Practical Speculation: The Framework

 

Topics in Part One

 

The first part of this book—Mumbo Jumbo and Moonshine—dissects the common errors, myths, fallacies, and propaganda that induce investors to lean the wrong way and make a maximum contribution to the market’s infrastructure.

 

Chapter 1. The Meme.                                                                                             

 

Everyone knew that the mere mention from a Federal Reserve chairman of fears about stock prices would lead to an explosive and completely unpredictable reaction in the market. Alan Greenspan’s December 5, 1996, “irrational exuberance” speech set off such a dire chain of events that we have devoted our Chapter 1 (with apologies to Guy de Maupassant’s classic horror tale, “The Horla”) to detailing all its consequences, including the reaction against technology, optimism, and growth.

 

Chapter 2. Earnings Propaganda.                                                                                        

As Kuhn noted in The Structure of Scientific Revolution, science often finds itself in a state in which a growing number of facts conflict with prevailing theory. Such was the state of Newtonian mechanics in the late nineteenth century as experimental evidence concerning the spontaneous decay of particles from the nucleus of atoms began to accumulate. Such is the state of today’s prevailing wisdom that stock market prices are determined by earnings, or price/earnings ratios. We subject the most widely accepted beliefs about the earnings-market relation to counting, and offer ways to spot earnings propaganda in media coverage, analyst reports and company pronouncements to help readers to reject the market’s numerous invitations to trade the wrong way.

 

Chapter 3. The Hydra Heads of Technical Analysis                                              

 

Violent declines in the market promote fear and dread. Being able to predict up moves in the market would guarantee immeasurable wealth and power.  It is not surprising, then, that there is a mythology of momentum, replete with stories of great heroes and heroines who have conquered the mighty forces, to ease investors’ anxieties, to fuel their hopes--and to keep them making wrong moves with no chance for improvement. We apply some science to the cult of technical analysis and its central mystery: “The trend is your friend.”  As we demonstrate, the trend is regrettably not your friend.

 

Chapter 4. The Cult of the Bear.                                                                             

 

How can a writer be wrong for practically his entire working life and still be the most influential figure in financial journalism? We interviewed Alan Abelson to find out why, after searching in vain for a hint of optimism in the hundreds of weekly columns he wrote for Barron’s during the great 1990s bull market.

 

Chapter 5. “We Are Number One” Usually Means “Not Much Longer”

 

To the ancient Greeks, the most grievous sin was hubris, the arrogance of power. Vic’s father, Artie Niederhoffer, who inspired and is memorialized in Vic’s first book, The Education of a Speculator, wrote with great insight on how this flaw impaired the judicial system. We will attempt to carry forward his analysis by studying the effects of hubris in the marketplace.

 

Chapter 6. Benjamin Graham, Mythical Market Hero                                          

 

The ancients had their gods and demigods, and we moderns have ours. In the Golden Age of Greece, as scientific thinking took hold for the first time, some thinkers began to question the reverence and sacrifices demanded by the gods. It is always a good idea to ask questions. A figure high in today’s pantheon -- Benjamin Graham – is the subject of this chapter.

 

Chapter 7. News Flash: Computer Writes Stock Market Story!                           

 

The brilliant mathematician Alan Turing once proposed that a computer might be said to be intelligent if it could fool a human into mistaking it for another human. The converse must also be true: If we can replicate a human’s speech by a computer, we can say the human is not acting intelligently. Most contemporary financial news reports could be done by computers working from a limited database of erroneous ideas and mediocre money managers. We explain why, and present our patented program for stock market reporting.

 

Looking at Part Two—Practical Speculation                                                                                    

Part Two offers a foundation for making rational decisions about the market. Survival comes first, and we start with a strategy that will keep readers from being wiped out before they can enjoy the fruits of their efforts. It is based on the thinking of one of the greatest geniuses ever in a pursuit that has demanded the best strategic thinking of sharp minds for more than a thousand years: chess.

