Daily Speculations

The Web Site of Victor Niederhoffer & Laurel Kenner

Dedicated to the scientific method, free markets, deflating ballyhoo, creating value, and laughter;  a forum for us to use our meager abilities to make the world of specinvestments a better place.



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The Myth Thread

Victor Niederhoffer: The Power of Myth

Each group develops myths than enable them to survive and grow and create order out of the uncertainty and risk they are exposed to. The greater the uncertainty, the larger the number of myths. Usually these beliefs in supernatural and non-causal relations eventually get overturned by reality. And in the case of markets this overturning serves the function of paying for the frictional costs of the upkeep of the system. What are some of the myths that serve this purpose in markets? One would have to be the tried and true that bad economic numbers are a time to sell. Another is that if a market goes below a given level by say 3% that it is good time to sell until it goes above that number. This latter has the virtue that it takes a long time for its dissipation and thus the payment of the frictional costs based on the false belief takes longer to observe. Indeed all of technical analysis might be said to be based on similar myths. Another is that increasing p/e's in an individual stock or stock market are another reason to sell. Value Line was reinvented by Sam Eisenstadt on the overturning of that myth. It is bad when the readers of this site themselves become a sounding board for such myths as it makes all of our friends and ourselves so much poorer. And we are needed. We are needed. Please tell me some other myths that serve this fruitful purpose in our world.

Hanny Saad Comments

Other myths we make a living going against:

Ironically they are mostly from the eternal bestseller "Reminiscences of a Stock Operator"

Russell D. Sears Comments

Myth 2: You should make your decision based on experts' advice.

Form 1: That experts hold closely guarded "secrets" that if release to the general public would make all rich. Truth is closely guarded secrets are closely guarded because their release would make them worthless. Most infomercials and seminars start with a guy telling how he got tired of sitting on his yacht watching the babies sipping piņa-coladas all day, so he decided to make something out of his life by letting the little guy (i.e. you) in on these closely guarded secrets.

Form 2: The best way to get trading business is to give clear, unbiased, "best money can buy" advice to the clients. First no one going to give you clear specific advice, because they will be sued, if they are wrong. Second is they don't have some other motive beside getting you good returns. Finally, for those whose job it is to give advice, pay is generally measured in audience size, not how good you are. If you have audience then you are worth paying for either/or two reasons. 1. You pump up somebody's business, at the expense of the public. 2. You drum up more trades, encouraging the public to overtrade. If you really had a talent to trade, you would be trading full time, not touting full time. And if you are trading for a living, touting on the side, then any touting should be considered first a tout for your current position, not the public's best interest.

Form 3: That there really are experts out there easily identified. That if you are a CFA charterholder, or profess in finance, or a Harvard business grad, then you are an expert. The idea that expertise is exactly measurable. It is not a track and field event, easily decided who the best is. Further it is not a diploma or tenure, once you arrived you have it made, for the young beta male is always looking for the alpha dog to stubble, have a bad day. Also it is not a transferable skill to all markets, Gross of PIMCO giving stock advice, Buffet giving currency advice come to mind. Finally, it is not a lifetime ranking for as the great Soros proves, rankings do not deduct points for not entering enough tournaments. In marathoning I have seen many highly ranked drop out with 1/2 mile to go, if they are out of the money, for most rankings do not consider your DNF's (did not finish).

Kim Zussman Comments

Trial balloon myths:

  1. The purpose of markets is the efficient allocation of capital to industry
  2. Steve Wynn is wrong ("The way to make money at gambling is to own the casino")
    1. The mean Sharpe ratio of market traffic is higher than that of the toll booths
  3. A backtested recurring chart pattern with statistical significance
  4. Current human populations don't suffer from survivorship bias

T.M. Ryan Comments

Myth. A more complicated system is always better.

Reality. A more complicated system increases frictional losses and makes managing the system much harder, thereby requiring expert assistance/upkeep, which of course increases frictional losses even more.

This is not limited to markets

I believe that this myth arises from the fact that we have this bias against father random, and towards determinism and this is reinforced by myth. When confronted with events that we did not predict or do not understand we instinctively build more complicated systems in order to accommodate or explain. We are infused with the idea of Aristotle's "A or not A" so when confronted with "A and not A" we instinctively believe that there must be some unknown factor or complication behind this logical conflict.

A corollary to this is that bureaucracy in all forms creates complicated procedures as a means of self procreation and survival. (you need a lawyer to navigate your way thru civil court, you need a mechanic to fix your car, you need an accountant to do your taxes, etc). The financial bureacracy is no different.

Steven Ellison Comments

Another myth: risk is to be avoided.

Evolutionary psychologists believe that early humans, faced with a dangerous environment, avoided risks as much as possible. Taking a risk might mean losing one's life. The corollary behavior was panic: when risk aversion failed, and their lives were truly on the line, people scrambled madly, taking huge risks.

