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31-Aug-2006
Briefly Speaking, by Victor Niederhoffer

Intel hit a high of 20 today for the first time since May 9th when the whole decline started, from an S&P circa 1325.

      op      hi      lo     clo
      19.63   20.00   19.56  19.84

Other destinations are 16,000 for the Nikkei and 6,000 for the DAX, and while the S&P played footsie with the 1,300 level, showing a high and low above and below it on 9 consecutive days ending August 29th, the FTSE in England is preparing to play footsie with the 6,000 level also.

Along these lines, O'Brian mentions in The Fortune of War that Maturin could tell by the way Johnson was sitting that he was playing footsie with Ms Wogan. All men should be careful of the posture of their importunate rivals in this regard.

31-Aug-2006
Turning Points, from Dean Teffer

I found the question you posted on August 25th regarding turning points very engaging. I hope you find the attached discussion interesting, it is a preliminary analysis entitled Turnaround and Breakout Analysis on ESU6 Time Series. I would greatly appreciate any feedback, and I am interested in pursuing the problem further if you feel there is any value in this line of reasoning.

Vasco Chatalbashev comments:

I very much enjoyed the article and think you are pursuing an interesting line of research. However after reading it a couple of times, I think it would greatly help to give precise, algorithmic definitions of turnaround point, "broken out", "breakout" etc. There is no need to have to reverse engineer what you did, especially when the point of the article was to share your insights. Again, great work.

31-Aug-2006
House Moving Perspectives, from Nigel Davies

Moving house last week gave me some new perspectives on a number of matters that I thought I might share.

I am renting a £500 per month property which would probably be valued around £130,000. This represents a less than 5% yield for the landlord without taking into account things like crazy tenant risk plus costs, and I should point out that the management agent seemed to think I was ideal tenant material. I do not know much about property but it seems to me that this yield is at historic lows and represents the end of a trend.

A self-move looks like one of the best heart checks available, especially for someone with several tonnes of chess and trading books. My survival seems to indicate that I need not burden UK inc's health service, despite urgent requests from my Doctor that I go in for cholesterol checks and the like. And right now I feel fitter than I have done in years.

A few pointers:

  1. Fan assisted ovens enable you to cook thincrust pizza from frozen.
  2. Broadband installation seems to be experiencing some delays here in the UK, though my trusty laptop detected some unsecured networks nearby and I am sending this via someone else's network. It seems to me that this indicates there may be a future in user friendly security, that some form of network sharing may have an impact on takeup predictions for individual broadband services, and that all this may have some influence on hacking, piracy and fraud.
  3. Future ex-wives show greater appreciation of your good points once you are gone.

31-Aug-2006
A Response to A Kiss of Death for the Commodity Index?, from John Michael Fidler

The author of this post writes that "stock bulls should be jumping for joy" in light of the technical breakdown in the CRB Index. The logic goes that a capitulation in commodities reflects a Fed victory over inflation, and implies a dovish rates policy. Okay. And assuming the commodity bubble has burst, and further assuming that implies the end of tightening, so what? Historically, and contrary to the long-standing mantra of those in the bovine camp, the end of rate tightening cycles is followed by uninspiring stock market performance, not the opposite.

Rather than regurgitate the standard "the market always goes up when the Fed stops tightening" dogma, let's do some counting: Since 1969, in the 6 months following the last hike in a Fed tightening cycle, the average return for the S&P was up 10bps, flat for the NASDAQ, and down 1.5% for the Dow. Hardly reason for jubilation if one is long equities. Returns were positive in 44% of observations for the S&P, 50% for the NASDAQ, and 44% for the Dow. Moreover, if one is playing for the positive outliers, max gains during those periods were 9%, 12%, and 8%, respectively, for the three indices, however max down periods were -14%, -17% and -13%, respectively.

On top of this, what does one notice when you overlap a chart of the S&P and a chart of the CRB since 2002? Are we really to believe that the equity rally since the 2002 lows took place in spite of the concurrent commodity inflation? More accurately, it seems to have taken place in a large part because of it. A rising tide lifts all boats, and dollar deflation + asset reflation = nominal appreciation in all non-debt asset classes.

31-Aug-2006
Women and the War Effort, from Stefan Jovanovich

One of the least mentioned but most important facts of World War II is how little the Nazis did to use women as part of the war effort. While American, British and Russian women were flying airplanes (some in combat), manning anti-aircraft batteries and working in shipyards and tank factories, German women were not even mobilized until 1944. This was deliberate policy, not some mammoth oversight. The inclination of devout Muslims to side with the Fascists can, in part, be explained by their shared misogyny. One reason to be optimistic about Iraq's future is that women are active in its politics in a way that no one could have imagined 5 years ago.

T.M.Ryan comments:

Anyone who believes that the increase in divorce since the 70s is due to a cultural shift and that relationships between men and women have fundamentally deteriorated in the last two generations has not read Shakespeare, Dickens, or Jane Austen. Human nature does not change that fast, personally I know as many self centered men as women.

What we do know, and it cuts across cultures, is that as women become more educated and enter the work force in larger numbers two things have happened not just here but in other countries. Divorce rates increase and birth rates decline. South America for example, is starting to show the same trends in the numbers on divorce and birth rate that the US and Western Europe saw in the 70s.

On a tangent here, I have always wondered to myself how can the islamsharriafascist culture survive in the long run if they marginalize and do not make use of 50% of their DNA?

31-Aug-2006
More Secrets, from Steve Ellison

I have finally located a copy of Secrets of Professional Turf Betting (at one time, I was outbid by Mr. Highland on eBay). This book has been discussed many times on the list, and I was already quite familiar with some of the key points. The most interesting part of the book that I had not read about was Mr. Bacon's emphasis on careful study of results charts and weight allowances. There was valuable information in details the betting public was too lazy to examine. The bettor should be able to construct an independent set of odds and lay out a likely scenario for each race (e.g., by noting which horses liked to run in front and which liked to come from behind).

What are similar techniques in speculation?

  • Estimating "fair value" based on fundamentals, as value investors do.
  • Digging beyond widely-publicized market commentary such as "Valero has gone below its 200-day average" to research what actually happened after previous such events.
  • Handicapping the market's likely reaction to, for example, core CPI of 2.0%, 2.3%, 2.5%, etc.
  • Looking for "weight allowance" parallels where expectations are so low (or high) that just about any news would result in a price rise (or decline).
  • 31-Aug-2006
    Jim Sogi on Free Money

    Money has the power to destroy, For those that made it, there is the pride and satisfaction, but even for those who received it in a random occurrence (for example a lottery or an Internet or Microsoft fortune), it can be destructive. The freedom and power it offers can often be destructive. Many fortunes were created quickly over the last decade leaving the owners coming to Hawaii seeking the good life with no need to work. The result can be sad cases of alcoholism, divorce and loss of motivation. It happens too often. Money can destroy motivation, self worth and meaning in life. It can create bitter feeling. The power money brings can be destructive to interpersonal relationships. The need for character development recedes when anything can be bought. The danger is amplified for inherited money with attendant feelings of loss of self esteem, distrust of others, and fear of losing it with no wherewithal to earn more, loss of motivation. There are many sad cases.

    Gates and Buffett leaving billions to loved ones would be destructive. The use of private foundations gives the heirs income and a job for life as well as a mission to save the world. The wealth will outlast generations with only a 2% tax structure and may grow beyond the wealth of nations in time. This is the best way.

    30-Aug-2006
    Victor Niederhoffer on the Markets Last Week

    S&P futures were down four out of the 5 days, but just 10 points in total after a rise of 1.5 points on Friday. The changes were so small that on 3 of the 5 days, Tuesday, Thursday, and Friday, the change in the the spot index was in the opposite direction to the futures.

    Futures so far have been above and below the 1300 level on 7 consecutive days.

               ______________S&P______________         Bond Close
     Date      open     hi      lo     close           (in 32nds)
     8/21      1302.7  1303.3  1298.5  1302.3            109.25
     8/22      1300.0  1305.5  1297.2  1302.0            109.28
     8/23      1301.5  1304.2  1291.7  1297.8            109.28
     8/24      1299.2  1300.5  1293.6  1296.1            110.00
     8/25      1296.2  1301.7  1294.8  1297.6            110.04
    

    It was a very narrow week with an average daily range of 8, and only 1 day (Wednesday) with a 2 digit range of 12. Bonds set new highs every day and at 110 and 4/32 are now at a 5 month high. The relationship between bonds and stocks is always changing, but on average the numbers of one are predictive of the other.

    Within the S&P, the best performing indexes were natural resource orientated, with gold, oil, gas and forest products up 3% or more. The 5th best performing group of all, up at 3%, was residential REITs. The worst performing groups, down 5% or more, were general merchandising, specialty stores, home furnishings, home improvements, and specialty construction services (down 8%).

    Gold, crude oil and the dollar also made very narrow moves, each ending up about 1 % on the week. The NASDAQ was down almost 2% after rising the previous week by 6%. The VIX was at 12.3%, near the average of last 2 years but below the Spring '06 level, and most levels in the four years prior to that. The rise in bonds corresponds to the decline in soybeans, down to a 16 month low at 557 for November contracts, with comparable declines in other grains (except for wheat at 400 -- about unchanged over the past 3 months).

    The backdrop provided by these markets brings to mind the importance of observing a framework, one that can provide a rudder for appreciating what has happened and planning and forecasting for the future. I have always emphasized that often news is backward looking and misleading having the effect of making you think and do the wrong thing so that you can contribute to the continuation of the market ecosystem. The agenda that you choose to review or be influenced by is key to your success.

    As an amusing exemplar of this, I have always said that the only news I read is that of the National Enquirer. While that's not true anymore under the new management, since it is very weak on what the common person is doing and rags to riches stories, but now is mainly about the stars and television programs, I do pay much more attention to markets than to purveyors of the news.

    I strive to let the agenda and forum that I follow be one that will not lead me down the primrose path to likely destruction. I constantly review this backdrop to help me set my agenda and create a framework for success. What you let yourself be influenced by is the key.

    Along these lines, I recently found myself subscribing to a forum that was constantly emphasizing the negatives and the pessimistic approach to the markets . . . to be continued.

    29-Aug-2006
    David Wilder on Delta Theory

    I read Craig Cuyler's post on Delta Theory with great interest and want to expound a bit on your comments. I feel well qualified for this given that I am personally acquainted with Jim Sloman, and Welles Wilder is my father.

    Between 1994 and 2000 I worked full time with Delta Members and Directors to do with all things pertaining to the delta phenomenon. I personally did hundreds of hours of work solving various time frames for markets as varied as stocks, commodities and currencies, foreign and domestic.

    During that time I had the privilege of meeting and working with individuals who applied Delta profitably across every time frame imaginable, from intra-day price patterns to longer term weekly and monthly charts. To be fair, this segment that was consistently profitable with delta, (the hallmark of a professional trader) was small, likely 5-10%. For these folks, Delta was a timing tool that enabled them to be more accurate on their entry points and their exit points, regardless of the system and strategy they employed.

    As you aptly described, it has its limitations. Delta timing does not tell us the price magnitude of changes in price. Delta simply tells us on average where highs and lows are due to be made.

    There are 5 delta time frames, Super Long term, (19 years) Long Term, (4 years) Medium Term, (approx. 1 year), Intermediate Term, (approx. 4 months) and Short term (4 days).

    For most position and momentum traders, the combination of the Intermediate, Medium and Long Term is sufficient. Using these time frames in tandem gives a trading operator the ability to allow price to confirm that highs and lows have been made. Thus, there is a segment of future time whereby the market will move higher or lower to the next delta turning point.

    The inability for a market to move up or down to the next point is important information, and should be viewed as a technical indication of strength or weakness. It would take too long to explain many of the variations possible, but one simple and logical way to apply delta is to trade in the direction of all three time frames.

    Example: If a security is in a long term uptrend, pulls back to make a Medium term low, and subsequent to the Medium term low you confirm the Intermediate low, the probability of using Delta profitably increases dramatically. Without doubt, position sizing, proper risk management, price confirmation and other technical indicators confirming this are of vital importance.

    Without discipline and patience, backed by an understanding of probability, no "system" can be profitable for very long. In pure terms then, delta is not a system. It is a time template. As you rightly pointed out, the devil is in the details. The "rub" is being confident that price highs and lows have in fact been made. Then, in conjunction with other tools and discipline, a trader has to step into the uncertainty that is inherent in trading. My belief worked out in experience to this day is that Delta helps ease that uncertainty, and when used properly is an enhancement to ANY trading system.

    For more information and to see how professionals use delta today, feel free to visit the Delta website. I hope this helps clarify some of the mystery.

    A Special Offer from the Delta Society:  Kirby Cooper at the Delta Society office in North Carolina would like to extend a special offer towards the Daily Speculations community on the Delta Phenomenon. The Delta Society consists of Members and Directors of Delta who have widely followed Mr. Wilder's work.

    "We want to offer you an opportunity to purchase the Delta Phenomenon Book at a special price of $75. This price has never been offered before by the Delta Society. Go to the site www.delta-market-trading.com and use the codes dp75 on check out. Along with the book you will receive a study guide. This guide will assist you in building solutions for the markets you are trading."

    30-Aug-2006
    Turn of the Screw: Equity Returns at Turn of the Month, by Dylan Distastio

    "To everything - turn, turn, turn
    There is a season - turn, turn, turn
    And a time for every purpose under heaven"

    With the end of the month rapidly approaching, I thought this study made some tasty food for thought.

    Abstract: A turn-of-the-month effect in U.S. equity returns was initially identified by Lakonishok and Smidt (1988) using the DJIA for the period 1897-1986. According to the turn-of-the-month effect, equity returns over the interval beginning the last trading day of the month and ending three days later are significantly higher than over other days. Using CRSP daily returns, we find that the turn-of the-month effect persists over the recent interval of 1987-2005: in essence, over this 19-year period (and over the 109-year period of 1897-2005) all of the excess market return occurred during the four-day turn-of-the-month interval. Thus, during the other 16 trading days of the month, on average, investors received no reward for bearing market risk. We further find that the turn-of-the-month effect is not confined to small or low-priced stocks; it is not confined to the December-January turn-of-the-month; it is not confined to calendar-quarter-ends; it is not confined to the U.S.; and it is not due to market risk as traditionally measured: the standard deviation of returns at the turn-of-the-month is no higher than during other days. This persistent peculiarity in equity returns poses a challenge to both "rational" and "behavioral" models of asset pricing.

