The frogs are chirping outside the local brook again en masse as of March 25. but they stop all noise whenever the local hawk flies by. One wonders if there is a comparable quietude in prey when predatory markets fly above. I often note such a quietude in prey markets while bonds make their move. It is good to quantify such speculations and to generalize them to other examples of foraging and deceptive behavior in markets and life.

The market mistress gave us something never before seen on Friday — a range of just 12 points from high to low, 821 to 809. Such hadn't been seen on a non-holiday since the very slow summer days before the storm of August '08. The day following on the most similar occasions, taking account of the down open, were bullish — but, not taking account of the open, were bearish. What cataclysmic event does the market wish to lull us into a false sense of security for with these unusual moves?

George Parkanyi responds:

Well, it is a bear market until after much hindsight some point down the road we determine that we are finally again in a bull market. Therefore, it is not unreasonable to assume for now that we are in a bear market rally. Although I think it's rather beguiling to think that the devil's number of S&P 666 was the ultimate low from which the market recoiled back on March 6. Did someone hold a cross up to the big board at the right moment? Or is that number the vortex back into which we will be drawn, kicking and screaming, much as a black hole sucks up all that unwittingly ventures into its grasp? This has been a very news-driven market, mainly feeding on the fear of systemic failure. I think this fear, and therefore the overall negative market psychology, have abated somewhat. The news of late is more along the lines of what is being done about the sky falling (and the bickering associated with it) than the sky falling itself. And spring I think tends to cheer people up a little. However, Q1 earnings are right around the corner, and much like a patient who has recovered a bit but whose immune system is down, market psychology is still very weakened and vulnerable to any blind-siding news that either validates or reminds that yes, the sky is still falling.

So I wonder, in Homeland Security parlance, would this be market orange-alert territory?

Victor Niederhoffer adds:

To test the Frog-Hawk Syndrome, I looked at all occasions when bonds changed by more than a full big handle, e.g. from 110 to 111, in the last 10 years while S&P futures changed in absolute value by less than 1/4%. I found that such occurrences are rare. While the bonds as of 12 noon change more than one point in absolute value about one in 10 days, 200 times during the period, the corresponding change in the S&P was less than 0.25% just 1/10 of those times. I found that the subsequent changes in the S&P on those occasions was random. Turning the situation around with the hawks being stocks with the bonds being the frogs, I found that the situation was more interesting, with a flight of stock market hawks with quiet bond frogs, inordinately leading to great subsequent continued energy by the hawks.



 Sometimes predator-prey models get knocked off-kilter by alien, invasive species. Perhaps analogous to certain market conditions and unintended consequences of government intervention in markets. Here is a good example from Louisiana. I have not had a chance to try one of these Cajun delicacies yet:

"But by the fifties it became apparent that the ever-expanding nutria population was having a devastating effect on Louisiana’s coastal wetlands, threatening the stability of the entire fragile ecosystem, damaging levees, ruining sugarcane crops, draining rice fields, and contributing to the decline of the fur-trapping industry. The nutria population soared to twenty million, all eating their little hearts out. In some areas, these voracious creatures completely denuded natural levees and severely weakened marshes. It’s been estimated that some 34,000 acres of wetlands are presently impacted by nutria, now included among the top hundred worst invasive species in the world."



 A little NCAA Tournament counting:

If you go to Yahoo Sports you can grab data on each team in the NCAA basketball tourney. For any team, determine an average weight and average height for the players that are actually playing.

Take the average minutes per game for each player and multiply this stat by the player's weight, and also by his height (in inches) to create two new stats that show an aggregate value of the weight and height that player contributed during the team's total time on the court per game.

Total these stats for the entire team and divide by the total of the average minutes played for all the players, and you have essentially an overall average weight and average height for the five players the team had on the court during games.

Here is an example:

University of Oklahoma

Player   GP  Min  HT  WT  min*HT  mi*nWT
Allen    18   4.7 83  267  7,022   22,588
Cannon    9   6.8 80  230  4,896   14,076
Crocker  35  29   78  206 79,170  209,090
Davis    34  14.9 77  208 39,008  105,373
Franklin 12   2.2 71  161  1,874    4,250
Gerber   13   2   80  228  2,080    5,928
Griffin  34  33.1 82  251 92,283  282,475
Griffin  35  29.8 79  238 82,397  248,234
Johnson  35  31.3 75  176 82,163  192,808
Leary    33  10.2 71  173 23,899   58,232
Pattillo 18  13.7 78  216 19,235   53,266
Warren   35  31.2 76  207 82,992  226,044
Willis   16   6.4 78  172  7,987   17,613
Wright   32   8.1 81  234 20,995   60,653

total team min:  7020.5
total height:  546,001
total weight: 1,500,630

Avg Team Height:  77.8 in
Avg Team Weight: 213.7 lbs

These calculations were done for the 32 teams that made it out of the first round.

Then the point differential was calculated for each of the 28 games that those 32 teams played in rounds 2, 3 and 4.

In 18 of 28 games, the team that won also had the heavier average player. In 19 of the 28 games, the team that won had the taller average player.

To run a correlation, a winner/loser score ratio was calculated for each of the 28 games (i.e., Big State beats Western U by a score of 100 to 80, then the score ratio is 100/80, or 1.25), as well as a difference between the two teams playing in average height and average weight.


Louisville 79, Siena 72

avg wt: 211.7
avg ht:  77.0

avg wt: 201.2
avg ht:  76.3

score ratio: 1.097
weight diff: +10.5
(i.e., winner heavier than loser by 10.5 lbs)
height diff: +0.712
(i.e., winner taller than loser .712 inches)

Running a correlation of the score ratio and height difference for the 28 games produced a surprising p of -0.24. So while the winning team was taller in 68% of the games, there were shorter teams that won by big margins, and taller teams that won by small margins.

The correlation between score ratio and weight difference was initially even more surprising - to me, at least, because I was certain a priori that weight mattered significantly. But the correlation was only +0.08. So, the winning team was usually heavier, but more bulk affected the margin of victory only slightly

The Final Four looks as follows:

Team / avg ht / avg wt

North Carolina 77.2  /  216.1
Villanova      77.1  /  207.7

Connecticut    79.0  /  215.5
Michigan State 77.2  /  212.2

So, it looks like Carolina beats Villanova on weight (though Pitt weighed in at 217.3), and UConn beats Michigan State on height. Then it looks like it's UConn on height again in the final against Carolina (with their weights being too close to matter).

All 32 schools, sorted by average weight:


Xavier  78.1  221.5
Pittsburgh  76.3  217.3
USC  78.4  217.1
Gonzaga  78.4  216.7
North Carolina  77.2  216.1
Connecticut  79.0  215.5
Syracuse  77.0  215.3
Memphis  78.7  214.7
Oklahoma  77.8  213.7
Arizona State  76.7  212.4
Michigan State  77.2  212.2
Wisconsin  76.9  211.8
Louisville  77.0  211.7
Duke  77.6  209.6
Marquette  75.6  209.1
Maryland  77.5  208.1
Texas  76.2  208.0
Villanova  77.1  207.7
LSU  77.7  207.5
Washington  75.5  207.5
Missouri  77.8  207.1
Dayton  77.2  207.1
Arizona  76.8  206.4
Oklahoma State  75.6  206.0
Texas A&M  78.0  205.8
Kansas  76.6  205.2
UCLA  77.2  204.7
Purdue  76.7  204.0
Siena  76.3  201.2
W. Kentucky  76.6  200.4
Michigan  76.1  197.7
Cleveland State  76.1  197.3

All 32 schools, sorted by average height:


Connecticut  79.0  215.5
Memphis  78.7  214.7
Gonzaga  78.4  216.7
USC  78.4  217.1
Xavier  78.1  221.5
Texas A&M  78.0  205.8
Missouri  77.8  207.1
Oklahoma  77.8  213.7
LSU  77.7  207.5
Duke  77.6  209.6
Maryland  77.5  208.1
UCLA  77.2  204.7
Dayton  77.2  207.1
North Carolina  77.2  216.1
Michigan State  77.2  212.2
Villanova  77.1  207.7
Syracuse  77.0  215.3
Louisville  77.0  211.7
Wisconsin  76.9  211.8
Arizona  76.8  206.4
Purdue  76.7  204.0
Arizona State  76.7  212.4
Kansas  76.6  205.2
W. Kentucky  76.6  200.4
Siena  76.3  201.2
Pittsburgh  76.3  217.3
Texas  76.2  208.0
Cleveland State  76.1  197.3
Michigan  76.1  197.7
Marquette  75.6  209.1
Oklahoma State  75.6  206.0
Washington  75.5  207.5



I got a Kindle-v1 Christmas 2007 as a gift. It's sorta great and it kinda sucks.

Great that I can load up just about any PDF on it (either through Amazon's email conversion service or via Mobi-book desktop PDF converter) and thus I can carry around a bunch of journal papers for quick perusal.

Great that if I read a review of a book, I can download the first chapter immediately and determine if I like the book, instead of hoofing it to a book store or ordering it from Amazon and discovering the book is a disappointment.

Kinda sucks because the Kindle (v1 at least) has a very fragile screen. I've cracked four of them, and while Amazon has been very good about replacing them, it is still disturbing that an e-ink screen, which is supposed to be more durable than an LED, seems more fragile than my iPhone's LED.

Another issue is that while one's notes/bookmarks/hi-lites are carried over from Kindle to Kindle for documents one loads up oneself, and for books that are purchased from Amazon, it's not so for periodicals. So when you get a new Kindle you find that while you have recovered that electronic copy of Reason, or The Atlantic, your notes/bookmarks/hi-lites have mysteriously disappeared.

Other problems of switching between Kindle and a replacement Kindle (at least for v1): your browser favorites don't carry over, and old transferred material isn't re-indexed for keyword search; i.e. the first time you purchase a book it's indexed for keyword lookup, but after you switch to a new Kindle anything you move over from the old Kindle is not indexed for keyword look up on the new Kindle. Last but not least, there is no file folders or file tagging. You are limited to sorting your documents by last read date, author, or title. Can't sort or organize your documents by fiction or nonfiction, can't classify documents as to subject area, etc. A folder structure/file tagging system was one of the first things that Kindle v1 users asked for in the Kindle support forums, and it disappointed lots of Kindle fans that it wasn't a feature of Kindle v2.

Nevertheless, with all the complaints, I was very glad when Amazon sent me my new replacement Kindle, as I was going through Kindle withdrawal. Using the Kindle app on an iPhone just isn't the same.

Dr. Corso specializes in modeling energy derivatives in APL, A+, J and k



 1. There is probably not one person in the financial community who does not look upon the enhanced level of intertwining of the government and Wall Street as unprecedented and mind boggling. To gain perspective on such things as the pointing of guilty fingers at one party or the other, attempts to deflect attention by claiming that an innocent party should b e pilloried, or most flagrantly the holding out of the sorrows that would ensue if one were not given alms and handouts, I have turned to Aesop for guidance and happiness. In particular I find the story of the two beggars that wished to share in the good but not the bad, the stork and the lion whose reward was not be eaten, and the many fables about troikas where the blame was cast on an innocent animal to be.

One guesses that the wagoner firing, and the AIG bonus rage is closest to the Aesop fable the wolf and the lamb. The lamb took refuge in the temple. The wolf said, do come out because the priest is sure to sacrifice you on the alter. But the lamb said, " better to take the chances here than be eaten by you."

2. In reading The Aeneid one comes upon the beautiful passage: "He falls, unhappy, by a wound intended for another, looks up to the skies and dying remembers sweet Argos" with reference to a spear thrown at Aeneas by Mezentius that glanced off Aeneas's shield and hit Anther. How often has a political decree, an economic announcement, of a ephemeral nature or one designed for another purposes, perhaps to garner votes, or grease the wheels of commerce been glanced off and hit the trader with such results, and does he dream of sweet Argos in such situations.



I have a question regarding Bollinger Bands. Is there such a thing as Double Bollinger Bands? That is when the stock goes down and touches the first Bollinger Band ring, you buy, but if the stock does not reverse itself and continues downward, you sell out when it hits the second Bollinger Band ring.

Jim Sogi writes:

Buy and Read John's Book, Bollinger Bands by Bollinger. He explains all the various signals there. He's a member of the list, so I will tout for him. My only comment, is that like other indicators, they are retrospective. They are better than most because of the prospective expectation of persistence of volatility. My theory as I have propounded here is that concurrent market internals are helpful if not better than many retrospective guides, and even prospective guides from prior data used alone especially on a short term horizon or at least for execution.



 What a difference in the complexion of the world markets from last year where at the end almost every market was down 50% with no exceptions. This year as of March month-end the world markets are down a mere 10% and there are exceptions galore, notably Israel up 15% and Russia up 31%. All over, anomalies exist. Norway up 10%. Pakistan and Taiwan up 17%. Indonesia up 10%. All over South America markets up from 10 to 30 % in Peru and Venezuela. Venezuela up 40% from 1999. Recapping the wisdom of Maturin during the French Revolution advising Sophie to buy stocks, a stridency relevant to today shortly.

George Parkanyi writes:

Many a financial network talking head these days pronounces that "buy-and-hold" is dead. Here, or somewhere around here, is the perfect time to initiate a buy-and-hold strategy. This is from where the $3 AMDs and Motorolas of the world go back to $30 or $40 in the next bull market. And what of it if it takes 10 years, not that it's likely to take that long. That's still 100% per year non-compounded. My ex-high-school teacher and stock market mentor Omar Sheriffe Vernon-el-Halawani in the last two decades of his life (he passed away in 2005) did just that for most of his portfolio — buy good companies on the incredible cheap when the opportunities arose, and just put them away. He introduced me to "Reminiscences of a Stock Operator" long long ago, and in his last few years kept admonishing "George, why bother to sell?" (Though he wasn't inflexible either — he did sell Sun Microsystems once it got to $200. A couple of his closer friends rode Nortel back down to nothing.)

Paolo Pezzutti replies:

What if in ten years from now Motorola and AMD do not exist any more because a Chinese or Taiwanese corporation has wiped out these companies in an already mature market of telecoms and semiconductors? Sort of a General Motors and auto industry fate in 2015? In the meantime we have to see if the Western countries will manage to lead the next wave of innovation. It is not a given.

Stefan Jovanovich adds:

Motorola may survive as a defense/government contractor like Studebaker did; but its days as a competitor in the mobile dial-tone device market are long over. It has a legacy business in walkie-talkies, but those devices are now commercial products for — oh, happy day! — the construction and events trades. The "next bull market" will be in businesses that do not need the help or money of the academic/finance/regulatory complex. Some pissed off genius who is dropping out of graduate school right now because he can't stand another day listening to a discussion about hockey sticks will be the guy who creates a viable alternative to the internal combustion engine. The fact that the next Henry Ford did it because his uncle died and left him enough money to allow him to pursue his dream of racing an electric motorcycle will definitely NOT make the history books. Instead, some not-so-bright but perfect resume student of "economic trend analysis" at Berkeley will write a seminal paper explaining how it was all due to the "convexity of the forces of ecological history" (assuming, of course, that CalPERS has not blown all the money and put the University of California into receivership — which may the wildest of all my surmises). On a happier note, the Cal Men won the national swimming championships this week. Go Bears!

Pitt T. Maner III writes:

"Hardened silo" companies, with strong management, that have survived through and handled multiple, steep cycles over the past decades by mothballing equipment as needed, sending seasoned hands "back to the house" when necessary, and which have high barriers to entry (and negative government support) into the particular business would appear value candidates now. High quality drilling and drilling service companies, over the longer term, are appealing at present prices unless solar, windmill, nuclear, and alternate energy supplant the need for hydrocarbons. There are many other groups and companies that probably fit this undervalued, "tough-times survivor" model that odds would favor moving forward.

Jim Sogi adds:

After such a rally, and now when more and more people and pundits are calling a bottom, and I hear news proclaiming a thaw, and I hear talk of people starting to buy, these are the type of things that put my radar up. It's funny that the news media is somewhat stultified in that despite their steady barrage of bad news, the markets are all up. They actually have to change their copy of bit as it's hard to proclaim, markets up 15% on steady barrage of bad news. Obama did make a good call to buy, the day before the low and gave everyone a chance to buy. He knew what was in the govvy cards of course. That was the time to make the big commitment, not now. There should be more chances before they proclaim the next bull market as the market tops.

Legacy Daily writes:

Given things stay roughly the same, I cannot disagree with any of these comments. The challenge right now is that nothing is given.

For people who trade via systems, I have a question.

At which point does one decide to a) modify the system (and to what degree and based on what), b) discard the system (and why), c) continue relying on the system (and for how long); if such a system is producing losing trades more recently but has worked fine for a long time (definition of time scales not relevant)?

Perhaps the answer contains clues regarding our recent government actions (and market reactions) where the scale of the system and the magnitude of its impact is great. The problem is further complicated by control over one's actions but lack of control over [negative] consequences of those actions in a human system.

The second question that does not leave me alone is whether a game of chess (or any other game) can be won if every few moves, the game rules are modified. Does the player quickly adjust and remain focused on winning the game according to the new rules ("queen can only move three squares at a time" for example) or does the focus shift on guessing what the next set of rule changes may be? After a few set of changes and corresponding adjustments, does the player begin to suspect the rule maker in taking one side or the other?



 Do we need to pay for a paper on this to see the results? Every 13 year old boy up to grown men know this…well, let me put it this way…the only reason "boys" do anything is for women.

Are people more risk-taking in the presence of the opposite sex?

Patrick McAlvanah Federal Trade Commission, Bureau of Economics Journal of Economic Psychology

This paper investigates whether exposure to the opposite sex induces greater risk-taking in both males and females. Experimental subjects evaluated a series of hypothetical monetary gambles before and after viewing pictures of opposite sex faces; control subjects viewed pictures of cars. Both males and females viewing opposite sex photos displayed a significant increase in risk tolerance, whereas the control subjects exhibited no significant change. Surprisingly, the attractiveness of the photo had no effect; subjects viewing photographs of attractive opposite sex persons displayed similar results as those viewing photographs of unattractive people.



