Notwithstanding the waste heat being generated by all the friction, the December S&P contract crossed the Century Round 1500 12 times already this morning and continues on up in a continuation of the Great Upward March. Increasing numbers of additional players are returning to the gaming tables at the approach of recent highs, as is typical. The effect is to squeeze down price movement to the grinding march upward of big capital. The last few upswings have had that characteristic. Big accumulation plans taking short breaks, then resuming buying on dips in the four to five day campaigns. The Great Upward March does not appear to be a bear squeeze, which would have a different signature with air gaps up. Do big firms take several days to accumulate huge size? Is it the huge new liquidity pools slowly seeping into the system from the low interest rates, or a pressure differential between stocks and bonds? Think of all the new capital created by the lowering of yields. That kind of money makes equities look like small potatoes. The fear displayed in the media and in chat rooms is a good sign. It's the wall of worry.

Nigel Davies remarks:

I must be missing something, as this looks to me like a trading range.



pink sheet companies
issue red herrings
once they are in the green
to become blue chips



I have two time series A and B with 120 monthly observations each. I want to test whether A's yearly changes predict B's yearly changes. But there are only 10 non-overlapping years. What is the least horrible method that would use overlapping 12-months changes? I am thinking of a bootstrap but looking around, I found mention of the Generalized Method of Moments (aka Generalized Estimating Equations) which looks complicated. Do readers have other suggestions?

Alex Castaldo replies:

The traditional approach used in the literature (by Shiller among others) is to do a rolling (i.e. overlapping) predictive regression and then correct for the overlap by using Newey-West standard errors (rather than the usual standard errors that regression software normally uses).

Victor and Laurel do not like the Newey-West approach, and the literature has been coming around to their point of view. The problem is that Newey-West is correct asymptotically (that is, as the number of data points goes to infinity) but in these problems we do not have a large amount of data (that is why we are resorting to using overlap). Simulation studies show that in small samples the Newey_West method can be biased.

What is the solution? I don't know; it is an open research problem. There is something called the Hodrick (1992) method which is said to be free from small sample bias. (It is different from the Hansen-Hodrick method). Also you might try to read recent papers on the subject, such as Ang and Bekaert "Stock Return Predictability" (2006) and the references therein.

Adi Schnytzer writes:

This is what Stata throws up: package lomackinlay from RePEc

      'LOMACKINLAY': module to perform Lo-MacKinlay variance ratio test


      lomackinlay computes a overlapping variance-ratio test on a
      timeseries. The timeseries should be in level form; e.g., to
      test that stock returns vary randomly around a constant    mean,
      you consider the null hypothesis that the log price series is a
      random walk with    drift. The log price series would then be
      given in the varlist. If the assumption of homoskedastic
      errors in the process generating the differenced series is not
      reasonable,  the robust option may be used to calculate a
      variance ratio test statistic robust to    arbitrary
      heteroskedasticity. This is version 1.0.5, corrected for errors
      in logic    identified by Allin Cottrell.

      KW: variance ratio test
      KW: random walk
      KW: heteroskedasticity
      KW: time series

      Requires: Stata version 9.2

      Distribution-Date: 20060804



HumbleI had a wonderful conversation the other evening with Rudolph Hauser. What an exceptional man. A true treasure of a person. He was introduced to me through Janice Dorn, a profound friend to whom I would entrust my life.

To date I have had the honor of being able to call Janice Dorn, Stefan Jovanovich, Scott Brooks, Rudolph Hauser, Laurence Glazier, and of course Vic and Laurel, friends.

Stefan is a gentleman above all and a true family man who loves his wife and daughter and who is cut from fine cloth. Scott has a heart of gold, and Laurence is a true British gentleman. I have also corresponded with Jim Sogi, Kevin Depew, Larry Williams, John Bollinger,  Alan Milhone, Pam Van Giessen, Marion Dreyfus and others.

I thank Vic and Laurel for the introductions through Daily Speculations.

Ken Smith extends:

I was just speaking with my spouse about an issue and I expressed concern about being able to solve something. She replied I would work it out because "You are smart."  I told her I am the only person who knows how much I don't know.  She thinks I am disparaging myself, but I speak truth.




Perhaps he found that the 20% returns of last five years were in fact the result of pushing into illiquid markets, with an amount of capital that allows one to set prices. I don't know that to be the case, but the opportunity is there, and I wouldn't want to be around when the house of cards collapses.



One of the reports of the Israeli intrusion into Syrian airspace mentioned that the Syrians fired missiles at the intruders, who then used jamming devices to befuddle the missiles. Now don't blame this on Syrian incompetence in operating the missile batteries, as the Russians were in Syria operating them. We know this as the Russian military advised Israel not to bomb the missile batteries as there were Russians present.

I believe this was a test of the jamming techniques. The Russians had sold those missiles to Syria as well as identical ones to Iran. If the jamming worked against the missiles in Syria, the same jamming will also work in Iran. So the question now is: who is going to intrude into Iranian airspace?



Trading CatalystsTrading Catalysts by Robert Webb is a worthwhile read. The author discusses market reaction to events like geopolitics, weather, intervention by policymakers, economic reports and fat-finger trades. The important message is that the market reacts inconsistently to similar senarios, and this in itself ought to be of value, espcially to a novice trader. the author recounts some of these events, in detail, recounting intraday price moves and then the subsequent days' price moves. Of course it is not possible to detail every catalyst, and one could criticize it for this; also, we have to take the author's word and interpretation for each topic. But for $25, let's not get too carried away! For those willing to turn the pages it will likely offer a few ideas.



A good piece on subprimes, from a Riskmetrics researcher: A Subprimer on Risk, by Christopher C. Finger, August 2007.



FingersThe word quant summons images of big computers, complicated algorithms, geeky guys programming computers. But the most basic calculations, such as measuring with two fingers, can offer up good rewards for prospective targets. The most basic counting offers insights into the heart of the markets without complicated formulae, calculus or statistics. They help, but don't overlook the most basic calculator of them all: your fingers. Even simple math offers profound insights about the state of the market to a sharp eye. It takes a little more effort than letting the computer do all the work on preprogrammed formulae, but sometimes it can pay off.



I am looking for an online/disc source for AMEX daily total volume data from 1960 to present. I have looked in all the obvious places without success. Can anyone advise? Trying to avoid the laborious task of newspaper scavenging.



GrapevineTowards the end of my heavy drinking days I lived in an efficiency apartment located within walking distance of several taverns and cocktail lounges, a liquor store, and a supermarket with a selection of cheap wine which could be purchased by the gallon.

I bought for $3000 the first Epson desktop computer to hit the market and sat for three years writing a manuscript, citing Scripture and an array of authors who had had a similar experience. I wrote an Index to the Big Book, which Alcoholics Anonymous Headquarters declined to authorize, but giving the rights to another writer after I had submitted my manuscript along with a request for permission to quote ÅA literature.

Of course Headquarters  had some reasons — I did fall off the wagon frequently, never showed any length of time sober while in Alcoholics Anonymous; was a complete failure in the outfit.  Nevertheless I wrote well and the Index was very good, if I say so myself.  They did publish several of my submissions to their monthly publication The Grapevine.

I was ten years in that apartment, making my tour of the neighborhood, the various iniquity dens, declining the solicitations of ladies of the night on the way to destinations, drinking establishments, since, after all, my compulsion was booze, not sex.

I give credit to Jerry Falwell's outfit for putting together a booklet to send out to those who heard the message on the airways.  That little booklet explained a life that was better and described in exact detail the steps, attitudes, and behaviors that would save folks.



VIXThe problem that a short lookback period does not account for potential volatility regime change is well understood. This is really two questions First, what is the lookback period? Second, how does one accommodate quantitatively for volatility change?  This might be addressed in different ways. First, look for volatility similar to high volatility regimes such as big moves. Second, in Iceberg Risk, Kent Osband suggests taking two distributions, a normal for current everyday entry/exit, and one for outliers and tail risks, and combining the two. Risk control, money management principles and use of leverage could be combined with the trading signals and by using eight-sigma for the risk factor but a normal curve for entries. Phase in could be graduated as survival odds of low volatility drop, and reduce leverage rather than increase it.

Strange CurvesAnother approach is from Strange Curves, Counting Rabbits, & Other Mathematical Explorations by Keith Ball from the field of information theory. The question in his example would be how to compute the minimum number of tests to give a robust reading on the number of children with a certain blood condition. The analysis is similar to the finding the one different coin out of nine with the minimum number of weighing problem, which is solved by dividing the 9 into 3 groups. Rather than equal probabilities as with coins, Ball poses the problem of testing children for a rare blood condition. This is similar to testing for a tail event in the market using a binary protocol — is, or is not, a tail. The number of tests is m and the test is computed as 2^m to be greater than n. For n=3200, then m=12, or 4096, which is greater than 3200. This provides a simple rule of thumb, that might be applied to divide the period into 12 samples, or a lookback of 266 days. The results is derived from principles of entropy as the minimum number of tests to detect the condition. Applied to markets, the lower number detects the cycle changes better. The number of tests might be the divisor of the sample to compute the lookback period. The rare condition to try to detect is the risk of a large excursion. The empirical occurrence of a four-sigma event has a probability of 1/400 or .0025. Another rule of thumb would be 1+2mnp, or 1+2*3200*12*.0025=196. Still some additional risk parameters are needed for the eight-sigma events we're seeing again per the Osband approach for protection in the turns.

