody a quiet beauty that remains timeless.



 There is a higher purpose in every substantial market move. The higher purpose of the recent moves in stocks, the largest weekly decline in a week in five years, includes getting the Fed to reduce interest rates, reducing the rate on mortgages, which are now back to year-end levels, providing the opportunity to show that there is grave concern for the small person, the chance to move the dollar lower, and the clearing of the brush and canopy so that the sun can shine through and growth can be even more vigorous in the future.

The February 27th decline accomplished it in one day. This time it took two weeks, and 750 Dow points. Without making a prediction for the future, let us all stand back and applaud the beauty of this grand scheme.

Hany Saad comments:

 And here I thought the decline of 300+ of the 26th was to give the shorts, who were at the point of throwing in the towel after the magnificent rise, some hope to feed the system the little change they have left in their pockets. But Friday’s decline was more interesting. It is the clever mistress's way to console the shorts and lead them to believe that this time it's different from the other declines when the market retraced the down move with a following up day of similar magnitude.

I was lucky enough to be out of markets, albeit not short, these two days. But I can clearly see the luck changing with a long position in case of a down Monday open. 

Greg Rehmke adds:

For the New York Times, last week’s downturn shifted liquidity stories dramatically. For weeks the stories have all complained about too much liquidity flooding into every conceivable scheme to enrich hedge funds and investment firms taking companies private or bringing them public–each reported as a bad idea hurting workers, damaging small investors, and weakening businesses to enrich financial manipulators.

Now the bad news is all of vanished liquidity. All sorts of reasonable business ventures suddenly and ominously can’t secure funding. Story after story fill the business pages and NPR interviews. The porridge was too hot, and now it is too cold! Newspaper reporters seem to suspect evil intent whenever markets change, as they do whenever climates change. A tornado is a natural though violent event, transporting energy and serving a higher climate purpose. Maybe occasional market "tornadoes" are similarly necessary. 



 A friend's son at the American University in Cairo who majors in business administration was telling us his class was assigned a project where they come up with a product and sell it on eBay.

The rule is that if someone reaches a million dollars in gross sales, he automatically passes the course with an A-plus, and the other top three in gross sales pass with an A. The students also can choose to concentrate on the study material and their efforts will be marked as if the sales project didn't exist. Very similar to choices and decisions we have in markets.

Upon further inquiry, I discovered that the teacher is an American. While the majority consider this utter craziness, I think it is an ingenious way to teach this specific course. It involves so many more disciplines than is apparent on the surface.

First, the student has to strike a certain balance between how much studying he will need to do vs. selling, as he might not be on the top of the sales list.

Second, the student has to figure out how the others are faring with their sales to guess where he will rank and determine how he will divide his time between studying and selling accordingly.

Third, and most important, the student who chooses the sales side will need to think of a product, find a distributor, market it, and ship it.

Only an American would think of designing a course like this. To its credit, the AUC approved of this course.



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

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

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

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

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

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

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

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

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

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

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

Sam Humbert comments:

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

Craig Mee adds:

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

Chad Humbert adds:

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

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

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

Yishen Kuik offers:

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

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

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

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

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

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

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

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

Barry Gitarts contributes: 

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

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

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

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

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

George Zachar strategizes:  

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

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

John Floyd adds: 

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

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

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

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

James Sogi comments:

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

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

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

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

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

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

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

Victor Niederhoffer extends:

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

Allen Gillespie replies:

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

Questions I always try to ask myself in those situations:

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

Hany Saad contributes:

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

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

Barry Gitarts adds:

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

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



 Given yesterday's moves by the market mistress, I'm inclined to set up a passive investment account and wondering: What is the most leveraged way to play the indices, specially NASDAQ, long term? Any case for or against ProShares such as QLD? I believe the optimal leverage historically for indices has been calculated as 2x.

Kim Zussman replies:

Dr. Saad's post recalls dating days, when so much emotion and gravitas spins moment-to-moment around the affections and afflictions of the deadly fickle opposite sex. About 99% of her moves are random (to you), not attributable to knowable causation, and there is as little merit in crowing when you are chosen as crying when you are dumped.

"Am I clever and erudite?" Or does she just like to boogie? "Am I dashing and dapper?" Or does she just like to boogie? "They were all cruel - I will show her true valor!" Or does she just like to boogie? "She danced with the others, but says I'm the one!" Or does she just like to boogie? "She moans and she shrieks!" Or does she just like to boogie?

Hany Saad responds:

No, no more confusion. I am certain now that she likes to boogie.

Her dance yesterday came out of the clear blue sky. To add insult to injury, I left the dance floor on Tuesday after three long weeks with her in my arms, leaving her to perform her best dance ever all alone while I watched from afar, sipping on a tasteless drink.



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

Nigel Davies comments:

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

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

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

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

Vic mentions:

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

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

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

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

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

Hanny Saad offers:

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

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

Craig Mee adds: 

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

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

That one little black swan can kick up some dust.

Gordon Haave comments:

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

Chris Cooper responds:

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

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

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

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

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

Russel Sears comments:

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



A day at the tracks: I took these photos at Woodbine racetrack earlier today. I used an Olympus DSLR E1 fitted with Leica lenses.



 Previous posts have focused on signals that baseball players make before the pitch, and the efforts that teams make to hide their own signals and decode the enemies'.

I have often thought that there are hidden signals in markets. My favorite signal is silver, which I call the omniscient market in that whenever something is good or bad it seems to hit the silver market first. Recently, I have been discovering the hidden signals in the Dow Jones, which seems to go the 50 and 100's during the day, much more than randomness would suggest. Another hidden signal is the movement in bond prices that always seem to predate a major move in stocks. Another one is the Israel market, which I have found quite useful in predicting where the US markets will waft.

In particular the move in the Israel market on the Tuesday morning before the war in Lebanon started was or should have been quite helpful in predicting the war. I note that the Israeli market at 1004 is at an all time high. I predict a good first day of the new quarter based on this signal.

Rodger Bastien writes:

I have spent some time in the last day or two trying to discern whether there are predictive signals one can ascertain prior to a baseball game that might parallel what has been mentioned here, as one seeks an edge in determining how activity in one market may be a precursor to a particular move in another. I would compare this to the preparation that a hitter or pitcher goes through prior to a game studying previous starts by said pitcher or at bats for hitters.

There is a tremendous amount of film study these days due to the availability and the predictive nature of the human animal, that has been successful and will be repeated. Taken further, it's no secret that crafty veteran pitchers will often change their pitch patterns, recognizing that success is often found by throwing the unexpected pitch. The truly clever don't wait until their pattern has been revealed before they change the pattern. Just as a pattern of trading is seldom successful in perpetuity, so goes a pattern of pitching.

Much has been made of successful pitchers pitching "backwards," that is to say, throwing a breaking ball on a fastball count (2-0, 3-1 etc.) and a fastball on a breaking ball count (0-1, 0-2 for example). Though not your classic example of signaling, it is certainly a great example of the importance of preparation and varying patterns to confuse the adversary.

Alston Mabry writes:

"Stylometry" is the use of quantitative methods to determine the authorship of written works. Methods have varied over the centuries, but much attention has been paid to a writer's use of unusual words or word pairings. The problem is that unusual words and word pairings are easy to mimic, should one intentionally seek to create a forgery.

However, because of modern stylometry's reliance on computers, researchers can now analyze a writer's use of very common words and word patterns. It turns out that these common words and patterns are much more subtle, tend to be generated habitually and unconsciously, and are, therefore, much harder to fake or to hide.

One thinks at least of the relationship between what is highlighted in the media, and what occurs in markets.

From J.T. Holley:

For what it's worth one of my favorite card tricks involving an accomplice is utilizing any of the four tens. You lay out ten cards making sure that one and only one of the ten cards is a ten. When they are set up you have it look exactly like the ten as such:

5H              2S

3D      JH      10C

6C      5H      KS

4D              7C

You simply ask the person involved in the trick to pick a card while your accomplice has his back turned. When your accomplice turns back around you start asking him "is this the card," "is this the card." He'll keep saying "no" until you give the hidden signal with the ten card (ten of clubs in the above example layout). You always must lead with placing your finger on the exact card that the person participating has chosen. The real magic though is when the person participating chooses the ten! Then your accomplice can guess it right out of the gate with the first guess. It never ceases to amaze me that very few people figure this out.

The Mistress might be playing the very same card trick as Vic mentions above. The Israeli market being the card the market points to first, then leads to let you know where the magic returns are going to be. Or could she have the ten chosen being the silver market whereas it is the one to be in first and right out of the gate?

Oh well, magic has it's own set of signals.

Easan Katir adds:

One hidden signal (perhaps hidden only to me) I've researched is stock option volume or increased implied volatility predicting a move in the underlying. An anecdotal example was GM in February. 30 February puts were extremely overvalued and stock proceeded to go straight down from 37 to 30.

Hany Saad writes:

This is very enlightening. One wonders why Vic thinks the Tel Aviv market is leading or helps predicting the American mkts. Now, for what it is worth, the best trader I know operates out of Haifa and we correspond daily. His very rare recommendations are money in the bank.

Kovner had a theory that the Russian markets were the same and his theory was that they open our mail.



 All news is not equal. Some news tells you what has happened in the past, other news tells you what is coming in the future. Some news becomes important again, like knowing the Sage had bid 15% below asset value for LTCM. That's where the market cleared in 2002. For example, on 9/11 there was news about the attack that drove stocks like INVN from $8 to $50 over the next three months, because it led to the installment of baggage screens at every airport. It led to a fundamental shift in air travel demand leading to airline bankruptcies.

Other news, like the Congressional hearings and the questioning of high profile investment bankers in July 2002 signaled a market low of significance. Currently, news of the Fed pause has led to expectations of a Fed rate cut, which subprime reinforced, so if there is news that shifts that expectation it would be dramatic — much as Clinton shifted expectations at the high in 2000 with a comment on genomics. That's why I continue to watch gold closely here, because the expectation is for an easing of inflation and gold at a new high would shatter that expectation.

Gregory van Kipnis remarks:

Words betray us and never seem to mean what they intend. What is meant by news, what is meant by prices? Here are the principles that guide me:

First, There is something called analysis; analysis of news or analysis of prices.

Second, if markets are very efficient there will not be many occasions when the analysis of news or prices will yield predictive insights.

Third, "news" is generally used to refer to fundamentals, i.e., events that shift supply or demand or any of the assumptions that govern the stability of prices. Prices, on the other hand, refer to the unfolding outcome of changes in views about fundamentals.

Fourth, most fundamentals are discounted, so prices move in advance or swiftly. Therefore, I rarely get an information edge about changes in fundamentals. Nonetheless, the persistent analysis of human action yields insights, from time to time, to the prepared mind. But there are false positives. Monitoring prices in relation to quantitative tripwires can also signal a fundamental is changing, but here too there are many false positives. I may never know why views are changing, so I would have to satisfy myself that it is sufficient to figure out that others are valuing things differently and that is all I need to know.

So I pick my poison.

I would always prefer to have an independently obtained opinion about the likely causes of changes in equilibrium rather than constantly trying to figure out if others are changing their minds about what to value, and never understanding why. However, there is a caveat. Just as when driving on a busy highway, to use an analogy, fundamentals first –but also a wary eye always cocked to discern technical signs to avoid risk. I don't have to know if a bad driver was drunk or having a heart attack, I just have to pick up quickly that something is wrong and make sure he doesn't take me out on his way to his maker.

