The study ‘Assassinations: Evaluating the Effectiveness of a Counterterrorism Policy Using Stock Market Data’ is by Asaf and Noam Zussman, brothers who work at Cornell University and the Bank of Israel respectively. The premise of the study is to evaluate the effectiveness of Israel’s policy of assassinating members of Palestinian terrorist organizations by examining Israeli stock market reactions to these assassinations and attempted assassinations. This works on the premise that the market reacts positively to moves that are thought to promote peace (effective counterterrorism) and negatively to moves that are seen as counterproductive to peace.Assassination is one of most controversial forms of counterterrorism for several reasons. Counterterrorist assassinations such as these could be seen as extra-judicial executions, and they can be morally objectionable most often due to the risk of hurting non-combatants. This paper considers that counterterrorist assassinations can be ineffective, or worse, counterproductive at times. The paper offers an unusual analysis of when counterterrorist assassination attempts are perceived as productive, and as counterproductive through quantitative analysis of the Tel Aviv Stock Exchange. This builds on the fact that ‘terrorism has had a significant adverse macroeconomic effect on Israel.’

The study focuses on the period of the Second (Al-Aksa) Intifada, charted from September 2000, until April 2004 (when the data was taken), a period in which 600 Israeli civilians were killed in Palestinian terrorist attacks, and Israel carried out more than one hundred known assassination attempts. Assassinations have been part of Israeli counterterrorism policy since the 1950s, but this period has seen a marked increase in their frequency, and with it an increasing debate focus in Israel on their effectiveness. This debate has to consider the destructive effect of assassination on the immediate capabilities of a terrorist organization but also the potential motivational effects on a terrorist organization, and their support base, of an attempt.

The Zussmans collated data on assassination attempts (successful and un-successful) and their success from several Israeli and Palestinian sources. Next they built a set of criteria for measuring each target’s importance, using a mixture of expert opinion and Israeli media coverage. Media coverage was used to incorporate more fully investor perception, but removes the study slightly from an attempted analysis of counterterrorist assassinations to one of market perceptions. This also means that the measure of a target’s importance is affected to a degree by the day’s other news stories. Classification of the target’s role in an organization (measured on a spectrum from military to political) was also used, but was done solely by experts.

The findings show 136 trading days in which assassination attempts took place, with an average percentage change in the Tel Aviv 25 of -0.01. On average the market did not react to attempted assassinations. This lack of reaction changes however when the targets are grouped based on their seniority and role. The Zussmans show several regressions of the data using varying group criteria, all of which find strong and significant reactions of the TASE 25 to the attempted assassination of senior terrorist targets. The results show that the market reacted negatively to the attempted assassination of a senior political leader (between a -0.7 and -1.1 percentage move) and positively to the attempted assassination of a senior military leader (between a 0.5 and 0.7 percentage move). The Zussmans also show that the market did not react to the attempted assassination of non-senior targets, whatever their role. All results were factored with the NASDAQ stock market index in order to nullify exogenous factors.

The length of time between the attempted assassination and the most recent terrorist attack on Israel, and surprisingly the success or not of the attempted assassination, were shown have an insignificant effect on the markets, whereas the number of non-combatants that died in any attempt had a negative and significant effect. The evidence also suggests that all effects persist for several days, rather than being ‘blips’ in the market, and that the Palestinian stock market, represented in the study by the Al-Quds Index, mirrored the results in the Israeli Index. This could reflect the reliance of the Palestinian economy on the Israeli economy, or perhaps show a common view regarding solutions to the conflict as held by Israeli and Palestinian investors.

The most important result of the Zussmans’ analysis is that the reaction of investor perception to assassination attempts depends on the seniority and the role of the target. The market does not react to low ranked terrorists (perhaps they are not reported?), but the assassination of a senior political leader is seen as counter productive, whereas the assassination a senior military leader it is seen as productive. This fits with the hypothesis that the military leader, in charge of planning, training, arming, etc. is much more instrumental in the short term capabilities of a terrorist organization, and is also perceived by the investors to be perceived by the Palestinians to be a ‘fair’ target — their assassination would have destructive effect on terrorist capabilities without too strong an effect on terrorist motivation. A political leader on the other hand, in charge of politics/motivation and very probably in greater contact with the Palestinian people than a military leader, would be much more of a motivational ‘liability’ to attempt to assassinate. Their death would also have a considerably smaller short term effect on the terrorist capabilities of any group.

Finally, the study does not look into any effect that the style of assassination may have, perhaps a rocket strike is perceived as more ruthless than a sniper? Obviously it is also a measure of perceptions of peace rather than actual peace. Despite this, it seems a very effective and unique study, giving insights into a very controversial Israeli defence tactic and investor mindset.



Everything has been topsy turvy over the last six trading days. To put it all into perspective, let me start with the beginning of the month on August 2nd, which was down rather than the old faithful up. Next, a weak employment report was followed by a terrible afternoon decline. The day before the Fed meeting (invariably bullish) was bearish. The move to the Fed meeting on Tuesday at 2 p.m. was also down, when, again, it is invariably always up.

When the Fed did not tighten, the market went down from 1277 to 1271. The next day the market had the expected rise to 1288, but then in the afternoon, for some strange reason, went back down to 1268. The next day news of the London arrests brought the market down to 1263 overnight only to rise to 1277 during the day, and close at 1276. Again, on Friday, the market looked like going back down to 1266, before closing strong in last half hour at 1272 with the United Nations announcement coming after the close, and the Saudi market up 2.5% on Saturday.

The one strategy that worked was do the opposite of what you should. When the news was good, sell; when the news was bad, buy. Five out of the last six days have been down. Two outside days in a row occurred on Tuesday and Wednesday. There were four lower lows in a row from Monday to Thursday, and a visit to within a point of that Thursday low on Friday at 1266.

At a time like this one can only take comfort in the thought that it is the summer, the market does not have its usual ways of making money, as trading is attenuated, and as usual, the unusual occurs.

I turn to the long term drift, the return from stocks of six percent a year, growing at five percent, versus a ten year bond yield of less than five percent, and quantify this in the Fed Model for a rudder in these stormy waters.

Jim Sogi adds:

The August 14th market was down on the day, on news of peace. Crude was down and gold was down. It again seemed topsy turvy. The market is up this morning (15th) obviously. I read that the Fed gets the economic releases a day early. I wonder how closely guarded this information is. In Ed Spec Dr. Niederhoffer mentions that the Japanese seem to have good early information about economic data. Japan looked pretty strong last night and yesterday. Question: Why would the Dax be up so much also on the U.S. P.P.I. news?



In last Sunday’s New York Times, there was an article regarding a paper done at MIT comparing a hypothetical portfolio of stocks - buying the 20% of stocks with the lowest put-call ratios while shorting the top 20% of those with the highest put call ratio - the positions were adjusted weekly based on the changes in data. They reported a whopping 62% average annual return over the 12 years from 1990 thru 2001. Perhaps Vic, you can send them a copy of each of your books (to the N.Y.T. and to the authors) to help explain why this article is at best ballyhoo and at worst manipulation of those who know no better- the most glaring key omission - they excluded transaction costs (which I imagine would be high with a weekly rebalancing based on P/C data). In addition, their data set seems somewhat small - listed options have been traded for much longer periods so why did the authors choose this period only? Why did they exclude transaction costs? And why would an obscure academic paper be mentioned in the N.Y.T.? Ah yes, the Chicago Board of Exchange just happens to be starting a subscription service at the rate of $600/month for deep datasets. I have not read the original paper — I plan to find and go through it — however I have read multiple sources commenting on it, and it apparently is gaining traction. I do believe a comprehensive dataset from the options exchange would be a valuable research tool, however this seems to fall in the “too good to be able to be realized” section of market lore.

To read the article …



Here is a review of The Cosmic Landscape: String Theory and the Illusion of Intelligent Design, by Leonard Susskind. Susskind is the “Felix Bloch Professor in Theoretical Physics at Stanford University since 1978, and is a member of the National Academy of Sciences.” So this is a high-powered author.His area of physics is string theory, an intensely mathematical area that has tried to bridge the gap between quantum mechanics and general relativity. My impression is that in order to really understand what is going on in string theory one would need to undertake a multi-year apprenticeship, plowing through some very difficult math. I have not done that, and I doubt I would be able to, so my feel for the subject is limited. I can try to read books like this one for the layman, and try to understand as much as I can through the simplified analogies that the author presents.

The author proposes that string theory provides perhaps the only way to understand the apparently coincidental facts about our universe that make life possible. It has long been observed that the universe appears finely “tuned” to enable the possibility of life. One can make a long list of fundamental physical parameters (e.g. the ratio of the electric to the gravitational force, the charge to mass ratio of the electron, the energy of a certain excited energy state of the carbon nucleus, etc.) which, were they to take on slightly different values, would make life, or sometimes even stars, planets, and galaxies, impossible.

The most astonishing case of apparent “tuning” of the universe has been clarified over the past decade or two, the value of the “cosmological constant”. Einstein proposed the idea of a cosmological constant in his first papers on general relativity. It was an ad hoc device that he put in the theory so that the universe would be static, with unchanging distances between galaxies. Soon afterward, in 1929, Edwin Hubble demonstrated with his observations that the universe is expanding and not static, so Einstein retracted the idea of the cosmological constant, calling it his “biggest blunder”.

Though Einstein did not propose any mechanism for his cosmological constant, there is a clear candidate mechanism. In quantum mechanics, the “vacuum”, or the volume of space that has been evacuated of all matter, is a very lively place, with “virtual” particle-antiparticle pairs forming and annihilating. There is energy and even an effective mass associated with these quantum effects, and that energy can be a factor that can cause the universe to either contract or expand, depending on its sign. “Fermion” particles (such as the electron) would cause a contraction, but “boson” particles (such as the photon) would cause expansion.

The problem is that if one calculates the cosmological constant from, say, electrons, its magnitude is absurdly large. If the total cosmological constant were anywhere near this magnitude the universe would either collapse immediately or expand at such a rate that matter could not form. Other particles (e.g. photons) make contributions of opposite sign and similar but not the same magnitude, so there is a possibility that the contributions from all the particles could cancel each other exactly. They would, however, have to cancel to about 1 part in 10 to the 120’th power, in order to be consistent with current observations! Nobel Prizewinner Steve Weinberg has also shown that even with an only slightly less perfect cancellation, say a one part in 10 to the 119’th, the stars and galaxies would never have formed from the early universe.

This incredibly precise cancellation of the cosmological constant is the most outrageous example of what looks like a “tuning” of the universe to galaxies, stars, planets, and life to form.

String theorists, in their initial efforts, hoped that string theory would provide a unique explanation of the values of the several dozen particle masses and coupling constants of the “Standard Model” of elementary particle physics. Susskind describes, however, the process by which string theorist were forced to conclude that their general idea could be consistent with about 10 to the 500 different possibilities, each of which would be kind of like its own little Standard Model, with its own value of the cosmological constant and just about everything else. The 10 to the 500 possibilities are the “Landscape”.

Initially this finding was thought to be a disaster for string theory. Susskind proposes, however, that it is actually a great blessing. He proposes a “multiverse”, that there are a very large number (presumably much greater than 10 to the 500) universes out there. Within one universe, all the other universes are beyond the “event horizon”, and therefore can not be observed. A key point (which I haven’t fully grasped) is that random factors cause each of the universes to be different, and to “populate” a different part of the “Landscape”. Therefore each universe would have its own little Standard Model.

From this perspective, it is not surprising that our universe appears remarkably tuned to life. The explanation is that there are many, many, many other universes where no life exists. Since there are so many, each with very different properties, it is not so surprising that you could find one (or more) that is remarkably tuned for the possibility of life. And once you believe that, you realize that there is nowhere else that we could possibly be living.

Susskind presents his work as a refutation of the idea of Intelligent Design. What a newcomer might take away, though, is how respectable the idea of Intelligent Design really is, that the best physicists must postulate a near infinity of unobserved universes out there existing in parallel with ours, in order that ours can have its exceptional properties as the result of random chance rather than design. The concern about the “fine tuning” problem is widespread among the physics/cosmology elite (see for example Steven Weinberg’s discussion.)

I have not emphasized here the experimental observations that have been emerging over the past couple of decades that have had great impact. The most important are observations and mapping of the “cosmic microwave background”, the faint afterglow of the Big Bang, which is sort of like observing the red glow of burning coals, except that instead of red we are seeing microwaves, and the coals are the early universe, observed now at a temperature of just a few Kelvin above absolute zero. These experiments, the “COBE” and “ WMAP” map out fluctuations of the night sky of 1 part in 10 to the 5 to predict the temperature of the early universe. This experimental subject is probably a little more accessible to us mortals than is string theory. I think astronomy buffs and others will find it fascinating.