Another method would be to change trade parameters to fit expanded volatility, and read the newspaper to follow fundamental changes. And there is truly no substitute for experience and good judgment and a good attitude.

Eric Ross writes:

Models are based on backtesting. Models are based on prior market moves that have happened. Thus, quants are nothing more than historians trying to predict future events from past performance. So, why is Wall Street looking to go black-box and and substitute historians for human traders? Isn't the human element of guts and feeling a powerful tool to trade by, when combined with charting and experience?

Rod Fitzsimmons Frey explains:

The heart of the scientific method is, say something testable, then try to disprove it by testing. If you cannot disprove a hypothesis, you may use it as though it were true (it is now a 'model'); however, continue trying to disprove it, and as soon as you do, cease using it.

Counters try to apply this method to markets. The only way to apply the scientific method to markets is to form a hypothesis (the market goes up every Monday after a down Friday) and test it against historical data. There are well-established statistical tests to take a certain number of outcomes (X number of up Mondays after Y down Fridays) and say something about the odds that such an outcome happened by chance. If the odds are long that something has occurred by chance, you may be wise to place a bet the next time the conditions occur.

AristotleInsofar as human beings have invented the scientific method and its servant, statistics, nothing could be more human than applying these tools to the market, as we have to medicine, evolution, physics, chemistry, physiology, agriculture, biology and botany.

Aristotle teaches us that we should apply only the level of precision to an inquiry that its nature allows: seeking more or less precision is a fool's path. The debate is about how much the markets will yield to scientific inquiry. The view of the Palindrome is that the markets are more akin to psychology and sociology than physics; the truth of the markets is determined by time and place and one must not trust the past. In other words, do not attempt to apply the tools of physics.Intuition, common sense, and experience taught many things that were eventually shown to be wrong when the scientific method was applied — the Earth's being flat and heavy objects' falling faster are obvious examples. I wouldn't trust intuition, but maybe I have no guts.

Fortunately, unlike psychologists, priests, or economists, we in the markets have an excellent scorekeeping mechanism.

Denis Vako remarks:

The "little birdy" model in the paper Mutual Information as a Tool for Identifying Phase Transitions in Complex Systems by Robert Wicks, Sandra Chapman and Richard Dendy covers regime change, clustering, entropy and velocity — all in one place!

Russ Sears extends:

NOAAThis is similar to the "credibility problem" actuaries face with Property and Casualty insurance.

Sometimes volatility changes due to a jump in the frequency of claims, but usually a regime shift occurs by when the size of the average claim jumps. New rulings or litigation or creative lawyers, besides more ordinary causes like inflation or new treatment cost.

The individual large jump should be looked at closely. Is it a new cause, or just an extreme example of current events? In other words, does this set precedent? Has the target changed, under new rules, or has the shooter changed, fighting more aggressively?

The volatility changes are important. Likewise it takes time and many more claims to establish a new norm.

Property and Casualty companies react to high-cost hurricanes poorly at first, due to the unknown of who got stuck with what claims. Then they rebound due to a softer regulatory environment and a mistaken assumption that because it happened once its more likely to happen again.

Gary Rogan writes:

Unlike regime changes in the physical world that are usually tied to the invariant physical laws, regime changes in the markets have no reason to have any specific characteristics because human beings are actively trying to outsmart the system while at the same time other human beings as well as random, from the financial markets point of view, physical reality changes inject error signals into the markets. It is also unknowable when the change phase is over and the new regime begins. It is futile to hope that any amount of backtesting will result in a reliable model. While the regime is constant, backtesting works, but when the regime unpredictably changes it stops working.



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



2012, from Larry Williams

September 10, 2007 | 3 Comments

The Mayans did not say the end of the world was 2012, but rather that a new cycle begins then. It was not an end-time prediction. Nor, based on what I have read and what I have been able to transcribe, was it a big deal — just a new cycle.

Their calander wheels are fascinating, as are the road systems they had, and the countless pyramids. Plunderers find the north point never has anything of value, while lots of goodies are available at the other points. Pyramid builders got all the way up to Wisconsin — some say Canada.



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

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

Sam Humbert replies:

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

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

East Sider notices:

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

Mike Desaulniers explains:

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



 I bought A Year Without 'Made In China' because it received very nice comments from disparate sources. The author, tired of seeing "Made in China" on so much merchandise, especially on the Christmas gifts of 2005, decided to see what it would be like to go on a full year boycott of anything made in that country.

It's a painful revelation especially if you have become accustomed to sunglasses, almost any kind of footwear (but flip-flops and tennis shoes especially), children's toys, staples, ink cartridges, almost any small (or not so small) electrical appliance, and costume jewelry.

Bongiorni leads us through a variety of events that demand replacement purchases and holidays which carry with them the expectation of gifting. If you, like she, decide to opt against Chinese merchandise, your shopping will be far more difficult or far more expensive — or both. In addition to the book's success in illustrating this, it is also a not-so-subtle screed aimed at Wal-Mart. In fact, Bongiorni admits she doesn't like the chain and uses it frequently as a punching bag.

Her husband (the "Weak Link") and two children are cajoled into joining her on this quest. Their initial support is less than whole hearted but in traditional American fashion, acquiesce to Mom. Obviously, they encounter many problems - otherwise this wouldn't have been a book, but a long essay - and, in fact, that is what it should have been. After a very short while the problems become predictable as do the various participants' reactions to them. What begins as an interesting study turns into a forecastable whine … much of it with merit.

If there's a hero in the book it's her husband. Despite an eye problem he gets along for several months without sun glasses; his coffee is prepared by boiling water in a pot since a non-Chinese peculator is not to be found; and he learns to sew so that, using materials from a multitude of countries, he can make sleeping bags for his children.

Don't be confused (as her five-year-old son is) into believing that she dislikes the Chinese, it is quite the contrary, as she protests over and over again. Some twists occur at the conclusion, including the reaction of the Chinese press. It's an interesting story which reveals just how much we have become dependent on China for many of our (affordable) daily necessities. What is even more frightening, and which Bongiorni touches on briefly, is that if her boycott had included any product that had even one Chinese component…the boycott wouldn't have lasted anywhere near a year. In that case, ubiquitous takes on a whole new meaning.



We're above water now in Texas, with 760 feet of sedimentary limestone and other detritus between us and sea level, all praise and honor be to G-d.  Thanks to having a house built on top of the levee on the City side of the 17th Street Canal (above the pumping station) we were spared any flooding in our house, though we got it underneath.

We pulled the ripcord when Nola re-elected the mayor. Katrina was a blessing for us, in a way — Nola is in a secular downtrend and has been since the mid-1960s — economically, culturally, etc. Katrina simply advanced the trend by about 10 years, and gave us the inertia jolt to get the heck out.



I'm looking for some advice from the statisticians. I'm interested in taking an open set of email messages and finding logical groups.  There are obvious ways to group them, including recipient lists, subject lines, etc. but what I'd really like to do is find sets based on the message content. What branch of statistics or area of research should I investigate to find some trailheads?



Weak hands chattering,
kibbitzers manipulate.
Strong hands place big bets.

Marion Dreyfus replies:

Nice haiku Big Al
despite arduous topic
Obvious: Gifted!



I was saddened by the death of Luciano Pavarotti, not only because he was the greatest tenor of the past 50 plus years, but because I was fortunate enough to see and hear him at his very best. What makes him the greatest is simple: none of the other tenors is/was capable of singing bel canto and Verdi's Otello. An amazing voice.

A recent broadcast of Rossini's William Tell reminded me of Pavarotti's superb recording. This really puts his greatness into perspective: How many tenors have recorded (or performed) this opera or the main, brutal tenor arias and Otello? To the best of my knowledge no one has done this between Pavarotti and Tamagno! And Tamagno was the first Otello.

Larry Williams adds:

These words are from the wife of one of Pavarotti's competitors and fellow singers, retired now, whose name is legendary in opera circles.  Many purists were not wild about Pavarotti — but here's as inside a look as you can get:

Luciano had a beautiful, clear voice, with an excellent technique, and a real connection to the Italian style. He did whatever he wanted. His control went beyond music and he understood his place and mission with no pretensions, unlike, say, Callas. I loved the individuality of his voice. You could never mistake him for anybody except himself.  I loved the ease with which he sang and the joy he took in performing.  He was an outsize personality that was able to spread the love of opera to many people, and for that the operatic world should be forever grateful. Operatic singers seem to be blander now, more cookie-cutter alike. I wonder if he would have made it in these times.