    Robert Gilbertson responds:

    In 27 out of the last 32 cases my portfolio has been higher at the end of the third trading day of the month versus the close of the penultimate day of the previous month. I also noted that in 6 of the last 7 years I was up after three days at the start of every year. This is not totally unexpected since over that period, my portfolio has been up on 59% of all of the days.

    However, upon cursory evaluation, I do not believe that all my profits were made during those four day periods. My average annual return for the past four years is 24% and the median 4 day "turn of the month" gain seems to be about 1/2%. This would account for a 6.17% annualized return, or only 26% of my gain. If annualized (There are 5.3 forty eight day trading periods in a year), these 12 four day periods would seem to outperform my annual rate of return by about 40 to 50%. This is significant. I will leave it to the mathematicians on the list to compute the level of significance. For their information, my standard deviation on my 24% ROR is 11.5%.

    Serendipitously, I just completed the first closing of my first hedge fund Monday night and became 80% invested as of 10:30 today. My thirty five stock portfolio is already up 0.9%. If you desire, I will report my monthly gains versus my four day "turn of the month" gains to you as they occur to give you prospective results.

    I am a long term, value investor who enjoys reading about how counters think and am a fan of Mr. E, Patrick O'Brian, and barbeque. My investments are based on a model that I developed at the University of Chicago in 1970 to attempt to disprove the efficient market theory. Obviously, my faculty advisors viewed my attempt as heresy, but they did admit that I demonstrated an astonishing model that retrospectively outperformed the market 2 to 1 over 75 years of history. It turns out that it kept working. With improvements such as screening for Z scores to avoid potential bankrupt companies, it now prospectively outperforms the market by 3 or 4 to one depending on which index over what time period is used for the comparison.

    I look forward to the next four days since they are the "turn of the month".

    29-Aug-2006
    Creating Problems, by T.M. Ryan

    With my mining clients for I have noticed over the years this perverse tendency to create problems in the operation if none exist. In other words, if things are running smoothly, there is a tendency to push the envelope harder and harder until it breaks ... and the higher the commodity price, the harder the push. First of all, on paper it is easier to justify the pushing on the envelope at the higher price after several years of a bull market than at the low (look at how much we could make next quarter if we only did ...), and if the situation becomes fubar, it is easier to find budget for the fix-up when the price is high and things are booming (incentives at the lower level of the food chain are different than at the upper). In other words there is this tendency to more risk taking in operations at high price than at lower prices because once the situation is broken in some fashion you have "to invest in loss" which involves lots of re-engineering and new equipment, upwardly revised budgets, etc. How else are you going to get that new Caterpillar 992 loader into the budget? It is similar to Bridge on the River Kwai were Col Nicholson builds the Japanese a great bridge even if it is helping the enemy, simply because it is the easiest way to keep his troops busy and hence him in command. "We must have a problem to tackle and sort out"

    I think there is a market analogy in here as well. It gets back to why the news focuses on the bad more than the good, and why people find it difficult to cut losses in market operations. The market news for example is particularly prone to this tendency, it is always full of "troubles" "climbing walls of worry, etc". As Vic stated earlier in the year, in part the reason why bad news outweighs good news in the media, is the fact that the potential to profit via reversion to the mean is always much greater for a doomsday scenario than the status quo, so people will always pay more for doomsday than for optimism.

    Secondly I think just as there is a tendency for the market to fluctuate and probe for weakness in the short run in order to pay for all of the fixed costs of the infrastructure, there is also a reflexive tendency to create problems in order to justify activity. Would we need so many people in the HF and banking industry if we didn't experience these occasional (2-5 times per annum) spikes in implied volatility? Probably not. There is risk so we need a risk manager....we have a risk manager so we better have some risk to manage. Its part of the reason why cycles will always keep changing.

    28-Aug-2006
    An Introduction to Modern Bayesian Econometrics, reviewed by Victor Niederhoffer

    Right at the outset of Tony Lancaster's book, 'An Introduction to Modern Bayesian Econometrics' he states that it is probably better not to have any background in econometrics or statistics because the Bayesian approach is so different from the traditional ways. This book will change the way you think about decision making, prediction, and description in all economic matters, and includes computational techniques, an elaborate discussion of Bayes' theorem, and computer programs and code.

    Econometric analysis is different from statistical analysis in that it deals with behavior of economic agents making choices about goods, and the interaction of markets. As such it is much closer to what the average investor is interested in than the typical statistics book. This book is the first to show how these decisions can be made using the modern tools available, and with these tools the way one would approach the problems of choice and decision making is radically different from what we have been accustomed to. In short, you start with beliefs about the probabilities of your hypothesis, you consider the consistency of the data with each of the realizations of your hypothesis, and then you come up with a revised tableaux of beliefs about your hypothesis based on the new ex-post probabilities of your hypothesis. This is the way most scientists actually do work . They come up with a hypothesis, they state what they would expect to happen based on the hypothesis, and they then examine the data to see it is consistent with the same. Finally they revise their hypothesis. This is a good model for scientists as well as traders.

    The basis for all the book is Bayes' theorem which the author emphasizes is the only way to revise beliefs based on numerical evidence. The basic theorem is as follows:

    Suppose you have a theory that has different possibilities , say that the market is a 50-50 proposition or that it is biased to 60% up with a 10% per year drift. Let us call that your prior probability A with two states, A1 with a probability 0.5 and A2 with a probability 0.5. Next, consider what you would expect to find in evidence if your theories were true. That is event B. For example , if theory A1 were true you'd expect to find 4 rises in a row 0.06 of the time. But if theory A2 were true, you would expect to find 4 rises in a row 13% of the time. Now if you find four rises in a row, theory 2 becomes more likely by a factor 13/6.

    Originally the theory was 50-50 . but now the theories have an ex-post probabilities proportion to 0.5 x 13 and 0.5 x 0.06. So the revised the probabilities of A1 and A2 is that A1 is now 13/19 to be true, and A1 is now 6/19 to happen.

    Formally, Bayes' theorem states that we start with a theory A and then revise it based on the evidence B according to the formula that the probability of A and B taken together is:

    P (A) x P (B|A) = P(B) x P(A|B)

    Alternately, P(A|B) = [P(B|A) / P(B)] x P(A)

    The right most term in the numerator is the likelihood. The left most term is the revised posterior probability and the denominator on the right is the prior probability.

    Bayes' theorem and all econometric decision making may then be formulated as a probability distribution for the various states of your hypothesis to find the likelihoods of various realizations of the data for each state of your hypothesis. Collect the data and then apply Bayes' theorem above to revise your probabilities. Then see how consistent your revised beliefs are with what you know about the situation, and how helpful it is for you to use it in the future, i.e. criticize and find out how useful your new model is through prediction.

    The book contains numerous examples, numerous models, numerous extensions of this algorithm along with the computer code to perform such analysis. Topics treated include linear and non -linear regression models, multinomial models, autoregressive models, time series models, Markov Chain models, binary choice models, duration models, survey data and recursive equations. Extensive use of simulation is made throughout the book, and the book also includes a computer program to help make the models come to life. The book is somewhat technical, especially since all the results depend on computer modeling that yields output that is not clearly derivable by hand without, however, it will change the way you think about decision making, and will be an important adjunct in how you think in the future, regardless of the mastery of all the technical details contained. This book is highly recommended for a nice pencil and paper read.

    Jim Sogi adds:

    Bayesian Methods by Thomas Leonard discusses the philosophical underpinnings of the Bayesian Method. Classical probability is the 'm over k rule' and is appropriate when outcomes are equally likely. The second type of probability is the frequency probability of an event in the long run, proportional to the number of times the event occurs. Subjective probability measures an individual's uncertainty in an event and may vary amongst individuals. An individual who always tries to represent his uncertainty by a subjective probability distribution is referred to as a "Bayesian."

    In terms of the parsimony principle of keeping models with few parameters, L.J. Savage felt that "a model should be as big as an elephant." Contrast this with the late Toby Mitchell's philosophy "the greater the amount of information, the less you know."

    An interesting twist on the subject is Simpson's paradox with lurking variables. The classic case is the death penalty by race which seemed to show no racial bias, but when the lurking variable of the race of the victim is introduced, the conclusion is the opposite. This seems particularly apt in the market where unknown variable are always lurking, seeking to turn your confidence in a bullish trade on its head.

    27-Aug-2006
    The Beauty of Competition, by Victor Niederhoffer

    The beautiful thing about competition, or what I like to think of as fighting for your own interests in a fair game, is that it leads to great personal rewards while at the same time making the world a much better place. It is easiest to see this by thinking about the struggle for existence memorialized by Darwin in the Origin of Species and The Descent of Man that leads us to come into existence at all by winning out in the struggle to find a mate and pass our characteristics on to future generations. The qualities we pass on, through competition are those that are most suitable for living, surviving, and breeding.

    On the economic front, Adam Smith in the Wealth of Nations and Friedrich Hayek, in the Road to Serfdom and Armen Alchian in Economic Forces at Work showed how the competition of business people leads to the material benefits and natural harmony that have so enriched and extended our lives. Smith concentrates on the salubrious process of competition between business people that leads to the quantity, and quality, and availability of the material goods that we all find so beneficent as well as total wealth for the Nation. Hayek showed that competition is a discovery process. What people want is dispersed, and idiosyncratic, and often unknown to consumers themselves.

    The process of competition leads to purveyors discovering those wants as an unintended consequence of pursuing their own interests. Alchian had extended these ideas to the profit maximizing behavior of business that leads to firms prospering and expanding that are best suited to meeting the particular desires of the consumers of their products.

    The terrible thing about not fighting for your own interests or altruism is that it leads to lack of success in your own life, mediocrity and lack of development of your own abilities and bitter disharmony in society. The alternative to winning by competition is often taking something from others by forces. That leads people to become frightened about what others might take from them or even worse what you can get from them. Extending this idea to its natural consequence shows why societies that do not have a proper outlet for competition tend to be poverty stricken and chaotic.

    My early training in competition was in the world of sports and games. I was raised at the Brighton Beach Baths, the largest country club in the world, with about 10,000 members paying 10 dollars a year with ample facilities for every kind of racket, water, ball sport and board and table game. One highlight of this training was the constant money games that were played on the handball courts with hundreds of hustlers trying to figure out a game or con, like playing with your lefty backhand or while sitting on a chair against an unfettered opponent.

    One of the highlights of early competition was that at the age of 11, I won a pair of sneakers by beating the best adult paddle ball player in a money game. But by far the biggest highlight was seeing weekly tournaments among the best handball players in Garber Stadium where the best handball players in the world vied for prize money of $25 for the winner of the doubles and handball tournaments.

    The person I developed my own competitive gestalt from in these tournaments was Vic Herskowitz, who many consider the best handball player of all time. His competitive style was to hit as hard as he could, as aggressively as he could from both sides of the court, never to complain and always to maintain a very pleasant and positive demeanor towards the game.

    However, the person I admired the most was my father, Arthur Niederhoffer. His competitive style was to try to win points by moving forward at all times, going for the "off the wall killer", comparable to a volley put away in tennis. His cardinal rule on the court was always to give the other side the benefit of the doubt. All the opponent's shots were called good, and all your own close ones were called out. Whatever the opponent did was considered as exemplifying the greatest of prowess and skill. Whatever shots you were able to hit were considered terrible, and your own game was "the world's worst" no matter how many people you could beat. It took me a long time to develop that approach in my own competitive activities.

    Read Extinction and the Markets, and other posts about competition.

    Mr G. comments:

    I was born in an ex-communist country so I grew up very aware of the deleterious effects of a government stifling competition. I also grew up with a father who taught me the beauty of competition in sports and in broader life. However, I think we have to approach this subject carefully; in some cases the pendulum has swung too far in the direction of competition in the US. What suffers in the end is our ability to take a nuanced approach to determining the optimum competition/ cooperation mix in any given case.

    Cooperation can be as powerful as competition in certain cases. If you look at the drug industry, you will see that they tout something they affectionately call "coopertition." Biotech firms compete with one another, as well as with pharma companies, but in very significant ways they all cooperate at the very same time.

    I head up global pricing at a medical device company. We are certainly not allowed to get together in a room with our competition and decide on pricing for our industry, but you can be sure we do end up cooperating on prices. Almost all companies do. A simple prisoner's dilemma two by two matrix will show you why and how. Just play out the "repeated interaction" version and you will see how cooperation through signaling will produce a maximum payoff for each player.

    Looking at it from a different perspective, you can see that, in some cases, the customer benefits if pricing cooperation exists to some degree -- stable prices lead to money for R&D, which in turn leads to innovation. Sure, the fear of declining prices driven by competition also serves as an impetus for R&D, but there is an optimum for each variable. If competition is out of hand, prices drop too quickly and the product launch does not make the R&D / plant expansion investment back, reducing the chances that there will be more investment in innovation. Again, the biotech industry serves as a good example. It has probably the least competitive markets (because of patents) but R&D spend is high, profit is high, and innovation is strong.

    I would extend this and argue that competition is neither good nor bad. It is just a framework for producing an outcome. The degree to which competition is beneficial depends entirely upon the values of those who are competing. Certainly I agree that competition is a more efficient way of getting something done, but the key question is what do you want to get done?

    What makes the West great is that we value better things than those who have not kept up. We value the open mind rather than fundamentalist thinking; private property rather than government owned property; money rather than whatever communists and others proposed as alternatives (although, I am not sure there ever was a clear proposal on the table for an alternative); industriousness rather than taking it easy; new technology rather than keeping things as they are; etc. These values have also led to problems, but I would argue that the net effect is positive. However, competition is only the framework that allows us to achieve these values more efficiently in some cases. It is like gearing an investment, you can gear the heck out of it, but if you picked the wrong direction, you are in trouble.

    In the past, we needed to sound off on competition with a clear, loud voice because we were fighting a competing ideology, which was itself sounding off loudly, but which got it all wrong. Today, we still have to sound off clearly, but it is also important to begin looking more closely at what the best competition/ cooperation mix is for specific cases.

    Russell Sears replies:

    The Death of Big Pharma has been Greatly Exaggerated

    Rather than subject Big Pharma to a slow painful death of torture at the hand of a tyrant. Let me suggest a couple of different scenarios.

    A fundamental tenant of Democracy is that regime changes will take place when the current regime becomes too tyrannical. Either the regime changes or the tyrant makes concessions to retain power.

