Daily Speculations The Web Site of Victor Niederhoffer and Laurel Kenner


April 1-15, 2006


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Bacon and Turf Betting, by Kevin Depew

Great Bacon summary, thank you.

Sometimes it can seem that Bacon and others (Cramer, Mark not Jim) are suggesting that the professional turf player is simply looking for "THE overlay" in the race, as if races are broken down into two categories - those with an overlay that the turf player can choose to play or not play, and those without an overlay that the turf player must choose to pass in order to maximize the slim potential for long-run profitability. If only life were so simple.

The reality, at the track as in markets, is that a race may contain many overlays. The task is to choose which overlay to play. This is where many turf players fall short. And this is where speculation at its finest enters the picture. What if there are three or four overlays in the same race?

Bacon's advice to always be thinking differently from the public, at first sounds quite reasonable and almost facile, but it might be just a bit more complex. Someone asked me not long ago, what is the best way to learn to handicap a horse race. I’ve thought about the question for a long time because I'm about to start "training" my 9-year-old son in horseracing degenerateness.

I came up as a horseplayer the hard way - absorbing all the nuggets of conventional wisdom and accepted tenets of handicapping as handed down from one generation of losing player to another. Lord, it was expensive. How nice if someone educated as a speculator at the track would have passed along some of the lessons I paid so much money to learn? Well, the truth is I don't I think it would have helped all that much. At least it wouldn’t have helped me.

Haruki Murakami once wrote that, "If you read what everyone else reads, you'll think what everyone else thinks." Thinking what everyone else thinks is quite comfortable. Most of us prefer it even as we generate advertising campaigns that say each of us should "Think Different" - the irony of a marketing campaign exhorting all of us to buy the same product, therefore uniting us in our thinking different-ness! If there is a secret to professional turf betting, or speculation of any kind, maybe it is hiding somewhere between Bacon and Murakami. Yes, if you read what everyone else reads, you’ll think what everyone else thinks, but understanding what everyone else thinks is critical to choosing a different path.

Bacon is at once dismissive of the public’s goal – finding the secret to winning at the track, the foolproof method that involves the least amount work – but he is sympathetic too. I think that his sympathy, Bacon’s cry - “He has no right to lose so much. It's almost as if he did it on purpose!” - is a profound insight. It is a necessary relationship between the winning individual at the track and the public at large. That sympathy keeps them playing, and as long as they are playing, the game can continue. Hurt them too much, or let sympathy descend into pity, and everything falls apart.

Everyone hates a winner, maybe it brings too close to us a sense of finality and conclusion - a reminder of the ultimate finish line we will confront; truly we will all be winners in the end. Hope, on the other hand, springs eternal, and losing affords the public an endless amount of hope - the next race will be better, there's always next year, tomorrow's a new day, hope for the best.

Steve Leslie comments:

One of the great quotes attributed to President Reagan with respect to the Soviet Union and their disclosure of weapons was "Trust but verify." The esteemed Chair says it a bit differently; to paraphrase: "test, test, test" and if in doubt "test again."

Now this is where I might take exception to Haruki Marukamis statement. "If you read what everyone else reads, you'll think what everyone else thinks."

This is not necessarily a bad thing provided you are reading the right things. IF you are reading the right "things" you are shortening your learning curve. and after reading such "things" You are working and expanding on the thoughts and views of the "things" that you just read and adapting them to your own particular skills, styles and limitations. It is up to the reader to ferret out the relevant and useful from the useless. I once heard a motivational speaker say knowledge is not power applied knowledge is.

You are thus climbing up the "intellectual food chain." By accepting everything at face value or blindly grasping at concepts and straws, you are merely being mentally lazy and driving down an expedient and lonely road to ruin.

This is where wisdom separates itself from knowledge or "information." This is what differentiates the achievers from the average. They are willing to go the extra steps to put the extra effort in go the extra mile. It only takes a nose difference to be declared the Kentucky Derby champion. Many races have been decided by photo finish. Now the winner gets the lions share of the prize pool. Even though the horse may have won by a blink of an eye. Is it fair. Not necessarily but as they say down home " that's how they do it!"

And you know something that is how they do it in real life also. Sometimes all it takes is that little bit more effort that one extra step that one extra push that one idea, that puts you onto the summit.

Does the Market Mistress Play Dice? by Victor Niederhoffer

A question I often have in the back of my mind is, "How long will it take for the market to show her full repertoire of moves?" For example, if you've had a string of 12 Wednesdays in a row where stocks were up, when will the mistress give you that next down Wednesday? What is the probability that the next Wednesday will be up? And what is the expected lifetime of the number of Wednesdays that will occur until you get the next down?

The question has theoretical and practical implications. According to the strong form of the random walk theory of market behavior, the distribution of future price changes is not affected by its previous path. According to the weak form, no inordinate profits, or at least no inordinate profits adjusted for risk are possible based on past price moves alone.

I like to approach the problem in practical terms as a variant of the hot hand problem. What are the chances that if a baseball player is hot, he'll get a hit the next time up. But more to the point here since I'm concentrating on the full repertoire is this. Consider the pitcher with four good pitches, a fast ball, a curve, a change up, and a slider. Given that a batter hasn't seen a certain pitch in his last three at bats, what are the chances that he won't see it on the fourth? Does the chance change when he hasn't seen that certain pitch for 4, 5, of 6 of the last pitches, and what is the expected number of pitches he can expect to see until that unused one comes up.

There are numerous anecdotes we know of in sports where the hot hitter or shooter knows that he's due for a certain pitch based on the past. That is the essence of strategy in these games.

OK, I'd like to apply this approach to markets. There are a plentitude of ways of attacking the problem. I'm going to concentrate on the occupancy problem approach. The market has four different patterns she can throw at you. What are the lifetimes in days or hours you can expect until you see that full repertoire?

A typical four pattern might be morning and afternoon of one day and morning and afternoon of the next day. Or, the last four days of moves up or down in a market. Let's say that each day can be up or down. Then there are 16 different permutations of (+) and (-) in the four days that can occur.

The 16 permutations ( 8 of which shown ) are:

             Day 1    Day 2         Day 3   Day 4
              -        -             -       -
              +        -             -       -
              -        +             -       -
              +        +             -       -
              -        -             +       -
              +        -             +       -
              -        +             +       -
              +        +             +       -
              .        .             .       +

Now given that one of these 16 hasn't occurred, in a few days, does it become due? Does the market mistress have a limited repertoire which she stores up, and throws at you when you haven't seen it for a while?

The problem is similar to the classical occupancy problem which has wide applications in almost all aspects of science. The mathematics of the problem are covered well in Ion Saliu's Monty Paradox; the classical occupancy problem.

As "always," the answer is a variant of 1/e. And the answer depends on a very exact definition of the problem and a very exact model that you attack it with. See for example the discussion of how Bose-Einstein models and Maxwell Boltzmann models would answer the question of "Suppose we place three indistinguishable balls at random into three buckets. What is the probability that one bucket will contain exactly two balls?"

I am going to concentrate on a event that's fairly common in the market to start the ball rolling, to prove that the market mistress likes to use up her full repertoire. I'm going to look at an event has four outcomes, for example: big up, small up, small down, or big down. Then I will look at four consecutive days of such events and look to see when one of the outcomes hasn't occurred, and whether it's more likely to occur than randomness.

How long on average will it take for all four outcomes to occur? What are the chances that each of the outcomes will appear once and only once in four consecutive events? That problem is relatively easy. Any of the outcomes can occur on the first event. Then it's 3/4 that one of the other three outcomes will occur on the next day, and given that two of the separate outcomes have occurred, its 2/4 that the the third outcome will occur on the third day, and 1/ 4 that the fourth outcome will occur on the fourth day. Thus, the chances that all four outcomes will occur on four consecutive days is 3/4 x 2/4 x1/4 = 6/64 or a little less than 1 in 10.

Let's look at a typical four outcome event in the market based on the directions of change in the previous (open to close) and the next open.

There are four possible outcomes:

    Pattern        Previous open to close          Next Open
       1                    +                           -
       2                    -                           -
       3                    +                           +
       4                    -                           +

In four consecutive days there are 256 ( four to the fourth different permutations of the four patterns that can occur). Do the four consecutive four different ones occur more than they should? What is the degree of certainty that the four different ones will occur in n realizations? There are a number of approaches to the problem and the short answer is that the full occupancy model, does occur too frequently for chance.

Here's one approach based on lifetimes which we like to use in these offices for humble purposes. Consider pattern #4, up (open to close) followed by an up (open).

What is the expected number of days, the lifetime to its next occurrence, given that it hasn't occurred on n days? Does the lifetime go down as the number of days in a row it hasn't occurred goes up? The baseball analogue is given that the pitcher hasn't thrown a curve in the last few pitches, what are the chances that he'll throw one the next time?

Expected Lifetime to Next Success:

For: an Up (open to close), followed by an Up (open),

after it hasn't
 happened in
 # of days                    # of obs
   1                  4.0            357
   2                  3.8            276
   3                  3.7            207
   4                  3.8            146
   5                  3.5            116
   6-10               3.3            239

A question, an approach, an answer -- a meal for a lifetime . And more important, a nice way of looking at the market. I encourage other contributions and approaches.

Prof. Charles Pennington offers:

Since 1996, S&P futures -- Drift adjusted (meaning I drift adjusted separately all the close to opens and opens to closes).

down down=0
down up=1
up down=2
up up =3

Look at the most recent 4 numbers. There are 256 possibilities (4*4*4*4). There are 24 possibilities for which none of the numbers repeat: 4*3*2*1=24.

One expects a fraction 24/256 of the sequences of 4 to have no repeats, and 24/256 is 0.09375.

Actual frequency of no repeats was 281 out of 2581, or 10.89%.

Expected is 0.09375*2581 = 242.

Probably the statistical uncertainty should be something like sqrt(281), which is 17.

281-242 is 39, which is more than twice as large as 17. So it seems there are an inordinately large number of no-peats.

Hal White and Friends, by Dr. Philip McDonnell

Dr. Kim Zussman brought us yet another interesting study:


(We) Use bootstrap procedures to show that some high-alpha mutual funds have persistent out-performance, especially in growth fund:
We test whether the estimated four-factor alphas of "star" mutual fund managers are due solely to luck or, at least in part, to genuine stockpicking skills.

After reading the study it is not clear that the entire conclusion is warranted. The figures shown as the bootstrap alpha t-statistic in Table VII on p. 49 seem to indicate that only the top fund each year may show significant alpha. On the other hand the bottom deciles 6 through decile 10 generally show statistically significant negative alpha.

The point is that the methodology of the study is very good at picking out inferior performance by what appears to be about one half of the mutual fund industry (!) but not very effective at identifying top performing funds, with the possible exception of the single top fund itself.

The reasons that half the funds under-perform are probably two fold. First, some may be proactively incompetent money managers to the extent that they are non-randomly picking bad stocks and exhibit poor market timing. Secondly, some may be crooks and are simply robbing their investors in one way or another. In some cases both factors may be at work.

In any event it appears to me that the four factor methodology employed in the study cannot reliably pick a good performing fund, but it can help one avoid the entire bottom half of the spectrum. On the other hand it may be a good model for regulators who wish to weed out the crooks from the majority of legitimate funds.

Jeff Rollert Finds an Article from the WSJ on Animal Behavior

"Buffalo Seek Consensus And Other Tales of How Animals Decide Things" April 14, 2006

The Manyara buffalo of Africa begin stirring from their postprandial rest just before dusk. Each beast raises its head higher than usual and gazes into the distance.

After much shuffling around, the herd treks toward a new grazing ground, but not in the direction -- north-northeast, say -- that a majority have set their eyes on. Instead, the buffalo compromise. They perform the bovine equivalent of vector algebra, biologist Herbert Prins of Wegeningen University, the Netherlands, has found, choosing a direction that represents the weighted average of the directions the members of the herd have "voted" for.

Compromise, consensus, plebiscite: When it comes to decisions, the animal world is as diverse as the human one, providing a menagerie of approaches that scientists believe can illuminate decision-making in groups of people.

In contrast to the buffalo's compromise strategy, Cuban leaf-cutter ants are more likely to follow the crowd. When placed in a box with two exits, the ants use each about equally under normal conditions. But if scientists drop insect repellent into the box, the panicked ants follow the herd: An average of 75% try to get through only one exit, scientists at the University of Havana reported last December in American Naturalist. When people do that, as when fire breaks out in a crowded room, the result has been multiple deaths.

Honey bees, biologists recently figured out, prefer quorums. In late spring, colonies divide, with the queen and half the workers leaving the old hive. The swarm forms a cluster outside its old home and goes about finding new digs. But the queen doesn't choose. Instead, the bees engage in what biologist Thomas Seeley of Cornell University calls "a plebiscite, where once you have a quorum in favor of one site it wins."

In a swarm of 10,000 bees, several hundred "scouts" visit a dozen or more tree hollows. Each visits only one site; there is no comparison shopping. When a scout returns to the swarm after finding a great site (lots of space, small entrance), she shows her enthusiasm for it by dancing. Much as the "waggle dance" tells other bees where to find food, the dances of scout bees tell watchers the location of prime real estate.

"When a scout really likes a site, she dances her little heart out," says Prof. Seeley. The number of times she scoots around the dance floor reflects her enthusiasm. The more circuits, the more uncommitted scouts follow her directions, also becoming recruiters for the site.

A scout that loves a site visits it repeatedly, returning to the swarm after each sortie to dance about it. But with each reprise she makes 15 fewer circuits, Prof. Seeley and colleagues will report in the May-June issue of American Scientist. (Enthusiasm dims with time.) As a result, scouts that visited mediocre sites and so performed shorter dances from the get-go eventually stop dancing for that site (Subtracting 15 from a smaller number gets you to zero sooner than subtracting 15 from a larger number.) Soon, uncommitted scouts are being recruited only to top sites.

Once scouts find a quorum of 10 to 20 bees at a site, they emit a high-pitched sound that tells other bees in the swarm to warm up their flight muscles. After an hour or so they take off for their new home, scouts leading the way. "The beauty of this process is that quorum sensing results in selection of a great site even though no one scout knows all the alternatives out there," says Prof. Seeley.

Even cockroaches manage to make collective decisions that, seemingly by magic, produce an outcome that benefits everyone (except the people whose kitchens they are in). When roaches decide where to move in, they must balance crowding against protection against predators. The goal: pack enough roaches into a shelter to provide strength in numbers, but not so much that dangerous crowding results.

When scientists put roaches into a dish containing identical shelters, they thought the roaches would fill one shelter and then use others for spillover. But the gregarious bugs defied expectations.

When more than half the bugs could fit into one shelter, they divided into two equal groups: For instance, when 50 had a choice of three shelters, each with a capacity of 40, 25 cockroaches gathered in one, 25 in another, and none in the third, biologist José Halloy of the Free University of Brussels and colleagues reported last month in Proceedings of the National Academy of Sciences.

Dividing up evenly, he says, "spreads benefits and risks among all individuals," rather than having 40 bugs safe and happy while the 10 for whom there was no room at the inn suffer. But when each of three shelters could hold 70, all 50 cockroaches packed into one. Each outcome was optimal, producing the greatest safety in numbers without crowding.

Yet no leader assigns lodging. Roaches just check out shelters, with later arrivals deciding that a crowd signifies "this is the place to be." Overcrowding means "find somewhere else." A group decision that perfectly balances protection and crowding emerges from dozens of such individual decisions.

Ideas Have Consequences, by Victor Niederhoffer

That's the thought that motivated me to study the stock performance of a company whose founder believes that he should never buy a technology company because he doesn't understand it, and that he should buy traditional companies whose products don't change from year to year, like shoe companies, retail candy stores, carpet manufacturers, mobile home companies, and companies with a brand that insures steady growth since it has been so well known throughout the world for so many years, and people never change their drinking habits. I have been criticized for taking a short position in such companies from time to time, and also for indicating that I don't believe that such a message has much mojo for those who try to follow this message in their own investments; as so many of the awards winners at the recent Mar meetings apparently do also as some of them quoted the elder partner of the founder to the effect that Simple and Understandable and Value is best.

But my views have to be tested. Thus in honor of this simple method, I calculated for the last five years, what would happen if every time this company performed better than average in the week: you sold it, and every time it performed worse than average in the week: you bought it.

The results for Moves in the next week following under and over performances:

                          Average       Std       Count     %Up
 Performs Better
 in prior week.           -0.14%       2.9%       159        48
 Performs Worse            0.55%       3.7%       158        55
 in prior week.

I would like to thank Mr. Dude Pomada for his calculations on this project that won him a fish dinner for two. I will run his extensions past the Minister and hopefully report them as this is a retrospective study, and one starts with the knowledge that during the last six years, when half the books sold have extolled this stolid founder's message, the stock itself has shown mediocre performance at best. Thus, the results are by no means generalizable.

Gerry Bertier, from Steve Leslie

Who was Gerry Bertier?

I doubt anyone has ever heard of him. I never had until I watched "Remember the Titans" on TV last evening. . He is one of those marvelous people who without the aid of being memorialized in a movie, I never would have.

The star of the movie was Denzel Washington, but the hero of the movie was Gerry Bertier.

So big deal, who was he? In 1971, he was one of the top 100 high school football players in the country. Highly recruited with offers from many colleges including Notre Dame, his football career ended when he crashed his new Chevrolet Camaro and became paralyzed from the waist down. This was just after his team had won the state high school football championship in Virginia and they were proclaimed one of the top football teams in the country. The cause of the accident was deemed to be a faulty motor mount.

He just happened to be in the wrong place in the wrong car at the wrong time. Gerry did not let this stop him from his greatest dream of participating in the Olympics. Not the Summer Olympics of course, but the wheelchair Olympics. In fact, he won a gold medal in the wheelchair Olympics in the "Shot-put" event.

Gerry spent the remaining years of his life, helping the handicapped obtain easier access in the world. He died in 1981. There is a scholarship in Virginia named after Gerry Bertier and his legacy lives on 35 years after his high school playing days ended.

Other than that I don't know anything else about the young man. I do know this, every day on this planet is a gift, a blessing from God. We all complain about the hardships we may have had to endure until we meet a Gerry Bertier. If not in person, perhaps through a book or a movie. It is at that moment that we need to step back, reflect on our lives and truly give thanks for all the marvelous things that we have received in spite of ourselves.

Thoughts on Diet and Training, from James Lackey

When training for the 2004 Grand nationals for BMX, I came to the conclusion about six weeks out, I could do "more" was a perfect "diet." That was an answer to the question "are you doing everything possible to succeed"

I knew the "gist" of diets from the Army. I had anecdotal evidence of "what was best for me" in my many years of racing. Now I just had to find the exact formula, routine to maintain power to weight ratio and to so called "Peak 6 weeks hence." The exact calories for 6 days of vigorous training and racing was divided to Protein 240 G carbs 287 G and Fat 47G with a 10% increase every 3rd day.

I had 2 problems. The first was my stealth tactic of arriving a week early and racing the grands track and not practicing the "event practice" two practice days prior to the race. The tactic was to rest while others worked, to be at my best after 12 hours of Qualifiers on Sat and 6 hours of Semi finals on Sunday and hopefully peak Sunday at 5pm. That seemingly was a huge edge as 50 of my friends did that routine for 2005.

My biggest problem is always on race day. I can't eat. Its much like a marathon racer that cant eat for the duration of the pre race and race. A simple solution of carb packs, sugar or Red bull as we do not have problems with dehydration prior to a 60 second sprint.

The problem is not being amped for the lap after one hour of rest prior to each 60 second sprint. On Sunday, you can be eliminated at any single race by not making the top 4 in the semis. All season I tested Red bull, sugar (look both ways caffeine which everyone said was stupid as it dehydrates you) Anyways almost everything caused a sharp spike and gave me the shakes and I smacked the starting gate, over cleared the first set of double jumps etc. It was in my head that none would work. What I did was wake up at 5 am eat pancakes, take a nap and diluted 50% Gatorade and water all day all season.

I stumbled on to 2 things that worked for me. One was an slight increase in body fat to carry me through the weekend. Next was caffeine to actually dehydrate myself by 5 pounds just prior to the end of the day, (after being over-hydrated all day) then a quick gulp of sugar (alertness) and a water bottle to keep mouth wet in staging lanes. It all seemingly worked. My fastest lap times and best performances were always in the main events.

Back to the point of food harmonics. I read all sorts of studies on Almonds carry a certain frequency etc and I kinda just gave research up there. It was too far over my head or mumbo. I dunno I just stopped.

However I did find what Vic has said many times about over all health. The amount of time food stays in the body has a correlation to overall health. It certainly did with performance. I did not eat much or any meat for protein 10 days prior to the Grands. It was protein bars/ nuts that supplied all my daily Fat and Protein requirements. It was awful. Yet, between training, resting, a bit of strategy that was successful Ive never felt better in my life.