Eli Zabethan rues:

Despite having a parterre center box at the Met for many years, sadly I never got to hear the Maestro except on CDs. I was always traveling and missed his performances.



S&P 500 earnings for 12 months ended June 30, 2007: 84.91

S&P 500 trailing earnings yield: 5.84%10-year bond yield: 4.368%

Ratio of S&P 500 earnings yield to 10-year bond yield: 1.3374

Average ratio of S&P 500 earnings yield to 10-year bond yield since June 1, 1988: 0.8025

S&P 500 index value that would result in an earnings yield of 0.8025 times the current 10-year bond yield: 2422.46

Bud Conrad replies:

The Fed Model is sometimes used with the year-forward earnings projection. If the current price is taken as the given, then forward earnings might drop to .8025/1.3374 or to 60% of current level. That amount is consistent with recession. I expect some of both ahead: Lower earnings in recession and perhaps not so big a drop in the stock market.



 One of the most valuable lessons a parent can teach a child is to be financially competent. A child that knows how to use money intelligently and responsibly will excel well beyond his peers. A young adult that naturally values the autonomy of self-sufficiency, the powerful exponential growth of delayed gratification, and the potent influence of incentives will be capable of success.

The signs of rampant monetary illiteracy in young adults are all around us. It is often found even amongst the intelligent and the affluent. Over half of college graduates will move back in with their parents. It is common for college age adult to have destroyed their credit rating with unbridled credit card spending. Marriage is often postponed, or even not feasible due to high debt. Many marriages are severely strained and end due to monetary issues. Possibly the most tragic, most of us personally know a well meaning parent whose unfettered generosity has enabled their child to fall into a costly nightmarish life of substance abuse.

In contrast, monetarily literate young adult will increase their potential success in career, marriage, influence and ambitions.

Toddlers through teens can be taught how to respond to money.

Much of the fundamental lessons can be grasped in toddler years. Money can be earned, spent, saved or shared. By their late teens these ideas can be mastered as a way of life.

Earning Money:

Instilling in children the lesson that work has it rewards is important. A child should expect some chores to be done for respect out of others. But incentives can motivate and encourage areas needing attention. An immediate gold star might help the youngest learn to consistently make their bed. Giving them money and a reward after reaching a goal will have many lessons.

Encouraging them with money can help them work on everything from earning good grades to staying fit. Kids are happiest if they are contributing and progressing. When a child earns money, it helps them realize a parent values their contribution, and gives them an immediate measurable mark of their progress.

Dont forget to teach the ability to bargain. Help them sell unwanted items on eBay or online. With some jobs a parent may want to negotiate the price. Mowing the lawn, for example, may depend on how hot it is or who is available. Teaching a child to take advantage of supply and demand may cost the parent more, but learning the lesson to value their effort is priceless.

Spending Money:

There are many ways to teach how to spend money wisely. To eliminate the give-me's on entering a grocery store, give them a dollar or two. A kid will learn with practice, that once its spent its gone, and weigh their choices. Allow them to make mistakes. It will not take too many times before they learn the frivolity in advertising. Perhaps the most important lesson is that money has limits and parents are not a magical ATM.

Rather than simply splurging on kids, let them be involved, even if its a trivial amount. A souvenir bought on vacation will have added significance if they chose it. Buying the collar for the puppy will increase their appreciation and responsibility towards the dog. Contributing to a family adventure lets them feel more valued.

As they get older, they can get more involved with fiscal planning. Have them research their spending. Take advantage of their tech savvy. Have them present which cell phone plan is best. Let them research internet plans. Get involved with vacation planning on the internet. If they have been involved researching such things as auto insurance, health clubs versus YMCA memberships; they are much better prepared to research college choices, cost and financing.

Having the kids involved in planning a budget for events that a parent is paying for will help them understand a budgets importance. Learning to make a simple listing of major cost will give a young adult a huge advantage over most of his peers. Young adults often are unconscious of the budget planning of Mom and Dads. They assume they can maintain their parents lifestyle. They often are oblivious that their fixed spending has them headed over a cliff. The reality check of budget skills can help them make informed choices.

Finally, a few years before they leave home, get them a credit card with a limit. They soon will get one anyways. Credit card companies have made it very easy and tempting for college age adult to be enslaved to credit card debt. A supervised introduction to responsible credit use may prevent a lifetime of high interest and poor credit.

Saving Money:

For the young, a simple and fun piggy bank can teach the important habit of savings.

When they are about seven and can do simple math help them open a bank account. Going over the statements will teach about interest and simple accounting besides the practical lessons in math.

When they are young setting shorter achievable goals can help encourage saving. As they get older longer goals are more appropriate. Matching parental contributions can help encourage saving, and show the value of an employer sponsored 401k account.

As they get older the investment lessons should progress. Teaching them about investing mutual funds and stocks can prevent paralysis due to fear. The young should take more short term investment risk to maximize their long term gains. But many do not, because they fear the unknown. They have never been taught.

Designating a part of their personal saving fund as an emergency fund has several invaluable lessons for children. The most important may be that Mom and Dad cannot always bail them out. Yet equally important is planning for rough times. It should be decided well before the ticket or car accident, how much they will have to pay and what restrictions will be attached. These talks should be held for any new responsibility prior to losing or breaking a costly item such as glasses, retainer, or the band instrument. These times will be emotional enough without the added fear of testing the limits or feeling abandoned. Having a plan and having an emergency fund available for these times are emotionally freeing, but still teaches responsibility.

Likewise open discussing the planning and savings for other major life events can teach as well as eliminate resentment. It should be clear how much a parent will contribute to college, a wedding, or even under what conditions they can move back home. Gifts and contributions to college saving, and IRA plans should often be discussed with the child. Again lessons can be learned with discussing the statements when they are young. It is assuring to know what a parent expects especially on long term goals that involve more independence.


Giving can be a valuable lesson to anyone, but especially to children that have so much given to them. A few big lessons are that nothing is free, that confidence and independence, comes through nurturing others and the joy of being part of something bigger than themselves. Encourage kids to be involved emotionally to their chosen charity. Helping them see the benefits of their gift. Show a child how they meet a need after a gift. Tracing the money to meeting the objective and then show how the blessing can multiply. Teach them to look for ways to expand this growth effect.

Among the many great charities are some frauds. Help them research how responsible a charity is with its money. Help them to consider if a charity is nurturing others to behave responsibly towards money, hence reproducing its effectiveness. A good charity will mirror a good parent/child relationship with money. Both will use it to foster independence rather than a dependency to inflate its own worth. Teaching a child to give generously and responsibly will bring the lesson full circle, enabling him as an adult, to effectively teach money intelligence to children.

Finally, a good example may be the best teacher of monetary intelligence. A parent should be a good example of monetary responsibility.



John BollingerJohn Bollinger and I recently had a very enlightening and far-ranging breakfast discussion in Seattle. He was in town to deliver a talk at the Charles Schwab presentation during lunch that day. If you ever get a chance to hear him speak I would encourage it. He is very good.

During our conversation John said he had been trying to convince Vic and Laurel that what they did was really Technical Analysis. As John defines it, TA is using prices (and other market data) to predict future price moves. That definition is data domain oriented. Vic and Laurel do use prices in their work, so by definition they fall under the TA rubric.

However, their definition of what they call counting is really more process oriented. It is more a question of how one analyzes data and tests one's hypotheses that drives their counting definition. It is the application of the scientific method to finance. Counting is a methodology which applies to anything which can be quantified or classified.

Perhaps most importantly, counting looks to repeatable observations and analyses. What one observer sees and analyzes looks the same to another counter. Observations are objectively repeatable. By contrast, TA allows chart interpretations. A pattern which one trained analyst sees on a chart may not be interpreted the same way by another. TA allows subjective non-repeatable interpretation whereas counting does not.

Counting requires some sort of significance testing. To my knowledge there is no TA testing software which includes any sort of significance testing. In fact the only time a standard deviation is normally used in TA is in the calculation of John's own Bollinger Bands.

Another difference between John's TA definition and counting is that counting does not restrict itself to the price, volume and open interest domain. It could include data on corporate fundamentals, politics, volcanos, earthquakes and anything else. Thus a data domain definition of counting does not apply. Only a methodology driven specification accurately defines what counting is all about.

John Bollinger is correct in many ways. There is much overlap between his definition and what many counters practice. Most counters do look at price data because it is high-frequency and thus offers more profit potential. But the essential difference remains. TA is defined by its data domain and counting by its methodology. That is the quintessential distinction.

Steve Ellison responds:

John Bollinger's book has many concepts that are countable and testable, including an innovative point and figure method and a taxonomy of price patterns. Bollinger Bands themselves are relative definitions of high and low at points in time based on a defined lookback period. They rigorously use only data that would have been known at the time, which is very important in counting correctly.