Everything has been topsy turvy over the last six trading days. To put it all into perspective let us start with the beginning of the month on August 2nd, which was down rather than the old faithful up. Next, a weak employment report was followed by a terrible afternoon’s decline. The day before the Fed meeting (invariably bullish) was bearish. The move to the Fed meeting on Tuesday at 2 p.m. was also down, when again it is invariably always up.

When the Fed did not tighten, the market went down from 1277 to 1271. The next day the market had the expected rise to 1288, but then in the afternoon for some strange reason went back down to 1268. The next day news of the London arrests brought the market down to 1263 overnight only to rise to 1277 during the day, and close at 1275.5. Again, on Friday, the market looked like going back down to 1266, before closing strong in last half hour at 1272.3 with the United Nations announcement coming after the close, and the Saudi market up 2.5 % on Saturday.

The one thing that worked was do the opposite of what one should. When the news was good, sell, When the news was bad, buy. Five out of the last six days have been down. Two outside days in a row occurred on Tuesday and Wednesday. There were four lower lows in a row from Monday to Thursday, and a visit within 0.8 of that Thursday low on Friday at 1265.8.

At a time like this one can only take comfort in the thought that it is the summer, the market does not have its usual ways of making money as trading is attenuated, and as usual the unusual occurs.

One turns to the long term drift, the return from stocks of six percent a year, growing at say five percent, versus a ten year bond yield of less than five percent, and quantifies this in the Fed model for a rudder in these stormy waters.



A grinder is a term used by golfers and it has two definitions:This is a golfer who is not of elite status and his game does not bring him victories. He is out there working for his money every week picking up the left-over purse money. As a result, he has to compete in more tournaments than a top-level player, play in more Monday morning qualifiers, compete in more pro-ams and corporate events, and is generally seen as struggling to stay on the tour. These are the guys who you see teeing off first on the weekend, and then quickly leaving after their round is over on Sunday and running to the next tournament. Ben Hogan was a grinder and almost quit the tour because of his abysmal financial state.

Alternatively, any pro can be a grinder for a tournament. This is when they just don’t have their ‘A’ game and are fighting on every hole just to stay above water. Even a Jack Nicklaus, Tom Watson or Tiger Woods can be a grinder for a period of time. They realize that all the pieces of the puzzle are not fitting but they still fight for every piece of real estate that they can and put every conceivable effort to put the ball in the jar. They know that eventually their game will come around and the results will be shown on the scoreboard and in their bank account.

After Tiger Woods breakout year in 1997 he actually went through a very difficult year in 1998 when he could not buy a tournament win. He was in the process of reworking his swing and as a result he struggled. It all turned around in June of 1999. Woods won the Memorial Tournament in June and 17 tournament wins in 2 years, 32 in 5 years and 7 out of 11 major tournaments.

I see this market as a grinder’s market. The solution to the puzzle is just not there yet and it is very difficult to make money. There is plenty of backing and filling and there is not enough liquidity for a sustained drive. It is quite disheartening to not see the results. But take heart. Things will change, they always do. They will get sorted out eventually and a trend will develop. The key is to stay solvent and survive to be a part of it when it does.

Think of yourself as General McAuliffe of the 101st airborne during The Battle of Bastogne in the winter of 1944. Patton’s 3rd Army 4th armored division is on its way to the rescue.



When I was a kid there was this little bit of matinee subterfuge that we would perpetrate at the movies.Seeing that there was a 1 o’clock screening followed by a 3 o’clock screening, my associates and I would would wait until the crowd from the first show would exit en masse, whereupon, ticket-less but determined, we would nonchalantly walk in backwards amongst them. Once upstream and within the safety of the lobby, we would then make our way to the emptying seats and patiently wait for the curtain to come up again. As childhood mischief goes, not exactly hotwiring cars for a joyride but OK by suburban standards.

Later, when I was a fledgling clerk in the silver pit, I soon noticed a variation on this theme.

Banks and dealers will all have phones directly to the pit, constantly manned by a clerk whose job it is to parrot the bid/offer, by who, and what size. The larger of these players will have two or more phones to different brokers on the floor, all in competition with one another for that bank’s business. And all the clerks know what other clerk is on with what bank, and what’s transpiring at any given time. The guys in the pit are largely in the dark about these clerk dynamics because a lot of this activity is happening behind them. Literally.

Having been doing this for all of a couple weeks, the trader from the bank asks me a couple of times to size up the bid in the ring after I inform him of a large offer out there. Now he knows that I’m going to ask the broker I worked for what the aggregate bid size is, and later realized that he also knows that other people are going to hear me. (It’s difficult to be deft at something you’ve been doing for two weeks.) Considering the confluence of circumstances and sensing an edge, the eavesdroppers would presumably get short, whereupon, he tells his other more seasoned clerk (around, say, 8 weeks — survival skills develop quickly in the wild…or else) to very discretely advise his broker to not hit any bids but rather to take the large offer. Then he bids for more through multiple channels, though in such a way that he probably is not going to get hit. Opportunistic shorts are now left in the lurch. As they cover, the fresh long in turn typically sells out the physical off the floor on terms friendly to his interests, I would learn later. His plan all along.

The first time this happened my naiveté was taken aback by how quickly and decisively a supposedly sophisticated bank could change it’s mind. The second time it happened, I smiled one of those small, private, epiphany smiles, thinking, oh, the old walk-in-backwards approach. How quaint. In the ensuing years, I cannot believe how many times I’ve seen this little stratagem deployed and the large scale on which it is sometimes done.

Just like the movie situation, timing is key. It was easier to salmon one’s way into a matinee than a night show because the ushers trying to prevent it had been in a darkened theatre for a while. But now they had to stare out into the sunlight looking for what was making its way against the exiting tide. Takes a little while for their eyes to adjust. Such was the salmon’s edge.

It is the same for the markets, and just like there will always be an unwitting rookie clerk out there to further the deception of a cagey participant, there will always be a media prone to being duped again into helping some concern get out of their large, long-term position. A colossal oil company suddenly discovers that it has not a localized leak but rather systemic corrosion problems over a vast network of pipes. Crude quickly jumps. But when everybody’s eyes adjust days later to the blinding sun of pervasive press coverage, it’s actually down for the week. While unleaded gas has plunged as if it were an anvil tossed from a cliff. Hmmm.

If you can artfully walk in backwards when everybody’s slowly coming out, it would logically follow that one can discretely exit when everybody’s rushing in. Especially when the hype is at high tide and the sun is in their eyes.



A Spec recommended this book written in 1933. The interesting thing about old books is that they adopt unused market theory from a different cycle, from a different paradigm than the current market thinking that the majority follows now-a-days. What was old may now be coming back into use in the changing cycles. Sometimes thinking out of the box leads to a winning strategy. This book is about grain trading and though some of the numbers are different now there were many grains of truth and wisdom and interesting approaches to trading that are worthy of mention and which should receive a warm reception by Specs, and present some good ideas and variations for testing. He presents tables of historical prices, averages of the lows and highs, and the ranges which give good information on descriptive statistics. He tested his systems and rules on historical data. A few points:

  1. Year Round trading in Wheat. Buy monthly lows during down season to line limit, then hold and sell on new month highs during up season.
  2. Scalping: Buy below prior day low and hold then sell above prior day high.
  3. The long haul speculator will outperform the scalper because of commissions and slippage.
  4. Stops cause losses. He tests this against historical data. Stops causes too many rinse outs. He does have a seasonal time stop method.
  5. Do not scale in, i.e. sell every 2 cents down or buy up as it leads to bankruptcy due to over extension of margin. Do Average cost down by buying new lows and selling new highs. Stay within a predetermined ‘line’ and keep margin available.
  6. Examine fundamentals of cost of wheat production vs. cost of gold production. Under economic law of relative cost the price can never get to zero nor several times cost of production, for long.
  7. During wheat bear markets only hedgers are short and the do not care if the price drops, thus there is no new supply to buy up price. He computed wheat bear markets to be 86 days in length.
  8. Mechanical and technical methods work better for commodities than stocks as they do not rely on honesty of management.
  9. “The culmination of a bull market comes at a time when the crop shortage receives front page comment in our daily papers.”
  10. A successful trader will not pick a price and will be willing to carry a loss. “The further a man goes in analysis of price the great the need for statistics.”

Would other knowledgeable specs offer comment on whether these ideas work in today’s grain markets?



I have been doing a lot of driving this last week and noticed some interesting things when there are delays and frustration sets in:More people try to get in the ‘fast’ lane, with the result that it becomes the slower one.

The distance between vehicles closes considerably as drivers try to get those extra few metres closer to their destination.

Scott Brooks adds:

I hate rush hour traffic. Back when I used to have to drive in it (early to mid 1980s and based on a 4 lane per side highway), I decided that I wanted to find a way to minimize my time in it. I started keeping track of certain things and came to a few conclusions which I will list here, strictly from memory. Here is what I observed.

  1. The fast lane was not the fastest lane to be in. However, contrary to Nigel’s statement, it was also not the slowest. I agree with Nigel’s statement that this is the lane that people were trying to get to, and thus, it became overcrowded and bogged down
  2. The furthest right lane (for those of us that drive on the right side of the road) was the slowest lane. I concluded what still seems obvious to me, that this was due to the entry and exit nature of this lane. So get out of the right lane as soon as possible.
  3. If there was a left entry or exit, the left lane would slow down. So fade to the middle lanes when this would happen.
  4. The fastest lane to be in, if all things were equal, was the second lane from the left (the lane just to the right of the far left lane). Get in this lane and stick with it. Don’t be suckered out of it, unless it is obvious something is going on up ahead (i.e. an accident blocking this lane.)
  5. Being aggressive helped in getting the trip started. In the early ’80s, I was working summer jobs and my co-workers were a bunch of blue collar white trash redneck ruffians. When work got out, rather than wait in line with everyone else to get on the highway, they would drive to the front of the line and cut some unsuspecting and/or timid person off to get onto the highway.
  6. Timing was everything. A couple of minutes made a HUGE difference in the traffic. Beating all the other people, who also got off at 4:30, to the entry ramp literraly meant 5 - 10 minutes on the commute home. Do not dawdle after work.
  7. Because of this it became important to pick a good parking space to ensure a quick exit. Therefore, even if I was one of the first people to arrive at work, I would still forego one the supposedly “primo” spots by the front door (primo in that you didn’t have walk very far) and park right next to the exit from the parking lot (one must take into consideration the shape, size, and distance from the building of your parking space to ensure the quickest exit. It may not always be that space nearest the exit, as it was in my case).
  8. Small cars had a disadvantage. Back then SUV’s and mini-vans played little or no role in the traffic process, but the guys with trucks got around a lot better and could nose into traffic with authority.
  9. Listen to the traffic report and adjust accordingly. However, keep in mind that traffic reports can be dated
  10. Therefore, when hearing a traffic report, note how accurate it really is. If they say, “south bound 270 is backed up between 40 and Dougherty Ferry due to an accident” but when you traverse 270 south for that stretch and see no accident, the report your probably listening to is not very accurate, or is getting second hand info. Find a station with accurate, up to date, timely reports. Just because it sounds like the guy is in a traffic copter, doesn’t mean that he really is
  11. Know your alternate routes so that you can deviate your travel route if necessary (sorry, there was no such thing as an in car talking GPS back then.)
  12. Drive a truck with 4 wheel drive. I cannot tell you how many times, back then, I got stuck in traffic and wished I had a vehicle that could drive over the median and go the other way for a mile or two to catch an alternate route. So today, I drive an SUV with 4 wheel drive. And even though I avoid rush hour 95% of the time, I do get caught in a traffic jam once in a while. I have driven through muddy medians, over shoulders, over concrete medians and other such obstructions to re-route myself to a speedier alternate route.
  13. There should be a law that says if you are caught rubber necking that you lose your license for a year and have to write a personal letter of apology to every licensed driver in the state.

In conclusion:

  1. Do not be in a hurry. Smile at the person who almost hits you. Wave the guy over who wants in. Wave thank you to the person that lets you in. Be quick to wave an apology to the person you almost hit. If someone is mad at you and cursing you verbally or with sign language, just smile and mouth “I’m sorry”, and wave…they will usually calm down.
  2. Do not be like my uncle who is like a play by play commentator, negatively deriding everyone else’s poor driving habits.
  3. Smile. Turn on some good music, whether Van Halen, Mettalica, Neil Diamond, Mozart, or Garth Brooks, and enjoy the ride.