Perhaps there is much to be said for working out, simple carbs, nuts and food harmonics. There are certain bottles drugs and supps that help (supposedly) the bodies ability to release lactic acid. That is every athletes "wall" I never bought into that idea as with any drug or performance enhancing agent, once you are with out it or wrong amount you are worse off than baseline. Therefore I always used training and work to hit the wall 1-foot after the finish line.

"Patrick said adding or subtracting anything from the eventually arrived at ratio, just lowered the frequency. (It wound up with 10 different ingredients). Research indicates that foods with an over- ride frequency of 72MHz or greater increase the body's bioelectric energy. Foods below 72 MHz deplete the body's energy.

Patrick says cost was never considered, only foods that potentiate the greatest life force energy were chosen. (This would explain their higher cost). He measures processed foods from 10MHz to 30MHz, fresh organically grown foods from 30MHz to 80MHz, and an average of 83MHz for ordinary super-food products. (Thus, his claim Life Source provides up to 36% more vital energy)."

Et tu, Governor Olson? by George Zachar

We have a Fed-misuing-futures Daily Double today. First Kohn, and now Olson:

With respect to inflation, although forecasting energy prices is risky, I should note that the futures market suggests that crude oil prices will move up a bit further in coming months before flattening out at $70 per barrel. If so, the drag on real income and spending from rising energy costs should diminish over time, as should the risk of additional energy cost pressure on underlying, or "core," inflation.

My takeaway, which is an obvious one, is that the Fed staff must be propagating this line of analysis for it to emerge so regularly and consistently in the bank's public pronouncements.

A corollary: the staff of the central bank of the world's reserve fiat currency is really really clueless.

More Chess Wisdom Carried Over to Trading Philosophy, by Michael Cook

I often think of something I read in Richard Reti's book, Modern Ideas in Chess.

"Those chess lovers who ask me how many moves I usually calculate in advance, when making a combination, are always astonished when I reply, quite truthfully, "as a rule not a single one." ... the power of accurately calculating moves in advance has no greater place in chess than, perhaps, skilful calculation has in mathematics."

More important to him than such calculation was a grasp of the position. There are won positions and there are lost positions which can be perceived without calculation. In Chapter One he says:

The earliest books on the game... are written by masters of that period, and, from the beautiful combinations contained in them, we recognize, quite distinctly, the chess talent of the particular authors. But on the whole they were groping in the dark, for the gross and glaring errors that occur in those works lead us to the conclusion that to obtain an accurate grasp of a position, or "sight" of the board, meant as much trouble to the experienced player of that time as it does to the beginner of today.

Application to trading: I ask myself, "Do I like my position?" and, "Do I like my portfolio?". I don't like to try to predict what's going to happen - this is like trying to think 10 moves ahead in chess. I prefer to form an understanding what is happening, and position myself accordingly.

GM Nigel Davies Warns Against Complacency...

It's the kind of thing strong players sometimes say to make a point. There is a lot of 'feel' in chess, but to thing there is no calculation involved is very naive. Korchnoi has to calculate a lot before he gets a sense of what's going on, Smyslov much less. The calculations act as a kind of probe into the position which give players a sense of what's happening.

Anyway, here's a game of Reti in which it looks like he played 29.Kf1 without calculating when 29.Kh1 Nd4 30.Qxe5 Nxb3 31.Nb6 would have denied Black the vital 31...Nd2 CHECK resource. Back to the drawing board...

Reti,R - Lasker,E [D15] Maehrisch Ostrau Maehrisch Ostrau (9), 1923

1.Nf3 d5 2.d4 Nf6 3.c4 c6 4.Nc3 dxc4 5.e3 b5 6.a4 b4 7.Na2 e6 8.Bxc4 Be7 9.0-0 0-0 10.Qe2 Nbd7 11.b3 a5 12.Bb2 c5 13.Rfd1 Qb6 14.Nc1 Ba6 15.dxc5 Nxc5 16.Ne5 Bxc4 17.Nxc4 Qa6 18.Bd4 Rfc8 19.Bxc5 Bxc5 20.Qf3 Be7 21.Nd3 Nd5 22.Nde5 Bf6 23.e4 Nc3 24.Rd6 Qb7 25.Re1 Bxe5 26.Nxe5 Qc7 27.Nc4 e5 28.Qf5 Ne2+ 29.Kf1 Nd4 30.Qxe5 Nxb3 31.Nb6 Nd2+ 32.Kg1 Nc4 33.Nxc4 Qxc4 34.Qf5 Rab8 35.e5 b3 36.e6 fxe6 37.Rdxe6 Rf8 38.Qe5 Qc2 39.f4 b2 40.Re7 Qg6 41.f5 Qf6 42.Qd5+ Kh8 43.Rb7 Qc3 0-1

GM Nigel Davies Brings Pattern Recognition into the Discussion...

Two interesting articles on the role of pattern recognition in chess skill, one by IM Jeremy Silman:

The Psychology of Chess Skill

Secrets of Chess Intuition

Silman asks an interesting question; what is the difference between pattern recognition and intuition? The point is that typical patterns often arise in chess, but the exact configuration will almost certainly have some original features which set it apart from the 'kind of thing' we've seen in the past. There is something at work beyond the primitive identification of salient features.

The World According to (Fed Governor) Kohn, by Steve Ellison

To say that participants in futures markets expect prices to remain approximately the same is at best a tautology. Aside from net present value considerations such as risk-free yield and storage costs, participants who expect the oil price to go up buy, and those who expect the price to go down sell. Thus the current price should already reflect the expectations of future prices.

Dr. Zussman in January brought to the List's attention a paper by Kat and Oomen that showed that average physical commodity returns approximated roll returns. Hence the expected return of a commodity in contango is negative, at a .05 significance level in the case of crude oil.

From Friend of the Chair Nassim Taleb, An Announcement of Note...

Infovest21 Staff

April 5, 2006 EST

The LongChamp Non-Gaussian Fund, which has been live since January 1 trading with about $20 million in propriety capital, is expected to launch in May to outside investors. The fund, which consists of a diversified portfolio of option-based strategies, currently allocates to eight managers but plans are to increase that over time. Nassim Taleb will play an active role in the fund.

The diversified, long tails multi-manager fund aims to benefit from large market moves while producing positive carry. The fund targets annual returns of 6-10% during quiet markets while being positioned to earn upwards of 50% in the event of a traumatic 1987-style crash.

The fund aims to benefit from the fat tails, the non-Gaussian attributes of the market; produce high return during financial crises; and gain from high volatility while earning positive carry during quiet markets.

The fund's investment philosophy is based on the empirical notion that markets rarely experience medium volatility. Most moves are either extremely violent or very mild. The Gaussian distribution implies that close to 68% of market moves take place within +1 or -1 standard deviation. Empirically, markets actually tend to spend between 80 and 95% of the time within this range.

The LongChamp Group, established in 1981 and which has about $1.2 billion in alternative investment and funds of funds assets, is the sub-advisor for the manager of the fund. LongChamp Management International Ltd is the manager of the fund. The LongChamp Group is an affiliate of Silvercrest Asset Management Group which currently manages over $6.3 billion, primarily for families as well as endowments, foundations and other institutional investors.

Nassim Taleb, author of the book "Fooled by Randomness" as well as a specialist on risk, derivatives hedging, portfolio protection and model risk, will act as a "vigil" overseeing trader selection and providing his comments to the manager of the fund. He will set up the analytical tools and methods to alert the fund to purchase additional insurance when necessary and will actively review the risk exposure in all sub-manager portfolios, focusing on each individual risk.

The fund consists of a diversified portfolio of option-based strategies, each exhibiting asymmetric return profiles. The fund currently allocates to eight managers but plans are to increase that to 12 to 15 over time. It may invest in bounded arbitrage positive carry managers, short credit managers, long volatility low carry managers, pure long tail managers, the stub as well as others.

The minimum investment in the fund is $1 million. There is a 1% management fee and 10% performance fee. Redemptions are permitted on a quarterly basis with 60 days notice.

Deloitte & Touche are the auditors of the fund. Farara Kerins is BVI legal counsel. Sterling Management (1985) Limited is the administrator.

A Review of "Secrets of Professional Turf Betting", by Kedrick Brown

I recently had the privilege of reading Robert Bacon's "Secrets of Professional Turf Betting."

Thanks to the chair for recommending this outstanding book. I am impressed with the unique and engaging way in which it explains the necessity of a professional turf speculator betting only when he believes he has a positive expectation, sizing his bets properly, developing unique viewpoints (that may often fly in the face of public opinion), and actually speculating as opposed to grinding out profits. If Bacon's advice is sage for turf betting, in which the track's take can be in the neighborhood of 15% plus, how much more so for market speculation (which has a relatively lower proportion of execution costs)!

In "Secrets...", Bacon exhorts the aspiring turf speculator to only bet on individual situations in which he believes that he has a positive expectation with respect to the displayed payout ratio (or "price") for a horse at the track. A situation like this is called an "overlay", as has been mentioned several times on this website.

The displayed payout ratio for a horse on the track board is formulaically related to the probability of winning that the horse must have for a bet on the horse to have a zero expectation. A speculator that is able to make bets with consistently positive expectations will not win every bet, but can expect to be net profitable over the long run (provided that he sizes his bets sensibly).

If we state the displayed payout ratio at the track as R:1, a turf speculator's actual probability of winning must exceed [1/(R+1)] for him to have a positive expectation. For example, a 3:1 payout ratio requires a probability of winning greater than [1/(3+1)] = 25% for the speculator to have a positive expectation. So if you believed in this situation that the horse's actual probability of winning was closer to 40%, this would be an "overlay", and it would make sense to bet on that horse winning the race. Another way of looking at this is that if you believe e.g. that a horse's probability of winning a race is 40%, its payout ratio must exceed [(1/40%)-1] = 3:2 for it to be worth your while to bet.

A speculator's percentage of winning bets thus doesn't reveal a whole lot by itself. For example, did that speculator achieve a 50% win rate betting only on situations with 3:1 payout ratios? Or did he achieve a 50% win rate betting only on situations with 1:3 payout ratios? Furthermore, how did he size his bets? The answers to these questions all have vastly different implications for his profitability. Further complicating the situation is the fact that payout ratios at the track are not static during the period when bets are allowed, but shift up and down based on the public's betting behavior.

Clear overlay situations do not come along in every race, and Bacon emphasizes that exploiting them requires tremendous patience and discipline. Hard work must also be put into estimating probabilities of winning, which Bacon shows to be both art and science, and the fruit of dedicated study of track conditions.

Bacon also shows in his book that the public seems to have a tendency to overly focus on recent performance and pay little attention to a large number of other details (seasonal factors, weight allowances, etc.) that may make certain horses great bargains at particular times. The books illustrates clearly that different things work at different times, and a turf speculator must constantly be on the alert, and thinking outside of the box, to take advantage of whatever opportunities are present.

The "music" of the track (i.e. payout ratios and musical intervals):

In the spirit of fun (based on the "Music and the Markets" thread found below)...The fact that payout ratios at the track are rational numbers in the form a/b (i.e. where a and b are integers with b not equal to zero), brings to mind an instant parallel to music. Perfect two-note musical intervals can also be expressed in the rational form a/b, which is a ratio of the note frequencies in the interval.

For example, if your root note (e.g. Middle C) is 440Hz, the next higher C which is 1 octave higher, would be at 880 Hz, which makes the interval ratio 880/440 = 2/1. The note G can then be set at 660 Hz, which equates to a ratio of 660/440 = 3/2. If musical intervals have rational number ratios, they sound more harmonious to the ear than if they have irrational number ratios, the latter which is the case on many modern pianos (due to a relatively modern tuning convention). This is a fascinating explanation of the history of tuning.

In any case, we have the fact that musical intervals can be expressed as rational numbers, and we also have the fact that all payout ratios are expressed as rational numbers. So imagine if you will that each payout ratio at the track is continuously played as a musical interval with the same root note (perhaps on a separate instrument for each horse). Lower priced horses (i.e. those most favored to win) would tend to have tighter intervals (e.g. 9:8, 1:1, 7:8). Higher priced horses (e.g. 4:1, 5:1, 10:1) would tend to have wider spaced intervals, with the respective second interval notes at higher pitches.

As payout ratios shift up and down pre-race, so would the individual intervals played, probably resulting in a partially harmonious / partially chaotic sound similar to the tuning of an orchestra.

Steve Ellison comments:

My brother is a music professor. I saw a presentation he gave once about overtones. In addition to the note being played at a particular frequency, most instruments also issue waves of higher frequency which are most noticeable at integer ratios of the original note. The most prominent overtone is at a 2:1 ratio to the original note, but subtler overtones occur at 3:1 and 4:1 also. Another professor at the same presentation played a recording of four New Guineans singing without instruments. At one point, overtones of their voices converged in such a way that it sounded as if a fifth very high-pitched singer had joined them.

The Learning Curve: Music and the Markets, by James Sogi

There are many ways to learn new things. I started learning guitar at around 12, first listening to my mother play, then a guitar teacher got the curve started. With little noticeable progress in the intervening 40 years, thoughts turned to how to learn and get better. Though now my lack of talent can be made up with expensive equipment, attempts at learning sparked thoughts on the different ways of learning. These ideas also come into play in learning market styles, statistics, and computer programming by an old dog trying new tricks.

In music, the quick and easy way is to learn by ear followed by trial and error, until the fingers learn the notes that the ear hears. It is possible to become accomplished by this method alone given natural talent. The Beatles, the Rolling Stones, and Eric Clapton listened to the old blues masters and achieved greatness. A second way is to learn the music theory, learn the scales, the notes, and to read music notation. All written music becomes accessible. Another new way now is called tabulation, where pictures of charts of the guitar fret board show where to put your fingers. It's fast and easy. There are also videos of instructors playing with explanations to help learn music.

Learning to play music and perform requires the ability to play without fear of making a mistake, to play naturally in a relaxed manner, not too stiffly, and even “play through” a mistake, without becoming flustered, having to stop at a mistake then start over, like a child. When a market entry is not perfect, the marketeer must continue the performance and there is no chance for a replay. Can’t get flustered and got to play through.

As always, in trying to apply meager knowledge and ability to the markets, how can one go about learning the markets? As with music and any other worthy endeavor, it is the journey of a lifetime. With the inspiration of the Chair and the List, the old dog learned statistics and computer programming the hard way by getting the text book and reading it over and over until some glimmer of meaning came through. There was no luxury of a teacher or tutor, but that is recommended to speed the process. The Wiz’s "zero to hero" jump start was a logjam breaker for R. Programming consultants are available to break the mental logjams in the learning process. The next project will be Java.

The Market can be learned by ‘ear’. After years of watching and listening, and even trial and error, skill might be obtained in understanding the moves of the markets at a gut level. Natural ability makes a big difference. A second method involves a tutor for instruction on the market basics and basic skills. A third method involves the study of the notation of the market and counting the permutations. Just as a given chord can be inverted and played in a number of different positions on the guitar fret board or piano with similar sound but with a different feel and effect, the market goes through various and endless permutations, often of the same basic chordal structure, but evoking different emotions. Study of the theory of the structural and statistical elements of the market, like a music notation chart, will help the performer understand the basics of the music to be played. But just as with music, rote recitation of black and white notes do not alone make music. There needs to be a basic emotional connection with the market moves. When the band plays there is no sheet music, but if it gets in gear, everyone ‘gets the feel’ of the music and rhythm. Everyone has individually studied or practiced the basic tune before the group plays. On a good day, with prior study of the structures, the marketeer can be ready to be involved with the current permutations on a deeper level than just the notes or bars on the chart. Like good music, the market is driven by emotional content. Learning to harness the emotive power in music parallels the process of harnessing the emotive power of the markets into profit.

GM Nigel Davies on Learning and Motivation

If there are two things I've learned, whilst studying and teaching chess, it's that people must educate themselves in their own way and that everyone's motivation will be different. It's possible to train people to perform to a certain level in chess, but if this training does not promote self education and a philosophical attitude, then the trainees will be little more than performing seals. They will be adept at catching a ball if it's thrown to a particular spot at a particular time, but unable to improvise or contemplate the nature of the ball.

Many people are very good at being trained whilst those with inquisitive minds, or who think differently, can find this difficult. It sometimes seems that schools cater to the conformists who make teachers' lives easier, but the unsurprising result is that many people who do well in school find university very difficult because they're suddenly called upon to do more thinking.

There is an analogous situation in chess, with children being pumped full of information by coaches hired by their all-too-keen parents. They win an under-11 championship but fall behind more thoughtful contemporaries when hitting their teenage years and beyond.

Thus, I think that the debate about fixed systems goes beyond the points at which one should buy and sell, it's about trainees versus thinkers, those who don't ask questions versus those who do. But then what makes a thinker?

It may have much to do with our ability to gain acceptance. Most people start out life wanting to be like 'everyone else', some just can't make it. Ethnicity may be a factor, so might culture or a genetic difference or deformity. I hypothesize that if one examines the life stories of the great thinkers from history, the vast majority will have had some reason why they were unable to fit in too well with the indigenous population.

A similar process may be involved in motivation. People who easily fit in will not want to lose this comfort by standing out of the crowd. For those who cannot fit in, standing out won't be a problem. In fact, their inability to do so may even be a great motivator. If one cannot fit in the best way to survive is through strength; woe betide those who are both unusual and weak. A darker reason to succeed might be a form of revenge, which one certainly detects in some chess champions. Bobby Fischer constantly referred to 'the weakies' and Victor Korchnoi has lauded the power of 'hate-energy'.

Can one learn to be a good speculator? Certainly it's possible to be taught how to calculate a z-score and glean information about the kind of patterns to look for. But learning to ask the right questions is not something that can be trained. Those of a philosophical disposition will be able to ask them once they know what they look like. But performing seals will need to be told what they are, and the information they acquire will have a very limited shelf life.

This is why the games chess and markets are so beautiful, they are an aspect of the world where mediocrity finds little reward. And this is why the mediocre hate them; they hold a candle to their souls and they don't want anyone to know that there's actually nothing there.

See our Buyback Study Update

Executive Hobos and 9/11, by Bo Keeley

Five Parts:

  1. The Pacific (below)
  2. The Sierras
  3. The Great Basin
  4. Milk and Honey Route
  5. Velvet Cushions

Their intelligence surpasses any in 150 years of hobo history. Arthur ‘The Wiz’ Tyde shoots aerial photos of the catch-out yard from his Cherokee Piper, Omid ‘Big Apple’ Malekan downloads train data from the Pacific to Rockies, Brian ‘Pronto’ Molver personally reconnoiters the first jungle, and Lisa ‘Clown’ Bradley shapes the group as a professional humorist. They call me Doc Bo, a hobo college professor and alpha of this brainy pack of business executives. We’re outward bound by freight train for 2500 miles that, strangely enough, will end with 9/11.


Follow any hobo on a California railroad track far enough and you penetrate the sprawling Davis Yard in Roseville, Ca. sixteen miles northeast of Sacramento. This is the Pacific junction, the largest rail yard on the west coast, with coastal Canadian northbounds and Mexican southbounds, and daily hotshots east to all points on the USA track gridiron. The Davis Yard, once in the heart of the gold rush, historically smothers America with freight traffic, and hobos.

It is sunset on July 25, 2001 as four business executives creep waist-deep the golden grass where nineteenth century tramps ducked bulls to grab the same ‘Dirty Face’ freight on to better fortunes. We enter our hobo jungle, a spare opening in a Live Oaks copse littered with bottles, cardboard that train tramps call ‘thousand-mile paper’, and a ring of seat-less chairs. We sit on the frames and evoke the first fast freights, their rolling steel wheels called cookie-cutters, and the joys of escape into a gritty, strange world.

Soon, we walk 100-yards through a red dusk to the Davis perimeter fence and part the barb-wire strands for each other to insert. Beyond lays our iron road, the original 1865 Transcontinental RR. It still runs east up the Pacific lowland, over the coastal Sierras, a flash through the Great Basin, along a steel ribbon above the Great Salt Lake, out the Rockies, and down beyond to the executives’ Denver destination. This rail is also the executives-to-hobos birth canal.

Hobo numbers swell and fall with the financial times. The rails blackened with men and families during the Great Depression. They slackened in the 1950’s with the loss of steam engines as the new diesels started faster and, with no need to take on water, there are fewer cross-country pauses. In 2001, I estimate there are 20,000 train tramps but only a few hundred out tonight on the rails and, certainly, we are the only executives.

Look at us, interchangeable with the overall tramps we’ll face during the journey. Each thought to grow a week’s beard in his respective workplace before the shove-off. Everyone’s outer clothing is dark as the night, boots are steel-toed, and each sports a baseball cap with a tether string against the freight wind. The rest is in their noggins… or deep in their packs: We carry clip-on ties for eventual business meetings, tablecloths for storm tarps, sleeping bags, gallon water jugs, two-days food ration, short libraries, and individual kits of high-tech instruments.

I feel like a Mensa scout leader. Meet Arthur Tyde III (The Wiz), the founder and CEO of Linux-Care computer systems; Brian Molver (Pronto), the Bay Area Chief of Disaster Response; Omid (Big Apple) Malekan, a New York computer programmer for high-roll investors; and Bryce Bradley (Clown), a Toronto stockbroker and professional comedian who’ll board in Colorado for the return to the Pacific.