The concept of a relative definition is very powerful. I have used it to develop other prospective relative measures. For example, I calculate percentiles of price changes using defined lookback periods.  Yesterday's 2% increase in gold was in the 97th percentile of the past year's daily changes.

The adaptive box sizing of the Bollinger Box point and figure method is another potent concept that opens many avenues of analysis. I have experimented with variations on box sizing. For example, one might, using logarithms, define a series of price points such that each successive point is 1.01 times the previous point. A tabulation of the moves between price points appears as a series of logarithmically equal jumps, which allows one to use the binomial distribution to look for non-randomness.

Steve Leslie extends:

After 29 years of investing in stocks, bonds, futures, commodities, real estate and collectibles I have come to this distinction between Technical Analysis and counting: counting is more science than art, and TA is more art than science.

I only trade stocks now and I use TA to confirm before establishing a position in a stock. I find it far easier to have an accomodative Federal Reserve with respect to interest rates, and invest during a bull market than to try and outwit the market and swim against the stream like a salmon returning to its breeding ground. People forget that most salmon never reach their hallowed spawning grounds, becoming victims to fishermen, bears and heart attacks from exhaustion.

I choose to have the wind at my back rather than in my face when I sail. Therefore the first thing I do when considering investing in a stock is to perform due diligence and conduct basic fundamental analysis.
I consider elements such as EPS growth, sales growth, and rely upon the excellent services of IBD and Zacks filters for such information.

Then when I look at a chart I am looking for an entry point for a stock. I use a variety of methods such as moving averages, relative strength volume breakouts, island formations gap ups, flags and pennants, Elliott Wave, point and figure.

The third leg of the stool is money management. Building a position in a stock, often called pyramiding, is a wonderful technique to use and also to use trailing stops to shave off a position to insure profits along the way.

The likelihood for success increases dramatically when one finds a company that has good financial strength, good EPS growth, is in the right industry group and is in the midst of a bullish stock market.

The techniques I mentioned are entirely useless in trading commodities and futures. Counting is the weapon of choice here and one which I have zero knowledge. Vic and Laurel are world class experts in this arena, and in my mind most excellent mentors, with a magnificent wealth of wisdom and insight.

To make money, one does not need to know everything about the markets to be successful but rather the goal is to become proficient in one area and focus on this. To be the Master and Commander. Look at it this way, physicians are very highly compensated professionals, and the highest are the specialists such as cardiologists, thoracic surgeons, and neurosurgeons. And in law, specialists reign supreme, from tax law, M&A, civil and criminal litigators and the like. The general practitioners are the lowest on this food chain. 



Vegetarian skeuomorphy — e.g. "Tofurky Roast" — why? Aren't vegetarians at peace with vegetables qua vegetables?

Laurence Glazier observes:

One assumes the aliens observing us still fear the cooking pot should they send missionaries.

James Wisdom writes:

It’s also a question of texture — while the whole vegetable universe certainly offers a wide variety of textures, many vegetarians still posses a yen for a meaty texture to masticate. Tofurky in particular has a certain chewy texture that no vegetable can imitate.

There’s an all-vegan Chinese restaurant in our neighborhood that features a huge variety of faux meat with varying results. We’ve had meat-eaters to the restaurant who have been literally amazed by the Pepper “Steak” and the “Pork” in the Hot & Sour Soup. But I must admit that the “Shrimp” Toast is a far cry from even faux crabmeat.

Furthermore, some flavors aren’t a great match for veggies — the one that comes to mind is “Buffalo” - both Boca and Morningstar have faux-chicken products that feature “Buffalo” flavoring (one nuggets, the other a patty) which are personal favorites. Perhaps I lack creativity but it’s hard to imagine “Buffalo Eggplant” or “Buffalo Corn”.

Mr. Albert replies:

As a long-time vegetarian, I am usually satisfied with non-meat food not looking like meat. But occasionally, especially at BBQs, with hamburgers and hotdogs, I want to eat what everyone else is eating and especially to partake in all the fixings. So at these times, I'll want a veggie burger or tofu dog.
That said, tofurky has always seemed extreme and too ersatz to be good. But who knows, maybe they captured to dryness of turkey perfectly. 

Scott Brooks explains:

TurkeyProper turkey is not dry — it is succulent and moist and the favor explodes with each bite!
It's all in the feeding, gathering, handling, preparation, accoutrements.

By the way, think about this logically for a minute: Turkeys eat vegetables and we eat turkeys — therefore, turkeys are simply a great delivery system for vegetables. Since we've cleared that up, you can go back to eating meat now! You can thank me later.
Feeding: Put out good food plots, with lots of clover and alfalfa for the turkeys as well as milo, soybeans, and corn. That will provide lots of nutrition for the birds and also attract bugs, which turkeys love to eat.

Gathering: I'll make this simple:
Me: Cluck, cluck.
Turkey: Gobble.
Me: Cluck, cluck.
Turkey: Gobble.
Me: Bang!
Handling: Grab the bird, throw him in your knapsack. Go behind my Morton Building, take a sharp knife, cut the breast skin away and peel it back. Carve out the breast meat. Take it inside and wash it in cold water to remove feathers, dirt, etc.
Preparation: Cut it into small very thin pieces and let it marinade in a balsamic garlic mixture for a few hours. Heat up a wok. Put butter in the wok. Add balsamic vinegar, garlic, and onion powder. Throw in the thin strips and quickly remove them just before they are finished. If you've sliced them thin enough, they will continue to cook on the cooling plate.
Accoutrements: Fresh corn on the cob. A tomato, red onion, crumbled bleu cheese salad covered with balsamic vinegar. Add the fresh fish your kids caught that morning from your pond, fried up in corn meal. Make cheesy mash potatoes.
Dig in! That meal will cure anyone afflicted with vegetarianism!



Austin's most famous unknown guitarist is David Grissom , who has a CD out called Loud Music . In the first four tracks and on tracks eight to 10 he shows why he's a favorite among those fortunate enough to hear him. As a boy wonder in 1989 on Joe Ely's Live at Liberty Lunch, he impressed the critics enough to warrant several Guitar Player magazine stories and an instructional CD deal. After playing on two more rock-oriented John Mellencamp CDs in the 90s, he left to return to Austin and do his own thing. Loud Music gives you a glimmer of his playing with sustain and getting a harmonic chime right up to feedback as he picks like a West Texas storm. Worth a listen. Find it at Waterloo Records Austin online , or elsewhere on the Web. One way I can tell if I really like a CD is to put it in the pickup and the next time I get in, if the volume startles me, then it is a good one. This one has some! Also, he has a new signature guitar out. 



 I continue to be pleasantly surprised by the book Python Scripting for Computational Science. Just yesterday I was contemplating the more efficient storage of higher frequency data and rather than turn to a Web search, went right to the book. Over 10 pages with four different methods. Also shows the flexibility and depth of the language. Chock-full of procedures and a more-than-cursory review of most topics one would be interested in.

Also, the Python for Bioinformatics blog is quite helpful, as the author is loosely translating a Perl book with the same subject. Slicing, dicing, filtering and commingling of data are all addressed.



There are many types of intelligence. A short list would start with academic, creative, and practical intelligence. Academic intelligence is the easiest to measure and hence is over-emphasized. Similarly, the readily available American football statistics of yards gained and touchdowns scored provide no way to evaluate the linemen who never carry the ball, but are critical to team performance. My observation is that practical intelligence is a larger determinant of success than academic intelligence.

Larry Williams remarks:

I failed lots of classes — I was a goof-off and did not care one twit about most classes. I snuck into college on a football scholarship. Never had any idea I'd end up as a trader — I was an art student. Then I found my great intellectual love, and my life changed. But at 13, 15 18, 20 I was a was a wandering generality — just like most kids.

Shui Kage adds:

My first attempt at a British A level:

Maths... Grade F (fail)
Chemistry... Grade F (fail)
Physics... Grade U (unclassified)
Biology... Grade U (unclassified)

On my second attempt I managed to enter the University, with honours in Chemistry as a bonus. I know I am not intelligent, I just worked hard. Kids should never be deprived by a one-time exam result alone. In fact, besides academic exams there are more important traits kids must learn at schools: common sense, manners, honesty, integrity, social skills. Jeff Skilling was a Harvard grad. He might be intelligent but totally lacks integrity.

I did not learn as much at University as when I was at a poor local state school where I saw the reflection of society: single parents, the physically disabled, the talented, the poor, the affluent, gangs, the terminally ill. I learned how to respect others and get along with all.



