Daily Speculations The Web Site of Victor Niederhoffer and Laurel Kenner


May 16-31, 2006


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Victor Niederhoffer Reviews Betting on Myself: Adventures of a Horseplayer and Publisher, by Steven Crist

Crist, while a medieval English major at Harvard, had an epiphany when he was introduced to greyhound racing in Wonderland in Boston. Everything he had done with English seemed irrelevant and everything he loved to do was handicap the races. He figured out that speed rating in the beginning and the end of a race were important. He became the racing writer for the NY times, started a competitor to the Daily Racing Form that was unsuccessful, and then finally bought the Daily Racing Form.

The book shows that he likes numbers but has no appreciation of how to analyze them quantitatively. He is good at collecting data. And he has a nice ear for seeing what's wrong with racing -- namely that everything starts with the public, but that the public is treated with disdain by the track and owners. His discussion of breakage is interesting in that on show bets on almost all tracks they round 219 down to 210 so the house take goes up by another 5%?

The public in the markets is often treated the same way as the public at the races and there are many good lessons that one can learn from the pitfalls of racing that one can apply to markets. He believes that handicapping horses is a respectable occupation but still thinks it somewhat impossible to overcome the track vigorish. His specialty was the Pick Six, where he was known as king of the Pick Six. However, his methods of handicapping seem qualitative with no system involved. The book suffers from an inability to generalize from his experiences, and a lack of statistical training and worse yet, no attempt at rectifying the situation.

There are some humorous anecdotes, e.g. how Governor Cuomo refused to get off the phone with him, and made him miss a Pick Six that he would have lost, thereby saving him $1400.

The last part of the book describes his takeover of the Racing Form and gives some inside info on what it's really like when you're dealing with hard hitters on the other side. The funniest part there occurs when he's negotiating a 50 million deal while doubling up on his dental work so his third party from the job he was just fired from can still pay.

One of the more erudite and amusing parts of the book comes when Crist discusses the importance of changing the cycles of the speed rating with Andy Beyer, who had dropped out of Harvard 10 years before Crist to write about racing for the Washington Post. They discuss the various speed parameter adjustments that should be made for the weather and wind and the stage of the meeting. It's exactly what the speculator must do if one wishes to keep on top of the changing relations in markets.

In short, a series of anecdotes that provides a cautionary tale of what not to do in racing and markets, and how dangerous gambling is.

Option Pricing, from Ed Humbert

Assume a stock is trading at 100. An instantaneous change can only result in the price moving up or down by 1. So the stock either goes to 101 or 99. Ignore the time value of money. Let's also say that the probability of the price moving higher is 60% and the probability of the stock moving lower is 40%. These are reasonable assumptions since the stock should at least return the risk free rate or the drift. Pretty simple stuff. What would you pay to own the option?

Most people would say 60 cents. That is entirely sensible. After all, it is the weighted average expected return of both outcomes. [(.6x1) + (.4x0)] or 60 cents. The answer is logical but it is wrong. You paid 10 cents too much if you said 60 cents. I have made this mistake my entire career. This is the difference between the real world and the risk neutral world. The point is that is easy to believe that in the real world, expected returns or probabilities drive prices. The risk neutral world says something entirely different. Look at the four tables below. They illustrate that the option should trade at 50, not 60. Under all scenarios, buying or selling the option with prices rising or falling will result in zero payoffs once you hedge half the underlying. That is the risk neutral world. Notice now that in the risk neutral world, we do not even need probabilities to get the right price.

1. Buy Call & Market ↑ 2. Buy Call & Market ↓ 3. Sell Call & Market ↑ 4. Sell Call & Market ↓

                  Payoff Premium     Delta      Option       Net

1.Buy Call           -.50             -.50       1.0         0.0	

2.Buy Call           -.50             +.50       0.0         0.0

3.Sell Call          +.50             +.50      -1.0         0.0

4.Sell Call          +.50             -.50       0.0         0.0

The Triumphant Trio on Equity Premium, from Dr. Kim Zussman

Here is another recent paper on historical equity premium by Dimson, Marsh, and Staunton:

They look at several international stock markets:

  1. Wars had less negative consequences than depressions and recessions.
  2. Tables of large positive and negative runs of different intervals show that US longest run of negative real return was 16 years, but Japan, Germany, and France had such runs as long as a half-century.
  3. Describes four "golden eras" for stocks; recovery from WWI and WWII, "expansionary 80's", and 90's "tech boom".

Letter to a Newborn Son, Part IV: The Importance of Books, by Victor Niederhoffer

If there's one thing that is the essence of the Niederhoffer tradition, one thing that is key to our being, it's the love of books. To put this in perspective, I grew up in a very small 1,000-square-foot apartment. Yet there were more books in that apartment than in the four big libraries that I keep today, which are written up in the "World of Books." The joke is that the reason my family had so many books is that my father, Artie, worked in the book publishing district and all the publishers would beg him to take their books for free so that they didn't have to pay the expense of dumping the books in the East River, which was the only way they had to deal with remainders in those days. But the truth is, my parents loved books and no matter how little money they had there was always money to buy a used one or rent one from a lending library. Five librarians came to my father's funeral, because every week he'd visit the library and take our three or four books and read them and return them with thanks.

From the day I was born, my parents read a book to me every night. I started the same tradition with you. Books are important for so many reasons, but the most important is probably that they can take you anywhere in time or space. A book can take you back hundreds of years, to different countries, into a myriad of different situations.  It can give you insight into different kinds of professions. It can arouse any kind of emotion: humor, suspense, happiness, pity.

The other reason books are so important is that they contain lots of knowledge. There's an expert on every subject and when experts have something really enduring to say , they publish it in a book. They do this usually out of a love of their subject, a calling to communicate with posterity. That's one of the keys to books. They are made to last. They contain what's known about a subject that everyone should know as of the time they're written, and that people should still know in a hard form in a hundred years.

We live in a verbal society where people who can use words well gain power and respect. No better way to learn about verbal power than through books, as almost everyone who's good with words eventually writes them. I'm proud to say that my mother and father wrote six, including one they did together, and I wrote one, and I also wrote one with your mother, continuing the tradition. I am also happy that one of your sisters has already written a very good book, and she has another one coming soon. I hope you will be the third generation to do so.

One thing you should know about books: Take them in many forms. Read them, listen to them in the car or at home, listen to your parents or friends when they read them to you, talk about them in book clubs, ask your friends to tell you a story from books , or write some yourself. Each form will develop new levels of knowledge and happiness for you.

I find that the best books were written many years ago -- I like to say 100 years ago. One reason for this is that books in the old days were read by a more thoughtful kind of audience, and books had to be of a higher quality to sell in those days. The other reason is probably related to survivor bias; the books that are old and still around are obviously the ones that still hold up. But I think there's something more involved than survivorship bias; namely, the books of the old days tried to talk about timeless, important things. The audiences were not quite as divided as they are today. The topics that the old books addressed were more expansive, adventurous, heroic. The negative reason that the old books are better is that they didn't have to worry about everybody being a victim in our society and they didn't try to write that people are entitled to thing, the idea that currently has the world in its grip. The old books often were about people using their talents, knowledge and effort to overcome the obstacles to achieve their individual goals.

One way I have of really enjoying good books is to read bestsellers like those of Louis L'Amour or Patrick O'Brian, or Frederick Forsythe, or John LeCarre, or Colleen McCullough, or Tom Clancy. They know what things people are interested in, they can construct a plot that keeps you moving forward and ties together beautifully, they know how to get you excited and then release you, and they know how to talk about important things that make you happy. One thing that ties all these authors together is that they write about important things, and they research their subjects so carefully that you walk away from the book with tremendous knowledge of a new field, as well as enjoying your visit to a new world.

I can't conclude this paen to the importance of books without telling you some of my favorite books. Presumably you won't like all of them now, but I can assure you that they each have been instrumental to the enjoyment and knowledge that I have picked up in my life. The one book that I find that I can read over and over again which people say is the greatest novel ever written is "Don Quixote." It's a book about a heroic quest, to right the wrongs of the world, to protect the weak, to uphold romantic values, to make the world safe for women, to enjoy nature, to uphold friendship. And yes, it's a book about books because the thing that inspired it were all the books about chivalry outstanding at that time that were full of holes and mistakes.

I have a recommended list of books on my site that I'm constantly adding to so I'll refer you there for a little review of some of the essentials that will make your life so much better, and on the other side, not to have read them will make your life so much emptier. Some of the highlights: "Atlas Shrugged," the Patrick O'Brian series about Jack Aubrey, for whom you were named, starting with "Master and Commander" and ending with "Blue at the Mizzen" (which most people who love Jack and Stephen never get to read because they're so sad to come to the end of the series that they don't wish to finish); "Gone with the Wind," by Margaret Mitchell (and be sure to see all the letters I have of hers that show what a great historian and wonderful woman she was); "Old Home Town," by Rose Wilder Lane; "Monte Walsh," by Jack Schaefer; "Moby Dick," by Herman Melville; and a few books by Louis L'Amour -- any will do,  but especially "Hondo," "My Yondering Years," "Son of a Wanted Man" and the Bowdrie series; "Memoirs of a Superfluous Man," by Albert Jay Nock; "Memories of my Life" and "The Art of Travel," by Francis Galton; and some Shakespeare since he has shaped the Western mind and is Mr. Literature, and some Mark Twain, because everyone should have a little bit of Tom Sawyer, Huck Finn, the Connecticut Yankee or the Traveler up the Equator, in him.

While you're at it you should read some of the most important investments books, and again these are reviewed on our site: "Triumph of the Optimists" by Dimson et al.; "Trading Exchanges," by Larry Harris; "Horse Tradin'," by Ben Greene; "The Economic Way of Thinking," by Heyne, a good book on valuation by Damodorian, and both of your father's books.

Start a library when you're very young and try to follow your parents' tradition of increasing it to beyond the previous generation. Make the ratio of books to space in your house exceed ours, and let there be a dozen librarians at your funeral. Love, Dad

Pamela van Giessen responds:

Books, whether they are fiction or non-fiction, give insight, show so many colors that our eyes miss. There is something about verbal communication that reaches deeper than any other form of communication or art.

Books, which are really just collections of words, may also be the final and ultimate refuge of the individual and individual liberties. You can read any book you want, interpret it any way you want. You can write anything you want. Words are the very basis of man's upward and evolving trajectory. Without words, there is no science, no math, no trading, no profits. Without words, there are no ideas. Words propel us.

Read the best books; read the most popular books; read even bad books. Read books by good people, smart people, knowledgeable people, and great storytellers. Read books by mediocre storytellers. And if you can parse what makes a message resonate with a peoples and time, you will be able to use that knowledge to propel your ideas forward.

I think the book is on the spec list reading list but I think that The Road to Serfdom is one of the most profoundly important books to read. It's a potent and necessary reminder that serfdom is just around the corner for all peoples and societies if they are not careful. Thus it is everyone's responsibility to protect words. In protecting words, we protect ideas.

In Memory of Elaine Niederhoffer

A Pair of Eights, from Ari Siegel

Here's an interesting poker play from a game I played with some friends this week. Guy next to me accidentally showed me his hand. It was Queen-Ten. I held Eight-Nine. He raised before the community cards came out. I announced to him that I saw his cards and then I called his raise. The flop is Queen-Eight-Three. He bets. I say, "well that flop hit you nice," and I call. Next card is nothing helpful, he's still beating me with pair Queens to my pair Eights. He bets again. I go all in, which is about 1.5 times the pot. But it was all his chips. He thought for long time, then folded.

Quote of the Day, by Victor Niederhoffer

"A company shareholder come West and spent a weeks' vacation sleeping in the ranch house, and loafing around on a quiet old horse, and he thought everything was fine, rather stern and hard, but fine, and he never knew the fact he had a quite horse, and the lack of any delighted attention to his tenderfoot antics meant anything at all"

--Monte Walsh, XYZ, a quote about the tension among the men when it was known that one of them had rustled a steer, thereby letting all the others down, but yet, even in 1880 the company shareholders sent their sons to see what it was like to get a little of the West in their boots.

Bear Necessities, by Grandmaster Nigel Davies

Look for the bear necessities
The simple bear necessities
Forget about the joyfulness of life
I mean the bare necessities
The Abelpretchnik recipes
That brings the bear necessities of strife

Wherever I wander, wherever I roam
I couldn't but ponder, my mortgaged home
The banks are on a lending spree
To make some profits just from me
When you look into the smaller print
And see that you will soon be skint
And maybe drink a few

The bear necessities of strife will come to you
They'll come to you!

Look for the bear necessities
The simple bear necessities
Forget about the joyfulness of life
I mean the bear necessities
That's why a bear can't rest at ease
Without the bear necessities of strife

Now when you pick a growth stock
Or a winning fund
And it then goes way down
Next time beware
Don't pick the growth stock on the rise
Instead just wait its demise
Have I given you a clue?

The bear necessities of strife will come to you
They'll come to you!

Cr@mer on Paulson, via Dr. Janice Dorn

I want to be honest about this. You simply could not put John Snow on television without people turning the station. That meant he could not be booked as a guest on key TV shows. He was so unimpressive a salesman that it was the kiss of death to have him on. That will not be the case with Paulson. That's because Paulson has tremendous bearing and is a great "get," meaning he's always wanted as a TV booking. That matters tremendously, perhaps more than anyone who is not behind the scenes realizes.
Now, the other important issues -- and I am adamant that the TV game is important -- have to do with whether Bush continues to consider the Treasury position as a sinecure or salesman post. Ever since Paul O'Neill did such a poor job as Treasury Secretary, I have believed that the job -- or any of the jobs involving economics -- means nothing to Bush. He took his own counsel, perhaps because he was a businessman in previous life. The problem is that Bush, too, is an incredibly inarticulate spokesperson. For goodness sake, he has 5% GDP growth and you would never know it.
I think that's because the chief spokesman obviously had no real touch with the president, the people or the communications people who convey the message. He was, alas, an empty suit.

James Lackey replies:

Oh yea I said the same thing when I saw the tone deaf one and then snowball on a speech. I wondered how in the world did these guys ever get the job? Didn't they take a media class?

I was impressed by the prolific professors TV performance. When I saw him asking "what color shirt should I wear" I went oh my goodness...as white on TV messes with the "white balance" on the camera and anyone that ever took a production class etc...but he obviously practiced his "pitch" or he is indeed prolific in speech.

All racing boys are taught at a very young age how to do an interview. We never say UGH or huh or what...or repeat as that is military for another artillery barrage "say again" If you don't hear the question, just answer your own question.

A Great (but over used ) transitional words are "SO" for a pause...very subtle you don't notice as they are carefully choosing the correct words...and if conducting an interview "let me ask you" is a pause to find where on you note card "your lost place" etc.

The canned phrases drive me nuts but that is the business "id like to thank my crew or fans or boss or wife" as they scramble for their "My Chevy, Home Depot, interstate batteries car was great today, but we came up a little bit short"

The gist is "practice every day" and over prepare so you are not nervous. A good spot is your local PBS station. You can rent or make friends and use their local set up and practice talking into the camera, switching cameras, reading teleprompters, dealing with the heat of the set, until you are an expert. The only thing "hard" about TV is the weather...that is to predict and deliver it on the green screen and have all the maps loaded correctly.

I was fortunate enough to have a PBS station at my high school. My mother was very upset when I chose not to go to school of broadcasting when I was a kid in Chicago. I said "but mom I am already making 3x that now."