‘Men with packs are sneaking into the yard!’ comes a muffled voice inside Wiz’s pack. Another responds, ‘I’m on them!’ The Wiz, grinning, pulls a police scanner from the pack and adjusts the volume. He has pre-programmed the device for every yard frequency from Davis to Denver. He reaches deeper and comes up with ‘Brownie anyone? My wife makes double-chocolate so I’ll come home faster after business trips.’ ‘Later! Let’s exit the yard,’ orders the disaster expert, Pronto. Big Apple, silently calculating probabilities, motions me, and I lead the team out the barb wire just in time.

Car lights crack the night 400-yards away pursuing two other unlucky tramps. We’re safe. The bulls- railroad police- are the hobo nemesis cruising the tracks in white Broncos with phallic CB antennas. Hobos use various evasion tactics: Hide in the weeds next to the rail to board a freight ‘on the fly’, secret inside a train car before it rolls, or use hobo interference as we do tonight. With the bulls busy in a snarl of headlights and shouting tramps, we boldly retrace a short distance to the mainline and continue deeper into the yard to ask yard workers for train info.

‘Tonight’s puzzle is peculiar to the Davis yard’, I brief the squad inside the yard. I point at starlight running along the main south, swing a finger to dozens of darker parallel tracks coursing into the stockpile area, up the yardmaster tower rising like the dollar’s eye a quarter-mile to the north, and finally rest it on a narrow bridge a quarter-mile beyond the tower. ‘The north mainline that we’ll ride tonight branches just after the bridge to send a track north and another track east. We want the latter, but without foreknowledge or at least ‘reading’ a train before its departure, there’s no way to tell if the next rolling freight will go straight after the bridge to Seattle or bend west to our Salt Lake, our wish.’

Apple scuffs the grit and nods south without looking up, and says, ‘For example, that approaching dot could be the headlight of our ride, or not.’ Pronto murmurs, We’re exposed!’ Wiz poohs, ‘What the hell, the bulls are busy.’ The bright dot enlarges, engines thunder, the ground trembles and the locomotives trudge ten feet from us and stop.

Read the Conclusion of Part 1

I've Discovered this New Show called "American Idol", by Charles Pennington

Circa 1996 I overheard my graduate school advisor, a third generation professor, and at that time the senior member of the Harvard Corporation, discussing basketball with a colleague. "My son has become simply fascinated with the play of a member of the Chicago Bulls basketball team. Perhaps you've heard of this fellow, Michael Jordan."

In that spirit I offer a glowing review of "American Idol". I've always had a favorable impression of it, but I've rarely watched it. Tonight though I got to watch it uninterrupted while trying to finalize a 1040. This is truly a great show. Here's why:

  1. It's innovative. There have been talent shows on TV in the past, but I don't think any really followed the full process of narrowing the field from thousands down to just one, all before a riveted national audience.
  2. It's inclusive. On this show "diversity" results from merit and nothing else. Not only is there every variety of race, but there is also a heavy representation of small-town America. As each contestant is introduced, footage is shown of their hometown friends and family, and the posters they made celebrating their Idol. For some reason, almost all the contestants were singing songs by Queen tonight, and one from Smalltown, North Carolina did a country version of "Fat Bottomed Girls".
  3. It's participatory. The viewer is active, not passive. The viewers votes make the difference, and their connection with their hometown idol is much more real than their connection with the nearby sports franchise.
  4. Punches aren't pulled. The most blunt judge, Simon Cowell, doesn't hesitate to criticize, and some of it's not PC, as in "You're too fat." This is a real competition.
  5. The stakes are high. The winner and a few runner ups will almost certainly rack up some big record sales and become certifiable stars or mini-stars. The contestants show genuine, unaffected emotion. The girls often cry. BUT..
  6. Nobody gets hurt. The losers miss out on becoming stars, but they can take their memories and some continuing level of local celebrityhood with them.
  7. They're good sports. The contestants at least appear to support each other. They applaud and dance and sing along while their competitors are performing. They hug and console those that get kicked out, and it's much more convincing than it is in beauty pageants. The show hasn't had its McEnroe or Nastase yet. Simon (who looks a lot like Mr. Dude here in Weston) is the only one who's allowed to say anything nasty, and everyone loves him anyway because he put the whole thing together.

What a great, great show. Perhaps you've heard of it.

Thoughts on Regression and Divergence, by Mark Mahorney

It has occurred to me that all technical analysis, whether it be contrarianism, trend following, regression analysis, or a statistical probabilistic approach relies on consistency and structure in the markets. If a company has a stable growth rate then logically that the stock would on average appreciate at a consistent rate. Less stable prices, volatility, implies opportunity at the extremes may be uncovered via regression analysis. If a company has a stable growth rate then the stock price should be expected to be relatively trendy, with a strong correlation to the growth rate. But, the more unstable, volatile, and random, a company's growth rate is, the less we know about where a stock will regress too or the direction a trend might take if any trend can be discerned at all.

When I look around and observe commonly held beliefs about technical analysis, trend following or contrarianism as the case may be, I seldom see any correlation being applied to fundamental information. I see this huge chasm between the two major disciplines. I see black and white. I see traders following what they perceive to be trends or bucking trends randomly. A stock has gone up a lot, whatever that means, and some traders think it will keep going up, some think it has gone up too much and take the other side, others believe the stock will regress to some arbitrary moving average.

All things being equal, a consistent and predictable company should have a relatively predictable stock, and when it is bouncing about irrationally it could reasonably be expected to regress to stability, regress to the rational, to the truth. Of course in the real world companies aren't perfectly stable. There are many unknowns from competition to macroeconomics and macro shifts among asset types. Traders that don't take these things into account try to ride trends that don't materialize when some factor or another changes the outlook causing the trend to reverse, or they expect the price to regress to some meaningless arbitrary average.

Regression to what?

The statistician, however, studies the volatility and produces probabilistic price expectations that, whether they realize it or not, correlate to the relative stability of a companies fundamental information and how it's influenced by outside factors. The statistician studies the probability of success and failure. Everyone else just guesses.

But even statistical analysis relies on consistent behavior, that stocks will not be much more or less volatile than in the past. There you get into Taleb's territory, black swans and all of that, what is the probability, or the expectation, that a stock price will behave unexpectedly? Can you diversify away that risk?

By my way of thinking, it comes down to balancing the intake of information. I want to know why things are happening, but not let myself get overly caught up in the minutia happening such that I lose sight of whether or not events are within the expected norm or not.

Yishen Kuik notes:

The most consistent and predictable company with the most consistent and predictable cash flow schedule is a Treasury Note, and the price of that is clearly volatile and unpredictable to most.

Because future short term rates are not easily predictable, the discount rates for future cash flows are not easily predictable. So even the exercise of clipping fixed value coupons yields a fluctuating present value, much less having to deal with further uncertainty of how big those coupons will be, when they will occur and what is their growth rate.

Proven Player or Flash in the Pan, by Mark Mahorney

And GM was a proven player, a forever, and Toyota got called up and was a flash in the pan. Now GMs like the guy who stayed in the game too long refusing to go out on top. Companies though are more like race horses than baseball players, put out to pasture, and carved up when they croak. If they're really good they get put in isolation with occasional conjugal visits to make more really good race horses.

Comments on a Trend Following Discussion, from Victor Niederhoffer

An interesting discussion appears on Elite Trader. The discussion starts with a recommendation of James Altucher's third book Super Cash, about how to make money. He suggests that trend following is not a viable strategy and that it won't be around in 10 years and apparently points to the recent results of the major trend followers for support. Many elite traders responded to say that this doesn't take into account the normal ebb and flow in any results. Others wrote in to say that European trend followers are still doing very well, or that modern trend followers who have adjusted their numbers do well, or how can you say that trends don't exist, pointing to silver. Others wrote in to say that such tests as the variance ratio test shows that there are trends. Also, that certain trend followers are billionaires.

One responder wrote that he found that all fixed systems are easy prey to the flexible and fast moving. That MFM Osborne first wrote about this in 1964. Also that Larry Harris made the same point in his magnificent book Trading and Exchanges, and that The Secrets of Turf Betting showed how just when any system was looking great, it was guaranteed to fall into oblivion.

The respondent also pointed out that trend followers face very large transactions costs, and that there is a reasonable working hypothesis that when one market is out of line with the other, it will fall back into line, as market moves cause loss of energy and disruption to the forces that have the world in their grip i.e., plucking the goose with the least amount of hissing. The moves create hissing and might make it harder for the balance of power between the parties that provides the semblance, the facade of checks and balances, and individual initiative that incentivizes people to work hard and contribute to the robbing of Peter to pay Paul that is at the heart of everything.

 Of course, belief in this last point is not a necessary prerequisite to believing that exacerbated moves in any market tend to be reversed, or that transactions costs from following the trend are much greater then going against, or that any systems that are easy to reverse engineer, like all the trend following systems, are easy pickings for the market makers who are so very good at making money against adversaries whose moves are known in advance. (Sort of like the one sensible thing that I've ever heard the wild man on tv say, which is that it's easy to make money by selling short his recommendations on day one after he makes it, but by day three things have settled back to where they should be).

The contributor said that because of survival bias, it was difficult to make an exact accounting of how much the major CTA trend following funds had made in recent years, but that he estimated it at perhaps -25% on 10 billion dollars. He also said that one shouldn't take anecdotes about this or that trend follower being a billionaire as proof of their success because many trend followers were very wealthy as a guaranteed feature of the fees that they took, and the tendency to make high returns with small amounts of money under management and low returns or negative returns when the billions chasing alpha, or commission houses marketing their funds for extra commissions flowed in. That contributor did not mention the actual results of the publicly held marquee trend following funds that folded, that was run by a famous large former soybean trader, as case in point albeit the cognoscenti might have inferred that he had that in mind.

That contributor said that he had received serious and worthwhile criticism for his views denigrating all trend following on the grounds that many of the biggest trend followers implicitly or explicitly took out 8% or so in fees from the total assets under management each year, and that the respondent should be computing the before fee returns of trend followers rather than the after fee returns in his efforts to find out if regularities, and non-random properties of trends existed.

All in all, I found the many points of view very educational containing many meals for a day, and interesting anecdotes to share with the kids similar to those about the famous trend follower from Lake Tahoe, who can see a trend so clearly from across the room, and who gives psychological counseling to those such as I, who have never been able to find a mechanical system that they can adhere to with impunity.

P.S. The Elite Trader site has about 50,000 contributors to it, discussing many threads of interest of the day and fray for traders. I find the discussions very good at generating fruitful questions to ask and answer. There are experts among them on almost any topic, and I find that by the time they work thru a particular thread, they are excellent at separating the wheat from the chaff, and exposing ballyhoo. Many of our own are already on it, and I would recommend the site to all who are interested in questions and answers about trading threads.

Ecological Stoichiometry, by Victor Niederhoffer

* Webmaster's note: Vic came across this book review in our archives and was reminded of how outstanding the book was that we've decided to republish his thoughts for our newer readers.

The book Ecological Stoichiometry by Robert Sterner and James Elser contains a land mine of provocative hypotheses about the way humans and the environment react that might provide the basis for a big and highly profitable view of markets. It combines the most powerful ideas of science; natural selection, the periodic table of elements, conservation of matter and energy, positive and negative feedback, the central idea of molecular biology, and the ecosystem to explain how chemical elements come together to form living systems. It pays particular attention to the constrained proportions in which substances react. Most of the chapters concern the balance between the composition within and the composition without and what makes for homeostasis and growth. A favorite chapter is "Stoichiometry in Communities." They answer the question, " How could we know before we observe them together when species will react strongly or weakly, or even change their interactions from beneficial to inhibitory or neutral. We saw several examples where even the sign and magnitude of ecological interactions changed according to stoichemetric balance.  There is so much to know in this world and so little time to do it; the components of the balance sheet of companies relative to the totals available in the economy, the movements of interest rates, stock markets and foreign exchange. These changing interactions might be well considered from this framework.

Movies: A Review of A Dispatch from Reuters (B&W 1940), by Easan Katir

An accurate biography of Julius Reuter, and the story of how he founded his eponymous news agency, beginning with a flock of carrier pigeons in 1850 delivering stock prices between Aachen and Brussels. Some nostalgic scenes of early European and London exchange floors, and how having prices a few hours early allowed traders to garner great wealth. He scooped all other newspapers when he relayed a major speech by Napoleon as it was being delivered, and later beat them again with news of Lincoln's assassination seven hours before the rival agency, allowing his financial backer to sell short before the news was confirmed.

Edward G. Robinson, usually cast as a tough-talking, cigar-chomping gangster, plays the highly ethical and entrepreneurial Reuter. Robinson was occasionally a guest at my grandparents' home in Beverly Hills, and they told me how he was the most humble and gracious of men, completely different from his gangster roles. In this film, the viewer gets this sense of his real personality. .

Uplifting Words, by Dr. Janice Dorn

In an age where technology is accelerating at exponential speed, people are hypertasking, hyperactive, hypertexting and just about everything else which leads to neurochemical hypomania, addiction, anxiety, depression and various states of disease, it behooves one to step back and take heed of what your body and brain are telling you.

What is serenity and how do we achieve it- even for a few moments every day?

The cardinal principles are simple, but not easy. Every day is a new beginning, a time to start again, to renew, to look in the mirror and decide-- in the first three minutes-- what your goals are for today. You are what you say to yourself as your face is staring you in the face. Just as trees have dendrochronology, so do your face and your body. Rigidity, obsessiveness, anger, paranoia, joy, anticipation, and every conceivable emotion show in the set of your face and your body. You are what you make yourself. It is about you and no one else.

What can we do each morning to make ourselves better human beings, and to allow ourselves to evolve in a way that is effortless?

Every week, I pick one day to send myself a note saying something nice about myself. I take the note to the florist and ask the florist to include it with roses which I send to myself. What a delight when the flowers arrive and I see what nice words have been written about me!

Many years ago, I came across a writing which has sustained me through triumph and tears. A worn copy of it is with me always :

After a while you learn the subtle difference between holding a hand and chaining a soul and you learn that love doesn't mean possession and company doesn't mean security. And you begin to learn that kisses aren't contracts and presents aren't promises and you begin to accept your defeats with your head up and your eyes ahead with the grace of an adult not the grief of a child. And you learn to build your roads today because tomorrows ground is too uncertain for plans and futures have ways of falling down in mid-flight. After a while you learn that even sunshine burns if you get too much so you plant your own garden and decorate your own soul instead of waiting for someone to bring you flowers. And you learn that you really can endure that you really are strong and you really do have worth and you learn and you learn. --Veronica A. Shoffstall

The Importance of Goals, by Victor Niederhoffer

In "The Seven Habits of Successful People,"  Steven Covey lists "beginning with the end in mind" which leads to the importance of having goals as the second key habit. A good way of remembering it comes from Alice in Wonderland. "Would you tell me, please, which way I ought to go from here?" said Alice. "That depends a good deal on where you want to get to..."

The importance of goal setting for achieving success leads one to wonder if the market has any goals. Covey suggests that goals be relevant, so that you can avoid distraction. To me the most relevant goal is a move, since wherever you are, you're always interested in where it is going as that will lead to profit or loss.

As a first step in defining a relevant goal, I decided to start with something simple, something that a humble person like myself might achieve, a goal of 1 point a day in the S&P. To put first things first, I thought a win-win scenario might be 5 points in a week or 10 points in 10 days or 20 points in 20 days.

It is recommended by Covey in Habit #5 that you seek first to understand. "To diagnose before you prescribe." Guided by this, I thought that I should start by asking some questions so as to understand better.

How hard is a goal of 1 point a day to achieve? And if you haven't achieved it for a while, how long can you expect to go without success? What's your life expectancy, and expectancy of a move to the next failure, and how does it change after failures and successes?

Let's start with a market move of 5 points up in 5 days using daily data from the beginning of 1999 to the end of March 2006. The positive goal of +5 points was achieved on 793 out of 1,804 days and the negative goal of -5 points was achieved on 874 days. This ratio of 1.1 in favor of achieving the negative goals is consistent with the 100 point decline in adjusted S&P during the period.

The question now emerges as to life expectancies. The following survival table gives some proactive relevant answers.

			Life expectancy in days to next 5 point move after
                	    not having achieved goal over last X days

          Life expectancy          For + 5 Pt Moves        For - 5 Pt Moves
          to next success
        after failure of days       # Obs  Life Exp.        # Obs  Life Exp.
                 1                   180     5.8             180     5.3
                 2                   128     6.7             126     6.1
                 3                   108     6.8             109     5.8
                 4                    99     6.3              93     5.6
                 5                    90     5.8              83     5.1
                6-10                 262     5.6             231     4.9
               11-15                  92     5.6              64     5.5
               16-20                  40     4.0              26     4.9
               21-30                  12     2.8              12     2.6

There is a hopeful message in this data. After a failure to achieve a successful 5 point move for more than 5 days, the expected number of days to the next success keeps getting lower declining to 4 days after 16 days of abstinence and 2.8 days after a long period of 21 or more days without a success. For those who are waiting for the decline, after 21 days without one, the life expectance until the next one occurs is a mere 2.6 days. Regrettably for such bears and bulls, the 21 or more days of abstinence only occurs 12 times each in this data.

The preliminary results of this study of failures, survivals, and goal setting moves is that if you only wait long enough, and then play for a successful achievement of your goal, on either side, you will have your day and achieve your goal.

P.S. As for the more proactive goal of achieving a profit, whatever the duration to success is, i.e., the expected move (+ or -) that follows a period of abstinence, one will have to run this by the office of the Minister.

The American Frogs, by Nat Stewart

I think most of the Mexicans who come here, are coming here for the same reasons most of our ancestors came here. for opportunity, and a chance to make a better life. Government seems to have set up a tariff with regards to immigration and work visas to the extent that many poor Mexicans are willing to risk life, pay large amounts to guides, etc, in order to get here, rather than going through official channels. I wonder, if 100-200 years ago if such barriers existed as we have now and, if the ease of travel existed then as we have in the current situation, what the situation would have been like?

Has there ever been a time when immigrants did not in some way disrupt the established order? Has there ever not been a time when group differences of the incoming population were not an easy target for ridicule? Something wrong with "that culture" that made it less than that of those who arrived sooner? Different words or insults, same old same old. Has it ever been different?

Here in Chicago, working class Mexican families travel to Lincoln Park on weekends to have family outings and cookouts. They bring BBQs, soccer balls, and all sorts of games. Is it an eyesore that creates irritation, or is it a pleasant sight to see families happy together enjoying their likely one day off? I think it is a choice, and not always easy. It has annoyed me on occasion, but, in the end they are enjoying the space, creating laughter for their children on a special day, and I am just jogging by as I might any other day of the week.

I for one have a hard time thinking someone who leaves familiarity for the opportunity to work hard and improve one's life to be deserving of scorn.

I walked through the heart of the huge Chicago demonstration. It was peaceful, and I saw as many or more American flags as Mexican flags. People are proud of who they are, but by and large they also seemed to love America and what it stands for.

Arbitrage & Collaboration, by Mark Mills

Some thoughts on the Kelly formula, arbitrage and philosophy inspired by reading Fortune's Formula and 141 Jackson St.:

  1. A dollar laying on the sidewalk is an arbitrage opportunity. By picking the piece of paper off the concrete, and moving it to a store, one can convert the worthless piece of paper into a cola.
  2. An economist will deny the possibility that a dollar bill could be found on the side walk. The market is efficient, therefore the no dollar bills can be found on sidewalks. If one see one there, it will be gone before one can bend over to pick it up.
  3. An philosopher would agree that it is impossible to successfully pick up the dollar bill, and add that the decision to bend over is immoral. All arbitrage opportunities are mistakes, and society as a whole is better off if no one acts upon the opportunities these mistakes create. As one's mother might intone, the person that lost the dollar bill will soon return for it.
  4. Since the average person is enchanted by complexity, when noticing a dollar bill laying on the sidewalk, they will invite the philosopher and economist to come and witness the impossible event and discuss its meaning.
  5. While the average person, philosopher and economist discuss the supernatural character of a "dollar bill on the sidewalk," a trader will run by, scoop up the bill. Both the trader and the bill disappear, confirming the opinions of all parties to the conversation.

One can avoid these delusions by taking the view of an evolutionary biologist:

  1. Life (arbitrage) cannot be "touched' or "captured," we can endlessly debate its existence without proving anything.
  2. All we know about life (arbitrage) is the detritus left behind after individual beings (arbitrage opportunities) have passed by.
  3. All individual beings are linked by genetic materials, energy processes and environmental constraints. Though it is impossible to pin down "life," we can learn useful things by study of the detritus left behind in the light of these principles.

As Fortune's formula suggests, one can look at markets in terms of "efficient markets" or "gambling." "Gambling" in the light of "information theory" becomes the decision making process upon which language is based.