I was glancing at the performance of the Vanguard family of funds today. Their REIT index fund is down about 26% YTD through March 23, 2009. According to Practical Speculation by our own Niederhoffer and Kenner there is a 50% correlation between REITs in one quarter and stocks in the next quarter. A quick eyeball check of the regression scatter plot in the book shows that this performance predicts something like a 12% move in stocks next quarter. Whether the move is up or down is left as an exercise for the reader. But pages 253-259 would be a good place to start.

Dr. McDonnell is the author of Optimal Portfolio Modeling, Wiley, 2008



1. Here is an interesting troika with the Nikkei, DJI, and S&P all first breaking 7000.

date market price time

3/09 Nikkei 6970 low

3/10 Nikkei 6985 close

3/02 SP fut 696 low

3/03 SP fut 686 low

3/02 DJI ind 6753 close

3/18 Nikk fu 8005 open

3/23 Nikk fu 8180 close

3/18 SP fut 800.3 high

2/12 SP fut 817 close

Dow current 7775

Consilience not yet achieved.

2. From 2/13/09 to 3/9/09 the market moved continuously from 864 to 680 and from 3/09/09 to 3/23 09 the market moved from 680 to 817. Chart . Is this random or predictable?

3. Moves before the light:

   date     price   market      Nikkei    Russia

3/19     675    Tel Aviv 25     7865      784                                    

3/20     681    Tel Aviv                       792                                      

3/21     694    Tel Aviv          8180     850        



Optical IllusionA search for the phrase optical illusions on Google throws up a variety of very interesting websites. For a speculator I feel there are many pertinent questions that arise from a survey of these sites and the ensconced illusions in them.

  1. Why is there an illusion of motion, inter-connected spaces, impossible possibilities in the pictures carrying optical illusions, when actually there is none?
  2. What market situations produce an illusion of motion and life, when actually there is none?
  3. Which analytical tools are taken by the illusion of motion and or direction in markets, when actually there is none?
  4. What attributes of any one analytical technique or set of techniques together would save one from believing the non-existent?

There is a long list of many questions possible when exploring some optical illusions that a student of markets will find. Why not identify some questions that are more relevant to the markets and then try to answer them?

The usual first hand cliché would be that chart-watching is an optical illusion, but it perhaps is better for us to avoid that, so as to get to more useful ideas.



 Given the current mortgage rates and the fall of the housing market, I want to purchase my first home. Since I am stationed at Fort Hood in Texas, I have been doing heavy research in the Killeen / Harker Heights area. I thought I would ask for some advice. I spoke with Tim Melvin about this earlier, and he mentioned that I should never pay more than 10 times the annual rental rate of comparable houses. Does anyone else have any other good valuation metrics like this or have any knowledge / advice that would help me out as a first time homebuyer?

Legacy Daily replies:

I have found 10x to be used in two cases:

1. High house prices relative to rent — get one to cool off and think more clearly about an investment and do additional homework 2. Low house prices relative to rent - get one to jump in without thinking clearly on a "bargain" investment without doing any additional homework 

Some initial questions worth clarifying:

1. Is this a home or a leveraged investment? a. home — ignore rules like this and find the best place to live, raise a family, pursue happiness… b. leveraged investment — do enough homework to be confident enough about the decision to ignore all general rules.

Assuming investment:

2. What is the holding horizon? What future plans could interfere with that holding horizon? 3. What is the appreciation potential for the country, state, county, city, town, neighborhood, subdivision, this property…? I have not yet been able to come up with sufficient justification to buy for income alone when it comes to residential real estate. 4. What segment of rental market would the property (subdivision, neighborhood, town, etc.) attract? Is that the segment one wants to serve? Real estate agent needed to rent? 5. How predictable is the income stream? How would economic booms/busts affect it?
6. What are the worst case scenarios? What could go wrong?
7. Financial analysis — P&L, tax impact, financing options, downpayment flexibility (very illiquid), initial estimated repairs, etc. 8. Legal analysis — zoning issues, easements, property title issues, locality department issues, neighbor issues, etc. etc.

Couple additional points:

1. Decent real estate attorney representing one's interests can save from numerous headaches (especially true in foreclosure/short sale cases). 2. Avoiding a buyer's broker saves one money, gives additional negotiating room, makes the seller's broker more willing to work extra hard for the deal. 3. Inspections are money well spent, even if one does not end up buying the property. 4. The market is generally very efficient (yes even during this recession). Why has the property one's considering not sold yet? etc.

I hope you find this useful.

Jim Rogers writes:

The rule of thumb I've heard used is 1% of sales price should be equal to or less than comparable monthly rent (that's a little more aggressive than Tim Melvin's measure, especially when you factor in the mortgage tax shield). I'd say, use either and stick to your guns.

Sam Marx replies:

Don't trust what the real estate broker says about a house's value or price. Do your own research.

Try to find prices of recent sales of similar houses in same neighborhood.

Check with the local banks to see what houses they now own and what are their asking prices.

If you can go to foreclosure sales, do it, not to buy a house but to get an idea of what the market in houses is and remember those prices when negotiating with a broker.

I don't recommend buying at a foreclosure unless you're experienced at it.

Don't be shy about making offers 25-30% below asking price when dealing with a broker.

Watch for estate sales, the heirs are motivated sellers.

I don't know your area, maybe it's reached a bottom, but in FL, housing prices are still too high. The stock of St. Joe Land (JOE), FL's largest landowner, was 69 a few years ago — now it's 15.

Phil McDonnell advises:

 Buying a first home can be a frightening prospect. It should start with a realistic look at your needs. How many bedrooms and baths do you need now and in the future? If your life involves one or more women strongly consider the extra bath. If you have the skills a fixer upper my be of interest.

I frequently advise my Realtor wife on the statistical aspects of our local real estate market. Pricing in this market is especially tricky. It is a declining market but that also means buyers have much more negotiating leverage. To measure your local market ask a local Realtor for the latest stats on number of homes on the market and number of sales in the last few months in your area of interest. For a normal market this is about a four month supply of homes at the current monthly sales rate. In this market it is running about 10 months of inventory per home sold. Hence the declining prices as sellers compete. One should consider staying out of the market until the inventory show signs of declining. However do not be fooled by a one month decline in local inventory. Buyers in the Seattle area are negotiating prices an average of 4% below asking. Get the similar number in your area.

As a buyer in this market it is best to view the prices as a price distribution. Suppose we have ten houses in your area. But only 1 will sell in the area in the next month. Clearly it is most likely to be the one that offers the best value on a relative basis. The other nine are over priced for these market conditions. By staying on the market for another month they will probably lose something like 1% in value per month.

There is an old saying in real estate. One should buy the least expensive house in the neighborhood. Generally this is true. After numerous regressions on homes it can be said that among comparables the most important single factor is square foot of the house. For the best resale find out which area has the best schools. Even if you do not have kids the people who ultimately buy your home may have them and it will help resale in the long run.

Check out all the government mortgage deals and tax subsidies. They are offering a tax credit of up to $8,000 for first time buyers. 30 year fixed rates are below 5%. The military may offer even better deals. Remember the $8,000 credit is only paid the following year via a refund so you do not have it to use as a down payment. It is more beneficial the smaller the house you buy. I saw a recent home sold for something like $80,000 in Killeen. The $8k represents 10% on that home, but only 5% on a $160k home.

Dr. McDonnell is the author of Optimal Portfolio Modeling, Wiley, 2008

Henry Gifford adds:

Home prices, in general, are still falling in the US, therefore waiting will probably bring lower prices.

As property prices fluctuate, one sign of high prices is easy loans. Times when prices are better tend to be times when loans are hard to get, with of course reasons for this relationship. But, as an affiliate of the military, there are sometimes special deals available to you that are not available to other people, which means you can be one of the few buyers out there at a good time to buy. Some of these loan deals only exist on paper now, as the price limits and interest rates make them impractical, therefore nobody talks about them, but because they are government programs which get updated slowly, and usually out of sync with the market, they can be really good deals at times. Therefore there may come a time when you can get both a good price and a good loan.

Buying near a military base involves risk of base closure (I owned a whole bunch of houses near a base that closed) or downsizing, and since you're in Texas where there is lots of land, upsizing the base won't put much pressure on prices - people will simply build more houses. Perhaps you can ask around inside the gates to get a feel for this.

Buying and selling property involves large costs for brokers, taxes, title insurance, etc., which penalize short term ownership, meanwhile you can get transferred to another base at a moment's notice, which puts you in the position of being in a hurry to sell. If, instead, you buy a commercial property, you can own it as long as you live, with far less management headache, which makes owning it while living elsewhere more realistic than renting a house to someone.

Phil McDonnell responds:

I think the truth in this statement is based on a defect in the way people perceive value. Suppose the average home in a neighborhood sells for $500k but yours is worth $400k. Then if the average goes up to $600k the innumerate masses will think that all homes have gone up $100k not the 20% they really should have. When they do this the $400k home appreciates by 25% not 20%. In other words people add when they should multiply by a percent increase factor.

Dr. McDonnell is the author of Optimal Portfolio Modeling, Wiley, 2008

David Hillman writes:

Another part of that defect is focusing on the value of the improvements v. the value of the land.

Some years back, a close friend bought a lousy house on a great piece of property in the best neighborhood. Even though it was a prestigious address in a 'branded' area, he got a deal on the property because the house was so undesirable. The plan all along was to demo the house and built a new one to suit, which is exactly what he did. He had realized the land was worth perhaps 90% of the true total value of the property before the new construction.

Many county auditors, etc. have searchable tax records online with the assessed values of land/ improvements parsed out. One might use that to figure a reasonable estimate of market value of land v. improvements. Don't forget the old saws apply….'land, they're not making any more of it'….and….'location, location, location.'

Bill Egan writes:

In the last 10 years, I have bought three homes and sold two. Did not plan to, but that's the way it worked out due to job changes. Sold both houses in < 1 week for a profit despite forced timing. We were not in subprimeville, either, and the last sale was 2001 before the real estate madness.

My wife and I kept resale value in mind because you never know what can happen to you. We made sure we bought homes that were average to excellent on the following criteria:

  1. School quality
  2. Exterior appearance and interior layout — good and normal
  3. Quiet, safe neighborhood that looks good
  4. Reasonable size (3/2 or larger)
  5. Likely demand due to commuting routes/distance to jobs

For example, I was working at a biotech in NJ from 1999-2001. We bought a 3/2.5 in a newer development, nice neighborhood in Burlington County, right next to an average-quality elementary school. However, the area was less horridly expensive than the homes closer to Princeton, where I commuted to. There was strong demand from people priced out of the homes closer to NYC/Princeton.

Rich Bubb replies:

1.  look at the neighbors. C-L-O-S-E-L-Y… look at the state of their domiciles (even getting "invited-in" for a look see if at all possible), and the state of the upkeeping… especially the immediate next door folk. You might end up living next door to your own personal nightmare. Believe me, it is Not Enjoyable. Even after almost 20 years. Thankfully everyone else on the entire block is somewhat more sane and respectful of their neighbors than my nextdoor nightmare. Or to put it another way: you might get the best deal that no one else could stand…

2. if you really know somebody in the real estate biz (my sister is an agent), have them look around for you. she got her daughter's family a fabulous deal in a great neighborhood. Or to put it another way: sometimes real professionals Do Know what they're doing.

3. look long at the deal, bid low for the deal (Game Theory might help a little here, here is a cool intro), then be prepared to walk away… even if not doing the deal means you'll have to go back and start the whole search-etc process all over again, and don't put pressure on yourself or let anyone pressure you into buying. My wife was not prepared to walk away from her last car purchase. She still got a good vehicle, but she could've strengthened her bargaining position by uttering the words, "Let me think about it." And then purposefully heading for the door. We went outside and argued between ourselves about leaving. She *wanted the vehicle*. It cost her almost $5k more than I wanted her to pay.

4. Consider the cost of long term ownership. I mean, Really figure it out… what's the cost of x, and y, and z, and can you afford it if those costs all hit at once.

5. Tangentially to #1 above, if there'll be kids living next door… would you:

(a) invite them in?, or

(b) chase them away?, or

(c) start scouting for really out-of-the-way burial sites?, or

(d) let them borrow your most deadly power tools?

Just mentioning this as my siblings and I were the 'b-c-d' and almost always the Never-more-than-once 'a'. And the neighborhood's less-than-model parents would often let their barbarians-in-training train at our place… Or to put it another way: your neighbors' kids might have fiends, er friends, worse than they already are…

Hmmm, karma might really exist…

Russ Herrold adds:

A anonymous blogger, 'Benjamin.Publicus' on Thomas Paine's blog  had this this observation:

… The author lives in a community that is (or was) at the epicenter of the mortgage crisis. The developer aggressively marketed the homes to young, first time home buyers, many of whom renters. No money down, own instead of rent, mortgage payments the same as the rent, etc, etc. The development was started in 2001, so the first wave of 5 year ARM's hit in 2006.

…and it goes on from there.

I have spoken to that author (and a couple others) about contributing to DailySpec, but he has been busy.

Dr. Herrold is Principal of Owl River Company, a high-end Unix consultancy

Rich Bubb adds:

As mentioned previously, my sister is a real estate agent. following are her comments on home shopping & buying.

Get a Real Estate Agent to represent YOU as a BUYER. Sign a contract as such. Tell them what YOU want.

There are surely things important to you that you would like to have in one of the biggest investment decisions you will make.

TAKE NOTES of likes/dis-likes of each home you view. re: Basement, Garage, Four Bedroom, Square Footage, LOCATION. I stress location because it can make or break the satifaction of your purchase.

Drive through the neighborhoods you are considering at different times of the day to see what the atmosphere is.Pay attention to the neighbors up keeping of their property. Schools?, established neighborhood?, new additions? child / adult ratio?
Comparison shop, don't just jump at the first home you look at just because you can afford it. Ask your agent to provide you with a CMA (a market analisis of a surrounding area - 5 mile radius ).

Get pre-approval from your lender, look at homes a bit higher than your range and offer LESS - the worst that can happen is, they will say NO or counter-offer and you may wind up with a nicer quality home.

BE Strong in making the decisions of your offers. Be prepared to give and take.

Then BE PATIENT thru the purchase process which seems like it takes forever because we are a see it, buy it, want it now, kind of people. It is a process that is in place to protect you. re: CLEAR TITLE

Again, don't just settle for a home, get as close to what you want as possible.



 When the Clintons came to power they pushed hard for socialized medicine via national health care. And that helped bring Republicans to power in Congress two years later. When the President is a Democrat and Congress is controlled by Republicans, that seems the best combination (short of having both controlled by Jeffersonians).The new trillion-dollar Fed infusion is standard monetarist policy, I think. A Forbes columnist recommended it a month ago. The MV in the monetary equation means that when velocity slows down dramatically, which it did, money supply drops dramatically.

So the Fed pumps in a trillion to rebalance the equation. This at least is better than Congress spending another trillion on pork-barrel infrastructure and green-energy projects.I would prefer a private currency system, or a gold-standard, but I don't see the Fed move as a disaster. Better the Fed try to deal with monetary problems than Congress and the Administration. Of course when velocity picks up, the Fed has to pull all that cash and credit back out.

Private firms and individuals trying to cope with heavy debt loads sell assets. The Federal Government has a vast array of assets to sell, from commercial lands in the west, to off-shore acreage, to buildings, parks, freeways, airports, unneeded military bases, etc. Moving these mismanaged and underutilized assets from opaque bureaucratic ownership to transparent publicly-traded firms (or to non-profits in the case of parks and wilderness areas), is an attractive option for soaking up dollars when the time comes, and shrink the physical size of the Federal Government in the process.

Last week's newspapers headlined the news that $11 trillion in American wealth "vanished." The articles complained that economy and American wealth is back where it was in 2004. But in 2004 Americans were the most prosperous people in the history of the world, with the highest living standards, most disposable income, cleanest environment, best working conditions, biggest houses, safest cars, and on and on.

The U.S. economy was heavily regulated then, and now it is more heavily regulated. Americans were heavily taxed then, with the upper 1/10, 1/5 and 1/3 of taxpayers paying way more of the tax bill than the bottom 50% (and getting little in the way of services besides traffic jams, foreign wars, and tax and regulatory confusion). Now upper-income Americans will face higher tax rates. This will likely lead to lower tax revenue for the government, as it has in the past, which could again lead to reducing tax rates.

China and India are in terrific shape compared to 2004 or to any year before that. "Millions are unemployed" scream the headlines. But what were these folks doing in 2004? How many were planting rice by hand in their villages. James Fallows article in the April Atlantic Monthly ("China's Way Forward") makes clear that the average Chinese worker is well aware of how much better off they are than just a few years ago.

Wealth has increased dramatically in China and India, and billions upon billions of dollars worth of incredibly productive machinery has been deployed across their economies for hundreds of millions of moderately-skilled workers. Skill levels are rising driving productivity up in places where production has stagnated for centuries. People who are used to working 60 hours a week with wood ploughs and old shovels now work with modern machinery. Farmers are increasing productivity (where they have property rights and access to markets), and have cell phones to track prices and nearby markets. This productivity train has been gathering momentum for over a decade in India and over two decades in China. Even without an additional capital and consumption push from the U.S., India and China are adjusting and coasting forward, lifting living standards for hundreds of millions more.

In Eastern Europe, Southeast Asia, and Chile, Brazil, Peru, and Mexico in Latin America, market reforms and new machinery lift productivity and living standards. The dramatic drop in U.S imports of clothes and other goods (our closets and kitchens were stuffed full anyway), will encourage firms to market their goods and services across their own economies, where vast numbers are reaching productivity and wage levels that allow them to enjoy living standards the U.S. and Western Europe enjoyed a century ago.