Hany Saad replies:

News does not drive prices. I would like to see empirical evidence to the contrary.

Prices predicted 9/11 and other events if you look close enough at the options markets. Now, if you suggest that 9/11 drove prices with an open gap down when the market finally opened, how would you have profited as an operator? In retrospect you were handed the same cards every other operator was and you had to make a decision based on your historical views, your system, your statistical edge — but not on news.

Even if news drives prices, it is very questionable that an operator will be able to benefit from public news from off the floor. Can one really profit from the news in real time? Yes, news might have an effect on price but this ignores the main use of news for the speculator — profitability. The correct question is whether a speculator can trade profitably using news.

I maintain that prices predict news, and trading on statistical patterns and measuring psychological biases is the only good niche in a market where there are more newswires than brokerage houses.

David Higgs adds:

It's the interpretation of when good news is bad news and bad news is good news. Changing cycles, sea changes. Those with the knack of getting these right become wizards.



 Mexican Carlos Slim, world’s 3rd richest person, sits several unattenuated standard deviations above the mean of a very poor nation.

"Diners at Slim's ubiquitous Sanborns restaurants can use Slim's wireless service to connect to Slim's Internet provider and check their holdings through Slim's brokerage, part of Slim's Grupo Financiero Inbursa group. Banking online, they can pay bills to Slim's car insurance company or credit cards for Slim's retail stores, among them Sears Mexico and the Mixup record store chain."

From Hany Saad: 

Here is what I wrote about Slim a few days back in response to Scott Brooks's post about the new Forbes list of billionaires. Slim had the most unusual jump in net worth.

News like this, while interesting to skim through, can be very valuable if analyzed deeply. In fact, they can give you subtle clues on what cycles are about to change (specially if you keep historical data of the list year over year). I certainly try to keep in mind that the data can be flawed especially when it comes to analyzing the net worth of the super wealthy. I will state here the obvious example as an exercise in analyzing humdrum data like the above profitably.

Notice how Carlos Slim, 67, Mexico, $49 billion, telecom, had the highest jump in net worth and is getting uncomfortably close to Buffet? You compare that with a chart of the peso to weed out the possibility of a huge jump in the local currency as the main reason for the increase in net worth. This is not really important in the case of Slim and most of the others since they mostly keep their wealth in US dollars. In fact, Slim doesn't even reside in Mexico. This exercise is, however, useful in the case of others like the Egyptian Naguib Sawiris, whose OTOH is required by law to keep a significant percentage of his "disclosed" net worth in the Egyptian pound.

Some other obvious questions to ask other than the general currency differentials include: What sectors are they involved in? How did the sectors do in general over the period? How did their specific company fare relative to the sector? Did they target new markets? Which ones? How did these new markets do? If all the above is not significantly changed compared to the previous year to warrant the big change in their net worth, then the info can become even more valuable and more digging can be worth your while.

In general, this can be a good exercise in ever-changing cycles, if you keep in mind the importance of incentive and self-interest as the only driving motives. This is how this trader reads the news.



 The Derivatives Expert writes:

I just had to withdraw a piece from publication. The copy editor wanted to "improve" the sentences. I pulled it out immediately upon hearing claims that she represented the "general public," with the assumption that she knew what the "general public" needed ? not realizing that she was talking to an empiricist who despises impressions (based on anecdotal evidence) and pompously stated superstitions. There is an expert problem with copy editors particularly when they are self-appointed representatives of the "general public." ("Advice" from book editors reminds me of Warren Buffet's comment about people in limos taking stock tips from people who ride the subway). Fooled by Randomness was not copy edited (with close to 200 typos in the hardcover edition). My next book will not be edited. An edited text is fake. Really fake. It is as shameful as ghostwriting [read more].

One doesn't have to believe in the black swan and the man behind the curtain to find the Expert's website, as messy as it is, dare I say, entertaining. OK, I admit I have been reading it. The text in French and his translation of Plato's passage on apology are highly entertaining. I was very critical of his book, yet he somehow manages to entertain me even despite all his scientific flaws.

I respect a guy who appreciates the writings of Voltaire. Voltaire's Histoire d'un Bon Bramin and Madame du Chatelet's Discours Sur le Bonheur are two well-chosen works, and I have to agree with the expert's recommendations. And I find his ramblings on Socrates and on Greek and French literature more enlightening than his stock market remarks.

Elsewhere on his website, he talks about how book reviewers hurt writers' feelings with bad reviews. I hope I didn't hurt his feelings with my bad rating of his book, but unfortunately I still hold that the book was scientifically flawed and can lead to vast losses in practical, day to day, humdrum trading.

That said, I would highly recommend his website.

Ken Smith adds:

HedgeFundGuy, writing on Mahalanobis, says the Expert "thinks his genius must be unedited and unrefereed."

But poetry need not be submitted to an editor. If edited it would not be an original poem. We do not expect a painting to be changed by an editor. Would a famous expressionist painting be authentic if it were edited? Would an Ayn Rand character submit to editing? 



 I started working as an auditor, at Price Waterhouse, one of the big six, right after my graduation from university. I worked very hard and very long hours. After eighteen months I was managing a very large group and was the youngest manager in the company's history. I was very good with numbers. I studied balance sheets, income statements, and statements of cash flow. I studied hard and learned a lot about companies. I was never satisfied and always thought I could do more. I started a few businesses in my twenties and overall made money. I spent sleepless nights managing people and working to meet deadlines. My businesses grew and I had to leave my auditing career for good.

One day I decided to liquidate everything and emigrate to Canada. The stock market always attracted me. It attracted me initially as the line of least resistance and the easiest way to make money. Boy, was I ever wrong! I read every book about markets from Peter Lynch's to the scoundrel of Omaha's and his womanizing mentor's. I decided I was more interested in the demand and supply curves of the stocks whose balance sheets I am studying more than the demand and supply for heir products.

I didn't know why but it made more sense to me to treat the stocks as the subject of examination, their supply and demand, their temper and their psychology and forget everything else. I felt I was getting closer to the Key to Rebecca, as one large fund manager calls it.

I studied everything about the supply and demand of stocks. I passed the three levels of the CMT in a record time among a zillion other courses. I studied hard and learned a lot. I was living alone and didn't work for a long time. I survived on the capital from the businesses I liquidated. I read every book on technical analysis. I learned about every pattern. I programmed every indicator known to man and developed a system that weighted indicators by their success rate. Even then, unwittingly, I was trying to be scientific. I invested everything I had in the markets and was making more money that I dreamed possible for someone my age. I started living large. I once owned every model of the Rolex watch ever manufactured. No exaggeration. I owned a violin that was auctioned for the equivalent of five years of my audit manager salary without a blink. I still have my tax bills to prove it.

It always worried me that it came so easily. Even then I guess I was smart enough to have my doubts. The more money I made, the more I wanted and the more I worried. I worried that my system might be flawed. The more I worried the more I studied. The more I studied the more I figured that I might not hold the Key to Rebecca.

I had charts everywhere in my bedroom. More quote machines and news feeds than a mid-sized fund operation would need. Financial journals scattered all over my floors. Books everywhere. I was a genius. If you wanted a picture of illusion de grandeur, I was it. I always felt I should enjoy it as best as I could, as it could be taken away from me without a warning.

Every time I surfed the net I worried that my Key to Rebecca wasn't really a secret. People used my indicators everywhere. I felt that everyone knew about them and shared them very generously.

The public newspapers had them. They were all over the free websites. The TV commercials, the financial seminars all had them. They were all over the place. They were haunting me. I couldn't take the uneasiness anymore. How could everyone get rich at the same time? How could everybody be profitable? Why are they sharing? Are they mad? Didn't I study that money is a scarce commodity? Something is wrong.

How could indicators so well known to people, indicators so publicly available, be so profitable? I read and read. I tweaked my indicators so I could be ahead of the public, but only in the sense that I naively used a 47-day moving average instead of the 50 and a 17 instead of the 20 and a different method of crossover. I applied similar naive ideas to all indicators so I would ahead of the public.

I didn't like my game even though it was profitable. I didn't have an edge. Making money doesn't mean you have an edge. But, what's an edge? How do I know I have one? I studied history. I read about wars. I tried to develop a philosophical framework of what edge really is. The more I read, the more I realized that whatever an edge is, I didn't have it.

While I was browsing a bookstore in downtown Toronto, I saw a picture of a barefooted trader with chessboard in front of him. I found out he was also a champion in squash, a sport I took up very seriously at the time. The cover also attracted me, and I started reading the book.

My first reaction was, "wow, this guy knew it all along!" How many traders tell you upfront that they will not unload any secrets on you in the book they are trying to sell you? None. This alone was worth the price of the book for me.

I read the book and Victor unloaded on me a dose of wisdom beyond my brain's ability to digest over a first read. Victor, the counter, knew it all along. Victor mentioned that Jack Barnaby caught him before he learned the game of squash the wrong way. Well, Victor caught me before I learned the game of speculation the wrong way.

Yes, money was scarce. No, popular indicators will not make money over the long run. Yes, cycles change. No, technical analysis and moving averages are not testable or falsifiable. Yes, Victor went through the same stages I went through, as he explains in his encounter with John Magee, the father of technical analysis. Yes, all hope is not lost. I am still young and I can change my game.

I designed trading programs based solely on Victor's wisdom. The wisdom he gave me so freely for the few dollars I paid for his book. Victor made millionaires of, and instilled wisdom into, countless students. Victor, who never bragged about his countless achievements.

Victor answered my first email in 1998. Victor takes the time to send me emails at 2 a.m. to compliment me on a contribution to Daily Spec. A contribution that is often nothing but a recycled and repackaged piece of his own wisdom.

Scott Brooks adds:

 We are all truly blessed to have this forum and opportunity to learn. I know I have grown as a manager, a father, a hunter, and as a person because of my affiliation with Daily Spec.

As a manager, I've learned how to look beyond the world of TA and see more than the shadows on the walls of the cave that my charts were.

As a father, I've been able to share with my kids, especially David, many of the life lessons on the site.

As a hunter — yes as a deer and turkey hunter — I've improved greatly because this site has given me an opportunity to write about my hunts and as a result, forced me to look more deeply at what I was doing and at the rationale behind my choices.

And as a person, I have grown from the friendships I've made with other contributors. As a businessman, from the knowledge gained from the great businessmen among them.

I am in a continuous state of awe and excitement at the knowledge of this group — and that this group actually accepts me as part of it! If you all knew where I came from and my journey, you'd understand how amazing it is that someone like me could be here in this group!

I am most grateful for Victor for allowing me in this forum. I am honored to be here. I am honored to call Victor my friend!



 Triumph of the Optimists: 101 Years of Global Investment Returns, by Elroy Dimson, Paul Marsh, and Mike Staunton, is considered by many to be the best book written about markets and in so many ways it actually is. The authors went to great lengths to collect the most accurate data available from sources including century-old newspapers and dusty books from university libraries among others. Their efforts were very rewarding in the sense that their findings debunked some mainstream beliefs.