Every short position in the market is a postponement of demand for the underlying into the future. If this is true, which seems clear since it cannot be negated, then every long position too should be a postponement of supply into the future.However, the majority of the positions in the market are long (if not leveraged then owned stock) and despite such postponement of supply into the future, prices of equity have multiplied at the fastest pace for over a 100 years. How does this add up? If such a perspective of interpreting longs and shorts was correct then the behavior of equity prices should not have been any different than of commodities etc. in the long run. What is missing?

Over and above the multiplication in value coming by due to re-investment in growth there appears to be another deeper explanation possible. The later one participates in owning the means of production and means of growth and value the more one has to pay for them. Like the insurance policy for a term of 20 years when bought at the age of 35 will cost substantially more than if done at the age of 25 and the same way in which an investor stands to capture more compound if she starts investing earlier in life. At a social level the Capitalist engine of markets seems to be dispensing equitable economic justice.

Those who are undertaking the risks of owning the means of production and the means of creation of growth and value are compensated increasingly by the latter participants. From each according to his capacity, to each according to his needs, as espoused by Lenin is actually thus being played out with genuine alacrity and fairness by the markets. The Socialist focus was on getting income in these ways, while markets have taken care of allocating the means of producing income and sharing of risks too in an equitable way.

So, despite a short position being a source of demand for a financial instrument into the future and despite a long position being the source of supply similarly, the under-ownership of risk as getting more and more evenly distributed is more than compensating for the inverted supply curve in the investment markets.

Could, deep in the unforeseeable future, there be such an even distribution of ownership of means of production per one’s capacity and per one’s needs that the under-ownership premium would then vanish? Is the drift in equity prices over the last 100 years a causation of the human enterprise or is it due to a skewed distribution of the ownership of the human enterprise?



Investors can certainly use a sector rotation strategy to produce returns which outperform the market, or even some hedge funds. Many hedge funds would be wise to consider such a strategy. However it’s not as easy as the plan described in this article’s abstract. Nor should we expect it to be; the market is not easy-pickings. But recognize what market returns we are talking about: since say 1990, the S&P has had about an 8 pct compounded annual rate of return, while experiencing about a 46 pct maximum drawdown. Those numbers can be beaten, and not just by the pros. As with any game, being an informed participant enhances your success. Without getting too far into proprietary methodologies, let me provide some insight as to what a sector rotator must consider (with a few tips included):Is the investor going to be fully invested all the time, or does he have an escape? That is, should the first set of sectors be equities vs. treasuries. Let’s call that a strategic overlay, or the first on-off switch. Then is the investment going to be long-only, long with a hedge, or long-short?

Next comes the equities universe. What group are you considering: 10 S&P economy sectors, the 64 S&P industry sectors (GICs), high liquidity ETFs of economic sectors, country ETFs, Fidelity funds, Dow Jones 18 European sectors, or small cap funds accepting new money. The list can be endless. We have rotated all of the above, and can attest that the hardest of the lot is the 10 S&P economy sectors. We would not even consider rotating a list of just four sectors, as was done in the referenced article.

Once you have chosen your universe, you have to pick an out-of-sample period and run cross correlations on the assets. The cross correlations should not be on the levels or changes, but on the scoring that you will eventually use. Your purpose here is to reduce the likelihood of always being in the same combinations of assets. You wouldn’t mind doing so if they were all moving up together, but the opposite would destroy you, and must be avoided. This is the only subjective part of the entire process: you will personally have to decide the level of cross correlation you will accept. You can of course test this also, but there will be obvious breakpoints that make sense to the experienced researcher. Thus if you start out with the 64 GICs, cross correlation may reduce that number down to about half. This should be done blind. Also, some of the 64 have only one stock, and you may want to eliminate such a sector.

The choice of ranking or scoring device is the most critical part of the entire process. Most of the industry professionals we know use a “quarterly” rate of change or relative strength calculation. For example, we have been told that R***x uses a moving 63-day rate of change for their sector rotation fund on the 64 GICs culled down to 56. They have passable results which outperform the market, and several hundred million in that fund alone. The problem with either moving rate of change or relative strength is that those calculations produce fairly erratic scores. They can be improved by some slight smoothing prior to ranking, or by skipping days (e.g. scoring and ranking every other day), but your task is to find what works best. We have done some work with counting as a ranking device, but our experience is that using counting works best only if we choose to be particularly risk-averse in a long-only program. Oh, and don’t assume that a ranking/scoring device is just one indicator, as combinations work best.

The best ranking device we have found absolutely knocks the cover off the ball, but it is not obvious. Although it is very robust and clearly non-random, we don’t yet understand why it works, and are reluctant to use it until we do.

Should the sectors be risk-adjusted? If telecoms and utilities have equal rankings on a given day, do you want to discriminate in favor of the least volatile, say by subtracting half a moving standard deviation? Our results show that doing so on sectors reduces both returns and drawdowns. That’s unexpected, as usually reducing drawdowns and increasing returns are handmaidens. However if you are ranking proprietary funds, risk-adjusting outperforms not doing so across the board. That is, penalizing managers for bad behavior really works. This suggests that (a) certain managers really have talent and fat tails, and (b) they can be discovered by some quant work.

Then comes the question as to how many assets out of our population are going to be traded. This can be tested empirically. R****x commissioned a white paper which suggested that 3-5 sectors was optimal. Yet R****x uses 8 out of their 64-culled-to-56, probably for marketing reasons (so we’ve been told). Our results show that whatever number you pick, numbers in that vicinity work well too, so it’s robust. We generally recommend using at least 3 assets to reduce volatility. But using more than 10 percent of the population curtails returns. Some of the professionals we have spoken with have told us that their “second quadrant” outperforms their “first quadrant”. Should that happen to you, you need to do more work at finding a better scoring method.

However many assets you choose to hold, add an equal number of money-market assets. That is, if you choose to buy 3 assets, then to your culled population, add another 3 assets, all consisting of money-market. Then rank the whole lot. If your top 3 assets are X, Y, and money market, then buy that mix. If an equity asset cannot outperform money-market, don’t buy it. This means you will have to construct an asset consisting of the compounded effect of money-market, which is a great thing to have in your toolbox anyway. Some professionals do not like holding money-market assets in a client’s portfolio for marketing reasons. If a client sees a large portion of his assets in cash, he’s inclined to find something else (usually wrong) to buy with it. There are also some programs that rank say 15 assets side-by-side with 15 money-markets. Then if the market tanks, you will probably be in mostly cash before that happens. That is a fairly conservative way to go, usually producing acceptable, albeit low, returns, but with very low drawdowns. Risk-averse types take notice.

How frequently do you look to change the assets? Recasting the investments everyday is not typically the best choice (as you will choose a lot of one-day-wonders), but there is a sweet spot that is robust. Interestingly, on some programs, recasting as infrequently as monthly isn’t all that bad. That is, it still beats the S&P hands down, and a whole lot of hedge funds to boot.

A variation on the question as to how many assets to hold, is the percentage allocation among those held assets. Equally weighting the allocations may be the first choice to consider, but it is certainly not the last. Then you have to deal with rebalancing the equity among the assets and the frequency of that rebalancing. The academic literature just on the frequency of rebalancing is quite substantial.

If you consider a hedged strategy, you have to choose whether you are going to hedge initial equity only (never readjusted for equity changes), a full hedge (adjusted daily for all changes), or somewhere in-between. The frequency of hedging is also a variable that should be tested. Upon doing so you will also find a sweet spot that is robust. Readjusting the hedge can also be subject to an on-off switch. That is, if your strategic overlay says that equities look weak, the switch forces you to go to a fully hedged condition from less so.

What is best depends on the yardstick used by the investor. The investor may seek to maximize returns, minimize drawdowns, maximize the ratio of the two, or some other statistic. Success is achievable. For example, it is certainly possible to create a program in which the compound annual rate of return exceeds twice the maximum drawdown, or with a Sharpe Ratio north of 2.

Given all of the degrees of freedom discussed above, it would certainly be naive to expect a simple four-sector program chosen on the basis of relative strength to produce hedge fund returns. It is wrong for the abstract to imply that investment success cannot be achieved. However, the author is right in that the typical investor cannot use such a simple strategy to produce superior performance. But that’s not because it cannot be done. Rather it’s because the typical investor is not up to the task of doing the research necessary.



I have to spend a little more time reviewing the concept in my head but I may have just read one of the best books I have ever read. Present Value, by Sabine Willet (a lawyer of all things), is sort of post 9/11 Bonfire of the Vanities that raises some intriguing and perhaps necessary questions. The story follows the travails of a couple, this time she is the hard driving over achieving spouse and he is a senior member of management with a large toy company who should have risen higher but prefers sailing and running to actually caring about business and finance. He is adequate, fairly compensated but not driven by any means She out earns him by 10 to 1 and unlike most North American males, he doesn’t seem to give a good crap. The bottom of course has to and does fall out of their world with some Enron style shenanigans and the book covers what happens to them each as the world falls apart. Sabine uses the artful device of a economics professor appearing in flashback to set the central tome and ask the critical questions. It is easy in one of these books to make the business world the bad guy and make it entirely touchy feely business is bad. Sabine avoids that by having the clever professor raise the questions. We all know that the supply and demand set the value of damn anything and that the marketplace is the final arbiter. Most of us on this list live are lives by these precepts and rightly so. Ultimately at the end of the day they are true. But are commerce and marketplace the only measure of value in the world or are their perhaps others? And if they are, asks the professor, can you run on two tracks at once. Ordinarily these books break down right here and insist that only some nebulous concept of true love is worthy and you must be poor as a church mouse to experience it. The book allows you to draw different conclusions if you so desire. The use of satire and rollicking humor helps tell the story and ask the questions that we all should ask ourselves from time to time. a good read that is also fun and thought provoking. A rare combination.



On a recent Sunday morning in Central Park, we sat in a wisteria-clad arboretum talking about life and markets. One tells Victor how significant his “letters to my son” series are in one’s own family, and that my son reads them with great interest. “Yes, we’re waiting for your contribution,” he replies.So here is one…

Learn computer language(s)

Once upon a time about four hundred years ago in Europe, and a thousand years ago in China, movable type was cutting-edge high technology. Tim Berners-Lee’s internet is as big an inflection point in western history as Johann Gutenberg’s movable type press in 1440, and as in eastern history as Bi Shing’s movable type press in China in 1041. Printed books and periodicals opened up a new world of intellect, previously known only to monks and aristocrats. There were two general groups: There were the intelligentsia, who could read and write. Then there were the illiterate, who couldn’t. The literate group had many more religious, commercial and intellectual opportunities. This new facility disseminating the treasures of the intellect set the stage for the development of science.

The internet is the stage for another evolutionary surge. One needs to participate or be left behind with those who only read, write human language, listen to iPods, watch television. These days as a basic skill one should at least be able to code a web page with XHTML and CSS as easily as one typed a letter on an IBM Selectric twenty years ago. One should learn a real computer language to work with data as a farmer harvests a crop, a miner refines ore. It’s a basic skill of this millennium. It’s another great divide. There is a joke which carries a kernel of this truth: ‘there are only 10 kinds of people in the world…those who understand binary and those who don’t.”

Understand how computers fit in to our life. Several generations ago one’s family may have had a cook, a driver and domestic servants. To communicate and give instructions one learned their language. They were intelligent and did what one told them, but of course, one needed to talk to them in a way they could understand.

Here in the early years of the millennium, computers and the internet appear to be our servants for the foreseeable future. Intelligent yet docile, with superior memory and reasoning powers, few personal problems, they will do what one tells them, they will help us develop and progress, as long as we speak their language. Therefore it is important that you learn how to talk to them. HTML is an easy way to start. C++ is a good way to continue. Other dialects abound. No problem. Gutenberg and the thousand printers who went into business around Europe had similar challenges.

Remember when your father taught you touch typing, and your resistance, sloth, inattentiveness? A few years later you said, “I’m really glad I learned to type,” as you happily spent hours IM’ing friends around the world, and completed school projects. Now one’s efforts to teach you to communicate with your computer are on the same trajectory.

For a reader intimidated by these thoughts, open up a page of Notepad. Type this: Hello New MillenniumSave the file on your desktop with name: Hello.html Now double click on it’s icon, and you will see your first web page. That’s it. No big deal. Easier than planting a petunia. A skill for these times.

There are other skills to learn, which seem to apply to any age. For example, after Gutenberg printed a calendar, he went on to print scriptures, then indulgences, over borrowing to expand his business, defaulting on his debts, and his creditor repossessed his printing equipment and went into business for himself. But that is a lesson for another letter.