As Steidlmayer says, price is the messenger rather than the message. If so, the message is a directive to act: "buy," "sell" or "hold." This is the underlying suggestion of any agent speaking to a second agent. The process of deducing the message is always going to involve gambling.

The mystery for many evolutionary biologists is cooperation (given the notion that evolution is guided by ''tooth and claw"). In this light, collaboration is as impossible as arbitrage. Perhaps there is more of a relationship between collaboration and arbitrage than one sees on the surface.

The Perfect Sacrifice in the Market Ecosystem, by Jan-Petter Janssen

Generally, in nature about ten percent of the energy from one level in the food chain makes it to the next level. Let's assume the market works about the same way.

I propose a rule of thumb saying that ten percent of your profits should be lost to commissions, market makers, bid/ask spreads and so on. If you lose more (while being profitable) it may be because you have not considered the black swans. If you lose less you are either too conservative, or just better than the competition. In the latter case, you will most likely make a super profit until your increasing impact on the market forces your sacrifice towards ten percent.

Just to make it clear, if you don't bargain for an edge or try to minimize the cost for every trade, the poor house is very near. But you should lose ten percent despite this. With black swans, I think an example is the scalpers who make a lot of small profits before they suddenly suffer a devastating loss.

I think being a lion is not any easier than a gnu. Nature has made it easy for a gnu to eat, but their big concern is to avoid being eaten. The lion, on the other hand, has no concern about being caught by a predator, but only the fittest lions will kill enough prey. If this is not the case, the populations will converge towards balance. So being either a gnu or a lion is irrelevant. Being a good gnu or a good lion is essential.

To conclude, if my reasoning is correct, the super profitable trader giving away less than ten percent of his profits to the market ecosystem will grow. When he reaches the ten percent sacrifice he will either have to find a new niche, accept a normal return or increase the sacrifice to maintain the super profit. If he goes above the ten percent sacrifice some rare event will sooner or later catch him.

A Brave Beginning, by Victor Niederhoffer

In Albert Nock’s Memoirs of a Superfluous Man, one of my five favorite books, he describes an incident of election night at the Wigwam, a venue I have passed all too frequently recently on my trips to the Lutheran Medical Center of Brooklyn.

Some devoted patriot very far gone in whisky wandered up in our direction and fell by the wayside in a vacant lot where he lay all night., mostly in a comatose state. At intervals of half an hour or so he roused himself up, apparently conscious that he was not doing his duty by the occasion, and tried to sing the chorus of "Marching Though Georgia," but he could never get through the first three measures without relapsing into somnolence. It was very amusing. He always began so bravely and earnestly, and always faded out so lamentably.

Nock goes on to say, "His sense of patriotism and patriotic duty still seemed as intelligent and competent as that of anyone I have met since then, and his mode of expressing it still seems as effective as any I could suggest."

Lamentably, I was reminded of this brave beginning by Friday's stock market performance. The S&P futures opened at 1318, quickly moved to a five-year high of 1322, but then ended down at a five-day low at 1304. How many hopes were dashed? How much tragedy was felt for example by those trading the 1.3 million mini S&P contracts traded that day?

To gain some steadiness of the feet, and to do my patriotic duty by the occasion I took it upon myself to examine such renditions for the past six years.

What we had was an outside day, where the high was higher than the day before and also the low was lower than the low of the day before. Let’s call that an outside day of 1. But also the day’s high was higher than each of the two previous days, and the day’s low was lower than each of the two previous days. Let's call that an outside day of 2. Similarly for an outside day of 3 and an outside day of 4. The following table shows the performance of the market on the days after such degrees of outsidedness since the beginning of the century.

Moves 1 Day After Outside Days
Length of Outsidedness# ObsExpected 1-Day MoveVariability

* The move after the outside day of 4 on Jan 3 2000 was -54 points.

One predicts in light of this variability that many a devoted market patriot will be three sheets to the wind tomorrow. And considering the imminence of that great day we share our vital spirits with the Service, such devotions will continue for at least five subsequent trading days.

Movies: Thoughts on "The New World", and Adapting in Trading and Life, by James Sogi

The New World” is about the colony of Jamestown. It would have been more interesting to have the details of the survival life back then than 30 minutes of Pocahontas romping through the field with the wind in her hair Hollywood style. The European immigrant’s lifestyle and rigidity led to starvation while living amid plenty. “Some traditional scholars of early Jamestown history believe that those pioneers could not have been more ill-suited for the task. Captain John Smith identified about half of the group as gentlemen who knew nothing of or thought it beneath their station to tame a wilderness.”  They would put fish into a hole hoping the corn would grow so they could make bread, and starved, meanwhile, ducks and fowl and game were abundant. The Europeans who immigrated were used to and apparently knew how to prepare grains as a staple and their narrow focus limited their ability to obtain nourishment. Many starved.

As opposed to the dung beetle who with Sisyphian stubbornness clings to his single narrow minded task of pushing his pile of dung around, even when it is removed, man’s ability to prosper is his ability to adapt. To the point, the adaptable person is able to utilize varied styles in a single situation to reap maximum benefits. The army, the boxer, the racquet player, the pitcher that utilizes a varied styles in a single session has flexibility and an advantage over the opponent who will not be able to pin him down, or may not be able to adapt to the change ups. We have seen this in many of our “Connections” discussions. In the martial arts there are the hard straight punch-kick styles, the circular, the soft styles, the grappling styles, weapons, and the spiritual. All have their advantages in the circumstance, but the best at least know the many styles, perhaps master a few.

For the trader there are many profitable styles. As with any discipline it is very hard to master more than a few at any level of comfort over years of development, but the payoffs are worth the effort. In a day, a week or month in a single market there are different styles, and many more among the different markets. Proponents of one style often are critical of the practitioners of other styles. Some say find a single style and stick with it, but the ability and flexibility to adapt with several styles is beneficial. The larger firms of course have staff to populate the specialties, but for the sole operator flexibility and knowledge of and the ability to use differing styles is helpful to prosper. The changing cycles demand the ability to change styles with the cycles. Knowing the weaknesses of the style is essential to avoiding blinding defeat. Many styles are represented on the List. Why starve when there is plentiful bounty surrounding us everyday in many markets.

Big Stock Blues, by Victor Niederhoffer

The S&P 100 index is a cap-weighted index based on 100 constantly updated big stocks. Its history over the last six years, typified by its level of 836 on March 31, 2000, and again in September 2000, approximately 600 at year-end 2001 and 587 today tells a distressing story of underperformance and lack of confidence.

The index has a small amount of turnover in it, so its 10 best performers over the past five years, from March 30, 2001, to March 30, 2006, is pretty indicative.

        10 best (% chg)                   10  worst (% chg)
        Rockwell              399%        El Paso            -82%
        Allegheny             251         Ford               -72
        Caterpillar           224         AES                -66
        Norfolk So            223         Lucent             -62
        Burl North            174         GM                 -59
        FedEx                 171         Time Warner        -58
        Harrah                165         Bristol Myers      -56
        Xerox                 154         EMC                -54
        Black & Decker        136         Merck              -51
        Lehman                130         Unisys             -51

Some other famous disasters: AT&T (-40%), Pfizer (-39%) Comcast (-36%), Eastman Kodak (-29%), CBS (-26%), Intel (-26%), Sara Lee (-17), GE (-17).

An article in the April 17 edition of Business Week, “Blue Chip Blues,” interviews the clueless former basketball player at GE and Intel executives who wonder why their stock performance is not as good as their governance or earnings performance. The anomaly is deep; on average, the earnings performance of these 100 companies has been pretty good, up approximately 50% during the period. A typical sobering story is GE, with earnings up some 50% during the period from the year 2000 to year 2005.

One has several thoughts on the matter. First, is that the terrible record compared with the small-cap and midcap companies of 13 to 14% a year shows that the public is always behind the form. Almost every best-selling book on the market has extolled the views of Jim Collins or the Sage that big and tried and true is best, and the best way to make money is just to sit tight with a company that can’t miss like Coca Cola (-7% in the last five years), that people are going to buy regardless of changing tastes or dietary habits because of its strong brand.

The second thought that comes to mind is that this was guaranteed to happen because the companies at the top of the ladder are those that have the least risk of falling into bankruptcy and thus should have the least return, based on everything that modern finance theory and practical experience has taught – i.e., that risk and return follow each other. The third thought is that many of the top companies were hurt by the fact that they stored earnings in a silo from many years before, and were able to smooth earnings out by selling assets at propitious times in the past, but now with the revelations from Enron and all the restatements, it’s no longer so easy to fool us with that trick.

The S&P Index itself makes a good attempt to track with proper statistical adjustments the performance of the large companies and it tends to prove the point I have made over and over again, as exemplified by the prospective Value Line study, that growth beats value in all the prospective-based studies.

It is interesting to speculate if the top 100 stocks will continue to lag behind representative entrepreneurial and flexible companies among the remaining 20,000 or so public companies in the future.

Barenboim Reith Lecture, from Laurence Glazier

Interesting lecture last night on BBC about Daniel Barenboim's thoughts on the nature of music. Notes and silences (rests) have their meaning in in context of their neighbors. When starting to play a piece which begins on a secondary beat, one joins the music as if it were already there. Timing and speed is critical.

Trading metaphors aside, he is thinking about the influence of music on society. My view is that the renaissance and romantic musical periods have played a very significant role in the evolution of Western society, though I can offer no proof of that, and it may be false logic (i.e. discerning a correlation when there is only coincidence in simultaneous developments).

His idealistic West-Eastern Divan Orchestra will be sorely tested should Hamas ban music, but how would the world differ if classical music education were central in schools, and much as I admire the passion of 20th and 21st century composers I mean training in performance and composition of pieces using the chord changes of popular music and classical harmony.

Various Thoughts on Position in Chess, by GM Nigel Davies

Position Assessment: A Difficult Aspect

One of the most difficult situations in chess is when you can formally count many advantages in your position but when you put them together they add up to a disadvantage. For example one might set up a position as follows:

White: Pawns h2, g3, f2, d5, c3, b2, a3
      King g1
      Rook d2
      Bishop a2

Black: Pawns h6, f5, f6, e5, c5, c7, a5
      King f7
      Rook b8
      Knight d6

One can count many advantages for White here - Black has two sets of doubled pawns, White's bishop APPEARS good (the only pawn which is on a White square is on d5), he has bishop against knight with pawns on both flanks etc. But Black is nevertheless better, and this is an example of why computers have such problems with our little game.

20 Ways to Lose Good, Equal and Bad Positions

Good Positions:

  1. Relaxing because the position is "won anyway."
  2. Boredom; why am I not windsurfing?
  3. Fear of change (wooden play rather than a willingness to transmute an advantage into a different form).
  4. Trying to be too fancy.
  5. Trying to be too safe.
  6. Premature victory celebrations (e.g. planning to take an early bus home).
  7. Overconfidence: I am a genius!
  8. Basking in glory: Will my friends see my position?
  9. Romance: Perhaps that tasty Lithuanian WGM will notice me when I've got 5/6.
  10. Trying to win too quickly.
  11. The feeling of incredulity that the opponent doesn't resign.

Level Positions:

  1. Failure to concentrate because the position is 'dead equal'.
  2. Boredom: Why am I not watching the tennis?
  3. Taking offence that the opponent has just refused one's generous draw offer.
  4. Fear of changing the position, in case this is unfavorable.

Bad Positions:

  1. Giving up because the position is 'lost anyway."
  2. Boredom: Why am I not in in pub?
  3. Desperation: Might as well try a swindle.
  4. Embarrassment: Better resign before my friends see my position.
  5. Under-confidence: I am a fool.

It was much easier to think of ways to lose a won position than an equal or bad one. And this is reflected in what 'should' happen over the board.

Strong and Weak

Strong players become weaker through lack of a challenge. Weak players remain weak through lack of talent. Good positions become bad through their lack of potential. Bad positions are blessed by the fact that there's lots to improve.

Round Number Theory and Smallmouth Bass, by J. T. Holley

I have recently finished Smallmouth Bass: An In-Fisherman Handbook of Strategies , by Sura, et al. for the second time in one month. I am brushing up for the spring season on the James River. As I read the text--the sentences and phrases of the distribution, life and patterns of the smallmouth bass, smallie, it is amazing the similarities and the striking resemblance to that of the round number phenomenon in trading and statistics.

The smallie is a "homebody" by nature, rarely roaming around a river, lake or reservoir during the year like other fish do. Unlike most other fish they stay in fairly limited areas. Because of this they must have all that is required to live and prosper in that limited range. The necessities in a smallie's life are "opportunity to reproduce, find comfort (quality habitat, adequate water quality, and temperature), and obtain sufficient food". They must be able to find these conditions within a fairly limited area to thrive and survive against nature and competition.

These groups of smallie's are based in distinct areas of the bodies of water they live in and aren't ones to travel far once they have attained everything they need. This makes them vulnerable to being caught! The fish aren't shaken very easily from these spots by much. The most common example of migration are caused by drought or low water and also they move during floods. It was very interesting to read also that "when fish are removed from a home range and released at a distant point usually return to a home area".

Lastly they stressed with fisheries the smallmouth have had forced multiplication of their kind. But, few environments offer the conditions mentioned above for their proliferation to take place. So even though the smallie has a fairly wide range of distribution today it is rarely the dominant fish in that distribution of which makes them less likely to be the principal fish.

Wow, when looking back at my notes the round number theory popped into my noggin'. Are we smallmouth bass? Do we simply choose round numbers when asked our weights because of convenience or is it just like the smallie in that we are "homebodies" and like to be around that number for comfort and ability to obtain food? When trading to bids and asks fight to find the "spots in the river" where "reproduction, comfort, and sufficient food" is located in that being liquidity and action. Do trades tend to stay in one area and not migrate or move much but only when droughts force us out or the flood of a bull market pushes us up to the next higher round number?

Food for thought at least.

Davis Cup Report, from Peter Gardiner

Earth, Wind and Fire. The Beatles. The Rolling Stones. Snare drums, tom-toms, and sticks. A concert? No. The first match of the Davis Cup quarterfinal, between Chile and the US in Rancho Mirage, near Palm Springs.

One grass court sunken between four temporary grandstands, each of which were half the size of the old grandstand court and West Side Tennis Club, where The US Open was held before it went disco. Close, intimate. Maybe 2,000 people, tops. I had driven out during what I feared might be the last of the first match between James Blake and Fernando Gonzales, only to find the fifth set was just starting after Blake had blown a 7-6, 6-0, 5-3 lead, and found himself looking at a 7-6, 6-0, 6-7, 4-6 scoreboard, hundreds of red Chilean jerseys in the stands, and an opponent who didn't seem to be the least bit fazed.

The temperature was about 80 degrees, and the grass court, chosen by the host US team, had been baked in a dry, intense sun for two weeks, and appeared to be playing very true and hard, with few if any of the spastic bounces so common to grass tennis.

Why grass? The inside word was that Andy Roddick had lobbied heavily for its use in order to increase his edge over Gonzales and his teammate Masu, who, while good on all surfaces, are known to prefer hard courts or their native red clay.

There was only one problem: whatever surface you play on, you have to want to win.

Even though Blake managed to get up 2 breaks in the fifth set, and lead 4-1, he seemed to be sleep-walking, tentative on his approaches, trying drop shots from the full run on the base-line, hitting his ground strokes so short as to be almost apologetic. I was close enough to the court to see the stiffening joints and weakening resolve so characteristic of court fear spread like a toxin through his body. Even after winning a point, his shoulders slumped, his gait was arthritic, his hands in a constant motion of restrained appeal to the tennis Gods. And this was when he was winning.

Once Gonzales decided, 'yeah, I'm tired, I'm down, it looks like I'm going to lose, but what the hell,' whatever powers of movement and resolve Blake owned ran out of him like blood from a gushing wound. He is a good guy, James Blake. A talented player. A coming star. And it was a sad, pathetic effort, almost grotesque in view of his ability. No fight.

And Gonzales just pounded one huge forehand after the next on every opportunity, being careful to avoid over playing or pulling the trigger too soon, using his backhand slice on return, his topspin from the back, not over hitting, but very purposely pushing Blake around the court. And when the opportunity came, no hesitation. No fear of failure. Just all out, unremitting, focused attack, even if the opening happened to come on Blake's first serve. But a smart attack, not a kamikaze. He wasn't going to give it to Blake; he would make him earn it.

On serve, Gonzales was equally impressive, alternating between a 125 MPH heater down the middle, and an extremely effective 90-100 MPH slice wide to the deuce court. It was a perfect use of variation in speed, spin, and placement to keep an opponent off balance. Mostly, he stayed back, but sometimes, he followed it in. And guess what: Blake found out that they can volley in Chile these days.

Then we were four hours in and it was 6-6. Somehow Blake staggered through and managed another break, only to serve for the match and fold. They sparred another round, and Blake is broken for the final time, as Gonzales, the supposed clay-courter hammers home an ace for the match.

There is no mistaking the lesson of this match: if one is afraid to lose, it is impossible to summon the strength, creativity, energy and control, which inhabit and drive one's greatest talents. You cannot surprise yourself, and therefore, you will surprise no one. Fear of losing is so natural, so common. We all feel it. And it can produce no victory. For victory, you gotta' play like you want to win, and really mean it.

Blackjack and Markets, by Steve Leslie

Blackjack is a very unique table game. It is the only game offered by a casino that can be beaten over time by a skilled individual . All of the other games offered from slots to roulette to dice to baccarat are guaranteed losers if you play them long enough. It is a worthwhile chore for the investor to study the game and apply the knowledge to stocks.

There are two steps in winning at blackjack. The first step is to play basic strategy with the hand that you are dealt. Basic strategy was developed initially by Ed Thorp and described in his book Beat the Dealer in 1962. The information Dr. Thorp revealed has since been expanded upon by other writers yet "Beat the Dealer" still stands as a breakthrough in the game of blackjack and a good primer.

Prior to that blackjack was viewed largely as a game of chance. He used computer models in order to determine the best statistical way to play a dealt hand vs. the dealers up card. Since the player gets to see one of the dealers cards, a decision to take a card or stand on the cards they have would be based on imperfect information. Statistically you know that app 1/3 of the cards in the deck count as 10 so you typically make an assumption that the dealers down card is a 10. Therefore if a dealer is showing a 6 you assume that his total is 16 and by the rules of the game he must take a card. This type of information will help you determine the play of your hand.

If you play "perfect basic strategy" your odds of winning assuming you make the same bet each time are a little less than 50/50. About the same as betting the pass line in craps or betting on a color in roulette. To make money in the game you need to acquire the skill in the second step.

Since blackjack only uses a finite number of cards, there are times when it is to the advantage of the player and times when it is to the advantage of the house. This is where card counting comes into play. In one of the easiest card counting methods to use, Card counters assign a value to each card for example 3, 4, 5, 6, 7 are assigned a plus one. 10, Jack, Queen, King, Ace, are assigned minus one. When there are more high cards in the shoe, it is to the advantage of the player. Conversely, when there are more small cards in the deck it is to the advantage of the house.

By simple representative counting, counters can then determine when the shoe is in their favor or hot and when the shoe is against them or cold. What they then do is put more money into play when they have the odds in their favor and put less money into play when the odds are against them. Played at the highest level a counter ends at an overall advantage of 1.5% against the house. In real terms, if a player makes an average bet of $50 he will expect to earn app. $75 per hour. That's it. An eight-hour session will yield around $600. Of course along the way there will be some major fluctuations and dry spells when the player will give much of his bankroll to the house. Most of the time the cards are in a such a tight range that neither player or house has any real advantage. It is only when things get really out of balance that a player can make money. Most of the time he is just passing chips back and forth waiting for something to happen.

The same thing happens in stocks. Most of the time they just sit there in a tight range no real trend has developed. The chips are merely being moved around. Nobody has a distinct advantage and then something happens that causes the balance to be disrupted. It might be a release of a new product, an unexpected purchase by a customer, a myriad of events. Suddenly the stock begins to adjust to the new information and the price takes off. That is the time to move for the speculator to take advantage of the imbalance and put their money into play.

The analogy to this market seem striking. Right now neither party has an advantage so the market goes up a bit and then comes back a bit. chips are just being passed back and forth. Things will change by some external event they always do and the odds will shift again to the players favor and money will come back into play. The patient one will recognize this and reach in his account and commit capital to his/her position. For further discussion on blackjack I would recommend Million Dollar Blackjack, by Ken Uston.

Interesting note is Dr. Thorp went on to start one of the first hedge funds in 1969 and has accumulated a significant fortune as a result of his outsized performance.

Nat Stewart responds:

"The analogy to this market seem striking"

The notion of counting is an obvious analogy, especially here. What do speculators count in the market to determine what the running count is, and when to put down a bet? Isn't this type of question a large part of what the list is about.

Rather than having a single deck to count, or even the decks at just our table, we seem to have many decks, decks at different tables impact each other, and we search for new relations between the decks and within the deck. We search for new specific counts to use, yet often different different counts can turn out similar as conceptually they are of the same family. Can different counts be classified together by conceptual characteristic when looking for significance to a market pattern or phenomenon?