In general, this is an outstanding work and one of the best-researched books on markets to date. It suffers none of the biases that previous research by Fama and French or Malkiel and O'Shaugnessy were guilty of, namely the easy data bias: the bias from incorrect rights-issue adjustment, bias of hindsight choice of companies, bias of hindsight choice of sector, and survivorship bias. All these biases are so well covered in the book that there is no need for me to repeat or explain them here. In this sense, the book is exemplary research and the authors deserve to be applauded for their efforts.

The book was recommended first by Victor Niederhoffer in his posts to the list and in his book as the best book written about markets. And in terms of data accuracy and elimination of biases I have to agree with Victor. No other book I am aware of before the trio came close to offering such a comprehensive study of markets with this impeccable accuracy, even uncovering the beauty of ever-changing cycles in some cases, as with the small cap out performance that stopped working once widely discovered, and its return in 2000 and so forth.

But (didn't you see this coming?), there is some critical observation I have about the trio's great research. In the few cases the authors gave their personal opinions and played the forecaster's role, they failed miserably as there was no empirical support whatsoever.

One notable example in one of the most crucial segments of the first part of the book, The Conclusion, the authors mention that an optimist as stated by Archy the cockroach is a guy that has never had much experience, and in this spirit they state, "statistical logic tells us that future expectations must lie below today's optimists' dreams. We cannot expect the optimists to triumph in the future. Future returns from equities are likely to be lower. As Archy the cockroach warned us, experience should teach us realism not optimism.

How deflating. After reading this conclusion I felt as if I had such a build up of pleasure with the great data provided, but failed to climax reading the conclusion. Isn't 101 years of data over 16 countries a sufficient dose of realism? Didn't their own research show how the stock market outperformed through two world wars, a Wall Street crash and Great depression, hyperinflationary and economic turmoil?

Yet the authors don't expect the future to be as rosy and they call it realism. I believe the authors' opinions were influenced by the tech sector crash prior to the book's publication. Other examples include their conclusion about value versus growth.

This is a great book only if you can skip the authors' opinions and concentrate on the data. I may well be the guy who has never had much experience. As in Archy the cockroach, the authors referred to but failed to provide me with empirical reasons not to be the optimist as opposed to realist according to their definition above. In fact, their research and data make me believe that, if anything, the next hundred years should even be better that the past, given the overall political stability (please don't thow at me the war in Iraq or the Israeli-Palestinian conflict, since they fade in compared to two world wars). The great technological advances are the universal availability of information for executives to make more informed decisions.

From Steve Ellison: 

In one important respect, the 21st century has a head start on the 20th century: the number of people engaged in trade. Thomas P. M. Barnett, in The Pentagon's New Map, identified three periods of globalization.

The first was "proto-globalization" from 1871 to 1914 involving Western Europe, the United States, and Canada. After the two world wars came "Globalization I," involving approximately the same countries plus Japan. "Globalization II," since 1980, has brought China, Korea, India, Russia, and Brazil, among others, into the global economy. One would expect the trend of increasing international trade, if not reversed, to increase wealth creation and opportunities for profit.

From Stefan Jovanovich

Dr. Barnett is the perfect theorist for an age when no one knows any history. Free trade had its most dramatic worldwide expansion in the period from the abolition of the Corn Laws to the adoption of Imperial Preference. The period of "proto-globalization" that Barnett refers to was precisely the period when the clear advantages of open economic exchange began to be overridden by the kind of awful grandiose geopolitical doodling that led to WWI and is still the essence of all "strategic planning." Barnett's popularity is, alas, one of those terrible hints that the anarchy of growing international trade is once again about to be brought to heel by the superior wisdom of the people who have seen the latest Power Point presentation. 



 There has been entirely too little thought given to the mechanism, pathways and reasons that negative feedback works in markets. Perhaps the main reason is that the feeding web is based on a reasonable stability in what and how much is being eaten and recycled.

The people who consume and redistribute must maintain a ready and stable supply of those who produce. They develop mechanisms to keep everything going. One of them is the specialization and great efficiency in their activities. If markets deviate too much from the areas and levels within which the specialization has developed, then much waste and new effort and mechanisms will be necessary.

Aside from the grind that trend following causes (i.e. the losses in execution), and the negative feedback system of movements in the supply and demand schedules that equilibrate, which Marshall pioneered and are now standard in economics, and the numerous other reasons I've set forth (e.g. the fixed nature of the system and the flexibility to profit from it), this appears to me to be the main reason that trend following doesn't work.

Here are a few interesting articles on the subject:

How Great Traders Make Millions in Up or Down Markets 

Does Trend Following Work On Stocks?

Interviews At RealWorld Trading

Why I Don't Believe in Trends

Briefly Speaking . . . 

Bill Rafter writes: 

Dr. Bruno had posed the idea of beating an index by deleting the worst performers. This is an area in which we have done considerable work. Please note that we do not consider this trend-following. The assets are not charted, just ranked.

Let us imagine an investor who is savvy enough to identify what is strong about an economy and invest in sectors representative of those areas, while avoiding sectors representing the weaker areas of the economy. Note that we are not requiring our investor to be prescient. He does not need to see what will be strong tomorrow, just what is strong and weak now, measured by performance over a recent period.

What is a market sector? The S&P does that work for us, and breaks down the overall market (that is, the S&P 500) into 10 Sectors. They further break it down into 24 Industry Groups, and further still into 60-plus Industries and 140-plus Sub-Industries. The number of the various groups and their constituents changes from time to time as the economy evolves, but essentially the 500 stocks can be grouped in a variety of ways, depending on the degree of focus desired. Some of the groupings are so narrow that only one company represents that group.

Our investor starts out looking at the 10 Sectors and ranks them according to their performance (such as their quarterly rate of change). He then invests in those ranked first through fourth (25 percent in each), and maintains those holdings until the rankings change. How does he do? Not bad, it turns out.

From 1990 through 2006, which encompasses several types of market conditions, the overall market managed an 8 percent compound annual rate of return. Our savvy investor achieved 10.77%. A less savvy investor who had the bad fortune to pick the worst six groups would have earned 7.23%. Those results are below. (Note, for comparison purposes, all results excluded dividends.)

How can our savvy investor do better? By simply sharpening one's focus, major improvements can be achieved. If instead of ranking the top 4 of10 Sectors, our savvy investor invests in a similar number (say the top 4, 5 or 6) of the 24 Industry Groups, he achieves a 13.12% compoundedannual rate of return over the same period. Note that the same stocks are represented in the 10 Sectors and the 24 Industry Groups. At no time did he have to be prescient.

One thing you will notice from the graphs above is that the equity curves of our savvy and unlucky investors mimic the rises and declines of the market index itself. Being savvy makes money but it does not insulate one from overall bad markets because the Sectors and even the Industry Groups are not significantly diversified from the overall market.

Why not keep going further out and rank all stocks individually? That clearly results in superior returns, but the volume of trading is such that it can only be accomplished effectively in a fund structure - not by the individual. And even ranking thousands of stocks will not insulate an investor from an overall market decline, if he is only invested in equities. The answer of course is diversification.

It is possible to rank debt and alternative investment sectors alongside equities, in the hope of letting their performances dictate what the investor should own. However the debt and commodities markets have different volatilities than the equities markets. Anyone ranking them must make adjustments for their inherent differences. That is, when ranking really diverse assets, one must rank them on a risk-adjusted basis for it to be a true comparison. However if we make those adjustments and rank treasury bonds (debt) against our 24 Industry Groups (equity) we can avoid some of the overall equity declines. We refer to this as a Strategic Overlay:

Adding this Strategic Overlay increases the returns slightly, but more important, diversifies the investor away from some periods of total equity market decline. We are not talking of a policy of running for cover every time the equities markets stall. In the long run, the investor must be in equities.

Invariably in ranking diverse assets such as equities, debt and commodities, our investor will be faced with a decision that he should be completely out of equities. It is likely that will occur during a period of high volatility for equities, but one that has also experienced great returns. Thus, our investor would be abandoning equities when his recent experience would suggest otherwise. And since timing can never be perfect, it is further likely that the equities he abandons will continue to outperform for some period. On an absolute basis, equities may rank best, but on a risk-adjusted basis, they may not. It is not uncommon for investors to ignore risk in such a situation, to their subsequent regret.

Ranking is not without its problems. For example, if you are selecting the top 4 groups of whatever category, there is a fair chance that at some time the assets ranked 4 and 5 will change places back and forth on a daily basis. This "flutter" can be easily solved by providing those who make the cut with a subsequent incumbency advantage. For a newcomer to replace a list member, it then must outrank the current assets on the selected list by the incumbency advantage. This is very similar to the manner in which thermostats work. We have found adding an incumbency advantage to be a profitable improvement without considering transactions costs. When one also considers the reduced transaction costs, the benefits increase even more.

Another important consideration is the "lookback" period. Above we used the example of our savvy investor ranking assets on the basis of their quarterly growth. Not surprisingly, the choice of a lookback period can have an effect on profitability. Since markets tend to fall more abruptly than they rise, lookback periods that perform best during rising markets are markedly different from those that perform best during falling markets. Determining whether a market is rising or falling can be problematic, as it can only be done with certainty in retrospect. However, another key factor influencing the choice of a lookback period is volatility, which can be determined concurrently. Thus an optimal lookback period can be automatically determined based on volatility.

There is certainly no question that a diligent investor can outperform the market. By outperforming the market we mean that he will achieve a greater average rate of return than the market, while limiting the maximum drawdown (or percentage equity decline) to less than that experienced by the market. But the average investor is generally not up to the diligence or persistence required.

In the research work illustrated above, all transactions were executed on the close of the day following a decision being made. Thus the strategy illustrated is certainly executable. Nothing required a forecast; all that was required was for the investor to recognize concurrently which assets have performed well over a recent period. It is not difficult, but requires daily monitoring.

Charles Pennington writes:

Referring to the MathInvestor's plot: :

At first glance it appears that the "Best" have been beating the "Worst" consistently.

In fact, however, all of the outperformance was from 1990 through 1995. From 1996 to present, it was approximately a tie.

Reading from the plot, I see that the "Best" portfolio was at about 2.1 at the start of 1996. It grew to about 5.5 at the end of the chart for a gain of about 160%. Over the same period, the "Worst" grew from 1.3 to 3.2, a gain of about 150%, essentially the same.

So for the past 11 years, this system had negligible outperformance.

One should also consider that the "Best" portfolio benefits in the study from stale pricing, which one could not capture in real trading. Furthermore, dividends were not included in the study. My guess is that the "Worst" portfolio would have had a higher dividend yield.

In order to improve this kind of study, I would recommend:

1.) Use instruments that can actually be traded, rather than S&P sectors, in order to eliminate the stale pricing concern.

2.) Plot the results on a semilog graph. That would have made it clear that all the outperformance happened before 1996.

3.) Finally, include dividends. The reported difference in compound annual returns (10.8% vs 8.0%) would be completely negated if the "Worst" portfolio had a yield 2.8% higher than the "Best".

Bill Rafter replies:

Gentlemen, please! The previously sent illustration of asset ranking is not a proposed "system," but simply an illustration that tilting one's portfolio away from dogs and toward previous performers can have a beneficial effect on the portfolio. The comparison between the 10 Sectors and the 24 Industry Groups illustrates the benefits of focus. That is, (1) don't buy previous dogs, and (2) sharpen your investment focus. Ignore these points and you will be leaving money on the table.