Computer Algorithms for Combining Trading Models, by Bruno Ombreux

Here is an interesting article. Instead of using speech recognition techniques for investment, the authors are using an investment technique, Covers's Universal Portfolio algorithm, for speech recognition. I can't understand half of their lingo, but their conclusion is striking. Such algorithms give good results when test data is unknown or changing over time.

Which applied back to finance, means that they could perform well in an environment of ever changing cycles, their use being to identify which dialect is being spoken by the market (dialect = so-called cycle = regime), with the goal of allocating funds to the strategies best suited to the dialect currently spoken by the market.

The good news is that their algorithms have strong ties to hidden Markov models, which have R modules available and are certainly easier to learn than a whole new science (speech recognition).

Recent Declines, by Victor Niederhoffer

The recent declines in the stock market indexes raise many interesting questions. Qualitatively speaking, we've had a decline of 82 points in a two-week period, and that decline appears in the same ballpark as the decline in October relative to the big commodity brokerage that went under, and the Service decline of April 2005, and the emerging market troubles of October 1997, the Long Term Credit bailout of August 1998, the anticipatory fake October 1987 decline of July 1986. But it was much smaller than the declines associated with troubles at the slash VNDVG ranch in summer 2002, the well known and anticipated activity in downtown Manhattan in September 2001, the bursting of the bubble of Nasdaq 2000, the interest-rate fear decline of October 1990 and the Secretary of State Baker decline of October 1987. Those are all the declines I see qualitatively on a chart that seem to have fallen to more than 50 points in the S&P or 10% from top to bottom in a reasonable lookback period from highest high to lowest low in a two-month period over the last 26 years. Many questions emerge and I donít think it remiss to pose a few hypotheses with my preliminary qualitative answer before the collective wisdom of my colleagues and partners puts the pencil and paper to them:

  1. The declines are inordinately associated with prior interest-rate increases.
  2. Declines of 4% or 5% are inordinately bullish when occurring in amalgamation with much bigger declines in recent times.
  3. The declines occur inordinately around times when the trend followers have been making easy ephemeral money.
  4. The waiting times for the next declines seems to follow a Markov process of order 2, with big declines occurring with much smaller waiting times after the last two waiting declines have been small then when they are big.
  5. The longer the waiting decline cumulatively from the last two declines, the greater the expected waiting time for the next decline.
  6. Over the period 1980 to 2006 when the adjusted S&P has gone up some fivefold, all declines except the one in 1987 were ideal times to take out the canes and then go on the grand tour for a few months, turning over operations of the business to one's attorneys while on vacation.
  7. The more time the has passed without such a decline, the longer the waiting time expected for the next one.
  8. Such declines when having occurred, are inordinately bullish for next month.
  9. There appears to be about as many large rises as large declines.
  10. There is considerable consistency with randomness relating to expected mean moves in the market relative to these declines.

I am interested in any other hypotheses relating to this seemingly somewhat harmonious sweep and generalization relating to living one's life or making or keeping one's stake that are related to such grand moves.

James Sogi on Markov Chains:

Computers can generate random rhythms that also express an underlying beat that can be easily heard even in a tempo curve. In this article discussing Markov Chains, the LISP programmers use a program using a second-order Markov chain to generate random rhythms that land on the beat and have some coherence. Music is a form of communication, and we have theorized that the market is communication. The mathematician hired speech recognition programmers to listen to what the market is saying. Rhythm is a simple form of communication. Additional content is understood and communicated in words, but seems to require repeating three times. Musical rhythm often use triplets, verses to ballads often are three. A second-order Markov process describes a triad. Content has a beginning, middle and end. The market shares these characteristics and the use of threes. Most market moves seem to have a classic lighting bolt, or ranges have an N pattern. A basic bid ask market will tend to go ask, bid, ask. Communication is basically send, receive, and confirm. Market timing or rhythm might have coherence and is a basic element of communication.

A Letter from Victor Niederhoffer to Barron's Columnist Michael Santoli

It was a welcome refreshment to see your column and it must have helped to cure Mr. Abelson to see that you actually had some testable propositions in your column and that he should come back to preclude that, as well as the curative impact of a market decline which he has been predicting continuously since 1966.

However, while Mr. Abelson is partial to the continuous against-the-wind prediction of a decline that may have caused more trillions of lost wealth to individuals than anything else in history, you are subject to the seemingly sententious statement that is either incapable of falsification or likely to be true by randomness in 99% of the cases. Such for example is your remark that "the indexes donít seem poised to stretch to new index highs". Yes, they are some 3% to 4% below highs of two weeks ago, and with the volatility that is consistent with the empirical record, it's about 1 in 50 that in the next two weeks they would go above a high.

You talk about proximity to 200-day moving averages, and moves relating to 13 weeks of gain, and levels of the beginning of the year, and unmentioned distance traveled back from 2000-2002 lows. All of these statements could be tested as to their validity, and numerous of a quantitative mode are consistently doing so, taking account of the law of ever-changing cycles, but regrettably the gist of these tests is that following moving averages in stock market trading does consistently lead to above average losses as does trend following.

You talk about qualitative markers of the end of a decline, and certainly that's an interesting subject but I would lean more to the influence of Father Bernanke and his predilection for pretty women, and his promise not to repeat his misstep with Maria, as more symbolic. And more important of all, the symbol of the 5% rate on the 10-year note. Many talk about slingshot moves after they take place as you do, and doubtless if Mr. Abelson were here, he would describe it as a dead cat bounce, but the problem is that right before such bounce, the pundits were as strongly insistent that we were in a new bear market, with pivots and moving averages confirming as you are retrospectively with your 5,000 trading desks with 5,000 buy programs. Regrettably for each such buy trading program there is a sell program among traders and chart watchers that "the bounce is worth selling into."

You talk about stealth weakness in the averages, but is this unusual, consistent with randomness, or bullish or bearish? You seem to have a most undeveloped sense of whether market conventional wisdom from this or that group of traders or chart watchers, with or without an axe to grind is worth following or fading. That's why the pencil and paper is very important. Aside from Mr. Abelson turning a new leaf and your colleague testing the proposition that a decline in the dollar is bearish for stocks, and the refraining from feathering the nest of those old codgers who are consistently bearish and have missed the 10,000-fold return of stocks in the 20th century, that would be the best way in my opinion for you to improve until the date that when stock market does "stretch to new index highs," you are called back into service again, either by general revulsion among your readers or the relapse that such a rise will likely, but hopefully not induce in your venerable colleague.

Memorial Day in Westport, by Steve Wisdom

Memorial Day is my favorite day of the year in Westport.

Westport is what I imagine all of coastal suburbia will look like in 20 years, as technology advances. A layer of small-town American "locals", overlain with a veneer of sophisticates, commuters/telecommuters/knowledge-workers, who are a bit too fabulous for small-town life and would just as soon be in a big city (Next Year in Manhattan!) but because of circumstance (e.g. small children to raise) find themselves stranded in the suburbs.

But on Memorial Day, it's all small-town mojo, and the "locals" who make up the muscle and sinew of town life are out in force at the parade. Every Mom and Dad needs to choose which affiliation to support (and it's a big deal, gossip goes around the horn for weeks before: "did you hear Elissa and her kids are marching with soccer!"). My wife is a den-mother, so we march with Cub Scouts (in preference to Little League et al).

It's a surprise there's anyone left to spectate (and indeed many do turn out) since it seems everyone has at least one reason to be in the parade. Even ladies of a certain age, long past their soccer-mom years, can choose among the Women's Club, League of Women Voters, Historical Society & etc. And of course the older gentlemen don their Army/Navy/Marines gear from WW II, Korea, Vietnam.

This year the Cub Scouts (along with my five year old, who donned big brother's old Tiger Cub outfit so he could "pass" for the day) carried a 6x10 foot flag lent to the pack by a local collector. A classic flag, 48 stars. I was deeply moved to notice the old soldiers in the crowd who stood ramrod straight (as best they could) and saluted as our crew of little boys carefully carried the flag by.

A crucial moment: the fighter-jets flew over, low and loud, just as the parade crossed the Saugatuck River, on a bridge lined with dozens of flags. Amazingly, there were cheers, rather than bile/curses/fist-shaking/denunciations, even in this seemingly 99% D3m0cr@tic hamlet. Only on Memorial Day...

Department of Personal Development: Human Be-ings, by Dr. Janice Dorn

There is an old Zen Koan that says: Don't just do something... sit there. How appropriate for these markets.

The most difficult thing for traders to do is to sit there and wait. Why? Because we are in a society that is on a total dopamine binge, and this is never more clearly manifested than by those who absolutely have to be in the markets at all times, absolutely need to be trading, and absolutely cannot wait. They are human do-ings. Continue Reading...

Dr. Alex Castaldo Reviews a Paper on the Asymmetric Volatility Phenomenon

Dennis, Mayhew & Stivers: Stock returns, Implied Volatility Innovations and the Asymmetric Volatility Phenomenon, Journal of Financial and Quantitative Analysis, June 2006, p. 381

The Asymmetric Volatility Phenomenon (AVP) is the finding that a decline in stock prices leads to higher future volatility while a rise in stock prices is associated with lower future volatility. This phenomenon was described as early as 1976 by Fischer Black. It was evident in the marketplace during the past two weeks and is well known to option market participants. Despite considerable research, academicians have not yet been able to understand the phenomenon to their satisfaction.

This paper examines whether the AVP pertains to individual stocks, or whether it is linked to the behavior of the aggregate stock market. The authors studied both S&P index options and options on 50 individual big cap stocks during the period 1998-1995. (The world of academic research moves at a glacial pace, the data is in this case 10 years old when the article is published!).

The authors use the VIX as a measure of the implied vol of the index, and they compute daily implied vols (IV) for the individual stocks. Because individual stocks respond both to market movements (the so called systematic factor) and to company specific information (the idiosyncratic factor) it is possible to similarly decompose individual stock IV's into an idyosyncratic IV and a systematic IV. The idiosyncratic IV is defined by IV_idiosyncratic = SQRT( IV_stock^2 - Beta^2*VIX^2).

The findings of this paper are clear cut: The correlation between S&P return and change in VIX is large and negative: -0.679, the typical correlation between individual stock returns and the change in idiosyncratic vol is much less, only -0.163. The authors conclude that the AVP is more related to market-wide systematic factors than individual firm-level influences.

The earliest explanation of the AVP, given by Christie in 1982, was a firm-level explanation: when a firm experiences a business setback the stock price goes down and the stock also becomes riskier (if for no other reason that the market value of the firm is now smaller compared to the firm's debt, so that the firm is closer to insolvency) i.e. more volatile. The findings in this paper raise doubts about this (and similar) explanations.

Two other explanations of the AVP are market-wide: According to Bekaert and Wu (2000) increased macro-economic uncertainty causes the market to become more volatile, when this increased risk is taken into account in valuing stocks the stocks have to be marked down to compensate for increased risk. In this expanation then, it is the increased vol that causes prices to drop and not vice versa.

According to the Avramov, Chordia, Goyal (2006) explanation "herding" on the part of traders (that is a tendency to dump stocks during declines and to get back in during rises) is the cause of the increased vol. (I have not read this paper yet and I may not be doing it justice, but the logic sounds plausible to me).

Other findings

The above analysis was essentially univariate. With a more complex, multivariate analysis the role of idiosyncratic volatility falls even lower: a correlation of -0.047 or essentially zero with the stock price change.

The authors also look at the IV smile. Consistent with previous studies they find that the slope for near ATM options is substantially more negative for index options than for individual stock options. The smile is largely an index option phenomenon.

Finally what is the relation between the implied vol and the subsequent realized vol? Although most papers find that it is difficult to beat IV as a forecast of future vols, many papers also find that there is a bias i.e. IV slightly overpredicts the actual vol. In this paper actual vol for the index is found to be equal to 0.813 times the index IV (meaning that the IV is about 18.7% too high), while actual vol for individual firms is 0.991 times the individual IV (i.e essentially the same). Given what we have learned earlier about the AVP, it seems plausible that writers of index options charge higher prices than writers of individual options because they face an additional risk: the AVP risk. While not proven in this paper, it seems a reasonable extrapolation.


Some of us on this list trade index options and some trade individual stock options. This paper is a useful reminder that, despite some superficial similarities, these are two rather different kinds of instruments. We should keep in mind that what applies to one does not necessarily apply to the other.

Alston Mabry replies:

Thanks to Dr. C for the interesting review that provokes thought even amongst those of us in the nosebleed section, who not only don't see the game clearly but also aren't always sure which game is being played.

That in mind, one looks at the S&P daily cash 1980-present (src: Yahoo). Compute for each day the log % change for that day and also the "minimal path" as a % of the final close. This would be:

minimum of the absolute point moves of either (Close[-1] -> Open -> High -> Low -> Close[0]) or (Close[-1] -> Open -> Low -> High -> Close[0]), divided by Close[0]

which provides a % measure of volatility during the day (maybe: "churn"), separate from just the net percentage change.

Number "up" days:  3522
Total % move for all "up" days:  +2524%
Total % minimal path  for all "up" days:  +6165%
% minimal path per % of positive movement:  2.44

Number "down" days:  3143
Total % moves for all "down" days:  -2277%
Total % minimal path  for all "down" days:  +6415%
% minimal path per % of negative movement:  2.82

Ratio of churn required per % of negative move to churn required for % positive move: 1.154.

Maybe the negative moves have to fight the long-term positive drift.

My membership in the Society for Non-Predictive Studies is now renewed.

The Art of Shaving, by Prof. Gordon Haave

Sometimes you get what you pay for, even if the price seems outrageous. Such is the case with shaving supplies from The Art of Shaving.

Some years ago I used to shave with a badger brush and shaving soap. I did this mostly because I had bought a nice brush and accoutrements from the always glorious Nat Sherman in New York City.

Over time, however, I eventually gave it up. For one thing, the nice shaving sets usually are not up to date on the latest Mach 10 razor technology, and furthermore the traditional shaving soap is not very good.

All that changed for me this morning. A few weeks ago I bought a shaving kit from The Art of Shaving at the Galleria mall in Dallas. I just tried it out this morning.

Boy, what a fantastic shave. Definitely the best shave I have ever had. My cheek skin has not felt so smooth since before I had facial hair.

There are a few keys to The Art of Shaving that differ from the fancy brush shaving sets. First, the Art of Shaving sells a pre-shave oil that you carefully rub into your skin. Second, it comes with a real, actual shaving cream as opposed to shaving soap.

The shaving cream comes in a tube, and I found that it lathered up as nicely as Edge Gel.

Third, you use your own razor. I have the latest Gillette with the battery in the grip.

And fourth, it comes with a nice balm to use in lieu of an alcoholic after shave.

The pricing on the products is quite high, so I suggest recommending it to a family member as a good birthday or fathers day present for you.

Either way, however, if you are at all dissatisfied with your current shave, I highly recommend the Art of Shaving Products.

And no, I have no financial interest in this recommendation.

Department of Fixed Income: George Zachar Analyzes Janet Yellen's Recent Speech

There is a painful grandiosity in Saturday's speech by San Francisco Fed President Janet Yellen. Perhaps it is her physical distance from hypercombative Washington and the capital markets. It's hard to say.

Her repeated references to the Phillips curve and NAIRU certainly lead one to think the Fed no longer pretends its economic role is anything besides calibrating the tradeoff between inflation and unemployment.