RoshIt is traditional before the New Year (for Jews, anyway) to ask forgiveness of those one may have injured or hurt. But it is also an adjunctive corollary of the cleansing period run-up to the New Year period to thank people for what they have done for one throughout the preceding annum. I want to thank Vic and Laurel and all the other Daily Speculations contributors for providing me so many hours of information, education, rigorous intellectual content, market tips and tops, insights, friendly comments and support when most needed, sophisticated and silly-goose humor,  the beloved trashy moment or two, and even joy. What a privilege to be among your ranks. Thank you, all.

Rich Bubb adds:

I echo Prof. Dreyfus's sentiment and thoughts. Vic and Laurel did a great deal of work, shepherding and entertaining at Spec Party last month. We had a great time.



OysterIn the US, those oysters along the Katrina coast are some of the sweetest and largest found. But here in the southern Chesapeake, which has the best oysters on the East Coast, those found on the Middle Peninsula are even sweeter, almost like butter. However, don't expect to find the best on a plane to NYC — waterman keep their best for local customers, as most in the cities have no idea how a good oyster tastes.  We have to call a tug captain named Puddin', who is about 400 pounds, and he'll send a diver down by a bridge support to get some of the really large ones in return for beer money. If you want the best, come down to the Urbanna Oyster Festival on the first weekend in November you'll be very pleased. On the Eastern Shore, the Chincoteague oyster is a saltier (brinier) lad with a taste that some NYC critics prefer, but in oysters (and music) it gets personal after a while.  I've been along the NW and NE coasts and those oysters taste like seaweed to me.

Alan Millhone adds:

A few years ago we stayed in Blainville with our French-Canadian friends Jean-Claude and Joelle. One day with the tide out Jean-Claude took me, my wife Vickie and our oldest grandson David out oyster hunting. The law there is that any oysters on the outside of the oyster cages were free for the taking by anyone. We waded into the soft seabed and collected a bucket of fresh live oysters. Jean-Claude and I shucked the oysters while Vickie and Joelle prepared a clear sauce for them. I prefer a hot sauce — but, when in Rome! They were great. Nice memories.

Bill Rafter advises:

Always go to a real oyster bar, where you can watch the staff shucking the oysters. Watch for a while (not just five minutes), ask questions and then tip the guy when you're done. Note that they can enter the oyster from either the bill end or the hinge end. If you are going to shuck them yourself, don't buy many, as you will probably give up. I like using an awl and entering from the hinge end. Avoid using a hammer and smashing the bill end to gain entry. The shells are quite brittle if hit that way and you will be picking the bits of shell out of your mouth.

You may want to try clams first, as they are considerably easier to open, but not as interesting. Do not waste money buying a "clam knife" which has a sturdy handle and a really dull blade. A paring knife with a sharp blade is best. Little Neck clams are small, tasty and considerably easier to open than Top Necks or Cherrystones.

At home: If you have access to clean salt water, get a bucket full and put the critters in there for several hours. As they have been shut up for hours or days in a cooler, they have been defecating in their shells. A couple hours in salt water and they will clean themselves. After you dump the water you will be most glad you did. You don't want to ingest that stuff.

Frequently, clams and oysters are sold at bayfront shacks. Most people are put off by that, but if the shack does of volume, patronize it. If you are coming to Long Beach Island NJ, there's such a place on Bay avenue in Manahawkin.



 On Sunday July 29th, I revisited Saratoga Racetrack, roughly twelve years after the scene that is recounted in Vic’s Education of a Speculator. Since I was meeting with my old friend and officemate at the time, hedge fund manager Andy Goodwin, the event elicited memories of days gone by.

The afternoon was clear and the track was fast. Based on my analysis of the Saratoga racing meet to date (which was four days old), my initial hypothesis (which was standing unless encountering clear data to the contrary) was that "early speed" horses running on or near the lead were at a clear advantage. Since my handicapping style is best suited to the aforementioned conditions, I felt conservatively confident in our prospects. Andy Goodwin (Hedge Fund manager), Seth Faler (insurance analyst and college roommate), and Nicole Carey (friend and drama teacher) were also feeling it, and all invested in a share of my wagers for the day.

The early results were not great. In the 1st, 2nd, and 4th we cashed no tickets. In the 3rd race we squandered a golden opportunity by swinging for the fences and investing 80% of our race allocation on two horses to finish exactly first and second. While our top choice won, our second choice was caught late from behind and finished third. Although we did have a "saving" trifecta ticket (1-2-3 in exact order), the second place finisher was well bet and therefore we made only a modest profit.

After the first four races were finished, I felt that my hypothesis had been confirmed: betting on horses with "early speed" on the dirt course was highly preferable to betting on horses that needed to come from "off the pace." The only problem was that my three losers (I had the winner in the 3rd) were further back in the early going than I had projected.

This thought was foremost in my mind while analyzing the 5th race for Maiden (having never won a race) 2 year old (youngest racing age, equate roughly to early teens for humans in physical development terms) fillies (females) who were bred in New York. These races historically are where I have my worst ROI (return on investment). The reason is the limited amount of printed information available for these young horses, especially the ones running in their first career race.

In the case of a "first time starter", the primary information available to the racing public is a) characteristics of breeding b) trainer profile c) jockey profile and d) the times of all recent morning work-outs (which can be very deceiving because it is hard to gauge the effort that was exerted in this type of "practice" run). Clearly, for a first timer, the main piece of relevant info is missing ….how fast will the horse run in a race? Many horses look like champions in the morning and are colossal underperformers at the races.

Due the huge unknown component in this category, and the fact that one often has very little racing history to base his decisions on, the betting public sometimes appears to engage in highly irrational speculative behavior. For example, imagine that some horseplayers actually employ a strategy which bases its selections on horses that seem over-bet (offering a much lower return than one would consider fair by the printed information) assuming that this overzealous betting activity is taking place because "somebody knows something" (info that is not available to the general public). The skeptical amongst us might suggest that this behavior is similar to weeding out used cars in the classifieds by the criterion of which ones are grossly overpriced and assuming that those who are charging too much for their cars must be doing so because the information that is difficult to discern (whether the car is actually reliable….or potentially a lemon) must be positive because said owners value their cars so highly.

My approach in these races has always been to stick to the facts, and one such fact caused me to eliminate the #3 in the 5th race as a potential contender immediately: The trainer of the #3 was 1 for 44 in sending starters to the track for the first time, and the ROI for these bets would have been 75 cents in losses for each $1 wagered. When the filly in question has done nothing at the races to cast doubt on that statistic, given no previous racing history, how can you bet on her? Prior to this race, I would guess that I had never bet on a trainer with a % of less than 3% for first timers.

However, I pored over the race 4 or 5 separate times asking myself the same question ….which of the contenders that I was considering had a reasonable chance to lead the race early (in line with the aforementioned "hypothesis") given the limited information available. If I was thinking that the early fractions would be somewhere in the vicinity of the "par" times for similar races….then the answer was "none of them."

 My attention kept reverting to the #3. Amongst the other facts were:

1)    The father of the filly (Hook and Ladder) showed stakes caliber early speed as a racehorse AND was one of the most successful New York bred "first crop sires" in recent memory in terms of winning % for first time starters. In other words…ideal breeding for early speed in the first career start.

2)    The filly showed the two fastest morning "workouts" of the field (both were fast relative to "par" best times for other 2-year-old maiden fillies).

3)    The jockey named to ride the #3 (Ramon Dominguez) was unquestionably the best jockey in the country YTD for shorter "sprint" distances, winning on an incredible 30% of such mounts in 2007.

Yet, despite the overwhelming evidence that this filly could come out running, I couldn't overlook the 1 for 44 trainer stat (and neither could the betting public … she was 14-1 on the tote board) until I was fortunate enough to ask myself the following two questions:

"How much weight was I giving to the trainer variable if I was willing to eliminate a filly @ 14-1 who would have been either the favorite, or a close second choice (certainly 3-1 or less) based on the other three variables and adding a better performing trainer?" Well, the answer to this question is obvious considering that I wouldn't even consider a potential 4x return versus what I would have gotten in the case of a trainer who was more successful with first time starters. Thinking about it this way, my approach didn't make much sense. Therefore, I had to ask myself a second question:

"Why had I made it a fundamental, unbreakable rule that one should never bet a first time starter from a trainer that had such a poor winning % and ROI?" After some deliberation, I decided that the main reason was "intent." Simply put, some trainers consider the first career race to be a warm up of sorts. These trainers win at a low first time % because they are not as concerned with winning the race at hand as they are setting the horse up for a successful career. Obviously, it would be foolish to bet on a horse (filly) whose trainer viewed winning as a secondary goal, unless this indifference towards winning was more than reflected in the odds.

Suddenly, my opinion of the race changed dramatically. Outside of the 1 for 44, there was strong evidence that the trainer was interested in winning that day. Consider these points:

-    Would a trainer who didn't care about winning a race work his filly briskly (from the starting gate, nonetheless) on two separate occasions in preparation?

-    Would a trainer who didn't care about winning a race solicit the top sprint jockey in the country (one who intuitively cares about winning EVERY race given his 30% success rate)? I would expect that a trainer could only do that so many times before this jockey (a valuable resource) would avoid him altogether.