So… I am optimistic. Had the current Administration come to power with a strong and growing economy, I don't think anything would have stopped the rush to national health care, green taxes via cap and trade, and pervasive new government intervention across the economy. Now at least we have a chance of avoiding these long-term disasters.



Is there a form for the typical market? Does it have a shape, a proper way of conducting itself? Is the form for a week regular enough to defy randomness or better yet to be predictive in any way? Is there a form corresponding to the a b a form of music in markets? How does rhythm and volume of sound enter into the picture? Those are the questions I'm pondering this after reading a great book on the walking bass by Jon Burr.

Thomas Miller writes:

I have always believed the markets are similar to musical pieces. A rhythmic sideways market lulls many into relaxed state only to burst higher or lower in mighty sudden crescendos, and a rallying or declining market moves in musical waves with mini crescendos noting momentary tops or bottoms. I wonder how many successful traders have musical backgrounds? Music and mathematics are universal languages and convey the messages of markets. I regret not having more formal training in either.

Newton Linchen replies:

I always thought "Metamorphosis IV" by Philip Glass to be the perfect "market music", not only by its crescendos and decrescendos, but by its impression of regularity (Philip Glass is known as the father of "repetitive music"). Nevertheless, its changes in tempo and volume (strength) gives a rhythm almost fluid. And there's a part of "explosion" (volatility) where the fast-pace is in order — without loss in harmony or structure. I always thought of moments of "trading range" of market going aimlessly followed by a explosion in price upwards or downwards. And it's kind of sad melody remembers us of the majority who only find losses in the markets.

James Lackey comments:

Yeah it's been brutal awful market music. Reminds me of all the VIP mumbo parades, changes of command formations, and dress blue parties I was forced to attend in the Army.

0300 with the Dax open its reveille. Then we all form up into one huge cluster in the parade grounds stand for an hour then "the stars and stripes forever" plays with a government official on the mic saying how far we have come our history and how they are committed to Change "us" with too many last hour's "retreat."

Then with so many brutal last hours "to the colors" reminds me of Flag detail after the close then the discussions with old Colonels passed over, that didn't want to go home to family asking "the kids" new soldiers over a 5pm coffee what we wanted to do with our lives "when I was your age and if I could do it all over" then every few nights after Chow we get "Washington post march" the tune used most in movies to sound off patriotism and how if we all work together, after the next bailout everything will be back to the normal American way… Then back at 7pm "Auld Lang song" to the Nikkei open.

I have noticed over the years my music tastes intra day trading go with the market flows, Baroque, Jazz, Fusion, and when the market is rockin', new alternative rock.

I am in a bad way when all music sounds awful, like Army band music. I would rather listen to the hum of the ceiling fan and as of late the birds singing to the open windows..and to my surprise, spring has sprung and a lawnmower engine sounds more inviting than the music of the markets. ha.

The U.S. Army Band Ceremonial Music Guide

Legacy Daily responds:

 When the Soviet Union collapsed, I witnessed the creation of foreign exchange markets and also of stock and other types of markets in Armenia. These images are very vivid in my mind. When I read about people trading on Wall Street (I mean before the exchange building was even a consideration), I can see how that trade took place, because I participated in similar trades in a few of the streets of Yerevan (different places of gathering for different markets). That experience always overrules the charts, the derived statistics, the counts, and all the jargon that I hear daily.

Does the market have a form, a proper way of conducting itself? This question brings up the picture of the crowd dealing in foreign exchange (with the usual guys leaning against their usual trees) against the typical crowd dealing in real estate or stocks or stamps or coins. Of course each market has its form, its unique characteristics, its shape, its place, its rules. Each market has its rhythm, its language. I have not had the opportunity (and never really wanted) to participate in the floor trade at the NYSE or in the outcry system. But having seen the seedlings in their early stages of germination, I only see supply and demand and the various factors that affect these.

In this digital age, it is easy for one to go long bonds and short stocks or long XOM short CVX without ever realizing that the market for every single security represents a unique gathering of those who run the market and those come to the market. If I had to put this picture into something related to music, I'd imagine a choir of professional singers that sing a particular song we recognize. At some point, we join in singing in our heads and then at one point begin to sing out loud thereby changing the overall experience of everyone around us until we move on to the next choir singing a different song. Could one be successful in singing with multiple choirs all at the same time? Can we really understand the market for the SDS and SPY which are derived from hundreds of unique markets with their tunes in addition to their own market creating noise at the same time? What about the noise from the "gold" room affecting the singing going on in the "dollar" room or the other way around?

When it comes to commodity markets, I remember the fruit and vegetable market where some of the sellers would sell what they had grown and the others would sell what they had bought from those who couldn't or didn't want to travel to the market. Does that have a music? If you have ever been in a similar market, you'd recognize the buzz, the "singing" of the man selling his delicious watermelon, and the aroma coming from the area where peaches are sold.

The big question - is all this random or is it predictable? There is nothing random to it, yet it is completely unpredictable. The market makers operate in a very normal expected way, yet those who come to the market act in ways I cannot anticipate or predict. The only elements visible are my own instincts, wishes and desires which happen to approximate those of the people who go to the market very well. Imagine you have a phone to your ear that is connected to a line on a speakerphone where hundreds of people are talking at the same time. What do you hear? Noise! Can you find patterns and conversations in the noise, in some cases yes. Are the conversations and patterns going to repeat? In some cases, absolutely ("How are you today?" is typically followed by "I'm well thank you." or some variation of that) I'd like to be convinced that they could be consistently reliable but then again if that was feasible someone would have already found a way and would have proudly advertised that "past performance does not guarantee future results" does not apply to them.

Jim Sogi writes:

One constant regularity of form in music is the return to the root or home base. I think the market tends to have a root or home for each of its pieces. Recent root seems to be 800. Prior jump on Fed had to return Treasury plan to resolve. 800 was a big theme earlier in the year as well. Now we are in the contrapuntal mode, as Bach would play it doing it from the reverse. In a larger sense, it all satisfies the craving for symmetry and resolution.

Often the craving is frustrated creating a tension. Music is all about emotions on different levels, as is the market. Musical gaps are one of the greatest sources of tension. We still have this Monday gap right below created by maestro Timmy G and the trillion dollar blues. Too much tension and disruption of rhythm to make good music.



 Hello Dailyspeculations:

Our Ohio film crew is in South Africa and now in Port Elizabeth to film and interview our man of color for a few days. Thought you might enjoy their blog so far….

Sincerely: Alan



Ken DrydenThanks to Ryan for recommending The Game by Ken Dryden. It is a very human and personal analysis of top level pro sports that makes it applicable to all high level activity. Also touching to me was the part about getting old. Ironically he wrote it in his twenties. I face this out in the big wave lineup competing with the young guys. I wonder how much longer can I do it. Of the many lessons in the book a few really jumped out at me. First was his routine before games designed to give him emotional equanimity and balance and to quiet all the inner voices that might throw him off. I've read of the trainers of the high level sumo wrestlers in Japan who protect their fighters from emotional upset that might affect their sport performance. I know I need to come to the fray each day on an even keel. If there is an imbalance in the force, I'll walk away.

Dryden wondered about the difference between his own, or his own team's, performance and other people's mistakes. In my life as a lawyer, I see people make mistakes, high powered guys who act like they should have known better. In trading, I believe I can see when people make mistakes. Today for example, bidding up the contract to a new high on the belief that the Fed can solve our problems. Well, that was a 2% mistake right off the bat. In the summer of '07 I wondered about the 9K plus bidders buying the tops at days end. I wondered what they were doing up there. They are too, now. Sometimes its not so obvious, but there are times to be aware of. I sure know when I blow it. The dangerous times are when you blow it and don't know it. Dryden always lived in fear of that, as should we all.



 The Chair advises us to use simple statistics for market analysis. They are good enough for sure. But I wonder every once in a while: why eschew the sophisticated stuff? It must have been developed for a reason, mustn't it?

Or must it?

Little by little, I am starting to see the light in keeping it simple. Today yet again, I got a glimpse of it while reading Unit Roots, Cointegration, and Structural Change by  G. S. Maddala and In-Moo Kim.

This is a book about complicated and modern stuff that is not being used in the tests posted on DailySpec. I am only half through, but I think I can already comment on it. This is an excellent book. It is very clearly written. Usually, when reading this type of book, I am left with the impression that the author is confused. Not here. Maddala and Kim are clear-thinkers who obviously understand their subject matter, to the point that they are able to write about it in an articulate and insightful way.

They understand it so much that they can distance themselves, warning that these tools are mostly ineffective — not to say bull. What I really appreciated upon reading their conclusions about unit root tests (which is just another word for random walk tests), is that they state without any passing thought for political correctness, that the ones everybody uses, like Augmented Dickey-Fuller (ADF) and Phillips-Perron (PP), should not be used, because of dismal power in small samples. This is based on Monte Carlo simulations from other researchers, whose results they provide in the book. These results are ominous and devastating for these oft-run tests. But they don't stop there. They add that they spent two chapters on answering the question: "Which Unit Root Test?". Whereas a better question should have been "Why Unit Root Tests?". To which the answer would frequently be: "They is no reason to perform unit root tests, they are useless for most purposes". I am exaggerating a bit, their statements are mellower, but that's the gist of it. And I like it a lot. A book about unit root tests saying that they are frequently useless (frequently, but not always, to be fair).

In a similar vein, there is a part on panel data unit roots where they mention that a Fisher meta-analysis test from the 1930s, is as good or better than some clever and modern stuff from the 1990s.

So let's Keep It Simple and Stupid!

For 90% of our needs, a grassroots OLS is just as good and more robust than all this rocket-science 20th Century mumbo.

A final word: this book also strikes a perfect balance in maths. They go deeper than usual textbooks, inasmuch as they don't only provide the formulas for the tests, but also the mathematical intuition behind them. But they don't do the full demonstrations, for which they provide an ample bibliography. This is still graduate to upper graduate maths and econometrics so please don't buy this book if you are looking for an introductory text.

Alan Millhone adds:

The game of Checkers when played scientifically follows the KISS method. Checkers is a game of utility. If you have a win on the board you execute that win in as few moves as possible. I remember a time when a novice (at times I think I am still a novice!) and my opponent had a King in each opposing double corner and I had three Kings and did not know how to consumate the win. With the help of a beginner's Checker book that win on the board is now 'old hat'. Knowledge is power in about anything.

Chair admonishes the Market trader maintain a hand written manuscript. I have a Checker manuscript and record my games for later reference. Any 'tool' that makes you more effective is valuable. 



 Here's an investment theory. Rather than buy when the expectation is greatest, buy when the risk is the least. The question is whether or not they are the same times. I define risk as the lowest probability of account drawdown from entry, rather than common definitions of volatility. A corollary of this is that buying at what appears to the public as the greatest risk is actually the time of least risk. A recent discussion here looked at expectation of range vs expectation of change. The theory of the least risk would be to buy at the expected maximum extension of range, at the time of greatest expectation. The other issue is the holding period and expectation of gain. Some argue that the maximum expectation period over time will reap the highest returns. The problem is that the deviation goes up as fast if not faster, increasing risk. The second problem is the issue of changing cycles and prior history may not match future performance. Dr. Phil has pointed out that profit stops reduce deviation but not necessarily rate of return. Yet account deviation is the bottom line. He has proposed formulas to optimize risk/loss vs return. But realtime trading demands some sort of realtime system. This is hard to implement. The underlying idea is that management of risk is more important than maximizing return. This has been the basic systemic flaw in the recent boom and bust. The idea is distinct from the idea of leverage as risk. The answer will differ from individuals to institutions and funds with differing goals.

Martin Lindkvist comments:

Try creeping commitment, that is, start with a small line and increase if market goes in one's favour. But this has a built in assumption of some kind of trending behavior of prices, which might or might not be true depending on other circumstances.

A twist to the creeping commitment of a single position is to start out a period (year, or other of your choice) and increase risk taking after profits have been made, and decrease if losses are incurred to the capital at beginning of time period; that is play harder with "market money". I believe that both this method and the first one might have some psychological benefits if nothing else.

Risk in the usual deviation sense has sometimes been disguised, through e.g asymmetrical strategies ("picking up nickels in front of a bulldozer") where the risk might seem far away only come back hard when least expected. Moral - one should always be suspect when one thinks one have found a good way of managing risk - "what am I missing". Liquidity issues comes to mind too.

Using leverage as the risk manager, still seems to me the most clean way to manage risk. Cutting off risk with stops or options also is a way but run of the mill costs for these should be higher over time. That doesn't matter though if you meet black swan on day one….

Phil McDonnell writes:

A knotty part of this question is to define risk. To academics it is probably something like standard deviation of returns. To traders it may be only the losing trades, in other words only the downside deviations need to be considered. Another metric might be draw down or maximum loss.

The risk measure one chooses makes a big difference. For example suppose we look at the standard deviation of the market after it has been rising for a while. Assume our criteria of rising is that the market is above its 200 day moving average. We would find that the risk measured by the standard deviation is less for all such periods than it would be for those periods which are below the 200d moving average.

When markets approach major bottoms they are often quite volatile. Currently we often have daily moves of 3 to 5%. If one were to study the subsequent behavior the probability of large down moves the next day are quite high as are the chances of large up moves at such times. This is true even though one can often argue that after such large declines the market is close to good value levels and has not much more to fall.

Note that one can get two different answers to the question depending on time frame. At a low area such as now, the long term risk outlook might be that it cannot go much lower. But because of volatility the short term outlook is for continued riskiness.

Dr. McDonnell is the author of Optimal Portfolio Modeling, Wiley, 2008

Legacy Daily replies:

As for this statement, "Rather than buy when the expectation is greatest, buy when the risk is the least," the risk of not being in the market is the least (assuming cash is constant). Perhaps you mean "buy the highest expected return for the lowest risk." Theoretically, "maximize return but minimize risk" may be suitable for a linear programming model where one would need to define the various constraints and let the machine solve for the best alternative to maximize return given the constraints. The challenge: the right definition of the constraints. Also, the optimal solution may change tick by tick.

And as for this statement, "a corollary of this is that buying at what appears to the public as the greatest risk is actually the time of least risk," I think many market participants buy and hold. Therefore, the main reason a market appears a great risk to them is because their money disappears. The more money disappears, the greater the fear (hence perception of risk). It also seems that these "emotions" are only visible during intermediate-term/long-term market turning points which may not be suitable for a day trader.Furthermore, "time in the market" and "percent invested" are also ways to increase/decrease risk when account balance rather than security price volatility is the key criteria. Account balance is an extremely useful risk manager. AUM does not have the same effect.I cannot remember where but I came across the concept of a very successful trader at one point or another getting completely wiped out and some being so good that they could build a fortune multiple times and get wiped out more than once in a lifetime. If true, is that possibly a manifestation of "buy when the expectation is greatest" with not enough focus on "when the risk is the least?"



 I read that Burpee purchased Heronswood Nursery from Dan Hinkley, a world-class plant hunter, and his partner, Robert Jones, with a promise to keep things as they were. But things change and Burpee closed/moved Heronswood.

The George Ball piece, entitled "The Fortuneteller's Garden"

This piece was written by George Ball, president of W. Atlee Burpee & Co. I'm passing it along as it speaks of the present, past, and future in an interesting manner.



MarionMarket prediction by riding around aimlessly:

Aside from the disheartening evidence of restaurants, businesses such as Circuit City and others that seemingly moments ago were thriving, I see a slight sign of what I deem an upturn.

As I traverse the neighborhood on my vehicle, I see the license plates proliferating. Just a few months ago, I saw severely strictured ‘plate-diversity’: NY, NJ; Connecticut and Pennsylvania. I do this every time I leave the house: I set a number of different plates from the 50 states, assigning a total of them before I arrive at my destination. I have a formula for this — essentially six blocks per 'new' license plate/state.

In NYC, of course, there is likely to be a profusion of people from all the states, so it works out as fewer than six blocks, but the formula holds for longer distances, so I use it. Recently jaunts yielded a maximum of five or seven different plates in a two-mile distance.

However, of late, I have noticed the plates are from as far afield as Indiana, California, Minnesota, Colorado and even, occasionally, Alaska. (I also count police cars — the first, anyway — as a separate “state” for some reason based on the paucity of police cars in the vicinity, most days.) The average two-miler produces 20-25 different plates. Could this be a leading indicator? People were clearly not traveling interstate when the price of oil was $145/bbl, but that is changing, and obviously, people are high-tailing up to NYC in their cars, parking on the street, spending on restaurants and hotels, groceries and department stores.

The license-plate index idea of mine is valid. At least as good as skirt length and applications for mortgages and short sales. Now we just need to assess by how many months it's predictive of market-and-general economy ascent.

Scott Brooks writes:

ScottThe license plate formula is very location-dependent. I could walk or travel two miles from my home and could see no license plates other than MO. If I go downtown or travel down the highway, I'll certainly see many different states as St. Louis is a crossroads (the Gateway to the West) for people traveling cross-country.

It is also very time-dependent. If one were to drive around during rush hour, one would likely see mostly MO or IL plates, but if one were to drive around during other times, it would seem logical to see more plate diversity.



 I am an Air Traffic Controller in New York at the NYARTCC (New York Air Route Traffic Control Center) and have been doing it for just over twenty years. I am a speculator as well and find the challenges of speculation far more abundant, subtle and difficult to meet than those of ATC. I can say that I love my job as it provides satisfaction on multiple levels. It is very rewarding from a problem/solution point of view, as complex scenarios in ATC can be solved with simple, sometimes truly elegant solutions. The more elegant the more rewarding.

The initial challenges in learning ATC involve acquiring knowledge of different aircraft types and their performance characteristics. For instance certain types of Cessna Citations are very, very slow but can climb to very high altitudes so a typical strategy for dealing with them might be to climb them and let following traffic run past underneath. But the absolute fastest civilian aircraft out there is also a Cessna Citation so it is crucial that you know which kind you are dealing with. Heavy jets tend to be fast, Boeing aircraft tend to outclimb Airbus aircraft by a large factor (which is why all controllers prefer Boeing as they can get out of the way faster), newer aircraft with highly efficient wings cannot descend quickly while going slow so that has to be taken into account when setting up an intrail operation where arrivals must be descended as well as slowed down.