"As the logic of the Phillips curve makes apparent, such long-lasting shifts in import prices would indeed require the Fed to adjust its monetary policy to keep overall inflation in the vicinity of the Fed's preferred target. To combat the "headwinds" associated with chronically rising import prices, monetary policy must be tighter, which entails greater slack in the labor market. Tailwinds due to falling import prices, in contrast, lower the degree of slack required to attain a fixed inflation objective. It is in this sense that ongoing negative supply shocks raise the NAIRU, while ongoing positive supply shocks lower the NAIRU."

I think it's fair to say Ms.Yellen might have been more circumspect if she had to face the periodic congressional auto de fe endured by Chairman Bernanke.

"...rapid productivity growth, which the U.S. still enjoys, enabled the Fed to keep unemployment at extraordinarily low levels for an extended period while simultaneously bringing inflation down to levels consistent with price stability."

Enabled the Fed to keep unemployment at extraordinarily low levels?

Perhaps I am old fashioned, but it's just unseemly for unelected technocrats to ascribe such powers to themselves.

"From the perspective of monetary policy, there is one notable asymmetry affecting the Fed's ability to combat any "headwinds" or "tailwinds" associated with globalization. The asymmetry results from the so-called zero bound on nominal interest rates-which sets a lower limit on the federal funds rate below which it cannot go should the Fed need to stimulate the economy to counter deflation. With sufficiently intense deflationary "tailwinds," the Fed could conceivably exhaust its scope for response, at least using conventional policy approaches. In fact such risks became palpable in 2003-for the first time in half a century. This episode stimulated not only thoughtful policy research but also a creative and constructive response on the part of the Fed."

The 2003 deflation scare is memorable for many things, though it is exceedingly UNlikely future historians will consider the era of super-easy money as a "creative and constructive" Fed operation.

Dollar Declines, Changing Cycles and Aberrations, by Yuri

The past few dollar declines seems to have occurred prior to bullish moves in US stocks. However this most recent dollar decline which started the week of 4/21/06 was followed by a bearish move in stocks which started week of 5/12/06. Two weeks ago on 5/19/06 the dollar started going up, and this past week of 5/26/06 stocks started going up. Is this a sign of changing cycles or just an aberration? How often do aberrations occur over such prolonged periods in highly liquid markets?

What to Make of Intel and Its New Product, by Victor Niederhoffer

I find it amusing to buy and sell individual stocks as I am such a rank amateur. But the funny thing is: when I buy a stock, invariably all the troubles of the world are crystallized in their news stories. I never knew so many things could go wrong for a company even though I have run quite a few myself and been associated with Dan Grossman in owning dozens more, and through my merger business, hundreds of others.

When I owned Pfizer, every problem that was ever possible having an impact on health, medicine, hospitals, executives or products was visited on the company as if it were some Biblical ten curses visited upon the Pharaoh by Y-hw-h as punishment for his errors. Finally it got too much, as I received the day by day of the transcript of the patent litigation with the Indians on Lipitor and it became clear that the company's only viable product was 50-50.

Now with Intel, it's even worse. First their seven-foot tall Chairman prostrated himself before a gathering of executives and admitted he hadn't done as good a job as Andy. Then they missed sales, lost customers, reduced margins, failed to compete against a lower power machine, had excess inventory, had an abysmal marketing strategy that confused everyone with multiple brands and numbers, wasted its research money, had too much hiring, had 97 of 100 funds reduce their holding of them in the last quarter, got whacked daily by the Wild Man, constantly had earnings forecasts reduced, or gurus discuss why they sold out in favor of other companies, failed like the world's worst commentator colleague of the dynamic Jon Markman said about Lucent -- that its problem was that people couldn't tell if it was a value or a growth stock and too high for value and not enough growth for growth et al, the new executive shouldn't quit because his performance has "not yet been a firing offence," the company isn't paranoid anymore like Andy said it should be, smart systematists are short it in pairs et al, downgraded by this or that, and it gets worse. Every day its price action sinks and it wins new records as the worst performer in this or that group in this or that period, be it the Dow, Nasdaq, or last year or this year, what have you.

Still, I haven't sold it yet as it's like me, it's so bad it couldn't get worse. Along those lines I always ask myself if people are so dumb that when a company misses its quarterly projections, and they know from past retrospective Compustat studies that when a company misses, it underperforms, that they will sell it en masse even though the humbled, almost fired CEO says that they have their biggest new introduction ever planned for the third quarter. My goodness, everything I know about business says that when you have a new intro, you get lots of business, whether it's a hot new thing from the East, or a new product that the testers say is beautiful. Along these lines, I'm ignorant enough not to know before I receive this that microprocessors are tested the same way cars are tested by critics and knowledgeable drivers. It was interesting to see this road test in this context, and I'm ignorant enough to hold this stock on the grounds that a company that has 80% of a market with the market growing 15% a year, that has a 20% profit after spending 10% on research, with a major new product that tests well on target for a quarter shouldn't be that much worse than the tried and true can't miss Dilly Bar like other companies in the Dow favored by the sanctimonious Sage. This test drive review was sent to me with the comment, "This is what people who know computers actually read. Important."

David Baccile adds:

Let's not forget Intel's $15 billion in cash - equal to that of AMD's entire market cap. INTC is the only other tech stock that makes me feel better about holding MSFT, "at least I'm not as bad off as those lowly INTC holders"...well, both have big new product offers coming out and typically the market is a little forward looking.

Kim Zussman mentions:

One question about Woodcrest, or any new processor breaking last year's speed barriers, is whether Moore's law or its analogies matter anymore. It is many years now that micro-processing is ubiquitous, and many years since latest versions of Windows pair traded with newest Intel mps, but now everything is about the web.

The law of diminishing returns comes into play, as it should when consumers seek new and better services rather than higher computing speed, which makes little difference to 99% of users.

I'll match the badness of my own stock-picking against anyone's, but it seems that when a good company gets beaten down enough the highest probability path is up, a la MRK, PFE, and recently MSFT.

1280 is a Key Number, by Mr. E

We are at a crucial juncture from 1286 to 1280. The key number is 1280.

David Hillman responds:

Since January of this year, the market has been trying the same level, for the third time. The winds are different this time. In my view the mistress is not treating the level either as a floor or a ceiling. She is testing it, first with small moves, now with bigger ones. She might try even bigger moves and even smaller ones. And the only way I know to play the game is 1. to choose sides and 2. to fight.

 from Casablanca.....

Captain Renault: "In 1935, you ran guns to Ethiopia. In 1936, you fought in Spain, on the Loyalist side."

Rick: "I got well paid for it on both occasions."

Captain Renault: "The winning side would have paid you much better."

George Criparacos responds:

One has drawn a horizontal line at the SPX 1280 level since Jan 1999, when the market first went to test that range. Back then it was usual to have 60+ point weekly ranges. Throughout most of 1999 one remembers many times the fight at that level, both before and after the market managed to overcome it. In my notes, one sees many instances where a question prevailed: Why didn't the market trade that level? meaning that it was either treating it as a ceiling, or as a floor but never traded it, let say between 1250 and 1310. Weeks went by until mid Oct.'99 - I had just finished reading ed spec, without which I would never have taken a long position when the market finally went to test, and of which I am greatly thankful to the chair for writing it.

Whatever gains were made the next months were unfortunately given back to the mistress in Feb. and March of 2001 when the same play was attempted, on the same 1280 level . but the gods were against that time around. Again, however, the market treated that level as a ceiling or as a floor but did not trade it.

The Return of Alan Abelson, by Mr. Krisrock

According to Barron's, Alan Abelson is to return from his illness leave in mid June.

Dr. Phil McDonnell responds:

It is good to hear that the augur of doom will be rejoining us. Somehow it seems ironic that the largest market drop occurred when he was not around to make his maleficent predictions.

David Baccile responds:

Perhaps it was the market drop that prompted his recovery?

Weekly Commentary from Dick Sears: "Thirteen Days in May"

Why Am I Buying That Stock? from Steve Leslie

Whenever I find myself challenged by the confusion of the stock market, I go to my library of favorite investment books to review. I have found invaluable insights time and again from such persons as Gerald Loeb, Ralph Wanger and William O'Neil through a re-read of their books. Each of these great investors have provided me with marvelous nuggets of wisdom that have chartered me through perilous times.

Perhaps, my favorite book dates back to 1989 and is written by the best mutual fund manager of all time. Of course that would be Peter Lynch.

Chapter Seven of Peter Lynch's book "One Up On Wall Street" is devoted to his description of the six general categories of stocks. It is titled "I've Got It-I've Got It-What Is It?"

Mr. Lynch says that it is imperative that the investor understand six major categories in order to assess the reasons why he should own a particular stock at this time. In fact, when he sits down with his staff of investment managers, they are required to explain their reasons to buy a stock and which category it falls in.

These are in order:

Slow growers. These are the large and aging companies expected to grow slightly faster than the GDP.

Stalwarts. Such as Coca-Cola, Bristol-Myers, and Procter and Gamble.

Fast Growers. These are small, aggressive, new enterprises that grow at 20 to 25 percent a year.

Cyclicals. A company whose sales and profits rise and fall in a regular fashion.

Turnarounds. Battered, and depressed and barely holding on.

Asset Plays. A company sitting on something valuable that Wall Street has overlooked.

Therefore whether an investor is considering General Motors, Exxon, Intel, Microsoft or the company on the cusp of the cure for cancer, we would all do better to classify it first and remind ourselves why we want to own it now at this particular point in time.

US Inflation brings "Quote of the Day," from Paolo Pezzutti

Two days ago news:

"Commonly used government price indexes overstate the level of inflation in the economy," Federal Reserve Chairman Ben Bernanke said Thursday. In a letter to Rep. James Saxton, R-N.J., responding to questions left over from his recent testimony to the Joint Economic Committee, Bernanke said, "both the consumer price index and the Fed's preferred gauge, the personal consumption expenditure price index, overstate inflation, but show that core inflation is well contained."

The continuous change of attitude towards inflation and interest rates that alternates in various statement from the Fed would be funny, if what is at stake was not investors' money. I would add also that most vulnerable to this approach are those investors who traditionally are the stock market ecosystem suppliers of energy: the small investors who read the newspaper in the morning and get confused by the "oraculum" language used in ever-changing-view statements.

Space Advantages and Implosions, by Grandmaster Nigel Davies

A space 'advantage' in chess is one of the most difficult things to handle. On the one hand your opponent may be 'cramped' and find it difficult to coordinate his pieces, on the other you have vast reaches of territory that require defence. Everything, as usual, depends on the disposition of the forces.

This got me thinking about markets, and how the price action over a particular time frame might show one side or the the other to have a 'space advantage', depending on whether the bulls or bears have encroached on the other's 'territory' on a chart. And this in turn led me to wonder if there are ways one can gauge the disposition of forces to know if such encroachments represent advantages or implosions waiting to happen.

Dr. Phil McDonnell responds:

As so often happens on this venue the Grandmaster's musings have spawned another Eureka moment on this side of the North Pole. Frequently we observe that the daily fluctuations of the market push one way and then seem to thrust in the other direction without any apparent news or clear reason.

One interpretation of these moves may be that the market is trying to create space for itself. One need only watch a low range, low volume day to realize its chilling effect on trader interest. Markets which become locked in between large limit orders quickly become dull and uninteresting. The lifeblood of the market ecosystem is order flow. Thus market makers and sell side brokers require space in order to continue to interest traders.

One way to create space is to make daily runs up to the highs in order to clean out the sell at limit orders. Then the market can turn down to make a similar run to clear out as many buy limit orders below the market. When the bears are in control the runs down will make lower lows as it is easier to clear out orders on the downside. Higher highs would indicate that the bulls are in control.

The GM's concept of space dovetails quite nicely with the Chair's oft noted observation that a large range can be an indicator of a buying opportunity. As the range expands the market has the space it needs to attract trader interest. New money enters the fray and prices are pushed higher. For an example of the converse of the expanded range theory, one need only look at the very narrow daily range of the market just prior to the recent sharp decline.

Yishen Kuik adds:

To tie in some other ideas.

Markets like to follow the path of maximum volume. As the market rushes upwards, it runs stops, forces weak bears out and entices fresh bulls to join in.

While this is happening, stops on the downside accumulate like barnacles at various obvious points. Markets then turn downwards to exploit the volume below, once again running stops, causing weak bulls to exit and enticing fresh bears to join in.

Brokers would love for this to continue ad nauseam, but with each up and down chop, breakout boys and trend-followers lose interest. The range created by the chops get smaller and smaller in amplitude, volume shrivels up. The chart looks like an attenuating sine wave.

The market knows that if it persists in this wanton act of abusing the audience, it will be killing the golden goose - so better to put on a good show at this point. Set up a nice extended run that everyone can talk about, easy for traders to hop on and boast of good returns later at happy hour.

Better to keep the audience coming in than completely decimate them with choppiness.

Further Thoughts on Space, by Briefly Speaking, by Grandmaster Nigel Davies

The classical view of a space advantage was that it naturally conferred superior piece play on its possessor, whilst the player with a 'cramped' position would have his pieces tripping over each others' toes. And there is probably some truth to this concept.

Yet stated in these terms is far too general to be a useful rudder in competitive play, and there are numerous caveats which must be considered. Here's a first attempt at categorising them:

  1. The side with the 'space advantage' is poorly coordinated so his pieces cooperate badly despite the control of terrain.
  2. The 'cramped' side has beautifully coordinated forces despite the lack of terrain, and thus the logic behind space is negated.
  3. The outposts conferring the space are not secure, creating the possibility of an implosion.
  4. The space advantage cannot be increased or transformed into anything else.

The last of these actually points to a single concept, and that is the idea of dynamic potential. Is a position being stretched beyond its elastic limit, or is it poised for a rebound.

Briefly Speaking, by Victor Niederhoffer

This market move back and forth was a classic involving disruption, promotion, symmetry, bear raids, Father Fed and, of course, the most important factor of all -- the function of markets to signal imbalances, provide information about the future and transport goods over time.

It started with a 2% decline on Thursday the 11th, continued with a 2% drop on Wednesday the 17th, and another horrible 1% on the 18th. VIX moved up a nice 80% from the mid-11s to 20. But through it all, the highest move in the actual November VIX futures contract barely budged from 14.40 to a high of 15.60. Thus the markets are always so much more prescient than the spot numbers themselves in forecasting the future and taking account of correctable imbalances.

The gold contract had to come down from 730 to a low of 636 and other inflation indicators followed south, with silver down 25% from a high of 15.20 to a low of 12.21, and oil down a mere 10% from 75 to 68. The Goldman futures index dropped just 8% from a high of 503. Once again, the markets showed that inflation was not a threat, or at least that the threat was was overblown. Those who bet on inflation lost their shirts. Most important of all, the ephemeral people who follow fixed systems, mainly trend followers, were crowing about the never-ending moves and ineluctable profits of just following momentum. What a beautiful setup for the trend following index to fall from 1250 to 1140 or so in a week. The markets again showed that ephemeral factors were at work, that fears were overblown and a correction to normalcy was in order.

As usual, emerging markets led the way. First the Arab markets plunged 50%, setting off the debacle in Europe and then the U.S. As soon as the Western decline got going, the Arab markets showed a quick 20% rise, signaling that they were ready to go back the other way. The European markets led the U.S. down, dropping a quick 10% for example from 6150 in the DAX on May 10 to 5550 on May 22. But then they led the way back, going up 3% on Tuesday while the U.S. market cratered, trying to squeeze the longs one last time.