    It is no secret that we have 2 powerful scientific forces converging, the power of computers and the understanding of genetics.

    Now suppose that these forces live up to their full promise, and individual treatment of disease becomes a reality, at least for countries that allow customized medicine.

    Such a migration of "medical tourist" are already occurring due to the high cost of litigation. Add too this a new wave, and you will see some major changes. Other countries will gladly welcome big pharma business enacting more business friendly laws. Local demand for these treatments will insist regimes or tyrannical rules will change.

    Lets suppose that a few companies do die. These are not just brands, pusher of mass drugs. These companies are life savers and supporter of the physically weak and vulnerable, but often rich and connected. This do massive public good for a very thin or even negative profit, many small unmarketable drugs, that are life savers to the few.

    Its not like driving a Ford, versus Chevy, you drop a big company and many people lives will turn into hell. Lay that at the feet of the current regime.

    The meal for a lifetime is that long term doomsday forecast often paint detailed and realistic rendering extrapolating the current conditions to terrible long term view. But miss that these very forces are what causes regime changes or at least curves in the current road.

    Full disclosure I own AMGN, PFE and probably have at tangled web of interest in big pharm. companies and the drug industry in general, because my wife is a Rph.

    Stefan Jovanovich comments:

    I think one can make an historical analogy between the position of the major drug companies now and that of the integrated steel companies in the middle of the last century. Like the steel companies then, the drug companies still have enormous cash flows that exceed their requirements for reinvestment - even with the assurance of continuing demand. Their problem is that they are an easy and obvious target for populist posturing. We have yet to see the political equivalents of Truman's threatening to nationalize the steel companies in the Korean War and Kennedy's "jawboning" with U.S. Steel as a means of controlling inflation, but they are surely coming. The question I have for the site is "What are the pharmaceutical equivalents of the mini-mills?" Is there an analog to what Nucor was in 1965?

    Dylan Distasio mentions:

    While I think you raise an interesting point, I do not necessarily believe that there is an equivalent of the mini-mill model in the pharmaceutical industry due to the nature of the drug approval process.

    A steel mini-mill can recycle scrap in a local geographic area, and sell it for a handsome profit. Bringing a new drug to market is incredibly time consuming, and expensive due to the government regulatory hoops that have to be jumped through no matter who is working on it.

    It is very difficult (probably near impossible) for a smaller, leaner biotech company to bring a drug to market without the help of either a major pharma or a very large biotech player like Amgen that for all intents and purposes is a big pharma.

    Unless the capital markets are particularly kind to a smaller biotech, they are going to burn through enough cash even after multiple trips via secondaries to get a drug to market without the help of a big pharma company via a licensing agreement. Even if they do survive on their own from a cash perspective, sales and marketing in the current environment is very tough without the resources of a big pharma firm to peddle it.

    I think the closest analogy to a mini-mill would be smaller players that focus on a pipeline of drugs for illnesses that have too small a target audience for the bigger players to invest the required resources into.

    I am sure that major pharma will once again come under the populist gun, but I think they have enough capital, political and otherwise, to survive most of these scenarios.

    28-Aug-2006
    A Book Recommendation, from Iris Bell

    Edward Tufte has a new book out called Beautiful Evidence. I own the previous three books by this author on how to visually convey information, and I am getting this one too. Even if you do not want to buy it you may find it interesting to read about it.

    ... Beautiful Evidence is filled with hundreds of illustrations from the worlds of art and science ... It contains historical maps and diagrams as well as contemporary charts and graphs. In one chapter alone, there's an 18th-century depiction of how to do a cross-section drawing of how a bird's wing works, and photos from a 1940s instruction book for skiing ... They all demonstrate one concept: Good design is timeless, while bad design can be a matter of life and death.

    28-Aug-2006
    The Origins of Value: Part II, by Jim Sogi (See Part I).

    An artist came over for breakfast today and during the discussion complained about all the paperwork that cuts into the time he has for his artistic endeavors. As I started to tell him about the book The Origins of Value, it hit me in a very funny and ironic way: the book is more aptly entitled, 'The Origins of Paperwork'. We all got a good chuckle out of that one. The book is a study of the actual artifacts of debt memorialization such as cuneiform loan tablets, the first paper money, the derivation of stocks. Sarah commented that the origins of writing itself was for the memorialization of debt instruments not the creation of art, poetry and prose. How ironic that the magic of written communication which enables us to skim over squiggly lines and spaces with our eyes and immediately and effortlessly fathom the deepest meaning of our fellows is so closely connected with the very subject of the site, the transferal of debt derivatives among us.

    The Chinese use of paper money in the beginning of the second millennium appeared to be a history of over printing to finance reckless government fiscal policies to fund military needs and profligate spending. If you think current inflation deflation is a problem, the Chinese regularly annulled currencies and issued new currencies or printed money willy nilly to pay for armies. The current market's preoccupation with the Fed and the value of money may be misplaced and not enough emphasis placed on the government fiscal policy.

    We currently see the exact same problem that devastated Chinese currencies occurring with printing money through monetization of debt to finance wars and profligate expansion of misguided government policies. It invariably leads to devaluation of the currency. Combine this with the fed restriction of credit to combat the devaluation and attendant inflation, and you get a recipe for stagflation. The fed slowing the economy down to fight inflation, while the government spending does its best to cause devaluation. The fed is fighting one cause, but the Government is creating the problem from another source. In effect the Fed is fighting the wrong battle. The problem lies with an over powerful executive branch, an emasculated legislative oversight and an apathetic electorate.

    The risk of misguided government is as great as the combined risks of the free market's structure and over-leverage or market risk. The idea is that the relationship of credit, business and the money supply and government spending to the value of the dollar and its effect on inflation are two different mechanisms. As Caroline Baum says the Treasury's job is to track the value of the dollar, not the Fed. In fact, she correctly points out, that in reality, there is no true dollar policy. There is only jawboning about a strong dollar, when in fact the de facto effect is a weak dollar policy. The mechanisms of credit and global dollar as a fiat currency are different.

    One Chinese species used for government payments was call 'feiqian' or flying cash, because it flew back to the capital without being carried when used to pay for supplies on the frontier.

    The recent changes from paper securities to an electronic market has far reaching ramifications whose effects are not yet understood and do not seem to be adequately studied. Take Mr. Melvin's startling report that the main CME bond and equity pits are empty. Take the rare use of cash for transactions by the populace and predominate use of credit/debit cards and checks for consumer transactions and all other business. Rarely is cash used for anything but the most trivial purchases.

    Where this technology is taking the financial system is not understood, and needs to be studied as much as the transition from a barter and metal based systems to one based on paper in prior millennia discussed in the book. Here is where the study of history is important for modern economist to avoid the exact same pitfalls that befell governments and financial systems in the past.

    The English in the 12th century used sticks of wood to mark loans. The stick was split into a tally kept by the creditor and a 'stock'. That usage continued for 600 years and was the derivation for the word stock we use now for equities.

    28-Aug-2006
    DCA Revisited, from Dr. Kim Zussman

    Many investors dutifully deposit some portion of their earnings into retirement or other (Victoria's Secret) accounts monthly. Financial texts advise of the wisdom of regular incremental investing as opposed to trying to time markets. Since historically stocks increase over time, albeit irregularly, why isn't it better to wait for the inevitable dips to invest, and thus capture more of the upward drift?

    There are many ways to look at this question, such as the cut-off for size of dip, as well as its duration. Then there is how much to invest at each irregularly timed dip of x in y days, to equal the amount that would have been invested monthly.

    The last question can be side-stepped by simply comparing mean returns of all regular investments to those which are initiated after dips. Using SPY daily with dividends, DCA monthly investment returns were defined as SPY close at the end of each month since 1993 to this last Friday's. This series was compared to three different strategies based on rolling 5-day returns of SPY. The first was if 5d dropped more than 2%. Next was drop more than 3%. Last were drops over 4%.

    Here is ANOVA comparison of mean returns, pitting (boring, un-intellectual) monthly deposits against those made after dips (here mean return is decimal; 0.767 means 77% gain over sum of all deposits to present):

    One-way ANOVA: to now lst, aft -2%, aft -3%, aft -4%

                                     Individual 95% CIs For Mean Based on
                                     Pooled StDev
    Level         N    Mean   StDev  ----+---------+---------+---------+-----
    to now lst  163  0.7671  0.8713                           (------*------)
    aft -2%     177  0.6082  0.7452                 (------*------)
    aft -3%     109  0.5176  0.6277          (-------*--------)
    aft -4%      62  0.4396  0.5117  (----------*-----------)
    

    The parentheses brackets give 95% CI, which shows that ALL of the dip-timing strategies have lower mean hold returns to present than dumb monthly deposits (-2% is N.S. however).

    Since the DCA and timing strategies have different number of deposits, you can check the results with final balance by scaling each deposit so the total is the same as for depositing monthly. Assuming monthly deposits of $1000, here are the adjusted deposits for timing strategies and the final account balances:

    Depos      N    $    gain  final $
    Monthly   163  1000  1.77  288037.3
    -2%       177  921   1.61  262136.6
    -3%       109  1495  1.52  247300.5
    -4%       62   2629  1.44  234651.9

    Which confirms that none of the timing strategies beats dollar-cost averaging, in building a buy and hold investment in stocks. (Which does not preclude other timing strategies that would win). However one conclusion is that buying dips only misses intervals of gain not preceded by declines, which are longer periods of upward trends.

    Kim adds:

    Just for fun (and prompted by a suggestion), here is a similar analysis of the S&P 500 monthly index returns since 1950. One investor bought at the end of all months and held to the present. Another bought and held only after down months. The third bought after only up-months. The following is ANOVA check on mean return for each strategy:

    One-way ANOVA: all months, after down months, after up months

    Source    DF       SS    MS      F       P
    Factor     2       11     6   0.02    0.97
    Error   1354   312967   231
    Total   1356   312978
    
    S = 15.20   R-Sq = 0.00%   R-Sq(adj) = 0.00%
                                    Individual 95% CIs For Mean Based on
                                    Pooled StDev
    Level      N   Mean  StDev    -+---------+---------+---------+--------
    sp5 mon  679  13.58  15.19         (-----------*----------)
    aft dn   277  13.73  14.50        (-----------------*-----------------)
    aft up   401  13.47  15.69         (--------------*--------------)
    
                                  -+---------+---------+---------+--------
                                  12.0      13.0      14.0      15.0
    

    Once again, there was no advantage to selectively buying either down or up months over dumbly buying every month. One interpretation of this is that although there may be short-term significant structure following declines and rises, the long-term upward drift subsumes any temporary advantage to putative opportunities. This in turn fits with greater compensation for summed risk over long periods than short ones.

    The dumber they get the smarter they look?

    28-Aug-2006
    Playing and Life Advice from Mike Caro, sent in by Nat Stewart

    I found this article and think that there are many direct applications to trading, and more useful ideas in one page than any book I have ever read on "trading psychology".

    I particularly like the notion of being aware of one's misery index, so that one can have the rudder, map and other rational navigational aids particularly close when the index is high and others may be dumping their positions overboard at just the wrong moment.

    James Sogi replies:

    As applied to the markets from Vic and Laurel's pearls of wisdom:

    No.Caro's AdviceTrading Application
    1.The cards probably won't break even--not in gin rummy, not in poker, and not in real life. Only trade the overlays.
    2.If you're a winner--in formal gambling or in life--you should never try to get even "for the night." Trading is not a short trip, its a long journey.
    3.Never make anything worse.Don't trade during bad life events.
    4.What you've already invested doesn't matter. Don't trade your P&L, trade the current market.
    5.Never seek sympathy.If your luck is bad, keep it to yourself.
    6.Keep your hand secret.Don't disclose your position.
    7.Don't humiliate your opponents.Have a humble mien.
    8.Don't even the score.Don't revenge trade.
    9.Act last.Be the last to buy (before the rally) and the last to sell (before the rally ends)
    10.Save your fancy moves for when you're running good. When you have the edge, hit the gas.
    11.Cheer for your friends.
    12.Don't fret over each injustice.60% win rate is still a winner, but the losses! Not personal, just business. The one about winning $20k, losing $3k and $5k is better than winning $5k, $3, $1k, though it may not feel like it.

    28-Aug-2006
    Zugunruhe, from Yishen Kuik

    I decided to spend this past week kayaking in Prince William Sound in Alaska - a chilly and wet but magnificent place to camp and enjoy the outdoors. The guides we engaged were avid students of the local flora and fauna and I learnt much from them.

    The growing season in Alaska is very short, summer lasts for a few months, and nature is consequently very aggressive. Trees go from buds to full foliage within days and baby animals start popping up all over the place as all mating is compressed within the summer window. One wonders if this has any applications to certain asset classes, such as emerging markets, that have historically suffered long winters of disfavour before a short summer of popularity whereupon a orgy of investing takes. Developed World savings trying desperately to mate with Third World assets.

    Migratory birds exhibit something called zugunruhe - a growing seasonal restlessness. Our guides said they could see this all the time, the birds start to stomp around, make gradually more noise over the course of weeks before finally the agitation finds release in the entire colony taking flight for the south. One wonders if there is zugunrhue in asset class migration, as capital, tiring of tepid returns in Equities, gets restless and starts migratory action into Bonds or Real Estate. Maybe good indications of such zugunrhue are funds flow data or life-death data of fund formation.

    Finally, our kayaking took us past the end of the Alaskan pipeline that runs from Prudhoe Bay to Fairbanks and finally to Valdez where it gets loaded onto tankers. I probably saw 2 or 3 tankers in the 5 days I was there.

    27-Aug-2006
    Black Holes Have no Hair, by Dr. Kim Zussman

    Information leakage beyond the event horizon of black holes does not occur, preventing observers from determining what the thing ate. This seems a bit analogous to how forecasting big declines seems impossible, but post-decline reactions are somewhat predictable.

    I think there is a lot of money to be made by improving probability forecasts of big declines, especially if/as investment pricetime becomes more and more riddled with quantum unstable derivatives. Speaking of pricetime, find below a 3d surface plot of daily SP500 closes v. time v. volume. Time increases left to right, daily close front to back, and volume is altitude.

    As an aside, most astronomy lovers also enjoy the mountains, and past expeditions to the heavens on the pinnacles were often accompanied by good music. One recommendation is American composer Alan Hovanhess' Mysterious Mountain. For the non-cosmic, if that big, dark, cold universe leaves you feeling small and insignificant, here is someone like you -- he is a pygmy marmoset, who is not S Les. but more Peter Lynch "holding what he knows".