It is important to teach trainees to get rid of their expectations and just see the data. Getting used to capturing the data from the screen is difficult; for instance, a controller might notice two aircraft in trail on the same airway and not notice a severe overtake especially if he expects the front aircraft to be faster. A saying we have at our facility is “The faster aircraft will always overtake the slower aircraft regardless of type.” Once controllers learn to “see traffic” (meaning conflicts) they have to learn how to solve the conflicts, preferably in the simplest, most advantageous manner. It can be as simple as stopping someone's climb/descent to pass below/above converging traffic or issuing speed assignments to insure constant spacing. But busy sectors with complex traffic require more.

Being able to work a heavy, complex traffic requires many things: the ability to communicate effectively with pilots and other controllers, ambiguity must be eliminated. Timing is important, prioritizing (arrivals must come down, departures can tolerate a delayed climb), an ability to run through possible solutions and quickly choose the best one is a skill that requires good training and lots of practice (I like to ask trainees on occasion to come up with five solutions to a problem whose best solution is obvious), being able to make a bad situation work after having made a poor decision is a necessary skill, that having been said, the ability to plan ahead is probably the most important skill in ATC (as in trading, plan the trade, trade the plan). A good plan will usually prevent boneheaded moves and their ensuing madness. The ability to maintain some semblance of calm during busy stressful periods is also important in ATC as in trading. I try to teach trainess to talk painfully slowly when busy as this tends to slow their breathing and calm them down with the additional and important benefit of making sure they are heard correctly the first time, preventing the need to repeat themselves.

I am constantly finding parallels between working traffic and speculating, but ATC is easy for me now and I fear speculating will never be. That won’t stop me though! For those with an abiding curiosity about the somewhat mystical world of Air Traffic Control, I can recommend where you can look for ATC radio frequencies near you and listen in on controllers and pilots in real time. The “Top 30 Live ATC Feeds” is a good place to start. Also of interest, for those who have the stomach for it, is a fascinating documentary of the events of 9/11 called “Chasing Planes” which is a special feature on the two disc limited edition of the film United 93.



 Indeed it's true, as we have learned via Snopes from Prof. Hutchison's experiments, that a frog, immersed in slowly heated water, will attempt to escape, contrary to the well-known canard. However, the other piece of folk wisdom involving boiling water, "A watched pot never boils", is in fact true, and has been demonstrated experimentally.

Famously, Einstein was never able to accept the implications of the Heisenberg uncertainty principle, and he repeatedly proposed challenges, "gedanken experiments", which Niels Bohr repeatedly and ably parried.

One such challenge involved our old "watched pot" friend. Einstein deduced that, were the foundations of quantum mechanics correct, then the very act of observing the water as it was heated would "collapse" the wavefunction of the pot (a macroscopic object, true, but, following Bohr's reasoning, still subject Heisenberg's limits) into the observed non-boiling state. (There is in fact a tiny buy non-vanishing probability of a "tunneling" event to the boiling state, but estimates put its likelihood at 1 in 10^7 tries.)

Einstein considered his challenge as a theoretical reductio ad absurdum demonstration of the incompleteness of the foundations of quantum mechanics. As he put it, "Gott spielt Schürstange nicht." Bohr, however, had other ideas, and in the end the pair agreed to meet in a kitchen in Copenhagen in 1927 to test the idea. A pot was set upon the stove in the kitchen of the legendary Godt restaurant, and both the two legendary figures pledged to watch the pot until it boiled, or until each reached his own limits of exhaustion.

As we know, Bohr turned out to be the winner, and Einstein was obliged to pay for dinner of kogt frogten ben.

Thanks to Mr. Leslie, whose comment on the post "Spectacular Leaps" recalled to mind this delightful topic.



 Dhirubhai H Ambani, India's largest wealth-creator and whose sons are currently on the Forbes list, chased the number 13 with an unusual vigor. What everyone called unlucky and hence under priced became his favorite bargain. The number plates of his cars totaled 13, the office floors that he would be happy to buy were 13 and so on and so forth. A perfect contrarian risk taker he was always, including in the choice of what constitutes luck. February 7th, 2001, I met him, perhaps primarily on the merit of the duration of the meeting that I sought with him was for 13 minutes. It was simple to decipher from the number plates of his cars what it would take to get me to meet him.

The day after I sent the letter seeking this meeting, his secretary called up asking why would I need to see Mr. Ambani.

I promptly replied to his secretary that, "I assume you must be someone close to him if you are aware that I have sought to meet him. However, without meeting him yet I do not have his permission to reveal to any other the need for which I seek to meet him."

His secretary fumed at me, "What should I tell my boss then?"

I quietly told him on the phone, "If I were in your position I would tell my boss exactly what I hear, though I am not going to the extent of suggesting to you how you should be doing your job."

The Secretary dropped the receiver.

Thirty minutes later he called up informing me that his boss wanted to see me the next morning at 11.30 a.m.

Dhirubhai was known throughout his career for his ingenuity and I hoped through this conversation with his secretary to communicate to him until I met him a certain level of ingenuity in my enterprise.

However, when I got to see him the next day, the charm and charisma of an all time tycoon gripped me very quickly.

At the end of a very motivating 13 minutes or so when I rose to greet him and bid good wishes I still continued to see a plain face.

However, as I reached the exit of his huge personal office I could hear him burst out in a hearty laughter. I looked back at him in amazement and he said, "Son, you have had your tea but you forgot to put the sugar in it."

I recalled his secretary had specifically asked if I would take a tea with sugar or without and I had requested some on the side.

Back in the elevator I thus realized, at the ripe age at which Dhirubhai was then, the power of such minute observation, the persistence to scan through a person without disturbing the process of observation and to derive pure innocent joy that only a child could from things understood minute by others is perhaps the hallmark of a visionary of any times.

Victor Niederhoffer comments:

Just to inject a bit of quantitative mumbo into the picture, the last 23 friday the 13ths have been visited with a rise of 1/4 of % in SPU and unchanged in bonds. Completely insignificant in each.



 A friend of mine invented a new style of acrobatic dance for ball room dance competitions that generally won him the national championships in his field. He liked to warm up for about 5 minutes before the competition started and do his lifts, sometimes as high as 25 feet for a few minutes, then leave. He finds that by the time he leaves his competitors are so demoralized and confused and awed that winning is much easier. One wonders if such effects happen in the market.

The editor of our site, Victoria Niederhoffer, likes the work of David Burns in creating happiness. One of his methods is to take the worst fear that you have and make yourself do it, e.g. talking to an attractive girl you haven't met, and showing that when it happens, it's not that bad. One wonders if the moves below Dow 7000 and Nikkei 7000 played a similar role to Burns' technique.

Of spectacular leaps is what I found in my rackets career. I found that dissipating energy by anything not related to the game itself was totally dysfunctional. In particular, arguing with the referees a la McEnroe, or romantic interludes before the game was always a sure precursor to defeat. I never did it again after I figured it out. I looked at spectacular leaps before the opening of the S&P to see if the ballroom dancers or the racket players experience was best. I found that all spectaular leaps before the opening were reversed shortly after the opening much to the cost of the leaper, and much to the confirmation of the hypothesis and experience of the racket player.



One possibility is that markets get more volatile after they go up.

Using SPY (93-present), checked daily close-close returns, as well as range defined as (H-L) / (H+L)/2

Then sorted c-c returns into down or up, and checked the next day's range. Here is the comparison of mean range for days following those
either down or up:

Two-sample T for range nxtD vs range nxt U

                    N     Mean    StDev   SE Mean
range nxtD   1872  0.0039  0.00309  0.000072  T=8
range nxt U  2187  0.0032  0.00230  0.000049

Indeed volatility after down is larger

To check whether the size of down or up moves has an effect on tomorrow's range, here is a regression of next day's range vs prior
day's return, just for prior days which were down:

Regression Analysis: range nxtD versus c-c D
The regression equation is

range nxtD = 0.00239 - 0.182 c-c D
Predictor    Coef     SE Coef     T      P
Constant   0.0024  0.00008  29.69  0.000
c-c D       -0.1819  0.00623  -29.17  0.000

S = 0.00256647   R-Sq = 31.3%   R-Sq(adj) = 31.2%

As expected, the bigger the down yesterday the bigger today's range. Here is the same regression, only for yesterdays which were up:
Regression Analysis: range nxt U versus c-c U

The regression equation is
range nxt U = 0.00250 + 0.0949 c-c U

Predictor      Coef     SE Coef      T      P
Constant   0.002498  0.00006  41.17  0.000
c-c U        0.094886  0.00503  18.85  0.000

S = 0.00213147   R-Sq = 14.0%   R-Sq(adj) = 13.9%

So both for up and down yesterdays, the larger moves mean bigger range the following day.  However the effect is more pronounced for down
days with 31% of variance explained vs 14% for up days.  Of course
this can also be explained by persistence of volatility.



 I wonder if electronic interface and interaction within and among our economic, political, and social realms of globalization merely permits a greater (prism-like) spectrum of ingenuity and imagination during the course of individual and collective endeavors.

Case in point:

Madoff victims say jail a good start Submitted By The Associated Press Submitted on Friday, Mar. 13 at 10:37 am

BANGOR — A Bangor area couple who lost their life savings to Wall Street swindler Bernard Madoff say his being jailed Thursday was more justice than they expected, but far from enough.

Marcia Ellis says she and her husband, Martin, lost their savings in Madoff’s fraudulent Ponzi scheme that cheated investors out of at least $65 billion.

The 70-year-old Madoff was jailed Thursday in New York after pleading guilty on 11 counts. He faces up to 150 years in prison at his sentencing in June.

With their savings wiped out, Marcia Ellis is going back to school in preparation for a possible retirement job. Her husband just took a test to be a U.S. Census worker. She says she might go to New York to watch Madoff’s sentencing for “emotional closure.”

From a forensic analysis, it may be said that a primary distinction between Madoff and Ponzi is electronics.

The pain for this couple in the article may be as real as had Madoff physically stole their savings. The issue becomes the facility by which electronic mediums alter standards and practices, for example, whereby exemplar or illicit activity is enabled or condoned.

Be it Nintendo or snowball fights, positioning is elemental if not determinative. Madoff was playing a game too – he often called it “one big turf war.”

A reported scrapper from the onset of his career on the Street, Madoff came to appreciate position. Thus, for “setting up” his Ponzi scheme, he knew how to segregate his illegal and legal activities as well as overlay and parlay both to minimize risk and maximize value in his operations.

Was the rather “to good to be true” halo above Madoff so digitally enhanced that investors like The Ellis’s allowed their greed to intercede or precede the observance of standard investment protocols?

We all are taught to “never put all your eggs in one basket” while growing up. Victor reminded me of it in his first email to me.

The Ellis’s too thought that they were playing a game of position. They had a “good thing” as their investment with Madoff was selective, not available to most of us in society. Madoff was exclusive. One had to know someone, right?

People like the Ellis’s where, simply put, out-positioned by allowing their greed for “abnormal” investment profits to dictate deviation from industry standards and practices found in any accountant’s or attorney’s due diligence list.

Madoff knew that, and he “played” it. Compared to the first-to-third tier houses’ standard churn and burn, illegal shorting, and insider-outsider ploys constituting many a firm’s daily practices, perhaps, among those players, it would be said that BM “got game.”

If you read his five page allocution letter, what is most ingenious is the simplicity of his constructed nexus between the physical and electronic worlds. I saw statements from Madoff’s trading operations during the winter of 2006. He electronically papered his scheme successfully because of his expertise and his firms’ positioning. In sports, the winning combination, yes?

Perhaps younger generations, because they are playing Nintendo instead of having snowball fights, will be more attuned, more competent within our ever globalizing world of electronic exchange markets?

Certainly, on this fine day after Madoff’s slide into his new digs, one may so hope.



 Actually this is a tricky question: Even after defining a bear market, could a given decline have occurred by chance — given a random arrangement of returns? One aspect of a bear market could be down weeks clustering more than would be expected by chance, giving rise either to more frequent or deeper declines.

4194 DJIA weekly closes were partitioned into non-overlapping 40 week periods. At the end of every such period, calculated the maximum decline as:

min(this 40) / max (last 40)

Done this way the maximal decline could have been as long as 80 weeks or as short as 2 weeks; the idea was to capture large drops over various periods of interest to investors.

A simulation was used for comparison: The same 4194 DJIA weekly returns were resampled 100,000 times, and multiplied ("compounded", without dividends) out to produce a 100,000 week series. Like the actual market history, the series was partitioned into non-overlapping 40 week periods, and every 40 weeks min/max was calculated for the current and prior period.

One definition of a bear market is "a decline more than 20%". In the actual series, such declines occurred in (a surprisingly high) 26% of 40 week intervals (27 out of 104 40 week pairs). If this were more often than random, it would have occurred more often than in the simulated series. However in the simulation declines more than 20% actually occurred 32% of the time.

So if anything, declines of 20% or more occurred less often historically than by chance along.

But what if 20% is too arbitrary to capture a bear? In the actual series, here are the 40 week pair declines above the 95th percentile (ie, declines worse than 94.2% of the rest):

Date    40 min/max
06/20/32    -0.751
04/03/33    -0.642
09/14/31    -0.564
12/08/30    -0.542
03/02/09    -0.499
08/15/38    -0.469

The mean of these 6 40 week pairs is -58% (all but 5 from the depression). In the 100,000 week simulation, the 95th percentile is -34%. The actual 95th percentile and above mean of -58% is lower than even the worst simlated 40 week pair decline of -56%, which was the bottom of 2496 pairs (99.96 percentile, like the Obama cabinet SATs).

The worst 5% of actual 40 week pair declines dropped much more than would be expected by chance arrangement of down weeks. This is consistent with "fat tails" (at least on the downside), but you have to go out further than -20% to see it.

Alston Mabry comments:

Great study, Dr. Z. One thing I would want to explore would be whether in the simulation process, one intermixed different volatility regimes. That is, in the actual 4194 weeks, you may have periods of high volatility and periods of low. High volatility periods would have larger moves in absolute terms than would low volatility periods, and if the simulation mixed them together, the simulation might tend to produce lower volatility overall - this might account both for more 20% moves but fewer +50% moves. If this were a problem, one solution might be to normalize all the weeks against some preceding period, say 52 weeks.

Kim Zussman replies:

 Knowing that volatility clusters, if one is resampling a long data series this gets shuffled up. So you'll get 4% days near a bunch of 0.2% days (though the stdev of the whole series should be the same -shuffled or not). But if the question is whether the market has structure which is not random, does it make sense to stipulate whether you are in a volatile regime or not? Relatedly, maybe sticky volatile regimes translate to down markets, which is kind of the point.

Alston Mabry responds:

Exactly. To be precise, what I'm saying is that the fact that the simulated distribution produces more +20% moves but fewer +50% moves is simply an artifact of the shuffling process, especially when you shuffle individual weeks and then use 40-week stretches for calculating results. I'm thinking that the shuffling takes the actual distribution of % moves and increases the kurtosis and pulls in the tails.

This is not arguing against the hypothesis, just questioning that meaningfulness of the % comparisons.

Charles Pennington adds:

Prof POne uncontroversial hypothesis that might unify and explain many of these studies is that "markets get more volatile after they've gone down".

If you compute the skewness of the weekly or monthly returns of the Dow since 1929, it's quite negative. However if you take those same returns and divide them by some measure of the volatility over the following week(s)(*), then you'll find that both the skew and the kurtosis are close to zero, i.e. it's similar to a normal distribution of returns. That means that someone trading backwards in time, i.e. he has next week's newspaper but not last week's, would experience safe, non-Black Swannish returns if he just adjusted his position size for the volatility that he had experienced in his recent future.

* for example, one might use the following week's high/low range, 100*(h/l-1), or the average of that quantity over the following N weeks, where N is "a few".

To illustrate, here is a model.

First, create a series of random normal numbers with standard deviation 1, with one number for each trading day.

Now, use the following rule: "If the average of the last three days' numbers is negative, then today's return is 2 times today's number. Otherwise today's return is 1 times today's number."

I ran 2500 simulated trading days using that rule, and it gave 715 5-day maxes and 622 5-day mins. That's similar to what the Chair reported for the market.

More generally, I suggest that whenever you see one of these apparent anomalies of "market falls faster than it rises", try to see if it can be distinguished from the uncontroversial hypothesis that "volatility rises following down moves".

By the way, over the past 10 years, the standard deviations of daily returns of SPY under two scenarios:

all days 1.39% after up three-day move only: 1.17% after down three-day move only: 1.61%

Kim Zussman replies:

The simulation made the skew and kurtosis go away.  Here for the 40 day min/max both from actual series and simulation:
Descriptive Statistics: min/max, sim

Variable   Mean     StDev      Min    Median   Max       Skew
Kurtosis         N
min/max  -0.1435  0.1463  -0.7506  -0.1134  0.0313    -1.70      3.66
sim         -0.1604  0.1008  -0.5576  -0.1504  0.0654     -0.53
-0.04         2496

Even accepting there could be non-randomly down markets, this is a different question than whether they can be predicted.  So a small decline results in higher volatility, and trading smaller long positions can be on average profitable.  But some of the small declines go on to become big ones, and its hard to tell one from another.  Using stops (physical or otherwise) is tuchass saving, but it's hard to know whether "cutting your losses and let profits run" is worse in theory or execution. Which doesn't preclude that others can discriminate good from bad dips, or that they found work-arounds using opportunities independent of short term decline-reversal.

Phil McDonnell writes:

It may be helpful to look at the underlying hypothesis a little more closely. When we randomize by individual time periods we are deliberately randomizing any period to period dependencies. I presume that this was Dr. Zussman's point. Thus we are implicitly testing a null and alternate hypothesis something like:

Null: The original distribution or returns is similar to the distribution of a randomly ordered sequence of returns.