The squeeze was a disruptive move of the kind that Gestalt psychologists would have endorsed. Irving Redel's theory of least observable change was rampant. When the market wants to squeeze you, it gives you some horrible news... and a horrible move. It did that on Tuesday in the last half hour, dropping some 2.5% on rumors planted on Drudge, presumably by the bears, that bird flu had been spotted again. It reminded me of the moves that prevailed in the last half hours of late 2005 when news that a suspected terrorist was thought to be surveying the Boston subways.

With all that was going on, the planted news about bird flu, Iranian missile tests, the release of the Bin Laden tape to heighten the Tuesday decline and the fear that it would be repeated on Wednesday, as well as the absence of two consecutive up days in the U.S. stocks for a month was all that it needed to set the bear trap. Of course it ended the same way it started, with a big Wednesday and Thursday up, to Lobogola the move down.

This is all merely description, and as for my predictions, ha, look at the food web and what I said about the consistently planted rumors by infallible forecasters who had called every previous move right.

And as always, romance played a role. The market dropped on the initial signal that Chair Bernanke couldn't control his emotions with a pretty reporter. When it was confirmed that CPI was actually up 0.1% more than expected the combination of the Oedipus complex and the security of the father syndrome went into play, and the market was ready to take its vast 7% plunge, which it hadn't done for four years. But then, the signal it was over -- "Why is it always romance?" as Rumpole would say, was when Bernanke admitted that he made a mistake in judgment and that he would never succumb again. The wife and markets must have been very happy, and that was all it needed in conjunction with the other things to return to go its normal course of 10% a year up, as holds in conditions when the earnings-price ratio is so much higher than the 10-year rate. The one truly bearish factor was the move above 5% in 10-year note yields. But when this was quickly reversed the next week and bonds quietly moved to a one-month high. With the promise of no more romance from the Chair of the Fed, it was clear sailing ahead.

Do Independent Directors Count? from Yishen Kuik

I was listening to Maurice Greenberg talk about his life, AIG, C.V. Starr, etc at the 92nd St YMCA. Mostly, the theme was how American competitiveness was being eroded by regulation, and how China should be embraced, not confronted. In the middle of his speech, he said that the stock price of companies with no independent directors on their board outperformed those with independent directors on their board. I don't have the means to test this, but thought I'd share.

Russell Sears notes:

It would be interesting to see how much of this out-performance occurs due to a switch from no independent directors to those with independent directors. Is this a signal or admission of guilt, and vice a versa?

Common Errors Made by Forecasters, by Victor Niederhoffer

During bear markets, the one thing you can count on is that all the people who have refrained from buying stocks over the last 10 years will come out of the woodwork, thumb their noses at you, and tell you they called it all along. The phrase "as predicted" "stock market" on Google has more than 100,000 entries.

As I point out in EdSpec, Harry Browne in his book Why the Best-Laid Investment Plans Usually Go Wrong has a hilarious chapter on this. He actually saves the forecasts of those who claim they caught it, and finds that their self reported results are usually far off the mark. Indeed there is a whole field in psychology concerning the tendency to overestimate success on routine tasks, and most astute decisions makers take account of this in their revised estimates based on such self reports. I have read numerous articles on this thread which comes under the "accuracy of predictions" "self reported" rubric.

I would point out some common errors that I find. One of the worst is those who say something like "1282 is a key level." Of course almost any level will be touched, and such forecasts, which donít tell whether they are bullish or bearish, are particularly likely to be self reported as incredibly accurate afterward. Another common error is the retrospective forecast. "Monday was the day I went long on bonds" the forecaster reports two days or a week after the event occurred. A third error common among forecasters is, "There will be an increase in volatility," or, "There will be rangebound days." Yes. There will always be rangebound days between high and low, because those are the extremes of the day. As for volatility, everyone knows that it has ephemeral moves to lows and highs. However, the actual contracts that pay off based on where the volatility actually will be in three months et al. take that into account. For example, the VIX futures for August haven't moved by more than a half vol during this whole market decline where the current VIX has moved from 10% to 20% or so.

It is good to evaluate the actual track record of forecasters who claim that they caught every move. Invariably they'll come up with some excuse; they only report it offshore to their clients because they donít want the amateurs to know what they're doing. If you ask them how they did last year, they'll come up with yet another obfuscation.

You get the gist: good decision makers are always very humble. They know how hard it is to forecast and they donít trash talk when they're right or bemoan unduly when they're wrong. The Palindrome was an exception here, and he never admitted to having a winning trade and always emphasized his losses, and aside from what he taught me about always playing tennis with two new cans, that is the most valuable lesson I ever learned from him, albeit I like most good athletes had adopted a similar technique, never admitting to a potential victor in advance in my athletic career and always emphasizing how much better chances the adversary had.

The Art of Defence in Chess, by GM Nigel Davies

Most of what I know about defence in chess is from Keres' chapter in 'The Art of the Middlegame' and 'Lasker's Manual of chess'. Here's the gist of their more important concepts:


When defending difficult positions, don't stake everything on an immediate all or nothing counterattack. Instead your job is to make it as hard as possible for the opponent to win, increasing the odds of his tiring or making a slip.


Make sure there is no weakest point in your position, trying instead to make all points equally strong. Try to avoid passive (immobile) positions as if have the potential to counterattack it can draw your opponent's pieces away from his own offensive.

Underlying Lasker's thoughts on defence is the 'theory of Steinitz', which suggests proportionality in our commitment to attack or defence depending upon whether or not we have an advantage or disadvantage. So when you have an advantage you must attack, but the attack should be in proportion to the advantage. And when you are on the back foot you must defend, but once again with the commitment to defence reflecting your disadvantage and the remainder of the pieces employed in counterattack.

I see this aspect of chess in terms of energy flows, with the disposition of pieces having to adjust with the cut and thrust of battle. It's rather more sophisticated than the single gear approach.

Desert Hazards, from Steve Ellison

The desert presents difficult survival challenges. Hot, dry weather dehydrates the human body rapidly. Clear visibility and sparse vegetation make distant objects appear much closer than they really are, occasionally luring a wanderer to try to hike to a mountain that is actually 30 miles away, with possibly catastrophic results. Richard Lingenfelter wrote in "Death Valley and the Amargosa: A Land of Illusion":

The first sensations of thirst begin with the loss of a little over a quart of water. By the time you have lost a gallon you begin to feel tired and apathetic. Most of the water lost comes from your blood, and as it thickens, your circulation becomes poor, your heart strains, your muscles fatigue, and your head aches. With further loss of water you become dizzy and begin to stumble; your breathing is labored and your speech is indistinct. By the time you have lost two gallons of water [which you can lose just by sitting in the shade on an average summer day in the valley] your tongue is swollen, you can hardly keep your balance, your muscles spasm, and you are becoming delirious.

Substitute money for water in the above passage, and it begins to resemble what the last several days have felt like for one who had counted out declines from recent highs and reckoned them to be bullish. I had a profit in sight on Tuesday, but, alas, it proved to be a mirage. There is a rally ahead, but how far away is it really, and will I die of dehydration before reaching it?

Dr. Kim Zussman responds:

Not since early 2003 has there been decline more than 5% in 10 days for SP500. Which recalls a (now naive) sounding recent question about how many times Nasdaq had been down seven days in a row (not many).

One would think the most relevant priors are the most recent ones, along the lines of "investors have been behaving this way lately," and a fair assumption is that they will continue that way. But when there are few or no recent analogies we are sent to wander a barren landscape and hope not all oases are mirages.

Why did the market start acting differently? Recent discussions focus on 1987 analogy, when the new Fed chair was still Green, prompted study of volatility around Fed chair changes. Finding no support for this, Ben and Maria gossiped and now the worry is that Greenspan really was a friend (recall my dead tarantula who proved his friendship by dying before biting).

Perhaps most cycle changes are not foreseeable, but only show post-mortem, and the thing to do is be ready for them and know how to adjust. The problem is this is a contradiction, since profitable strategies have to assume something and that something is the recent past. Or, for others, 1987 or 1929.

Helm's Deep, from Andrew Moe

The track of the S&P E-mini (ES) with excerpts from JRR Tolkien's, Lord of the Rings.

ES 1330:

It was now past midnight. The sky was utterly dark, and the stillness of the heavy air foreboded storm. Suddenly, the clouds were seared by a blinding flash. Branched lightning smote down upon the eastward hills. For a staring moment the watchers on the walls saw all the space between them and the Dike lit with white light: it was boiling and crawling with black shapes, some squat and broad, some tall and grim, with high helms and sable shields. Hundreds and hundreds more were pouring over the dike and into the breach. The dark tide flowed up to the walls from cliff to cliff. Thunder rolled in the valley. Rain came lashing down.

Arrows thick as the rain cam whistling over the battlements, and fell clinking and glancing on the stones...The assault on Helm's Deep had begun...

ES 1310:

Against the Deeping Wall the hosts of Isengard roared like a sea. Orcs and hillmen swarmed about its feet from end to end. Ropes with grappling hooks were hurled over the parapet faster than men could cut them and fling them back. Hundreds of long ladders were lifted up. Before the wall's foot the dead and broken were piled like shingle in a storm; ever higher rose the hideous mounds, and still the enemy came on.

ES 1300:

The men of Rohan grew weary. All their arrows were spent, and every shaft was shot; their swords were notched and their shields were riven. Three times Aragorn and Eormer rallied them, and three times Anduril flamed in a desperate charge that drove the enemy from the wall. Then a clamour arose in the Deep behind. Orcs had crept like rats through the culvert through which the stream flowed out...

ES 1270:

A hundred ladders were raised against the battlements. Over the wall and under the wall the last assault came sweeping like a dark wave upon a hill of sand. The defence was swept away...

ES 1250:

But even as the gate fell, and the Orcs about it yelled, preparing to charge, a murmur arose behind them, like a wind in the distance, and it grew to a clamour of many voices crying strange news in the dawn... And then, sudden and terrible, from the tower above, the sound of the great horn of the Helm rang out...

ES 1247:

The hosts of Isengard roared, swaying this way and that, turning from fear to fear. Again the horn sounded in the tower. Down the breach of the Dike charged the King's company ... The White Rider was upon them, and the terror of his coming filled the enemy with madness. The wild men fell on their faces before him. The Orcs reeled and screamed and cast aside both sword and spear. Like a black smoke driven by a mounting wind they fled. Wailing, they passed under the waiting shadow of the trees; and from that shadow none ever came again.

The Executive Hobo Story, by Bo Keeley

Fed Chair Testimony Q&A Haiku from George Zachar

Ben's dinner gaffe a
"lapse in judgment on my part".
He's learned his lesson.

Bernanke's banter
all "regular and formal"
from now on. Promise!

Ecology and Markets, by Victor Niederhoffer

One of the functions of ecology is to steer us to think of the interactions between species and the effect our habitat has on our behavior. A person familiar with ecology always looks in wonderment at the complex and changing web of interactions between all the forms of life and their environment and the mutual connections so necessary for their survival that they have with each other.

Interacting prices of markets play a similar role in shaping our behavior that the environment does. However, whereas the effect on form and behavior of a changing environment in species are often written over generations, the effects of markets often take place in seconds.

With these thoughts in mind, consider the landscape of markets that investors face this week versus the one about ten days ago. The situation two weeks ago was bleak with the dollar and bonds getting killed, the trend followers making new highs with momentum investing every day at 1150, and commodities at all time highs with newspaper articles each day proclaiming this the great wave of inflation. But, now compare the current landscape. Commodities and stocks have suffered their worst week in three years. Trend followers are down some 10% from their previous levels, and about 1/5 of the S&P 500 stocks are down at least 10%, with Freeport, Nvidia, JDS, BJ Services, Allegheny Tech, EOG Resources, Carnival, Nobel, Rowan, and Phelps Dodge all down 15%. Bonds and the dollar are at a one-month high, up about 2% from their low one week ago.

In short, the markets have played their function in redeploying goods from the future to the present, signaling the likely impact of current conditions, and correcting any imbalances that existed. As to whether this redeployment is finished no one knows. Obviously the bears, like Alan Abelson on October 26, 1987, will take the line that it's only a start and the bulls will say that the market has now gone through a period of 1.5 years with merely a 4% rise during a period of some of the most bullish economics and earnings time and earnings price relative to bond yields in history.

The only way I know to answer such questions is to ask what is now more likely relative to Fed activities now versus one week ago. Are they really that behind the cusp that they're still going to be taking anti inflationary actions after commodity prices and other forward looking markets have suffered their worst one week decline in history? Perhaps there is ambiguity here. Thus, one turns to markets themselves to look what has happened in weeks similar to this, where the bond yields are way down and stock yields way up, with the dollar strong and metals weak. Fortuitously for the markets, but regretfully for the past statistics, only 20 observations over the last 10 years qualify as fitting the bill with the two salient characteristics, and one or two of the dollar and metals similarities. Such ecosystems show that the markets had a leading, signaling and salubrious forecasting impact on the next week's change, with median expected changes and standard deviations both of order of plus one or two percent.

George Zachar adds:

One mistake I've repeatedly made, and labor mightily to avoid, is substituting my judgment for that of the Fed. Put another way, I have to ignore what I would do, and try to divine what the children on Constitution Avenue will do. The famous metaphor of judging the beauty pageant judges applies.

Right now, there is not a single FOMC member with in-depth capital markets experience. Yes, the Street will certainly take phone calls from the Board, but there's scant capacity there to synthesize intelligently. The CIA's ability to gather but misread! copious datastreams comes to mind as an obvious parallel.

Put another way, Fed decisions will be made by government lifers, time-servers, academics, and "suits". Speculators must set their sails accordingly.

James Sogi offers:

On a recent trip to New York City I had the opportunity to study the taxis. I rode all around the city during all of the 24 hours in a day to all areas, and not once did I have to wait for more than two or three minutes, and often no time at all, for a clean, late model, metered cab with a profession driver who picked me, drove me door to door to the requested destination, without much direction, avoiding the more expensive 'scenic' routes, expertly avoiding the traffic, at high speed, all for a relatively low low price agreed to in advance. If you have ever driven in New York City, you know it's more stressful than holding a large position in a crashing market. These pros do it all day long. What's more, when I did not need the car, it cost me nothing. The one day I did have a car, I circled for over an hour looking for parking in the full parking lots, the rare on-street parking, and faced exorbitant rates while burning $3.50 of gas. The taxis are, except for loose regulation and some registration requirements, free to roam the city as independent agents. They compete against each other for fares, and need to distribute themselves to where the fares will be or face no income. A driver, by my estimate, could make over a thousand dollars per day working for himself, which provides work for immigrants. The market forces are at work here, using incentives to provide a highly efficient and adaptable system at low cost, to provide transportation on a moments notice to a city of millions at all hours of the day or night. No regulated system could work as well. When will central planners learn this?