I got my paws on a 1897 CBOT telegraph code book which provided shorthand words to describe market activity. Rather than type the entire phrase, individual words were designated to substitute.The chapter ‘State of the Market - Upward’ provides 80 different ways to describe rising prices and provides 16 blank keywords for individuals to create additional phrases.

A few examples:

Plebian — Short sellers are buying freely
Pledge — Everything offered is being taken
Pledging — More disposition to buy
Plentiful — Everything on the market has been taken
Plenty — Good enquiry and few sellers
Pliable — Good enquiry

It ought to be republished and issued to many in the trading community as Financial Phrases on Demand.



The story of of the war in Iraq is not going well, the actual war is going so well that for Americans it is largely over. The casualty rate from IEDs is now down to little more than twice what the rate would be if the same number of troops were being deployed in continuous live fire exercises. Non-combat transport accidents are now almost as significant a risk as getting attacked. The security situation in Baghdad is ‘worse’ only because the end game is now being played out - principally with the Sadr militia. What is remarkable is that most of the work is being done by the Iraqi army rather than U.S. forces.The story of the war is being written by al Reuters and the holy trinity of the Los Angeles and New York Times and the Washington Post. These are the lineal descendants of the same people who sat around the Hotel Caravelle in Saigon and were so pissed off at having the war actually come to them during Tet that they were determined to see Westmoreland pay for their spilled drinks and other inconveniences.

When the British won their counter-insurgency wars in Asia and Africa in the 1950s, no one in the London press celebrated. The victories in this war will be equally unheralded.

If anyone needs a political conspiracy theory for last night and today’s events and their likely follow-on, a better one would be that the Republicans have been devilish enough to take away women’s cosmetics and grooming aids. Talk about uniting the home front!

Ashton Dorkins replies:

I’d like to respond to your statement “The story of of the war in Iraq is not going well, the actual war is going so well that for Americans it is largely over.” While I think the first part of your claim has some merit, the second part is utterly preposterous. It seems the basis for your claim “the actual war is going so well ” is that US fatalities/casualties are declining.

The primary reason for this is because Iraq is mired in civil war. The target has shifted from the occupying force to enemy at home & this new reality makes the US military position untenable. No point getting bogged down in a civil war, forced to choose a side, might as well stay out of it. So yes,” the war for Americans is largely over.” But how many more Iraqi lives will be lost before the real war is over? How long will the country tear itself apart before a lasting peace is in place? And to what end? A country bitterly divided along sectarian lines?

Of course the media focus has been largely negative & many good stories failed to make the light of day. But death & destruction should be emphasized over a few feel good stories. Then hopefully the true costs of war will be considered by future generations before they decide to embark on such grand nation building adventures.

For a true picture of what’s going on in Iraq, I’d thoroughly recommend you read “Fiasco: The American Military Adventure in Iraq” by Thomas Ricks. Perhaps then will you grasp just how bad conditions are in Iraq & really understand why the war is largely over for Americans. If this is your idea of a war going well, I’d hate to see one not going well.



Announcements of expected moves, like yesterday’s break in the 17 consecutive interest rate hikes by the Fed, are often accompanied by dialogue to the effect that ‘this by no means indicates that the end is near.’ I remember the ‘once is enough’ mantra that Larry Lindsay was always dispatched to repeat when the Fed began to increase interest rates in the past. One is also reminded of the Hungarian saying ‘the more they deny they are going to do it again, the more I count my silver.’The last two Fed announcements, which were seemingly bullish but were greeted with revulsion and bearish reactions in the news, bring to mind the ‘beaten favorite’ syndrome at the races — it is always good to consider betting on a beaten favorite after they lose, and their odds go up. The overnight move, after seemingly disappointing reactions to a Fed announcement is a horse from that same stable, frequently opening up, after the bears and the news boys beat it down in the favored race the previous day.

The Harness Eye, a racing paper, gives statistics on the money made by betting on beaten favorites. It will be interesting to see the outcome of today’s beaten favorites tomorrow.

Steve Leslie replies:

Your post on Good Odds made me think of corollaries.

One in particular, is in professional football. Sports bookmakers will tell you this is by far the most popular sport that the public wagers on and the most profitable for the casino. Year in and year out, pro football pays for the entire year for the casinos other wagering activities. As an anecdote, bookmakers generally lose big in baseball.

An interesting factoid about the wagering public is that they have a tendency to bet on the favorite, so they are consistently laying points. In a sport, where spreads are tight and teams are evenly matched, the results of the game usually hinge on intangibles such as turnovers and injuries. Therefore betting on a favorite can turn out to be a losing strategy in the long run.

Also, one other interesting fact about pro football is that the performance of a team last week is totally irrelevant as to what is going to happen this week with respect to the posted spread. So gamblers tend to fall prey to Gambler’s fallacy. They will bet against a team, because the team had a bad week and then find themselves on the losing end of the bet. This happens so often in pro football that the term “On Any Given Sunday” was invented.

This force is so powerful that many handicappers will never bet the spreads in the pros choosing instead the lines where it it at least more statistical. Or they will leave the pros alone and concentrate on college football, especially the smaller conferences such as the Mid American Conference or Big Sky where information is not so readily available and therefore edges can be found.

In the end, sports wagering is very difficult to win at and football is the most difficult of all, so if you do decide to wager, and we are a gambling public, keep the bets reasonable, accept the fact that you will probably lose your bankroll by the end of the year, and only bet for entertainment.



You have forced your way through the shop past the thick barricades of Books You Haven’t Read, which were frowning at you from the tables and shelves, trying to cow you. But you know you must never allow yourself to be awed, that among them there extend for acres and acres the Books You Needn’t Read, the Books Made For Purposes Other Than Reading, Books Read Even Before You Open Them Since They Belong To The Category of Book Read Before Being Written. And thus you pass the outer girdle of ramparts, but then you are attacked by the infantry of Books That If You Had More Than One Life You Would Certainly Also Read But Unfortunately Your Days Are Numbered. With a rapid manoeuvre you bypass them and move into the phalanxes of the Books You Mean To Read But There Are Others You Must Read First, the Books Too Expensive Now And You’ll Wait Till They’re Remaindered, the Books ditto When They Come Out In Paperback, Books You Can Borrow From Somebody, Books That Everyone’s Read So It’s As If You Had Read Them, Too. Eluding these assaults, you come up beneath the towers of the fortress where other troops are holding out:

  • the Books You’ve Been Planning To Read For Ages
  • the Books You’ve Been Hunting For Years Without Success
  • the Books Dealing With Something You’ve Been Working On At The Moment
  • the Books You Want To Own So They’ll Be Handy Just In Case
  • the Books You Could Put Aside Maybe To Read This Summer
  • the Books You Need To Go With Other Books On Your Shelves
  • the Books That Fill You With Sudden, Inexplicable Curiosity, Not Easily Justified
  • Aug


    I grew up with an atheist dad. He digs math and problem-solving and his middle name is work. I married into a Christian family. I was in Gulf being a scud-stud (Garry Trudeau, the Doonesbury dude, gave me the cartoon scud-stud button in Kuwait after the war). Anyway, I found myself praying to something.Always back and forth with my father in law. He is a MD and Bible salesman. For years I just appeased him, went to church yada yada. I figured if I kept it to the basics it would be cool to have G-d back me up as a dad for the kids. Well, sometimes everyone takes things too far. I just had to put my foot down on a few things. One was guilt and I refuse to lay it on heavy and raise my children to feel guilty about too much. Must be balance is the gist. Funny, my wife studied child psych in college. Yes, she busts out the textbooks and I lose 10-1. However I don’t put up with the shades of grey mumbo jumbo when it comes to science and my kids.

    But today I just went ballistic. There is a book called SOZO: Survival Guide for a Remnant Church. The author, Ellis Skolfield, paints a picture of what the next few years may be like for Christians everywhere, then outlines what believers need to do if they wish to survive the “Satanic holocaust that will soon engulf us.”

    Okay, so the Bible salesman sent me this book maybe three years ago. I flipped through it and it reads like the Prudent Bear site, At the Crest of the Tidal Wave, Debt Disaster, and any other bearish Wall Street publication you can think of. I do not need that nonsense in my subconscious, so like all things repugnant, I listen to little and put it down. When I am sad I read a bit about Africa and I usually “feel better about the good ol’ USA.”

    Point is, around the Christian campfire, SOZO is really making the rounds. From Nostradamus, “a Persian madman will start the end,” to Revelation “when the desert blooms,” every time there’s a conflict near some mystic place or some terrible storm hits: “the end of the world, are you ready?” Heck no.



    Speaking of cheating in cycling, which seems a hot topic in the world of sports right now, the picture here shows what has been found by a collector, who bought a racing bicycle dating from the 1930s. In the handlebar, concealed in the interior empty space, there was a bunch of nails used to flatten opponents tyres. Please note that in those days racers had their spare tyre on them and to change a flat one required quite a lot of time. Interesting tactic, but I wonder if it can be applied to the markets.



    Fed Day was no fairy tale. The problem with story lines is that they are linear and backward looking. The market is future discounted. Thirdly, the story is usually someone else’s agenda, not your own. Believing in fairy tales is not conducive to the bank account. Chair also notes in Ed Spec that turning points are volatile, and that when the Fed makes rare changes in direction it often continues for a long time in the same direction.Despite this, Grimm’s Fairy Tales are a gold mine of entertaining lessons on life and trading to be learned. Take for example The Story of a Youth Who Went Forth to Learn What Fear Was. Market action often shows fear at work, causing unforced errors by market participants and traders. This story is about a dull boy who lacked fear, and in the typical three vignettes endured three scary situations without fear, dealt with his adversaries ruthlessly and ended up with the treasure. Another interesting analogy with fairy tales and the market is the use of threes: three scenes — three scary drops. The announcement made believers in fairy tales go long at the false pop. Same story as last Friday.

    ‘When I asked him how he was going to earn his bread, he actually wanted to learn to shudder.’

    During the first trial he grabs the scary black cats and nails their paws to the table and drowns them, and then cuts up the rest. In the second trial scary things failed to make the boy shudder where others would have run in panic. He plays nine pins with dead men using skulls for a ball. He says nonchalantly without fear, “lost a couple of farthings.” In the last trial, the old ghost says, “If you are stronger, I will let you go”, so he seized an iron bar and beat the old man till he moaned and entreated him to stop, when he would give him great riches…The old man led him back into the castle, and in a cellar showed him three chests full of gold. “Of these,” said he, “one part is for the poor, the other for the king, the third yours.”

    During these scary trials the best course is not to shudder, but to seize an iron bar and beat the living daylights out of it to collect the treasure. Secondly even a dullard without fear can do well by applying the unique ability to deal with scary situations without fear.



    One of the key chapters in price theory books such as Price Theory and Applications by Peter Pashigian, is on the pricing policies and resulting profits for companies, which are based on the degree of competition they face, the elasticity of demand for their products, and their durability. One important conclusion is that the more differentiated a product is, and therefore less competition it has to contend with, the greater that company’s profit margins. The basic theorem initially being that all firms price where the extra unit of revenue equals the extra cost incurred by the production of one more unit.Other conclusions are that the lesser the degree of competition, the more inelastic is the region in which the company prices, i.e. demand will be less responsive to any given price increase. Increases in demand for firms that do not face much competition increases their profits in the short run, and may do even more so in the long term when plant size can change to accommodate the extra demand. Cost innovations are also very profitable for such firms.

    Since profit margin serves as a proxy for how differentiated a company’s products and processes are relative to its competitors, I thought it might be helpful to have a list of companies classified by profit margins. Note that the high profit margin companies all tend to trade at a much higher p/e than other companies, however, the basic economic model shows that companies that face many competitors will have their profits reduced to the point of the risk free return — so this is to be expected. Any studies on profit margins versus stock market return would be interesting.

    Thanks to Mr. Dude Pomada, who is soon to tie the knot, for the following calculations.