Alternate: The original distribution is not similar to a randomly reordered sequence of returns.

One good test of the difference between distributions is the non-parametric Kolmogorov-Smirnov test. Also one can use the more powerful D'Agostino test.

Another way to preserve the known autocorrelation in variance is to perform block resampling. From memory I believe the autocorrelation fades after about 35 days or so. Block resampling of 40 days should keep something like 97% of the variance autocorrelation and even other unknown dependencies even non-linear effects in that range. Comparing the distribution of the original returns to the 40 day resequence might tell us if there is something non-random even beyond the 40 day block level.

Dr. McDonnell is the author of Optimal Portfolio Modeling, Wiley, 2008



 I wonder if snow, for example the deluge on Feb 1, 2009, in New York has a negative impact on stocks. It had a positive influence on the ability of youngsters in the 1950s to buy stamps, as school was out and Nassau Street was accessible by train. Now you can't even find kids having snowball fights as they are all inside with Nintendo or Twitter or IM.

Paolo Pezzutti comments:

Last evening I left my girls to spend a few hours at some friends' place. I left them playing with a "Chinese" toy pen with very basic videogames such as bowling or skying in it. When I came back they were still playing with that silly toy. They were hypnotized, although sleepy, but they would not give up. What is the power of these applications — even as simple as this? We can track a parallel with a trading screen and its ability to hypnotize wanna-be traders (and not only them) creating a compulsive attraction and dark force to trade even when it is not the best setup.

I was somewhat nervous about my daughters because they were not stimulated to do something different. It seems that if they are not "educated" and addressed to healthier and outdoor activities kids (and adults too) in most cases prefer spending their time following action on a screen. This is what game companies and stock brokers exploit.

Michele Pezzutti adds:

 That's true. This is something I always think about when I reflect on the way kids are growing. I often wonder if the way the kids play today is healthy. I do not want to sound old-fashioned. I do not come from the 18th century. But are fantasy and creativity stimulated the same way by a computer game as they are by Legos, for example? I think that the problem is not in the technology itself but in the use we make of it as in everything else. Too much is poisonous. And I feel relieved when I see that my kids, when they feel like, can still play as only kids can do. From nothing they are still able to create their world and stories. They have plenty of imagination. Then my worries fade away as I can see in them the same kids we used to be. In the end, every new generation must have asked the same question.

Jim Sogi replies:

J SogiWhen my son was younger, we also worried that he also loved computer games and stayed up all night playing. I reasoned, better playing at home than out on the street. He was also an athlete who surfed, snowboarded, skate boarded. But the training he got playing games serves him well now in his new career in the financial markets. Is what we do 24 hours a day glued to a screen any healthier? I say no. It's really the future of work and communication and social structure.

Speaking with my daughter, we compared our contacts with old high school friends and family. She right pointed out that it is easier for her with IM, Twitter, email, sms, and use cell phones to keep in touch. Don't be old fashioned. It's a new world.

Alan Millhone writes:

 On the news tonight it was reported on a program in El Paso, Texas schools that has a regular exercise program in the schools that shows that regular exercise in youth produces better test scores, etc.

When I was a youth the neighborhood kids played outside till dark and our parents had to call us in for supper. In the Winter we built snow forts that we defended with snow balls against attackers. In the Summer if a new basement for a house was being excavated when the workers left we had dirt clod battles!

I began collecting stamps at age seven when that Christmas my parents gave me a Coronet stamp album and some stamps from H. E. Harris and Co. of Boston. In my early years they gave me sets of Lionel Trains (still have both sets in the original boxes ). We had no computers, cells, Ataris, etc. to fritter away our time and no TV for several years. We played board games, rode our Huffy bikes with a baseball card held in the rear spoke with a wooden clothespin. Modern technology is good to a point for youngsters. Much though that was good and wholesome has been forever lost. Just like the Checker players that at one time could be found on a daily basis in Central Park under the wooden canopied shelters. Tom Wiswell would not believe the changes there.

Jeff Watson comments:

I just got through watching the excellent movie Surfing For Life. Written and produced by David Brown and narrated by Beau Bridges, it chronicles the lives of people who are still surfing in the twilight of their lives. The movie took a sampling of notable surfers from the ages of 60-93, gave brief bios, and showed them surfing well as seniors. Surfing for Life is much more than a surfing documentary, it's a celebration of man's optimism and the results of living a life of optimism. It showed one particular surfer who visits senior facilities on a volunteer basis, and most of his charges are younger than him. It then cut away to him surfing a nice 6' wave. The central theme of this movie is that living a life with an optimistic bias will ensure personal happiness. My favorite scene is the closing where they show Doc Ball, 93 years old, riding a skateboard. Not only was he riding a skateboard, it was obvious that he was clearly enjoying it like a little kid. I've been told by many that I'm just like a little kid, and take that as a compliment whether they meant it as such or not. Little kids enjoy playing games, are optimistic by nature, and receptive to new experiences and knowledge. I'm of the view that trading is a game, an extension of the games we played as children. It can't be mere coincidence that a plurality of traders I know usually excel at one form of game or sport. Whether it's checkers, chess, poker, the racket sports, or surfing, these games played for a lifetime keep one's mind sharp, and mentally nimble. Game playing also keeps our competitive edge well honed, which serves us well in the markets. Surfing for Life is such a positive, uplifting movie that it should be seen by all, as it exudes optimism. It would be an interesting study to analyze the optimism/pessimism ratio for all market players. I have a hunch that the successful players would fall into the optimistic category. Optimism breeds self confidence.

Russ Sears says:

 When I hear tales of the freedom of youth my thoughts often turn me back to my 7th grade year, in Pauls Valley OK, where I delivered the Pauls Valley Daily Democrat door to door on a rusted out Schwinn bike I had spray painted baby blue.

I recently went back and visited the town 33 years later. The drugstore where my brother and I spent our share of the subscription price on comic books, baseball cards and soda fountains chocolate shakes had moved from across the street from the newspaper to the new Wallmart. Parts where still the same, with only a fresh coat of paint, others totally gone.

We had a great time "owning" our part of town. However, I think we were one of the last two kids to deliver papers this way. The only reason they gave me the job, since the Sunday papers weight more than me, was cause they were desperate. Few parents would let their kids do something like this even in small town mid late 70s. And thinking back, there were several times where I think "what were my parents thinking"… As I had a machete to my neck from a high druggie, learned where to drop my collection money off before I went to certain areas, and narrowly escaped a pedophile.

Bottom line is it's not all the kids' fault.

Anton Johnson writes in:

In addition to dirt clod fights, we would play king-of-the-hill on construction excavation mounds, resulting in the occasional emergency room visit. During spring-time we played Monkey-in–the–Middle and 500, honing our baseball skills, all the while dodging vehicles and swatting mosquitoes. On moonless sultry summer nights, we played neighborhood wide team hide-in-seek, some of us subtly maneuvering to get close to the object of our affection. Not even brutal winter weather could keep us inside. Often a dozen would-be Bobby Hulls would play ice hockey, taking brutal hits without pads (some of us even wearing figure skates). We shoveled our own rink on the lake, and hauled seemingly endless buckets of water to fill in ice cracks. Almost nothing could deter us, we played whether +40F or -15F degrees, sometimes coming home soaked after falling through the ice or occasionally with a frostbitten appendage. I wonder whether the electronic generation will reflect on their childhood with a similar nostalgia.



 My favorite excerpt and handout for all MBA (Finance) students before starting a class on Forex or Financial Markets is "The Old Speculator and the Yen" from EdSpec. The mind starts playing games once you are on long wait with the market. Particularly in India where I am forced some times to trade in the Brokers' office which is not very different from a poker table. The situation is exactly like the post "How not to run a trading Operation." No wonder public always loses more money than they have any right to. With unsolicited, free opinions flying around, cries and howls of a missed trade recognized by hind sight, reckless regret of past mistakes, criminal recounting of past price in comparison to present prices (as if price has an obligation to return with out regard for the operating context) losses are guaranteed to happen.



 Here is a little something I wrote regarding air traffic control and trading some time back. This was made in the larger context of Dr. Steenbarger’s study on Implicit Learning as applied to trading performance; the meeting point being a purposed ‘change in tempo’ (ie. an intended screen blank-out of air control elements), leading to a ‘mini-crisis’ demanding an immediate resolution from the air traffic controller. [Dr. Steenbarger’s study and references may be relevant to your thoughts above]

I have no special insight into being an ATC, and look forward to hearing the experience of others with practical knowledge in the field.

“Don said…

The moving dots test sounds a lot like part of the multi-layered testing and interview process used in air-traffic-controller recruitment: watching dots move across the screen, a sudden blank-out, then tasked to place the current dot position after an unexpected time interval; given a set of rules (eg. aircraft velocity, wind speed, altitude, angle of approach etc), to sort different scenarios and to sequence aircraft landing accurately; and others.

I learned later that ATC testing were carried out to measure important skills like time pressure reactions, attention diversion, time monitoring & estimation, pattern recognition, coordination/prioritization abilities.

While I eventually did not take up the ATC job (confession: I applied in a lark, having always been intrigued after watching the amazing Billy Bob and John Cusack in Pushing Tin), it was a revelation in a later interview for a trading position. The similarities in the skill- and mind-sets required as an ATC or as a trader was personally insightful.

While I may have missed out on pushing tons of tin across the skies as an air-traffic jockey, I’m still watching colorful blips and lines on multiple screens. And the biggest upside is that the worst that can happen is I lose money for my firm and/or for myself. Almost no lives are on the line when I do make trading mistakes.

And well, the money is better.” 

I have always been fascinated by this subject, having spent many enjoyable days and nights (even now as an adult) watching and mapping the landing/takeoff corridors used by the local airport; as well as timing and counting the interval cadence of the successive planes.

On some busy nights, you can see the rush of approaching planes from various directions: from the western hemisphere, east from across the Pacific, north from Asia, from Down Under – all gracefully playing under the baton of the ATC and eventually melding from their diverse orthogonal vectors of directions, velocities, altitudes into a beautiful straight downward line approaching the airport (sometimes stretching as many as five planes into the horizon).

It is a delight to watch such technical artistry at work, painted against the ever-changing canvas of the skies and a privilege to be able to get into the head of the ATC-artist, if only for a moment.



 Recently I finished reading Ken Dryden's The Game , which is widely regarded as the best book on hockey and one of the best sports books ever written. Ken is a very deep thinker who graduated from Cornell and earned a law degree from McGill while goaltending for the Montreal Canadians. In his 8 season career, Ken won the Stanley Cup 6 times before deciding to retire at age 32 and currently serves in Canadian politics. It is a timely book to read as I've been thinking over the state of trading, what works or no longer does, and most of all how 'the trading game' relates to myself. The book opens with a couple quotes I found interesting for him to choose:

"The trouble with people like us who start so fast….is that we soon have no place left to go." - Pomeroy in Joseph Heller's Good as Gold

"I leave before being left. I decide." - Brigitte Bardot

Continuing with the theme of impending retirement, Ken wrote:

“I have thought more about fear, I have been afraid more often, the last few years. For the first time this year, I have realized that I’ve only rarely been hurt in my career. I have noticed that unlike many, so far as I know, I carry with me no permanent injury. And now that I know I will retire at the end of the season, more and more I find myself thinking —I’ve lasted this long: please let me get out in one piece. For while I know I am well protected, while I know it’s unlikely I will suffer any serious injury, like every other goalie I carry with me the fear of the one big hurt that never comes. Recently, I read of the retirement of a race-car driver. Explaining his decision to quit, he said that after his many years of racing, after the deaths of close friends and colleagues, after his own near misses, he simply ‘knew too much.’ I feel a little differently. I feel I have known all along what I know now. It’s just that I can’t forget as easily as I once did.”

The above citations stuck me not because I'm looking to step away from trading but perhaps looking to retire certain methods and strategies that are losing their effectiveness. But it's not easy to reinvent oneself and drop old ways while they still work.

To share another quote that Ken opened up a chapter,

“More often than I like, I am saddened by a historical myth….. I can’t help thinking of the Venetian Republic in their last half century. Like us, they had once been fabulously lucky. They had become rich, as we did, by accident…..They knew, just as clearly as we know, that the current of history had begun to flaw against them. Many of them gave their minds to working out ways to keep going. It would have meant breaking the pattern into which they had crystallized. They were fond of the pattern, just as we are fond of ours. They never found the will to break it.” – C.P. Snow, The Two Cultures and the Scientific Revolution

Further in the same chapter, Ken described how the Soviets, in the 1972 Summit Series against NHL All Stars, changed from playing a game which was "too patterned, too predictable" to a more ambiguous way which left him with the following conclusion:

“So where do we stand? There can be no more illusion now. We have followed the path of our game to its end. We have discovered its limits. They are undeniable. More and better of the same will not work. The Soviets have found the answer to our game and taken it apart. We are left only with wishful thinking. We must go back and find another way.”

The cycles of change being reimposed on competitors is something common to the markets and I'm grateful for having read this book during my search for a new formidable edge.



 A chess game usually features a number of phases with many mistakes appearing when the 'crisis' has passed. So it was interesting to find the following paper discussing what appears to be the same effect in air traffic controllers. I've also heard that for drivers most accidents happen a mile from home.

Simply being aware of this effect should help because you can 'force yourself' to be more vigilant. But this may also introduce issues such as health and energy levels - the more tired someone is the harder it will be.

"The analysis of the incidents suggested that they were happening via what may be called ‘layered situation awareness’. Layered situation awareness relates to the need to handle significant traffic and their demands, against a background of other traffic. The controller, in order to deliver high capacity and a quality service, focuses on traffic that has short term demands, e.g. a need to climb or descend, or to be at a certain lower sector exit flight level, yet wanting to remain at a cruising altitude as long as possible. The controller therefore (mentally) suppresses or (in the extreme case) ‘filters out’ not only unassumed aircraft (traffic no longer under his or her command), but also certain assumed aircraft that are relatively ‘invariant’ in their passage across the sector (e.g. they are staying at cruise level). These aircraft are akin to ‘blind spots’ – they are not seen. This approach to controlling traffic is borne from a proactive approach which is continually looking ahead, using a more complex strategy perhaps, than in lower workload air traffic control centres. This more complex approach which is partly proactive and partly opportunistic, and is focused on giving a good service to aircraft, means the controller is thinking ahead much of the time, rather than focusing exactly on what is on the radar screen at the time. This theory could explain the incidents at busy and medium times. However, in order to explain the incidents that occurred at non-busy times, it needed to be expanded. The first additional aspect was that this way of working would carry over into low and/or medium workload times after a busy period, when the vigilance ‘resources’ of the controller are lower or even depleted. Therefore, it is suggested that this filtering or suppression process becomes ‘second nature’, and so is more likely to continue to operate when the controller is tired or the normal required vigilance level drops (and the controller is ‘under-stimulated’). It could also operate when the controller is less experienced, and has not yet had what may be called a ‘correctional’ incident that stops controllers from going too far when being ‘proactive’."



One way to see if cycles occur is to rank closing prices and see if the distribution of ranks is consistent with independence.

take 5 prices          800, 801, 799, 804, 803,                                 

let's rank them         2      3        1    5     4                                from lowest to highest.                                                               

The distribution of actual ranks for the last 10years, 1, 1 99 to present in S&P adjusted futures prices is as follows:                              

rank    number of times                                                         

1       637                                                                    

2       418                                                                    

3       338                                                                    

4       404                                                                    

5       733                                                           

Queries: Is this consistent with independence? What does this show about the shape of the distribution? How can this be generalized? How does it compare to other markets? Is there any predictive value to such studies? 

Victor Niederhoffer adds:

mkt rank   S&P   Bonds   Bund  Yen  Gold Crude

1                  637  612      624  672  395      430                                       

2                  418  328      354  409  277      294                                       

3                  338  382      352  405  265      257                                       

4                  404  406      404  431  318      295                                       

5                   733  781      789  709  596      529                                    

drift             -03   01       02   00   03       00        per day
Sd                154  69       37   27   81       142                                     

The starting point is 1/1/1999 to present daily for all except gold and crude. Note unusal number of rank 2 for bonds. The surprises are the number of rank 5 for stocks which exceed the rank 1 even though there was a drift of -03 a day. This is consistent with larger big declines than big rises.

Charles Pennington comments:

Prof PYou got 733 "fives" and 637 "ones", a difference of 96.

I looked at ten simulations of a 2500 step random walk, using numbers drawn from a normal distribution. In only one of the ten was there a difference between the number of "fives" and "ones" that exceeded 96. In that one instance, the difference is 137. The standard deviation of the 10 differences was 42.

So an effect this big should show up randomness alone on the order of 1 in 10 times. It's probably a non-random effect.

Victor Niederhoffer asks:

Excuse me, Professor, but did you use the drift of -03 a day and given standard deviation of 137?

Charles Pennington replies:

That seems like false precision to me, with the market's own real-time estimate of volatility having varied by a factor of ten over the period, and with the drift flattish until the last year of the ten year period. If the point is that "the market has gone down rapidly over the past six months", then count me in. Even over that period, though, four of the top ten 1-day magnitude moves have been in the positive direction, including the biggest and the second biggest. And even from 1929-1939, the biggest 1-year magnitude move was the UP year of 1933 with the market up 78%. I think if you or I had lived through that, then..*, **

My friend, you would not tell with such high zest; To children ardent for short selling glory, "Teres quod tardus est, ut venalicium oriri".

* mangled version of poem "Dulce et decorum est", 

** Online English-to-Latin translation of "Smooth and slow it is, when markets rise". I have no idea if the translation is right, but it looks nice.

Victor Niederhoffer requests:

I'd appreciate it if someone would test whether the distribution of ranks for S&P for the 5 day periods is consistent with independence with actual changes since 1/1/1999.