As a side note, whether it was the pleasant spring weather or good economic climate, New Yorkers were uniformly pleasant, courteous, friendly, from the waiters, doormen, taxi drivers, club and bar patrons and workers, musicians, restaurateurs, hoteliers, old friends, new friends, right on up to the very top of the ladder, and even people on the street were all uniformly of contented disposition and mien, all seemingly going along with the "program", and intent on their occupations in a professional, friendly, courteous manner. No anti social behavior was observed anywhere in the seven days, no "scenes", no bums, no beggars, no frowns, no scowls, no yelling, little graffiti, no line pushing, no cursing, no complaining. I do not think it was my effort to emulate the Dalai Lama and give respect and compassion to all people that created this amazing experience of an entire city, New York, being entirely comfortable with itself. For one who grew up there and saw the breakdowns of the 70's, filled with angry youth, bad attitude, heavy crime, social unrest, it was an amazing display of ecological, cultural, social and market forces successfully at work. No dictator could create or plan such a city or such a society. We live in a wonderful time and have a wonderful economic and social climate. Those with a contrary opinion are advised to take a look for themselves.

The same type of incentives and independence are available to the market participants. They are loosely regulated. They compete with each other and need to place themselves where the best "fares" will be. Those speculators who provide the independent service of placing capital at the places where no others are or are willing to are able to get good fares. At SP 1250's, there were few cabs and little capital available, but a quick fare uptown to the upper east side in the 70's in a few minutes was a good tip to the independent drivers of capital who were there to take the fare. An amazing thing is that when not engaged in utilizing capital, not only does it cost anything, but they pay you 4% to kick back and wait for the next ride. Next week should be some good taxi driving in a pleasant economic climate, in a great city and a great country when some fares likely to go back and forth in the mid town area below 125th street, but those eight and ten block fares can provide a pretty good income. Sometimes the wait for the fares out to the airport require a longer wait or risk getting stuck in traffic.

This focus on the true nature of speculation in the bigger picture creates a mental focus on the true forces with which the Speculator deals, and provides a better foundation for success than the ephemeral issues which cause losses more than that to which traders have a right to lose, or the ephemeral issues reported by the press or other market advisory services, or things tracked by spurious indicators.

A Good Take-Off Spot, from James Sogi

Yesterday's big waves in the markets reminded me of big wave surfing. The big 15-point moves are like 15-foot waves. Either you are in the right spot and catch the ride of your life or you eat it big time. My favorite big wave spot Mahaiula is very tricky to ride big waves. The 15-25 foot waves come marching in from outside the reef and the big ones tend to break early on the outside cloud break reef, and the white water washes through and sweeps most of the surfers waiting into the beach under water. After surfing there for 25 years with my best friend, whose family used to own the property when we surfed for days with the place all to ourselves, I noticed that there is a small area about 15 feet long and 6 feet wide in a triangle shape in the middle of the ocean that is not marked. This spot is only found by triangulating certain palm trees against a certain lava dome, and certain shaped rocks, which formula is of a highly proprietary nature, but which allows me to sit in the midst of giant breakers crashing around, and be untouched, and when ready, to paddle a few strokes and be in position to ride a giant wave, sometimes without getting my hair wet. It takes courage to sit in place and not turn and run, as a huge 20-foot wall of white water comes rushing towards you at high speed sounding like a freight train rushing at high speed, but amazingly just at the last minute, the white water backs off, and reforms into a perfect shaped wave.

Yesterday's market had some big moves up and equally big and rapid moves right back down, and then right back up, at least looking at a typical bar chart would make it seem that way, but perhaps may mislead as to what is going on, and obscure where to sit or enter. Look at just the hourly time and sales below. Look at just the closes. It would seem nothing much happened all day with four-point range in closes. The highs are relatively clustered as are the lows. Looking back on the day always seems so easy, but looking forward at levels is something I've heard long time traders talk about. Some say: look at such and such a level. Chair talks about rounds. But there are many levels. Chaos and stampedes go in either direction, but what is good to have is a safe spot, or safe level to sit and wait for the thundering freight trains to go by safety and a spot to get on and off without getting worked over and dragged underwater. As Tom thoughtfully suggests, it's good to have these levels worked out in advance with your methodology because stampedes are distracting. Yesterday's violent back and forth had method to the madness. Simple addition and subtraction provide more accuracy than estimates based on colored lines moving around.

                       Low       High       Close
05/22/06    10:00    1262.50    1268.75    1265.00
05/22/06    09:00    1262.75    1265.75    1264.75
05/22/06    08:00    1262.50    1265.50    1265.25
05/22/06    07:00    1264.25    1265.75    1265.25
05/22/06    06:00    1262.75    1266.00    1265.50
05/22/06    05:00    1259.25    1264.25    1263.50
05/22/06    04:00    1262.25    1267.75    1263.75
05/22/06    03:00    1267.50    1271.00    1267.75

Federer on Clay: How Does He Get an Edge? by Alfonso Sammassimo

Adapting against an opponent often requires us to play shots we are not as comfortable with in an attempt to exploit their weaknesses, and sometimes it simply means playing to our strengths as often as possible.

Federer has a positive expectation at the net, even on clay. That positive expectation won't last long if he attacks the net every point -- selective approaches matter as much as his ability to execute the volley. But increasing the opportunity is so important when there is an edge - so how good does the approach set-up need to be to attack? Increasing opportunity may incorporate more risk - there is always a delicate balance. But where is the risk higher? In making more approach shots which may end up in the player getting passed? Or being too careful and end up being slowly eaten by a monster (sorry Rafael) who dines from the baseline? We decide on how big an edge we require when we trade -- demanding too much of an edge may lead to many missed opportunities. The size of the edge required may vary depending on the court we're on.

It is easy for any player to lose track of where the positive expectation is during a match. Getting passed three or four times in a row will often convince an attacking player to stick to the baseline -- which may be just the place where he is more likely to lose most of the points. Experience helps a player distinguish between a short term swing against him and an end to the success of the strategy. The better he knows his opponent, the easier this distinction becomes (until his opponent comes up with something new!).

A little nugget from John McEnroe in Tournament Tough, by Carlos Goffi:

The key to beating a player on his favorite surface, or on one which suits his natural game better than yours, is to get him out of his preferred game, make him do things he doesn't like to do.

Applies to almost endeavor you can think of.

GM Nigel Davies notes:

Nice commentary in Financial Times about Federer's chances in combating Nadal on clay. There seem to be many analogies with chess and markets here, with adaptability being the key.

James Tar adds:

The Federer versus clay, Federer versus Nadal argument is very much like the current Stocks versus Rates-Inflation-Gold-Crude debate that is presently dominating our daily speculative lives. "On clay, Federer's attacking style is thwarted, as the surface negates the speed of his attack and the friction in the surface favors the speedy, powerful, counterpunching brilliance of Nadal," is the common conclusion. "Stocks are less attractive when rates and other inflationary forces slow the prospects for earnings power." Perhaps the one thing that can be certain in such explanations, is that they are generally made quickly and are widespread to an extent that they become conclusions. It only takes a few recent and minor setbacks to cast a spell over tennis fans and market enthusiasts to think that the battles are now indefinitely one-sided. Like the stock market, you can bet that Roger Federer will be the one to be pulling out his Canes on his way to a more than conclusive victory over his temporary foe in the next fortnight.

Comeback of Martina Hingis, from Paolo Pezzutti

Yesterday, Martina Hingis won the WTA Rome final. Her first title in four years, a 6-2 7-5 defeat of Dinara Safina. Her Russian opponent made too many mistakes as the Swiss #2 cruised to her first title since the Pan Pacific Open in Tokyo in 2002, and first since returning to the tour.

It is great to see a champion back. I was there today, at Foro Italico. I was impressed by the way she moved around the court and managed to keep her opponent far behind the court, constantly off balance. The geometry of her tennis simply was too difficult for the powerful Russian player.

A comeback must not be easy. Especially after three years, that's a long time in tennis. And a long time for a 25 years old player.  Even for a champion like her. It would be interesting to know why she's making a comeback. Many thoughts must have been in her mind. The possibility of failure? Does a champion fear failure? Or  are they just too determined, and sure about their capabilities? However, when she gave an interview at the end of the game, her voice was filled with emotion, just like a little girl, smiling, she thanked her mom for being there with her. I was not expecting that. You are always brought to believe these champions are machines, robots programmed to win. Well, at least she is not. And may be she was also scared to death of losing that game. Must have been hard, the preparation, all the matches. But she won. And, today, she is great.

My Favorite Business Story, from Victor Niederhoffer

I have always had a love of stories, as they calm me, let me experience great events, transport me to great places, and make me happy -- especially because they remind me of the immemorial custom in my family to have a story read to me each night by my father or mother. My favorite book of stories is Monte Walsh, a collection of tales by Jack Schaefer about two men -- Monte Walsh, an expansive free-wheeling genius on horses, a la Jack Aubrey on the sea, and his more reflective and competent-off-the-horse sidekick, the future country banker Chet Rollins -- as they perform their jobs, and meet the challenges of the open range cattle business in the 1880s.

Schaefer, who knows his field as well as L'Amour or O'Brian know theirs, describes his goal as "to sketch the over-all story of the open-range cattle business, its brief beginning, and its myth-making heyday, and its inevitable decline, symbolized in the single lifetime career of my Monte Walsh, a man fitted fully to it, faithful to its spirit to this own finish, with counterpart supplied by his more adaptable, once inseparable companion, Chet Rollins."

My favorite story by far is Payment in Full, and I'd like to share some of its highlights with you. The story opens with an accountant, "the desk man" paying his annual visit to the Consolidated Cattle company division in Colorado to check on the books. He sits with his derby hat by his side as he examines the revenues, percent foaling, and expenses of the general manager, Cal Brennan. The Consolidated Cattle Company was apparently a limited partnership, paying out annual divisions based on profits. That partnership has bought and leased the range land, built the structures, wells, windmills, and tanks, cattle and horses and hired Cal to run it for them. "But the Slash Y was really a group of men alike only in general cattle-country background, and rawhide toughness of muscle and willingness to risk their necks to get a job done, loyal to each other and to the outfit that paid their wages, brought together by Cal Brennan."

Cal apparently had his wife and kids killed by Comanches, and knew everything about the cattle business that anyone from Texas ever knew. The preliminary audit of the desk man turns up some problems this year in the p&l, with the calf crop only 82% and some expenses for a party which he calls to Cal's attention. "As a matter of straight fact, if you can find another outfit in the whole territory that done better'n 75, I'll eat that silly hat lying there begging somebody to put a bullet through it," Cal said. I often wish to give a similar answer to potential customers and those who had a winning trade or two they'd like to brag about when they ask me about what happened in this or that bad month that I had along the path of my fund's or my partner's performance. I can see that fat hat right now. With a touch similar to MFM Osborne who liked to say when he found some academic like Morgenstern or Madelbrot writing about something they had no experience with, "Somebody's going to eat crow, raw, squawking and fully feathered, and something tells me that ain't going be me," Cal's drawl fades, "Plain too, no sauce to help it down."

A new problem emerges. There's a claim from the Santa Fe railroad, for 1,000 bucks for damages to their equipment that arose from a practical joke the Fe train men wanted to play on the Slash Y'ers after they had spent three days rounding up stray horses as an economy measure for their owner's back in Chicago. "Something intangible suddenly swept suddenly into the room, something between two men suddenly indifferent to the desk man's presence, a big dusty cowboy standing relaxed yet watchful, looking down, and a lean ageless man, Cal, sitting easy and limp in an old armchair. This is the story they told.

After breaking their necks for three days, the Slash Y was about to corral all the horses that had cost them limb and sleep for three days when "In the locomotive cab the engineer sat relaxed on his stool, head out the window. A slow smile spread on his ruddy rough featured face. Hey he said. Let's have a little fun. He reached up and took hold of the whistle cord. SCReeeeeeeeeeeeeeeeeeee!"

The horses, they's killed themselves to collect scatter, a fight breaks out, a trainman pulls out a wrench, a Slash Y shoots it out of his hand, the Y's win, they go collect the horses and bring them back. The desk man at first figures he'll get the Y's to pay. "Oh, they'll pay all right, my boys pay if I put it to them. They'll get together, them that was in on it and them that wasn't an they'll hock all they got if they have to, except of course their saddles. An they pay. But that be might y expensive for the company because they'll quit rite after" Cal said. Well at least I can file some counterclaims. "No, you don't understand this thing at all. The boys had the best of it. They tromped on that train crew right through. That means there's got to be no quibblin'. Payment in full.

In a nice touch of understanding of the business mentality, Cal says to the desk man, "The boys have good feeling to the company. They're proud to the company, of this outfit. Proud to be working for it. They ain't bright enough to understand the reason they're proud of this outfit is the work they been doing for it, what they've made of it. They just proud they mad the Slash Y brand an the boys that carry that iron mean pleny everywheres cowmen still ride horses an swing a loop."

The desk man reflects and says, "I'll do my best for you boys." A chorus of Yow-ee's and you're all right Plug Hat " greets the desk man as he leaves.

I know that the people at my establishment and the remainder on the spec list feel this same sense of pride in their accomplishments and pursuits that the boys at the Slash Y and other good firms that are built on proper foundations feel. Hopefully those who like to brag and bluster as they ride their ephemeral trains, will keep the low character of the Sant Fe engineer and fireman in mind.

Hany Saad Reviews J. P. Getty's "How To Be Rich"

After taking a nice beating in the markets, I decided to clear my mind by reading J. Paul Getty's book, How To Be Richh. I broke my vow to never buy a book that has the word "rich" in the title, but this book was recommended by people I happen to respect very much.

I was pleasantly surprised to see so much wisdom in a book so naively titled. Notice that the title is "How to be Rich" not "how to get rich". Some argue that Getty meant that being rich is a state of mind. Others argue that his father, who was also in the oil business started him big enough to become a billionaire.

At any rate, let's move on to some of the priceless nuggets from Getty. Getty, like any businessman shows humility and acknowledges the role of luck in his success in business: "The independent operator had to possess a certain amount of basic knowledge and skill. He also needed reliable, loyal and experienced men. But, beyond these things, the most important factor was just plain luck."

He also mentions ever-changing cycles and how he adapted to them to survive and prosper: "We became flexible, adaptable and versatile -- adept at improvisation and innovation -- if for no other reason than because we had to in order to survive."

He shows contrarianism and courage (very timely for today's markets and universal pessimism and yes, now it is turning into a quick meme) "The business situation can only get worse," they predicted. "The economy is going to disintegrate completely! I didn't see things that way at all. I was convinced the nation's economy was essentially sound-it would eventually bounce back, healthier than ever. I thought it was the time to buy-not sell. The business man who moves counter to the tide of prevailing opinion must expect to be obstructed, derided and damned." The chair's columns at money central and readers' reactions to them are a great example.

On the economical way of thinking in today's cut throat competitive markets: "In an all out business battles to capture markets, it is necessary to reduce all costs wherever possible." Did you ever think how different your performance would be had you used limit orders in place of market orders? An acquaintance started his own trading business "in style" according to him. His overhead was incredible. He used the most expensive trading platform that exists before making any profits. Short of six months he went belly up. I can't tell you whether he would have survived had he been as economical as Getty or not, but it would have definitely helped.

On risk and credit: "A business man must be willing to take risks - to risk his own capital and risk borrowed money as well when, in his opinion, the risks are justified" It always amazed me how supposedly educated people advise you against using borrowed money. I dismissed all Gann's mumbo jumbo even before reading about his fixed systems, pivots and retracement percentages blah blah after I read that one of his most important rules is to never use a margin account. How could a businessman with great ideas prosper without using the leverage of "borrowed money".

On dealing with adversity: "The successful businessman is usually the one who is always relaxed-even in the face of adversity." "An occasional crisis is good for the businessman. There's no better exercise for him than to have a few messes to clean up every now and then" In a given day, it's very hard to tell if the best traders are up or down. They maintain their composure when down an never boast when making a killing.