    Here are the Dow 30 companies, based on the previous 12 months both operating margin & profit margin, sorted by profit margin:

    DOW30    Oper Margin    Profit Margin
    MSFT        37.20         28.45
    INTC        31.46         22.31
    KO          26.13         21.09
    MRK         27.51         21.04
    JNJ         26.47         20.61
    C           24.46         20.44
    PFE         29.90         15.76
    AXP         18.68         15.39
    MO          25.14         15.14
    MMM         23.66         15.11
    PG          19.42         12.73
    MCD         19.52         12.72
    GE          15.07         11.05
    XOM         14.93         11.01
    T           14.06         10.91
    JPM         19.40         10.62
    VZ          19.02          9.85
    AIG         20.82          9.62
    IBM         10.29          8.71
    DIS         12.86          7.93
    CAT         10.41          7.85
    DD           8.07          7.71
    UTX         12.13          7.18
    HD          11.49          7.16
    HON          8.97          5.98
    AA           8.15          4.71
    BA           4.02          4.69
    WMT          4.90          3.59
    HPQ          5.72          2.77
    GM          -7.30         -5.49

    Peter Gardiner comments:

    A direct comparison of profit margins (without adjusting GAAP statements) may be quite misleading, as for example r&d for a software company like Microsoft, or advertising for a consumer products company such as Proctor and Gamble is expensed, while the massive capital expenditures required for, say Intel, are amortized. The amount of net invested capital required to produce $1 dollar of revenue, or $1 of pre-tax income may yield a differently ordered list.



    Inspired by the postings Sentiment, by Timothy Roe and Pessimism, from Victor Niederhoffer on the Daily Speculations website, I decided to investigate these observations in more detail.General market sentiment tends to lead investors down the wrong path. There exists a negative relationship between the sentiment of the American Association of Individual Investors (AAII) and future Dow Jones Industrial Average returns.

    The AAII has been conducting a weekly sentiment survey of its members since July 1987. It asks respondents to categorize themselves as Bullish, Bearish or Neutral. They then assign a percentage to each group from the total sample. (For the purpose of this study, I use the percentage of Bearish individuals as a gauge of investor sentiment.)

    Since 1987, the average percentage of Bearish individuals is 28.31% with a standard deviation of 9.25%. For the week ending 21/07/06, the Bearish percentage stood at 58%. That is over three standard deviations from its mean. Indeed, a very high percentage of Bearish individuals. With this in mind I decided to record all the occasions whereby the Bearish Individuals measure, strayed three standard deviations from its mean, to roughly 56%.

    There have been 8 occasions when the AAII percentage of Bearish individuals recorded a score of 56% or more and 12 months later the DJIA was up on average by approximately 20%, with a t stat of 2 and a win rate of 100%. The percentage return is almost double that of all other rolling 52 week periods. In reality the data slightly overstate forecast returns and does not approach statistical significance due to some overlapping and clustering of data. However, the data are suggestive of much higher levels for the DJIA 3, 6, 9 and 12 months out.

    I also decided to test future returns when the percentage of Bearish Individuals fell between three and two standard deviations from its mean or roughly 56% to 46%. For mine, still a relatively high outcome. The data in this group were consistent with the previous findings that a high level of Bearish sentiment is positive for future returns. I found 33 occasions that produced a 12 month average return in order of 15%, with a t stat of 2 and a win rate of over 85%. Again the data are somewhat overstated due to overlapping and clustering of data, but the general picture appears to be positive.

    Interestingly, if we include the reading of 58% recorded on 21/07/06, then 8 times out of 9, three standard deviation observations occurred when military conflict was omnipresent in the mind of investors.

    Six readings of greater than or equal to 56%, occurred between August and October 1990, a time when Iraq invaded Kuwait. The DJIA never traded below its October low again.

    A reading of 56% was recorded in October 1992. The month’s news was heavily dominated by the US Presidential campaign. Again the DJIA never traded below its October low.

    In late February 2003, Bearish sentiment was at 58%, approximately one month before coalition forces invaded Iraq. The first week of March marked the low for the DJIA, a low that till this day has not been breached.

    The recent reading of 58%, recorded in late July 2006, coincided with the Israel & Lebanon conflict, & the DJIA trading at 10,868. Perhaps this could be a multi year low. We will find out over time.

    The data are consistent with Lord Nathan Rothschild’s musing that he liked “to buy when the cannons are thundering and sell when the trumpets are blowing”, circa 1810.

    For Australian investors the data are also suggestive of positive things to come. Of the 8 times that the AAII percentage of Bearish individuals was equal to or above 56%, the All Ordinaries Index gained on average 16.58% over the next 12 months versus all other rolling 12 month returns of 7.03%. Just over double the average, with a t stat in order of 2 and not one negative 12 month period.

    Maybe our Bear will not be depressed for too much longer, because he can be associated with an up stock market.

    James Tar objects:

    The foundation “Bear Sentiment as a Contrarian Indicator” rests on is flawed. Mr. McCauley makes an obvious mistake. What needs to be considered is that everyone is finally looking at Bull/Bear Sentiment Gauges these days to help formulate an opinion on market direction. Present market chatter, and everyone is saying it, is “The Bear Sentiment is so high we cannot go lower.” Everyone is fixated on this, so much so that the herding on the weekly polls and data (AAII releases) for a contrarian indication of market direction should be a clear warning to the speculator that such a method has now become extinct. The market has perhaps outsmarted once again. Meaning, it might be time to look to these polls as confirmation.

    I deeply regret writing such bearish commentary. But if we are truly going to advance our study and discussion of the markets, such a reversal in the foundation of such a widepsread utilisation of “contrarian indicators” must clearly be considered.

    Andrea Ravano comments:

    I have seldom seen so much negative feeling and low expectations in stock markets, than those surrounding me at present. Private bankers from here and there (I will not mention the countries the calls come from, because I am afraid to offend) mention again and again the risks of war in the Middle East, the price of oil, the risk of inflation etc.. The consensus seems so large that I am a bit puzzled by the market show of strength relative to the so many, possibly sidelined, if not straight short investors.

    Which, of course, leads me to believe that if nothing unreasonable happens in terms of terrorism, we might see world stock markets rally by year end, if not sooner.



    It is not good to take another’s property.Not good spiritually. Not good in terms of the real world of Smith and Wesson and lawyers; it doesn’t work. There is a penalty to be paid.

    All ultimately pay for violating others’ rights. Socialism sells itself as fair by taking property from one class and giving it to another. I grew up as poor as anyone but was shown, early on, that it is wrong to take — steal — my neighbor’s raspberries, simply because he had them and we didn’t. Why should his work reward me? Can you answer this in your doctrine of fairness? The raspberries were not mine, not of my work, and for me to take them injured my neighbor. That’s the key to socialism: injure someone to gain control over another group.

    Is it fair to another person for me to use what he has built and not compensate him for it?

    Is it fair that I come over to your house and take something you created and convert it to mine? Give me your address and tell me when you won’t be home and I’ll know how much of a socialist you really are.

    Give me your address and I will only take what I want — like all good socialists. It is inherently wrong that you have things I do not have and the only way to correct this is for you to give them to the state to give to me, or give them directly to me.

    The most important right of them all is the right to own property. Abridge that right at your expense. That’s how I see it.



    This post by Terry Zink was the winner of a writing contest on the blog site Fickle Trader, which is hosted by Jon Tait. Jon ran the competition, inspired by something Vic once said in an interview with Dave Goodboy — “In general you get paid for taking risk in the market.” — hoping to get people to think more about what they are really doing when they trade; managing risk.To Read Risk Management, by Terry Zink



    The idea that higher returns are preceded by periods of higher risk is pretty well known around these parts. This idea was successfully put to the test by the Chair and the Collab in PracSpec with the VIX swing system (p. 109).Value-at-Risk is a popular risk management (or possibly risk description) measure. It is widely used (and abused) in finance. Basically, the (1-day) VaR of a portfolio is the critical value in the left tail of the normal distribution, below which (usually) 5% of daily portfolio returns would fall. The VaR says nothing about the magnitude of the returns that fall below the critical value.

    Instead of just using the normal distribution, VaR can be calculated using a Monte Carlo simulation of returns (the generating distribution can be one that is fatter-tailed than a normal one). Also, VaR can be calculated by re-sampling from the empirical distribution of returns, and ranking them according to magnitude. The VaR number then becomes the xth-percentile of the re-sampled returns. This can be repeated many times, and an average VaR number calculated from the many simulations.

    I wondered whether the market’s VaR was in any way predictive of its future returns. To answer the question, I calculated the 1-day VaR for the QQQQs (NASDAQ 100 etf), and compared this to the subsequent QQQQ returns. The way I calculated the VaR number for each day was to resample from the empirical distribution of the previous 30-days of one-day returns. I did this 1000 times, and took the average VaR number from each simulation. This was done daily from 26 April 1999 through to June 23. This VaR number was compared to the subsequent QQQQ returns. Note that VaR calculation periods are overlapping.

    There seems to be little correlation between VaR and subsequent returns. I looked at both subsequent 1-day returns and subsequent 30-day (overlapping) returns.

    Found here is the (heavily commented) Matlab code I used to calculate the VaR numbers, for those who would like to try the same (or try to find errors).



    I came across much in A History of Bel Canto about the outpouring of optimism and creativity that led to bel canto and the Baroque period, following the defeat of the Turkish at Lepanto in 1571. I wonder whether this is a general phenomenon at the end of a war, especially between different religious groups? I wrote a report in 1975 on the likely impact of the end of the Vietnam war, and what happened after the end of the Second World War, which had a similar theme.

    Art Cooper mentions:

    G.K. Chesterton’s poem about this battle is one of my favorites. I also believe that the optimism and creativity of the roaring 20’s is further to this effect.

    Stefan Jovanovich comments:

    The explosion of brass band music after the Civil War might also fit the paradigm. It brought us both John Philip Sousa and Dixieland. In one of his recorded interviews Louis Armstrong talks about how the war surplus (every regiment in the Civil War had had a full band) made brass instruments cheap enough that even the poor blacks in New Orleans could afford them.

    In 1867 Sousa’s father, who played trombone in the Marine band, enlisted John Philip in the Marines at age 13. It was, in John Antonio’s opinion, the necessary parental cure for his son’s having tried to run away from home to join a traveling circus band.



    We have all read Education of a Speculator, but how long has it been since you have picked it up? I have recently been re-reading it again for the fifth time, and having had the privilege of meeting Dr. Niederhoffer, studied his ideas in depth and meeting many who are mentioned in the book, it all takes on a completely new meaning. I highly recommend a re-visit as there are many hidden gems.On page 136, Sir Francis Galton says, “An incapability of relying on oneself, and having faith in others, are precisely the conditions that compel brutes to live in herds.” The necessity of self reliance is self evident, but faith in others is an easily overlooked and important idea that brutes miss. It is part of what makes them brutish and causes them to be many time losers.

    Dr. Niederhoffer says, “Trading from the middle is a sure recipe for disaster.” Where is the middle? A price volume chart shows where the greatest number of trades are, and typically it is in the middle of the daily range. The trades on the edges are the hardest to take, but will definitely not be with the public, and may present and overlay. A lesson learned from the visit to the racetrack was that in handicapping, the public favorite is almost immediately tossed out in the initial screen or process of elimination, which increases the odds of an overlay due to the parimutuel system of decreasing the layout to the odds on favorite. The basic process appeared to be a binomial system of eliminating the worst half, and by doing so increasing the probabilities in the remaining. Dr. Niederhoffer discusses a similar system in analyzing test questions. In the markets, elimination of even 40% of the sure losers with negative bias, and eliminating over 50% of all the losers will give some sort of edge. Add that to a good execution system which executes in the correct 50% of the range and there is a recipe for some success.

    “A good speculator builds his position from a single base linked to a long, flexible chain of trades. …The dollar’s going to be weak because the government’s going to keep the interest rates down so jobs will be good when the election comes.” (Sound familiar?) But caveat! “Mix it up! The patterns are reshuffling and realigning.” p. 139

    On the endowment effect Dr. Niederhoffer reflects on his 90s fund’s investors’ complaints about their 150% gains being eroded by a 30% drop in one day. They felt entitled to that money under the endowment effect. I speak authoritatively about the endowment effect because I am an expert. The key to greater gains, Dr. Niederhoffer advises, is to hold on to trades longer, and this past two weeks is a perfect example. In order to makes the large gains, drawdowns are part of the process. The endowment effects makes unrealized capital gains too dear to part with, and so they are realized prematurely. The thinking goes like this, ‘I can buy them back at a lower price.’ Jump forward to 12 points lower. Now the buy back is obvious but the thinking goes like this, ‘what if it keeps going down and I lose my hard earned gains to which I am eternally entitled to as mine?’ Whereupon the market jumps back to new highs. A big joke in our family is the observation, and now the recollection, of young children playing with each other, and the ever present dialogue is, “MINE!” It seems to be an ingrained part of the psyche.



    What is the difference between a professional and an amateur investor? One way of distinguishing the two is via management fees, the pro trades other peoples money with a structure of fees whilst the amateur trades his own money.The phenomenon of funds charging fees whilst underperforming the index is well known to all of us. Fairer funds will charge on profits only, but even here there is a problem. A fund that breaks even after a down year and an up year is much worse for investors than one that breaks even in both years. This is because of the charges on profits whilst not returning money to investors if the fund loses.