An Artful Simulator writes in:

Using 1000 randomly resampled (w/replacement) data series, I get

obs = observed distribution of ranks
exp = expected number of ranks from simulations
exp = 95% empirical confidence interval from the simulations

rk   obs   exp  95% conf
1    658   702  [644,767]
2    434   417  [382,454]
3    349   366  [332,397]
4    419   396  [360,432]
5    741   720  [656,782]

(i added some random noise to break ties)

doesn't look that non random to me.  Also, the chi squared statistic
for observed as a function of expected is 6.28 with p val of 18%

Victor Niederhoffer comments:

The Professor was right.



 These days all one hears is hundreds of billions here, trillions of dollars there. It almost seems like the B and T keys must be getting worn out. At the very least any politician who doesn't think in terms of billions is clearly not a visionary. Since we do counting here perhaps a little back of the envelope counting is in order. Suppose the government were to guarantee every sub prime mortgage out there. What would happen and how much would it cost? Clearly every sub prime mortgage would dramatically rise in value perhaps even higher than the value when they were issued. Their value on the bank balance sheets would rise dramatically. In many cases 3 fold to as much as 10 fold. Suddenly the banks would be wonderfully solid and flush with money. This massive infusion of capital into all the banks would come without a dime of Federal capital injection.

Just because the government guarantees a loan does not mean that the homeowners would or could keep making all his payments. Some will certainly default. Suppose also that the Government took over all such homes and kept them off the market for the duration of the current unpleasantness. Real estate would turn around much faster without the burden of more new homes being sold in foreclosure. Foreclosures would actually decline because a rising real estate market would give homeowners more skin in the game. But what would the cost be? There are 109 million full time homes in the US with $8T in mortgage outstanding. Supposing that the average mortgage is about 6% then the average payment is about 0.5% per month. This amounts to $40B per month. But in the 4th quarter Bloomberg reports that 0.83% of all mortgages defaulted. So the government would only have to $332M in new monthly payments every quarter. It is somewhat embarrassing to write a number as small as millions these days. Millions are so Twentieth Century! But the reality is we could save real estate, the mortgage market and banks by just making relatively small payments over the next few months.

Dr. McDonnell is the author of Optimal Portfolio Modeling, Wiley, 2008

Stefan Jovanovich comments:

Our Dr. Phil's definition of "the banks" is interesting. It includes (1) the borrowers and implicitly (2) the counter-parties to Citi and the other Tennessee Williams banks' outstanding swaps, asset-backed paper and other promises and (3) the bond-holders for these wonders of financial construction. The one group that has been left out of the discussion so far have been those terrible villains of the present economy - the people who insist on saving instead of borrowing and spending money - aka (4) the depositors.

The FDIC has made a belated move to acknowledge that their reserve fund and the contributions of the healthy country banks will not be enough to save the money center bank depositors. As recently as November they were still pretending that everything was OK; now they are realizing they better get in line at the Treasury window if they expect to be able to avoid a bank run. The current increased guarantees for the people who put money into the banks expire at year end. The Treasury barely has enough credit left to make good on its indirect promise to the depositors. If, as Dr. Phil suggests, the "banks" and their mortgagees are going to be allowed to have priority, everyone who can will swap their checking account balances for T-bills and cash. (No doubt Paul Krugman will then decide that it is declining velocity that is the problem.) Having already seen the rerun of 1930, we will see 1933 all over again.

The "crisis" is one that businesses face every day but that most academics literally have trouble understanding (it must be that they can endlessly recycle those same old lecture notes) - namely, the market had changed and a lot of inventory has gone bad. You can changing the price tags on the shelf all you want; no one is going to buy them for cash.

George Parkanyi writes:

I agree with Dr. McDonnell. Western governments should guarantee MOST of the paper (not the worst of the pure sub-prime stuff that's basically uncollectable - something needs to be written down) - at maturity, and not buy it outright now. In fact I would make the interest tax-free in the US, and get the Europeans to do the same in Europe. Make them government muni-bond equivalents.

I would even re-securitize them (make them collateral) for essentially new standardized government Treasury mortgage and asset-backed securities - that would then be traded openly on exchanges - with associated derivates like futures and options created (think the T-Bond or T-Note markets) so the owners can risk-manage them. Banks and financials could then move them off their books over to investors, who would have collateralized government securities - ironically now more safe than unsecured Treasuries.

For all the billions being thrown at the problem, surely a billion or two out of that could buy a lot of accounting and book-keeping horse-power to document, track, and value the "collateral" - the income streams from the mortgage and loan payments, and the value of any re-possessed assets. Create a single clearing house for all these securities that come into the program, managed with a war-time urgency as a matter of national security. The current income, and recoveries from property sales, would fund the first waves of re-payments as they come due. This would serve to defer the un-secured at-risk portion of the total package well out into the future, buying time to resolve all this leverage in a more orderly fashion.

Then move toward solving the structural problems. Still allow financial engineering, securitized products and derivatives, but never again unregulated, off-exchange, or off-balance sheet.

Legacy Daily replies:

I just cannot figure out how the numbers work.

According to this, mortgage debt outstanding is about 15T.

Based on this article around 11% are delinquent.

If government guarantees 1.65T, at 6% average that's 8B per month? Ignoring moral hazard (since already ignored anyway), we still have the issue of 11% increasing as a result of unemployment.

Giving a government ability to hold real estate at a large scale is only a leap or two away from certain factions pushing to "increase" the living standards of the proletariat (similar to what created the sub-prime fiasco in the first place) at the expense of others. With all its issues, the current system of private real estate ownership is a key factor in protecting freedoms. I am sorry but I see many negative "unintended consequences" in the proposals mentioned.



 Deep Survival by Laurence Gonzales is good re-read in these troubled times. I've reviewed it before, (see past discussion on the site here) but so many big and small are not surviving. Live a river, a good book is never the same when read over. He has some good advice.

There are two aspects to survival: avoiding getting into trouble, and surviving once in deep.

How to avoid getting into trouble.

Tao Te Ching says, The farther ones goes, the less one knows. There are a number of phenomenon at work that put you in deep trouble.

1. When in danger, the IQ goes down and the mind starts shutting out appropriate input, or goes into a stupor. This compounds the danger and leads to death. 75% of people react this way. Perceptions themselves change. Its very dangerous. Training and preparation help avoid shutdown.

2. We make mental models and as a result of confirmation bias, ignore cues that the model is not appropriate. Experts are especially susceptible to this. Models are simplifications, and complex systems can go way out of bounds. Like the current market situation. Then the models are no longer appropriate but we cling to them, putting us in harms way. Models come from past experience, limited experience and may not be appropriate as new situations arise, as they always do. Here is where humility comes in. A Zen saying,"In the beginners mind there are many possibilities: in the expert's mind there are few."

3. Be able to perceive, change plans, adapt, bail out.

How to get out of trouble.

4. The right positive mental attitude can keep one out of trouble, and allow survival when in deep. Some aspects of the right attitude are humility, awareness. Take personal responsibility rather than blaming outside factors. Surprisingly empathy and taking on the role of rescuer, rather than victimhood helps with survival. Death comes when people lie down and give up.

5. An interesting aspect of survival is friction. More effort cannot overcome friction. It only leads to exhaustion. Plans never go right, there are always delays, at the worst possible moment. Its Murphy's law at work. Its the vig. The cure is to conserve energy. Only go at 60%. Keep a reserve. Exhaustion is often the cause of death. When in danger or lost, people panic, and start flailing about, become exhausted, and lay down and die. Rather, be still, rest, observe. Then start to consolidate and make a plan. Get your bearings. Don't hurry. Get back on path.

Epitecus said, "Let silence be the general rule, or let only what is necessary be said, and in few words." The idea is to avoid chattering. Mental balance and focus is critical in survival situations.

"If you get a lucky break really use it. You have to fight like a bastard." Says one survivor. Other use other mantras repeated, to help survival mentality.

Last thing: be cool.

George Parkanyi writes:

In late October 1999 I went into a cold river and pulled someone out who had jumped off a bridge. Luckily her winter clothing had kept her afloat, and as it turns out thankfully the rescue was not all that difficult. . When I saw her shadow floating in the dark under the bridge, I remember thinking she could sink at any time, and for all I knew she was already dead. She'd been in the water at least 5-7 minutes. (I had run from the nearby video store to see what was going on when someone rushed in to call 911.) I quickly threw off my coat, sweater, and shoes so I'd have something dry to come back to, said a split-second prayer, and waded in. Then time slowed down — and I felt more like a detached observer. It was like something or someone else had taken over and was driving, and I was just watching it happen. I don't remember feeling the cold.

When I reached her, surprisingly she was still afloat, face-up and conscious. I was up to my chin in water but didn't have to swim. I introduced myself with "Hi I'm George. I'll be your rescuer for this evening. What's your name?" "Nobody", she murmured — par for the course I suppose as she was trying to kill herself. So I grabbed her coat and literally just towed her in. I heaved her onto shore and threw my coat over her, but about half a minute later the firefighters and paramedics arrived and took over.

Before then, I never knew what I'd do in that situation, or what it would be like. As Jim says, the mind really does go into a totally different state. And I think it starts at the point where you've fully committed yourself. But before I went in I did make some quick calculations; perhaps 30 seconds worth — help would be on its way, I was a strong swimmer, pretty cold water, shoes off, need something dry later, how much time to get there, how much time would she have, how much time would I have. So the rational mind is still key.

The one funny thing about that night was the look the video store clerk's face when I sloshed back into the store all wet and finished renting my video.

Russ Sears writes:

Just today, I was thinking about what makes US strong is that we all face the "prisoners' dilemma" together, but most of the people I know tend to think of it instead as the "rescuers' dilemma".

Best case, small gain, most likely case cold, pain from an ungrateful soul, but the worst case…

Do you risk it?

When the neighbor's barn burns or is hit by a tornado, we all pitch in to help. Because we know it could have been us. She may not have wanted help, but if she was your daughter, you would have been delighted that someone like you was there. People here in fly over country are talking survival of buying guns and heading for the hills of Canada or Alaska, if things get ugly and bad. But it is just talk, always will be, we have a duty.

George Parkanyi replies:

Helping others is critical, because as you point out "There but for the grace of G_d go I." I'm sure everyone has been in a position of vulnerability at some point in their lives when a helping hand made a huge difference. It has for me, many times over, and my regret is that sometimes I forget that. And everyone has also been in the position of being that helping hand. I think on balance people will rise to the occasion and do more good than harm to each other as times get tougher here in the near term.

Marion Dreyfus comments:

It doesn't sound as if anyone made a big fuss about your bravery and cool under the crisis conditions. I will make such a fuss: Since I am fairly terrified of water, having drowned when I was 11 and been brought back to life by a doze-y lifeguard who saw a woman take me to the deep end of the pool when I could not swim, I am impressed at your calculations that did not impede your swift and funny intentions. Did you really say "I'll be your rescuer for the evening"? That is hilarious. Belatedly: You are a hero! You deserve some sort of acknowledgment that those people back then forgot to give you. Bravo!

Victor Niederhoffer adds:

My father did the same thing. But it wasn't so heroic because he was a policeman and had to do it. I have the letter from the woman he saved, and she was very grateful he saved her life as she came back and enjoyed life. I know a few people who tried to kill themselvees and they have had very happy lives afterwards including a frequent contributor to this site, who is one of the happiest guys I've ever met, even though his life style might not appeal to those who dont like 150 degree weather. The video store operator —- to make the story complete: "When I sloshed bak into the store, the clerk looked at me in amazement. He said "my goodness, you're a hero. That will be 2.50 by the way ." I said " 2.50!!!! After all that!" He said, "Oh, right, I forgot to add the VAT. Sorry."



 This paper makes one think of the effect of actually having money in the trade, vs just sitting analyzing data on a Sunday. And the real question is still, how to be free of it? Or control for it?

"The tree of experience in the forest of information: Overweighing experienced relative to observed information." Uri Simonsohn, Niklas Karlsson, George Loewenstein, Dan Ariely


Standard economic models assume that the weight given to information from different sources depends exclusively on its diagnosticity. In this paper we study whether the same piece of information is weighted more heavily simply because it arose from direct experience rather than from observation. We investigate this possibility by conducting repeated game experiments in which groups of players are randomly rematched on every round and receive feedback about the actions and outcomes of all players. We find that participants’ actions are influenced more strongly by the behavior of players they directly interact with than by those they only observe.

[ … ]

One important distinction, when it comes to the process leading to acquisition of information, is whether the information was obtained through personal experience—i.e., in a process that had or could have had direct consequences for oneself—or only by observing the experience of others. We refer to the former as “experienced information” and the latter as "observed information."

Legacy Daily adds:

In Battle for Investment Survival Loeb says: "Knowledge born from actual experience is the answer to why one profits; lack of it is the reason one loses. Knowledge means information and the ability to interpret it marketwise. But, in addition, making money in the market demands a lot of "genius" or "flair." No amount of study or practice can make one successful in the handling of capital if one really is not cut out for it." I think that the education of one's own $1000 put to work in the market cannot be substituted by reading, theoretical analysis, or observation. My questions are: "Do you feel that making money in the market is a natural gift or a learned skill? To which one or two key factors would you attribute your success?"



The recent high regime of volatility may be coming to an end. How could this happen, as fear is currently running high and investors have given up on fundamentals? There are a number of reasons that the market volatility may have peaked. Like a fever it has swiftly risen and the beginning of this year has brought continued high levels above 50 in the VIX. No one can be certain but companies have cut and cut their staff, profits and dividends. But the next batch of earnings expectations is so low that they will be difficult to surprise on the downside.



Frugal duchesses, tightwad gazettes, penny-pinching, and the "money or your life" philosophies are back in vogue and selling well.



LoebHere are some interesting quotes from The Battle of Investment Survival, by Gerald M Loeb, Simon and Schuster, 1957 (14th printing).

"There are some rules that hold, and my first is to buy only something that is quoted daily and can be bought and sold in an action market daily. The greater the volume of trading and the broader the market in a particular security, the closer to a fair price at a given moment that security is likely to be."

"In my opinion, the primary factor in securing market profits lies in sensing the general trend. Are we in a deflation or inflation period? If the former, I would hardly bother to analyze most equities."

"In short, in my opinion everything of an analytical nature covering specific securities should be persistently linked to past market appraisals and set up for use solely to determine future market possibilities."

"Any program which involves complete investment of all capital at all times is certain to fail unless the amount of it is extremely small."

"All this suggests the question - are we learning to trade for the quick turn or to invest for the long pull? We are investing for appreciation, and the length of time one holds a position has noting to do with it. I lean towards rather short turns for many reasons. To begin with, experience is gained much more rapidly that way. Short-term investing once mastered has very much more the elements of dependable business than the windfalls or calamities of the long pull."

"Obviously, our ideas will sound wrong to the most people. Any investment policy followed by all naturally defeats itself. Thus the first step for the individual trying to secure or preserve capital is to detach himself from the crowd."



I am giving a talk on a paper that I read. The problem under consideration is the following: you have risky assets in which you can invest, and you will have to cover a contingent claim at some future time which depends on the future value of the risky assets (e.g., a put option on one of them). You have some initial wealth and wish to invest in the risky assets so that you can cover your contingent claim. The problem is to find the minimal wealth that will allow you to do this. This paper finds a way to determine the minimal wealth that will allow you to hedge your contingent claim with a prespecified probability. (Stochastic Target Problems with Controlled Loss by B. Bouchard, R. Elie and N. Touzi)

I am working with a professor who would like us to apply these techniques to optimal investing with drawdown constraints. If you set out to find the optimal investment strategy subject to the condition that your final wealth is not less than its running max, you will stay out of the market. We want to see what happens if you optimize under the constraint that your final wealth is not less than its running max with some high probability.

Here are the slides of my talk.



 Most of us have heard the proposal that we should temporarily ban "mark to market" rules as a quick fix to the current crisis. But FASB, the accounting rule making body, is opposed to this. Further, many agree in principle, rightfully in my opinion, saying company accounting should fully recognize the reality of the market place. However, many conclude this by saying this means use "mark to market" accounting. It is obvious to all that deal with many of these markets that the securities have a very thin or frozen market. I would argue this just as real and even more obvious that what the "market" price is…

Many have blamed the new accounting rule FAS 157, for these frozen markets. I blame the implementation of FAS 157, not the rule. While a subtle difference, this suggest a fairly simple but decisive solution to the problem.

The problem with FAS 157 is that we don't have any disinterested party determining what is an "Active Market" or what is an "Inactive Market". By the current guidelines, a company "marks to market" any security in an "active market"… And is required to use a "mark to model" approach for a security in an "Inactive Market" . The "market to market" approach uses similar securities that traded to determine a price. A "mark to model" uses an expected cash flow, with an interest discount that incorporates an appropriate risk premium for those cash flows.

Theoretically the difference between these values is the liquidity premium.

The financial companies would like to mark-to-a-model everything that has an implied Market Value they do not like…One that is lower than their model's valuation.

The auditors would like to declare anything that has a poor market value active, no matter how thin the actual trading is on these securities and how big a "fire sale" that similar traded security was.

The auditors will win this argument.

The consequence is that what should in a reality based world be "marked to models" becomes "marked to market". This inability to quickly recognize "Inactive Market" in the accounting world makes market liquidity premiums grow quickly in any market beginning to freeze. Further, the frozen market hogs capital and makes it  more difficult for institutions to keep trading in other markets. This quickly makes frozen markets spread like a contagious disease in the real world.

This suggest a simple response: make the accounting world more quickly recognize an "inactive market" before it spreads.

The obvious solution is enable financial companies to have a swift and responsive arbiter of these conflicts. They should have a disinterested third party organization with authority to declare securities as being in "active" or "inactive" markets. This organization would swiftly determine and issue updated rulings for what securities should be "marked to market" or "marked to model".