On propaganda: " The first failure of a businessman is his inability to distinguish between facts and opinions" In markets, the only fact I know is the price action. Anything else is opinion and noise.

On incentive: "Unquestionably, financial reward is the principal motivation that causes people to work" It's very curious how this obvious idea is often overlooked in corporate America. A slight change in the compensation structure could affect productivity greatly.

On contrarianism and the impossible: "All top businessmen I know have made their biggest strides up the success ladder because they were able to see the possible in what others rejected as the impossible."

Not to tap myself on the shoulders since I know my limitations specially now after a long losing streak, but when I first immigrated to Canada at 22, the first thing I did was to drive around the country to explore my new home. I thought it was more important than to look for employment right away. I was always astounded by how vast Canada is , how much undeveloped land this country possess and how many more immigrants this country can admit. Of note, immigration to Canada requires one to have certain qualifications and bring a huge sum of money into the country.

The more I drove and observed, the more I realized that the Canadian Banks must be great investments and should never be dealt with as value stocks but growth stocks as long as there is land for immigrants. They have to put their money into the Canadian Banks. They have to borrow to develop lands, buy homes and start businesses and as you know the banks make their money on the spreads as well as the foreign exchange differentials.

My ideas were reinforced after I spoke with a broker who told me that the Banks are for widows who need the dividends. It is impossible their price is going anywhere. I couldn't see it. I looked at the charts of the financial sector of all immigration countries (Canada, Australia and New Zealand) and sure enough they all outperformed the S&P. Notice that Canada admits more immigrants during recession than booms. I also studied the numbers from their immigration sites. I made it a habit since to put some spare money into Canadian Banks regularly. One wonders if Stock Markets of immigration countries with vast lands outperform. This needs to be tested. A quick look at Triumph of the Optimist is in order.

On culture: "They (Europeans) have learned that culture bestows many rewards and benefits - among them a better more satisfactory life, great inner satisfaction and mental and emotional refreshment and inspiration."

And his very good advise on investing in antiques and fine art: "The astute art investor's experiences serve to underscore the fact that many tourists and people who travel on business often overlook chances to invest wisely in fine arts during their travels. They have a habit of shopping for gaudy and frequently costly souvenirs that have little or no value. They fail to realize they could acquire objects of considerable and permanent value-without expending any more effort or money than they spend in buying the trivial. They need to shop carefully and off the beaten track."

I will skip Getty's stock market advise as it ranges from the mainstream too obvious to the too naive as in, "buy low and sell high,"  "buy good companies that pay dividends," etc.

Denis Vako says:

The keyword is "father random" from Mr. Niederhoffer:

I first was able to cognize the meaning of it when I tested thousands of variables only to find out that few-less then 1%-are significant at the usual statistical level, that is of course before catching that "ever-changing cycle."

I figured if numbers, which we cognize as unmovable, are so temperate at providing knowledge, then what about words, talking and opinions of others however friendly and close to us?

Aristotle said in one of his works that he first study digestive system of an animal to get understanding of what kind of animal it is.

Consider 2 cases:

  1. One is generating 30% p.a. over 30 years.
  2. Another made 1000% p.a. over 3 years.

One is a true achiever, from a human point of view; another is a lottery winner, with no knowledge to convey, still some call them oligarchs or oil barons.

Marting Lindkvist responds:

I would argue that the amount of decision making enters into the equation too. A trading example could be: if the person having had the 30% p.a. return, made one decision 30 years ago to buy a stock that then has performed brilliantly, and the person having had three years of 1000% p.a. has made hundreds or thousands of buy and sell decisions, then definitely the roles of luck harvester and true achiever is the opposite to what you describe. An extreme example of course, but one that should bring the point across.

A New Spec

A good month to be born! My son, Christian Michael, joined us Friday morning, May 19th! My wife, Leanne, and I couldn't be more proud. He is one day old and already giving us attitude. He joins big brother, Gabriel (5) and big sis Mira (4). He is perfectly healthy, something that you just can't take for granted given all the many variables that can go wrong during pregnancy and labor. In Christian's case we had to be concerned over little things like a knot in his cord! The courage to be a mother is immeasurable. Oh, but more importantly, when I asked the little man what he wanted to be when he grew up...I'm pretty sure he said "Speculator"...although it might have been a burp, I'm pretty sure it was "Speculator." Best, Dave Baccile

The Cult of the Mac, by George Zachar

I walked past the new Fifth Avenue Apple store shortly after it officially opened at 6 pm Friday. The line wound around the plaza in front of the GM building (opposite the Plaza Hotel), up 58th Street to Madison Avenue, up Madison to 60th Street, and back along 60th as far as I could see toward 5th. The queue had "all types", with a skew toward the young, of course. Nobody seemed the least bit impatient.

Weekly Commentary from Dick Sears: "Are We All Corrected Yet?"

Thoughts on Panics, from Dr. Kim Zussman

Like courage, is panic unidentifiable without hindsight? Perfectly efficient markets ought not to over-react, but there is plenty of evidence that they do (not the least of which is you reading this). The problem is telling at what point sell-offs are overdone (and will be reversed over some period), and when are not (and won't reverse in a meaningful period, e.g. Nasdaq 03/2000 top).

Obvious panics should not occur, because anyone who "knows" that a sell-off is a panic would buy and the opportunities would go extinct..

The debate between counters and political traders is about who can discount, better than the market, the impact of current and future events. You can look for panic in time-series patterns and claim to know as a result of numerical precedent. Or you can try to define panic in hyperbole (media, magazine covers, gas rationing, Muslims, etc) that rarely gets it right.

One way not to settle this is by looking at who was right this week, or last week, or last year, etc. because everyone gets it right sometimes. Furthermore, were any one category of analysis superior by dint of p&l, all the brainpower would flock to it and the advantage would arb away.

Maybe it's best just not to panic.

Charts vs. Quotes, from James Sogi

A wealthy trader mentioned that he didn't look at charts when trading. That got me thinking. Do charts create a false sense of correlation between uncorrelated pieces of data? Do charts create the visual illusion of motion and momentum when none exists as the bar develop and move? Do charts create a sense of vertigo that is unrelated to the fundamentals by comparing today's price to the price ten years ago when there is no connection between then and now that might affect trading? These artifacts of the display may mislead. The eye may see patterns in random noise. The chart rubbish indicators may really mislead many people.

When I visited the coffee pits, I learned that the pit traders don't use charts. They have numbers and levels in their heads. The numbers on the quotes for a single contract are not that complex that they can't be memorized or manipulated in the head. The average range is only about 12 points and fit in a few inches of display space. Do charts waste screen space? You can get much more data in the form of numerals than graphics in a smaller space. Do different people have different styles of processing information? Why skip the charts and use the quotes? What are the advantages?

A Man's Guide on "How to Crash," by James Lackey

"Real Men Don't Apologize" by Jim Belushi is a new book. I saw him in an interview and he was cracking me up. I never thought Jim as "very funny" but of course who could be, as compared to his Brother John Belushi, one of the best comedians ever. One of his best quotes was "Never cry in front of your woman, she needs a man. She may say she wants a sensitive guy, but what she needs is a man."

He made a quote that really hit home for me. My wife is famous on the spec list for saying, "Don't worry baby you'll make it back." Belushi says don't cry in front of your woman. The gist is she will say "it will be fine" then go into the other room and cry. A few days later you'll ask her to pass the pepper and she'll "freak out on you. Our life is always on the edge of disaster and you never take out the garbage." You'll look at the kids and say, "what's wrong with mommy, were you kids bad today?"

I was talking with an old friend today about market panics and crashing cars. We agreed, in a crash often the best thing to do is nothing. If you slam on the brakes you can actually make matters much worse. He said, "yea on a road racing bike if you crash the worst thing to do is try to get up or roll before you stop sliding. That is, when you go to stand up and tumble because you don't realize your still sliding at 50mph after running 150mph. You break ankles, wrists, arms and lose a finger or two."

There are as many types of racing as there are investing. In motocross the worst thing to do is bail off your bike. Which is the opposite on a road racing bike. In MX you really want to try to hang on to that bucking bronco and get your feet on the pegs or squeeze the fuel tank with your knees as hard as you can. Another seemingly opposite thing is we do not slide on the dirt, so do not extend your legs as that is where most all terrible knee injuries occur, full leg extension, the first to hit a barrier, the next jump or hay bail and, boom, a torn ACL.

In race cars and drag racing, the first rule is never ever touch the gas or the brakes in a spin, just try to steer. You only have a split second and if you hit the wall you must not hold on. You tuck your arms under your arm pits to keep from breaking your hands on the steering wheel or roll cage. We had arm restraints or straps on the fire suit that go through the seat belts that keep you arms in the car chassis in case of a roll over. Those restraints will not save your hands from a beating on the steel chassis.

The worst is an engine explosion at 200-330MPH, followed by a fire -- you can't see, can't breathe, oil is everywhere on fire, you hold your breathe, hold the brake after pulling the parachutes that quickly burn off the back of the race car. Pray that you come to a stop before hitting the sand trap, only then, can you release your 5-point harness and bail out of the car. Every fiber in your being wants you to unbuckle and get the hades out of there. The problem is, you gotta' stop first.

In a stock car, you stand full throttle on the gas as you spin backwards. This is an attempt at pushing the car away from the wall. Yet full throttle is also an attempt to keep the engine from spinning backwards as the car is going 180 MPH backwards. If the rear wheels gain traction while the car is pointed south and you don't push in the clutch the engine will run backwards. That might hurt the motor and blow up a few laps later even if you don't hit anything.

My Dad taught me how to drive a car after about a year of riding MX bikes. I was 11 years old or so. The first thing he taught me was "if stuck WOT (wide open throttle), don't panic." On his hot rods or race cars some times the throttle will hang up and stick wide open. He made me practice over and over. Hit the kill switch or shut the key off and push in the clutch and breathe. Never hit the brakes or waste seconds trying to pry you foot under the throttle to pull it backwards.

His next lesson came before antilock brakes.  I was still eleven. It was the first snow fall of the winter in the high school parking lot. He made me drive 25 mph, kick the full size Chevy van in neutral, lock up the brakes, turn the wheel, then let off the brakes and spin. A van is the worst thing is the world besides a bus to turn. But, he taught me over and over exactly how much to turn the wheel to correct to "make a corner" also that anything in motion will stay in motion with the brakes locked up. After a few tries I had the exact amount to turn with out spinning the van around in circles once I let off the brakes.

Then he was a big show off and taught me how to spin a car without the brakes or steering, how to drive in reverse, backwards and spin back around: lock 'em up, put it in forward gear, unlock the brakes. We had all sorts of fun, holding the wheel one turn, kicking the van sideways and steering with the throttle. By the time I had my learners permit all my friends could drive a car sideways down the road on the ice and steer with the throttle, let off the gas and make the corner at the end of the street. That is without ever turning the steering wheel, but once at the start, and just holding it for a block. That was "the game". If you moved the steering wheel you lost.

Now for the game of trading. I've heard a lot of retrospective woulda', coulda', shoulda' this week from race car traders. These are guys that are driving high performance accounts: "I felt the market get loose, I should have made a pit stop, then boom a tire went flat and I scraped the wall."

My immediate response is the same for racing. "That is unfortunate, but calm down. We had no plans to pit for new tires for many laps. You didn't do anything wrong. Now all we can do is bang out the sheet metal, put on four new tires and do the best we can with what we have for this race." Okay thanks. Oh wait, "Next time we racing for a victory and the car feels a little loose just like last time, if you don't stand on the throttle and go for the win then you are wrong. Just because you crashed this time doesn't mean you will lose it next time. "Fast is loose, the only way to win is to have an aggressive loose set up on the machine. Just forget about it and drive."

Something only day traders would think was funny:

Trader one: "I lost loads of money yesterday but had a very sound sleep and was finding it difficult to wake up at my usual 5:45!"

My quick joke. Yes, that's the same as when a criminal is finally caught. That's how the cops know if he is innocent or guilty. The innocent can't sleep and cry all night in jail. The guilty, finally relieved it is over, sleep like a log.

A Basketball Thought, from Rodger Bastien

As I follow the misfortunes of my favorite basketball team, the Detroit Pistons, I am reminded of the similarities between trading and sports. Oh how much easier it is to be the underdog rather than the favorite! I have on occasion demonstrated the smug over-confidence that a modicum of successful trading generates. The rarified air of invincibility has captured me more than a couple of times as I find myself giving a tick or two to the house at execution or disregarding a stop, so certain that things will eventually go my way. Not so fast. Trouble is, once you allow yourself such luxuries, once brought back to reality it's doubly difficult to catch that wink of the Market Mistress, as if she knows you've taken her for granted. And hell hath no fury like...well you get the picture.

So tonight my Pistons, transformed from the hunted to the hunter, facing elimination in a hostile environment, in a perverse way should have an easier task ahead. That is if they are humble in their work and contrite about their haughty approach to the previous three games. Be it basketball, golf or markets, "never!" let the gods or goddesses hear you say you've mastered their domain, for only then will they allow you to win once in a while.

Steve Leslie Shares Lessons from "Winnie the Pooh"

One of my favorite Children's classics is "Winnie the Pooh," by A. A. Milne.

Alan Alexander Milne (January 18, 1882 - January 31, 1956), also known as A. A. Milne, was a British author, best known for his books about the teddy bear, Winnie-the-Pooh, and for various children's poems. Milne was a noted writer, primarily as a playwright, before the huge success of Pooh overshadowed all his previous work.

Through the Winnie the Pooh series we meet many varied characters such as Owl, Tigger and Eeyore. On the surface each is playful and lovable something that every child can relate to. However for the adult, they individually display far wider and quite complex personalities that can have profound significance and meaning if one takes the time to study them.

For the speculator and investor, we meet two which are to be feared. They are the Heffalumps and Woozles. They are in search of one thing, Honey, which we all know is the Bear's most prized possession.

Please read and enjoy this passage and consider how this can relate to your own search for "Honey":

Heffalumps And Woozles
They're black, they're brown,
They're up, they're down
They're in, they're out
They're all about
They're far, they're near
They're gone, they're here
They're quick and slick, they're insincere
Beware, beware, be a very wary bear

A heffalump a woozle is very confusle
A heffalump a woozle's very sly, sly, sly
They come in one's and twosles
But if they so choosles
Before your eyes you'll see them multiply, ply, ply

They're extraordinary
So better be wary
Because they come in every shape and size, size, size
If honey's what you covet
You'll find that they love it
Because they'll guzzle up the thing you prize

Beware, beware, be a very wary bear

They're extraordinary
So better be wary
Because they come in every shape and size, size, size
If honey's what you covet
You'll find that they love it
Because they'll guzzle up the thing you prize

They're black, they're brown
They're up, they're down
They're in, they're out
They're all about
They're far, they're near
They're gone, they're here
They're quick and slick, they're insincere
Beware, beware, beware, beware, beware!

Trading Noise, from Paolo Pezzutti

Every asset has its own characteristics, based on type of investors, liquidity, etc. You can assume that every day's move is composed of signal + noise. Instead of considering the signal, with inherent difficulties in forecasting both direction and magnitude, I would consider noise. Why not trading noise? Regardless of concerns like "I believe the market is going up because the moving average....." or "the market will go down because it is negatively correlated with the dollar...." and so forth. If you consider only noise, you have a number of advantages, including the fact that you do not have any "forecasting stress". Noise is not constant because market players change, therefore the market characteristics change.