    What effect will this have on professionally managed money? I believe there will be a bias in favor of accepting greater risk, just as weekend chess tournaments (typically with 3 prizes) foster a high risk strategy with volatile outcomes.

    Is this good for investors? I do not think so, and frankly the hairs on the back of my neck stand up whenever I see advertised ‘bonuses on profits’. Markets are hard enough (monkeys with darts beating ‘pros’ most of the time) without giving people bonuses for achieving volatile results.



    I dropped in on the Orioles vs. Yankees game yesterday and found the Yankees fans to be far more entertaining than the locals. In fact the amusement cause me to miss seeing some pitches, (the Orioles’ pitchers must have been Landis-ized or the NY hitters on Prozac so it was worth watching the performance from the mound).Having said that … as if one can say they actually see the pitch. When the Yankees would come to U.N.C. and play the Tarheels in March, I used to think the pro game was all about pitching, but seeing the guns on every fielder makes you appreciate defensive play and at the least notice other parts of the game more.

    A friend says he would rather watch the games on TV, and that actually going to one is too distracting, like attending a Formula One race and only remembering what tops the Ferrari girls wore. I have to say that this is true for everything but college basketball it seems.

    Markets are similar with bits and pieces of honey draped on every news release, only to discover that each is meaningless and the price action says all:

    Market gets all it wants and needs nothing — last Friday …

    If retail data over the next two weeks confirm the long bond, late August will be a nice buying opportunity to early August’s selling opportunity.



    Of Wind and Waves is an inspirational documentary about the life of Woody Brown, pilot, surfer and sailor. He was the son of a wealthy Wall Street broker but left New York for life in California and Hawaii where he pioneered sail planes, surfing and catamaran sailing. I knew him when he was younger in Honolulu, where he was a local legend. The film portrays a vibrant and positive thinking adventurous man, and at 93, he still has that same vibrancy and tells stories of his big wave exploits. The move captures his love for life and love for people and shows how his positive attitude shaped his life. He eschewed Wall Street for a life on the ocean. Woody was also featured in the film, Surfing for Life, about seniors surfing and keeping the stoke alive which is also highly recommended — a great movie to inspire the elderly and those who will be soon to keep active, fit and positive.The wonderful thing about modern technology is now a life on Wall Street and a life on the ocean are no longer mutually exclusive. It is possible enjoy the company of wonderful friends at Delmonicos on Wall Street one weekend and at the Beach Club at Kukio the next. There was a wonderful reception for Woody at Kukio private Beach Club where we met Woody. He is more lively at 93 than most at 40 and regaled us with surf stories. When I introduced Woody to pro-surfer Shane Dorian, they compared stories of surfing 60 and 80 foot waves! Our neighbor and cover model, Lokilani McMichael, and others of our local water-men and water-women community were there for a beautiful and glamorous evening under the moon and stars, next to the ocean with the trade winds blowing.



    The trading week began with agents searching for liquidity above the previous weeks high, unable to create a bait ball. The effect was that agents spent the balance of the Monday session and most of Tuesday’s puking longs. Late in Tuesday’s session though began the signal that something was afoot — commercial users started to cancel back month resting orders and aggressively pay up. On the Wednesday session the market opens higher and vacuums up. The market moves up so fast that not many agents could get long. Thursday finds the trend followers heading for the same exit but this time the decomposers are waiting; bid it up then give it to them.That has been the price action in coffee this week. The explanatory narrative will be Hurricane Chris heading to New Orleans coffee warehouses, and supply problems in Vietnam.



    I specialize in analysis of Outlier situations, and no you will not find information about this product on our web site. This is a proprietary process we share normally with a few clients and friends. The premise is simple — Standard deviation + Trend + Volume = Excellent signals. We stop ourselves if the signal does not work after five days.Our latest call is the British Pound Futures to roll over as of today’s close. We will follow up this call with our results.



    Lucille Ball was once asked which television shows she enjoyed. Upon reflection she mentioned Three’s Company. As you remember this show’s premise was a bachelor sharing an apartment with two single women. The original cast included John Ritter who played the handsome and very available Jack Tripper and supported by Suzanne Somers, as the gorgeous yet ditzy Chrissy Snow, with Joyce DeWitt as the cute yet practically minded Janet Wood. Three’s Company was one of many situation comedies of its era that had very little depth to it and whose story-lines were very simple and oftentimes insulting to one’s intelligence. Although fun to watch, the show was extremely transparent and cutesy. Surprisingly or not, it enjoyed a run of seven years on television and spun off a sequel entitled The Ropers.The interviewer asked Ms. Ball, who took her acting and role as executive producer of Desilu Productions very seriously, why she would watch such a basic show as this. Her remark was “Sometimes you just don’t want to have to think a lot.”

    I muse over this quote from Lucille Ball when I observe the great and ever increasing popularity of NASCAR racing. Only Professional football ranks higher in popularity in American Sports, and NASCAR has become hugely popular with women. If you have ever been to a race you will see this extraordinary phenomenon at work. Fans come adorned with t-shirts exhibiting their favorite driver and they outfit their cars with numbers reflecting their car and/or man. They flock to on-site retail trailers and consume great volumes of memorabilia which are sold during the event. Many, will drive their Motor Homes, buses and other RVs from all over the country and park them in the infield of the track for the week. Dale Earnhardt ‘the intimidator’, probably the most popular of all modern day drivers and founder of an amazing corporation that bears his name, is revered today as a messiah rivaling that of Elvis in popularity. He actually died on the most famous of all tracks on the last lap during a wild dash to the finish at the 2001 Daytona 500, almost like a great gladiator who is finally defeated in one definitive battle in the Roman Coliseum.

    On the surface, NASCAR racing is extremely easy to follow. The cars go around in a circle very fast, and the first one to the finish line is the winner. In between, you have numerous crashes, mishaps and fights in the stands along with a few inebriated souls who may just pass out beside you. If you are lucky you might be given a free philosophy lesson from the gentleman or gentlewoman nearby who seems to be missing one too many teeth. You don’t have to pass a test, you don’t need a deep understanding of x’s and o’x or explain why a baseball diamond is 90 feet from each base, or even how soccer players can be offside and a game can end in a tie.

    All that is required is to know a driver’s name, his car number and that Tom Cruise really didn’t win the Daytona 500. If you wish, you may sit in the stands for 4 plus hours while you drink your favorite beer or other form of spirit, moonshine included, smoke your particular brand of cigarette, eat your favorite type of fried food, all of which are prominently displayed on the automobiles which circle the track, and scream to your hearts content. During the race, you can complain about or admire Tony Stewart for being a driving hazard, voice your displeasure that Jeff Gordon is too good looking to win a race or wonder aloud whatever happened to Dick Trickle. It could be a very rewarding experience for those who happen to be wired that way.

    In the end, perhaps that is all that the public-at-large really wants, something that allows them to find relief and escape their own world for a short time… and concomitantly, this is the role of industry, to find out what it is that the masses want and deliver it to them in the least abstruse way possible.

    J. T. Holley replies:

    Mr. Leslie’s assumptions about NASCAR are so far from reality that it isn’t funny. Knowing his poker background, I can assure you that 100% of the pit crews in NASCAR have forgotten more math than he knows. Half the Bubbas that he would sit down at the track beside could talk circles around him in regards to the nuances of racing and what it takes to triumph. My father was part of the #21 pit crew for eight years, and I grew up in NASCAR traveling the U.S. This is where I learned competition, very much as Vic did on the beaches and boardwalks of Brighton.



    There was an interesting article on Bloomberg recently about pessimism in the U.S. markets due to the war in the Middle East, and I always wonder, in a situation like this what it would ever take to make a pessimist change his views? Perhaps a move above a moving average, a fall in yields below five percent, a move in Israeli stocks to above the 800 level (TASE 100) that it was at on July 5th, a week before the kidnapping. Perhaps a cessation of interest rate increases or the end of the secular bear market? Are we now due for the sixth consecutive significant excursion downwards after the employment report?



    If you want to see some spooky quote slippage, try to get quotes from different sources (Yahoo, Google, MSN) for the newer ProShares index ETFs for the S&P, QQQQ and MidCap 400. Each fund is meant to track 200% of either the index move (QLD, MVV, SSO) or the inverse of the index move (QID, MZZ, SDS).These pairs are supposed to be opposites, but meeting the 200% target must be tougher than it looks:

    QQQQ: + 1.12%
    QLD: 64.67 +1.17 +1.84% 217,500
    QID: 73.20 -1.50 -2.01% 374,900

    MidCap 400: +0.65%
    MVV: 71.63 +0.60 +0.84% 47,200
    MZZ: 72.65 -0.92 -1.25% 54,700

    S&P: +0.60%
    SSO: 73.70 +0.56 +0.77% 73,200
    SDS: 69.69 -0.82 -1.16% 137,800

    Or maybe there is somebody arbitraging the heck out of this stuff!



    Even though I do not trade in grains, I know that many around do, so I thought I would write a report about what is happening at ground level with grain. This report is based on my farm in N.W. Missouri.First, let me cut to the chase. It is dry. Very very dry.. But the problem goes deeper than that … literally.

    It all started this winter. Whereas we normally get a couple feet of snow, we only got a few inches. That snow sitting on the ground, slowly melting into the soil, creates a water store deep within the soil that the plants can draw on during bad times. Think of it as an emergency fund, a build up of cash to be tapped into when times are rough. That emergency fund does not exist this year.

    Now, you may think that we are not having a bad drought because the rainfall numbers for the spring and summer are only off by around six to nine inches, but that is very misleading. You see, we had a giant rainstorm in the spring that dumped over 5 inches of rain on my farm in period of a couple days. The problem with that is that the ground cannot absorb that much rain that quickly, and most of that water merely washed away top soil on its way downstream. So it looks like we are not that far behind in terms of actual rainfall, but in terms of moisture in the soil, we are hurting pretty bad.

    After that initial rainfall it was a fairly dry spring.

    Since the spring we have had a fairly steady rainfall during the growing season, around half an inch to three quarters of an inch every couple of weeks. That is not great, but that rainfall is allowing the soybeans and corn to grow. Unfortunately, this years grain crop has a lot in common with many Americans in that it is living rain fall to rain fall (paycheck to paycheck), just one step ahead of disaster.

    Now disaster is staring us straight in the face. Just like most of the country, we are bogged down in a stifling heat wave with temperatures having been above 100 for over a week now. Couple that with clear sunny skies sucking the moisture out of the ground, and even the plants themselves, and you have got a potential problem brewing.

    There is no subsoil moisture because of the lack of snow and steady spring rains, and no real surface moisture because of the heat and blaring sun. The only good news is that the heat wave is scheduled to break on Friday, August 3rd. They predict Cooler temperatures, only in the upper 80s to mid 90s, and some rain is forecast. The bad news is that we are coming into what my grandpa called the ‘dog days of summer’ — the hottest time of year with the least amount of rain.

    Time to start hoping for one of those years that are a statistical anomoly. We desperately need to have a wet August.



    If you have ever lost your keys or your wallet you will understand this problem. What is the best way to find things?Every student of Computer Science is required to learn a technique called a binary search. The primary requirement of a binary search is that the list of items to be searched must be sorted in order from smallest to largest or A to Z. Given that fact, the search examines the item in the middle of the list and is able to rule out all of the items before or all of the items after the examined one. Half are eliminated in one look. For the half which remain we again look at the middle element and further reduce the remaining possibilities by half. Using this technique one can search a list of up to 1,024 items by examining only 10 elements.

    Sometimes we do not have the luxury of a perfectly sorted list of items. Occasionally the list may have increasing values up to a certain point and then declining values thereafter. Such an arrangement is known as an unimodal distribution — it has only one peak somewhere in the middle. For example a list of the probability values of the normal distribution would have one peak in the middle and a decline thereafter. In optimization problems such a pattern arises quite naturally, with the values to be optimized rising up to a certain point, after which they will fall. That point is the optimum (maximum).

    To search a unimodal list the search of choice is called a Fibonacci Search which relies on the spacing between the Fibonacci numbers to calculate its next step size. As such it is more adaptable than the binary search. Under certain circumstances it can be shown that the Fibonacci search is an optimal search algorithm for such problems.

    The Chair has frequently noted that the financial ecosystem requires much upkeep; a massive numbers of people and huge capital investment are required to keep the markets functioning all cost money. The source of revenue to fund these operations comes from three main sources, commissions, market spreads and professional advice and the key driver of all of these revenue sources is volume. The relationship between volume and commissions and market making profits are obvious. Order flow is everything to a commission broker or market maker. However those who sell advice also thrive on volume which is a proxy for interest in the market. When the public is interested in the market more money flows in and a certain portion of that money needs advice. The entire ecosystem of the financial industry thrives on volume, when volume is maximized the health of the financial system is maximized.