 

Chapter 8.  How to Avoid unkantverstenhenlassenhummels (Spurious Correlations)                                                                                                                             

 The main tool for succeeding in the investment battle is so simple that a child can comprehend it: the scatter plot. By plotting the joint values of two things, the investor can determine whether and how much the things are related. The technique provides a way to understand almost all information about the stock market. We explain it step by step and show how to use it to analyze the effect of interest-rate moves on the market.

 

Chapter 9. The Future of Returns                                                                           

 

 In the twentieth century, stock markets in all major industrialized countries recorded returns on the order of 1,500,000 percent. That is the remarkable conclusion of three London Business School researchers who assembled a magnificent 102-year worldwide database on stock prices and wrote what we consider the best investment book available today, Triumph of the Optimists. We describe some systems we have developed from their database to improve on a long-term buy-and-hold strategy.

 

Chapter 10. The Periodic Table of Investing                                                            

 

We tell the story of Value Line’s beginnings from the perspectives of Sam Eisenstadt, the firm’s research chairman and Henry Hill, the Florida investor who made millions by religiously following Value Line’s systems. The tale includes Value Line’s conclusive demonstration of growth’s superiority over value.

 

Chapter 11. When They Swing for the Fences, We Run for the Exits

 

A remarkable predictive relation exists between baseball and long-term trends in the market, and it all begins with Babe Ruth.

 

Chapter 12. Boom or Bust?                                                                                      

 

Real estate, fixed and immovable, might seem to be an ideal alternative to a roller-coaster stock market. Yet real estate investment trusts (REITs) -- the main way in which small investors can invest in large-scale income properties -- have failed to measure up to stocks as long-term investments.  We demonstrate that great profits may come from studying the patterns linking real estate and business cycles.

 

Chapter 13. Market Thermodynamics.                                                                   

 

The fundamental laws of conservation and entropy are amazingly helpful in making predictions in a world of seemingly constant change. We demonstrate with experiments and a day in the life of Vic’s youngest daughter, Kira.

 

Chapter 14. Practical Market Lessons from the Tennis Court                              

 

Vic has won numerous championship titles in racket sports of all kinds, and in 2001 was among the first players to be named to the newly founded Squash Hall of Fame. He shares strategies that have proved useful both on the court and in the market, before, during, and after the game.

 

Chapter 15. Negotiating for an Edge                                                                       

 

Everyone has a right to state the price he or she is willing to pay. Investors should not hesitate to use bargaining methods to gain an edge in the market.

 

Chapter 16. An Amiable Idiot in the Biotechnology Revolution                

 

The main criticism of Vic’s first book was that it had a lot of principles, but nothing to help people make money. When we began writing columns, we found ourselves on the firing line every day to come up with specific recommendations. Readership of our column went up by a factor of 10 when we began mentioning individual stock purchases and sales. Happily, although our dedication to readers goes beyond the dollar and the clock, our stock-picking efforts on their behalf have not been without benefit to us. We put drug stocks on trial for money-making efficacy.

 

Chapter 17. Earnings Impostors

 

Constantly evolving techniques of “earnings management” have made net income—once known as “the bottom line”—a chimera. We show how to mine information in balance sheets and cash flow statements to arrive at a truer picture of a company’s financial health. Stock buybacks, dividends, inventory, accounts receivable, and tax payments all are helpful in differentiating between reality and artful distortions.

 

Chapter 18. Finale                                                                                                    

 

We hear four questions more than any others. We explain whether we use any technical indicators in our trading, what books we recommend for speculators, and why we say such awful things about Alan Greenspan. We also divulge the secret weapon that keeps us on our toes and eager to learn: a group of investors and sages we met through our columns. We communicate with them daily by e-mail to discuss market philosophy and strategy. We include a few of the tens of thousands of extraordinary posts these eagles have generously shared over the years.