-    Finally, if you had a filly from a Sire whose progeny were winning at an amazing rate (57% according to my forms), would you throw away such a good opportunity and send the filly out for a jog without the intent of winning?

My answer to all three questions was …..of course not. As a result, my reasoning was that if the filly with the best breeding (to win that specific day), the best workouts, and the best jockey was saddled by a trainer who had come to the track that day intending to win………well then why couldn't she? In my eyes, she had a very realistic chance.

After returning from the betting window, and immediately prior to the race, I started to get exited. 14-1? This was madness. I grabbed Andy Goodwin by both shoulders and started shaking him while laughing, "Ever-changing cycles, ever-changing cycles …hah, hah."

Sure enough ….ever-changing cycles, indeed. The filly came out running, went straight to the early lead, and held on to win. She paid $30 and was the key to what became a very profitable afternoon for all of us.

What is to be learned from this story? Does it have any relevance to us as financial markets practitioners? I think it does.

First of all, it reinforces one of my primary opinions about the markets: Most of the best proprietary trades are the ones that are the most difficult to do. The ones that you really need to dig for …..and that also have an element of uncertainty that make them emotionally uncomfortable upon first analysis.

 My math super-genius collegue, who aspires to build successful algorithmic trading models (which we will call ALGOs for short), often bounces hypotheses off me for systematic trades. My reaction to his ideas is almost always the same, "This is too easy to do, and therefore I don't think that you can make money at it." What can be visually observed by a programmer while trading his personal account part-time is probably not representative of a systematic market inefficiency that can be modeled and exploited for profit …..or that's how I see it, at least. My best ideas trade ideas are usually a combination of a lot of "tinkering" quantitative analysis, and observing the effectiveness of the best subset of those ideas (that become hypothetical models) through trial and error. I need to watch a lot of prices and make a lot of trades to stay on top of what is working and what isn't working. Any attempt to shortcut this process inevitably costs me money. Maybe I need to watch hundreds of horse races before encountering an opportunity like the one described above.

I am (and was) absolutely convinced that the filly in question was an excellent bet at 14-1 in that her pre-race chances were much better than 1 in 15. Interestingly, of all the serious horse players that I showed the sheets to retrospectively, not a single one guessed that this filly could have possibly gone off at odds higher than her 6-1 morning line price, which is amazing given the fact that all could have probably predicted the final odds of the winner in all of the other nine races that day within an allowance for error of +/- 30%. Yet, with this filly they were all more than 100% off.

Now, would these same handicappers have been able to overlook the 1 for 44 trainer stat in real-time, and bet on what seemed to be an extraordinary value. In the majority of the cases, I would say no. My guess is that they probably had similar concrete rules regarding NEVER betting on a trainer with such a low first time success rate and ROI, and while they would have been disappointed after the fact for not having bet on the filly at such a big price, I would assume that they would have eliminated her the same way that I did in my first four passes.

On the car ride home from Saratoga to Vermont, I pondered at length the afternoon's experiences with relation to another theory of mine (and one that I often debate with my Quant and ALGO trading associates), namely that it will be a long time before computers are able to fully replace humans as decision makers in parimutuel gambling environments like horse racing ….or even financial markets. For now, and into the foreseeable future, I think that there will continue to be opportunities for human "traders" to prosper in the markets.

A frequent argument by supporters of fully systematic trading (and by inference, skeptics regarding the usefulness of humans in any trading role) is "Provide me one concrete example of where a reasonably well informed and highly competent human would surely make a better decision than the best ALGO model." My answer…… "variable weighting" in cases of uncertainty or disequilibrium (similar to our horse racing example). Coincidently, a perfect example was provided for me in the same calendar week.

In support of the aforementioned, consider the events of August 3rd. Largely influenced by negative developments related to the housing market and sub-prime credit, the S&P 500 had declined roughly 5% over the prior two week period. Before the open, Bear Stearns had issued further negative guidance in a statement which was to be followed up with a conference call @ 2:00 PM.

 Since sub-prime debt was experiencing a period of huge uncertainty (as portfolios were losing huge chunks of their value), and the implications of the quality of this debt had such strong correlation with many other parts of the economy including housing, banking, other financials, and all sectors sensitive to the purchasing power of the lower middle class etc., the market was completely focused on Bear Sterns since they are widely considered the biggest player on Wall Street in the credit arena. Few would have debated that Bear Stearns was by far the most influential stock in the market on that morning.

Was it possible for an ALGO (if unassisted by a human trader or analyst) to know that Bear Stearns was so important to the health of the market? Not in any way that I can imagine. The best chance was that this ALGO could have had a news reading component that noticed that Bear was the most prominently mentioned company in the news that day (and several other days over the proceeding two weeks). However, this same ALGO would intuitively have absolutely no chance of understanding that today's headline stock (as opposed to on a "normal" day) was so important and its influences so wide reaching. Even a database of business segment inter-relations would have only been of limited value. While this tool might have been helpful in identifying what stocks might move (due to good/bad performance in certain areas), the ALGO would still be missing the crucial "weighting" factor … sensitive the market had become to the sub-prime issue, in general, and Bear Stearns, in specific.

Although both the S&P 500 Index and Bear Stearns stock (down 6%) sold off sharply in the early stages of trading that day, both rallied to roughly unchanged by the time of the conference call based on a street-wide sentiment that "the cat was out of the bag" so to speak and the worst news was already priced into the market.

However, on the 2:00 PM conference call, instead of reassuring investors as anticipated, Bear Stearns representatives unexpectedly painted a picture of doom and gloom, describing the credit picture as "the worst in decades." Upon hearing this, most discerning humans who were immersed in the US equity market immediately recognized that the catalyst for the big rally had disappeared instantly and left a great deal of negative sentiment, and huge uncertainty, in its wake.

Immediately, Bear Stearns stock fell from the sky, erasing a good chunk of its retracement gains in a few minutes. Logically, the rest of the market, which was focused that specific day on sub prime and Bear Stearns, followed suit and slowly but surely grinded down 40 points (or almost 3%) to the close.

While it could be argued that the market direction after the Bear Stearns call was not clearly predictable (although it was my strong impression that the market was heading down and I was short to the close), all of the following seemed relatively certain:

The huge change in sentiment regarding the credit market (immediately reflected by the sharp decline of Bear Stearns stock) signaled a new disequilibrium for the price of hundreds of stocks that were strongly influenced by the health of the sub-prime market ….or even credit market in general. Clearly, selling volatility in such an environment or applying mean reverting strategies (that might have been successful under normal conditions) could potentially be a dangerous activity for an ALGO that had no understanding of what had occurred or the implications thereof. In addition, any correlation relationships (the basis for many "pairs trading" or "relative value" ALGOs) for companies having reasonable sensitivity to sub-prime were also in danger of busting, depending on the relative exposure to sub-prime. Consider a homebuilder that sold to rich people versus one that sold to poor, sub-prime candidates. Although these companies might have traded at a very high correlation historically, that kind of relationship was in jeopardy of breaking down going forward.

Clearly, in such a disequilibrium or uncertainty period, many ALGOs are in significant danger of putting on a lot of really bad trades before figuring out the peril of the situation and modifying their behavior and either scaling back, shutting down, or changing their strategy altogether. This is reflected by the unusually high number of quant or ALGO trading hedge funds that blew up as a result of these events.

What's worse, this big disequilibrium move occurred in the wake of a year of extremely low volatility (relative to the mean for the prior 10 years). Since short-term ALGOs are often trained on limited data sets going back only three to six months, some of them knew little of high volatility environments (outside of a couple of big down days from the previous two weeks), and were surely caught somewhat off guard.

In summary, computers are extremely valuable tools both for analysis and execution. In many cases, computer programmers, despite little interaction with the markets, can build ALGO trading models that can outperform the great majority of human traders. However, it is my contention that 1) In some cases, many ALGOs could benefit from more (even if extremely limited) human involvement that could assist them, or at least keep them out of trouble, in times of disequilibrium or spontaneous uncertainty 2) There is still a place for human proprietary "traders" in the markets because they are able to identify and exploit occasional inefficiencies that simply can't be recognized by machines. Given the open ended nature of the problem, and the myriad of variables to be considered, I don't think that this is going to change for the foreseeable future.

Dan Murphy is the owner/CEO of Green Mountain Analytics

Jim Sogi comments:

Systems traders don't like to make the real time decisions, but the decisions are merely moved up a level. Is it time to change the system, change the parameter, adjust here, adjust there, keep it the same? Always decisions. The other issue, in addition to the human variable weighting, is: can an astute trader add value through execution to a system? This relates to trader performance and human foibles. We make stupid mistakes sometimes.