    In this context it may be that the objective of the markets is not to maximize the price discovery process but rather to maximize the volume of trading, after all the health of the markets is integrally bound to the health of the financial system itself. If volume optimization is the real goal of the market is it not likely that the market uses an efficient search technique to discover the optimum. In this context the Fibonacci search is the best known algorithm for such a search in a unimodal volume environment.

    One hastens to note that this is quite different from the mystical application of Fibonacci numbers which some traders try to apply in the price domain.



    To throw a small coin into the fountain:A quick look at the TASE-100 (Tel Aviv Stock Exchange top 100 Index) provides only randomness, but I wonder, do the year to date daily TASE-100 adjusted closes cluster around the tens?

    For the TASE-100 daily adjusted closes y.t.d., calculate the distance for each to the nearest ten, for example:

    Date: 11-Jul-06
    Adj. close: 831.77
    Nearest ten: 830
    Distance: 1.77

    For all days y.t.d.:

    Mean: 2.37
    Standard Deviation: 1.48

    Which appears consistent with randomness.

    Victor responds:

    Is it useful to think of the market as traversing various stops on a grand tour, a la Around the World in 80 Days? Right now for example the 10 year bond yield, which has been above 5% for several months has just dropped below that point. The Nikkei has spent much time below and around 15,000 and is now at 15,500. The TASE was below 800 at the start of the war in the Middle East, and has now gone above. The NASDAQ is around 2,000. The Dax is now confronting 5,700, having got to 5,697 today. Are these levels necessary for other markets to perk? Are they predictive or absorbing? What are your thoughts?



    Last week I got infected by the C.F.A. Meme, the Meme is telling me that if I want to achieve something in this life then I must have the C.F.A. certification. I decided to follow the Meme blindly, and ordered the materials to study for the December exam.The company from which I got the materials also offers an every Tuesday video chat with the guy that prepared the whole course, in which he answers questions. Yesterday’s best question was, ‘Why are you such a jerk?’

    Everything was going fine until the last minute when our mentor made the following comment, “I would suggest you guys read Barron’s Magazine, which is a must read publication in this industry, and especially Mr. Alan Abelson’s column, which I’ve been reading for decades”.

    It frightens me to think how many C.F.A.s that have been prepared by this guy have followed his advice and became Abelson’s fans, which means that the cult of the bear keeps growing.

    Rick Ackerman mentions:

    Keep an eye on those housing stats, J. P., since they are the most powerful recruitment tool the cult of the bear has possessed since the Dust Bowl. This forum’s Roger Arnold — no cultist in my book — makes them go down like a soufflé.

    Regarding Alan Abelson, whom I have worked with, he is the last, and the very best of a dying breed of hard-hitting journalists. Maybe a little too hard-hitting, since his relentless devotion to unpopular facts probably cost him his managing editorship job in the wake of the ‘mild’ recession of 1990-91.

    Andrea Ravano adds:

    It is things like this that mean there are more cheap stocks for us to buy. Is the fact of opposing views not a great opportunity for careful speculators?!



    On Monday we experienced a substantial flood event on the Rillito River which runs east-west through the city here. Measurements of the peak flows indicate the largest ever measured for the Rillito, and the second largest based on models (the models of the 1913 flood indicate slightly higher flows). Now that the water has receded, it is clear that the end result is:U.S. Army Corps of Engineers 1, Mother Nature 0. The river did not jump the flood protection structures on the banks, and very little damage resulted, compared to the last two floods in 1983 and 1993. As a result of those two floods the feds and the county engineered the Rillito Riverbed in the 1990s, widening in places, raising banks, and soil cementing twelve feet thick on all banks, in effect ‘channelizing’ the river. Well it worked although the high water came within a few feet of topping throughout the course of the downstream section of the river and topping the nine bridges across the river (two of which were damaged enough to be closed).

    There are some other interesting aspects to consider:

    Leverage. Although the volume of the flow appears to be in the 50-100 year return period category, the precipitation that created the flow was in the 5-10 year category (2-3 inches in 12 hours).

    Pre-conditions. The large flows resulted from a relatively small amount of rain due to the ground already being saturated by previous days of rain.

    Efficiency. Rainfall was concentrated in the foothills of the Catalina Mountains, rather than the valley or high up in the range. This led to a rapid concentration, high water mark effect.

    Unpredictable Consequences. The worst damage to the banks from scour and to the bridge piers is from objects (tree trunks, propane tank, Honda Civic are just a few of the items I witnessed) entrained in the flows hitting and snagging on the bridges and structures.

    Market analogies left to the reader!



    It is necessary to separate profits from trading for oneself from those managing other people’s money. Those proceeds derived from fees and percentages of profits from trading other people’s money where those other people bear the risk of loss do not count.Trading is a way of earning a living. The investments are starting capital and time and effort spent trading, with the latter measured against opportunity costs of not have engaged in alternative activities. Results include not only net worth but also the income taken out over the years for personal needs, alternative investments, gifts, etc. The question from a personal view is whether the returns on time/effort and capital have been adequate to justify the risk and emotional impact of such risk.

    Extraordinary returns cannot be achieved without taking extraordinary risks as a general rule. Sometimes a small bet like in a lottery that can easily result in a 100% loss but is insignificant relative to total net worth/ income can result in a huge killing, but the odds of that are very small. But for larger sums and as a general rule it means taking major risks to one’s entire net worth in that to make such gains one has to place most to well in excess of one’s net worth at risk. The only shelter is to use legal means to shelter some assets, such as doing one’s trading in limited liability corporate forms. By such risk one not only means that the incompetent will lose. Such risks consist of factors difficult to know in advance, to unknowable. Skill and ability will give one an edge on the former but not on the latter. A certain amount of diversification and skill at cutting and hedging against losses will also help. But given the risks talked about, it means even the best will fail at times either because of a lapse in the skills (mistakes that could possibly have been avoided) or pure bad luck with regard to the unknowable.

    Some have developed great skills and abilities and have been able to make those amazing profits over time. Reversals will happen and results have to be judged over a career. One should compare not to the peaks when one really lived well but to what life would have been like had a different less risky course been followed from the start. Better to have lived well for a time than not at all, unless the final result is so much worse than it would have been with the less risky course. (This ignores the possible psychological costs such as the negative effect of letdown vs. a steadier path even if less on average, which have to be considered as the overall criteria should be one’s happiness properly defined. When considering psychological costs one also has to consider the psychological benefits from riding high etc. and utility values placed on different outcomes and timing impact. These will vary with the person, so that only the person himself can really judge, not the outsiders. This is because only the person him or herself will know their preferences and utility values and state of mind, and then only upon much reflection.)

    The best course is to know when one has enough, and to focus on keeping that rather than getting much richer. That is if one has gotten rich, know when to stop taking such risks and getting out while one is ahead. As to having someone invest for one, you can only hope to get super rich doing so if the person doing the investments is able to deliver such results for prolonged periods. One time results, mixed track records or no prior success means the odds of the person having the right skills is less and the odds of success are lower. The odds are higher with someone like Vic or Krisrock who have shown evidence of such skills. But one can never know when the risk will catch up with them. So do not place all one’s assets with any one trader over one time. It may just turn out to be when the skilled turn unlucky. Diversify over time and traders. Returns could be higher by concentrating or they can also be a total wipeout. My guess is that chess is mostly skill and not luck, but trading, which is not governed by fixed rules like chess, has a much greater element of luck. Even a chess player turned loser because of personal distractions could come back when those distractions are removed. A skilled traded turned unlucky just has to get lucky. To the extent that losses were due to the avoidable, the lessons learned might have made them a better trader. On the other side, there might be negative emotional scars from the experience that will reduce trading ability (which requires ability to restrain emotions). And new mistakes are always possible. But the odds of one who has shown skills over time doing well again are probably higher than those of one who has never demonstrated such skills convincingly in the first place.



    This book by David M. Raup, a biologist at the University of Chicago, of the Stephen Jay Gould genre, identifies everything about extinction that we thought was true but is not. The author’s main thesis is that extinction is a mostly random event; due to catastrophes and bad luck, and not related to the process of evolution that is part and parcel of the Darwinian idea. The author believes that the most likely explanation for the major extinctions that we have had is not competition, nature, or physical causes, but meteorites of colossal energy that fell on the earth regularly some 18 million years ago and still threaten us today.In the process of debunking everything that we have been taught about extinction the author comes to six conclusions that are of great explanatory value for all species, all companies, and all investment styles:

    1. Species are temporary. Almost all species die out, and almost all lifetimes are very small relative to the age of the earth.
    2. Species with small populations are easy to kill. This is a consequence of gambler’s ruin, that if you let random events run for a long enough time you are bound to hit the zero point, unless the probability of success is inordinately high. This is something that all traders with fixed systems, and all companies with specialized technological innovations and unique niches should contemplate.
    3. Widely spread species are harder to kill. Geographic diversity, and niche diversity are very important in precluding narrow events from causing a species’ extinction.
    4. It is much easier to kill a species if you get a substantial number with the first strike. The importance of not losing too much in one fell swoop is paramount in any field.
    5. Extinction is most often caused by new stresses that the organism is not accustomed to. Long-lived species have usually developed mechanisms to cope with everything that has occurred to them in the past, so the thing they must fear the most is the meteor … or the spacemen!
    6. Mass extinctions require stresses that cut across all biological boundaries. In the market this would be such a thing as a big war or a global rise in interest rates.

    There have been five major extinctions in the history of the earth. They are usually classified as Ordovician-Silurian, 440 million years before present, Late Devonian, 365 b.p., Permian-Triassic 250 b.p., End Triassic 200 b.p., and Cretaceous-Tertiary, 65 b.p., and a high percentage of species and genera were killed off in the years surrounding each of these markers. The author has developed some nice graphs to show what the likely number of species that died are, given the number of genera that were killed in each cataclysm.

    There is an interesting but naive chapter in the book on the relation of extinction to industries. Raup argues that most of the companies around today were not in existence 50 years ago, and the cause of their disappearance, merger or bankruptcy corresponds to the causes of species disappearance or phyletic transformation. The author draws parallels between such things as that the total number of companies names was lower 50 years ago, just as biodiversity was less, and that certain industries wax and wane just as species do:

    Above all, stock prices as well as the composition of the entire market, are virtually unpredictable from… decade to decade. And so it was with biological evolution in… the most recent 500 million years.

    There is an excellent chapter in this book on the history of life, some nice methods of graphing durations and the branching of species, and some good anecdotes about all the famous species like the trilobites and the dinosaurs that did disappear with a debunking of the common explanations.

    The book focuses on an extremely important part of the process of life, and shows some interesting methods for sorting fact from fiction.

    A Few Points on Extinction in the Markets from Jeremy Lyter

    1. Species are temporary but the energy manifested in individuals and markets carries on beyond the gradual understanding of science and reason. (Corporate) death is nothing but an opportunity. Time is nothing but a hubristic attempt to contemplate the unknown.
    2. Individual entities, while susceptible to a variety of ills, are more inclined to survive attacks based on the presumption stated in point four, which assumes a large group is present and available to be taken out with the first strike. Less mass = Less possible chance of extinction.
    3. Diversification in multiple markets should prove a trusted strategy?
    4. 90/10 rule?
    5. Extinction would have taken its toll on multiple organisms, yet somehow these organisms were allowed endure. Perhaps, spacemen and meteors are mere market chatter.
    6. Markets are the perfect non-biased teachers of self-reflection and discipline. A survival rate has less to do with war and more to do with the preparation of war’s outcome.

    Gary Rogan adds:

    This book should be required reading for those who advocate “focused” portfolios. What you do not know will eventually kill you if you are too concentrated. The most amazing thing for me about evolution has always been the fact that for over a billion years the range of temperatures and other environmental conditions on earth were within a narrow enough range not to kill every organism in our branch of the evolutionary tree. When the dinosaurs were wiped out, the mammals and many other species did manage to survive. What are the chances that over such a long time the temperatures were not high enough long enough to kill all non-extremophiles on Earth? Perhaps we are simply unbelievably lucky and there is essentially zero chance for other intelligent life in the universe for this very reason.