    28-Aug-2006
    The Death of Big Pharma, by Dan Grossman

    Earlier this week there was a post about making some money in Pfizer's recovery from 23 to 27. It was a very reasonable post. It is certainly possible to make good money in declining industries, tobacco being a prime example.

    But what I want to discuss is the decline of big pharma -- from the leading (by profits), highest-margin industry in the US, contributing significantly to our improved health and lifespan -- to a scientifically irrelevant, financially pedestrian shadow of its former self.

    I believe three companies, PFE, MRK and BMY, have declined in market value to the order of a quarter of a trillion dollars (my figures are from memory). More important has been the decline in the economics and productivity of pharmaceutical research. Notwithstanding large increases in pharmaceutical research budgets and favorable developments in rational drug design and high-throughput screening, the number of new drug applications filed with the FDA has steadily declined over the last decade. Let us look at the drugs that are approved, for example in the crucial area of cancer therapy: If we look at most of these approved drugs honestly, they should classified as ineffective. They increase a cancer patient's lifespan by an average of perhaps two months. Unhappy months of painful, nausea-inducing chemotherapy. But some of them (e.g., Avastin) still sell in the billions and are considered blockbusters. This is a sorry state of pharmaceutical therapy for our most dreaded disease.

    Pfizer alone spends $6 billion on pharmaceutical research annually, an incredible amount. What do they get for this? Approval of perhaps a couple of not-too-exciting new drugs a year, half of which are licensed from smaller companies rather than originating at Pfizer.

    Ten years and the $1 billion average cost of developing a new drug is well-publicized by the industry and has become something of a cliché, but have we really considered how ridiculous this is? A billion dollars? For a single drug, usually a me-too or slight improvement of an existing drug, rather than a true breakthrough? Suppose each new software product cost a billion dollars to develop? How advanced would the PC revolution be with such a cost structure?

    In fact the original IBM mainframe computer industry may be a good rough analogy to the current state of big pharma. Suppose (which is actually very possible -- it happened in the Soviet Union) computers had required government licensing, being considered highly technical, dangerous devices that could for example hack into the Pentagon and leading financial institutions, and after testimony by scientific and government experts Congress had created the Information Technology Commission (ITC) on the model of the FDA, to regulate the development of new computer hardware and software. We can easily imagine the result; computers would still be large, fantastically expensive mainframes made by IBM and the still-existent Sperry Rand and Digital Equipment Corp. The PC revolution would never have happened.

    A decade after the height of its prestige and profitability, big pharma is limping and broken. With rare exceptions it is no longer contributing to significant advances in our healthcare. From a financial standpoint, it is about as exciting as investing in the supermarket industry. Either the industry/government pharmaceutical set-up has to change (unlikely), or the next revolution in healthcare will come from new technology outside of the pharmaceutical industry.

    Dr. Kim Zussman offers a few thoughts:

    1. The expectation was unrealistic to begin with. The idea that billions in R&D would lead to proportionate life extension presumes too much. It is possible that the major steps have already been taken (antibiotics, vaccines, statins) and periods of major breakthroughs, like physics circa 1900, are distributed irregularly.
    2. The analogy with software and computing is problematic. If you write a bug-free program you can make a million identical copies and expect it to work the same for all the users. But drugs, and medical care in general, are much less deterministic because of patient risk variables. Statins prolong life, but many still die of cardiovascular disease while on them. In addition, drugs are diluted within the body's own amazing healing mechanisms, which likely subsumes many effects elicited at the molecular or cell level. (i.e., "First do no harm")
    3. What is the value of 2 months? For one thing, this usually refers to mean increased survival, which will include those who die immediately and others who live another 5 years. Individualistically, isn't the value of the added time up to the patient, and not society? This gets to the question of why health care seems so expensive; I want to spend more to help my mother than some woman in Louisiana.
    4. Tech and other industries are not nearly as plagued by litigation costs as pharma. MRK just lost a couple of Vioxx cases recently, and there are thousands of cases queuing up. Like asbestos and tobacco suits, the industry of class-action is like a negative dividend stream stretching into the distant future, and how do you value a company with such exposure?

    (Caveat: I own PFE, SGP, a number of minor pharms, work down the block from Amgen, and have a Naproxen-loving L5-S1)

    R.L. offers:

    Big new technology always comes from outside the industry. Recombinant DNA and monoclonal antibodies did not come from pharma; neither did immunoassay or mass spec. That is not to say that pharma (and now that biotech is increasingly part of pharma, biotech too) does not improve technology -- we would be nowhere without humanized antibodies. If technology comes from outside, great. What is wrong with that? The real issue is: who will recognize the technology when it becomes available? In this case -- biotech did. And so we have some really cool biotech companies now to invest in.

    No disagreement about the failures of Big Pharma R&D, though the judgment that treatments in cancer have not improved at all seems harsh (Herceptin, Gleevec). Merck and probably GSK have possibly dispensed with cervical cancer--thanks to their HPV vaccines. But in any event, cancer is a tough disease -- not an excuse, of course. But there are plenty of people in countries outside the US, without an FDA, that have not solved it either. Given all that is going on in China, you would have figured -- sticking with your IT analogy -- that they would have licked it by now, right? Not the case.

    Meanwhile, what about HIV? Likewise a very tough disease -- but it is at least a more or less individual disease (cancer is MANY diseases). It needs a very tough class of drugs. We went from the mid-1980s, when we had maybe one or two anti-virals that were effective against any viral disease at all, to a bunch of anti-virals for HIV -- nearly all from the pharma industry. HIV is now a chronic disease -- 10 years ago it was a death sentence.

    I am tired of the IT analogies. Of course an FDA for computers would be ridiculous. But coming up with a new computer is pretty goddamned easy compared to coming up with a new drug. You do not test computers inside human beings. And it does not take several years to see whether the computer works or not.

    You both know I am not a fan of the drug business' managers, either. But in my view a big part of the problem is not that Big Pharma R&D did not get the R&D done. They did not recognize it when they could have -- either outside their own organizations or even inside. There is plenty of R&D outside pharma that they saw and could have funded, but did not -- all pharmas got a shot at erythropoietin (where would J&J be without it, one wonders). And pharma often did not even recognize good science when they had it (in part because their marketers weren't interested in the diseases). Bristol had several of Gilead's drugs but gave them back. Actelion's bosentan was part of Roche. All the hospital antibiotic companies (e.g., Vicuron, Peninsula) that have been acquired at nice prices or which got huge deals from pharma, got their products from pharma in the first place. Pharma ignored biotech for a long time -- at least ignored the commercial potential of injectable and other specialist drugs, allowing what even Dan would have to consider high-value companies, to flourish and reward investors. Now part of that research blindness relates to commercial blindness -- the unwillingness to accept the value of non primary care markets. The R&D guys did what the commercial guys told them to -- look for primary care small molecule drugs. They did not find them ... nor did they find what they could have found: acute care large molecule drugs.

    On the subject of commercial blindness, Pfizer's problems began, in my judgment, with the cocooning of senior management. From all their acquisitions, they have retained just two top managers -- one of whom will leave with the consumer products business and one who will retire at the end of this year (Peter Corr). They have continued to follow the commercial model that made them a success in the 90s -- a big sales forces. But major launches have underperformed (e.g., Geodon, Relpax, Caduet -- compare Vytorin from Schering/Merck or Abilify from Bristol) and they missed the fact that Lipitor sales were slowing down (given the 12k reps they had out in the field, you would have figured they would have heard about this, and the reasons for it long before they announced the news last year that Lipitor had stopped growing in the US).

    There are lots of things pharma can do to become a growth industry, and it ain't getting rid of the FDA. (The FDA is a rule we play by. It is like the net in tennis. You learn to deal with it. Federer does not give up and play soccer instead.) Nor is it just inventing new products. It is recognizing them when other people find them; it is the readiness to embrace new markets; it is openness to different ideas.

    I am not happy about pharma either. But pharma, which is increasingly biotech by the way (given the valuations of Genentech and Gilead and Biogen Idec) -- is not dead.

    27-Aug-2006
    Scott Brooks Reviews Poseidon

    For those of you that have seen the original Poseidon Adventure, here is what the modern version, Poseidon, has in common with it. There's a boat named Poseidon, it gets flipped over by a rogue wave on New Years eve, and the people have to go up to the bottom of the hull to get out. That's where the similarities end.

    It has its own story line, different characters, and different set of adventures (as though having to swim underwater, get away from fires, and falling debris could be made materially different).

    First of all, let me say that it was one wild action ride. There were so many close calls and scary moments that I found myself on the edge of my seat several times and caught myself holding my breath more than once.

    There were more than a few scenes that had trading lessons. In one scene where the group was trying to escape rising water, they had to go into a vertical ventilation duct and shimmy up the duct. When they got to the top, the vent was closed and they were stuck. The whole group is now stuck in this ventilation duct, one stacked on top of the other. And the water was rising up the tube. One of the main characters, played by Josh Lucas, was at the bottom of the line of people stuck in the tube. The water was rising, and he was stuck. He could not go down, and if he tried to go up, he would simply get stuck, because there was not enough width in the vertical duct for more than one person. So he simply had to take a deep breath and let the water go over his head. The character at the top was played Kurt Russell. He and a small boy (with smaller fingers) were tying to release the screws on the other side of the vent, so they could open the vent. After what seemed like an eternity (I had to take a breath, as I couldn't hold it any longer), they got the vent open and climbed through. As they all came out of the shaft, they showed Josh Lucas' character come out of the water and take a huge breath. What was interesting was that his character was extremely calm, didn't get mad at anyone for had almost happened, and then took the approach of, "okay, what next, we've got to get out of here". Lucas' character was the epitome of calm in desperate situations. At times, you could see the extreme strain he was under, but he still stuck with a straight analytical approach to the situation at hand. I've got a job to do and I'm getting to get it done. Things get bad, and sometimes we get sucked underwater by the market mistress, but as long as we're alive, don't give up, and maintain an logical analytical approach, we will not fail.

    There are a few other scenes with trading lessons. There are scenes analogous to and showing how sometimes you have to sacrifice a position to save the bulk of the portfolio.

    Another interesting, but very brief scene made me think of traders negotiating price, fills and transactions. Kurt Russell's character tells a steward on the boat, "if you show us how to get to that stairway, I'll double (he holds up 2 fingers) what you make in a year." The steward looks in right in the eye, holds up 3 fingers, and Russell says, "done!"

    One thing this movie does better than the first, is that it takes a far less altruistic tact. In the first Poseidon Adventure, Gene Hackman's character sacrifices himself for the group, people he barely knew. Very altruistic, very Hollywood.

    In this modern version of Poseidon, a sacrifice is made, but it is far more believable. Actually, this character really doesn't make a sacrifice. They simply choose a higher value. The value of the lives (specifically a life) that they saved by their actions was of a higher value to them than their own life. When it became apparent that everyone was going to die, unless someone fixed the problem (which would result in their death), the only logical person to perform that action, went. The scene of that person dying is quite disturbing.

    However, the movie is not without problems.

    The ugly head of Hollywood and the PC crowd was reared.

    It was completely unnecessary to make Richard Dreyfus' character gay. It added nothing to the movie. Dreyfus' character's sexuality was totally and completely irrelevant to the movie.

    Hollywood also seems to think that all parent/child relationships have to be dysfunctional and over-reactive. If parents and children truly interacted like Hollywood portrays them, its amazing that home life is tolerable for anyone.

    The movie is also weak on character development. Its a relatively short movie (98 minutes). It could have used another 30 minutes of quality character development. For instance, the character that Kurt Russell plays, was the former mayor of NY. He was a fireman before that. Now he's on this boat in a luxury suite and playing poker at a table betting nearly 6 figures on a single hand. Its never developed how he went from being a fireman to being able to bet nearly 6 figures on a single hand of poker.

    The scenes where they try to develop the characters are full of holes, superficial, and don't really make you bond with them. I felt like I wanted to know the people better, or at least some have additional information about them to make me feel a sense attachment to them. The movie didn't do it.

    There are several characters that take away from the movie. They try and play homage to the original Poseidon with a few scenes, involving the singer in the band, and the crew that wanted everyone to stay. It didn't really work. Kevin Dillon's character was one that really takes away from the movie. He plays a complete and total jerk. Not just a little jerk, either A huge, unnecessary jerk. He is so out of line and inappropriate that it strains believability. He is more interested in picking a fight than getting out of the boat.

    There are also the usual scenes of people doing illogical things, such as having unnecessary conversations, or milling around when they should be running like heck to get out.

    A word of caution to parents. This movie is not for the kids. Those of you on the list know I'm a bit of a prude. So let me give you my "protective parent prude dad" run down of the flick.

    It is intense. Too intense for my younger kids. I would consider allowing my oldest son (age 11) to watch it as the action is not to intense for him (along the lines of Lord of the Rings. Lots of action without the gratuitous gore) There was a bit of gore, but none of it was over the top. However, my 11 year old will NOT see this movie because Hollywood seems to feel the need to have unnecessary 4 letter words and sexual innuendo's, and "intimate", non-sexual, but unneeded situations (I'm not talking about a passionate kiss, or a loving embrace). If Hollywood would have simply left out the unneeded 4 letter words, and unneeded situations, and behaviors, this would be a good movie for as young as pre-teens. There was no nudity in the movie.

    If you can overlook these philosophical and moral flaws, you may find this to be a fun movie.

    Once the action starts it non-stop! The special effects are incredible. But I recommend you watch it with someone so they can revive you if you pass out from holding your breath!

    26-Aug-2006
    To the Tune of Pink Floyd's Wish You Were Here, by Craig Maccagno

    So, So you think you can tell, a buy from a sell, good buys from pain.
    Can you tell a good deal from a cold pure sell? A smile from a veil?
    So you think you can tell?

    And did they get you trade, your Euros for gold?
    Live Cattle for trees? Nat gas for a cool breeze?
    Cold comfort for change? And did you exchange a walk on job in the pit, for a lead role in a cage?

    How I wish, how I wish you were here.
    We're just two lost bulls, buying with the old fools year after year, running over, the same old ground. What have we found?
    The same old fears,
    wish you were here.