Today, most people take far too few non-life-threatening risks and hence fail to live up to their potential.

Daniel Flam Comments: Going Up the Mountain

It occurs to me that trading based solely on the charts could be compared to traveling on a mountain range walking backwards, and trying to predict the next cliff based on the gradient of where one comes from. Sure, you'll find most of the time, that the gradient *does* predict the next dip until the inevitable AHHHHH......... If only there were a way to put your foot out and feel the stock cliff without putting your full weight on it....

Ross Miller Comments: The Myth of Math

It ain't the math, it's how you use it. I think that this is the key message of the transcendental spec, who does appear to use math to beat the market. To paraphrase myself wrt/LTCM: Assume infinite capital and infinite liquidity and you get infinite grief.

James Sogi Comments

There are two great myths: randomness and fate. Events are not truly random, but rather the causes of events elude human comprehesion and prediction. The history of science is the road from ignorance to understanding and prediction. Ancient and modern man attributed events that they do not understood to either noncausal circumstances or to forces beyond their control. Mathmaticians speak of randomness; investors speak of the Fed, the economy, and Goldman Sacs moving the market. While philosophically randomness and fate are opposites, for the human faced with the crux of decision, they have the same practical effect. The unfolding of events, whether explained by randomness or determined by fate, are both unknowable and uncontrollable. Human nature seeks order, thus the tendency towards fatalism and mythology. As objectivists, we must reject not only mythology and fatalism, but also the myth of randomness, and extend the boundary of science into the foggy realms of the random world.

T.M. Ryan Responds

Sorry Jim, forgive me but I am compelled to rebut this to a certain extent. I think that the implication of quantum theory, which as feynman once said, if you aren't shocked by it then you truly don't understand it, is that the world is fundamentally undetermined. And probabilistic. That's not to say that there isn't order underneath much of what we perceive to be random, maybe sometimes there is and maybe sometimes there isn't. In any case, in a social system like a market whether there is an order underneath the random results is a moot point anyway because the arrow of time flows in one direction only and because you can't stop time you will never be able to fully study and comprehend the system in its entirety. The system is constantly changing, and we have heisenberg's uncertainty to contend with in our measurements. Hence the need to embrace randomness rather than reject it, which is in opposition to superstition which has historically ascribed some type of deterministic cause to the events which confront us in our lives that we might perceive as capricious. It seems to this poor speculator, that the lesson of the last 100 years of science, physics and ecology in particular, seem to be pointing out that the more we drill down to understand, shed light on the unknown as you have so aptly put it, the more indeterminate we find things to be.

Like the discussion on noise that we had last year, I often find, to use another quote from feynman, that often when stuck on a problem it is useful to invert, "always invert". In other words would it be more fruitful to accept that randomness is simply a part of life and focus instead on deviations from randomness when they occur, in an attempt to find causal relations and the possible future implications of those occasional deviations from randomness. This might prove more useful to the speculator who requires actionable ideas. This is somewhat of a timely topic for me at present as just the past two weeks I have been looking at deviations from randomness in market movements, and testing large deviations from randomness as trading signals and finding actionable ideas from this.

As an example, Mandelbrot was right when he saw all of these natural phenomena described by power/weibull functions and one can readily demonstrate the same with survivor distributions of earthquakes, rainfall events, durations of economic expansions, and yes open market prices as a number of us have struggled with in the past. But as Alix Martin was quick to point out, the knowledge of this form in and of itself does not provide predictability in the timing of the next tail event- only the general form to which the long term record holds.

Along these lines one good book that I have enjoyed in the past is - Fire in the mind, Science, Faith, and the Search for Order by Johnson.

James Sogi Responds

Tom, Thank you for your very enlightening comments and admit that you have hit to my "weak" hand. I don't fully understand Heisenberg or the implications that The more precisely the position is determined, the less precisely the momentum is known in this instant. Feynman's idea of inversion, as you describe, is brilliant as is your analysis of statistical method is to use randomness as a base assumption rather than a barrier to compute relationships. Randomness is the hypthesis. However, I think that you agree, that underlying the assumption of randomness for the sake of computational ease, is an reality, albeit ultimately unknowable. But the problem of creating an actionable thesis still remains, though you have a method for quantification. The time line drives inexorably forward, and waits for no man. We must have a thesis for action. As Popper and Snedcor confirm, tests of significance act as a rule to accept or reject a hypothesis. This allow one only to reject and never prove a hypothesis on the basis of observation. My point is, and I don't think we differ so much in principal, To accept randomness as reality rather than as a hypothesis would leave us on the level with the mystics and and other followers of randomness and bally hoo. I accept your use of randomness as a hypothesis to test alternate hypotheses for their significance.