We have done this work with many different assets such as ETFs and even Fidelity funds (which require a 30-day holding period), both of which can be realistically traded. They are successful, but not overwhelmingly so. Strangely, one of the best asset groups to trade in this manner would be proprietarily-traded small-cap funds.

Unfortunately if you try trading those, your broker will disown you. I mention that example only to suggest that some assets truly do have "legs," or "tails" if you prefer. I think their success is attributed to the fact that some prop traders are better than others, and ranking them works. An asset group with which we have had no success is high-yield debt funds. I have no idea why.

A comment from Jerry Parker:

 I wrote an initial comment to you via your website [can be found under the comments link by the title of this post], disputing your point of view, which a friend of mine read, and sent me the following:

I read your comment on Niederhoffer's Daily Spec in response to his arguments against trend following. Personally, I don't think it boils down to intelligence, but rather to ego. Giving up control to an ego-less computer is not an easy task for someone who believes so strongly in the ability of the human mind. I have great respect for his work and his passion for self study, but of course disagree with his thoughts on trend following. On each trade, he is only able to profit if it "trends" in a favorable direction, whether the holding period is 1 minute or 1 year. Call it what you will, but he trades trends all day.

He's right. I was wrong. Trend following is THE enemy of the 'genius'. You and your friends can't even see how stupid your website is. You are blinded by your superior intelligence and arrogance.

Victor Niederhoffer responds:

Thanks much for your contributions to the debate. I will try to improve my understanding of this subject and my performance in the future so as not to be such an easy target for your critiques.

Ronald Weber writes: 

 When you think about it, most players in the financial industry are nothing but trend followers (or momentum-players). This includes analysts, advisors, relationship managers, and most fund or money managers. If there is any doubt, check the EE I function on Bloomberg, or the money flow/price functions of mutual funds.

The main reason may have more to do with career risk and the clients themselves. If you're on the right side while everyone is wrong, you will be rewarded; if you're on the wrong side like most of your peers you will be ok; and if you're wrong while everyone is right then you're in trouble!

In addition, most normal human beings (daily specs not included!) don't like ideas that deviate too much from the consensus. You are considered a total heretic if you try to explain why, for example, there is no link between the weak USD and the twin deficits. This is true, too, if you would have told anyone in 2002 that the Japanese banks will experience a dramatic rebound like the Scandinavian banks in the early '90s, and so on, or if you currently express any doubt on any commodity.

So go with the flow, and give them what they want! It makes life easier for everyone! If you can deal with your conscience of course!

The worse is that you tend to get marginalized when you express doubt on contagious thoughts. You force most people to think. You're the boring party spoiler! It's probably one reason why the most successful money managers or most creative research houses happen to be small organizations.

Jeremy Smith offers:

 Not arguing one way or the other here, but for any market or any stock that is making all time highs (measured for sake of argument in years) do we properly say about such markets and stocks that there is no trend?

Vincent Andres contributes: 

I would distinguish/disambiguate drift and trend.

"Drift": Plentifully discussed here. "Trend": See arcsine, law of series, etc.

In 2D, the French author Jean-Paul Delahaye speaks about "effet rateau" (rake effect), here and here .

Basically, our tendency is to believe that random equals equiprobability everywhere (2D) or random equals equiprobability everytime (1D), and thus that nonequiprobability everywhere/everytime equals non random

In 1D, non equiprobability everytime means that the sequence -1 +1 -1 +1 -1 +1 -1 +1 is in fact the rare and a very non random sequence, while the sequences -1 +1 +1 +1 +1 +1 -1 +1 with a "trend" are in fact the truly random ones. By the way, this arcsine effect does certainly not explain 100% of all the observed trends. There may also be true ones. Mistress would be too simple. True drift may certainly produce some true trends, but certainly far less than believed by many.

Dylan Distasio adds:

 For those who don't believe trend following can be a successful strategy, how would you explain the long-term performance of the No Load Fund X newsletter? Their system consists of a fairly simple relative strength mutual fund (and increasingly ETF) model where funds are held until they weaken enough in relative strength to swap out with new ones.

The results have been audited by Hulbert and consistently outperform the S&P 500 over a relatively long time frame (1980 onwards). I think their results make a trend following approach worth investigating…

Jerry Parker comments again: 

All you are saying is that you're not smart enough to develop a trend following system that works. What do you say about the billions of dollars traded by trend following CTAs and their long term track records?

Steve Leslie writes:

 If the Chair is not smart enough to figure out trend following, what does that bode for the rest of us?

There is a very old yet wise statement: Do not confuse brains with a bull market.

Case in point: prior to 2000 the great tech market run was being fueled by the hysteria surrounding Y2K. Remember that term? It is not around today but it was the cause for the greatest bull market seen in stocks ever. stocks and new issues were being bought with reckless abandon.

New issues were priced overnight and would open 40-50 points higher the next trading day. Money managers had standing orders to buy any new issues. There was no need for dog-and-pony or road shows. It was an absolute classic and chaotic case of extraordinary delusion and crowd madness.
Due diligence was put on hold, or perhaps abandoned. A colleague of mine once owned enough stock in a that had he sold it at a propitious time, he would have had enough money to purchase a small Hatteras yacht. Today, like many contemporary dot.coms, that stock is essentially worthless. It would not buy a Mad magazine.

Corporations once had a virtual open-ended budget to upgrade their hardware and software to prepare for the upcoming potential disaster. This liquidity allowed service companies to cash in by charging exorbitant fees. Quarter to quarter earnings comparisons were beyond belief and companies did not just meet the numbers, they blew by them like rocket ships. What made it so easy to make money was that when one sold a stock, all they had to do was purchase another similar stock that also was accelerating. The thought processes where so limited. Forget value investing; nobody on the planet wanted to talk to those guys. The value managers had to scrape by for years while they saw their redemptions flow into tech, momentum, and micro cap funds. It became a Ponzi scheme, a game of musical chairs. The problem was timing.

The music stopped in March of 2000 when CIO's need for new technology dried up coincident with the free money, and the stock market went into the greatest decline since the great depression. The NASDAQ peaked around 5000. Today it hovers around 2500, roughly half what it was 7 years ago.

It was not as if there were no warning signs. Beginning in late 1999, the tech market began to thin out and leadership became concentrated in a few issues. Chief among the group were Cisco, Oracle, Qwest, and a handful of others. Every tech, momentum, and growth fund had those stocks in their portfolio. This was coincident with the smart money selling into the sectors. The money managers were showing their hands if only one could read between the lines. Their remarks were "these stocks are being priced to perfection." They could not find compelling reasons not to own any of these stocks. And so on and on it went.

After 9/11 markets and industries began to collapse. The travel industry became almost nonexistent. Even Las Vegas went on life support. People absolutely refused to fly. Furthermore, business in and around New York City was in deep peril. This forced the Fed to begin dramatically reducing interest rates to reignite the economy. It worked, as corporations began to refinance their debt and restructure loans, etc.

The coincident effect began to show up in the housing industry. Homeowners refinanced their mortgages (yours truly included) and took equity out of their homes. Home-buyers were thirsty for real estate and bought homes as if they would disappear off the earth. For $2000 one could buy an option on a new construction home that would not be finished for a year. "Flipping" became the term du jour. Buy a home in a hot market such as Florida for nothing down and sell it six months later at a much higher price. Real estate was white hot. Closing on real estate was set back weeks and weeks. Sellers had multiple offers on their homes many times in the same day. This came to a screeching halt recently with the gradual rise in interest rates and the mass overbuilding of homes, and the housing industry has slowed dramatically.

Houses for sale now sit on the blocks for nine months or more. Builders such as Toll, KB, and Centex have commented that this is the worst real estate market they have seen in decades. Expansion plans have all but stopped and individuals are walking away from their deposits rather than be upside down in their new home.

Now we have an ebullient stock market that has gone nearly 1000 days without so much as a 2% correction in a day. The longest such stretch in history. What does this portend? Time will tell. Margin debt is now at near all-time highs and confidence indicators are skewed. Yet we hear about trend followers and momentum traders and their success. I find this more than curious. One thing that they ever fail to mention is that momentum trading and trend following does not work very well in a trendless market. I never heard much about trend followers from June 2000 to October 2002. I am certain that this game of musical chairs will end, or at least be temporarily interrupted.

As always, it is the diligent speculator who will be prepared for the inevitable and capitalize upon this event. Santayana once said, "Those who cannot remember the past are condemned to repeat it."

From "A Student:"

 Capitalism is the most successful economic system in the history of the world. Too often we put technology up as the main driving force behind capitalism. Although it is true that it has much to offer, there is another overlooked hero of capitalism. The cornerstone of capitalism is good marketing.

The trend following (TF) group of fund managers is a perfect example of good marketing. As most know, the group as a whole has managed to amass billions of investor money. The fund operators have managed to become wealthy through high fees. The key to this success is good marketing not performance. It is a tribute to capitalism.

The sports loving fund manger is a perfect example. All of his funds were negative for 2006 and all but one was negative over the last 3 years! So whether one looks at it from a short-term one year stand point or a three year perspective his investors have not made money. Despite this the manager still made money by the truckload during this period. Chalk it up to good marketing, it certainly was not performance.

The secret to this marketing success is intriguing. Normally hedge funds and CTAs cannot solicit investors nor even publicly tout their wares on an Internet site. The TF funds have found a way around this. There may be a web site which openly markets the 'concept' of TF but ostensibly not the funds. On this site the names of the high priests of TF are repeatedly uttered with near religious reverence. Thus this concept site surreptitiously drives the investors to the TF funds.

One of the brilliant marketing tactics used on the site is the continuous repetition of the open question, "Why are they (TF managers) so rich?" The question is offered as a sophist's response to the real world question as to whether TF makes money. The marketing brilliance lies in the fact that there is never a need to provide factual support or performance records. Thus the inconvenient poor performance of the TF funds over the last few years is swept under the carpet.

Also swept under the rug are the performance figures for once-great trend followers who no longer are among the great, i.e., those who didn't survive. Ditto for the non-surviving funds in this or that market from the surviving trend followers.

Another smart technique is how the group drives investor traffic to its concept site. Every few years a hagiographic book is written which idolizes the TF high priests. It ostensibly offers to reveal the hidden secrets of TF.

Yet after reading the book the investor is left with no usable information, merely a constant repetition of the marketing slogan: How come these guys are so rich? Obviously the answer is good marketing but the the book is moot on the subject. Presumably, the books are meant to be helpful and the authors are true believers without a tie-in in mind. But the invisible hand of self-interest often works in mysterious ways.

In the latest incarnation of the TF book the author is presented as an independent researcher and observer. Yet a few days after publication he assumes the role of Director of Marketing for the concept site. Even the least savvy observer must admit that it is extraordinary marketing when one can persuade the prospect to pay $30 to buy a copy of the marketing literature.

Jason Ruspini adds:

 "I attribute much of the success of the selected bigs to being net long leveraged in fixed income and stocks during the relevant periods."

I humbly corroborate this point. If one eliminates long equity, long fixed income (and fx carry) positions, most trend-following returns evaporate.