    27-Aug-2006
    A Book Recommendation from Easan Katir

    The Amazing World of John Scarne, autobiography, 1956. Starting as a 13-year old "broad tosser", he went on to become an expert on gambling and card magic. He recounts his invitations to Arnold Rothstein's Manhattan Central Park Hotel apartment every evening for a week, so a group of card mechanics could try to figure out how Scarne could cut a new, shuffled, inspected deck to an ace infallibly.

    One notes many market lessons about deception, misdirection, bravado.

    John Kuhn replies:

    Scarne's autobiography was one of my favorites as a child. His story is also reflective of the discussion sponsored by the GM of expertise and what is really entailed to acquire it. And, although the "trick" described below seems suggestive of deception, it's really a story of incredible persistence, commitment, and hard work. Scarne worked so diligently and had such feel and recall, he was able to always tell exactly how many cards he held in a stack, and from the merest glimpse, the order of the cards in the deck. And much more. I think I read this one almost 50 years ago. Found it more credible and every bit as astounding as the then purveyed lives of the saints and their ability to float about during prayer --staple reading in the parochial school in Boise I attended in the early 1950s. Hand magic is extremely exacting and difficult, whether with cards, coins, silks, or balls -- frequently just hollow shells to encase others and make them mysteriously vanish with a flick of the fingers. One of the biggest treats of my childhood was an occasional trip to San Francisco and a visit to the Golden Gate Magic shop, the only one on the entire west coast at that time.

    I also liked, along the same lines of individual effort and achievement, Bob Cousy's autobiography which I read in the same "era", as well as Surviving the Extremes: A Doctor's Journey to the Limits of Human Endurance, by Kenneth Kamler. This is a worthy read for a window on a few of the persistent spec themes: Man against the environment, adaptations to specific niches in nature, and -- what is to me quite fascinating -- the extreme complexity of the human system. Kamler minutely describes physical reactions to several different environments; extreme heat, cold, under water, and even outer space. One thinks one has a pretty good idea of what the body's reactions probably are, but Kamler provides an intense granularity to what goes one inside the body and I at least found the intricacy and complexity surprising, illuminating, and astounding. It is also a good book for those of us who might prefer to enjoy being stranded in the middle of the Sahara or on the top of Everest in a blinding storm from the comfort of our own living rooms.

    25-Aug-2006
    Briefly Speaking, from Victor Niederhoffer

    The following chart might provide a practical lesson in counting. Since 1:30pm yesterday for example one notes six turning points at 1299. Does a turning point, defined as an extreme with a price more than one away in the next hour, tend to be broken to any extent greater than a normal price? Do the number of turning points at an exact level forecast anything about the move subsequent to the break, or failure to break, of the turning point within a certain point? Are turning points of this nature consistent with randomness ? What is the best way to define such a turning point?

    25-Aug-2006
    Victor Niederhoffer reviews Patrick O'Brian's Navy, by Richard O'Neill

    The book Patrick O'Brian's Navy by Richard O'Neill provides the background and foundation for any who wish to understand how the British Navy was able to secure peace, and trade and win battles during the Revolutionary and Napoleonic wars. The book is profusely illustrated with paintings and diagrams that for every point, and it has an excellent glossary and index.

    It starts out with a point first made by author Ken Ringle, that there are six great literary themes; Man against Fate, Man against Nature, Man against Man, Man against Woman, Man against Society and Man against himself, and that O'Brian deals with all of these themes in each of the 20 novels.

    The market trader faces the same forces and he does it in the same perilous atmosphere as O'Brian captain's, where shipwreck, foundering, enemies, sickness, bad seas, political favoritism, poorly constructed ships and mutiny are constant hazards.

    The trader knows that the market is fated to do what it is going to do, regardless of the ephemeral factors that influence it from day to day. It will go up for example over many years, and especially during years when the earnings yield is much higher than the bond yield, but then it will go down to the point of least resistance of any major but weak players who can be stopped out. The nature of the market is not only the influence of weather, hurricanes, floods and tsunamis, but there are also the political factors that are known to the powers that be. The struggle of the trader is with other traders on the other side of each trade. It is a less than zero sum game where much is taken off the top by friction, and those with superior maneuverability and liquidity. The only way around that is to go with the drift and to stay within ones means.

    The trader's worst enemy is himself, so he must always conquer his emotions and his weakness, for example not selling at the point when the decline is steepest, or not pyramiding and getting in over his head when the market is strongest. The political backdrop is the war against society that the trader must fathom. There is the constant battle between the political parties to make things look good or bad so that they can get re-elected, all within the backdrop of plucking the geese with the least amount of hissing.

    As the war between man and woman, the market mistress is that woman, and she always has something new to throw at you to maximize your foundering and uncertainty so that she can keep the feeding chain working.

    The book has an excellent chapter on the world that Jack knew, which describes all the wars, coalitions, trade, politics and economic forces that Jack faced. It is essential for understanding why the British navy was involved in each of its activities. It also has a very nice discussion on the industrial revolution and how this changed the locus of power from merchants to manufacturers, and its effect on the East India company and the power structure.

    The next chapter talks about England itself, its population growth, its trade, its allies, its relations with colonies, the strength of its navy and its relationship with the army, the administration of the navy, the system of impressment, life on board a ship as well as on land (an area where Jack was as inept as he was an expert at sea). There is a detailed chapter on the construction and equipment in O'Brian's navy with numerous helpful diagrams that are a great aid to any who are not nautically trained and wish to understand what is going on in the nitty gritty of the ship.

    The next chapter describes what life on board the ship was, and what the incentives and working conditions were like. Finally, there is a chapter on the tactics of battle, the achievements of Britain, the conventions of battle, the methods of communication, the tactics of blockade, the relative strength of the various combatants, the obligatory discussion of Nelson's accomplishments and abilities and the condition of the equipment they had to work with. There are three case studies of a fleet action: The Battle of Cape St. Vincent where Nelson's Master stroke in preventing the enemy's escape is detailed; a single ship action that the English lost in the Battle of Lake Erie against the United States' Admiral Oliver Perry; and the Walcheren Expedition where the English besieged Dutch ports for strategic advantage.

    I found the book the ideal companion to improve my understanding of the times that O'Brian wrote about. I found that when reading of the sorrows, and hopes of the men he wrote about I came away with a much greater feeling and awareness. As the famous book review from the New York Times said:

    Although the times change , people do not, the grief and follies of these men and women who were here before us are in fact the maps of our own lives

    No group will find O'Brian's 'map' more accurate to their own lives than traders.

    25-Aug-2006
    A Question Regarding "Alternative" Investments", from David Baccile

    What are the hidden pitfalls behind the marketing of alternative investments? For example, I am looking at two funds marketed by one of the biggest brokerages for hedge porters. They market better returns than S&P, low correlation, and very low drawdowns. Is the lower volatility real? Or a matter of mark-to-market methodolgy? Is there survivor bias? What risks are they glossing over?

    Professor Gordon Haave replies:

    We have been through this a number of times before, and there is some disagreement. But the academic research suggest that there is very large survivorship bias in hedge fund returns. Hedge funds do not have to report returns, and so a certain percentage of them don't start reporting until they know they have a good track record, and others stop reporting when things go bad; 

    Search on "correlation". A few days ago there was a good post on this. Correlations have gone up a lot in the past few months. Even if traditionally there is low correlation between "hedge funds" (a loose term that my Friend Justin Klosek has pointed out is not always useful), correlation is most important, some would say, when the equity markets turn sour. So if the hedge funds are highly correlated to the equity markets when things go bad, then the low correlation argument loses some of its power.

    The maximum drawdown statistics are also impacted by survivorship bias, i.e. a lot of the funds with large drawdowns never report that they had large drawdowns.

    There is also an issue on marking to market with regards to the low volatility. This is not going to be an issue with the long short equity, convertible arbitrage, risk arbitrage, and a lot of the other mainstream strategies. It is certainly an issue on timber and the real asset strategies that funds have been pushing in to.

    The main risk being glossed over is the accounting fraud/actual fraud risk. There is no conclusive answer as to what the risk actually is, but that is one advantage of going through a reputable fund of fund or platform where perhaps Merrill Lynch or whoever (I have no opinion on Merrill Lynch hedge fund offerings and a low opinion of Merrill Lynch in general) is doing good due diligence on the funds. Make sure any fund that you are in has a well known accountant and auditor.

    "Hedge Funds" have a role in portfolios. The ultimate question depends on the goals of the portfolio, but the major philosophical dispute is if the role is the 10-20% alternatives allocation or if it is the 50%+ allocation of the sort that Yale et al. are starting to do.

    For what it is worth, I am in the 10-20% camp.

    25-Aug-2006
    People of the Lie, a challenge from Nigel Davies

    Many moons ago I posted a recommendation for Scott-Peck's People of the Lie. I want to repeat it now because it addresses the issue of human evil, defined simply (and very accurately) as a willingness to destroy others in order to maintain the integrity of one's self image.

    Readers should not be put off by the apparent spirituality of this book or his earlier work, The Road Less Travelled. I think there are strictly secular ways of interpreting the message of these works and would even go so far as to say that the religious aspect is entirely unnecessary.

    'People of the Lie' is about self-deception in all its forms, and suggests that this in turn is the ultimate enemy of humanity. Its appearance is most stark in activities such as chess and trading in which the punishment for self-deception is swift and decisive. In less critical activities people can more easily maintain their delusions.

    I read these books together with Jung's Modern Man in Search of a Soul around the time I ascended to Grand Master status and think that these two events were not coincidental. The process of self improvement is tied to the stripping of illusions, especially those which we hold most dear.

    One of my good friends on the spec-list has sometimes wondered why several members, notably Adi and Kurserock, have felt impelled to attack me on so many occasions. I believe the answer lies in the philosophy I have outlined above that may come out 'between the lines'. I suspect that it irritates these two members because of their delusions.

    Adi's mentality is built around the death of his father at the hands of the Nazis, and whilst one sympathises with this it rocks his objectivity on almost every issue. With Kurserock I simply do not understand the man, though I see a clear connection between his admiration for 'one gear' Patton's mistaken view of strategy and the horrible losses his clients have suffered.

    Perhaps these two members would like to answer me here, now and directly rather than indulge in a sniping campaign. We are here, after all, for the goal of self improvement and education rather than sniping, self-justification and self aggrandizement.

    25-Aug-2006
    Lulls, by Jim Sogi

    Waves are created by global powers and todays big waves were from Antarctica. The waves that arrive in Hawaii are manifest in patterns of waves and lulls. Waves come in sets, groups of 3-10 waves together, but in between the sets are often lulls that are two to three or more times the length of the sets. The length of the lulls is important to count, as they display some consistency in time around a normal distribution, depending on the swell, between a 5 and 20 minute wait between sets of waves. The lull is the period between the 3rd to 7th wave sets when the water is flat and there is a quiet time just sitting and waiting for the next set of waves. If you know the length of the lulls, then you know when the big waves will arrive next.

    While the surfers sit there it is important to keep a number of things in mind. One should always position in the lineup for the biggest waves of the day, never the smaller ones. That means do not sit inside, sit outside, wait for the big ones. Some surfers get impatient and start to paddle closer to shore to try catch the smaller waves for some action. The danger with that is that it is usually exactly after an inordinate wait that a huge set of waves comes. When these surfer move too far inside, they cannot paddle out side of the breaking wave soon enough and they get hammered by a big set. That is called getting "caught inside". It is not fun especially when in over your head or worse yet, underwater.

    The similarity to the current lull in the markets around the 1300 level is that it might be good to wait for the set before taking off on a wave or a big position so as not to get caught inside. Counting the market lull, its been 10 days of below ranges (14.6 average) and 25 days since a 12 point c-c drop.

    The other problem with the lulls is that it is hard to locate your position in the water because the underwater topography is revealed by the shape of the waves, but when there are no waves, it is hard to tell where you are sitting. Often I see surfers drift out of position during a lull, and they lose their bearing. When the set comes they are out of position and get hammered or miss the wave. With the markets just drifting around the round over and over and over it is easy to lose bearing where one is.

    Nigel Davies replies:

    There are also such changes of tempo in chess. A quiet game can explode into action whilst fireworks can fizzle out. How players deal with these moments is a critical factor in their competitive success and handling them calls for an ability to put aside the past (and the associated emotional baggage) and deal with the position as it stands.

    Some cunning players are adept at tacking to and fro in an apparently lifeless position to lull their opponents into a false sense of security. When they sense frustration setting in, or should their opponents run short of thinking time, they strike. And even when not taken to extremes it's good to repeat the position before proceeding with the 'real' variation.

    The greatest specialist in these changes of tempo was probably Salo Flohr, a World Championship candidate in the 1930s. He would play a cunning manoevering game and then suddenly switch to the attack when his opponents least expected it.

    Tom Marks responds:

    That was a wonderfully instructive metaphor. As a former floor trader, the dynamics and energy of which easily fall prey to the perils of overtrading, the hardest thing to do was resist the gravitational pull of feeling compelled to do something -- anything -- when nothing was there. It was difficult to physically stand in one spot under those conditions all day long and keep all the powder dry. As it was to figure out that inert is sometimes sublime. Coffee trader Tom Printon has it down to a Zen form, always avoiding the noise.

    25-Aug-2006
    A Question on Bayesian Updating of Distributions, from Tony Humbert

    the classic example of Bayesian updating:

    There is an urn containing red and black balls, so with 2 choices of colors your instinct is that the black versus red ratio is 1:1. You withdraw 10 balls, 7 black & 3 red ... what do you believe about the ratio of black to red balls? i.e. how confident should you be that the ratio is 7:3 black versus red, how much should you doubt that its the 1:1 black to red you believed before you started withdrawing, etc.

    Bayes' Rule tells you how you should update your original beliefs (a.k.a. 'the prior') every time you withdraw a ball.

    My question is a little different.

    Suppose I calculate that the returns of a stock for the last 30 days had 30% annual std. dev.. (lets ignore skew & kurtosis for now). The following call butterfly ...

    long a single 95
    short 2 100s
    long a single 105

    ... is the approximate probability that the stock will be at exactly 100 when the options expire, so by looking at option prices one can bootstrap an inferred distribution, (there are better techniques to infer the distribution, butterflies are the easiest to explain).

    Suppose that inferred distribution has a std. dev. of 35% (again, lets pretend there is no vol. smile so that we do not have to consider skew & kurtosis). While I know how to update my beliefs for the urn problem, it strikes me that combining distributions is a different sort of problem.