Kim Zussman Responds

From the department of where one's nose sticking shouldn't be:

Quantum particle behaviour may be best modelled, with uncertain human mental limitations (a different answer for brains bigger than Texas?), on a framework of randomness and probability. Not to worry.

Detach for the moment from the thin shell of human existance and consider:

That randomness may only be the current heuristic expanation of the unknown, like pagan gods of the ancients The mind is finite-there are not infinite neuronal connections nor potential connections (Hint-you can weigh the brain) The possible pathways of human judgement are finite The sum of human minds participating in market-moving impetus is very very finite Then market behaviour is not random, but just appear as such to human brains observing same.

Think of a much higher evolved intelligence (from somewhere else..) running their "functional MRI's" on every human market participant. It won't take long, they are very advanced. On individual basis, all of your learning and reactionability is mapped and they can and will tell you anything you will think or do when confronted with X. So what Mohammad will do is knowable, along with Dr Greenie, GW, Putin, and even hedge fund honchos.

Our problem is we don't have this scanner (yet?), so isn't it hubris to assume the unknowable is random?

Karamvir Singh Bisht Comments

Like the discussion on noise that we had last year, I often find, to use another quote from feynman, that often when stuck on a problem it is useful to invert, "always invert".

As related by Mr. Ryan, the "always invert' advice by Feynman seems to have been the concept that started the ball rolling for the scientific method in the sense that it led , for the the first time, to Kepler s theory of planetary motion which was not inconsistent with the observed facts courtesy of Tycho Brahe. As Gribbin describes in "Science - A History", Kepler was struggling with the problem of the different orbital speeds of Mars when near the Sun and further away. The observations just could not fit into the circular orbit theory. He then 'Inverted" his point of view to calculate the orbits as if he was an observer on Mars. This then led to his elliptical orbit theory and the other laws thus consigning the "elegant" theory of circular orbits, epicycles etc to the department of myths.

Joseph Zuzevich Comments

Kevin mentioned an interesting point. Most myths attempt to protect believers from something. I question the idea that chartists are protecting themselves from profit. Most of the material that i have read on charting suggests use of stops (in case the future fails to materialize as expected). The myth doesn't protect the user from profits, it keeps the user playing. Is a postive feedback loop...trades that are randomly sucessful reinforce the power of observed pattern. Using the chart to set stops for patterns that fails allows user to keep searching for the pattern. Regardless, user keeps trading.

Makes me wonder how you can quantify the value of stops.

Ross Miller Responds

May I suggest the excellent best-selling book "Market Myths," by Kenneth Paine, the top performing mutual fund manager over the past ten years. This former Rhodes Scholar uses examples from Greek, Roman, Hindu, and assorted mythologies to show you how to make big bucks in the market.

Drat, he's from my fictional world.

Peter C. Earle Comments: Another Myth

"Stock markets are a zero-sum proposition."

A particularly dangerous myth given that under certain conditions it exhibits aspects of veracity: specifically, conditions of time horizon. An individual staying away from equity markets under the belief that stock markets are a 'zero sum game' should be informed that in general, over a short-term time frame certain traders and speculators will indeed deliver some or all of their capital to other traders in a way evocative of a so-called zero sum game. However, considering the value proposition offered by equity ownership, voting participation, dividends, and in particular the demonstrated long-term return on equity investment (1,000,000% in the last century, for example), over a long-term time horizon stock ownership is quite definitively a positive sum game.

Linden Doerr

At first, everything was myth. Everyone feared everything. There was counting and differentiation but they were yet a weak defense against fear and myth. A giant myth maker, P, spoke of caves and philosopher-kings, telling the world that fear and tyranny are joined at the hip. On the shoulders of this giant stood another, A, who taught the world logic and how to avoid the fear. For many years, his word ruled. But fear returned and so did myth and so did tyranny. Almost 1000 years of darkness later, T rediscovered A and the light began to return. And then, three hundred years later, another giant, B, told the world of hypothesis and experiment and proof, and the scientific method was born. More light. Another three hundred years passed and then the giant, G, developed statistics so that phenomena where effects with multiple causes could be (incompletely) explained with sampling, in the form of X = Y + Z + e, where 'e' is the error resulting from sampling and the incompleteness of the discovery of the multiple causes. (But 'e' is most important because omniscience is the illusion offered by the myth-makers.) Finally came H and R to tell the world how human action worked and ought to work, most importantly authenticating everyone's mind and his right to act in self-interest . Now there is no excuse for fear and myth, but they continue. It is far easier to appeal to fear because it demands less. And in demanding less of themselves, people give themselves up to fear and tyranny. The struggle continues because everyone can choose. Now someone like Janeane Garofalo, another in a long line of worthless myth-makers, would consider this to be the dead white man ravings of a right-wing lunatic.