Metals and energies have helped recently, after years of paying floor traders.

Victor replies:

 I don't agree with all the points above. For example, the beauty of capitalism is not its puffery, but the efficiency of its marketing and distribution system as well as the information and incentives that the prices provide so as to fulfill the pitiless desires of the consumers. Also beautiful is in the mechanism that it provides for those with savings making low returns to invest in the projects of entrepreneurs with much higher returns in fields that are urgently desired by customers.

I have been the butt of abuse and scorn from the trend followers for many years. One such abusive letter apparently sparked the writer's note. Aside from my other limitations, the trend following followers apparently find my refusal to believe in the value of any fixed systems a negative. They also apparently don't like the serial correlation coefficients I periodically report that test the basic tenets of the trend following canon.

I believe that if there are trends, then the standard statistical methods for detecting same, i.e., correlograms, regressions, runs and turning point tests, arima estimates, variance ratio tests, and non-linear extensions of same will show them.

Such tests as I have run do not reveal any systematic departures from randomness. Nor if they did would I believe they were predictive, especially in the light of the principle of ever changing cycles about which I have written extensively.

Doubtless there is a drift in the overall level of stock prices. And certain fund managers who are biased in that direction should certainly be able to capture some of that drift to the extent that the times they are short or out of the market don't override it. However, this is not supportive of trend following in my book.

Similarly, there certainly has been over the last 30 years a strong upward movement in fixed income prices. To the extent that a person was long during this period, especially if on leverage, there is very good reason to believe that they would have made money, especially if they limited their shorts to a moiete.

Many of the criticisms of my views on trend following point to the great big boys who say they follow trends. To the extent that those big boys are not counterbalanced by others bigs who have lost, I attribute much of the success of the selected bigs to being net long leveraged in fixed income and stocks during the relevant periods.

I have no firm belief as to whether such things as trends in individual stocks exist. The statistical problem is too complex for me because of a paucity of independent data points, and the difficulties of maintaining an operational prospective file.

Neither do I have much conviction as to whether trends exist in commodities or foreign exchange. The overall negative returns to the public in such fields seem to be of so vast a magnitude that it would not be a fruitful line of inquiry.

If I found such trends through the normal statistical methods, I would suspect them as a lure of the invisible evil hand to bring in big money to follow trends after a little money has been made by following them, the same way human imposters work in other fields. I believe that such a tendency for trend followers to lose with relatively big money after making with smaller amounts is a feature of all fixed systems. And it's guaranteed to happen by the law of ever-changing cycles.

The main substantive objection to my views that I have found in the past, other than that trend followers know many people who make money following trends (a view which is self-reported and selective and non-systematic, and thus open to some of the objections of those of the letter-writer), is that they themselves follow trends and charts and make much money doing it. What is not seen by these in my views is what they would have made with their natural instincts if they did not use trend following as one of their planks. This is a difficult argument for them to understand or to confirm or deny.

My views on trend following are always open to new evidence, and new ways of looking at the subject. I solicit and will publish all views on this subject in the spirit of free inquiry and mutual education.

 Jeff Sasmor writes:

 Would you really call what FUNDX does trend following? Well, whatever they do works.

I used their system successfully in my retirement accounts and my kids' college UTMA's and am happy enough with it that I dumped about 25% of that money in their company's Mutual Funds which do the same process as the newsletter. The MFs are like an FOF approach. The added expense charges are worth it. IMO, anyway. Their fund universe is quite small compared to the totality of funds that exist, and they create classes of funds based on their measure of risk.

This is what they say is their process. When friends ask me what to buy I tell them to buy the FUNDX mutual fund if their time scale is long. No one has complained yet!

It ain't perfect (And what is? unless your aim is to prove that you're right) but it's better than me fumfering around trying to pick MFs from recommendations in Money Magazine, Forbes, or Morningstar.

I'm really not convinced that what they do is trend following though.

Dylan Distasio Adds:

 For those who don't believe trend following can be a successful strategy, how would you explain the long-term performance of the No Load Fund X newsletter?

Michael Marchese writes: 

In a recent post, Mr. Leslie finished his essay with, "I never heard much about trend followers from June 2000 to October 2002." This link shows the month-to-month performance of 13 trend followers during that period of time. It seems they did OK.

Hanny Saad writes:

 Not only is trend following invalid statistically but, looking at the bigger picture, it has to be invalid logically without even running your unusual tests.

If wealth distribution is to remain in the range of 20 to 80, trend following cannot exist. In other words, if the majority followed the trend (hence the concept of trends), and if trend following is in fact profitable, the majority will become rich and the 20-80 distribution will collapse. This defeats logic and history. That said, there is the well-covered (by the Chair) general market upward drift that should also come as no surprise to the macro thinkers. The increase in the general population, wealth, and the entrepreneurial spirit over the long term will inevitably contribute to the upward drift of the general market indices as is very well demonstrated by the triumphal trio.

While all world markets did well over the last 100 yrs, you notice upon closer examination that the markets that outperformed were the US, Canada, Australia, and New Zealand. The one common denominator that these countries have is that they are all immigration countries. They attract people.

Contrary to what one hears about the negative effects of immigration, and how immigrants cause recessions, the people who leave their homelands looking for a better life generally have quite developed entrepreneurial spirits. As a result, they contribute to the steeper upward curve of the markets of these countries. When immigrants are allowed into these countries, with their life savings, home purchases, land development, saving and borrowing, immigration becomes a rudder against recession, or at least helps with soft landings. Immigration countries have that extra weapon called LAND.

So in brief, no - trends do not exists and can not exist either statistically or logically, with the exception of the forever upward drift of population and general markets with some curves steeper than others, those of the countries with the extra weapon called land and immigration.

A rereading of The Wealth And Poverty Of Nations, by Landes, and the triumph of the optimist may be in order.

Steve Ellison adds:

 So Mr. Parker's real objective was simply to insult the Chair, not to provide any evidence of the merits of trend following that would enlighten us (anecdotes and tautologies that all traders can only profit from favorable trends prove nothing). I too lack the intelligence to develop a trend following system that works. When I test conditions that I naively believe to be indicative of trends, such as crossovers of moving averages, X-day highs and lows, and the direction of the most recent Y percent move, I usually find negative returns going forward.

Bacon summarized his entire book in a single sentence: "Always copper the public play!" My more detailed summary was, "When the public embraces a particular betting strategy, payoffs fall, and incentives (for favored horsemen) to win are diminished."

Trend Following — Cause, from James Sogi: 

Generate a Brownian motion time series with drift in R

WN <-rnorm(1024);RW<-cumsum(WN);DELTAT<-1/252;

MU<-.15*DELTAT;SIG<-.2*sqrt(DELTAT);TIME<-(1:1024)/252 stock<-exp(SIG*RW+MU*TIME) ts.plot(stock)

Run it a few times. Shows lots of trends. Pick one. You might get lucky.

Trend Following v. Buy and Hold, from Yishen Kuik 

The real price of pork bellies and wheat should fall over time as innovation drives down costs of production. Theoretically, however, the nominal price might still show drift if the inflation is high enough to overcome the falling real costs of production.

I've looked at the number of oranges, bacon, and tea a blue collar worker's weekly wages could have purchased in New York in 2000 versus London in the 1700s. All quantities showed a significant increase (i.e., become relatively cheaper), lending support to the idea that real costs of production for most basic foodstuffs fall over time.

Then again, according to Keynes, one should be able to earn a risk premium from speculating in commodity futures by normal backwardation, since one is providing an insurance service to commercial hedgers. So one doesn't necessarily need rising spot prices to earn this premium, according to Keynes.

Not All Deer are Five-Pointers, from Larry Williams

 What's frustrating to me about trading is having a view, as I sometimes do, that a market should be close to a short term sell, yet I have no entry. This betwixt and between is frustrating, wanting to sell but not seeing the precise entry point, and knowing I may miss the entry and then see the market decline.

So I wait. It's hard to learn not to pull the trigger at every deer you see. Not all are five-pointers… and some will be bagged by better hunters than I.

From Gregory van Kipnis:

 Back in the 70s a long-term study was done by the economic consulting firm of Townsend Greenspan (yes, Alan's firm) on a variety of raw material price indexes. It included the Journal of Commerce index, a government index of the geometric mean of raw materials and a few others. The study concluded that despite population growth and rapid industrialization since the Revolutionary War era, that supply, with a lag, kept up with demand, or substitutions (kerosene for whale blubber) would emerge, which net-net led to raw material prices being a zero sum game. Periods of specific commodity price rises were followed by periods of offsetting declining prices. That is, raw materials were not a systematic source of inflation independent of monetary phenomena.

It was important to the study to construct the indexes correctly and broadly, because there were always some commodities that had longer-term rising trends and would bias an index that gave them too much weight. Other commodities went into long-term decline and would get dropped by the commodity exchanges or the popular press. Just as in indexes of fund performance there can be survivor bias, so too with government measures of economic activity and inflation.

However, this is not to say there are no trends at the individual commodity level of detail. Trends are set up by changes in the supply/demand balance. If the supply/demand balance changes for a stock or a commodity, its price will break out. If it is a highly efficient market, the breakout will be swift and leave little opportunity for mechanical methods of exploitation. If it is not an efficient market (for example, you have a lock on information, the new reality is not fully understood, the spread of awareness is slow, or there is heavy disagreement, someone big has to protect a position against an adverse move) the adjustment may be slower to unfold and look like a classic trend. This more often is the case in commodities.

Conversely, if you find a breakout, look for supporting reasons in the supply/demand data before jumping in. But, you need to be fast. In today's more highly efficient markets the problem is best summarized by the paradox: "look before you leap; but he who hesitates is lost!"

Larry Williams adds:

I would posit there is no long-term drift to commodities and thus we have a huge difference in these vehicles.

The commodity index basket guys have a mantra that commodities will go higher - drift - but I can find no evidence that this is anything but a dream, piquant words of promotion that ring true but are not.

I anxiously stand to be corrected.

Marlowe Cassetti writes:

 "Along a similar vein, why would anybody pay Powershares to do this kind of work when the tools to do it yourself are so readily available?"

The simple answer is if someone wishes to prescribe to P&F methodology investing, then an ETF is a convenient investment vehicle.

With that said, this would be an interesting experiment. Will the DWA ETF be another Value Line Mutual Fund that routinely fails to beat the market while their newsletter routinely scores high marks? There are other such examples, such as IBD's William O'Neal's aborted mutual fund that was suppose to beat the market with the fabulous CANSLIM system. We have talked about the great track record of No-Load Fund-X newsletter, and their mutual fund, FUNDX, has done quite well in both up and down markets (an exception to the above mentioned cases).

For full disclosure I have recently added three of their mutual funds to my portfolio FUNDX, HOTFX, and RELAX. Hey, I'm retired and have better things to do than do-it-yourself mutual fund building. With 35 acres, I have a lot of dead wood to convert into firewood. Did you know that on old, dead juniper tree turns into cast iron that dulls a chain saw in minutes? But it will splinter like glass when whacked with a sledgehammer.

Kim Zussman writes:

…about the great track record of No-Load Fund-X newsletter and their mutual fund FUNDX has done quite well in both up and down markets… (MC)

Curious about FUNDX, checked its daily returns against ETF SPY (essentially large stock benchmark).