"When there are more small cards in the deck it is to the advantage of the house."

What is the market analogy? trading in the middle or a range rather than a range extreme? Maybe the big cards are like the larger price fluctuations that create states of advantage/disadvantage that the spec can take advantage of. Maybe a warning against grinding it out for small profits-fluctuations when one is not the house? I learned this in PracSpec. but, as is my usual had to bang my head against the wall before moving on.

"Played at the highest level a counter ends at an overall advantage of 1.5% against the house. In real terms, if a player makes an average bet of $50 he will expect to earn app. $75 per hour. That's it. An eight-hour session will yield around $600."
Is this type of computation less useful to traders do to the changing cycles? Even if less useful, does it still have some merit?
"It is only when things get really out of balance that a player can make money"
This seems to suggest trading when our market counts are also at relative extremes. Yet the perfect trade for me at least seems to never show up, when it does its easy to think "just a little more" and if I wait too long for it or am too demanding I miss the trade except those times I suffer a winners curse. When i set a limit closer, It is easy to look back and wish one had held out longer.
"The same thing happens in stocks. Most of the time they just sit there in a tight range no real trend has developed. The chips are merely being moved around. Suddenly the stock begins to adjust to the new information and the price takes off. That is the time to move for the speculator to take advantage of the imbalance and put their money into play."

This seems to suggest a momentum strategy for stocks, would a similar or opposite strategy work in index with regard to news adjustments? When price is impacted by new information, does our running count in our other decks have an impact on the future distribution?

John Lamberg offers:

  1. Not a literary masterpiece, but a good read: Blackjack Autumn: A True Tale of Life, Death, and Splitting Tens in Winnemucca, by Barry Meadow. Join Barry Meadow as he takes two months off to play blackjack in every casino in Nevada.
  2. Here's a true blue riverboat gambler who can really send it in, and his stamina is equal to that of a champion thoroughbred. Flies in on his privately owned G-9 custom super jet with his bodyguard and an occasional friend or two. He's been clocked at 16 straight hours on a Blackjack table, playing three hands -- $10,000 a hand. Seldom speaks to the dealer; mostly just hand and eye contact. Although CBS's 48 Hours featured Mr. Flynt's winning $1 million at the Las Vegas Hilton, they did not follow up with the Las Vegas Hilton vs. Larry Flynt to recoup the $3.2 million he allegedly lost in two months. Next, Caesar's Palace vs. Larry Flynt for $2.5 million in markers that was in dispute and contested. He then switched over to the Rio Suites and continued to play to sky high Word has it that Larry finally determined, "The right side of the counter is behind the counter." This gentlemen publisher and mega millionaire is building a $30 million dollar poker casino parlor in Gardena, CA.
  3. "All gamblers die broke."

Rick Ackerman comments:

Most of the top blackjack players migrated to the CBOE after it opened in 1973, and Thorpe himself had traders stationed on several option exchanges from their respective beginnings. The card counters eventually abandoned blackjack simply because the odds were better on the options floor. Also, compared to the thuggish pit bosses of Las Vegas, SEC regulators were relatively avuncular.

Of course, with relatively few rocket scientists in the game 30 years ago, option premium levels were stratospheric. For one, at- and near-the-money calls were so juicy that one could put on butterfly spreads for a net CREDIT. In retrospect, it's hard to believe that this situation could have existed for as many years as it did. The beginning of the end was in the early 1980s, when airline pilots and dentists were enticed into partnerships that used riskless spreads to roll taxable income forward each year.

Blair Hull, who later founded Hull Trading, may have been the most successful option trader of them all. He had also been one of the most successful card counters, using a system called Revere Hi-Opt II to win at blackjack. Traders often like to boast that they don't care which way stocks move, that they'll profit regardless. Blair was one of the few guys who really and truly didn't care, and the strategies he used were typically free of directional bias. For example, he wrote a program that took the randomness out of option exercise, allowing him to sell naked puts and calls an hour before they expired at (in percentage terms) exorbitant prices.

By the way, roulette can be beaten by systems play, but the technique is even harder to master than the ones employed in blackjack.

Bruno Ombreux adds:

I looked into blackjack at some point. I don't think it is possible to make a living playing this game. I am not even sure it is possible to beat the house.

A long long time ago, when Thorp first published his findings, players could get an edge over the casino, But casinos are not charities. They are businesses who make money by exploiting favorable odds. Don't think for a minute that they haven't read all the gambling books, aren't employing statisticians, aren't running experiments and simulations, aren't using the latest marketing techniques and aren't maximizing their profit.

Since Thorp, casinos have changed their blackjack rules. Over the years, they suppressed early surrender, increased the number of decks, changed the number of cards cut out of play, and more importantly, moved to non-random shuffles and limited shuffles. This is best explained in Patterson's: "Blackjack: a winner's handbook". I've got the 1990 edition and haven't played since the mid-nineties. I am suspecting this book is already obsolete in terms of techniques used by casinos.

A bit more on casino shuffles. Blackjack basic strategy is based on the premise that cards are randomly dealt. This is not the case in real life. Cards are ordered in brand-new decks. Some shuffles are more thorough and better than others at creating randomness out of initial order. Also, simulations have shown that one needs 7-8 shuffles before the deck achieves near randomness. In the nineties, casinos were using shuffles that are poor at creating randomness, like the zone shuffle. They were also limiting the number of shuffles before decks are discarded and replaced by new ones. Some shuffles are designed to completely destroy card-counting strategies. They result in "-1s" and "1s" clumpiness. People who come to the casino with only basic strategy and card-counting knowledge are bound to lose more money than ignorant gamblers.

In order to maintain a modicum of edge over the house, players have to go beyond basic strategy and card counting. Patterson suggests such things as shuffle-tracking, team play, use of miniaturized computers... As I said, this is probably already obsolete. Today's edge, if it still exists, must be so low and such tedious work, that one can make more money and have more fun flipping burgers at Mc Donald's.

Even more interesting than Patterson's book, is an Amazon comment on his book, by a reader called "Gary". Two rules from "Gary":

Rule #1: Players who play a system lose systematically.

Rule #2: Casinos have made much money on those that think that they can outsmart the casinos.

and :

If you found a great system for beating craps, blackjack, the slots, horses, or NFL playoffs, then would you publish how others can similarly benefit, or, if it is such a great system just go about making your good money?

Publishing books and systems on how to beat the casino is a way to make money. It is not very good money, but good enough with decent sales. This, of course, wouldn't approach what may be implied in the money that could be made if following this "system" in the field. Right? So, again, if you have a winning formula, why go hawk it to the public, if not to make sure, but small, money on it from publishing rather than seldom successful practicing of it.

Think about this until it makes sense.

This is eerily reminiscent of traders and the trading literature. How many people have read a couple books on technical analysis, then come to Wall Street thinking they could beat the house? How many beat it?

This said, I think Blackjack is a wonderful tool to prepare oneself for trading. The event sets are similar: past and future stochastic occurrences of "-1s" and "1s" or "ups" and "downs". The principle is the same: try to identify situations where the player has an edge, bet in such situations.

It is also a good means to get a hands-on, physical, almost sexual, experience of randomness, something which is difficult to achieve reading a book about probabilities or statistics. When ones spends many hours dealing hands, training himself to count the cards until it becomes second nature, until it become something that can be multitasked, performed while shuffle-tracking, trying to pick up a beautiful table neighbor, after a couple drinks, like a two-brained chameleon. After hundreds of deals, one gets a physical understand of randomness idiosyncrasies: the existence of unpredictable streaks, the long run effect of even a small edge, the wide short term variability...

Blackjack offers excellent training to aspiring traders.

Steve Ellison responds:

I have two friends who were on the MIT blackjack team. One entered a casino last year after not playing for 15 years and was ejected within 10 minutes.

Dr. Kim Zussman adds:

A basic tenet of markets is that investors are compensated for taking risk, and the corollary that profits are payment for bearing risk.

Gambling is a game of risk. What then, with gambling always having a negative expectation due to vig and rake (for the unThorpian), inspires the great masses to take on such risk? Isn't it the same as buying a security with a negative dividend (recalls short selling)?

Martin Lindkvist adds:

The dream of a windfall. Some people perhaps don't see that a negative expectancy game is just that, even if just playing every once in a while. Some definitely think they can outsmart the game, even though they barely can spell to "Kardcounting" or "Raacing Program". Or one of a zillion other reasons.

I don't like to play negative expectancy games, but must (think I) have some edge. But I can't blame people that do play them, because for them it's the dream of the big score through but a small fee, which is a bit like paying for insurance to avoid the big nightmare, only the other way around. And most people pay for some form of insurance.

Variations on the Analysis of Variance for Markets, by Victor Niederhoffer

The analysis of variance is a set of statistical techniques, procedures, and models for dividing the total variability into variations between group and within groups based on dividing up the squares. It formerly was used frequently in experimental design, and it is still very familiar in the normal regression outputs of computer programs which divide the sources of variation into unexplained error, explained error, and total error but it has been supplanted in the main by regression techniques in modern uses. This is unfortunate because it does many things that regressions don’t including coming up with a global measure of the differences between many means that the normal t-tests don’t. It also has a sensitivity and less restrictive conditions for proper use that results from combining two different estimates of the sources of variation, one due to the treatment or independent variable, and the other due to variations within the groups.

Any good book on statistics has a nice section on it but the best one I've come across is in my favorite introductory statistics book, The New Statistical Analysis of Data by T. W. Anderson and Jeremy D. Finn. A good internet discussion can be found here.

While analysis of variance is well used in almost every field from deep well drilling to zoology, the area where it has perhaps the most direct application, i.e. analysis of the sources and estimates of the magnitude and differences of these variations in the field of markets has been sadly neglected. Such a study might be very useful in analyzing such things as the estimates of risk, stress testing, and option pricing so the potentials from study seem great and we rush into the gap with some preliminary calculations and approaches which we will continue in the future.

The results of one study show the variation of the market between years is much higher than that computed by averaging the internal variations within years. A good way to see this is to start by looking at the variation between years as follows:

Yearly % changes  in S&P 500

          S&P      Net Chg     % Chg
12/30/05 1248.29   +36.37      +3.00
12/31/04 1211.92   +100.00     +8.99
12/31/03 1111.92   +232.10    +26.38
12/31/02  879.82   -268.26    -23.37
12/31/01 1148.08   -172.20    -13.04
12/29/00 1320.28   -148.97    -10.14
12/31/99 1469.25   +240.02    +19.53
12/31/98 1229.23   +258.80    +26.67
12/31/97  970.43   +229.69    +31.01
12/31/96  740.74   +124.81    +20.26
12/29/95  615.93   +156.66    +34.11
12/30/94  459.27     -7.18     -1.54
12/31/93  466.45    +30.74     +7.06
12/31/92  435.71    +18.62     +4.46
12/31/91  417.09    +86.87    +26.31
12/31/90  330.22    -23.18     -6.56

Some figures now for variances based on between group changes only are mean % change = 9.6 % a year and variance = 3% and standard deviation = 17.5%. Now a basic formula used in all calculations for analysis of variance is that the variance of the sum of two independent variables is the sum of the individual variances. This is usually written as var( x1 + x2 + ... xn) = var( x1) + var(x2) + ... + var(xn)

Let's start by looking at the current level of variance in the market computed from internal variations within the year. That's as we know for implied variations a standard deviation of 11% of the current level. Squaring that number gives an estimated yearly variance of 1.2 %. (This is slightly higher than the historical volatility of the daily changes over the last 2 years which has an annual volatility of 10% and a yearly variance of 1%). Since the yearly changes have a mean change of 9.6, we can look to see how many changes on the right and left tail of the normal or in this case the Student's t-distribution should be. It turns out that with 16 observations, for each side away from the mean, 10% of the observations should be more than 1.3 times a standard deviation away from the mean, and 5% should be 1.7 times away. We would expect 1.6 observations above 22% and less than 1 should be above 28%. But indeed 5 or 6 are above those levels. Similarly there are 3 negative changes that are way out of line with the 10% and 5% levels of the t-distribution.

Looking at it more formally; according to the two estimates of variance 3% from between years and 1.2% from the implied vol, the ratio of variance computed from between years to the variance computed from the internal implieds is 2.5 (such a ratio has an F distribution and is well under 1 in 100 to have occurred by chance with these mean observations and groups).

Looking at the problem with actual levels of internal volatility that have occurred in recent years, we find that over the last 10 years, the average standard deviation of the daily changes has been 1.16%. That comes to a variance of 0.00013. Multiplying that by the 251 daily changes in the year comes to an estimated variance for yearly changes from internal sources of 3.4%. This compares to the actual variance between years of 3.8%. This ratio is only slightly higher than would be expected by chance.

Thus, we can see that the variances computed from between years are much higher than the current levels of variance computed from internal daily changes. Such internal changes are the basis of most option calculations and pricing. We must conclude that unless there is a radical change smoothing out the variations in the between year variations, options on indexes are priced much too low.

Thanks to my colleagues the Minister, Saurabh, and Mr. Doc, for their assistance on this project.

Turning to Peruvian Affairs, by Tom Ryan

Peru got themselves a Hugo? As Peru prepares to vote in Sunday's presidential, it seems the campaign has been transformed from a three-way race into a referendum on front-runner Ollanta Humala.

"Hurricane Ollanta is the center of attention in Peru."
While Humala touts his determination to bring Peru into "the Latin American family" of liberal and left-wing Latin American governments, his leading rival, pro-business lawyer Lourdes Flores, talked openly of joining forces with a third candidate, the populist former president Alan Garcia, to ensure his defeat.
And the race is tight. Polls give Humala a slight lead over Lourdes with Garcia a close third. If no candidate wins 50 percent of the vote, there will be a runoff within a month.
Humala edged ahead of Lourdes in the final weeks of the campaign, winning a large following among Peru's poor with a simple message.
"We are the victims of an unbridled capitalism, a global economic imperialism," he told Spiegel Online, the German newsweekly. "The competition from multinational companies is destroying our industries, exploiting our resources and forcing us into an export-oriented economy. I am running against this."
He has also gained notoriety for his family's extremism. His father has advocated releasing imprisoned Shining Path guerrillas who terrorized the country in the 1990s. His mother suggested that homosexuals should be shot dead. And his brother (who is running for Congress from jail) proposed the same fate for President Alejandro Toledo and 120 members of Congress for allegedly selling out the country.
Humala's background as a military officer has gained him a reputation as authoritarian. When he said that Flores, if elected, "would not last a year" in office, she charged he was threatening a military coup. Humala denied it, saying his point was that Flores' neo-liberal economic policies guaranteed failure.
Though he has tried to distance himself from his family and smooth his image, his challengers insist: "Humala is a danger."
"He represents the deception of a certain sector of the population that is against democracy," Garcia told El Universal of Mexico. "This sector, desperate, deprived and furious, is being channeled behind his candidacy. His style of vertical dictatorial orders, threats and firing squads and cutting off of heads, has a certain appeal."

A Description of My Trading Day, by Martin Lindkvist

Ten Years in Wall Street is a wonderful book. It teaches among other things that we should not be bulls, bears, or pigs, but birds:

"On that day I made the acquaintance of one of that class of stock-operators whom we shall designate as panic-birds. These men are the stormy petrels of Wall Street. They are never seen in the market when everything is bright and buoyant, but let a tempest breed there and when stocks are going down by the run, they flock to the scene of disaster, prepared to take advantage of it by buying stocks at low prices. Any one who has passed through panics will remember those strange faces standing near where the contest is raging, and quietly giving their orders.

Who are they, and where do they come from? All of them are veterans of the market, who have learned by sad experience that the only way to make money in stocks is to buy when everybody else is selling; that is during panics. Some come from the country, stay over one train and then depart, loaded with securities bought at a low price, and all of them take their flight the moment stocks turn and react upwards."

Cr#mer is Brilliant, by Pamela Van Giessen

I hadn't watched CNBC's Mad Money in quite some time but had the opportunity to today and was thunderstruck by its brilliant development. It is some of the best television I may have seen this century. I do not say this tongue in cheek but with all due respect. Not sure if credit goes to Jimmy or his producers or a combination thereof, but kudos to all for combining what is appealing about talk radio and the visual effects of modern TV, with great vaudeville thrown in for good measure. The vaudeville is an especially great touch and is a part of so many great shows since man has been acting.

Today's episode opened with Jimmy reclining on a Sealy bed holding a book in one hand, hugging a blind-folded Teddy Bear, classical Musak playing. It was a derivative, homage, and riff on Mr. Rogers Neighborhood - all at the same time, and it was superb. The rolled up shirt sleeves which my husband, who is in the construction trade, informed me, means "all business" or "I'm seriously working," and when you roll them up to the upper arm muscle then you are showing a little (the male equivalent of a woman showing some belly, I suppose), combined with suit/tie look -- brilliant!! The sound effects are fantastic. The stock charts are simple, clear, and easy to see (something about the black and yellow colors). It's part advice, part doctor, part therapist, part Howie Sterns (Jim made a few non-PC remarks). It's got elements of Sesame Street, a lot of Zoom (anyone remember this show), and a little HR Puffnstuff. "H.R Puffnstuff, Who's your friend when things get rough? H.R. Puffnstuff, Can't do a little cause he can't do enough." It's those great 1970s PBS kids shows all grown up for adults. It's awesome.

I may have to break down and get Tivo or figure out how to program the DVD recorder. I encourage everyone to watch it, at least once a week, and to raise your glass in a toast to Cr#mer for making markets less scary, fun and funny, and even a little sexy for everyone. It's a benefit to society, and it takes real talent that Jim has clearly worked very hard at developing. A round of applause for his tenacity at perfecting his art.

Saving Zillah the Newfy, by Pamela Van Giessen

We are fortunate to live in a time when so many strides have been made in health care that even our pets benefit in ways unimaginable just 20 years ago. Fortunately the practice of veterinary medicine has not been made outrageously expensive by insurance, regulation, and quasi-socialist schemes, and has been permitted to explore new treatments. In fact, I'm thinking of going to the vet if I ever get sick. Can the vet treat me?

I have a Newfoundland dog named Zillah that is 9.5 years old. Newfies have a life expectancy of 10-12 (with some obviously dying of disease much earlier and some living much longer). Zillah has developed congestive heart failure. An EKG performed on Sat. showed a heart rate of 270 (it should be 100-150). On Mon. I thought he was going to die. I cried almost all day. But the vet gave us digoxin (approx. $10). Tonight we went back for a blood test and office visit to check his heart. While his pulse is still quite high (230), there is movement in the right direction. We got some more medication (Tiazac), and special low-sodium, supplement food for heart disease. We discussed adding CO Q10 to his diet (no harm, no foul so give it a try as some studies show it to be beneficial). And I got a (free) stethoscope so I can do some home heart readings and call them in. Total cost: approx. $385, all in, and which I gleefully paid. Less than $500 to save my Zillah's life, extend the quality of his days, give him more days at the beach fetching sticks out of Lake Michigan and me endless joy? You bet.

We can't know how many days Zillah has left but his treatment has been relatively painless, professional, compassionate, and hopeful yet reality-based. It has been reasonably priced. And the vet is involving me in helping me help my best friend and greatest therapist (walks along beach with big black dog are excellent for whatever ails the mind, soul, or body). Some may say that it's silly to expend so much in resources on a pet but I treasure every life in my life and believe in doing whatever I can to extend a life that can be enjoyed, even one more day.

We truly are fortunate to live in time when so much can be done to therapeutically treat disease without invasive, costly procedures. Makes me wonder if we paid for our own healthcare and got rid of insurance and high malpractice claims if it would be even 100 times better than it is now.

A Hanging Offense, by Victor Niederhoffer

A spec is always attentive to his duty to develop queries about the future course of the market ship. While I have not carried that duty as far as my daughter Galt, the movie producer, who carries her cell into bed with her, in case the West Coast is ready to close a deal after their partying, I do carry the pencil and paper about at all times, especially when reading a book.

I was reading a very good book the other night, A Hanging Offense: The Strange Affair of the Warship Somers by Buckner Melton, which describes the summary hanging without a trial of the 18 year old Midshipman Spencer, son of the Minister of War, by a Bounty-like captain Alexander Mackenzie, for talking about mutiny without any overt acts. Mackenzie's defense was that he had to protect the reputation of the American Navy from a dishonorable act like this even if it involved a violation of due process. James Fenimore Cooper commented that if 100 American ships were lost with a lengthy trial by a jury of peers, with due process including the right to confront and cross examine witnesses, it would be a small price to pay for upholding the American Constitution and liberties.

My pencil and paper came out where the author speculates that mutinies are more likely near the midpoint of voyages, especially when an island of delights beckons. In the Bounty's case, the island was Tahiti, and in the Somers' case, it was the paradise of Madeira. The author comments "A ship is a perfect place for unrest. Lack of space, lack of privacy, terrible food, constant damp and motion, broken sleep, can grate on the nerves." One must immediately add the ever present possibility of unexpected disaster, and changing conditions, before noting the obvious similarities with the market and its mistress.