Clock's comment about the short training period for the algo systems is critical. The lookback needs to consider historical max drawdown for money management purposes, even if the algo system parameters are set for a shorter time. This brings up another issue. Are also systems and money management different? Can they be combined? I think money management is better accomplished by leverage than by stops.

James Tar remarks:

In my experience as a horse owner and racing speculator, the fall meet at Belmont offers the public a considerable amount of mean reversion regarding payouts. This follows the NYRA's blatant stealing from the public during the Saratoga meet.

Today in Race 4 there are some interesting horses entered into the race that are right up the speculator's alley:

#3 - Bearish
#8 - Moral Compass

You can bet my money is on the #8 horse. 

Vincent Andres mentions: 

In reference to Mr. Sogi's comments: For/from the few systems I tested, it seems me obvious that MM cannot be considered as external to the used system. There is MM1=MM/system1, MM2=MM/system2, etc. MM has to be combined/adapted to the system.

This prevents of course not most MM to have some (good sense) common points.

(And also if our edge appears to be really only 50/50 … then there's no need to worry about MM.)

Jim Sogi comments:

The problem with combining risk in the trade system is that any system has in it a bias due to the time frame in which it is framed. That bias may not protect against the long term risk parameters and a built in risk system will not "see" the regular 8-10 sigma events which occur every few years. Bringing in an outside crash protection risk system is a possible add on module to a trade system and may require separate calculations. A robust example of this idea is from Triumph of the Optimists. 1.9 x would have multiplied the 1.5 Million percent return many many times over through compounding. 2 x would have gone bust. A risk add on might limit exposure to an average of < 2 x. An individual system may say, heck go 20 x, as this arbitrage is fool proof (see LTCM). Longterm plug in says, cut it at 2 x.



Charles MurrayTonight our monthly Junto meeting will hear Charles Murray, a foremost expert on human intelligence, expanding on his essay on "Jewish Genius" from the April 2007 Commentary magazine. Charles Murray first came to national attention in 1984 with the publication of Losing Ground: American Social Policy 1950–1980. This was followed in 1988 by In Pursuit: Of Happiness and Good Government, in 1994 by The Bell Curve: Intelligence and Class Structure in American Life (with Richard J. Herrnstein), in 1997 by What It Means to be a Libertarian: A Personal Interpretation , and in 2003 by Human Accomplishment: The Pursuit of Excellence in the Arts and Sciences, 800 B.C. to 1950. His latest book is In Our Hands: A Plan to Replace the Welfare State (2006).

He's a fine speaker who always knows his subject thoroughly. I hope Daily Spec readers will come and hear Murray, and say hello to us. There's no admission charge, and please bring your friends. We meet at the General Society Library, 20 West 44th St., in Manhattan. We have a general discussion period starting around 7:30 pm, then the speaker comes on at about 8 pm, and after he presents his case there will be plenty of time to question him.



The doc who runs the "real age" site at the University of Chicago was once asked whether sex could replace exercise. He opined that if you could have 120 or so orgasms a week, you wouldn't need to do any other exercise! This is a tough one, of course. My wife and I keep getting tired after about 100 and we have to do some rowing to make up the shortfall. (Just kidding - we don't row!)



Hardly equitable: ruin a team, a school, kids' lives — and spend 24 hours in lockup. This defines travesty. How do the students regain themselves, hundreds of thousands of dollar in legal bills and  a year or two of their lives? Very sick, but shows how the judges treat insiders. Disgusting.



From a behaviorist psychological viewpoint an organism's behavior and beliefs are shaped by stimulus. Many random patterns in stimulus form what is called superstitious behavior or known statistically as spurious correlations. Training shapes us towards our desired belief and behaviors by controlling the stimulus.

As to choosing beliefs, that is the role of philosophy.



…And now it's springtime for Hil'ry and Cigarman



PiggyIt's a myth that US households have negative savings rate as a whole. Simply not true. Turn on the TV — all you see are ads for the investment industry. Minus the past few weeks, investments has been as big a boom industry as tech. How can it be that the savings rate is negative, yet the amount of money pouring into mutual funds and banks is so huge? The answer is that the data are no good. The savings rate is in fact very positive.

Riz Din adds:

General thinking on this issue amongst economists is considerably less alarmist than the journalists' version. Importantly, the official savings calculation completely ignores capital appreciation of household assets (housing, stocks), of which there has been much in recent years. This has a balance sheet effect of increasing households' net worth and also encourages further consumption; only the latter is caught by the savings calculation. Also, taxes paid on capital gains are included in the calculation with the effect of lowering disposable income. Oops!

Furthermore, work by economists has revealed that in the US, most debt is distributed amongst the better off segment of society, and it is these people who have experienced the greatest capital gains in recent years. All in all, if we incorporate measurement problems into our thinking and account for the distribution of debt across the population, we should be able to sleep better at night. One fewer 'end of the world' gremlin to worry about.



MastermindThe greatest projects in civil engineering are undertaken by young children digging. Whether at the beach or deep within a closet, you haven't built a bridge until you've built one of sand and you haven't tunneled until you've hit the back corner of the family game closet. My kids excel at both and a recent expedition to the dark hinterlands of our home unearthed Mastermind, a code breaking game for two.

Play is simple. The first player has a choice of six colors to make a four-peg secret code. The second player must then solve the code in 12 or fewer turns by making guesses with the pegs. After each guess, the first player provides feedback as to:

  1. How many pegs are the right color but wrong place (white response peg)
  2. How many pegs are the right color and right place (red response peg). Information is transferred both by the response pegs and the absence of same. Player two has 12 turns to deduce the pattern.

This is a wonderful game of feedback systems, deduction, intuition and chance. It's one of those games that can be created and played from scratch with sticks, stones, leaves or whatever is at hand and enjoyed for hours. Also, you start with a completely random guess and use incoming information to deduce complete signal. What a lesson to teach kids! It's like cross training for the spec mind.

I've yet to be prouder of my five year old then when she cracked her first code with no hints. "Daaaaaad, I know…just let me do it".



Fear, from Ken Smith

September 4, 2007 | 2 Comments

PumpkinBad news is always around. Bad news and dire predictions are reasons to dump holdings and perspicacious traders are aware of this. They game the news, game economists, game everyone. Fear drove me out of a position Friday; had I held I would have had a profit to take as of half an hour into the trading day. I let fear temporarily overtake logic.

Eric Ross adds:

Join the team! Fear and emotions have driven me out of trades, have prevented me from taking positions. Today, after dawn patrol, I wanted to enter the market, but emotions prevented me. It seems one should just buy the dips and not look back, accept the risk of a drawdown.

Alan Millhone remarks:

I wonder if we had no TV, did not look at magazines or newspapers, and stayed focused on the data at hand — would that exclude emotions and thus make traders more successful? The news media can twist anything — and when you see something you automatically believe it!



Prey, from Jim Sogi

September 4, 2007 | Leave a Comment

AkuHanai O Kalama is the name of my friend's new ultimate turbodiesel fishing/surfing expedition boat. Hanai O Kalama refers to the new crescent moon. The two horns point south and are a valuable navigation tool when at sea. This weekend we trolled out on the grounds dragging some big lures for big game. At "The Grounds" the deep ocean currents hit the corner of the island underwater and push up cold, nutrient-rich water. Birds and small bait fish gather there. We watch the birds. The birds lead to the bait fish. Soon we are surrounds by acres of jumping feeding fish, splashing water and hundreds of birds swirling around. The birds indicate where the fish were. We went there. The fish dove. The birds sat. Three times, then we realized our lures were too big. Adapting to conditions, we switched down to small lures and light tackle. Watching the birds, I realized that they would sit and move slowly until the fish came up. Taking the birds' cue, I slowed the boat, matching the speed of the schools of fish. Soon we were catching double hookups and the fish fought and jumped in flashes of silver and blue, fighting and diving, bending the rod.

A few ideas here. There are deep underwater currents that can't be seen, but exert powerful forces at the surface. It's good to know the underwater geography as well as the shore and the motion of large currents. Sometimes the waves are huge and, if they hit the current wrong, can capsize the boat. Second, the predator need not look directly to the ultimate prey, but can look indirectly at two or three levels of predators above and infer where the prey might be. In this case we look for the birds who prey on the little fish under which big predators lurk. So it is important to watch the birds and little fish, even when you are a predator seeking big game. Third, timing is important. Be there when the fish are, when they are eating, and when the current is there. Have the right equipment. Adapt to conditions. See the thing you can't see. True in the ocean; true in the markets.

To barbecue the Aku, which are skipjack tuna, we land on shore. We had briquettes ready. We found an old rusty grille, banged off the rust. The fish are scaled, cleaned, and sliced in ¾ deep slices vertically along the length of the fish. In the slices, rub rock salt and pepper. Throw on the grille until cooked. A delicious delicacy. We had the potato salad already made. S'mores for desert with Degobas chocolate. Soon, the stars and Milky Way filled the sky. Shooting stars streaked by. By the time the moon rose, everyone was fast asleep in the rocking boats as small waves lapped on shore.