    The urn problem only admits two observations (black or red), the empirical & inferred distributions admit a continuum of possibilities (all the prices twixt zero & infinity). So it is not so clear to me how to combine the empirical and the inferred distribution using Bayes' rule. Its not even clear to me if the empirical distribution should be considered the prior, or if the inferred distribution should be considered the prior.

    Do any probability savvy specs have any suggestions as to how I might combine these 2 distributions in a Bayesian manner?

    Brian Haag replies:

    "Corollarily", but not "orthogonally", would it not also be worth examining changes in *implieds* using the same methodology?

    That is, if the market was assigning a certain distribution at time t (the "prior"), and an "updated" distribution at time t+1, what new information did it get that made it change? Seems these new pieces of info could be counted.

    Tony Corso responds:

    That was going to be one of a number of follow up topics in a post entitled ''other interesting things to ask about the distributions'. But asking your question still depends on combining or pooling two continuous distributions according to Bayes rule. It is easy enough to understand with the urn problem, but I'm stumped how to do it for continuous distributions, and to answer your question we have to answer that question first.  But a question like yours, ''How different is today's implied distribution from yesterday's implied distribution'', or ''How different is the distribution implied by ATM options from the distribution implied by OTM options'' is easy to answer, just run a chi-squared test -- but I still think that the answer to the Bayesian pooling question would allow more interesting applications.

    25-Aug-2006
    Artificial Ants from Andrew Moe

    One of the great difficulties in robotics/security today is fast pattern recognition from a pixelated image. Whether it is a robot trying to drive a tank, a camera scanning airport travelers or a 'bot chomping live tick data, the ability to process and interpret patterns quickly is essential.

    Ramos and Almeida propose a fascinating approach which is akin to dropping a box full of ants onto a picture. The ants cluster on the dark areas via and avoid the lighter ones via artificial pheromones, quickly forming the likeness of the underlying image. Check out how they recognize the picture of Einstein over several iterations.

    25-Aug-2006
    Offshoring Eldercare -- It Begins, from Arthur Cooper

    The squib 'Move Offshore' in today's Wall Street Journal describes how some retirees:

    ...are moving to Costa Rica, Mexico and other countries where health-care costs are appreciably lower and the quality of service, they say, is significantly better [than in the US].

    For retirees whose families have to make an airplane trip to visit them anyway, the geographical separation of offshoring eldercare has become a non-issue.

    24-Aug-2006
    The Power of Negative Thinking, by Dr. Kim Zussman

    A friend and I once tried to enter a Caltech public lecture, with him carrying a can of coke. The student/usher at the door said no drinks allowed, and my friend asked her major. "Math", she said. He offered that whether he drinks it now and brings it in his stomach, or drinks it inside Beckman auditorium is equivalent. Evidently still pure, she disagreed with a smile and it was guzzled.*

    Today I bumped into an actor friend, and I asked him whether his awaited TV piece had aired. "Yes!" he said, and I reminded him he forgot to call me beforehand so I could watch it.

    "You can make it up to me" I said. "Next time you are going to be on, call me, and then I won't watch it".

    A while back I posted a study which (seemed to) show that simultaneously skipping the top and bottom return week-pairs in the S&P 500 was beneficial to compounded returns, up to a point. The reason was that matched extreme down weeks had more of a negative effect on returns than extreme up weeks. And a friend follows this up with "How does one preferentially skip' extreme downers?"

    One way to think about this is that for every week you are out of the market, you are equally likely to miss an extremal low or high (since the study paired them). So what are the effects on final returns of randomly skipping weeks? This has been screened for irrelevance so it should pass muster.

    Using historic S&P 500 weekly returns (with dividend) since 1950, the sequence was randomly rearranged 62 times (out of convenience). The compounded returns are the products of all weeks, so deleting weeks from the randomly rearranged sets is equivalent to being out of the market during random weeks. So from each series, a random week was skipped, and the compound return calculated. This was repeated for the 62 series by randomly deleting 2,3,4,5,6,7,8,9,10,11,12 weeks.

    The prior study showed that up to over 300 extremal pair deletions are beneficial to compound final return. BUT (a big but), though some of the runs had higher returns, this experiment showed declining mean compound return with successive week deletion. Here is final mean compound return for each week deletion, the first column is the number of random weeks deleted, the second is compound final return in percent:

    W %
    0 7756
    1 7732
    2 7726
    3 7719
    4 7695
    5 7694
    6 7692
    7 7687
    8 7679
    9 7653
    10 7638
    11 7652
    12 7661

    This declining performance does not include transaction costs or tax consequences, so the results understate (yet again) how hard it is to beat buy and hold.

    * In penance for prior insufficient innuendo, here I point out that older/more experienced women transform such calculations through an attention function, which in turn amplifies the probablility of getting in with your drink.

    23-Aug-2006
    The Origins of Value, by Jim Sogi

    Sometimes it is easy to get lost in the trees (ticks) and miss the forest. Following Vic and Laurel's always worthwhile book recommendations, it is with pleasure and pride that I now own such a beautiful book as the Origins of Value by William Goetzmann, published by the Oxford University Press. A beautiful large format book with glossy pages, big print, and nice pictures that shows how our present financial capital markets and economic structure were created, and looks towards the different possibilities for the future. The mark of a great book is that it inspires creative thinking of your own, and this book does that. Right off the bat it hits you with the idea that life itself is a loan from God and death is repayment. That will knock the wind out of you.

    The question is, are our capital markets path dependent, basically an accident of history? Can they be recreated? Is it not that we are so brilliant, but rather a random incarnation? (Dr. Taleb, where are you?) If it has been engineered by our brilliance, why is capitalism so difficult in Russia, China and Africa. Can the same be said of democracy? Was democracy an accident of path dependent history, or can it be recreated? If Iraq is an experiment, the answer is no. This raises the issue of the robustness of the present incarnation of financial architecture which is patched together from various creative financial experiments some of which were failures, and some of which work. Will the success continue? Where are the weak links? Surely it is the human element, such as the Fed and their hubris, that will be the weak link in the system.

    Our current financial architecture is radically different than it was 50 years ago or even 20 years ago, and is constantly changing to meet economic needs. Some devices do not work, such as the gold standard. It is not clear whether the fiat monetary system will succeed at this point.

    John Law came up with creative ideas for financing government, derivatives are a recent invention or variation of securitization, the modern corporation has not always existed, loans and interest did not exist until Mesopotamian times. Fannie Mae did not always exist, but makes modern real estate finance possible. It is good to reflect on past failures to help design new instruments to meet changing economic needs.

    The Chinese invented paper money when travelers needed a way to travel light over long distances. Then after some centuries, it disappeared there. They invented fiat currency and now are the masters of it. What the book does not discuss, and should have, is what it is that creates value? Why is gold or silver valuable?

    The need of the agricultural society between planting and harvest created the need for original loans and the birth of modern finance. In Mesopotamia, interest was 1/3 for barley and 1/5 for silver. The rates were derived from the mina and shekel and the sexagesimal weight system of 60 parts. These were in turn derived from agricultural realities. The price of barley was high before the harvest, when loans were needed, but low afterwards when they were repaid. A funny thing is that the terms were written in stone, literally. The advances in mathematics by Fibonacci and by the Arabs allowed for computations of compound interest that were not possible before. In reading texts on probability, advances in mathematics in the 20th century allowed development of probability theory and advances in statistics.

    Our current financial architecture is constantly evolving. There have been spectacular breakthroughs in the past that have led us to the current situation, but also some spectacular failures, to which the current structure is not immune. The work of Bernanke appears to be tentative experimentation. How long will they succeed before another failure. Part of the limitation of and demise of Rome was based on the inability of their financial and legal systems to accommodate their changing needs and cycles. Not only does the private sector need capital, but the massive needs of a growing government and bureaucracy need to be financed, and the markets need to accommodate that gorilla.

    To be continued . . .

    22-Aug-2006
    Victor Niederhoffer reviews Trees: Their Natural History by Peter Thomas

    Almost every page of the book 'Trees: Their Natural History' teaches one new things about the workings and adaptations of trees, and I find these lessons of great value in improving my understanding of the markets.

    The chapter on the shape of trees starts with the idea that one of the objectives of a tree is to raise its leaves above a competitor's, so that it can get the greatest possible share of light. It makes its shape based on a compromise between this and its other needs; its ability to pollinate and disperse its seeds, how much trunk it needs to support itself against wind, snow, and moisture, the conditions of the soil, the threat of fire and insect pests. All of the compromises vary with age.

    One thing learned is that trees found at a high latitude and altitude are cone shaped with short downward sloping branches, and that the broad crowns of most hardwoods are associated with moist sites, deep shade, or harsh tree line conditions. In Britain there is a moist environment so most of the trees take on spherical shape.

    Pines further south develop a flat topped umbrella shape which helps resist drying winds and maximizes convective heat loss by allowing free passage through the canopy

    The tree is an expert in shifting its center of gravity so as to minimize stress on any part of its structure. The principle it uses is to minimize lever arms. This means making the weight that any branch carries away from a fulcrum as small as possible, reducing the possibility of breakage. This principle keeps the horizontal length of a branch as small as possible, always subject to the compromise that the further a branch is extended outwards, often the more light it can get.

    What the tree does is to bend its branches upright, so that the lever arms are not pulling the tree sideway. This applies not only to branches, but to the leaning of trees towards the sun. A beautiful set of diagrams illustrate the similarity of the adaptations that the tree makes to maintain a center of gravity to the adaptations a human makes to maintain their center of gravity. Trees use their terminal buds to build modules that change their shape, while humans use the brain to decide to change our center of gravity, for example when we bend forward whilst we are climbing up a hill.

    Sample market hypotheses generated by this way of thinking are:

    The horizontal moves of markets would seem to be the reversals that they take from a given center of gravity. The more that they reverse to one side from a central point, perhaps a round number, the more likely that structures and activity will grow on the other side to minimize the stress. Eventually, conditions of light (competition) cause the market or a stock to move.

    Alternatively, the greater the rate of ascent or descent, the more likely a market or stock is to show movement in a opposite direction to bring its center of gravity to a more stable level.

    Steve Leslie adds some Bamboo facts:

    What I find particularly striking about bamboo is how it develops its root structure first, which may take up to three years, and then the plant explodes in growth and may grow to over 100 feet tall in several months. Without building its roots first, it would never grow to its planned dizzying heights and you cannot rush the process.

    I always think back to Peter Lynch who commented that his greatest success stories in stocks, most of his ten plus baggers, occurred in the fourth year and beyond of holding the stock. It just takes time for the great stories to unfold, such as turnaround stocks, and especially in growth stocks patience has its reward. As a wise plumber once told me before I undertook a job "patience is the key".

    There is much to be learned about speculating from the growth and characteristics of the bamboo. The similarities between bamboo and growth stocks are remarkable and the investor and speculator alike can dramatically improve their financial returns by studying the bamboo.

    J.T. Holley responds:

    Something that I have dealt with recently is the feeding of dying trees to resuscitate or bring them back to life. 'Spiking' trees with silly fertilizer spikes works well with the smaller trees, but you need bigger guns when you have the limbs leaning downward towards the ground. In parks and high traffic areas this is a huge hazard, the tree will seem to shed the limb to relieve the stress that Vic has mentioned above.

    The only thing I learned regarding saving a tree is to take an auger, pipe, or some large metal rod and drive it into the ground. Rotate this until you have a two to three foot deep hole and pull it out. Fill this two thirds full of 10-10-10 and cover the rest with dirt and put your grass back over. These holes must be done around the 'drip zone' coming off the base of the trunk just inside the 'splash zone' from the outermost limbs.

    I too believe, and should test, that the markets use these round numbers or spots to relieve their stress. These spots of light and competition allow it to be able to gain strength in times of weakness (sell off) to gain the nutrients to move higher and become stronger than before! Its like testing and finding Trend followers spots where they utilize "reversing stops" with their "fixed system". The Drip Zone is where the fertilizer is planted to pick 'em off and gain the edge.

    22-Aug-2006
    The Definition of a Trend, by Jim Sogi

    In Practical Speculation Vic and Laurel discussed the definition, or really the lack thereof, of a trend for quantitative testing purposes and a defined entry and exit. He concluded that various common definitions of a trend he tested did not work or make money. A few observations often can become a basis for a model or a test and then a trading system, or at least a trade or two in a cycle.

    After 5 new daily highs in a row on August 18th after the fact, it was probably fair to say descriptively that the the afternoon 'trended up', and there were a few interesting characteristics of the situation. One was the large number of standing orders in the 5 tick market depth for the ES Sept on Globex. At various time up to 20,000 lots were being offered in the five ticks above the market and a similar number bid. The data is ephemeral and soon disappears, but the average number of offers or bids is less than a quarter of that. What is the effect of such a large number of orders? The range or volatility was low, and the price never went down, only up in a steady up tick in price without fluctuation. The large number of orders appeared to damp the ability of the market to move around as it usually does. There is a micro structural effect occurring.

    On a longer scale a similar kind of situation occurred this last spring with the prices marching up to mid 1300s with very narrow ranges during the day. This is distinguished from the type of swoosh up where the market is then at the bottom when all the sellers are done selling, and the ask disappears bringing the market up in a vacuum suction effect. What are the distinguishing micro structural features of each? Why do there appear to be separate mechanisms for rising prices with different market characteristics? Which conditions come first and are they predictive? Do the conditions presage the end of a trend? If a trend is only apparent after the fact, perhaps this is the right question to ask. As usual more questions than answers.

    Russ Herrold adds:

    I had taken the discussion in Practical Speculation to be Vic and Laurel's setting up a windmill in the hopes that some brave soul would come along, sharpen his lance, frame a testable refutation in limitation of that strong assertion, and have at it.

    It is easy enough to state such a set of assumptions, and to test them with 'good science', stated 'null hypothesis' and the rest. But there are landmines about for the unwary. A really crippling one is the need to avoid patents, and their externalities.

    From my friend, on Google and the search argument:

    patent infringement research exemption
    35 U.S.C. 271(a) contains the general prohibition of patent infringement. It provides that "whoever without authority makes, uses, offers to sell, or sells any patented invention, within the United States or imports into the United States any patented invention during the term of the patent therefore, infringes the patent."

    Researchers have some comfort in the so-called Research Exemption but it is a cold comfort, as it is in the nature of a defense which may or may not work in the eyes of the tribunal, once the author has been sued in an infringement action.