In any case, the pencil and paper came out. What are the historical likelihoods after a paradisal voyage, near the middle, with hardship looming in the future? The thoughts elicited an immediate study of the quarterly changes in the S&P 500 Index from year end 1969 to March 31, 2006. During this period the Index moved from 92 to 1294, a gain of 1306% (before dividends of some 3% a year). That works out to 2% a quarter, (without dividends, and a 3800% return with dividends of 3% a year thrown in), with a standard deviation of 8% per quarter. It turns out that a simple regression of the current quarter move based on the previous two quarters yields a completely insignificant relation with the previous 2 quarters having at most a 1/20 impact plus or minus on the random prediction. However, looking at the data a bit more closely, one notes that there appears to be some unusual non-paradisal results occurring after runs of exactly 4 quarters up. Indeed, there were 08 occasions when the previous 4 quarters were up, and these were followed by a decline on 4 of those occasions, the total expectation being -3% as follows.

Moves following Positive Runs of Exactly 4 in S&P Index:

Qtr Ended    Move Next Quarter
 09/30/76		 +1%
 03/31/81		 -3
 06/28/85		 -5
 09/30/87		-23
 09/29/89		  1
 03/31/03		  0
 12/29/95		  5
 03/31/04		  1
 03/31/06		  ?

Such a difference, some 7 standard errors away from expectation, gives one pause, even with this small a number of observations, and even without asking the artful simulator to verify that it's probably about 1 in a hundred that differences this large would arise by chance factors alone.

Such a summary result would be grounds for court martial without noting the main feature of the consecutive quarterly returns. There was a highly paradisal run from end of the 1994 to the second quarter of 1998 of 14 consecutive quarters up in the index from 459 to 1133. Such a run of 14 in a row, regrettably as much as a 7% shot by chance alone in conjunction with the 3800% return mentioned above makes the exercise proper material for the Minister of Non-Predictive studies Log book, albeit it does underline the perilous nature of market voyages in such conditions.

Roger Arnold comments:

I always find it interesting when the discussion of the US constitution comes up as it relates to anything. To listen to any rationale offered by anyone considering any interpretation of the US constitution is fascinating in that the subject of the way in which the US civil war altered its applicability to the functioning of the US Sovereign government is almost never mentioned by the media, the pundits, the judiciary, or elected officials.

It is like listening to two religious leaders discuss the Christian bible, one quoting from the old testament or torah and the other from the new testament. In many ways the rules as set forth for human interaction are diametrically opposed pre and post Jesus Christ. Such is also the case with the US constitution pre and post the US civil war.

Why is this so rarely discussed?

In the post US civil war era the law of posse comitatus was passed; i.e. US military will not be used on sovereign US territory.

CHAP. 263 - An act making appropriations for the support of the Army for the fiscal year ending June thirtieth, eighteen hundred and seventy-nine, and for other purposes.

SEC. 15. From and after the passage of this act it shall not be lawful to employ any part of the Army of the United States, as a posse comitatus, or otherwise, for the purpose of executing the laws, except in such cases and under such circumstances as such employment of said force may be expressly authorized by the Constitution or by act of Congress; and no money appropriated by this act shall be used to pay any of the expenses incurred in the employment of any troops in violation of this section And any person willfully violating the provisions of this section shall be deemed guilty of a misdemeanor and on conviction thereof shall be punished by fine not exceeding ten thousand dollars or imprisonment not exceeding two years or by both such fine and imprisonment.

And yet we now have the US Army building civilian prison and labor camps on US military bases.

The Army doesn't even mention it in their plans for establishing civilian prison and labor camps; with the exception of a footnote. So, while the media debates the constitutionality of using the US military to protect the sovereign borders from illegal immigrants the US Army is using US citizens as slave labor.

The Biggest Loss, from Craig Maccagno

This post is being written so that you stop for a second and think, about whatever comes to mind. The following is a synopsis of how today went for this trader.

It started out no different than any other, wake up and reach over to flip open the laptop, check to see if anything was filled and the current price. Ahh nothing much, a few more minutes of sleep couldn't hurt, after a quick snooze up and off to quickly fire up the Francis Francis X3, a beautifully designed espresso machine, fresh beans arrived from  via UPS on Monday, so certainly a wonderful time to pull a few double shots of the Leftist blend before the Bonds open, I snag a protein bar and walk back to the office. A day like any other.

Not much going on early a couple of piker shorts early in the SP, then another double espresso wait to see if this SP can get back up near the early highs to throw on another couple of pikers out of boredom. Then the phone rings, I don't recognize the number but the area code is from my hometown so I pick up, it is the sister of a dear friend and she seems distraught, "Craig?", yes I answer, "It's Amy............." a bout of silence and I can tell she's sobbing, "Amy what happened? F--K is your brother all right?" she answers "No, mom found him this morning he's dead, Craig, Brian's dead" she breaks down and becomes incoherent. "Dead?! How the f--k can he be dead, Amy?! What the hell happened?" She goes on to tell me that her mom discovered my dear friend, who was only 39 years old, on the floor of his home, dead with no signs of foul play or anything really out of order. How is it that my dear friend of 25 years could seemingly just have dropped dead? It was Sunday night when I last spoke with him, we'd been playing phone tag for the last few weeks since he'd been busy with a new love in his life; just Sunday night he was telling me how great this new girl was and what a wonderful time he'd been having lately, in all aspects of his life.

Strictly for background purposes, Brian had been in an accident when he was 15, he fell 30 ft. from a tree swing and had broken his back, been a paraplegic ever since. From the time he was 15 until the time he was 20, he had to have been one of the orneriest SOB's I knew. He spent that five years drunk much of the time, and angry at the world the rest. Through this time I can think of at lest eight or nine times he most certainly should have ended up dead from some escapade that seemed to always include at least one combination of alcohol, firearms, drugs or car accidents. However he made it through them all, the fall, the alcohol etc etc. Then at 20 he turned things around and found AA, this was his 19th year of sobriety. His spirit was unstoppable, he was a purveyor of good cheer and inspiration whether or not he realized it, what a wonderful person he'd made himself. Often times we'd be out someplace and it was always amazing to me how blatantly obvious people were with their pity for the poor boy in the wheelchair, he would often joke about it, "They sure wanted to help out the poor cripple didn't they?" we would laugh and I'd come to refer to him at "the least crippled person I knew".

So life throws all those things at my buddy and he rises up to each and every one of them, takes them head on and becomes the better for it, until today. Today he died and I will forever miss him, you should all feel unfortunate for not having the pleasure of knowing him. Rest in Peace dear friend.

So if you took some losses today, or made some profits, keep in mind they really don't mean much in the big picture. I took one of the biggest losses of my life today, and each and every one of us will take a similar loss at some point.

Which is the Better Investment, Timber or the Land Underneath it?, by Tim Hewson

According to a story by Barton Biggs:

"Bismarck ... was convinced that investing in paper securities was a fine and quick way to get richer, but that the repository of true wealth should be land on which you could grow trees."
"Bismarck's appetite for timberland was insatiable. His theory was that the price of land would gradually appreciate in line with population growth, or about two percentage points annually."

Another Lesson Learned, by Rodger Bastien

As I toed the imaginary rubber I leaned in to examine the batter, my son. The stern determination on his face belied the gentleness in his 11-year-old soul as before me stood my little boy, tickling the underside of manhood. This was the first batting practice session of the spring but this was a winter where Carter had taken several large leaps through childhood instead of the baby steps I had grown accustomed to. There was something different about him, from the subtle deepening of his voice to the faint hint of swagger as he wiggled his bat toward me, imploring me to throw one down the middle.

I was not too sure about what kind of Dad I would be to my sons. I was almost relieved when my first two offspring were girls, as I feared I would morph into my father--uncompromising in a quest to relive and fulfill my own unfinished dream. Aren't we the sum of our parental influence, after all? Funny thing, the lessons that prevailed upon me long after my dreams had disappeared were lessons not taught but absorbed through my less than perfect upbringing. These include:

  1. Always play catch when your child asks. Always quit the moment they lose interest.
  2. Every player needs to learn to sit the bench, Being a good teammate is more important than being a star.
  3. Every kid needs to be a kid. No matter what, he needs to goof off, build a tree fort, go to an amusement park and do what the other kids are doing.
  4. Humility is a must, especially if he is the best player. Without it he will foster jealousy among the other kids.
  5. Do not enroll your child in a sport until he is ready, be it six or 15. ( I believe tee ball is a waste of time). Until he likes the sport enough to play it in his spare time, he's not ready.
  6. Love them, not their talent. Never let a bad game or match diminish them in any way.
  7. Understand that your child will probably never be a pro player. Utilize athletics to shape their character and help them grow mentally and physically. If they are that one in a million who does turn pro, their personal challenges will be tenfold greater than the average Joe faces when the cheering stops--only he will be 10-20 years older when he is forced to face the last 50-60 years of his life.

"C'mon old man, throw one down the middle, " Carter laughed, further stretching his transitional legs from child to adolescent.

As I wound up, I felt a tug of what to do versus what must be done and I threw the pitch a little harder but no less direct, plunking him lightly in his none too fleshy rib. Immediately, he glared at me with a look of both surprise and indignation. But then, just as quickly, it gave way to his little boy smirk and he stepped back into the box, another lesson learned.

Rodger Bastien adds:

There once lived an impetuous man living a superfluous life. A former athlete of some repute, he found it impossible to exist without the din of the crowd cheering his every move. In fact, most of his accomplishments were soon forgotten as he became a footnote lost in the footprints of others who created greater legacies. Although life had blessed him abundantly with great children, a successful career and a dutiful wife, it was all lost on him. His heart, once his greatest attribute, had hardened and turned to stone.

This great depression overwhelmed him. He lost his marriage. He ignored his kids. His worked suffered. Finally, he went to see his doctor for something to help him sleep, for only then did his demons rest too. Tests were given, strange results, then more tests. Finally a diagnosis, an answer, no -- a sentence. Leukemia. Five years, tops.

So this is the way it ends, he thought. The protocol was prescribed. Injections. Chemotherapy. Radiation. Five years, tops. What was the use? Wasn't this a mere formality, the physical deterioration finally catching up with the demise of his spirit? He would now have to fight for his life with very little left at his disposal. Not much other than his heart.

Somewhere wedged between the hopelessness and self pity in those next few days, something within him began to stir. He recalled a time when nothing was assured but everything seemed possible. When the beauty in life was just as much the journey taken as the destination reached. He realized that tomorrows had never been guaranteed and that in some way knowing his adversary in this fight was easier than facing the insidious struggle for self that he could not seem to overcome.

The battle was waged. One week of continuous chemotherapy, a tiny drop of poison delivered every six seconds through a vein, designed to kill IT without killing HIM. On the eighth day, his body depleted, he checked the charts at the foot of his hospital bed. Zero red blood cells. Zero white blood cells. Zero platelets. "I should be dead", he thought, but in some way he felt more alive at that moment than he had at any time he could remember. Tabula rasa. Blank slate, a new beginning. He placed his hand on his chest and he felt his heart beating, vibrant and strong.

That young man's story taught me that we as human beings are blessed with an indomitable spirit that allows us to overcome just about anything, sometimes in spite of ourselves. There is no doubt that there have been countless others more deserving than him, who fought the good fight but for some reason were not blessed with one last chance to get it right. Out of respect for them, the discussion about an athlete's courage or his heart seems a bit trifling at best. By comparison, it takes relatively little to take that last second free throw or face that 3-2 pitch with the bases full. You see, that impetuous young man was me, and I'm sure our hearts are reserved for much more important things.

Thoughts From Abroad, by Anonymous

I am in Caracas for a few days and am fascinated by what Chavez is doing here. He is making a move to make himself, and I think his country, a major power in the world.

The people here say he genuinely wants to help the poor and gracious sakes, there are plenty to help, so one wonders what they think of the billions he has spent to buy power in South and Latin America; billions that could/should have been spent here.

A large question concerns Chavez...Is he a Castro? A commie socialist...or is that part of his hustle?

Today's papers show him sitting in a newly acquired Rusky helicopter. Yesterday he was offering oil at low prices to the U.S.

My sense is he's a pragmatist that wants power and will use the various elements; capitalists or socialists or whatever, to establish Venezuela as a player in the world game.

This guy is making a huge play to be on the same status as the Arab states with his oil....he is a visionary in that sense.

Another learned and well traveled anonymous observer responds:

That is interesting because I have been to Venezuela each of the last two years and many times since the 1980s. My impression is somewhat different. For example, there are substantial coal operations in the western region on the border with Colombia in Guajira. The same coal (Cerrejon formation) occurs on either side of the border. Chevron used to operate in Venezuela and Exxon in Colombia (now its Anglo American). The difference in the operations is striking. It takes 2-3 people in Venezuela to do the job that one Colombian is doing, and the Venezuelans haven't been able to ramp up production during this cycle. Equipment lies broken and idle. There has been no reinvestment. I suspect the oil industry is the same story. Having said that, my sense is that Venezuela and Bolivia are the tip of a larger iceberg. Elections in Peru are next...

More Anon Notes from Abroad:

Some comments in the local papers:

A fourth American Airline flight between Caracas and Miami did not resume on Tuesday after the Venezuelan Civil Aviation said the plane did not have the proper permit.

My local friends say the permit is hard to get with the name American.

Today, I counted the number of times I saw the Coke trademark (14) and Nike "swoosh" (27). Stores sell lots of merchandise labeled with American names. I saw the same thing in Iran.

"Bankers advise Caution" headline in English newspaper here. "Citibank said that business environment in Latin America is "better than ever" but investors should remain "extremely cautious".

I'd say so. At the US embassy today some Americans that live here told me three college age boys from the states were kidnapped four days ago. That did not make the papers here. My bet is you never saw it either. The parents made a huge error I was told -- they went to the Police -- all three boys were found today with bullets in their head.

There is social life here, the local papers brought me up to speed on James Levine's recovery and that he will open the Boston Symphony's 2006 season. Levine's a cool guy and friend of fellow commodity traders.

Finally: "Prison abuse admitted" made headlines in English and Spanish papers. Of course, it was from 1992 and it will be hard to punish now the people who were responsible. All topped off with: A picture of Ollanta Humala dressed up like an Inca and promising to respect foreign investment, private property and free speech if elected. He is not expected to win. Nice threads, though.

Continuing the Study of Full Moons and Security Prices, by Vince Fulco

Similar to the previous SPX study, here are results of a look at oil and corn prices around the time of a full moon. Suffice it to say, both studies were as equally uninspiring as the prior one. For the crude data, Z-scores of .346 for the 1 day return window and .702 for the 3 day window were calculated. Mean change on a points basis were -.0009 for 1 day windows and -.0132 for 3 day windows. Standard deviation were .634 and 1.1177 respectively for the same period. These were in line with all non full moon periods. I double checked the max drop in oil for the 1 day period and yes during Gulf War I, there was a $9+ drop.

As for the corn results, Z-scores of .251 for the 1 day return window and .774 for the 3 day window were calculated. Mean change on a points basis were -.1361 for 1 day windows and -.5458 for 3 day windows. Standard deviation were 3.7394 and 5.7268 respectively for the same period. These were also in line with all non full moon periods.

Crude Futures (WTI)-
		       Oil- All Periods             Oil- Full Moon Period
                       Three Day Window             Three Day Window
                       Point Change                 Point Change

       Min.               -11.01                        -4.25
      Median                0.07                         0.03
       Mean               0.0509                      -0.0132
       Max.                 4.55                         4.01
       NA's                    0                            0
     Non-NA's               1596                          161
       S.D.               0.9681                       1.1177

                       Oil- All Periods             Oil- Full Moon Period
                       One Day Window          	    One Day Window
                       Point Change       	    Point Change

       Min.               -9.66                        -2.50
      Median               0.01                         0.03
       Mean              0.0167                      -0.0009
       Max.                4.15                         3.56
       NA's                   0                            0
     Non-NA's              4789                          161
       S.D.              0.6091                        0.634

                  Z Score- Three Day Window

                  Z Score- One Day Window
Corn Futures-
		      Corn- All Periods         Corn- Full Moon Period
                      Three Day Window          Three Day Window
                      Point Change	        Point Change

       Min.                 -32.25                  -26.50
      Median                 -0.25                       0
       Mean                -0.2191                  -.5458
       Max.                  33.75                   21.75
       NA's                      0                       0
     Non-NA's                 1984                     202
       S.D.                 5.5807                  5.7268

                     Corn- All Periods          Corn- Full Moon Period
                     One Day Window             One Day Window
                     Point Change	        Point Change

       Min.                    -18                     -15
      Median                     0                   -0.25
       Mean                -0.0692                 -0.1361
       Max.                   20.5                      18
       NA's                      0                       0
     Non-NA's                 5952                     202
       S.D.                 3.3005                  3.7394

                  Z Score- One Day Window

                  Z Score- Three Day Window

La Belle France, by Dan Grossman

It's a sophisticated concept, that subjecting oneself to the possibility of being fired increases the chances of being hired in the first place. Perhaps an analogy is the benefit to a homebuyer of a law obligating him to repay his mortgage loan. Why is being subject to a burdensome obligation a benefit? Because without such a law, no one would give the homebuyer a mortgage loan to buy his house.

But it's not just the young people who are objecting (though they are of course the best rioters). Polls show the new law is wildly unpopular throughout the French population, and Villepin is now a dead duck. Must be that the older, employed French view the law as a first step towards more competitive "Anglo-Saxon" capitalism for all.

Speaking of polls, I have heard that only 36% in France approve of capitalism altogether, the lowest figure in any country (does that include Venezuela?). And given all their inflexible, outmoded views (anti-McDonalds, anti-English words, anti-anything the US ever favors), I would have expected France to be going down the tubes economically.

But its stock market is up twice as much as the S&P since 2002, it has one of the highest per capita incomes in the world, and the country seems to get along just fine.

C'est un conundrum.

Tyler McClellan comments:

I have posted my thoughts about France before and appreciate Victor's joke about buying real estate in France ahead of the flood of Chinese capitalists who will buy it up by the spoonful. In the case of France, I believe it might actually be in their best interest, paradoxically, to retard modernization. Because when you think about it, how many Chinese-made wrenches are you willing to substitute for a glass of Romanee Contee. The answer is very revealing as are most exercises at going backwards into the land of barter and seeing how the price of a piece of Beaufort cheese in relation to the average car or some such has evolved overtime. One certainly would never have expected to be able to buy an incredible automobile for the price of a case of premier (but not yet old) Bordeaux. But, in 2006, that is certainly a possibility. Which brings my point home, why not simply exchange Bordeaux for Chinese automobiles and forget the project of trying to make the automobiles. Certainly we know of a company by the name of Disney where the experience is not even authentic. French Disneyland is no good, but what about the notion of France as a grown up Disneyland the whole country over?

Pitt T. Maner III asks:

Could it have something to do with the French embracing nuclear energy (for over 70% of their electrical generation) and in fact having the ability to export electricity? It would seem a stabilizing factor to have a predictable cost for power.

Bruno Ombreux mentions:

I think France has a deep-rooted problem in that the school system and media are controlled by leftists. Those kids are just brainwashed. Moreover, since surrender is an old French government tradition, demonstrators get what they want.

On the bright side, the riot police is displaying incredible professionalism. They can receive stones on their heads for hours without moving one inch. They only move when told to, with great coordination, and they arrest hundreds of troublemakers. On an even brighter side, it doesn't affect the CAC 40 the least, which is going on its uninterrupted merry ride North.

Running the Back Stretch, from Andrew Moe

As we thunder around Q1, I thought it interesting to examine various horse racing strategies for running the back stretch. Speed horses often force the action with a torrid pace out of the gate. At this point, each jockey must make a tactical decision on whether to engage the frontrunner, let someone else do it or let them burn out from too fast an early pace. Unexpected moves jumble the riddle. Several great accounts, such as '55 Kentucky Derby can be found via the link below:

From "The Sport of Kings" by Mike Resnick

"The 1955 Kentucky Derby The heavy favorite was Nashua, with Eddie Arcaro riding him. Nashua had had a pair of all-out wars with Summer Tan, ridden by Eric Guerin, and Arcaro felt that was the horse to beat. An unknown California horse, Swaps -- who would not remain unknown for long -- got a comfortable 2-length lead going around the far turn. Nashua was laying third, a length ahead of Summer Tan, and Arcaro didn't want to use his horse up and soften him for Summer Tan's stretch run, so he kept him under light restraint. And he kept him, and he kept him -- and by the time he realized that Summer Tan was never going to pass him, and Swaps was running far too easily at the front end, it was too late and he never could catch the California colt."

A Word from the President of the Old Speculator's Club:

This post in conjunction with Mr. Leslie's earlier one reminded me of a fact regarding Secretariat's Belmont run. Not only were his time and winning margin records but he also managed to achieve something else that no other winning horse has ever accomplished: he ran each successive quarter in the mile-and-a-half race faster than the quarter that preceded it. Has the market ever had six successive up quarters where each S&P quarterly gain exceeded the gain of the quarter preceding it?