Regression Analysis of FUNDX versus SPY since inception, 6/02 (the regression equation is FUNDX = 0.00039 + 0.158 SPY):

Predictor    Coef         SE Coef           T             P
Constant    0.00039    0.000264        1.48        0.14
SPY            0.15780    0.026720        5.91        0.00

S = 0.00901468    R-Sq = 2.9%   R-Sq (adj) = 2.8%

The constant (alpha) is not quite significant, but it is positive, so FUNDX did out-perform SPY. Slope is significant and the coefficient is about 0.16, which means FUNDX was less volatile than SPY.

This is also shown by F-test for variance:

Test for Equal Variances: SPY, FUNDX

F-Test (normal distribution) Test statistic = 1.17, p-value = 0.009 (FUNDX<SPY)

But t-test for difference between daily returns shows no difference:

Two-sample T for SPY vs FUNDX

            N          Mean      St Dev       SE Mean
SPY      1169     0.00041  0.0099       0.00029
FUNDX 1169     0.00045  0.0091       0.00027   T=0.12        

So it looks like FUNDX has been giving slight/insignificant out-performance with significantly less volatility; which makes sense since it is a fund of mutual funds and ETFs.

Even better is Dr Bruno's idea of beating the index by deleting the worst (or few worst) stocks (new additions?).

How about an equal-weighted SP500 (which out-performs when small stocks do), without the worst 50 and double-weighting the best 50.

Call it FUN-EX, in honor of the fun you had with your X that was all mooted in the end.

Alex Castaldo writes:

The results provided by Dr. Zussman are fascinating:

The fund has a Beta of only 0.157, incredibly low for a stock fund (unless they hold a lot of cash). Yet the standard deviation of 0.91468% per day is broadly consistent with stock investing (S&P has a standard deviation of 1%). How can we reconcile this? What would Scholes-Williams, Dimson, and Andy Lo think when they see such a low beta? Must be some kind of bias.

I regressed the FUNDX returns on current and lagged S&P returns a la Dimson (1979) with the following results:

Regression Statistics
Multiple R                0.6816
R Square                 0.4646
Adjusted R Square   0.4627
Standard Error        0.0066
Observations           0.1166

                    df         SS          MS         F            Significance F
Regression       4      0.0444    0.0111   251.89    8.2E-156
Residual      1161      0.0511    4.4E-05
Total           1165      0.0955

                Coefficients  Standard Error  t-Stat        P-value
Intercept  8.17E-05     0.000194           0.4194        0.6749
SPX          0.18122      0.019696           9.2007        1.6E-19
SPX[-1]    0.60257      0.019719         30.5566        6E-151 SPX[-2]    0.08519      0.019692           4.3260        1.648E-05 SPX[-3]    0.04524      0.019656           2.3017        0.0215

Note the following:

(1) All four S&P coefficients are highly significant.

(2) The Dimson Beta is 0.914 (the sum of the 4 SPX coefficients). The mystery of the low beta has been solved.

(3) The evidence of price staleness, price smoothing, non-trading, whatever you want to call it is clear. Prof. Pennington touched on this the other day; an "efficiently priced" asset should not respond to past S&P price moves. Apparently though, FUNDX holds plenty of such assets (or else the prices of FUNDX itself, which I got from Yahoo, are stale).

S. Les writes:

Have to investigate the Fund X phenomenon. And look to see how it has done in last several years since it was post selected as good. Someone has to win a contest, but the beaten favorites are always my a priori choice except when so many others use that as a system the way they do in sports eye at the harness races, in which case waiting for two races or two days seems more apt a priori. VN 

 I went to the Fund X website to read up, and the information is quite sparse. It is a very attenuated website. I called the toll free number and chatted with the person on the other line. Information was OK, but, in my view, I had to ask the proper questions. One has several options here. One is to purchase the service and do the fund switching themselves based on the advice of their experts. The advisory service tracks funds that have the best relative strength performance and makes their recommendations from there,

Another is to purchase one of four funds available. They have varying levels of aggressiveness. Fund 3 appears to be the recommended one.

If one purchases the style 3 one will get a very broad based fund of funds. I went to yahoo to look up the holdings at

Top ten holdings are 47.5% of the portfolio, apparently concentrated in emerging markets and international funds at this time.

In summary, if money were to be placed into the Fund X 3 portfolio, I believe it would be so broad based and diversified that returns would be very watered down. Along with risk you would certainly be getting a lot of funds. You won't set the world on fire with this concept, but you won't get blown up, either.

Larry Williams adds:

My 2002 book, Right Stock at the Right Time, explains such an approach in the Dow 30. The losers were the overvalued stocks in the Dow.It is a simple and elegant idea…forget looking for winners…just don't buy overvalued stocks and you beat the idex.

This notion was developed in 1997, when i began actually doing it, and written about in the book. This approach has continued to outperform the Dow, it is fully revealed.

Craig Cuyler writes:

Larry's comment on right stock right time is correct and can be used to shed a little bit of light on trend following. This argument is at the heart of fundamental indexation, which amongst other points argues that cap weighting systematically over-weights overvalued stocks and under-weights undervalued stocks in a portfolio.

Only 29% of the top 10 stocks outperformed the market average over a 10yr period (1964-2004) according to Research Affiliates (this is another subject). The concept of "right stock right time" might be expressed another way, as "right market right time." The point is that constant analysis needs to take place for insuring investment in the products that are most likely to give one a return.

The big error that the trend followers make, in my mind, is they apply a homogeneous methodology to a number of markets and these are usually the ones that are "hot" at the time that the funds are applied. The system is then left to its own devices and inevitably breaks down. Most funds will be invested at exactly the time when the commodity, currencies, etc., are at their most overvalued.

Some worthwhile questions are: How does one identify a trend? Why is it important that one identifies a trend? How is it that security trends allow me to make money? In what time frame must the trend take place and why? What exactly is a trend and how long must it last to be so labeled?

I think it is important to differentiate between speculation using leverage and investing in equities because, as Vic (and most specs on the list) point out, there is a drift factor in equities which, when using sound valuation principles, can make it easier to identify equities that have a high probability of trending. Trend followers don't wait for a security to be overvalued before taking profits. They wait for the trend to change before then trying to profit from the reversal.

Jeff Sasmor adds:

As a user of both the newsletter and the FUNDX mutual fund I'd like to comment that using the mutual fund removes the emotional component of me reading the newsletter and having to make the buys and sells. Perhaps not an issue for others, but I found myself not really able to follow the recommendations exactly - I tend to have an itchy trigger finger to sell things. This is not surprising since I do mostly short-term and day trades. That's my bias; I'm risk averse. So the mutual fund puts that all on autopilot. It more closely matches the performance of their model portfolio.

I don't know how to comment on the comparisons to Value Line Arithmetic Index (VAY). Does anyone follow that exactly as a portfolio?

My aim is to achieve reasonable returns and not perfection. I assume I don't know what's going to happen and that most likely any market opinion that I have is going to be wrong. Like Mentor of Arisia, I know that complete knowledge requires infinite time. That and beta blockers helps to remove the shame aspect of being wrong. But there's always an emotional component.

As someone who is not a financial professional, but who is asked what to buy by friends and acquaintances who know I trade daily (in my small and parasitical fashion), I have found that this whole subject of investing is opaque to most people. Sort of like how in the early days of computing almost no one knew anything about computers. Those who did were the gatekeepers, the high priests of the temple in a way. Most people nowadays still don't know what goes on inside the computer that they use every day. It's a black box - opaque. They rely on the Geek Squad and other professionals to help them out. It makes sense. Can't really expect most people to take the time to learn the subject or even want to. Should they care whether their SW runs on C++ or Python, or what the internal object-oriented class structure of Microsoft Excel is, or whether the website they are looking at is XHTML compliant? Heck no!

Similarly, most people don't know anything about markets; don't want to learn, don't want to take the time, don't have the interest. And maybe they shouldn't. But they are told they need to invest for retirement. As so-called retail investors they depend on financial consultants, fee-based planners, and such to tell them what to do. Often they get self-serving or become too loaded with fees (spec-listers who provide these services excepted).

So I think that the simple advice that I give, of buying broad-based index ETFs like SPY and IWM and something like FUNDX, while certainly less than perfect, and certainly less profitable than managing your own investments full-time, is really suitable for many people who don't really have the inclination, time, or ability to investigate the significant issues for themselves or sort out the multitudes of conflicting opinions put forth by the financial media.

You may not achieve the theoretical maximum returns (no one does), but you will benefit from the upward drift in prices and your blended costs will be reasonable. And it's better than the cash and CDs that a lot of people still have in their retirement accounts.

BTW: FOMA = Foma are harmless untruths, intended to comfort simple souls.
An example : "Prosperity is just around the corner."

I'm not out to defend FUNDX, I have nothing to do with them. I'm just happy with it. 

Steve Ellison writes: 

One might ask what the purpose of trends is in the market ecosystem. In the old days, trends occurred because information disseminated slowly from insiders to Wall Streeters to the general public, thus ensuring that the public lost more than it had a right to. Memes that capture the public imagination, such as Nasdaq in the 1990s, take years to work through the population, and introduce many opportunities for selling new investment products to the public.

Perhaps some amount of trending is needed from time to time in every market to keep the public interested and tossing chips into the market. I saw this statement at the FX Money Trends website on September 21, 2005: "[T]he head of institutional sales at one of the largest FX dealing rooms in the US … lamented that for the past 2 months trading volume had dried up for his firm dramatically because of the 'lack of trend' and that many 'system traders' had simply shut down to preserve capital."

I saw a similar dynamic recently at a craps table when shooters lost four or five consecutive points, triggering my stop loss so that I quit playing. About half the other players left the table at the same time. "The table's cold," said one.

To test whether a market might trend out of necessity to attract money, I used point and figure methodology with 1% boxes and one-box reversals on the S&P 500 futures. I found five instances in the past 18 months in which four consecutive reversals had occurred and tabulated the next four points after each of these instances (the last of which has only had three subsequent points so far). The results were highly non-predictive.

Starting        Next 4 points
Date      Continuations  Reversals
01/03/06        3            1
05/23/06        1            3
06/29/06        2            2
08/15/06        2            2
01/12/07        1            2
             —–        —–
               9           10

Anthony Tadlock writes:

I had intended to write a post or two on my recent two week trip to Cairo, Aswan, and Alexandria. There is nothing salient to trading but Egypt seems to have more Tourist Police and other guards armed with machine guns than tourists. It is a service economy with very few tourists or middle/upper classes to service. Virtually no westerners walk on the streets of Cairo or Alexandria. I did my best to ignore my investments and had closed all my highly speculative short-term trades before leaving for the trip.

While preparing for taxes I was looking over some of my trades for last year. Absolute worst trade was going long CVS and WAG too soon after WalMart announced $2 generic pricing. I had friends in town and wasn't able to spend my usual time watching and studying the market. I just watched them fall for two days and without looking at a chart, studying historical prices and determining how far they might fall, decided the market was being stupid and went long. Couldn't wait to tell my visitors how "smart" a trader I was and my expected profit. It was fun, until announcement after announcement by WalMart kept causing the stocks to keep falling. The result was panic selling near the bottom, even though I had told myself before the trade that I could happily buy and hold both. Basically, I followed all of Vic's rules on "How to Lose."