Lehrstuhl fuer Rechnerorientierte Statistik und Datenanalyse (RoSuDa) offers some nifty R-related and visualisation programs for free.



BBC America on DirectTV is airing the new season of Top Gear on Monday nights. It premiered last week with homemade floating cars and a convertible minivan segment –and the Stig wrecked a Koenigsegg CCX.

Alston Mabry adds:

Top Gear also runs on BBC Canada.  It's a great show.  Funny, informative, very well produced.  The three hosts are clever, and the show is like watching Monty Python meets Road & Track.  Strong recommendation.



Anne BaxterI just saw All About Eve for the first time. The film, made in 1950, holds up well, other than a very few scenes that now read as over-the-top. It was well-written and clever, scripted by Joseph Mankiewicz (1909-1993), starring all the venerable stars of the age: Anne Baxter, Bette Davis, Celeste Holm, George Sanders, Gary Merrill, Thelma Ritter and Marilyn Monroe — even Eddie Fisher in a tiny role.

The code of film ethics at the time forbade overt mention of the subtle philogender goings-on between Eve (Baxter), Margo (Bette) and Celeste Holme, and between Addison and unnamed presumed other men. But it was indicated, if you have the sensibility to note its telltales.

What dawned on me as I saw the meretricious opportunist Eve Harrington, "born Gertrude Slusjcowich," as George Sanders's character says with acid deconstructional relentlessness, was that she pretended a sincerity she never knew, she lied at every opportunity to advance herself, she connived behind the scenes and feigned innocence when caught, she was a Janus-faced royal rhymes-with-rich who cannibalized anyone she could feed off, yet who unaccountably won a few hearts of proles watching her without much 20:20 insight: She is, in short, the incarnation of America's presumptive 44th President.

The George Sanders character, Addison DeWitt –though flawlessly cynical, analytical and too reflective by half to embody anyone who should want to come within a mile of Eve, yet wants to become her possessor (for want of a better term). Why, after he dissects her horribleness, should he then pursue affiliation with such a reprobate? Perhaps one could ask America's 42nd President…



Using DJIA daily closes from 1930-2006, at the end of each calendar year, I found the low close of the last 125 trading days of that year, and the high close of the first 125 trading days of that year. The maximal decline was defined as:

[(min last 6mo)/(max 1st 6mo)]-1

These maximal declines could range in duration from a few days to the entire year, and were used to compare intra-year declines by last digit of calendar year. I performed a comparison using a variation of ANOVA, which compares individual means to the global mean.

Note that none of the year last digit maximal declines were significantly different from the global mean (the bar does not cross the red 0.05 alpha line). XXX7 years are lower than most, but XXX1 and XXX2 years are similar.



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

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



1915 DodgeAt the farm-market in Greenfield Hill today, a restored 1915 Dodge pulled up, and as the wife browsed the corn and tomatoes, hubby gave our family a quick tour of the car.

What struck me was how close the user-interface is to today's. Gear selection was via a floor-mounted shift-lever on the driver's right, with gears 1-3 and reverse in an H-pattern. The gas/brake/clutch petals were arranged right-to-left on the floor. Steering was via a hand-controlled wheel. Round tick-marked analog gauges indicated speed, RPMs, electrical current, oil pressure.

Essentially, today's UI is unchanged from this setup (excepting the automatic transmission, popular with Californians who need a free hand for the cell phone). The driver of a 1915 Dodge could step into a modern auto, nearly 100 years later, and operate it immediately.

When I remarked on this, the owner told me that in the years just before 1915, there was widespread experimentation with user-interfaces in the auto industry, and the 1915 Dodge's layout was the design that "stuck."

The QWERTY keyboard comes to mind as a parallel. And I wonder if the computer GUIs of 100 years hence will still involve overlapping windows, icons of running programs at the bottom, pulldown menus at the top, left-click to select, right-click for context menus…

Arthur Cooper adds:

The experimentation period is illustrated by the autos in the collection of the National Auto Museum in Reno NV. It's definitely worth a visit.

Alan Millhone writes:    

I have a four-door 1948 Chevy that needs restoration. The motor is frozen (not original, a re-built Sears six-banger). The car is an antique, which makes me one as well — '48 is my birth year!



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

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

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



Yesterday a good friend's mother's obituary arrived, listing a number of her lifetime achievements of which I was unaware. Besides marking the calendar to attend her memorial, I thought, "what will mine say?" I picked a likely date — being optimistic of course — and wrote my own future fantasy obituary. I feel more focused now. The items on my to-do list for the month have fallen into order of relevance. I plan to review my obituary every few months. A way of planning from the past tense.



GenniferLike elephants, humans retrace. In my 20s a lady friend, whom I had been dating for a couple of years, ended our relationship. But I kept retracing my steps to her threshold. Kept the phone line open to her abode. Wrote notes. For quite some time. Couldn't give up. Not stalking, mind you, nothing rude.She reinforced my behavior by occassionaly allowing me to seduce her. Her desire for my embrace had not burned out. I retraced to her doorstep, her phone number, again and again, sometimes to be rewarded. More often to be denied.

And it was fruitless in the long term.I look back on that and wonder about my common sense.

After March 2000 I retraced my actions in the markets, time and time again, only to be randomly rebuffed or rewarded — but mostly punished. Kept retracing the trades that had rewarded me so much for so long. I could not believe this had turned against me irrevocably.

And it was fruitless in the long term. I look back on that and wonder about my common sense.

Marion Dreyfus explains:

Intermittent reinforcement is actually more powerful than the usual normal, regular reinforcement, and explains our futile return to occasional love-objects as well as to the volatile and heartless Market Mistress. Both give us a seductive taste, then whip it away, but the chance of succeeding again is so tantalizing we hate to give up that chimera of opportunity/reward.



Oak TreeIn August, the stock market ended up, but with the interest rate vs. earnings yield differential at its all time high. Disruptive moves abounded. The Fed established a reversal in policy, cutting the discount rate. Through history, the average run of Fed moves in the same direction has been about eight. A 10% decline occurred in the S&P 500, and a 1000 point decline in the Dow, events unseen in five years. Some hedgefunds lost, some gained. Exchange margins were raised many times. In niche markets where the strong had ample capital, much fear was raised and many weak longs were washed out. Earnings continued apace, with some sectors down and others up — housing terrible, technology good.

Now the market can go its merry way with much less baggage. A nice replay of 1907, with a few actors changed. All this was brought to mind by the calmness and serenity of nature, exemplified by a few stately oak trees I saw at the Bronx Botanical Gardens today,  trees with their horizontal perimeter as great as their vertical, and many branches on each side, starting very low.

Ken Smith remarks:

Reading of charts indicates most years were good years for the stock market, in that regression to zero has never occurred for a major index. 1987 and 1998 took some percentage off the top, yes, but a recession of drastic dimensions did not occur. In an essay Causes of American Business Cycles, 1998, Temin claimed the only crashes that had a severe impact on the economy occurred in 1903 and 1929.



WiswellOn September 17-21 the Plaza Hotel in Vegas will host the American Checker Federation (ACF) World Qualifier, with players coming from all parts of the globe to compete for the right to challenge for the Go As You Please ("Freestyle") World Checker Title, currently held by Ron "Suki" King of Barbados. Playing for draws will not win this tournament. Players will have to sharpen their lines of play, be innovative and play for wins. Players will have to play for strong mid-game positions, then hope for favorable endgames with an edge that can secure a win.

The late GM Marion Tinsley used to quip, "Many tournaments are won before the tournament begins". A player will find previously played games of possible opponents and study their style, look for a chink in their armor, see if they play a strong endgame (many Masters neglect endgame study) and rely too much on knowledge of prepared lines of play.

In checkers, with the red pieces beginning 11-15 is supposed to offer a slight advantage by coming directly out of the "single corner." Checkers is a constant battle for control of the board's center. I will be at the World Qualifier as an observer and ACF Official and will observe the methods players use in their games to score wins. "Stepping out" can lead to disaster, as can overextending one's position. "Keep the draw in sight," the late GM Tom Wiswell used to admonish.

There will be turmoil between rounds of play. The market of late has also exhibited much turmoil and one has to be as careful as possible in seeking an advantage when making trades.  Tom Wiswell also used to say that "Moves that disturb your position the least disturb your opponent the most." In checkers, many times "waiting moves" are indicated, to avoid disturbing your position. Then your opponent has to show his hand. Many times, by waiting you cause your opponent's position to crumble right before your eyes.

Making "sound moves" in the market during troubled times is important in "holding your position" till an "opening" presents itself. "Move in haste, repent at leisure," said Tom Wiswell. 

Nigel Davies remarks:

A major difference between markets and board games is that in markets every score is carried over to the next tournament. I believe this puts the onus on consistency and strong defense rather than a high rate of scoring.

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