Allen Gillespie notes:

The longer the race the more important the jockey

Grossman's Law, by Steve Wisdom

I ran across an instance of Grossman's Law of Parking Spots this morning. The Law (as fleshed out by Dan in a prior post) states that you can tell the real beneficiary of an organization by examining the layout of parking spaces. For instance, a supermarket reserves the best spots for the customers; a hospital, for the doctors and nurses; Congress, for the honorable Congresspersons.

Today I went to get a calcium-heartscan at a radiology clinic. This is generally a non-covered medical expense (bringing to mind another Law, perhaps unnamed, that any medical procedure truly useful for maintaining your health isn't covered by HMOs). On checking in, I not only had to pay cash on the barrelhead, I had to sign a form acknowledging that I needed to pay out of pocket (I asked the clerk why Starbucks doesn't adopt this policy and require me to sign a form agreeing to pay $2 for the cup of coffee). So anyone at the clinic was there by choice, on his own nickel.

Anyway, the parking spots adjacent to the front door of the facility were all labeled "FOR PATIENTS ONLY", and the doctors, nurses and staff parked farther away. I couldn't believe my eyes. I've never beheld such a wonder at any medical facility. Amazing.

Traders, Problem Solvers and "Folk Psychology", from GM Nigel Davies

This article about Asperger Syndrome might explain the difference between problem solvers and traders. It argues that there is a cognitive difference (rather than disability) in people with Asperger Syndrome which can be described by a Folk Psychology vs. Folk Physics model:

"Folk psychology involves understanding how people work. Folk physics involves understanding how inanimate things work. The model assumes that all individuals on the autistic continuum show degrees of folk psychology impairment, whilst their folk physics may be intact or even superior, relative to their mental age."

Could it be that we all lie somewhere along this spectrum by virtue of our genes, and that a higher degree of analytical skill will tend to accompany a less acute understanding of "folk psychology"?

Interestingly some phrases that are often coined on the list came up in this article, with strength in "Folk Physics" being associated with things like taxonomy whilst "Folk Psychology" appears useful for understanding false beliefs.

Do the twain ever meet? Perhaps, in a few individuals.

An Educational Experiment with Applications, Victor Niederhoffer

One of the commonest mistakes that people make is to believe that seemingly unusual results that are based on a small sample of observations is due to some regularity rather than chance or ephemeral factors. For example, a stock goes up four times in a row, or an investment adviser has four good years in a row, or a Wednesday is up ten times in a row. A nice experiment to defuse such erroneous thinking is described in the highly recommended, excellent book Data Matters: The Conceptual Statistics for a Random World, by Nicholas Maxwell. The experiment is to take a deck of cards and find a worthy opponent, preferably a kid, or an attractive other. Then deal four cards to the opponent and twenty to yourself. Count the proportion of hearts that each of you gets. You'll find that you win some 60% of the time. The reason is that for large numbers the observed proportion of successes tends to come close to the true proportion in the universe under consideration. As Maxwell puts it after playing the game with his son, "When we are faced with things like a top performing mutual fund, a string of six strikeouts in baseball, or seven failed sales calls, we tend to think these small samples represent the nature of what's going on." Playing with cards is a good way of showing your other that proportions in small sample vary a lot and the explanation is simply chance.

A tip you might want to follow when playing this with your other, if you wish to win quickly,  is not to use the four-card example because the number of items to be removed is fairly large. And, the difficulty in winning is that the chances of getting exactly 1 heart out of 4 is 42%, so you're going to lose in all those cases unless you came up with exactly 4 in your 16, a mere 3%. (Do check this latter with table).

Nevertheless, do be wary of assuming that the hot stock picker, the guru, the market, the system, your great superior results or any recent terrible luck is anything more than the 31% chance that you'll catch zero hearts out of four cards, or the 1/2 of 1% that you'll catch four out of four.

Scott Brooks comments:

Wouldn't a corollary to this post be the discussion on the list of late about having "heart" or having "it". If we look at those that succeed and "make it" in life, I'll bet we'd find a lot of them have "it". I'm not sure "it" is quantifiable (sorry to all the quants on the list).

But Vic's post seems to give us some clues.

In order to truly succeed, one needs to get to larger numbers (have more cards dealt to them). However, unless you've got the deck in your hand, life just doesn't deal you all the cards you want. You have to earn the right to have more cards dealt to you.

When I started in this business 19 years ago, there is no way that I could have dealt with the clients that I deal with today. Heck, they wouldn't have even given me a sniff. Therefore, I had to start with clients that I could get. Like the guy who wanted to do a $2,000 IRA, or the gal who wanted to do a $25/month mutual fund investment. I had not yet earned the education and skills necessary to have any more cards than that dealt to me.

But those of us that did hang around, we earned the right to have more cards dealt to us. We earned the right via the price we paid to develop the skills necessary to get wealthier clients to listen to what we had to say. We had the ability to put up with more crap, more disappointments, being told "NO", being rejected more than our peers. Our peers simply did not have what "it" takes to stick with it through the failures (read: lessons) that this business (or any business for that matter) makes you put up with in order to earn the right to have more cards dealt to you, thus increasing your chances of winning.

So maybe "it" is having enough of a thick skin and a belief in oneself that is so deep and so intense, that you are willing to simply put up with more crap and failures than anyone else. It is simply a numbers game and those that are honest, hardworking, and have, at least, a modicum of working grey matter, will almost certainly succeed.

The numbers don't lie (well, not always).

Andrea Ravano adds:

One of my favorite games is backgammon. In this game, which consists of a mixture of dice playing and checkers, it is quite common to confuse randomness with one's ability to play. I remember some years ago spending some afternoons playing with friends during long hours. One of the most common mistakes of the "unaware" was to mix up chance and ability. The "fools" could not see that they were pulling the right combinations of numbers at the right time. This can work for only a limited amount of time. But out of a larger sample, those that didn't play the game counting probabilities, inevitably lost in the end.

Fed Chatter, from Rudolph Hauser

The real problem with the typical Keynesian Phillips curve analysis was that it was too simplistic and plainly wrong in its simplistic form. Inflation is basically caused by too much money chasing too few goods and services. Now in measuring this the problems are how to define money, determine demand for money and to determine the available amount of goods and services. The Fed has little to do with the long term real growth potential of the economy.

What does matter is the stability of the inflation situation. Uncertainty with regard to future inflation and monetary related cyclical swings in economic activity increase risk and as such raise the required return on investment, which has the effect of reducing investment and growth potential. A stop-go monetary policy increases economic risk. When inflation is increasing and the Fed becomes more restrictive, it disrupts real economic activity, causing unemployment to rise, creating what is commonly referred to as stagflation. Decisions as to employing people are based on estimates of real returns. An unexpected and unrecognized increase in money that is excessive relative to demand therefore will result in an increase in nominal demand which can be mistaken for real demand. That results in more hiring and expansion than will be profitable in real terms. That in turn also causes both prices of products and factors of production to increase. But if money has been less than demanded and the adjustment process to that lower than desired level of money has not eliminated the divergence by changes in the factors determining the demand for money, an increased rate of monetary expansion would have a real stimulative impact.

The problem comes when money available is in excess of what will be demanded at the level the economy can produce at the attainable level of real profitability. When that is exceeded the initial impact can be a fall in the unemployment rate below its natural rate because of money delusions as to real demand, which is a harbinger of future inflation acceleration. It is only in this limited time frame that the Phillip's curve inverse relation between inflation and the unemployment rate makes any sense. The problem comes when the Fed misjudges the natural unemployment rate, or when looking at the whole picture, any of the factors noted above. Sorry I do not have numbers on historical data on hand or time now to do work to compile such.

Thoughts on Gold, from Kevin Eilian

I see gold as more than a "curiosity." I've always thought that gold is a real asset and that its value is being constantly measured against any other currency (or similar store of wealth). If the Fed, for example, tried to monetize high oil prices (as they did under one former president), there would be a significant incremental demand for the metal within this "hyperinflative" environment. The advent of the Federal Reserve system, the closing of the gold window, cannot completely shut out its usefulness as a legitimate store of value (in very specific circumstances).

Real estate can be quite illiquid, and entails significant maintenance/cash carrying costs and taxes. Of course there is a cost to holding gold, but it's an opportunity cost vs. for example hard costs of real estate ownership (maintenance/governmental taxation). On this note the same factors that caused housing to "move first" in this cycle, may make it particularly risky- i.e. a portion of housing's perceived value is a function of its special tax status that can be legislated away (500K exclusion, 1031B exchanges, special interest/real estate tax deductibility and a general "moral hazard" to lending). There could also be a change in the tax system which might equalize all forms of savings. These and other factors may cause homes to "move first" the other way.

With the supply of gold unlimited (in the sense that all that's been mined remains above ground) wouldn't that make effective long term Central Bank intervention a challenge?

Mr. Krisrock adds:

If one ratios gold against real estate, it now takes 350 ounces to buy a home vs. 500 ounces a few years ago, same for stocks, bonds, dollars even crude. It seems the counters aren't doing a lot.

Epidemics and Markets, by Victor Niederhoffer

One of the pervasive features of market dynamics is the transmission of rumors, ideas, ways to make money, fears about disaster, new industries ready to take over the world, stocks ready to take over the world or sink into oblivion, hot analysts, stocks that a guru thinks great or bad, what the hot products are going to be, what consumers are going to buy or sell, the next moves from the Fed, the expected earnings announcements of key companies, what the Palindrome or the Sage is buying or selling, the leak of the next announcement, the next federal approval or contract, or the next big blowup (hopefully not me again). In medicine, contagions  have traditionally been a specialized branch of biology called epidemiology, and there is extensive and informative literature in that field. The work has spread to include culturally transmitted bits of information, and good background for current work in the field and its current research extensions in such related fields as memetics, urban legends, percolation theory, occupancy and emptiness problems, random networks, graph theory, is well covered in the Santa Fe-like book Six Degrees: The Science of a Connected Age, by Duncan Watts. The author seems like a humble practitioner, with a model up his sleeve for almost any field that can retrospectively provide a description of what happened and it's a highly recommended good place to start.

  1. Speed
  2. One of the striking things about these epidemics is how fast they travel nowadays. We've all heard about Claire, the girl in England who complimented a lover on his technique in an email. The gentleman involved, Brad Chait, an attorney shared the compliment with six of his friends. Within a matter of days, 7 million had read the account. Why some rumors spread rapidly, some die out and some persist is well covered in Andrew Noymer’s paper The Transmission and Persistence of Urban Legends..” Noymer uses simulation to extend the basic SIR (Susceptible, Infected, Recovered) model to different rates of transmission in age groups. He's able to explain why rumors transmitted among the naïve, even when disbelieved and refuted by cynics, spread like crazy and stay with us. Noymer compared the spread of urban legends to stock traders’ susceptibility to rumors, and concludes that rumors spread most rapidly and persist longest “when skeptics play an active role in trying to suppress a rumor.” Perhaps I am doing a disservice by publishing tests demonstrating that this or that technical analysis mantra has no beef. Similarly, regulatory agencies might unwittingly help maintain false information by insisting on truth in financial statements. Everyone agrees that the spread of rumors is much faster in the Internet age, where connections can be made instantaneously and without cost. However, many of my 19th-century books have passages showing that even in those days, a ship seen in the waters of Spain or a meeting between the president and an interested tycoon could quickly cause world markets to crumble.

  3. SIR (Susceptible-Infections-Recovered) Model

    The standard references for the spread of epidemics are Bailey "The Mathematical Theory of Infectious Diseases", Anderson and May "Infectious Diseases of Humans", and Kermack and McKendrick "A Contribution to the Mathematical Theory of Epidemics", a 1927 Royal Society of London paper. A Google search of “epidemics, stock market” calls up 627,000 papers and courses, and "epidemics, ecology" yields 4.8 million entries. So it's an expansive field. A good review with numerical examples is contained in this summary from the artful simulator.

  4. Occupancy Theory

    Occupancy theory deals with such problems as the probability of putting five balls into five urns so that each urn has at least one ball. The expected number of balls in each urn after five balls are chosen is one each. And the chances that one urn will have none in it is (1- (4/5)^5). But it's not quite so simple how many urns will be empty if you have 15 urns and 8 balls, or "m" balls and "n" urns. The simplest solution to the problem I've come across comes from Dr. Math. He discusses several solutions to the problem, including one using a simple transition matrix that is highly instructive for working out the solutions to simple versions of the problem. The approximate solutions which of course all turn out to be some variant of n/e are particularly poetic. The occupancy problem is relevant to epidemics because the number of urns is comparable to the number of “possible diseased” in the population. The chance that the virus will strike any human is the chance that a given ball will be delivered to a given urn. The number of occupied states in the urns when the game begins corresponds to the number of humans already infected. And the probability of a ball going into any urn corresponds to the infection rate of the disease. The chances that the disease will spread relate to the probability that an urn is already empty, the chance that an empty urn will be selected by a virus and the speed with which the balls are chosen. In real life, certain urns have greater probabilities of being chosen if they are already near others which are occupied. These give rise to clusters. Extensions of probabilities relating to these clusters compared to the non-dependent chance of any nonadjacent urn being chosen lead to the theory of percolation, which also has many applications to epidemics. Most of these extensions can be developed with pencil and paper and a good simulator. I find the game of dots; the five-by-five dot game that all kids play where you draw lines between dots and try not to let an opponent connect a square, a great guide to thinking about percolations and epidemics.

  5. Tipping Point

    Many of the models of epidemic spread talk about a tipping point below which the disease quickly dies out or above which it inevitably spreads to the whole or at least half the population. I have looked at models based on the transmission rate, a constant probability of contact based on the number who already have it compared with the number susceptible in the population, and the urn models with different degrees of spillover between the urns very rarely contain such a tipping point. The data sometimes support another model, the logistic growth curve of spread: a small rate of growth at beginning, a high rate of growth in the takeoff phase, and then a tapering-off of growth once exposure has been given its chance to take its ugly effect. It's particularly relevant that for all reasonable prevalence of infective, susceptibles, and transmission rates, the artful simulator himself, Mr. Tom Downing, from above, was unable to find anything like the notable and frequently remarked tendencies like tipping points, logistical rates of growth or other standards described by the uninformed liberal layman, Malcolm Gladwell (who doesn't seem to understand any of the models he writes about), or those even posited by the well-meaning and certainly much more knowledgeable former MIT student, Duncan Watts.

  6. Market Applications

    I find many applications of epidemics to stock market trading systems. Such things as the optimal state of occupancy of levels in a market before you take a position come to mind, and many systems related to but different from those derived in the sultan's dowry problem come to mind. However, the simplest applications seem to be the spread of rumors about hot fields, the one or two leaders in a field that set the pace, and the other traditional areas of rumors being spread mentioned above. The difficulty is to quantify how these rumors spread. In this direction, I have been inspired by my daughter, Dr. Kate Niederhoffer, who measures the spread of information and communication links on the Internet through her position as senior research analyst at Buzzmetrics.

Gary Rogan comments:

Imagine that instead of making an analogy between markets and epidemics you want to estimate the effect of a future epidemic on a specific group of stocks. Say you want to know whether the market has sufficiently (or excessively) discounted the effect of avian flu on the stock prices of major U.S. poultry producers, most of which fell out of bed through the month of January and continue to flounder at the lower end of their recent range. This is what you have to consider:

These are just some of the things to consider. It seems like estimating the effect of future epidemics on anything in particular isn't a walk in the park. Does it seem feasible to even consider estimating something like this considering the non-linear nature of the interaction between various factors?

From Dept. of Non-Predictive Studies, the Minister reports

Is "Don't Fight the Fed" good advice?

Since 1986, there have been 2,087 trading days such that the most recent change in the Fed Funds rate was negative, i.e. interest rates were falling. Stats for the S&P on those trading days:

avg 0.053%
std dev 0.86%
count 2087
t-score 2.8

There were 2,130 trading days with the Fed Funds rate rising:

avg 0.043%
std dev 1.12%
count 2130
t-score 1.8

The market was a little better when Fed Fund rates were falling, but the difference was not statistically significant, and in fact more than the entire difference is accounted for by the crash on October 19, 1987.

George Zachar adds:

The Fed itself has "changed cycles" in terms of its reaction and communication functions several times during the studied span, reinforcing the idea that simplistically not "fighting" the Fed represents simple-mindedness in the markets.

Dicka Boelcke, from J.P. Highland

Due to rain delay on MLB's Opening Day I was forced to play TV roulette, on the History Channel I watched the interesting story of Oswald Boelcke, who by the summer of 1916, had become Germany's top fighter pilot. Boelcke draw a summary of principles (Dicta Boelcke) that should govern every air fight. The application of some of these principles to trading is interesting.

1. Try to secure advantages before attacking. If possible keep the sun behind you. Advantages for WWI aircraft included: speed, height, surprise, performance and numbers.

Speed - the pilot with the faster of two machines has control over the combat. He has the choice to break off combat and retire. The slower machine can not catch him. The pilot of a slower machine must stay on the defense. He can not run to safety. A fast moving aircraft can perform elaborate manoeuvres, giving its pilot many options. A machine flying close to its stall speed can do little beyond wallowing in a more or less straight line. Aircraft engines available in 1914 and 1915 provided just enough thrust to keep machines airborne at 80 mph, and not much more. Level flight was fine, but climbing to a higher altitude took several minutes and cut air speed nearly in half. Diving, on the other hand, could add half again to a plane's top speed. By 1916, engine power and speed increased. By the end of the war, aircraft were operating regularly at speeds over 130 mph. Speed was critical.

Height - From the advantage of flying above his opponent, a pilot had more control over how and where the fight takes place. He could dive upon his opponent, gaining a sizable speed advantage for a hit and run attack. Or, if the enemy had too many advantages, numbers for instance, a pilot fly away with a good head start. On average, WWI aircraft climbed slowly. Altitude was a hard earned 'potential energy' store not to be given away capriciously.

Surprise - getting the first shot before one's opponent is prepared to return fire was the 'safest' and preferred method for attack. Most air victories were achieved in the first pass. Without all-seeing devices like radar, a pilot could approach his foe stealthily, using clouds, haze or even using the enemy aircraft's own wings or tail to conceal his approach. The glare of the sun, especially, provided an effective hiding spot.

Performance - Knowing the strengths, weakness and capabilities of your own aircraft, and that of your foe, was also critical. Who was faster, who could turn tighter, how many were there, etc.? He argued against foolish acts of 'heroism.' If he could not 'secure advantages,' he would not attack. One of Boelcke's pupils, Manfred von Richthofen, learned this rule very well and became the war's top scoring ace.

A documented example of Boelcke 'securing advantages' took place on 17 September 1916. Boelcke and his pilots intercepted a flight of bombers and fighters crossing the lines. He chose not to attack right away, but had his Jasta climb higher above the bombers, keeping themselves between the bombers and the sun. There they circled and waited. When the bomber pilots, observers and fighter escort pilots were preoccupied with the destruction they were causing on the ground, Boelcke signaled for his pilots to attack. Several enemy aircraft went down and Jasta 2 lost no one.

2. Always carry through an attack when you have started it. Rookie pilots would start a fight, but instinct (fear) would convince them to break it off and run. This inevitably presented the rookie's tail to his opponent's guns, making the rookie an easy victory for his enemy. Boelcke learned that it was far better to stay and continue mixing it up -- waiting for his opponent to make mistakes or flee -- than to break and run. To turn tail and run was to surrender most, if not all, of the advantages a pilot might have had.

As an example, when Manfred von Richthofen met British ace Lanoe Hawker in November 1916, each persisted in trying to get on the other's tail. Both stuck to Boelcke's second dictum. When their endless circling had brought them down near the ground behind German lines, Hawker had to chose between landing and capture or fleeing. He chose to flee. Richthofen was then able to get behind him and shot him down.

3. Fire only at close range and only when your opponent is properly in your sights.A common rookie's urge was to start blasting away upon sighting his first enemy machine. Shots taken at ranges of 1000 yards stood little chance of hitting their mark. The rattle of machine gun fire would alert the intended target and gave them time to react.

The machine guns available for aircraft during the Great War were not highly accurate at longer ranges. Add to that the difficulty of aiming from a moving, bouncing gun platform at a fast moving target and it is a marvel that anyone ever hit anything. Boelcke preferred to fly to within 100 yards or less before firing, to ensure hitting what he aimed at with his opening burst. Once the rattle of his guns was heard, the advantage of surprise was gone, so it was best to make that first shot most effective.

Another aspect of making each shot count was the limited supply of ammunition carried in WWI aircraft -- usually only several hundred rounds. This could amount to less than 60 seconds of sustained fire. Reloading in the air varied from dangerous to impossible. Spraying the sky with lead in hopes of hitting something, eventually, was not an option. Shots had to be chosen carefully. Early in the war, when a sense of chivalry still held sway, some men allowed their opponents to depart if they were out of ammunition or had jammed guns. Total war did not allow such courtesies to last for long.