    Clearly "New Concepts" reflected an already outstanding body of knowledge. It gathered together in one place and laid out clearly a lot of existing material as well as some original work. Wilder's book is mostly dismissed as a collection of trading systems that don't work. Though there is _some_ truth to that charge, there are a number of important tools and concepts presented there that can be used by the rigorous practitioner to their advantage. It is a book best approached with an open mind.

    And that is the crux of it. Without question, there is a large body of 'prior art' documented outside of the timeframe covered by possible submariner patent sharks, but it is not safe to document use of it. The recent NTP vs. Research in Motion travails make it pretty clear that there are much happier places to be other than as a defendant in an infringement action.

    A non-researcher (i.e., commercial) user of any trading system potentially using any non-prior art or non-out of patent element will be scrutinized closely and, one assumes, if collectible, etc, accosted and solicited by a swarm of patent holders seeking to sell a license to 'buy peace.'

    In the real world, we can see that even pure researchers feel the chilling effects.

    I do not look for published work even by a pure researcher, of a rigorously defined systematic trading methodology (trend following or otherwise), for fear of describing having 'made' an (inadvertently?) infringing invention. There is too much downside for an unclear benefit.

    Dr. Phillip J. McDonnell comments:

    Patents imply a product franchise and therein a lack of competition. Absence of competition would seem to grant license to monopoly pricing, however one must remember that there are always substitutes. Thus in many cases the competitive advantage of a patent is quickly negated by the many creative substitutes which competition can invent. One researcher, Prof. Haugen has estimated that the average time for this is about 2-3 years at most.

    For investors the other question is one of value and the recognition thereof. If a company has a viable patent, for which there is no near term competition, theory says it should sell at a premium price to reflect that fact. Assuming the company is young it would be quite irrational for the insiders and founders to underplay the value of their patent. Rather they should want to maximize its value, both to increase the value of their own shares as well as to minimize dilution of any shares sold in an IPO or subsequent secondary offering. The point is that there is every reason to expect that the share price has fully discounted the future prospects of any patent and for that matter any competitive advantage whatsoever.

    22-Aug-2006
    Roger Arnold on the Housing Market

    The global housing crunch is here now. The cycle is not as smooth as the last 3 cycles but the trend is generally the same; i.e. Australia, the UK and Canada lead the US up and then back down for housing.

    Within each of these 4 main areas there are large swings in values; i.e. Western Australia and Western Canada are performing well but slowing while the eastern parts of each are clearly contracting; the coastal markets in the US are consolidating rapidly even as most non-coastal areas remain mostly unaffected.

    However the UK market is performing well as is commercial real estate in the US; so it is not a perfect match for previous cycles. But it is looking pretty close.

    In other words, from my vantage point, things look a lot worse than even the real estate bears have admitted so far.

    C. R. adds:

    From my perspective, anecdotal evidence indicates that pain is coming . . .

    My wife and I have just recently listed two properties for sale in the Las Vegas metro area. Our (very experienced) Realtor is a trusted family friend who was quite up front in his suggestion that we list at least 5% below available comps if we hope to attract any lookers. We have been told to expect to be on the market for six to nine months. No doubt further price cuts will be the order of the day before it is over.

    Local home builders are in a slash and burn mode offering anything and everything in the form of incentives to dump their bloated and (apparently) grossly overvalued inventories. It is said that there are over 20,000 homes available for sale at this time and god knows how many condos; and they are still doing apartment conversions on every corner! Plans for further expansion and development of outlying areas have either been scrapped or are being scaled down to present reality. "Vacantvilles" are beginning to appear, as they have in Phoenix, where builders simply abandon projects and walk away from half completed properties. Commercial activity and the up town hi-rises are said to still be strong, but for how much longer?

    In my opinion it is just a matter of time until the serious lay offs begin (they have already started with the sales and financial staff). That is when the next down cycle will start. In a town (like Vegas) that is dependent on never ending growth as an integral part of the economic engine, any significant stall in real estate will have serious and rapid consequences. And yet the casinos remain full. Go figure.

    I went through this in the early eighties and it was not pretty then either. The overall "feel" is just bad, like it was then. Several of my associates speculated by taking on properties they could not afford to service and now they appear stuck with no down side margin in which to wriggle out. It is thought that 15-20% of local housing is now held in the hands of just such individuals.

    Soft landing? It does not appear likely. I just want to get out while the getting is good. Assuming it still is.

    22-Aug-2006
    Tiger's Head Game (a.k.a. playing with a full deck), by Mark Goulston

    What is Tiger Woods' secret?

    Anyone who has played golf can attest to how much of a head game it is. So what is in Tiger's head that keeps him ahead of everyone else, and in my estimate ahead of anyone who has ever played the game.

    Get ready for some shrink rap (I am a board certified psychiatrist). Tiger is heads above all others because he is a triple threat, neurophysiologically, psychologically and physically. There are three major classes of neurotransmitters the fuel our brains: dopamine, serotonin, and endorphin. Dopamine causes you to feel powerful; serotonin enables you to persevere; endorphin lets you feel pleasure.

    In golf terms: dopamine makes you a "hitter" (= power); serotonin makes you a "striker" (= precision); endorphins makes you a "swinger" (= swinging freely). The hitter, striker and/or swinger is not just a physical process, but a psychological mindset as well.

    When you think hitter, imagine John Daly; when you think striker, imagine Tom Lehman; when you think swinger, imagine Fred Couples. If this one approach lasts four rounds you can occasionally win a tournament. If the wheels come off, and you do not have a back up way of approaching the ball, forget it. You are gone.

    Jack Nicklaus, Arnold Palmer and Tom Watson were all double threats, because they could hit the ball and/or strike the ball. If one was not working they could reach inside and use the other.

    Tiger is the first golfer ever who is a triple threat, i.e. he has three ways to approach his game. Watch him and you will see that he can hit, strike or swing at the ball at will. If you imagine what is going on inside that corresponds to these you come up with power (dopamine), perseverance (serotonin) and/or a freewheeling (endorphin) approach to the game. So whenever Tiger runs into trouble and reaches inside to overcome it, he has two backup plans in reserve and instead of the wheels coming off, he can tighten them, bear down and play even better.

    J.T. Holley adds:

    I will have to speak up and say that he is not the first. Bobby Jones was the first. He was the first to win 'The Double', the U.S. Open and the Open. He won 13 of the 20 Majors that he played in, calculate that winning percentage! One of those losses occurred during a playoff where he called a penalty stroke on himself and lost by one shot at the US Open.

    I might also add that Tiger won all four majors in a row, but he will even tell you that only Bobby Jones won them all in one year. Bobby had all three! He had the beginning , middle, and end game.

    Steve Leslie offers:

    Both Tiger and Annika are the greatest golfers of their particular gender, and of their generation -- no question.

    Annika is a remarkably accomplished golfer and she is acknowledged for it. She is overlooked in many ways, being a victim of ratings, as fewer people watch women's golf and it does not have the global appeal of men's golf. That is just the way it is. Sports are misogynistic. There were others who preceded her who had great accomplishments also, such as Kathy Whitworth and Babe Zaharias.

    Tiger Woods is totally unique. Tiger is the greatest dominator of the sport ever. At 21 he won the 1997 Masters by 12 strokes. At the 2000 U.S. Open, in an event that is decided by one or two strokes year in and year out he won by 15 strokes! That would be like lapping the field at the Belmont. He is 12 for 12 in major tournaments when leading the tournament after the 3rd round. As an amateur he won the junior U.S. amateur three straight times and the U.S. Amateur three straight times also. That is six straight years without losing a match play event. Butch Harmon his former coach said that when Tiger brings his complete game to an event he is unbeatable.

    His consistency is even more staggering. He made 142 consecutive cuts. That is over seven years of qualifying for the weekend, and the tournament where he missed the cut, The Byron Nelson Classic, was by only one stroke. Most golfers cannot make a cut for a whole year. He has missed one cut in a major tournament. The rest of his accomplishments would fill chapters, and people will write about him for the next hundred years. Like Babe Ruth.

    His dominance is so breathtaking that it seems like there is no competition around. Golf has true athletes and they come from all over the world to play on the U.S. tour. Far greater competition than Bobby Jones, Walter Hagen, Sam Snead, Tom Watson or Jack Nicklaus ever faced.

    Plenty of golfers came from privileged backgrounds. Davis Love III and Hal Sutton for example. Tiger's father was a career military man.

    Finally, he does all this while under the greatest scrutiny ever. Only Muhammad Ali and perhaps Michael Jordan can rival him in worldwide recognition and appeal.

    Publicly he does this with never a hair out of place or with a politically incorrect statement or insensitive remark. Once in a while he is caught on camera with blurting out a curse word or phrase. His charisma is very reminiscent of Arnold Palmer. Tiger's father said that he knew that when Tiger was born he was special. But he also emphasized that his goal was not to raise a great golfer but a great person.

    What ever or however he was created is subject to debate. Perhaps it is indescribable, like Leonardo da Vinci. Maybe the planets were just aligned specifically or God threw down a bolt of lightning that day and said "today I make something very special."

    My suggestion is savor the moment for what it is and for what he is. The rest takes care of itself.

    22-Aug-2006
    On Professional Turf Betting, from Chris Cooper

    I am sure that there are a very select few who can 'beat the races'. I tried to do it nearly 30 years ago and failed, and I doubt that the situation has changed much.

    It is not difficult to build such a system that will win if the track take is minimized, but that is not the reality. The vigorish is so incredibly high that it becomes very hard to overcome it. Perhaps even more importantly, you have problems scaling up.

    The nature of pari-mutuel betting makes this a built-in problem. You should focus on racetracks with the largest handles -- I understand that there are syndicates in Hong Kong who have been successful.

    If the race track regulators in the U.S. would lighten up on the vig, they would find their ultimate revenues increasing. Only the more desperate gamblers will participate for long when they can quickly see how much they are being ripped off.

    Kevin Depew adds:

    If only you had come along with us on the Spec List day at the races. While venturing through the neighborhoods near Belmont Park in a grand tour bus on an overcast, rain-tinged day, you might have noticed out the left hand window, just before we turned into the racetrack, a small pub to your left with yellowish-brown, faux wood-paneling on the outside, a customary Guinness sign above the door and dark windows with neon bulbs painting hopeful traces of the electric mercy promised by domestic U.S. beers. The name of the pub? The Pour House. Of course.

    But then, the neighborhood near every racetrack in the country is chock-a-block with one or two Thoroughbred Motors (featuring a high fence with rolled razor wire), a couple of Thoroughbred Pawn Shops, at least one Crazy Horse Liquors, a Thoroughbred this and a Thoroughbred that. Secretariat Laundromats are a dime-a-dozen. Only Saratoga, Keeneland and DelMar (the boutique meets; think Rodeo Drive or Madison Ave.) seem to have escaped the curse of the racetrack neighborhood. At least until you venture far enough from their park-like settings. They are there too, it is just the gamblers have to walk farther to find their familiar places of refuge.

    Now ordinarily, that would be all we need to know about a business. A business is often perceived to be only as good as its neighborhood (Kansas City's Arthur Bryant's Barbecue - and probably all other BBQ restaurants - excepted). But no, we like to give the racetrack business the benefit of the doubt. After all, we are smarter, savvier, more capable than the average punter trekking down the block to feed the horse racing eco-system, right?

    Anyway, I have known a lot of gamblers over the years with a lot of systems and databases and promises. I have been one. Unfortunately, Chris Cooper is right, the vig. is too tough. It is complex, and there are a couple of syndicates that operate even now in the massive pools (comparative to small U.S. tracks) in Hong Kong and even from time to time in NYRA, CA, KY, and FL, but I am not sure what the point is other than the ego involved. They're picking up dimes in front of a bulldozer. Cycles change.

    Speaking of ever-changing cycles, as an example, one of the bread and butter plays of professionals used to be the hidden form in maiden races. especially when running back at a boutique track (read: lots of frivolous money). Maiden races are races for horses who have not won their first race. Because many of these races feature horses who have never raced before, its difficult for the average citizen to handicap. As an aside, the few professionals I know these days specialize in these races (note: I believe specialization in horse racing is ridiculous) by paying a lot of money for very detailed training and workout notes. Anyway, the 7th race at Saratoga this past Saturday was a hidden form race that in the old days would have been worth its weight in gold (the really old days, like when gold was below $275).

    A horse called Sam P. was coming off a single debut maiden race at Churchill Downs where he had some trouble and finished a decent fifth in a field of 11 horses. He was nearly 4-1 that day. Last Saturday he was taking an apparent step up in class against a full field of presumably more talented horses. The hidden form was that the top four horses in Sam P.'s debut race all came back to win their next start. Unfortunately, that information was disclosed in the racing form by an astute public handicapper. He went off at 2-1 in 10-horse field with four first time starters. Hard to get rich that way.

    So the bad news is that the vig. makes horse racing a non-starter for all but the most talented and dedicated thinkers and handicappers. The good news is that for those who need a hobby horse racing is often fun and full of problems for problem solvers. I just think it is too bad that most hobbyists try to solve horse racing problems from the professionals' perspective. Look at it this way, suppose you prefer to keep all of your hard earned dollars under a mattress because that's just what works for you. But each year, maybe once or twice a year, and only on "big market moving days," you take out a little bit of "play" money from underneath your mattress to go down to the floor of the NYSE and play stocks. Should you play your money the way a professional stock player who shows up every day on the floor does?

    21-Aug-2006
    Dr. Kim Zussman on the Bignor Roman Villa

    The Bignor Roman Villa was discovered by a west-Sussex farmer in 1811 whilst plowing his field. The ruins are the foundations and floors of a structure which housed wealthy Roman farmers of the third century, and house some of the best floor-mosaics of Roman Britain.

    During a recent stay near Amberley and Arundel, we ventured out on a motor trip to visit the excavation. Driving in England entails many risks, not the least of which is left-side forward, dating from times when one's right hand was kept free for opposing combat. There are three kinds of roads: M (motorways), A, and B. Motorways are British expressways, with the added adventure of fellows on the right (fast lanes) exceeding 80 mph wherever speed-cameras were absent. A-roads are like two-lane highways, and B's are narrow and often treacherous, even without the ubiquitous pub-crawlers.

    These trips are very enjoyable though it is easy to get lost, since signage is inconsistent and often obscured by overgrown shrubbery. We found the Roman villa after a leisurely home-cooked lunch of chicken pie at a pub in Arundel, on a warm afternoon driving in light rain.