Who should do this ? The rating agencies would be the obvious choice. The SEC gave the rating agencies power by creating the "Nationally Recognized Statistical Rating Organization for this very reason (needing a 3rd party to legally determine credit worthiness) in 1975 for capital requirement ratings. This prevents them from being sued by either party, i.e. the investor or the company being rated.

This is a simple proposal, that could quickly to be implemented without either side admitting a mistake or revising what guidance they already provided. Now if the SEC, the rating agencies and financial regulators of the financial industry are up to the task of implementing this quickly and with the needed responsiveness, there is another battle of redesigning their incentive structure that is best left to another day.

The current default alternative, of leaving everything as is, will destroy many if not most of the financial companies and require us to start anew. But this new financial market will be one with little money available for illiquid assets. Nor will it have a stomach for assets that are liquid but can become illiquid in a matter of months… like home loans.



The DJIA has now gone down for four consecutive weeks after an up (UDDDD), and the total decline is about -20%. Looking back 1929-present, this decline of 20% is the 7th worst out of 104 instances of UDDDD.

What usually happens next ? X for UDDDDX was insignificantly negative:

Variable    N     Mean     StDev   SE Mean     95% CI             T      P

nxt wk    103  -0.0028  0.0328  0.0032  (-0.0091, 0.0036)  -0.85  0.398

And regressing next week's return vs return of prior 4 weeks suggests bigger declines do not make for a better return (see scatter diagram ):

Regression Analysis: nxt versus dn 4

The regression equation is

nxt = 0.00799 + 0.142 dn 4

Predictor     Coef   SE Coef     T      P

Constant   0.0079  0.0053  1.50  0.136

dn 4         0.1415   0.0563  2.51  0.014

S = 0.0320660   R-Sq = 5.9%   R-Sq(adj) = 4.9%



 Approximately a month ago, more than an eyebrow was raised when Fiat said it would enable Chrysler to access its technology. I would like to remind us that the revolutionary "Common Rail" system for diesel engines was invented by Fiat's "Magneti Marelli" and later sold to Bosch which has, until today equipped some 50 milion engines around the globe. Today Fiat anounced the launch of an engine that can virtually burn almost everything from gasoline to ethanol to diesel etc. The engine is being presented at the Geneva motor show. I link an article from Italy's major newspaper (Corriere della Sera) albeit in Italian, sorry for that.

John adds:

Here is a link in English.



Closing prices:

April 21, 1982 (inception) 670.45
Oct. 19, 1987 712.1
today             686.1

A remarkably quiet market.

George Parkanyi writes:

I'm just workin' the drift. man, workin' the drift…



 A LoBagola, as described in The Education of A Speculator by Dr. Niederhoffer, is a phenomenon whereby a market makes an historically large run in one direction, usually up, and then at some unpredictable point begins an equally extreme run back to where it started.

Some recent cases in point would include virtually every asset class there is. Most certainly oil and other commodities have retraced much of their spectacular run ups. Stocks have now retraced the last 12 years of gains with no bottom in sight. Real estate is another prominent example.

To understand LoBagolas we need to understand how they start. They start with some early optimism. Things start improving for a certain stock or asset class. Some early profits are made as more investment dollars chase the emerging bull market. These profits add to account equity and can be used to compound returns through increase margin borrowing. In futures there is not really borrowing but the effect is the same - investors can take larger positions as prices rise. In effect there is a feedback mechanism. Higher prices result in even higher prices as more leverage is added.

But when the price finally cracks the effect is reversed. The first selling causes some short term holders to exit resulting in a further decline. At some point the decline reaches the level where the latest thin margin players are forced out. This results in another round of feedback selling. As prices come down it almost seems like they break in waves. Each successive wave forces another round of margin calls and forced selling. Finally the entire bull run is retraced. All the new holders who were enticed in by the lure of quick profits have been forced out as the whole bubble unravels. That is a LoBagola.

Dr. McDonnell is the author of Optimal Portfolio Modeling, Wiley, 2008

Victor Niederhoffer writes:

The question about LoBagola, especially since he was a charlatan, is whether the migrations that he described with an exact retracing of the path but variable in time exist to a non-random extent. How can this be tested, and what predictive value does it have? The picture of me in the WSJ with Lobogola overlaid did give James Lorie the biggest belly laugh of his life and for that it is undeniably valuable.



CurveHow can we avoid curve fitting when designing a trading strategy? Are there any solid parameters one can use as guide? It seems very easy to adjust the trading signals to the data. This leads to a perfect backtested system - and a tomorrow's crash. What is the line that tells apart perfect trading strategy optimization from curve fitting? The worry is to arrive to a model that explains everything and predicts nothing. (And a further question: What is the NATURE of the predictive value of a system? What - philosophically speaking - confer to a model it's ability to predict future market behavior?)

James Sogi writes:

KISS. Keep parameters simple and robust.

Newton Linchen replies:

You have to agree that it's easier said than done. There is always the desire to "improve" results, to avoid drawdown, to boost profitability…

Is there a "wise speculator's" to-do list on, for example, how many parameters does a system requires/accepts (can handle)?

Nigel Davies offers:

Here's an offbeat view:

Curve fitting isn't the only problem, there's also the issue of whether one takes into account contrary evidence. And there will usually be some kind of contrary evidence, unless and until a feeding frenzy occurs (i.e a segment of market participants start to lose their heads).

So for me the whole thing boils down to inner mental balance and harmony - when someone is under stress or has certain personality issues, they're going to find a way to fit some curves somehow. On the other those who are relaxed (even when the external situation is very difficult) and have stable characters will tend towards objectivity even in the most trying circumstances.

I think this way of seeing things provides a couple of important insights: a) True non randomness will tend to occur when most market participants are highly emotional. b) A good way to avoid curve fitting is to work on someone's ability to withstand stress - if they want to improve they should try green vegetables, good water and maybe some form of yoga, meditation or martial art (tai chi and yiquan are certainly good).

Newton Linchen replies:

The word that I found most important in your e-mail was "objectivity".

I kind of agree with the rest, but, I'm referring most to the curve fitting while developing trading ideas, not when trading them. That's why a scale to measure curve fitting (if it was possible at all) is in order: from what point curve fitting enters the modeling data process?

And, what would be the chess player point of view in this issue?

Nigel Davies replies:

Well what we chess players do is essentially try to destroy our own ideas because if we don't then our opponents will. In the midst of this process 'hope' is the enemy, and unless you're on top of your game he can appear in all sorts of situations. And this despite our best intentions.

Markets don't function in the same way as chess opponents; they act more as a mirror for our own flaws (mainly hope) rather than a malevolent force that's there to do you in. So the requirement to falsify doesn't seem quite so urgent, especially when one is winning game with a particular 'system'.

Out of sample testing can help simulate the process of falsification but not with the same level of paranoia, and also what's built into it is an assumption that the effect is stable.

This brings me to the other difference between chess and markets; the former offers a stable platform on which to experiment and test ones ideas, the latter only has moments of stability. How long will they last? Who knows. But I suspect that subliminal knowledge about the out of sample data may play a part in system construction, not to mention the fact that other people may be doing the same kind of thing and thus competing for the entrees.

An interesting experiment might be to see how the real time application of a system compares to the out of sample test. I hypothesize that it will be worse, much worse.

Kim Zussman adds:

Markets demonstrate repeating patterns over irregularly spaced intervals. It's one thing to find those patterns in the current regime, but how to determine when your precious pattern has failed vs. simply statistical noise?

The answers given here before include money-management and control analysis.

But if you manage your money so carefully as to not go bust when the patterns do, on the whole can you make money (beyond, say, B/H, net of vig, opportunity cost, day job)?

If control analysis and similar quantitative methods work, why aren't engineers rich? (OK some are, but more lawyers are and they don't understand this stuff)

The point will be made that systematic approaches fail, because all patterns get uncovered and you need to be alert to this, and adapt faster and bolder than other agents competing for mating rights. Which should result in certain runners at the top of the distribution (of smarts, guts, determination, etc) far out-distancing the pack.

And it seems there are such, in the infinitesimally small proportion predicted by the curve.

That is curve fitting.

Legacy Daily observes:

"I hypothesize that it will be worse, much worse." If it was so easy, I doubt this discussion would be taking place.

I think human judgment (+ the emotional balance Nigel mentions) are the elements that make multiple regression statistical analysis work. I am skeptical that past price history of a security can predict its future price action but not as skeptical that past relationships between multiple correlated markets (variables) can hold true in the future. The number of independent variables that you use to explain your dependent variable, which variables to choose, how to lag them, and interpretation of the result (why are the numbers saying what they are saying and the historical version of the same) among other decisions are based on so many human decisions that I doubt any system can accurately perpetually predict anything. Even if it could, the force (impact) of the system itself would skew the results rendering the original analysis, premises, and decisions invalid. I have heard of "learning" systems but I haven't had an opportunity to experiment with a model that is able to choose independent variables as the cycles change.

The system has two advantages over us the humans. It takes emotion out of the picture and it can perform many computations quickly. If one gives it any more credit than that, one learns some painful lessons sooner or later. The solution many people implement is "money management" techniques to cut losses short and let the winners take care of themselves (which again are based on judgment). I am sure there are studies out there that try to determine the impact of quantitative models on the markets. Perhaps fading those models by a contra model may yield more positive (dare I say predictable) results…

One last comment, check out how a system generates random numbers (if haven't already looked into this). While the number appears random to us, it is anything but random, unless the generator is based on external random phenomena.

Bill Rafter adds:

Research to identify a universal truth to be used going either forward or backward (out of sample or in-sample) is not curvefitting. An example of that might be the implications of higher levels of implied volatility to future asset price levels.

Research of past data to identify a specific value to be used going forward (out of sample) is not curvefitting, but used backward (in-sample) is curvefitting. If you think of the latter as look-ahead bias it becomes a little more clear. Optimization would clearly count as curvefitting.

Sometimes (usually because of insufficient history) you have no ability to divide your data into two tranches – one for identifying values and the second for testing. In such a case you had best limit your research to identifying universal truths rather than specific values.

Scott Brooks comments:

If the past is not a good measure of today and we only use the present data, then isn't that really just short term trend following? As has been said on this list many times, trend following works great until it doesn't. Therefore, using today's data doesn't really work either.

Phil McDonnell comments:

Curve fitting is one of those things market researchers try NOT to do. But as Mr. Linchen suggests, it is difficult to know when we are approaching the slippery slope of curve fitting. What is curve fitting and what is wrong with it?

A simple example of curve fitting may help. Suppose we had two variables that could not possibly have any predictive value. Call them x1 and x2. They are random numbers. Then let's use them to 'predict' two days worth of market changes m. We have the following table:

m x1 x2
+4 2 1
+20 8 6

Can our random numbers predict the market with a model like this? In fact they can. We know this because we can set up 2 simultaneous equations in two unknowns and solve it. The basic equation is:

m = a * x1 + b * x2

The solution is a = 1 and b = 2. You can check this by back substituting. Multiply x1 by 1 and add two times x2 and each time it appears to give you a correct answer for m. The reason is that it is almost always possible (*) to solve two equations in two unknowns.

So this gives us one rule to consider when we are fitting. The rule is: Never fit n data points with n parameters.

The reason is because you will generally get a 'too good to be true' fit as Larry Williams suggests. This rule generalizes. For example best practices include getting much more data than the number of parameters you are trying to fit. There is a statistical concept called degrees of freedom involved here.

Degrees of freedom is how much wiggle room there is in your model. Each variable you add is a chance for your model to wiggle to better fit the data. The rule of thumb is that you take the number of data points you have and subtract the number of variables. Another way to say this is the number of data points should be MUCH more than the number of fitted parameters.

It is also good to mention that the number of parameters can be tricky to understand. Looking at intraday patterns a parameter could be something like today's high was lower than yesterday's high. Even though it is a true false criteria it is still an independent variable. Choice of the length of a moving average is a parameter. Whether one is above or below is another parameter. Some people use thresholds in moving average systems. Each is a parameter. Adding a second moving average may add four more parameters and the comparison between the two
averages yet another. In a system involving a 200 day and 50 day
average that showed 10 buy sell signals it might have as many as 10 parameters and thus be nearly useless.

Steve Ellison mentioned the two sample data technique. Basically you can fit your model on one data set and then use the same parameters to test out of sample. What you cannot do is refit the model or system parameters to the new data.

Another caveat here is the data mining slippery slope. This means you need to keep track of how many other variables you tried and rejected. This is also called the multiple comparison problem. It can be as insidious as trying to know how many variables someone else tried before coming up with their idea. For example how many parameters did Welles Wilder try before coming up with his 14 day RSI index? There is no way 14 was his first and only guess.

Another bad practice is when you have a system that has picked say 20 profitable trades and you look for rules to weed out those pesky few bad trades to get the perfect system. If you find yourself adding a rule or variable to rule out one or two trades you are well into data mining territory.

Bruno's suggestion to use the BIC or AIC is a good one. If one is doing a multiple regression one should look at the individual t stats for the coefficients AND look at the F test for the overall quality of the fit. Any variables with t-stats that are not above 2 should be tossed. Also an variables which are highly correlated with each other, the weaker one should be tossed.

George Parkanyi reminds us:

Yeah but you guys are forgetting that without curve-fitting we never would have invented the bra.

Say, has anybody got any experience with vertical drop fitting? I just back-tested some oil data and …

Larry Williams writes:

If it looks like it works real well it is curve fitting.

Newton Linchen reiterates:

 my point is: what is the degree of system optimization that turns into curve fitting? In other words, how one is able to recognize curve fitting while modeling data? Perhaps returns too good to believe?

What I mean is to get a general rule that would tell: "Hey, man, from THIS point on you are curve fitting, so step back!"

Steve Ellison proffers:

I learned from Dr. McDonnell to divide the data into two halves and do the curve fitting on only the first half of the data, then test a strategy that looks good on the second half of the data.

Yishen Kuik writes:

The usual out of sample testing says, take price series data, break it into 2, optimize on the 1st piece, test on the 2nd piece, see if you still get a good result.

If you get a bad result you know you've curve fitted. If you get a good result, you know you have something that works.

But what if you get a mildly good result? Then what do you "know" ?

Jim Sogi adds:

This reminds me of the three blind men each touching one part of the elephant and describing what the elephant was like. Quants are often like the blind men, each touching say the 90's bull run tranche, others sampling recent data, others sample the whole. Each has their own description of the market, which like the blind men, are all wrong.

The most important data tranche is the most recent as that is what the current cycle is. You want your trades to work there. Don't try make the reality fit the model.

Also, why not break it into 3 pieces and have 2 out of sample pieces to test it on.

We can go further. If each discreet trade is of limited length, then why not slice up the price series into 100 pieces, reassemble all the odd numbered time slices chronologically into sample A, the even ones into sample B.

Then optimize on sample A and test on sample B. This can address to some degree concerns about regime shifts that might differently characterize your two samples in a simple break of the data.




Alexander Elder calls a bar that sticks down (or up) by itself on the chart a kangaroo tail. Price goes to a new level, but quickly pulls back. For example, the second to last bar on the attached chart is a kangaroo tail.

I defined a kangaroo tail as a bar on the 30-minute chart* that had at least 50% of its length either above the high of both adjacent bars or below the low of both adjacent bars. I also required this 50% or greater protrusion to be at least 50% of the average 30-minute range.

I found 18 kangaroo tails in the S&P 500 futures since October 24, 2008, of which 10 stuck down and 8 stuck up. I then calculated the change in the S&P 500 futures from the end of the bar after a kangaroo tail (the earliest point at which a kangaroo tail can be identified) until the same time the next day. Results appeared consistent with randomness:

Close    Close

1 bar     24 hrs

Date           Time  Low          Protrusion Direction     later    later   Change
10/24/2008 9:00   835.0              51% down              860.0 868.0   0.9%
11/17/2008 1:00   850.4              50% down              865.6 831.9 -3.9%
11/20/2008 9:30   774.5              58% down              801.5 747.0 -6.8%
12/31/2008 15:20 890.5              75% down             904.8 920.8 1.8%
1/15/2009 15:00   829.5              60% down              839.3 848.6 1.1%
1/27/2009 7:00     832.6              62% down              840.0 859.3 2.3%
1/30/2009 13:00    823.0              54% down             830.5 815.2 -1.8%
2/11/2009 15:00    826.3              56% down             831.5 835.4 0.5%
2/16/2009 1:00      810.1              70% down             816.5 789.8 -3.3%
2/18/2009 9:30      778.2              50% down             784.0 787.7 0.5%

Average -0.9% Standard deviation 3.0%
N 10
t -0.69
Average of all 24-hour periods -0.2%

Close Close

1 bar 24 hrs

Date            Time      High         Protrusion Direction    later     later    Change
10/24/2008 12:30  882.0       51% up                          860.0    885.0     2.9%
10/27/2008 9:30   881.5         52% up                         871.5    846.5    -2.9%
10/27/2008 10:30  881.0       53% up                           869.0     857.5    -1.3%
11/20/2008 12:00  820.0       72% up                           797.0     753.5    -5.5%
1/9/2009 8:15       915.8        50% up                          890.5     880.5    -1.1%
2/2/2009 15:00     827.5         89% up                          821.3      831.5     1.2%
2/5/2009 11:30     847.5         58% up                          843.5      860.8     2.1%
2/25/2009 11:00   765.0         69% up                           755.5     765.5     1.3%

Average -0.4% Standard deviation 2.8%
N 8
t -0.17
Average of all 24-hour periods -0.2%

* My "30-minute" charts use longer time periods per bar during the overnight session



Or put a servile gentleman on a horse and he'll gallop.                                    

date      3:00     3:30  close     open                                            

03/05                                    696                                             

03/04     720   723   708      707                                              

3/03      708   696    689      711                                             

03/02     707   704   706      719                                             

2/27      745   737    734      735                                             

02/26     757   753   752      773                                             

02/25     767   777   761      767                                             

02/24     768   772   769      748                                              

2/23      746   745    745      778                                                  



 John Von Neumann:

"With four parameters I can fit an elephant, and with five I can make him wiggle his trunk"

"You wake me up early in the morning to tell me that I'm right? Please wait until I'm wrong.[Note: the phone call in question took place at about 9:30am.]