4. Always keep your eye on your opponent, and never let yourself be deceived by ruses. The first part, 'keeping your eye on your opponent,' sounds obvious enough, but it needed to be stated. In the hustle and bustle of an air fight it was easy to lose sight of your adversary. A restatement of this rule might be: never assume you know where your opponent is or will be. If a pilot 'lost' his foe, the advantage shifted to the foe. A successful pilot did not allow himself to be distracted from his opponent.

Ruses. It was not an uncommon practice for a pilot to feign being hit, going into a supposedly uncontrolled spin or dive, in order to exit a fight that was not going well. This practice traded on the chivalry of their opponents. To continue hammering a man who was already going down, was thought unsportsmanlike. Boelcke recognized that too many enemy were being allowed to escape and return to fight another day. War for national survival was not sport. He taught against the accepted notion that once a machine began to spin down, that one could move on. If it was a ruse, the enemy pilot would pull out at the last moment and either escape or return to attack, perhaps now having gained the advantage of surprise. Boelcke wanted his pupils to follow their opponent down. Make sure they were out of the fight or resume the fight if necessary.

5. In any form of attack it is essential to assail your opponent from behind. Firing at a machine flying across one's path required 'leading' the shot -- aiming ahead of a moving target to compensate for its speed. While a few pilots were adept at the mental calculations necessary and good areal marksmen, most were much less adept. The velocity of a moving gun platform, the speed of bullets plus the speed and direction of a moving target could be a lot to consider in the heat of battle. Furthermore, in deflection firing, the target could cross the stream of fire whose bullets were 200 feet or more apart. Such crossing gave less exposure to the bullets.

Head-on attacks or head-to-tail attacks required little or no calculated deflection in aim. Head-on attack, however, exposed one directly to the enemy's guns. Far safer and more effective to have one's target and bullet stream all traveling in more or less the same direction. This required little or no 'leading,' and exposed the target to a greater concentration of fire. Because of the prevalence of attack from the rear, aircraft design adapted to allow for rear firing guns in two-seaters and larger bombers.

6. If your opponent dives on you, do not try to evade his onslaught, but fly to meet it. This rule is related to dictum #2 above. The instinctive reaction of many rookies was to turn and flee from an approaching attacker -- especially a diving one. This simply presented their tail to the attacker, usually with disastrous results. Boelcke taught that a pilot had to conquer that instinct. Turning to face the attack could force the attacker onto the defensive, or at least keep the situation unsettled, which was far better than presenting your tail. Even though climbing to meet an attack would reduce speed, it was better to try to bring one's own guns to bear than flee.

7. When over the enemy's lines never forget your own line of retreat. If a pilot chose to flee a superior force, or was coming down with damaged machine, it was critical to spend what little time he might have going in the right direction. This rule sounds as though it is stating the obvious, but Boelcke found it necessary to include. More than a few pilots came down behind enemy lines because they got confused and lost their way. In WWI, areal navigation was done mostly by sight. Taking regular note of landmarks helped a pilot get his bearings quickly, perhaps making the difference between safety and captivity.

8. For the Staffel: Attack on principle in groups of four or six. When the fight breaks up into a series of single combats, take care that several do not go for one opponent. In the first year or so of WWI, air combat was more of a one-on-one affair. The early aces, like Pegoud, Garros, Boelcke and Immelmann, hunted the skies alone. Later in the war the sheer number of machines in the sky increased. Several reconnaissance machines traveled together for mutual protection, further protected by escorting fighters. Boelcke recognized that the days of the lone hunter were over. Many young pilots, however, still came to the front expecting to dash valiantly into battle alone as an errant knight, only to be quickly overwhelmed by multiple enemies.

Boelcke tirelessly lectured his pupils on the need for teamwork -- sometimes scolding them for acting too independently. Attacking in a group allowed the leader to concentrate his attention exclusively on his target, while his 'wingmen' protected his tail.

Air battles later in the war could involve dozens of aircraft from each side at the same time. The sky could become a swirling tangle of machines. When 'your' side was at a numerical disadvantage, it was especially important not to double up on one opponent. The concentrated fire was of dubious value, since you were just as likely to get in each other's way as hit the enemy. Doubling up also left an enemy machine somewhere unbothered and free to tail one of your side's machines. Later in the war, teamwork became the primary key to success and survival.

McKinsey's Quarterly On Finance, from Vince Fulco

Couple of snippets from an interview with Lee Ainslie at Maverick Capital:

When companies decide to stop providing guidance, that decision often induces volatility- often because companies do so in a moment of weakness. During difficult times, the market usually interprets this change to mean that the company is not giving guidance either because it would be so bad they would prefer not to talk about it or because they have no confidence in their own ability to predict the business. I would strongly advise companies, if they are going to discontinue giving guidance, do so after a great quarter- do it from a point of strength and it will be a much less destabilizing event.

Speaking on returns being diminished because of the overabundance of hedge funds:

...[U]nlike arb strategies, different L-S equity funds may come to different conclusions about opportunities...as a result incremental capital does not necessarily force spreads to close. Indeed if you look at the spread between the best and worst performing quintiles of the SPX you see that the annual spread has averaged around 70% over the past 15 years- which was almost exactly the spread in 2005. At Maverick, we are very excited about the potential to extract value (from said spread)....

This spread history needs to be looked at further, but I would have guessed a more pronounced narrowing in the last few years.

Tornado Season, from Scott Brooks

On my way home from my dad's house (just down the road), the sirens went off. The sky, which already looked ominous, was letting loose with a torrent of wind. I pulled into my yard and saw my four-year old playing by herself near the swing. I yelled for her to get in the truck, she of course wanted to know why before she would come over. I yelled at her to get in the truck now and she got the drift.

By the time I had driven around the house to the garage, the wind was whipping something awful. Gwen and our visiting guest were already heading to the basement. My eleven-year old was still upstairs trying to get the new puppies downstairs. I ran up and opened a few windows. Gwen already had the kids and guest under the basement stairway, with each persons 72-hour kit in hand.

I went to the basement garage door and watched the storm for a moment. The winding was whipping and swirling everywhere. The kids were asking lots of questions, and but for the most part, didn't seem scared. My seven-year old son, Hunter, decided that we should say a "tornado prayer". We all agreed that was a good idea, and Hunter said the prayer. He was very proud of himself.

When things calmed down, I took my four-year old to the basement garage door to watch the last of the storm. She saw the wind blowing through the trees and proudly proclaimed to everyone that she had just seen the "tomato" and there was nothing to worry about.

I was very proud of my family and how they handled things. Each kid new what to do. David grabbed the dogs, Abbey (9) cleared out the area under the basement stairs, Gwen and Hunter got the 72-hour kits out (at Hunter's behest). Lydia (4), just kept playing and asking questions about when the "tomato" was going to get there.

 Abbey said that she was really scared. I said that she handled herself really well and no one could tell she was scared. She said that even though she was scared, she knew it wouldn't do her any good, and besides, she had to get the stuff out from under the stairs. I told her that the best definition of bravery I've ever heard was "doing what you're supposed to do, even when you're scared to death!" It was really neat to watch the family in action. Needless to say, I'm a proud daddy right now!

An Unprecedented Stability, by Victor Niederhoffer

Remarkable stability. The moves in the stock market indexes have been extraordinarily stable . Last week the range between the 5 highest highs of the day in the S&P 500 was a mere 7.5 points., from 1311.50 to 1319. The range between the 5 lowest lows was also 7.5, from 1300.50 to 1308.00. Such ranges of 7.5 and sum of ranges of 15.0 are among the lowest in the past 6 years, and compare to averages twice as great.

On another front, it has been three years since a daily change has registered more than 25 points. And as Dr. Zussman points out, it's been  three years since a weekly move from high to low registered more than 5%. Also the VIX at 11.4 is less than half of its level four years ago. One wonders when will the shoe drop. When will the volatility that is necessary to get investors to do the wrong thing, shake them out of their long positions so that strong hands can take over, come into play?

One answer is that there is no need for same because there are still so many bearish commentators around, and so much skepticism about the ability of stocks to go up, that the weak are either out of the market, or ready to sell out at the merest rally, the way Grandpa Martin and every other weak long ruined by the depression of 1929 was in the subsequent 40 years when they unsuccessfully traded such bellwethers as Union and Radio.

Another answer is that the best predictor of future volatility on a yearly basis is probably something like the average of the vol over the previous two years. A look at the numbers shows that there is a macroscopic inertia of vol between years. For example the number of daily moves above 20 points in a year, or 2% for those unlike me who like to deal in percentages, is twice as great after a year with five or more the previous year, than after years with four or less. Similarly for the Dr. Zussman stats appended below.

The stability of the moves has had two benign consequences. Those who sell volatility must have shown extraordinary returns in the past several years. A look at the rankings of the CTAs bears this out, and hardly a month passes where some article doesn't appear extolling the latest adviser who has delivered 15% a year consistently to his customers over the previous three years.

Such would not seem possible in the future, as eventually, with such returns, they would have too large a share of the wealth in the world. Or, as the academics would put it, they gained during the last years from a one off decline in the level of vol from 25% to 11 % and such like the rise in P/Es from 10 in the 30's in 1900's could not be repeated.

That's the kind of argument that one could look for regularly in the pages of Barron's each week while its bearish commentator was on the beat, but regrettably during the last six weeks he has been "Out". One can only say that with stock markets registering new highs almost on a daily basis, the DAX at 6000, the Dow at 11100, the S&P at 1300, and 293 of the other 300 markets well up for the year, except for Iceland, Slovenia, and Dubai (Down 31%) (How did I miss buying it on the way down?), all in the main except for the Mid East ones at or within 1% of their six-year highs, there would have been a firestorm of protest over what would have been his normal bearishness these past six weeks, probably leading for calls for a changing of the guard in connection with his 80th birthday as he has not been bullish for one week during the 40 years of his stewardship. The current commentators at the weekly who are bearish mainly because of the trade deficit which in their wisdom they feel is bearish if foreigners were to decide with greater celerity to sell than other existing holders of stocks, and is not already taken into account in the existing current and future levels of the dollar are a poor substitute for the witches brew of reasons to be bearish that were served up in those pages so consistently during this movement to the highs.

Let us call for a return to the good old days when volatility was high, a seller of insurance could collect ample premiums for his desire to absorb risk, the weekly commentator was not "Out" or "On Leave", and those who looked for the 20 sigma events to come with much greater frequency than the normal distribution would predict, were in the catbird seat. ( Why do the words "Don't worry, you miserable b#stard, You'll get your wish in spades very soon!" -- and the opening number of the Music Man, 'He's a Music Man' come to mind?)

Jim Sogi responds:

Crashes might be considered a different process than the daily distribution of variance. The Fractious Fractalist and Expert throw out the baby with the bathwater by virtue of crashes, however use of two separate mechanisms or models may be workable, one for crashes, and one for day to day analysis. The theory is that crashes are a different mechanism than day to day dynamics, just as tsunamis are caused by a different mechanism than ground swell waves, but are both "waves". Poisson distributions might be helpful to answer the question how many crashes will occur in a given time. Or better yet, bootstrap methods might yield some results. The question is not when will it hit, but is better phrased as given there have been two years without a crash, a 25 point drop in one day, what is the probability there will be a crash this year or this quarter or this month, or for that matter, tomorrow? So the question would be how long is the time between crashes and what is the probability after duration x? As the probability goes up, exposure would be adjusted accordingly. Of course this might all be spurious if the prior high volatility regime encompassed in our data is over, and we return to a low volatility regime. Perhaps the use of points increases the occurrence of "crashes" as the price increases as 25 points is smaller percentage move.

The number of events in a given interval has the Poisson distribution if (a) it is the cumulative result of a large number of independent opportunities each of which has only a small chance of occurring, and (b) events in nonoverlapping intervals are independent." Good, In Introduction to Statistics Through Resampling; Snedecor, Ch. 7 p. 130. For a much better and more advanced discussion see Bootstrap Methods and their Application, Davison and Hinckley (with S code). Hinckley uses computer bootstrap methods to derive relevant statistics and explains and demonstrates them much better than Good and is the preferred and recommended text. Crashes have a small chance of occurring. Crashes can be considered independent in that knowledge of one is never of value in predicting another. Initially, for this test, independence might be assumed, but further testing of a clustering effect should be studied as a separate study, but as Chair says, its probably a function of volatility regimes.

Dr. Kim Zussman brings the numbers:

Dividing the SP500 daily closes since 1950 into non-overlapping five-day periods, how often is the lowest close of recent five-day more than 5% lower than highest close of the prior five-day? Below is the count on a per/year basis, along with stdev of daily returns of each year:

 Yr #    SD         Yr #    SD        Yr #    SD
1950 5  0.009     1969 3  0.006     1988 5  0.011
1951 1  0.007     1970 7  0.010     1989 3  0.008
1952 0  0.005     1971 0  0.006     1990 5  0.010
1953 1  0.006     1972 0  0.005     1991 1  0.009
1954 0  0.006     1973 9  0.010     1992 0  0.006
1955 6  0.010     1974 21 0.014     1993 0  0.005
1956 2  0.008     1975 2  0.010     1994 1  0.006
1957 3  0.008     1976 0  0.007     1995 0  0.005
1958 0  0.006     1977 0  0.006     1996 1  0.007
1959 0  0.006     1978 3  0.008     1997 2  0.011
1960 0  0.007     1979 2  0.007     1998 8  0.013
1961 1  0.006     1980 6  0.010     1999 5  0.011
1962 8  0.010     1981 4  0.008     2000 11 0.014
1963 1  0.005     1982 6  0.011     2001 9  0.014
1964 0  0.003     1983 1  0.008     2002 10 0.016
1965 1  0.004     1984 0  0.008     2003 2  0.011
1966 5  0.007     1985 0  0.006     2004 0  0.007
1967 0  0.005     1986 3  0.009     2005 0  0.006
1968 0  0.006     1987 11 0.020     

Not surprisingly the correlation between count of large drops and that year's stdev is 0.80 (big drops would cause stdev to be high, but does high stdev cause big drops?).

2003 was the last year with such a decline, so it has been two full years without one. Over this period there were six back-to-back two-year periods without big declines, and only one of them went on to three in a row (1960).

This graph helps (those of us good neither at problem solving nor making money) see the correlation between large decline frequency and realized volatility .

The horizontal axis is a proxy for date, from 1950-2005 going from left to right. The vertical axis is count of large declines within each year (blue line), as well as that year's stdev (x 1000 to scale with declines) in pink. The prior period like the present is the early '90s, with 92, 93, 95 around 43, 44, 46.

Hany Saad responds:

Stability - Low volatility - trading range - consolidation area - distribution area - support area - resistance area, etc. all these terms could mean the same thing.

The doctor is talking about stability during last week where the difference between the 5 highest highs was 7.5 and the same for the lowest low and that the market won't function for long with such a stability as the expensive wheels of commerce have to turn and the market upkeep has to be paid for by the weak. In other words, the volatility has to increase in order for the weak to contribute his share to the mistress.

This is the same concept that technical analysts define loosely as a breakout from a range. After a certain period with low volatility/ stability/ trading range, you would expect the market to decide on a direction. Tens of books were written on trading the breakout by technical analysts. Magee explains that the longer and the narrower the range the more powerful the breakout. While neither Magee nor any other technician bothered to define a range quantitatively or explain the economical or even logical reason for an inevitable breakout to occur, I find this to be the only concept in Technical Analysis of any validity.

Now, let's throw a spin at the trading range. Let's call it the trading range expansion ( a term borrowed from Tudor Jones). If the market shows the same stability Vic is describing above for a longer period than a week but the range is expanding to the downside, in other words, if hypothetically the difference between the highest highs is 7.5 and the difference between the lowest lows is say,12, are the odds favoring an upside move or a downside move (in the direction of the expansion)?

I hypothesize that the market will resolve in the opposite direction of the expansion as it will be performing two functions at once, namely wrong footing the weak while paying for the market upkeep with the increased volatility-but-that needs to be tested.

Alston Mabry adds:

Approximate changes in volatility between 2000 and Mar 2005 - Mar 2006:

VIX              -57%
BSE 30           -53%
RUT              -48%
Euro             -37%
VAY              -35%
Bovespa          -32%
Israel           -30%
All Ordinaries   -19%
SFr              -15%
Yen              -10%
Malay rubber      +6%
Coffee           +13%
M2               +16%
TYX              +17%
Oil              +30%
GLD              +32%
$CAN             +44%
Br Real          +83%

The Heart of a Champion, by Steve Leslie

It is often said one thing that separates a champion from all the challengers is their heart.

Now there is the physical heart and there is the intangible heart. The heart within the heart. The spiritual heart. The heart that cannot be defined by physical measure. The true spiritual heart cant be quantified by mechanical means, it cant be captured nor conquered. There once was a champion who had the rare blessing of both.

Secretariat was in all likelihood the greatest racehorse of all time. He was sired by the marvelous champion Bold Ruler and foaled March 30th 1970 In a sport that measures margins of victory as "by a nose" or "by a neck" and a "photo finish" Big Red as he was called was so majestic and powerful he won he just didn't win. He vanquished. He crushed. He completely destroyed the field at the 1973 Belmont Stakes winning by 31 lengths and establishing a world record at the mile and a half distance that stands to this day. Although I watched the race on television and it happened 33 years ago, I will never forget the image of Secretariat charging toward the finish line on the backstretch with no horse in sight. And even though the race was never in doubt, there was absolutely no quit in him at all. It was as if he were telling the racing world that I am going to give you a show that you will never see again. You bought a ticket to watch me run and I will not disappoint you. And the ground shook and crowd thundered. They should have created a word to describe the event that day. Secretarian. Even though I grew up in a blue collar town in the rust best of the United States, from that moment on, I became a life long fan of the Sport of Kings. He gave me a story to tell to my children and my children's children that I had the honor to watch the mightiest of the mighty. The greatest of all the greats.

He also set speed records at the Kentucky Derby and the Preakness. The only horse in history to accomplish that Herculean feat. He thus became the the first triple crown winner since Citation in 1948. All in all, there have been only 11 horses to have been christened triple crown winners. This requires an entrant to win 3 races in 5 weeks against the most elite field in its sport and across 3 varying distances on three different tracks. A bronze statue of the great horse stands in the paddock area of Belmont Park in Elmont NY forever immortalizing this most unique of equines.

After his unfortunate death in 1989 due to laminitis an incurable hoof disease, he was euthanized on October 4th. He was buried whole at Claiborne Farms in Paris Kentucky. This is such a unique honor befitting the great champion. By tradition, thoroughbreds are buried by parts, their head to symbolize intelligence, their heart to signify strength and their legs to describe power.

An autopsy was performed at the University of Kentucky; by Dr. Thomas Swerczek, the veterinarian who performed the autopsy. To his utter amazement, he found that Secretariat's heart was the largest he had ever seen in a horse—approximately three times the size of a normal horse's heart. Unlike most enlarged hearts, Secretariat's showed absolutely no signs of disease. The heart weighed 21 pounds (9.6 kg); the normal is 7 pounds (3.2 kg). (source: Wikipedia)  He had a powerplant that was nuclear when all the others were running on diesel.

In 1999 a commemorative stamp was issued by the United States Postal Service to honor the spectacular champion. A fitting honor to one whose likes we may not see for a hundred years or more.

As we approach the Kentucky Derby and the Run for the Roses I wanted to take the time to honor this most amazing turf warrior with a humble tribute befitting him . I can only say that if you ever saw him run My Lord you would never forget it.

Kevin Depew mentions:

Whenever the subject of the equine heart comes up, I think of Sham, a horse so perfectly named that one can't help but think perhaps he was named either posthumously or with such damning foresight and clarity the owners hands shook with alarm when submitting the name to the Jockey Club.

It is anecdotally true that Secretariat's heart was estimated (never weighed) by Dr. Swerczek to be about 10 pounds heavier than the "normal" stallion, but the largest heart to actually be weighed was Sham's, checking in at a whopping 18 pounds. Secretariat's heart was estimated by Dr. Swerczek to be about 21-22 pounds. This means that while poor Sham's heart was twice as large as the "normal" equine heart, and perhaps good enough for a Triple Crown sweep any other year, it was ~20% smaller than Secretariat's, and thus only good enough for second in the Derby and Preakness in 1973.

In the Belmont Stakes, the final of the three Triple Crown races, Sham broke quickly from the gate with Secretariat and those two set a torrid early pace, moving ahead of the remaining three horses in the field by 10 lengths at the half before Secretariat began to draw away. Sham finished last. And to this day horseracing fans say his heart was broken by Secretariat's dominance.

And so as one heart emerges a champion, another is broken, proving that the line between first and second is thin and harsh. Were it not for Secretariat, Sham's time in the Kentucky Derby would have stood as a record until Monarchos equaled it in 2001.

Of course, what we call "heart" on the racetrack can't be quantified, though many of us frequently say "we know it when we see it". In the absence of quantifying "heart", I think it is worth noting that horses are herd animals, and all herds have hierarchies based on a variety of factors. It is a special horse in the first place that will respond to being trained to run away from the pack, fighting its natural instincts to stay within the safety of the herd, and actually getting somewhere, say, a finish line, first; a special horse indeed.