Trends: If only following a trend meant being able to draw a straight line or buy a system and buy green and sell red. The trend I wrote about several months ago about more babies being born of affluent parents still seems to be intact. I have recently seen pregnant moms pushing strollers again. Planes to Europe have been at capacity my last two trips and on both trips several crying toddlers made sleep difficult, in both directions. Are people with young children using their home as an ATM to fund a European trip? Are they racking up credit card debt that they can't afford? Depleting their savings? (Oh wait - Americans don't save anything.) If they are, then something fundamental has changed about how humans behave.

From James Sogi:

My daughter the PhD candidate at Berkeley in bio-chem is involved in some mind-boggling work. It's all very confidential, but she tried to explain to me some of her undergrad research in words less than 29 letters long. Molecules have shapes and fit together like keys. The right shape needs to fit in for a lock. Double helices of the DNA strand are a popular example, but it works with different shapes. There is competition to fit the missing piece. They talk to each other somehow. One of her favorite stories as a child was Shel Silverstein's Missing Piece. Maybe that's where her chemical background arose. Silverstein's imagery is how I picture it at my low level. 

Looking at this past few months chart patterns it is impossible not to see the similarity in how the strands might try fit together missing pieces in Wykoffian functionality. The math and methods must be complicated, but might supply some ideas for how the ranges and strands in the market might fit together, and provide some predictive methods along the lines of biochemical probability theory. I'll need some assistance from the bio-chem section of the Spec-list to articulate this better.

From Kim Zussman: 

Doing same as Alex Castaldo, using SPY daily change (cl-cl) as independent and FUNDX as dependent gave different resluts:

Regression Analysis: FUNDX versus SPY ret, SPY-1, SPY-2

The regression equation is FUNDX = 0.000383 + 0.188 SPY ret - 0.0502 SPY-1 - 0.0313 SPY-2

Predictor     Coef           SE Coef       T        P
Constant     0.000383    0.00029      1.35    0.179
SPY ret       0.187620    0.03120      6.01    0.000*            SPY-1        -0.050180    0.03136     -1.60   0.110           SPY-2        -0.031250    0.03121     -1.00   0.317 *(contemporaneous)

S = 0.00970927   R-Sq = 3.2%   R-Sq (adj) = 3.0%

Perhaps FUNDX vs a tradeable index is the explanation.




 If a market trades with regular volume of 20 lots a side, and trades fairly rapid fire throughout the day, you can bet your kids college fund on the fact that if a market then goes 2 lots on the bid and 80 on the offer and holds there for 4 x plus of a time period greater than the normal time of an execution without the small volume being given, that offer will be lifted pronto.

You can almost count it 1 … 2 … 3 … mine.

Victor Niederhoffer writes:

 This is a most interesting and creative observation that suggests many fruitful extensions. It may be the best way to show that volume matters - of course it's the opposite way from what is usually thought. Still, Justin Mamis had similar speculative insights.

Hanny Saad writes:

Very well stated and I agree with you [Craig]. Do you care to take a stab at what you think might be happening behind the scenes? 

Craig Mee replies:

There're probably a few options here, but certainly at times you do have one or two key buyers or sellers driving the market. When this happens, the small retail traders will lean against solid offers time and again. This will continue until a situation develops where the market has traded through several levels and where no more small sellers are there to be found, yet the one or two hungry sharks are still circling. Thus you get the situation, whereby we have only two on the bid (all retail punters are now already short or have been burned trying to lean against offers) and 80 on the offer. Thereby no one hits the bid, market holds, 1/2/3/ bang… the big fish can get size on and lift the offer….

So, in a nutshell, one reason this happens, I believe is due to one or two large corporations shipping in volume for a hedge (though I'm sure the list could offer other reasons). And if you have big enough pockets it can often pay to fade this move. Its not, however, always a smart move, unless you have a direct line to God.

Bruno Ombreux writes:

"[A]nd if you have big enough pockets in can often pay to fade this move, however its not always a smart move…"

That's one thing I've seen a few times when I was a professional oil trader. It is entirely anecdotic and not testable, but relevant to the subject. The nice thing about being a professional, is that one has people on the floor, and they comment on what's happening like, "Goldman on the bid for 10,000 lots."

Now, in the 1990s, 10,000 lots WTI was big size. And if it were Goldman, and not their commodity subsidiary J. Aron, it meant they were acting as brokers for a fund that was an outsider. When professional traders tried to move size, they rarely showed it that way. They worked it all day long, preferably through several floor brokers, to hide one's intentions.

What usually happened in bygone days, is that a lot of small people tried to front-run the 10,000 lots, on the theory that a big buy order is like a free call option. They probably expected it to be taken piecemeal, if it were to be taken, which would leave time to sell and get out if the size showed signs of being eaten away. And if the market went the other way instead of filling the order, it was free money.

But instead of the order being eaten piecemeal, we often got information like, "Hess just booked Goldman." Which meant a commercial filled the 10,000 lots in one go, probably for hedging purposes.

The market moved toward size and the result was that all the frontrunners saw nothing below, and got into a panic. It cascaded as they hurried up out of their longs and the market collapsed. It can be really fun if it happens a few minutes before the close.



Sparked by an article on euphemism in politics, I have been studying the tendency of market participants and commentators to present themselves in a favorable light. The topics I have reviewed include the theories of boasting, euphemisms, biases in self reporting, self evaluation bias (325,000 entries), the superiority complex, the halo effect, and presentation of self in everyday life and deception. Nothing quite fits. However, considering that there are 132,000 entries for "as predicted" stock market on Google, I feel the topic deserves some serious consideration. Lacking theories or quantifications exactly on point, I'll have to take a crack at the subject myself.

 My previous forays into this subject in Education of a Speculator started with the consideration of how the oracle of Delphi was able to maintain its prominent place in Greek life for over 2000 years. I concluded that the key was never to administer a forecast that could be falsified, maintain an impressive site and a mystical ambience, evaluate your forecasts yourself, deceive with the startling forecast when you already know the answer, and mix in Bacchanalia. I gave examples of market people who had adopted these principles and classified them as mystic (the secrets of pi), unappreciated (I stood alone in making the forecast), other worldly persons ("the parking lots are as empty as the ships in the harbor"), mathematicians (the lognormal distribution explains it), the traditionalist (the opera chairman, the palindrome and the abstract mathematician use my methods), the Washingtonian (I met with the Fed chair often), the correlation expert (soybeans traditionally fall before a rally in bonds), the loner (I am on an around the world cruise), and the Insider ("a bullet bid has been made").

I also reported favorably on the late Harry Browne's magnificent analysis of self administered reports. He gives repeated hilarious examples of "as predicted" that actually weren't the way they predicted. He also gives examples of pretended modesty in admitting a gap in accuracy that is designed to make you feel that the forecaster is so much more honest than you or I that he's a model of integrity as well as a genius. (Such a deceptive technique is particularly relevant today as the world's worst forecaster in my opinion, the weekly financial columnist, who has been consistently bearish on stocks 100% of the time while the Dow went up from 800 to 12,500 over 40 years, admitted in his January 22 column that he gave a terrible forecast in saying that oil would go to 70 before 50). "The only thing positive about that prediction was that it didn't take more than a wink for us to be proved wrong." This technique is also detailed in The Perfect Lie of distracting attention from the real deception (i.e. his grotesque record on stocks, while admitting the oil statistics to be wrong).

Such a typology holds up pretty well after 12 years, but I feel it misses the essence of all the "as predicted" ones. For example, it doesn't focus on the multiple prediction, the person who predicts so many things that he has to be correct on one of them. A beautiful example of the same, as it's so compact, would be the person that says "X is the key level" and then boasts about being right if it goes up or down from that level. Also missing is the retrospective forecast, the forecaster that lets you know that he was bullish well after the bull move has started. Another omission is the survival biased forecaster, the person that reports just the fund or stock results that are extant right now, leaving out the results of the funds that have folded, or less insidiously, just the years or the results that were completely unfavorable. Another omission is the academic forecaster (the academic who writes a paper uncovering an anomaly with almost a clarion call for funding contained in the retrospective low priced impacted data presented). Another more subtle fudger is the person who reports their results while the going is good and then hides ostrich-like in the sand when the going is bad. (I have used a variant of this in my own business where I was happy to report while I was making returns sufficient to win awards but stopped when the going got tough. All I can say in my defense is that I figured that if my future results were good, it would create less supply against me and more demand with me. If they were bad, why should I give my adversaries the platform on which to drive in the final nails?)

Here are preliminary suggestions for those who wish to present performance figures without undue boasting and hype:

1. All results should be presented with a view of providing the truth, the whole truth, and nothing but the truth, and should be accompanied by a statement to that effect.
2. Particular care should be made to present the results of programs and funds that are no longer in existence or no longer reported for any reason with which you are associated. For example, one should never report 40% a year returns on the one program or two programs that you still have outstanding if others, invariably involving much higher amounts of money under management, have been eliminated.
3. A complete enumeration of money contributed, money taken out, profits made, commissions taken out, fees taken out, and net to customers should be made by month.
4. A similar enumeration should be made for any funds the manager was associated with that are not included in 3. (for example, the biotech fund or the growth stock fund or the trend following fund in stocks that is no longer in existence)
5. All changes in style of investment, markets invested in, fee schedules and leverage used should be noted with a fair discussion of how this would change results.
6. Third party arrangements of any kind with selling groups or brokers or service providers should be enumerated by year.
7. The independent third party that reported and calculated these results should be noted and addresses should be given and auditors enumerated.

In addition to following the above guidelines where applicable, those who make forecasts should add the following:

8. The exact time and levels of the items being forecasted and what it is you are forecasting and how to measure what is being forecasted.

9. A complete enumeration of all forecasts made over the last five years with the information required in #8.

10. An assessment of the accuracy of the forecasts made in the past, with the bad forecasts as well as the good ones equally featured.

11. A measure of the a priori likelihood of the forecast being true due to chance factors alone, for example, the forecast that oil will be higher in the future would have a 100% a priori chance of being true.

12. The independent party, like Hulbert who has vetted your forecasts or advisories in the past.

13. The amount of self interest the forecaster has in what he's forecasting. For example, whether he has a position in the recommendation, did he front run, and what his policy is in extricating from the forecast with respect to his own positions.

 No matter how carefully one develops a set of guidelines, it will always be possible to violate it in some way even when someone is not overly lax in presenting the truth, the whole truth, and nothing but the truth. As such, a letter from the forecaster describing any problems or gaps that the user might have in using the forecast should accompany the forecasts. For example, was the manager once managing a considerably larger set of assets? Has his organization changed now that he is a mere shadow (what used to be called a ghost in the stock markets of the 19th century) with a much smaller organization? Or have the financial circumstances of the manager changed so that he has an interest in a Hail Mary kind of prediction because he has been so devastated recently or as in the case of the weekly financial columnist, he's been short for so long that if he ever closes his trade, he'll realize a 1500% percent loss or so?

These are just preliminary suggestions. Remember that even with perfect reporting, past results have little or no reason to be predictive of future results because of the problem of ever changing cycles, and ageing as described by Bacon. However, exceptionally bad past results would seem to be somewhat predictive to the extent that they usually result from excessive fees and grind paid to the house.