Additionally, noise is also related to volatility. But there is a minimum threshold of noise which presumably will not be touched at least in the short-term. That is where you will find your profits. If you are able to quantify noise, you could build a typical strategy based on high probability trades and small gains. Something that no trading book will ever consider as a winning approach. So, may be that's exactly what you have to do to be successful! If you buy randomly without specific rules at any given moment, what are the probabilities to print a higher/lower price of (n) ticks within the next (n) bars? If you apply it at the edges of the trading day, if it is true that markets spend more time congesting than trending and if it is true that moves to new areas of balance are fast and short, then this approach becomes interesting especially in those markets that present the favorable structural features to apply ii

Three Common Fallacies, by Victor Niederhoffer

  1. It's going to be up but first down: Often someone talks about an imbalance that is expected to be corrected by the end of the year, and says something like, "I expect the Dow to be 10% higher by the end of the year, but to have an immediate 5% correction." If the expectation is prevalent that it will be 10% higher than investors will start buying in anticipation and the market will rise accordingly. Invariably such forecasts of a dipsy-doodle, which don't take account of the function of speculation and rational expectations to move prices forward in time rather than moving goods across boundaries, are wrong.
  2. The number was very weak. The market's going to get killed: There are at least 20 important economic numbers each month, and each of them has a major random component, and many of them are contradictory of the other. The stock market is valued based on an infinite stream of earnings. The effect of one number is transitory, and merely an opportunity for weak ephemeral traders to be shaken out and churned for the benefit of long term players.
  3. The mechanical system will have its day: The trend followers are up 15% from beginning of year. That proves that trend following is good. No sooner does one believe in a mechanical system than it's ready to go the other way, as Bacon said. It's dangerous to have a fixed believe in a system's inevitability because it can lead to holding on until the end. On another front, the recent 5% decline in the trend following index, is probably a cause of the stock market decline as the markets that were up were commodities and the non-American currencies, and oil, and grains, and stocks. The markets that were down were bonds. All such markets benefited and had their moves exacerbated by mechanical aspects of trend following. As the ephemeral factors get reversed, or as random moves set in motion counter ephemeral trades, all markets that had benefited from the buying power and additional money elicited from the public by such activities will tend to reverse.

'Short Talk' (Lyrics by Laurel Kenner and Victor Niederhoffer)

Original lyrics and music from the song "Small Talk" in the 1952 musical "Pajama Game" by Richard Adler and Jerry Ross

I don't want to sell stocks short
When there's been a big decline
I don't want to sell stocks short
Buy and hold is more my line

Let's not talk about metals
Or how China's buying oil
Why don't we stop all this short talk?
we've got something better for our cash to do,
And that takes no shorts at all.

Deficit is getting bigger,
Gold is headed to four figures
                  Short talk!

The Fed will act to curb inflation
There is too much speculation.
                  Short talk!

Heard on the news the other day
That rents are nuts out Hamptons way
Wall Stree4t guys agreeing to pay
a three-month rent of six hundred K

Heard on the news the other night
That stocks will fall when money's tight
And corp'rate rates are getting high and
Bush is going to bomb Iran
In our next war.

[I don't want to talk short talk...]
What do you think they charge for gas now?
Got so a buck ain't worth a damn now.
Real estate is slowing down
The Fed's not going to fool around.
Dollar's headed to a crisis
'Least that is what David Tice says

I don't want to sell stocks short
When there's been a big decline
I don't want to sell stocks short
Buy and hold is more my line

Let's not talk up the bear side
I don't think the sky will fall.
Why don't we stop all this short talk?
we've got something better for our cash to do,
And that takes no shorts at all.

Bond Blather, from George Zachar

Just so the stock guys don't think all the nonsense is concentrated in their asset class, here's a gem from a primary dealer: "We remain cautious on the broad market and suggest selective buying of quality credits at attractive levels."

Why is it So Easy to Lose Money? from Ed Humbert

Interest rate traders typically face at least six or more factors that affect the value of their portfolios. A quick list would include duration, curve, currency, asset swap or residual exposure, financing or carry and, of course, a random component.

That is my list of six factors. You may have more or less. It does not matter. The point is that there are 63 combinations of factors that can go wrong in even the simplest portfolio. Where do I get 63 from? Use Combinatorics as the Chair has previously instructed.. Combinatorics (discovered in 300 BC by a Jaina mathematician according to Wikipedia) is very different from permutations.

A permutation tells us how many discrete ways we can order objects. Combinatorics on the other hand tells has how many different combinations of factors can unite to separate us from our money. The formula is easy:

  ∑ Cn, r  = n(n-1)Ö.
(n-r+1)/r!   For example C6,3 = 6x5x4/3! = 20. 

That means there can be twenty separate instances of three combinations sets when we start with six factors. If you work through the formula, you will see that it totals to 63. So on any given day, 63 combinations can work against your position. Iím sure the real number is much higher. Of course, the combinations can be a positive surprise as well, but that is rarely the case. You can as well hedge out all the factor risk and get the risk free rate in return. You might as well just buy T-bills! So what is the point?

Obviously, simple portfolios and structures are usually best, limiting exposure to unwanted factors. More importantly, you should know approximately how many combinations your portfolio includes. You will sleep a little better.

A Question of Courage, from Dr. Janice Dorn

"How does one, without the benefit of hindsight, discriminate between courage and foolishness?" This is an excellent question, and I present, for discussion, a possible hypothesis:

Without precognition, one would likely not be able to discriminate. Moreover, having "experienced" both courage and foolishness, one would require the laying down of neural patterns which would subserve recognitive description of something as being either courageous or foolish. This implies that there is the presence of discriminatory insight or introspection. Additionally, there would be perception or assignation by others as to whether any given act is courageous or foolish. This might easily be in contradiction with one's internal perception and might be correlated with a type of cognitive dissonance, neurosis or -- in the extreme -- psychosis.

Russell Sears notes:

Perhaps the contrapositive of the question gets to Janice's answer in a clearer direction. If one is paranoid, then how do you recognize this as being irrational fear?

But from a practical standpoint in investments, I use either the "would I recommend it to my Grandma" or "would I be embarrassed to have it posted on the spec-list with my name attached" indicators (even in hindsight as a bad idea) as both internal perception of my intuitive belief of its "foolishness" or "courage".

Stock Trading Seminar, from Laurence Glazier

Recently, I attended a stock trading seminar. the demonstration was a little "Blue Peter" (UK term) -- like "here is something I prepared earlier" -- where the test was run for stocks in a single market sector, and indeed produced a very high return. Someone from the audience asked to see this reproduced over the universe of stocks. He was told, with some hand-waving, that it would take too long.

For some reason I was assailed at every interval for advice, while not in any position to to give it. I suggested there were three stages in development as a trader:

  1. Start Trading.
  2. Stop Losing Money.
  3. Start Making Money, explaining that I was at Stage 2. (It was true at the time)

Sometimes at these events there can be unexpected insights and information, thus talking to a trader currently at Stage 0.5, Philip Nizetic, a man of many other talents, I may have disclosed that I know the moves of chess, whereupon he recommended some chess books to read, the last of which is of special interest to me as it is, Philip tells me, by another musician.

(Phillip was very particular about going for the Dover editions.)

As it happened, I had been reading until recently a very fine chess book, "How Purdy Won", given to me many years ago in Dayton by C. J. Purdy's niece. Philip did not know of the book but is an admirer of Purdy who was the first World Correspondence Chess Champion. I remember playing correspondence chess as a youngster and even won, if I remember rightly, some significant junior tournament. On one occasion, when I was alone at home, our house was visited by a member of Britain's secret services. At the time I had a number of games on with opponents overseas, using a numerical international notation. It had come to the notice of Her Majesty's Government that postcards filled with strange codes had been arriving from Russia to a house in North London. A cup of tea and a brief explanation proved my innocence (unless of course they are still watching me!)

Random Thoughts While Recovering from Disneyland, by Tom Ryan

I took the kids to Disneyland last week. Although it looks like some of you had the wilder ride in the market while I was gone.

My first observations are on people and choices. Disney has the Fastpass system for the most popular rides which lets you get on rides faster if you obtain a Fastpass ahead of time. Trick of course is that you have to visit the ride area to get the Fastpass from the kiosk right next to the ride, and you are limited in the number of Fastpasses you can get by a computer monitored time interval (after getting a fast pass you have to wait a certain amount of time before getting your next one). And the Fastpass gives you a window of time in the future when you can ride (like a reservation). Yet if you plan a little, you can make use of the Fastpass every hour or so. And each time we had a Fastpass, we were on the ride in less than five minutes. This despite the fact that some of the rides had regular lines extending out up to one hour of waiting time (some cases more). And we never encountered a line at the Fastpass ATM's. so we had no problem getting in our fun to our hearts content. In fact we ended up giving away Fastpasses several times because we ran out of time or energy. The question remains however, why are not more people using the Fastpass system? We came to the conclusion that:

  1. A lot of folks were just not paying attention and were ignorant of the system.
  2. Even when they were cognizant, they didn't want to be bothered with having to plan out when to go on a ride (despite the fact that you could get a Fastpass for some of the more popular rides, go sit and have a bite to eat and then get on the ride faster than if you simply just went and stood in the regular line, that is, the Fastpass reservation time was sooner than the time to stand in the regular line), and;
  3. For some groups (namely, teenagers) the ride is not the primary purpose of being in the park, socializing is.

In other words, the vast majority of folks were not interested in maximizing , but rather "good enough". My kids however, must have the trader gene because they were always stopping to ask, now how can we get the most out of the rest of this day? That would be a good question for the daytrader to ask as the trading day unfolds. There is always the potential for another trade coming down the tape right up until the close.

The other interesting thing I noticed this time was the incredible efficiency that Disney has developed in maximizing the flow of people thru their rides. Everything is structured to get the maximum amount of people thru the system and loading and unloading in the least amount of time. This is done by minimizing the effort required to get on and off the ride. They do this by loading on one side of a car and offloading on the other. Also people who are loading are sorted and funneled into lanes with numbers to eliminate any personal choice or conflict over where everyone sits. They also have a special loading area for the handicapped with most rides, and allow "switching off" with parents who have very young toddlers so that one parent can hold the baby while the other rides and vice versa. In the Buzz Lightyear ride (Andrew's favorite, what is it about boys and shooting laser guns?) they even had a moving flat walkway that matched the speed of the cars as you were being loaded. Similarly, I have been finding the market has been developing very efficient means of getting everyone positioned before making a big move. Lack and I call this the "4x2 move"; rally or drop 4-5 points in heartbeat then trade within two ticks for the next hour allowing everyone to square positions or get on board before the next 4,5 point move. Last week for example in the S&P looks like they were loading up for the log ride on Mon-Tue-Wed then over the waterfall on Thu-Fri. Of course it is always so much easier to describe than to predict. What would an efficiently loading market look like?

As for the rides themselves, the thrill rides like Space Mt (over-rated in our opinion), Splash Mt, and Indiana Jones (a must see) tend to employ four main techniques to promote the scream factor. First there are alternating periods of fast and slow movement, second plunging into darkness where you can't see where you are going, third, sudden changes of direction (left-right, up/down), and finally the Disney folks like to employ the telegraphing of future thrills technique, for example the slow ride up the escalator before going over the waterfall in Splash Mountain, and the giant boulder heading straight for you at Indiana Jones while your car is "stuck" requiring the car to drop and duck under just in time. The market analogies are manifold but I will leave to the reader.

Finally, the 50th anniversary celebrations are still going on. We were impressed by the fireworks show, and they have this massive show at night called "Disney Fantasmic" where they are employing the use of large high pressure jet nozzles to create large mist curtains 30 feet high onto which they are projecting film. It was very unique and unusual and worth seeing

Stephen Alpher adds:

Similar behavior to folks not using the Fastpass lane at Disneyland can be observed on my drives between Philadelphia and DC on the occasional holiday weekend - that is the vast majority of folks do not yet have a E-ZPass box for tolls.

Anybody with a credit card can get an E-ZPass box - thus allowing them to zip through toll plazas without a wait and without having to ever reach for money. Yet most folks do not have one, instead choosing to wait in lines sometimes stretching over a mile for the privilege of handing a couple of dollar bills to a toll taker.

Possible reasons:

I suppose the last two reasons are the most likely. Can't say I understand it though.

Apologies to the Residents of Anatefka, from George Zachar

To the tune of "Tradition" from Fiddler on the Roof.

Positions! Positions! Positions!
Positions! Positions! Positions!

Who day and night, must scramble trading minis,
Buy and sell new issues, hit a bid on bonds.
And who has the right as master of the list,
to have the final word on line?.

The chair! The chair! Positions!
The chair! The chair! Positions!

Who must know the way to make a proper count,
A robust count, a useful count.
Who must surpervise the work and error check
So the chair's free to keep his alpha up?

The minister!  The minister! Positions!
The minister!  The minister! Positions!

At one he started posting screeds.  At 10 he sold more spus.
I hear he's up a grillion bucks. I hope he keeps it.

Kris Rock! Kris Rock! Positions!
Kris Rock! Kris Rock! Positions!

And who does the List teach to count and test and check,
Preparing them to each earn their own cane?

The kiddies! The kiddies! Positions!
The kiddies! The kiddies! Positions!

Recursive Functions, from Victor Niederhoffer

Whenever the market declines more than 30 S&P points in a week as it did in the week ended May 12, 2006, I like to read a few good books for perspective and enjoyment. As always, I turned first to my latest combinations textbook, Discrete Mathematics with Combinatorics. This one has excellent chapters on directed graphs and trees, number theory, probability, algebraic structures, recursions, generating functions, networks, computation, codes, enumeration of colors, ring and fields, and group characters among its 800 pages, and is a great source of new ways of looking at markets as well as a solvent for fuzzy thinking.

I have supplemented the chapter on combinations with study of the problem set "combinations some important results" because you can never practice combinatorics too much, as the number of scenarios that the market can throw at you is very limited, and the master problem generator, the market mistress, likes to economize by keeping the outcomes limited and fresh at the same time. I found the questions relating to permutation most inspiring this time because they're so close to what the market is asking all the time. Here's a typical one, "How many ways can five boys and six girls line up for a picture if two of the boys refuse to be lined up next to a girl?"  The general solution to such problems is the number of permutations of (n) different things taken (r) at a time when (p) particular things never occur is: n-p C r x r !

The particular situation that comes to mind in markets is: what is the expected number of ways the market will arrange three consecutive days relative to up and down, in a three-day period when it refuses to repeat any of the patterns that occurred in any of the last five days?

Inspiration from the minister. I was so inspired by the reading of these book that I asked the Minister of Non-Predictive Studies, Professor Pennington, to do some work on problems inspirited by counting. Here's his response:

The Chairman asked the Ministry for some simple example of permutations and combinations. Sometimes the Ministry must struggle to find something non-predictive, but that was not the case today.

We look at the 756 trading days of the S&P continuous futures ending 4/20/2006; actually we look at the 378 successive non-overlapping pairs of trading days.

A pair of trading days can either be down-down, down-up, up-down, or up-up. At first glance one would expect each possibility to happen 1 out of 4 times, but since the market moved upward, that makes the expectation that the probabilities involving "ups" will be higher. Therefore, we adjusted each trading day's return by subtracting off the drift over the period. The average trading day returned 0.46 points, and therefore that was subtracted from all.