    Steve Ellison mentions:

    In January I reviewed Evolutionary Catastrophes: The Science of Mass Extinction by Vincent Courtillot:

    “Courtillot presents evidence that at least seven major hotspots have emerged under continental plates in the past 300 million years. The initial emergence of each of the seven hotspots resulted in clusters of massive volcanic eruptions that coincided with large numbers of extinctions. Courtillot theorizes that major hotspots originate deep in the mantle, at the boundary with the core. This layer of the earth’s interior is also associated with the magnetic field. Intriguingly, the two greatest mass extinctions in the period studied, at the ends of the Permian and Cretaceous periods, each occurred after abnormally long periods of magnetic field stability. Usually, the earth’s magnetic field reverses polarity every few million years, but it went 35 million years between reversals in the Cretaceous period. Courtillot theorizes that the lack of reversals might have been due to the boundary layer between the core and mantle growing to a greater than usual thickness, which might have inhibited polarity shifts while at the same time becoming more unstable and leading to a more dramatic ‘correction’, i.e., formation of a more intense hot spot, than usual.” [Read More]

    Generalizing this idea, long suppression of needed adjustments leads to cataclysm in other disciplines as well. In seismology, the longer the interval between major earthquakes, the more devastating the earthquake is likely to be. In politics, the century-long period of European stability after the Napoleonic wars gave way to World War I.

    Jim Sogi adds:

    1. All trading systems are temporary.
    2. Traders with small balances are easy to kill.
    3. Diverse trading style less likely to go bust.
    4. If the first strike knocks you down to margin limits, your chance of going bust increase.
    5. Always protect against the 6 sigma event to prevent extinction. What is the greatest historical draw down on the system? Is there enough margin to cover that event or worse?

    On Extinction — Sharks have survived since 100 million years before dinosaurs. They have a simple system. They constantly cruise around and eat the weak or struggling fish, they never pick fights with the strong. They go check it, they give it a test, and then they eat it. If there is any problem, they are gone. They are really really tough skinned and lack any emotion whatsoever. Smaller fish are dominated by fear. The small sharks hunt in packs. The big ones travel the globe. There are always always going to be dead, dying or injured or weak struggling fish around.

    On Diversity — Changing cycles demand diverse trading styles. The 1980s favored buy and hold. The late 1990s were great for short term trading opportunities. Early this spring was terrible for short term, and these past few months are great again for short term trades with multiple 7-15 point moves. Horizontally it is good to be able to trade several styles to fit the seasons and cycles. Vertically, like a fund, allocate portions of capital to different styles or asset classes to achieve diversity. The issue is not whether short term or high frequency trading is in itself good or bad, but how it fits in with the current cycle and with asset allocation.



    A phrase that comes to mind when looking at the fate of the original Jack Schwager’s Market Wizards, is ‘A pat on the back is a few small vertebrae away from a kick in the rear end.’ Countless times no one sees the ass whoopin’ coming due to the warm feeling they feel for being on top or the taste of success, resting on laurels.Every time someone is mentioned in an article, book, or put up on a pedestal for the World to emulate and trade after, the edge vanishes, the trader goes bust or has his first down year, standard deviation increases dramatically, his wife leaves him with half of his wealth. When does Vic suggest to Count or test those strategies of our colleagues? After the pat on the back or the kick in the rear?

    Do these things happen simply due to the fact that they happen to everyone in life and we are just forcing a correlation? Maybe. Is it because a pat on the back is the magic formula to hoodoo someone, the abracadabra of forced failure?

    I do not know, but I do know that one of the most powerful principles that Mr. Bill espoused was anonymity. It is a word in the namesake of A.A.. Anonymity keeps one out of the light and focused on current affairs, wax still clinging to wings. Want to quit smoking, do not tell a single soul! The more people you tell you are going to quit, the more people you will have asking you if you are thinking about a cigarette, which triggers a craving. It is the same thing with positions taken during the day, week, month or quarter. You know the significance points, the edge, but if you share your new found trade with everyone then they call you on the down ticks, adverse headlines and such and once again trigger your ’switching’ cravings.

    I would just rather keep my name and face out of the books, TV, award ceremonies and stadiums and stick to doing what got me there anyways. It is easy for me because I suffer from fear of success, but anonymity is powerful in so many ways. Principles before personalities.

    How many CTAs, Hedge PMs or Speculators do you know that run from the press, keep below the radar, do not accept awards, and donate and give anonymously or without fanfare? Are they always doing it to conceal and protect positions, net worth, personal information and liberties? No. I say they know and fear a little bit, the fear that comes from that ‘kick in the butt’ after the ‘pat on the back.’ There is no upside from being a part of financial pornography, but discretely sharing and learning amongst friends who practice the same principles as you do is priceless. That way we grow as speculators and individuals and maintain our edges for the most efficient amount of time.

    Rudolf Hauser adds:

    Part of the problem is the tendency to engage in grand projects or take greater risks to keep up the reputation established by publicity, but I suspect that to a greater extent this is just a symptom of overconfidence in one’s ability as a result of great success. This leads to exaggerated expectations of what one can get away with in terms of risks, grand assumptions, and a reduction in the fear that keeps one sharp and trying harder. These attitudes can exist without the publicity as well, and of course, it is a natural human tendency to attribute success mainly to one’s abilities and insufficiently to luck when one is doing well, and the reverse when one is doing poorly.

    Dr. Janice Dorn comments:

    It is posts such as this one that elevate the spirit, give pause, put so much into perspective, and remind us to be, always, in gratitude and humility. Thank you, J.T..

    In his early writings on market psychology, circa 1912, Selden said that the man with a million dollars is a silent individual, the time when it was necessary for him to talk is past, and now, his money does the talking. The one thousand men with one thousand dollars each however, are conversational, fluent, verbose to the last degree.

    Steve Leslie offers:

    Here are my two cents:

    I heard Lou Holtz the great football coach once say “Things are never as good as they might seem, nor as bad, they are always somewhere in between.”

    ‘Pride Goeth before a Fall.’ Pride is considered by Pope Gregory to be the the most severe of the Seven Deadly Sins.

    I saw an interview with Greg Raymer WSOP Champion of 2004. He said that when he won the WSOP bracelet he did not let it go to his head. He realized that it was more a reflection of great fortune and luck for one week, than the fact that he was that much better than the field. He did not want to be one of those who won the title and then went broke the following year, so he plays within himself.



    Most people assume that a daytrader is a guy losing his $10,000 account in CMGI, who will have to go back to moving refrigerators for a living. Sadly, that is not too far from the truth for a guy running his own money, given time, using any investment approach.Another reason for the negative reaction is jealousy. It makes people green with envy to imagine a guy taking down mid six figures while working four hours a day in his pajamas from home.

    But the reaction that I respect, is the more experienced traders who recognize that there are size limits to daytrading and that if one wants to play in the big leagues one has to develop a higher level of sophistication, no matter how successful one may be as a daytrader. These same experienced souls recognize how easy it is for a guy running his own money to destabilize when the market changes and crash and burn.

    My professor, who was at Solly when it was Solly and was the fourth guy at LTCM, looked at my resume and my sheets and told me that I had the worst resume he had ever seen (after 10 years of daytrading) and that I needed to get beyond daytrading because if I was not careful I would be 40 when cash equities went away and then I would be a greeter at Wal-Mart.

    Of course the flip side is that for many of the investment/trading guys out there who are not doing something as 'easy' as daytrading to make a living, their 'sophistication' is just a crutch to hide behind as they will under perform indexing year after year.

    The bottom line is that dollars are green and if you have got the nerve to do it on your own and can do it, then you can write your own ticket and live the way you want to live. As has been well discussed on the list, money doesn't buy happiness once one can pay the bills, so it is mostly the intellectual challenge that should push any successful daytrader into the 'big leagues.'

    Nat Stewart comments:

    In the 1990s and 2000s some on the sidelines missed opportunities and were afraid to take a chance. They often now manifest their impotence in hatred for those who shoot for a dream and are willing to assume risk. The day trader phenomenon of the late nineties created a mass mob of little Abelsons, waiting for the fall and relishing the reports of young upstarts getting their comeuppance.

    Yishen Kuik adds:

    In the late 1990s thousands of otherwise unremarkable young people were making a great deal of money as day traders. Public knowledge of this was fairly widespread — perhaps you recall the television ad where stock trading Junior lands his helicopter on the front lawn of the family home, as Dad looks on bewildered.

    It was about upsetting the perceived status quo, young upstarts making fortunes doing apparently nothing too strenuous while 'the rest of us' were left behind, looking stodgy and foolish. When the NASDAQ collapse came and a lot of these mo-mo fortunes were destroyed, the moment of schadenfreude was too delicious for the general public to resist. The public's smug satisfaction that "we were right after all" led to the comforting notion that those who day trade are indeed fools who will soon lose all their money.

    I think therefore that the public's enmity towards daytrading is partially explained by the need to protect its own fragile ego — it hurts too much to believe that someone sitting at home in his pajamas can draw down 7 or 8 times the median wage while Joe Public sits in his cubicle cursing out the boss.

    Craig Cuyler mentions:

    I came across some guys that had a fund in Switzerland about a year ago they were posting plus ten percent returns per month scalping the Dax and Dax options. They developed some software for the Deutsche bourse and had a data pipe line that was a few seconds faster than the rest of the market. The were buying or selling bullets and making five to ten ticks all day on many many trades. It lasted about six months until their method was discovered. Articles on the Flipper have also appeared over the past year, and it is the same story, they have a very short lifespan. There are some other very short term strategies that I have seen for trading futures based on NYSE tick, that work quite well. I just think that, for the reasons I have given, the equities are very risky, and perhaps you bleed to death slowly until rampant markets like pre 2000 come along again.



    In order to price-discriminate, a firm must be able to prevent the transfer of the good once it is sold. So, for example, if a Broadway producer knew exactly who was willing to pay $5 for a ticket, and who was willing to pay $1000, it would have difficulty trying to charge $1,000 to those willing to pay $1,000 because the people willing to pay $1,000 would contract with those who are willing to pay $5 to buy their tickets for $10.Restaurants get around this by creating different meals for children and delivering them only to children. Movie theaters and other outfits check IDs before giving their discounts to seniors. Airlines charge based on customer profiles (how soon in advance you buy, or whether you stay over Saturday night) and do not let you transfer tickets to others. Universities charge everyone the $1,000 and then pretend to be generous by giving aid to those who they think can only afford the $5.

    So what does this mean for markets?

    1. Traders and dealers should be able to make more money and markets where there is less public information, i.e. when the person willing to pay $1,000 for a ticket is unaware that others are paying only $5 for it.
    2. There is money to be made by customer profiling and knowing who is willing to pay how much for a security, so that you can buy it at a better price from someone else and re-sell it to the person willing to pay more.



    Victor and I have written extensively about stock market cons, but I realized recently that we missed one crucial aspect: entertainment value. In fact, drama has been important in the marketplace for as long as the marketplace has existed, as merchants need to attract a crowd if they are not to go hungry. What brought it to mind is my study of the Commedia dell'Arte, the 16th-century Italian folk comedy whose archetypal stock characters have permeated Western culture from low to high over the past few hundred years – the rich old miser, the boastful but cowardly military man, the wily servant, the hapless lovers.

    The link between charlatans and comedy is explored with great sagacity in John Rudin's handbook for Commedia actors. Rudin views the charlatan as a kind of shaman who enchants the audience; the spell can only be broken by the transfer of hard cash.  He passes along this list of the various types of charlatan from his own teacher, the great scholarly practitioner Antonio Fava:

    I would add:

    Rudin urges actors to observe street merchants making their pitch. What these hawkers do, he notes, is to broadly hint that the goods just might be stolen. Students of big and small cons will observe at once that this technique is fundamental to all cons. If you can appeal to the mark's dishonesty, you've roped him! (At one point in long history of the Commedia, the actors wore out their welcome in Italy and dispersed all over Europe, sometimes falling so low as to serve as come-on men for quacks, as pictured in the print of Notre Dame above.)

     Here's an English tourist's description, published in 1776, of St. Marks Square in Venice, which served as a center of the charlatan world thanks to the toleration of the local authorities. (The word “mountebank” comes from the practice of these sellers to mount benches fastened together as a makeshift stage.)

    These Mountebanks at one end of their stage place their trunke, which is replenished with a world of new-fangled trumperies… the principal Mountebanke opens his trunk and sets abroad his wares, [then] makes an oration to the audience of almost an hour. Wherein he doth most hyberbolically extol the virtue of his drugs and confections…though many of them are very counterfeit and false. They would give their tales with such admirable volubility and plausible grace that they did often strike great admiration into strangers that never heard them before.

    One could not say more of our own modern-day market mountebanks. In fact, today's charlatans could learn a great deal from the Commedia dell'Arte.


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