"There's no sense in being precise when you don't even know what you're talking about"

"There was a seminar for advanced students in Zürich that I was teaching and von Neumann was in the class. I came to a certain theorem, and I said it is not proved and it may be difficult. Von Neumann didn't say anything but after five minutes he raised his hand. When I called on him he went to the blackboard and proceeded to write down the proof. After that I was afraid of von Neumann." George Pólya, in How to Solve It (1957) 2nd ed

And the most intelligent of all:

"With the Russians it is not a question of whether but of when. […] If you say why not bomb them tomorrow, I say why not today? If you say today at 5 o'clock, I say why not one o'clock?"



 This seems like a way to manipulate a lot of variables very quickly in an intutive fashion.

"Siftables aims to enable people to interact with information and media in physical, natural ways that approach interactions with physical objects in our everyday lives. As an interaction platform, Siftables applies technology and methodology from wireless sensor networks to tangible user interfaces. Siftables are independent, compact devices with sensing, graphical display, and wireless communication capabilities. They can be physically manipulated as a group to interact with digital information and media. Siftables can be used to implement any number of gestural interaction languages and HCI applications"




 It's unusual for a President to give a buy tip on stocks, but he did. The Japanese government has threatened to buy stocks as well, a thumb in the dyke so to speak. Do you think the mythical "plunge protection" team might be getting ready? I wonder if this is the usual jawboning or something else.

On another subject, I watched The Seven Samurai by Akira Kurosawa for the umpteenth time. The phrase that really jumped out at me was, "If you only defend you will lose." The other interesting aspect was the counting of the deaths of the bandits, one by one. Kind of like these continuing down days. They must be getting desperate.

George Parkanyi replies:

Oh yeah? What's he buying? (Thinking out loud: How many stocks out there have the name Lincoln or Roosevelt in them? Franklin? BEN! … nahh, it can't be that easy …)

This is not unprecedented. Not two years after taking over taking over Hong Kong, the Chinese government bought Hong Kong blue chips (and probably took a few shorts out back to shoot for good measure) to shore up the market during the Asian crisis. It worked; the market rebounded shortly thereafter and they gradually sold off the positions. (They kept the up-tick rule for a while, but only for sentimental reasons.)

I wish I could print money to buy stocks. But people on the whole seem to be purists, and react negatively when I try, for example, to add zeroes to a $10 bill at the check-out counter.



 The current Administration is very concerned about the poor and the middle class. But little concern is expressed for the upper middle class or as the Administration likes to call them 'the rich'. One wonders if there is a downside to this asymmetric outlook.

About a month ago the National Association of Realtors again called for an easing of terms on the large jumbo mortgages. Their argument is that the upper end of the market has seized up. In fact the data bear this out. In the upper end very few homes are being sold because of the difficulty in getting financing. Only cash buyers are nibbling and there are very few of them.

For example in the Seattle market in some areas there are 30 homes for sale but only one will sell in a given month at the high end. At the high end prices are not necessarily coming down at the rate the Case Schiller index claims. The sellers are not making concessions on a comparable same house basis. Rather, what is happening is that they are financially able to hold on hoping for some light at the end of the tunnel.

So why is there a disconnect between what the Case-Schiller and other median type indices say and the ground truth? Let's take a simple example of a neighborhood with 5 homes sold at the following prices (in thousands of dollars) :

Median = 700

Let's say that was a year ago. Now pretend that the exact same houses are sold for the exact same prices with one exception. There are no transactions above 750 because of mortgage financing issues. So now we have only homes below 750 that are sold at the same prices at which they were purchased:

Median = 600

So comparing medians one might superficially conclude that in the last year that home values have dropped from 700 to 600. But we know that the prices in fact are unchanged from the year before. The point here is that the drying up of mortgage financing at the high end has created an appearance of a greater decline in real estate prices than has actually occurred. The fix is simple and obvious. We must relax rules on high end mortgages and allow that market to function again. The interesting thing is that it will reverse the statistical anomaly and create the perception of a real estate price increase. Most importantly it will not cost the government a single dime in bailout money.

Jason Thompson writes:

J TAs a prospective home buyer that has thus far legged the trade the right way, I've been doing a lot of counting in the arena of luxury homes — following the higher end of the market in my current locales, Chicago and Reno/Lake Tahoe, and a future destination, southwest Ohio. Though I'm leaving Chicago as I've tired of the nanny state and sky-high taxes (10.75% sales tax anyone, or how about a $125 dollar parking meter fine?) I admit I'm going to a place not much better, Ohio, though at least there I will be next door to my kin. While what Dr. McDonnell says about the state of the jumbo mortgage market and the lack of compromise on pricing back to reality is largely true, his observation that easing credit will fix this is not.

Rather, there has been a collapse in the pool of buyers, combined with a glut of custom built homes by small builders that have populated the exclusive suburbs of this country for many a moon. Further delinquency checks call in to serious question the belief that these "homeowners" (they don't own anything, rather are renting from creditors) have the staying power to remain in their homes.

One market I am now knowledgeable about is Indian Hill, the most exclusive suburb of Cincinnati. Median income is $188K per household (its $47K per for Ohio overall) and median home value was $1.1 million in 2007. There are around 6K residents, enough of whom wish to sell their house such that there are 338 listed homes or prepared lots (80% are completed houses). Based on 2008 sales levels, Indian Hill has 11 years of home inventory, yet based on transacted prices, "values" are only down 18% from 2007 levels which were in-turn flat to 2006. To me this is beyond nonsense, especially when some smart sleuthing can determine 90+ day delinquency rates for loans in the 45243 zip code is rising faster than the DJIA is falling. Market clearing prices are likely 30-40% lower, just to adjust to the wealth effect, not to speak of executive level job losses and the imminent sale/forced merger of FITB.

Albeit it is a sample of one market, but it is in the Heartland of America and as Ohio goes so goes the nation, no? What rose-colored glasses should I be using if above not correct?

Kim Zussman comments:

It's relatively easy to look up foreclosures/REO in your area of interest. Realty-Trac sells lists of these (notice they don't call it "Reality"), and the ghost of Countrywide has about 20,000 nationally:

Prices won't bottom until there is no one left with money or interest to buy, and judging by the size of the recent bubble that could take some time. The wealth effect should work both stocks –> housing and vice versa.

Upscale homesellers of coming years have the same problem as stock-invested boomers: sell to whom?

One can quibble with Shiller's methodology or his optimism, but he is certainly on the short list of market timers of the millennium.



Not only was the S&P drawn to the magic 700 round but others were as well in odd ways. The Dow index was down almost exactly 300 points on the nose. The NASDAQ was down almost exactly an even 4% (really 3.99%). Somehow it does not seem random. Even though one was price level, one in points and one in percent change, still all were quite round.



 Should one trust the judgment of the 'experienced'? Experience counts for a lot as long as positions behave normally but in a non-standard game it can lead to stereotyped responses. This probably has market applications in times when everyone is looking for a rock to cling onto.

Here's a question: does a stats based approach to markets equate to an experienced one? If so, how can one avoid being stereotypical?

GM Davies is the author of Play 1 e4 e5: A Complete Repertoire for Black, Everyman, 2005

Scott Barrie comments:

Not quite the answer you are looking for but experience vs. youth reminds me of two things… besides approaching middle age I am not young, but still not old enough to be experienced. Back in early 90s when I worked on the CBOE, I heard stories about the founding days. The CBOE was a dumping ground for the "Men Who Don't Fit In" (aka the rabble) or the young, seeking opportunity, or both. Those quick to adapt to the environment, were doing arbitrage trades (boxes) left and right and making a pretty penny –with very minimal risk to boot. It was those who adapted to the difference in trading options vs futures(equities) quickly who scored big and quick. As I heard the stories told, they were STUCK there, away from polite society — like many would consider the CBOT polite society. My point is the young, the pioneers, made good money, and pretty easy money as I heard it told (of course, things are always better in the past, so the story is probably just that).

The second market based example comes from the SEOS crowd. The small players ruled for a few years, making fortunes on a shoe string — as legend would have it. The pickings were easy, as the rules changed and those who spotted the change and were able to implement its nuances made lots of money, at least for a while. Many were young, or off the beaten path (rabble) hence they became known as "bandits" for stealing the tick or two that was the "god given right" of the specialists and market-makers (exchange members). In both cases, I have only been able to meet people who heard the stories of these developments years ahead of me. Those who survived and prospered, gained experience and have lost their youth. Those who didn't only managed to lose their youth. 

George Parkanyi replies:

It depends. You also have to assess the motives. General, broad experience can come in handy when things change greatly or rapidly. There are more potential avenues and adaptations open to someone who has seen how things turn out in many different situations. However, say someone is experienced, but they are willing to live within their existing paradigm come what may (e.g. someone owns a house in a hurricane zone, knows the risks, but is willing to accept those risks - even of death - because they CHOOSE not to change their lifestyle). You may have a very experienced captain that suddenly finds himself in overwhelming circumstances, but ultimately chooses to go down with the ship - that may not be your choice. Depending on your own motives, you may want to follow the example of someone who may not be that experienced, but is determined as hell to survive.

In the current situation as a trader, your first question should be — are the financial markets themselves going to survive? If you think not, then maybe selling everything now and buying some guns and a 5-year supply of Spam is the way to go. If you CARE not (like me), then keep trading and if it goes it goes. Your screen trading experience won't count for much in a Mad Max world, and then your choice is to accept its over and just take what comes.

After you've decided that you'll keep trading, then markets typically do one of three things, go up, meander sideways, or go down. If you're really smart and have lots of experience at reading the signs, you may be able to deduce which environment you are in and likely to stay in for a while. Trade accordingly. If you have no idea, then you may want to build an approach for each scenario, risk manage each, and hope the correct one delivers you more profits than the loss management of the other ones costs. I still think experience will be decidedly helpful to the person who was creative and flexible on the first place, regardless of age. Successful traders tend to be students of human nature — and I would think have a better understanding of how people are likely to react in different situations and environments, and use that to advantage.

As to the stats question, it would depend on what you are measuring. You would still have to assess relevance to current circumstances on a case-by-case basis for each metric you are using. And to avoid being stereotypical, you might want to turn basic assumptions and sacred cows upside down and see what falls out, and just keep asking lots and lots of questions and thinking them through. Also broaden the scope of scenarios you could imagine — it would be kind of like thinking many moves ahead in chess.

It would actually be very interesting to have a brainstorming session on the case for each type of potential market — up, down, sideways or even total collapse.

Nigel Davies adds:

I have a concept I use in my chess teaching which is something I've called 'gardening moves'. This is when you try to find a move which is useful in 'all possible worlds'. These tend to come when one has falsified most of the one dimensional possibilities.

Is the decision to trade a good one in all possible worlds? Probably not. Are there investments that would be good in all possible worlds? Probably not. But there are certainly those which can be OK in most possible worlds.

Go down with the ship? Not flamin' likely! I take the view that any creature worth it's salt has a duty to adapt and survive as well as it can and ensure that its progeny do the same. In my book there's no glory in defeat.

GM Davies is the author of Play 1 e4 e5: A Complete Repertoire for Black, Everyman, 2005



SageI recently did a very crude estimate of the value of Warren Buffett's puts betting that the price of the S&P would be above, relative to their price at trade entry. Conservatively, they're roughly up 3.5-fold, using Bloomberg analytics.

Phil McDonnell writes:

A similar back of the envelope estimate shows that his short puts are up by at least 1.5 fold using current volatility estimates.  Given the rise in volatility the puts are more likely up something like 4 fold.  Thus the write-off should be something like $5.5B * 1.5 = $8.5B (at a minimum).

In a Yahoo article yesterday it was reported that Buffet received $8B for the puts he sold.  So on the higher end the exposure might be $8B * 4 = $32B.  In any event the current write off clearly seems to be understated.

The Oracle espouses such virtues as clean accounting and a preference for mark to market accounting.  And yet, the companies he owns are not marked to market for the most part because they are not publicly traded.  Thus they continue to be carried on the books at a valuation determined by the Oracle.  If we use the S&P as a reference, the market value of the typical company has fallen by something like 50%.  BRK carries something like $250B in operating assets (excluding cash).  Thus it is reasonable to estimate that if his portfolio of companies was marked to market that it has declined by about $125B in current market value.  If this loss was taken today it would more than wipe out the $120B of equity that the company claims.

There are other hidden gems on the balance sheet.  For example one wonders what $4B in deferred long term asset charges are.  The $34B in Goodwill basically represents what the Oracle over paid to buy his companies.  In the current environment one wonders if any of that is left.  The $17B in deferred liabilities remains another mystery.

Dr. McDonnell is the author of Optimal Portfolio Modeling, Wiley, 2008

Michael Cohn comments:

The sale of puts was hardly free — just look at Berkshire's stock performance. However, what makes this strategy tenable for Berkshire was that he does not have to post margin, unlike 99.97 percent of counterparties on this trade.  This is the major advantage that allows him to play long term nominal drift and benefit from survivorship bias.  Had anyone else sold those puts they already would have been downgraded by rating agencies.



 1. Tax savings to the shareholder.  The shareholder receiving those dividends must pay taxes on them at a fairly high rate, and in that tax year.  If alternatively the corp uses that cash to repurchase its own shares on the open market or otherwise, the overhanging supply of shares decreases resulting in a higher price for all shares.  Thus the shareholder experiences a capital gain, which historically has been taxed at a lower rate.  Thus his after-tax return increases.  And he can choose the tax year.  Taxes deferred are taxes denied.

2. The shareholder receives the dividend at a time not determined by himself, and the odds are that it is not the most desirable time for him to receive that payment.  If the shareholder wants some cash, he can sell some shares when it is convenient and/or necessary for him to do so.  If you want some annoying experience with dividends, buy some HOLDERS (an early/anachronistic version of ETFs).  You will get dividend announcements several times a week and your accountant will be delighted with all of the work you have given him.

3. (Opinion) Corps that have cash available to pay dividends are not efficient investors of the capital entrusted to them.  By giving the shareholder a dividend they are saying effectively, "we do not have any good investment ideas; take the money because you probably can do better."  This is not to suggest that all corps should be acquirers of other companies, but they could put some money in R&D to either enlarge share or reduce expenses in the future.  And R&D expenses are tax deductible.

4. (Opinion) The payment of dividends is a public relations game to get investors to hold the stock for long periods.  The process lulls investors into not reevaluating their investment options as regularly or often as they should, which is not in the shareholder's best interest.  (N.B. That opinion is different from what the "buy and ignore" crowd will tell you.)

Thank YOU for your service to our country.

Stefan Jovanovich comments:

I think the point about the taxation of dividends belongs to an earlier time.  The taxable portfolios of individual investors (as opposed to IRAs, SIMPLE IRAs, 401(k)s, etc.) are not a significant part of the overall market.  Most of the shares owned are in the hands of tax-exempt institutions.  Most of the taxable investors are corporations; because of the dividends received exclusion their effective tax-rate on payouts from other corporations is - at most - 15%.  I would hardly want to quarrel with Bill's maths, but it could be argued that the advantage of having a cash payout diminished a 15% by tax could be a better return than allowing corporate management to hold on to the cash and then use it to speculate in their own company's securities.  There are very few Henry Singletons.

George Parkanyi adds:

The dividends-are-bad argument misses the point that dividends are not always static, and when companies keep increasing them regularly, after a while you can be earning a very high yield on your original investment in addition to the capital appreciation.  Companies can also squander money, and perhaps paying a dividend is a better choice than overpaying for some acquisition that blows up.  Dividends can also be good indicators of value where your primary objective is capital appreciation.  Look around you now.

I also would be careful using generalizations like "hope for the buy and hold crowd", implying they are a bunch of bovine followers.  A lot of people have gotten rich by holding on to companies that have grown and dramatically appreciated in value.  In addition to the appreciation, there are tax-deferral and transaction cost avoidance benefits.  In fact, it takes a LOT of discipline to be that patient, especially if you follow the markets regularly.

As for dividend-paying stocks, they're just another useful tool - not for everyone, but for many - in the arsenal of investment vehicles available to traders and investors.  Personally I think that quality companies paying dividends are going to rocket off the bottom first when things turn around because of the yield support and recognition of value, and many of us will be lamenting "How did I miss _________ at 6%?"

Phil McDonnell replies:

Dividends can be an important part of returns.  Most studies of long term stock market returns show that re-investment of dividends accounts for about half of the long term return.  So in the long term they are very important.

In the short term they may be less important.  If a stock pays a dividend of $.50 then it will probably drop and average of $.50 on the day it goes ex-dividend.  So there would seem to be no apparent gain.  But if the dividends are reinvested in the stock the investor is buying the stock a little bit cheaper after the ex-dividend event.

Added to this are the benefits of dollar cost averaging. Specifically when the stock is generally at a low price more shares are purchased with the dividend.  When the stock is high fewer shares are purchased with that same dividend.  Over time this leads to an average price per share that is below the average price of the stock during the same period.

In looking at yields and total returns it is important to look at how the reporting institution does its calculation.  You would think that this is not important and that people like S&P report things on a consistent basis.  A good case in point is that the S&P index is a cap weighted index.  Big cap stocks like IBM, GE and XOM get far more weight than their smaller brethren.  But when S&P reports the earnings for the index, bizarrely, they do not use cap weighting.  The earnings are equal weighted.  Thus an earnings to index level comparison for the S&P is completely meaningless.  An example is that S&P calculates the equal weighted reported earnings as negative for the first time in history.  But if they were cap weighted the earnings would be positive.  If the operating earnings were reported on a cap weighted basis they would be 80% higher than the equal weighted earnings that S&P actually reports.

Dr. McDonnell is the author of Optimal Portfolio Modeling, Wiley, 2008


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