Here are the numbers of occurrences of each combination:

down-down  81 (21.4%)
down-up    103 (27.2%)
up-down    83  (21.9%
up-up     111  (29.3%)

("down-up" means the first day was down and the second day up.)

From this table, you can infer that the number of "up" days was 2*111+83+103=408, 53.9%, and the number of down days was 348, or 46.0%.

So, somewhat surprisingly, the number of up days was greater than the number of down, even on the drift-corrected data. That means that the up days were frequent and made relatively small magnitude moves, while the down days were infrequent, but had larger magnitude moves.

Here's a bit of a puzzle--given that the first day was down, the probability that the next day would be up was 1.27 (=103/81) times the probability that it would down. Given that the first day was up, the probability that the next day would be up was 1.34 (=111/83) times the probability that it would be down.

Both those numbers (1.27 and 1.34) are greater than the ratio of total up days to down days, which is 408/348, or 1.17. Any ideas (Bueller?, Bueller?) about the apparent discrepancy?

Next we look at waiting times. How many pairs of days do we typically have to wait for a "down down" or an "up up".

Here's a table:

average waiting time in day-pairs
down-down        4.68
down-up          3.65
up-down          4.52
up-up            3.42

With a large enough sample, you'd expect all four numbers to be four. I  haven't done any analysis here of statistical significance. Does what we observe depart from randomness in a statistically significant way? Without doing any thinking, I'd say that it probably does, but that the anomaly stems from the excess number of "up" days that we had even after drift adjustment.

Altogether, we have a fine and appropriate product of the Ministry. 3, There is an excellent chapter in the Anderson book titled recursions revisited that solves linear and non linear recursive relations using various trigonometric identities. A good discussion of the Fibonacci recursive function is given using characteristic occasions to solve. Fib. functions are used often in books on technical analysis and regretfully I have never seen any evidence that is anything but mumbo and a marketing tool as it applies to markets, similar to the work on fractals of the descriptive bilious mathematician, B.M.

However it did inspire the following thoughts on a related recursive series and possibly this will lead to mutual education in the field.

We are accustomed to thinking of markets and measurements in natural philosophy in terms of the Fibonacci sequence:

Fib(n) = Fib(n-1) + Fib(n-2).
The resulting series: 1, 1, 2, 3, 5, 8, 13... 

Let me give equal prominence in market projections to the Catalan numbers:

Cat(n+1) = Cat(n) * (2*(2n +1)/(n+2))     
The resulting series: 1, 2, 5, 14, 42, 132, 429...

Radoslav Jovanovic gives a nice discussion and a diagram of the uses of such numbers. I query, "Is there any reason to believe that markets move or levels achieve one set of numbers versus the others to an extent that is greater than random numbers might generate?" I'll give a prize for any reader who can differentiate between the utility of the two sets of numbers for markets and solicit your thoughts on the uses of these sets of numbers and others generated by similar recursive relations.

Alston Mabry contributes:

Running a quick simulation 1000 times gave the following statistics, showing: (1) the pattern, (2) the average number of occurrences in the simulation, (3) the SD of the simulation stat, and (4) the Minister's observed number of instances:

(1)    (2)    (3)    (4)
Up-Up 109.75  4.88   111
Up-Dn  93.71  8.74    83
Dn-Up  93.70  8.72   103
Dn-Dn  79.85  4.88    81

One posits that the Up-Dn and Dn-Up patterns be added together and treated as one grouping, since their distribution viz each other is just a function of where you start your count, or which direction you go in. Adding them together, the simulated average is 187.47 vs. observed of 186.

Also, if for a series of Ups and Downs, the number of sequences of either Ups or Downs of length N should be:

UpUp_length(N) = (Ups^N) / [2*(Ups+Downs)^(N-1)] =
(408^2)/(2*756) = 110.1
versus observed 111

DownDown_length(N) = (Downs^N) / [2*(Ups+Downs)^(N-1)] =
(348^2)/(2*756) = 80.1
versus observed 81

So far, so good.

The Minister writes:

Here's a bit of a puzzle--given that the first day was down, the probability that the next day would be up was 1.27 (=103/81) times the probability that it would down. Given that the first day was up, the probability that the next day would be up was 1.34 (=111/83) times the probability that it would be down. Both those numbers (1.27 and 1.34) are greater than the ratio of total up days to down days, which is 408/348, or 1.17. Any ideas (Bueller? Bueller?) about the apparent discrepancy?

Here you have two ratios:

DownUp/DownDown = 103/81 = 1.27
UpUp/UpDown = 111/83 = 1.34

The issue is that the DownUp vs UpDown split is a red herring. They aren't really two categories, but one. They just have to add up to 186 (103 + 83). And the further we skew that split from 93/93, they higher these two will get. Examples:

DownUp/DownDown =  *120* /81 = 1.48
UpUp/UpDown = 111/  *66* = 1.68

DownUp/DownDown =  *140* /81 = 1.73
UpUp/UpDown = 111/  *46* = 2.41

However, if we set these values at 93/93, we get:

DownUp/DownDown =  *93* /81 = 1.15
UpUp/UpDown = 111/  *93* = 1.19,

For an average 1.17, which is the overall Up/Down ratio.

The Minister then looked at waiting times.

Each of the waiting time values is derived from the formula:

(total # pairs) / (instances of pattern)

DwnDwn = 378/81 = 4.67
observed: 4.68

DwnUp = 378/103 = 3.67
observed: 3.65

UpDwn = 378/83 = 4.55
observed: 4.52

UpUp = 378/111 = 3.41
observed: 3.42

Altogether, a very satisfyingly non-predictive exercise.

Sushil Kedia adds:

Quoting verbatim from The Alchemy of Finance:

Using simple mathematics, reflexivity can be depicted as a pair of recursive functions:

    y = f (x)   cognitive function

    x = f (y)   participating function


    y = f[f(y)]

    x = f[f(x)]

So, it may be interesting to find which of the recursive functions do qualify under the Soros's Theory of Reflexivity and which if there are any functions that are outside the scope of this theory. Before going on further, it may be useful to bring up here the basic argument that the Theory of Reflexivity focuses to dismiss the concept of Economic Equilibrium and much rather embraces continual ongoing change.

R.N. Elliot (incidentally, one can't fail to note the use of the term phi in the Soros's equation even though in another sense) postulated a theory based upon observation of some historical price data on the Averages. Not very dissimilar in his theory though at a more rudimentary level of fitting observations to a possible explanation he too way back in 1932 had expressed an idea that:

Every market decision is both produced by meaningful information and produces meaningful information. Each transaction, while at once an effect, enters the fabric of the market and by communicating transactional data to investors, joins the chain of causes of others' behaviour. This feedback loop is governed by man's social nature, and since he has such a nature, the process generates forms. As the forms are repetitive, they have predictive value. -- Robert Prechter, The Complete Elliott Wave Writings of A. Hamilton Bolton

Focusing on the immediate task at hand, the simplest observation coming to mind is that series of the Fibonacci type are constant growth functions, where the (n+1)th term is a fixed G% (in the Fibonacci case 61.8% or so) higher than the nth term, while the Catlan series has a power relationship where each subsequent term in the series is growing faster than the previous one. If prices were subject to such a power(ed) growth rather than geometric, the drift over the 100 years would not have been in a single digit, but possibly in higher 2 digits if not already three digits. Indulging in a guess, if at all the recursive functions of the type of Catlan series are seen at all in prices they may be present in hyper-inflationary markets leading finally to an inevitable collapse. This of cause is a purely speculative framework of thoughts pending counting and conclusions.

Gary Rogan notes:

One of the known interpretations of the Catalan numbers is this: if you have (n +1) outcomes, how many binary decision trees, meaning ways to organize yes/no decision points to come up with the (n + 1) outcomes are possible? The answer is the Catalan number of order (n). If you want to create a back-tested approach that attempts to predict the future based on some known factors, one way to do it is to create all possible decision trees based on whatever factors you suspect are important and mechanically test them against past data. The Catalan number will help in estimating the feasibility of this approach given the number outcomes you want to consider. If you have more factors than (n) for (n+1) outcomes, each set of (n) factors will of course require it's own Catalan number of binary decision trees.

Richard Miller shares his thoughts on Fibonacci:

As a scientist (fiber physics and statistics), I too question the usefulness of technical indicators. Let's face it, most -- like moving averages (20-, 50-, 200-, etc.) -- are important solely because people are conditioned to expect support and reversal there. They perpetuate the myth and thereby create the usefulness.

Pullbacks defined by Fibonacci ratios, I humbly submit, are another story. While they too define reversal areas that are perpetuated by expectation, they, as I'm sure you know, are also found throughout nature: from the number of spirals in a pinecone to the logarithmic spiral of the chamber nautilus. Too, they have been important throughout the world of art, in the architecture of many historical pieces, and in many fine pieces of music.

Additionally, the Golden Ratio has special mathematical properties: the one I like most is the fact that one can start with any two beginning numbers, build a sequence by summing the prior two members, and the ratio of consecutive numbers in the limit is this Golden Ratio.

(7, 9), 16, 25, 41, 66, 107, 173Ö    173/107 = 1.6168

Thereís just something aesthetically pleasing about this ratio, as well as natureís propensity to use it wherever it needs an efficient method for packing.

As to the stock market, I think that there too thereís a tendency to expect a reversal near the Fibonacci ratios (0.38, 0.50, 0.62). Letís face it; stocks donít rise straight up. One of the things they do is to rest, some pullback. Many of these pullbacks reverse and continue their climb. Again, individuals look for entry points. I presented 100 traders with a visual, a multi-day rising pattern that was topping. I offered them eight levels marking different pullback depths (from 12% to 91%) that were unmarked and asked them to choose where they expected the reversal. Over 78% chose one of the above three Fib levels. Since there are 112 ways to choose a group of three from the eight levels, the 78% finding is far more significant that the 1/112 chance one might expect from just random choice. Thereís a special link between nature and Fibonacci. (in this universe anyway).

Bruno Ombreux adds:

Here is a nice article that brings together Gauss and Kalman.

An Ode to the Daytrader, from Tom Ryan

Because I appear to be the only one of my daytrading friends to lose money today I offer the following poem as a small token of honor to the daytraders who thru their finely honed craft of doing a small thing well day after day help to set the prices that provide the guiding light for the economy.

From B. H. Fairchild:

Song of the hammers

A small thing done well, the steel bit paring
The cut end of the collar, lifting delicate
blue spirals of iron slowly out of lamplight
Into darkness until they broke and fell
Into a pool of oil and water below
A small thing done well my father said

So often that I tired of hearing it and lost
Myself in the shop's north end, an underworld of welders
Who wore black masks and stared
Through smoked glass where all was midnight
Except the purest spark, the blue white arc
Of the clamp and rod. Hammers made dull tunes

Hacking slag, and acetylene flames cast shadows
Of men against the tin roof like great birds
Trapped in diminishing circles of light
Each day was like another. I stood beside him
and watched the lathe spin on coils of iron
climbing into dusk, the file's drone, the rasp,
And finally the honing cloth with its small song

Of small things done well that I would carry into sleep
and dreams of men with wings of fire and steel

Aromatic Tomatoes, from Sushil Kedia


(If due to lack of practice plucking each leaf is tedious, hold them in smaller bunches after washing cutting the leaves out in a bowl leaving aside as much of the veins as possible, since the veins contain less flavor and much fiber distorting the texture of cooking)

Any other fresh green herbs that have an aroma appealing to you treated the same.

Additionally if you like the taste of fresh green peas and cauliflower then a fistful of lightly boiled green peas and finely broken cauliflower heads could be buttered as onions and capsicums.

Salt (as per taste), crushed pepper (freshly crushed is better), cumin-seed (lightly roasted on a dry frying pan) 1 tea spoon, another table spoon of butter.

On medium flame, melt 1/2 or 1 table-spoon butter in a low frying pan. Fry the chopped onions to pink and donít let them turn brownish & keep aside. When onions turn brown they lose their kkhrunch. With another Ĺ Table spoon melted butter lightly fry the chopped capsicums without losing their kkhrunch. Keep aside. Low flame frying helps.

Mix the fried Capsicum & onion with the mashed potatoes. Put another teaspoon of butter in the frying pan & lightly fry the cumin seeds, put salt to taste and drop the entire mix & saute around while gradually dropping the cheese grating for 2 minutes or so. Mix freshly grinded black pepper to measure of taste. Pour the juice of tomatoes that was separated earlier & move the mix around in the pan for another minute or until the paste is thick again. Mix the chopped mint, coriander and any other herbs you like.

After the mix has cooled down its better to handle then, fill up in the tomato shells using a tea spoon, not too tight not too lose. Seal the hole at the top with some more grated cheese.

Arrange the Filled Tomato on a griller plate.

Preheat the OTG for five minutes at 200 degree C. Insert the plate with tomatoes. Bake for 10 minutes.

Serve while hot. Finger chips or wafers on the side. Tabasco sauce for those who like it hotter. Great with Garlic bread. Could be served on a bed of noodles or rice also.

n.b. cumin seeds are no necessity, go ahead even without or try any other condiment flavors that you like. Put only sufficient mashed potato to help bind the rest of the stuff.

Survival, from James Sogi

Survival advice when disaster strikes.

Standard Fire Order #10

  1. Stay Alert
  2. Keep Calm
  3. Think Clearly
  4. Act Decisively

Fight like a bastard. Don't just sit there waiting to get lucky.

Myth: More and more effort can overcome friction. (This is a corollary of the Law of Diminishing Returns Chair advised his son) To engage in frivolous, panicked frenzy can deplete limited resources needed to survive.

How to avoid disaster:

Many disasters are self induced. At any point, the series of mistakes that lead to disaster could be avoided, but an outside observer could see the actor leading himself to disaster. Many time the failure to update a faulty mental model, denial of the current input, leads to a series of unforced errors leading to disaster.

Definition of being lost: "30 minutes of not knowing where you are". 75% of those who are lost could extricate themselves by backtracking, but by pursuing a faulty mental model, expending unneeded effort deplete their resources, through panic, leading themselves on a path to disaster.

After disaster has struck, there are the stages of bewilderment, anger, denial, and resignation. Once resignation has set in, often the victim gives up and dies. The survivor, in contrast, does not give up and die, but fights like a bastard and takes control.

Many of the same accidents happen over and over. The propensity for these disasters are built into the design of the system. Examples include mountain climbing, river rafting, and of course, in trading. Study of classic mistakes, the methods to extricate from danger, and practice of these, will assist in avoiding disaster or extricating oneself from danger, and increase the chances of survival.

Thanks to Ryan Carlson for the recommendation of Deep Survival, by Laurence Gonzales

Chess Symbols, by GM Nigel Davies

Interesting to see some chess symbols on the list. Here's a brief and incomplete summary for the uninitiated:

+ -  White is winning
- +  Black is winning
+/-  White is clearly better
-/+  Black is clearly better
+/=  Slight advantage to White
=/+  Slight advantage to Black
=    Equal position

It's not on my keyboard but when we don't know what's happening we use an infinity symbol meaning 'unclear'. And equal sign followed by infinity means that we have compensation for the material, which I guess could be applied to a bullish situation in which we're down on the trade.

In Lev Alburt's, Test and Improve Your Chess the former US champion suggested they be awarded based on the expected score from particular positions, for example +- should be something like 85% in favor of White between Grandmasters of equal strength. Of course very few positions in chess have been tested in this manner, but I think the idea is a good one.