I would be interested in any augmentations or suggestions that the readers might make here that would improve reporting and predictive methodology so that the users will have a better backdrop for decision making.

Vic further adds:

What he wrote for Mr. Wiz and myself, which he considered his best book, was that "when a master seems to fall into a trap, be doubly careful." This is an extension of what the able Mr. Mee had in mind and I am sure that Mr. Grandmaster Nigel Davies will have a few apt comments on this point.

Vincent Andres comments:

Another omission is the survival biased forecaster, the person that reports just the fund or stock results that are extant right now, leaving out the results of the funds that have folded …

This reminds me of a scene in Groucho Marx's biography (hope not to confound). Groucho was negotiating a contract about an advertisement using his image. The man proposes Groucho $500. Groucho laughs and says no. The man proposes Groucho $5000. Groucho also says no. The man proposes Groucho $15000, and Groucho agrees. Then the man brings out of his pocket a $15000 check, already written.

"By the hell, how did you know I will agree at $15000?" asked Groucho.

Well, I have four pockets said the man. In pocket one a $500 check, pocket two a $5000 check, pocket three a $15000 check, and pocket four a $30000 check.

Aaaaaaaaaaaaaarg! said Groucho.

Sorry for the approximate English and certainly an approximate remembrance.

Hany Saad adds:

While this is a very valuable framework for thought and it definitely will give one a significant edge in markets as well as the proverbial "don't take things at face value," I suggest looking at the other side of the coin, which admittedly is less common but every bit as valuable in solving market puzzles. I am talking here about the money manager who only talks about his losses and how tough it is to manage funds yet one realizes at year end that he outperformed all his peers by a large margin. The money manager who always starts his speeches with "I am a smaller fish than I like to admit" or "what do I know" or "after a very tough year" or my all time favorite, "yes, finally a good one" in response to a congratulation over a trade so outstanding that it can no longer be hidden under the carpet. The money manager whose performance is so mediocre that he was debating retiring in his thirties and only stopped when he realized that this year could be a good year as well … so why not? The lessons are very valuable since this practice keeps the enemy away and prevents envy, or so goes the tale. The only problem with such a practice is that year after year, the adversary starts noticing your bluff, and as he's leaving your office after you utter your usual "yes, finally a good year," you hear him murmur invariably "yeah, right."

It is mind boggling how people learn so quickly that you are laying low, but they hardly ever call your bluff when you practice your shameless grandiose on them a la Ableson.

Gordon Haave offers: 

The most common euphemism that I noticed was the naming of every downturn in almost any asset price as a "correction." One of the reasons that I find it notable is that those who call it a correction invariably are implying that the long term trend is still up. Well, if the future price will be higher, then why is having it go down today "correct" in any manner?

A good example of this would be today's bloomberg story about Rogers saying that the downward movement is just a "correction" and that the price will later go up to $100. If the price is going to $100, then any significant downward movement is not a "correction." Rather, it is a "mistake."

I for one think that oil is going to stay down, but that's not the point. The point is that this idea that anyone who is long can at the same time justify or excuse a downward price movement as being an ok event will still proclaim a long term rise in price.



The two belonged to almost the same generation, and both witnessed the 1929 crash first hand. One became wiser and prospered as a result, and the other committed suicide.

I always considered Livermore the ultimate mythical figure in markets, and not Benjamin Graham. If I had one criticism of Practical Speculation, it would be the exclusion of Livermore as the man who decimated the most ill founded wisdom about markets. I contribute that to the fact that his method was simple enough for the high school drop out to understand and apply, as well as to his colorful lifestyle and womanizing.

Livermore’s work can be summarized in very few words. Buy when stocks are going up and always buy at market, and do the opposite with down trending stocks. It is mind boggling how any logical person can believe that such an easy to follow system would make money over the long term.

I believe I had the same copy of How to Trade in Stocks that Victor has, and actually went out of my way to program the formula in red and blue at the back of the book into a simple computer program, before I realized that what he calls natural reactions of six dollars and more, according to the formula, mean that you should sit through decreases that will wipe out any margin you could have. He neglected to use percentage points, so according to him a six dollar reaction on a hundred dollar stock should be dealt with the same way as on a four hundred dollar stock.

In brief it is totally inapplicable in this day and age where computers execute millions and millions of dollars worth of trades at the click of a mouse, and where even arbitrage opportunities became obsolete in consequence. Its applicability to today’s markets is questionable even if you are sensible enough to change the numbers into percentages and apply it to the thousands of stocks that are under the hundred dollar mark. I even question its applicability at the turn of the last century when it was believed that Livermore prospered just by using this simple formula.

Yet, seemingly very smart people idealize Livermore, but probably more for his life style — his Yachts, his mistresses, his cigars and his mansions.

I ended up selling the book to The C.E.O. of a brokerage firm for a few thousand dollars, it is a thin book of under 100 pages. Like Ben Green (not Ben Graham) I felt I made a very good trade given the useless content of the book, but left the new owner with the impression that he got a steal out of this little boy who probably does not even know who Livermore is.

Ben Green advises that you should never show anxiety to sell to the buyer. I dare say that unlike Livermore he would have never bought stocks at market.

Green also put a very high price on his horses to test the knowledge of the buyer. While Green’s techniques could be useful in today’s markets, some twists are appropriate if not necessary, as buyers now have more choices, and again at the click of a mouse can find out the prices of a product at a hundred different suppliers around the globe.

In fact today, sellers do the opposite and fake urgency and anxiety to sell a product, just to get the buyers foot in the door. Everything Must Go, be it due to bankruptcy, a new season’s merchandise, renovations, etc … Once the buyer gets into the store to take advantage of the seller’s urgency however, he/she finds out that the seller used Green’s second technique of setting the price too high to test the buyer’s real knowledge of a bargain.

GM. Nigel Davies responds:

My reading of Livermore is different.

When reading his two biographies it seemed to me that first and foremost he was an intuitive tape reader. What he was not was an educated man, so his attempts to systemise what he thought he was doing were pretty bad. Those looking for something similarly poorly organised and unscientific should take a look at Nimzowitsch’s My System or Hans Berliner’s The System. The latter in particular would seem to have little excuse as he is a professor of computer science at Carnegie Mellon University.

I would argue that given the size Livermore was trading he must have been rather remarkable to do as well as he did, and this may well be indicative of a substantial market edge, at least in his heyday. And inevitably he got wiped out when he was wrong, a simple case of wild money management.

Larry Williams comments:

I would argue that he was a market manipulator … the Reminiscences [Full PDF] book was not exclusively the life and times of Jesse, it was a composite that first appeared in the Saturday Evening Post.

The real life and times of the man links him to Joe Kennedy and lots of market “campaigns”. His personal life was a disaster — deep depressions, children shooting one another or their mother, I forget which.

His fortunes wane almost the instant the SEC came into power, but it is certainly a well written book that has captured the imagination of traders ever since.



First let me preface my post by emphasizing that I am only posting this model because the analogy presented below ceased to exist within the sector (Canadian Banking Sector) subject of this model. I still believe that the model can provide a meal for lifetime with some modification and/or refinement. In this very simplistic model, I assume that all the Jockeys (CEOs) on top of the horses (Canadian Banking Stocks) are of similar skill set and reputation in the street (which in this case they actually are), I also assume that all the horses are of similar quality (the Bank Stocks are of equal fundamental quality, an assumption I make due to my inability to dig into fundamentals and pick favorites); and I also assume that every month is a different race.

In other words, Jan 1st to Jan 31st is the first race, Feb 1st to Feb 28th second race, etc…

A different model might want to consider Jan 1st to Sept 30th as the 1st race and Oct 1st to Oct 31st as the second since mutual funds report results then and since they own the biggest chunk of the sector under consideration. Another variation might regard the 12 months as one long race and each month as one lap in a 12 lap race and so forth.

For example, in the table below, at the end of January, BMO (Bank of Montreal) was the winner, followed by RY (Royal Bank) and so forth.

CM (Canadian Imperial Bank Of Commerce) was at the bottom of the list. Notice how the slacker for the first 5 races (CM) ended the year taking the lead.

My theory, playing on psychological biases and incentive is that given equal horses of same weight, speed, history, etc, the 2 jockeys with the most incentive to compete in a given race are the second horse that was so close to winning the previous race and the horse that came last since coming last race after race will cut into the jockey’s bonus that’s very highly correlated to where his pony ended in the overall race.

but, that needs to be tested …

This is how my racing form usually looks:

January - February bmo ry td bns na cm
February - March td ry na bmo bns cm
March - April ry td na bmo bns cm
April - May ry td na bns bmo cm
May - June ry na bns td bmo cm
June - July ry bns cm bmo td na
July - August ry bmo bns cm td na
August - September ry bmo td cm bns na
September - October ry bmo cm td bns na
Year to Date cm ry bns td na bmo
1 month na bns ry cm td bmo
3 months cm bns bmo ry td na
6 months bns ry bmo cm td na
1 year ry cm bmo bns td na




Speculation is a very consuming endeavor that involves all the senses and extends to the imagination. You often hear these statements uttered by traders:

As you can see these statements all involve the senses, the reflex and the imagination. One should normally find it beneficial for speculators to sharpen their senses and reflexes to pursue this potentially profitable but ever consuming game of speculation.

For example, you can listen to a flawed piece of music and try to spot which note is out of tune. You can also just play an instrument (more time consuming) to develop your hearing and imagination. You can develop your reflexes by playing a quick sport like Hockey or squash.

One endeavor I would like to talk about and that I trust no one has touched upon before is Photography. During the last three months, I spent most of my waking hours trying to sharpen my photography skills. Why photography? Photography is the process of making pictures by means of the action of light. Light patterns reflected or emitted from objects are recorded onto a sensitive medium or storage chip through a timed exposure. The process is done through mechanical, chemical or digital devices known as cameras. To catch that perfect photo, you need a good tool (camera), skills, good reflex and most importantly the imagination/vision and the sight to spot that perfect frame in the first place. Photography also involves treachery and deception. For instance, You want the viewer to focus on a certain subject in your photo. In that case, you put the subject in focus and blur the background (known as shallow depth of field). While the camera took a photo of a certain frame, the photographer used his skills to ensure that the viewer is focusing on one subject and ignoring all else.

Notice how in this picture the butterfly and the flower are in focus but the background is all blurred? You do that by using a wider aperture (lens opening) Other techniques involving moving subjects where you want to give the viewer the impression that a car is moving for instance is called panning. In this case you move your camera in the same direction as the moving subject for the effects.

While in photography the deceptions (a.k.a. art) are very well defined, It is not as cut and dry in markets. Let us start a discussion on deception in markets and how the markets want you to "focus" on a certain subject while ignoring the blurred background. What are the tools (aperture) the market uses to make you focus in the wrong direction.

Vic and Laurel started with the news, propaganda and the other doomsday scenarios including wars, bankruptcies, SARS, etc. that make you pay attention to a subject in focus (the news) and forget all about the blurred background (the markets' general upward drift) to your detriment. I will offer another (more micro) deceptive tool — it is the bid and ask size. Amateur traders pay attention to the size of the offer and bid which are insignificant most of the time but the big carnivores of the markets use them to "wrong foot" the naive into selling when the should be buying and vice versa.


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