    The site is a bit run down, quite far from the main roads, and you pay 8 pounds to get in. The man selling tickets is quite friendly and after a while you realize this is his family business: He is the owner of the site!

    It is a self-guided tour, and there are a number of meticulously detailed mosaics depicting various scenes, including a sequence with a gladiator who gets injured. There is an odd sense of luxury in an age of antiquity, 1700 years ago, when one might expect that people were too primitive to strive for a gloriously embellished home. There was a large dining room, with an under-floor heating system (hypocaust) of tile pipes which conducted hot smoke from adjacent fires and made indoor life temperate and hospitable.

    Evidently the mosaicists would lay down their patterns on sand and carry them stuck to cloth, to set onto masonry floors. The dining room showed spots of wear on the tile, and I wondered out loud to the manager whether this had occurred under the legs of tables. He was not sure, but suggested that movements of overlying soils and rocks over the millenea may have caused the effect.

    I asked him about local roads built by Romans, and he told of one Stane Street very nearby, which would have been the main artery from Chichester to Londinium, and served his Roman predecessors. The directions to Stone Street were too full of myriad turns on B-roads, as well as a hike up a hilly glen, so we decided in the late hour to bypass this ancient highway. Then the proprietor produced a map of Roman roads, and described the paradox of Stane Street.

    He told how Roman roads are characteristically straight, as a result of military needs as well as their methods of survey. It turns out the Romans would post men with tall flags on hilltops ahead of road construction, and sight with plumb-bobs sequentially along the line formed by the flag positions. This way, roads would be almost perfectly straight and easy for the army and others to follow. But how, he asked, did the Romans know how to go in a straight line all the way from Regnum (near modern Chichester) to Londinium, before the invention of the compass?

    We wandered around the ruins, and saw a Roman infant skeleton that spoke through eternity of the hardships of ancient times. I wondered about his question, and realized that it presupposed that Romans decided to build Stane Street after Regnum and Londinium had already been settled. But what if Regnum grew in a coastal spot along an arbitrary line formed by building a road south from Londinium?

    I posed this to him, and he paused as if stumped. "But", he said, "I think there are Roman artifacts that show Regnum was there before the road was built". Many of the roads of modern England follow those the Romans built almost 2000 years ago, and it is interesting to contemplate how much and how little has changed since then.

    Steve Ellison adds:

    The same phenomenon is evident, although with a greatly reduced degree of antiquity, in the U.S. Mountain West. Many modern highways follow the paths of the original railroads, which in many cases followed the paths of rivers. For example, Interstate 80 approximately follows the tracks the Central Pacific Railroad laid down in the 1860s when they built the western half of the transcontinental railroad east from Sacramento. The reason for this reuse of routes is that there is an identifiable optimum path for transportation across mountainous terrain, attributes of which include minimizing elevation change and sloping the route gently enough to prevent runaway trains or tractor-trailers (which precludes straight line routes in many cases).

    William Fraser Rae traveled in 1869 on the Central Pacific Railroad and recounted:

    The engine-driver had been running extra risks in order ... to arrive on time. The descent [from elevation 7,000 feet] was thus made with exceptional rapidity. The velocity with which the train rushed down this incline, and the suddenness with which it wheeled round the curves, produced a sensation which cannot be reproduced in words. The axle-boxes smoked with the friction, and the odor of burning wood pervaded the cars. The wheels were nearly red hot. In the darkness of the night they resembled discs of flame. Glad though all were to reach Sacramento, not a few were specially thankful to have reached it with whole limbs and unbruised bodies.

    Pit T. Maner III mentions:

    There was a very funny engineering paper running around in my office that I can not find now, but the gist of it was that the Space Shuttle was being moved on tracks whose width was determined by the Romans. Is this another urban myth? Talk about being stuck in a rut for 2000 years!!

    A partial internet reference follows:

    Another example of how rules from the past influence the present is how the standard gauge, or width, of train tracks came to be what they are. The gauge of the American rail system is actually the same as England's because British engineers were the ones who designed our railroad system.
    The width of the English railroad track was based on the availability of tools for making axles for horse-drawn carriages. (Why retool if the machinery already existed?) The carriage axles were designed to fit the ruts that existed on British roads. Since the British roads were originally Roman roads, it was Roman chariots that initially made the ruts.

    Stefan Jovanovich offers:

    There were four different railroad gauges in use in the U.S. before the Civil War: 6', 5', 4'9" and 4'8 1/2" (what is now considered standard gauge). Most Southern railroads used 5 ft. track. If the Confederacy had won the Civil War, we would probably be using that gauge today. When the Southern Railways converted to a narrower gauge in the 1880s, they switched to 4 ft. 9 in. which was the gauge used by the Pennsylvania Railroad (at that time the rail line with the most rolling stock in the U.S.). As track was maintained and replaced, both the Pennsylvania and the Southern lines narrowed their rails by half an inch to conform to what had by 1910 become the standard gauge. It is doubtful that the Roman chariots has much to do with it since the British supplied almost all the railroad locomotives to the South before the Civil War and built the engines to the broader gauge specifications of their customers (just as aircraft manufacturers to this day allow their customers to specify the turbines to be used on the planes they order.) The San Francisco Bay Area remains determinedly out of step with the rest of the country; its BART trains run on a 5 ft. 6 in. gauge.

    Henry Gifford responds:

    A horse-drawn vehicle that used two horses side-by-side had reasons to have an axle the size of two horses' asses.

    A shorter axle limited the size of the cart or wagon, while making it more vulnerable to tipping over. A longer axle would make the whole apparatus wider, which would require wider roads and/or gaps between obstacles.

    Thus we are stuck with obscenely short railroad axles - less than 5 feet for a train that can be several times that width. The great English engineer whose name was Isambard Kingdom Brunel tried hard to add standardization on a much wider gauge to his long list of achievements, without success.

    The US was not always on one gauge, and still isn't when mine railroads are counted. But there were thousands of miles of "different" track, mostly in the South of the US, and trains with 3 wheels to accommodate both, etc., until one day all the nonstandard railroads shut down and sent crews out to change all the tracks, and then got back to business in a few days.

    Just the sort of thing a business can accomplish when there is a profit motive.

    21-Aug-2006
    British Championships Round 11, from Nigel Davies

    I managed a grandstand finish (queen sac) to scrape into the prize list.

    Davies,N - Cobb,J [A29]
    British Championships (11), 18.08.2006
    [Davies,Nigel]

    1.c4 Nf6 2.Nc3 e5 3.Nf3 Nc6 4.g3 d6 5.Bg2 g6 6.d4 exd4 7.Nxd4 Bd7 8.b3 Bg7 9.Bb2 0-0 10.0-0 Re8 11.Nc2 Bf5 12.Ne3 Rxe3 13.fxe3 Ng4 14.Qd2 Nxe3 15.Qxe3 Bd4 16.Qxd4 Nxd4 17.Rad1 Qg5

    [After 17...Qf6 White has 18.e4 Ne2+ 19.Kh1 Nxc3 20.exf5 etc.; 17...Nc6 is answered by 18.Nd5 Kf8 19.Nf6; and 17...c5 by 18.e3 Nc6 19.Nd5 Ne5? 20.e4 Bg4 21.Nf6+ Qxf6 22.Rxf6 Bxd1 23.Rxd6 etc.; But 17...Nc2!? is interesting.]

    18.Kh1 [18.Bc1! Qg4 19.e4 is simple, as pointed out by Fritz.]

    18...c5 19.Nd5 Qh6 20.Rf4 Be6 21.Rdf1 Nxe2 22.Rh4 Qd2 23.Nf6+ Kf8 24.Nxh7+ Ke7 25.Bf6+ Kd7 26.Ng5 Re8 27.Rh7 Nd4 28.Nxe6 Rxe6 29.Rxf7+ Ke8 30.Bxd4 Qxd4 31.Rf8+ Kd7 32.R1f7+ Re7 33.Bh3+ Kc6 34.Rxe7 1-0

    21-Aug-2006
    Global Lola, from Dr. Kim Zussman

    I have been thinking about the recent lobogola, and the aphorism, "bulls making money and bears making money, but pigs are not halal". In fact there are far more ways for bulls and bears to lose money than to gain at the moment -- transaction costs, the pain of losses far exceeding the pleasure of gains, frequent monitoring and subsequent over-trading, martingaling gambler's ruin, worrying more about recent results than long-term ones, showing off, risk-taker's thrill as a drug, etc.

    Human nature wants to put a story to events, so there is never a shortage of 'whys' about this rise or that decline. Recently stocks went up on terror threats and down on the Fed pause. In the end all the explanations seem so pathetic and vacuous that perhaps it is better to understand the market as a temperamental woman who is randomly kind but often a spiraling raging psycho. The storms just come and go without warning or reason; so if you decide to live with her do not try to understand her. Just sit at breakfast and learn to read the newspaper.

    Again this time one was reminded of the banality of loserdom, even if only temporarily. All of a sudden, from the recent lofty perch of philosophical questions of human possibility, we are reduced to worrying about whether the vacation is too expensive, too many dinners out, private schools, what was all that talk in 1999 about retirement, and who is that tired old guy hiding in the mirror?

    It seems a mystery how frequent traders using leverage can pass through such cycles without losing their capital and minds, and this one hardly even ranks, (my own tests suggest the pain attributed less to the moderate decline than the 'volatility out of nowhere' scenario, which would have made the dynamic expert investors finally happy if they still existed). Despite long-term drift, there is never any certainty as to when declines will reverse; just the historical likelihood that it will go up eventually. Buy and Hold types can weather these inevitabilities better, and I can officially testify that checking less often is not only less painful, but more profitable.

    Of course there is that ecosystem thing; the weak traders are killed off, or are pummelled to the vomit point, and thus fuel the next stampede. But the subliminal temptation to become someone else's meat, like the allure of a nasty young beauty, can be so hard to resist that for most of us it is just better not to look.

    21-Aug-2006
    Steve Leslie on The World According to Garp

    There is a great lesson for the speculator from the movie 'The World According to Garp', written by John Irving and starring Robin Williams as T.S. Garp and Mary Beth Hurt as Helen. It reminds me of the 'Bring out the Canes' metaphor that is used frequently by Vic in his book Education of a Speculator. For those unfamiliar with the term, 'bring out the canes' it is an allusion to the days when gentlemen would outfit themselves with their walking canes and march calmly and elegantly down to their local brokerage house with the intent of investing their money in downtrodden equities. This spectacle would unfold after a disastrous event such as the 9-11 terrorist destruction of the World Trade Center. The gentlemen would walk in ones and twos with money in hand ready to place their investment in their security of choice. In many cases these events were ephemeral and thus it required a certain nimbleness for the speculator to quickly and quietly take advantage of.

    To provide background, Garp and Helen are looking for a house to purchase. As they are looking at one home in particular they are standing outside it and a small single engine plane appears out of nowhere and flies directly into the house. This naturally leaves severe damage and destruction to the house and shakes the confidence of all those in attendance. Quickly Garp collects himself and blurts out:

    We'll take the house.
    Honey, the chances of another plane hitting this house are astronomical. See? It's been pre-disastered. We're going to be safe here.

    It is the astute one who recognizes an opportunity and seizes it before others have time to collect their thoughts, call a quorum, place their calls and react. This is the heart and soul of the speculator and is what they live for, to wait patiently for an unusual event to occur in order to exploit the frailty and fragileness of the human psyche, and their subsequent largesse, and thus use it for their personal and particular financial gain.

    18-Aug-2006
    Briefly Speaking: Part I, from Victor Niederhoffer

    Let us play the round numbers game. so far the S&P 500 has been back and forth three times across the 1300 benchmark. How many times must it go back and forth before moving to the next duplicitous level?

    J. T. Holley comments:

    This reminds me of the old Tootsie Roll Pop commercial, one of the most valiant attempts to use the scientific method or countin' in an advertisement. I can see the Owl now asking "How many licks does it take to get to the center" "One, Two, Three... " "Crunch".

    18-Aug-2006
    Briefly Speaking: Part II, from Victor Niederhoffer

    Gold is near $600 ($613), Oil is at $70.00, the Dax at 5,850, the Nikkei above 16,000, the S&P at 1300, Israel at 820, bond yields are at 4.9%, and the CPI and PPI are benign. With other markets also harmonious, everything is better off than when the whole orgy of knocking hats off began. How easy it is in retrospect and when you are not in over your head. One does not know whether to laugh or cry.

    James Lackey comments:

    Just laugh and call it another... like this week for me. It did dawn on me, and I mumbled "get the joke, Lack" after the big up day and then another big up open. Perhaps too many had Armageddon bets on. I am always the last to 'get the joke' and my few friends I have left after this last panic say to me "at least you were not short." Thanks buddies, that is not comforting, yet funny.

    My wife always warns me never to ask "could it get any worse?"

    18-Aug-2006
    An Excellent Way of Gaining a Rudder, by Victor Niederhoffer

    It is always enjoyable and educational to turn back to the annals of Wall Street 100 years ago, and one of the best articles in this genre is Wall Street by Edward Riggs that appeared in Volume 1, Part 1 of the Quarterly Illustrator of April 1885. Because of its importance, and because it is not available on the internet I thought it might be well to review some of the highlights, with comments about their relevance today.

    The article is a 42 page review of the old financial titles, the history of the exchange, its growth and methods, its dramatic scenes and peculiar jargon, and how speculators make and lose fortunes.

    Here are the characteristics of wall street brokers in those days, who could often be found playing checkers and chess in the rooms provided for them in their new quarters at 30 Broad street.

    Wall street brokers never grow old ... Their free and easy practices on the Exchange, their fondness for knocking each other's hats off and jostling each other, their Christmas and New Year's pranks are well know. However, in the old days the brokers frequently settled their differences by resorting to fisticuffs. Notably in one week of 1887 during the panic of that year, their was a rough and tumble every day.

    Panics were a frequent occurrence in those days, and the pages of the article are filled with stories of brokers, ghosts, and old and lame ducks who made and lost fortunes, including our friend Henry Clews.

    Clews at the age of 60 was one of the old timers of the street along with The Commodore Vanderbilt, Dan Drew, Jim Fiske, Jay Cooke and Jacob Little. He apparently never associated with Little, the chronic bear of wall street, who was always rushing around trying to take the short side before he went under.

    Clews, as is well known, got his golden opportunity by selling U.S. bonds during the Civil War.

    Many capitalists were induced to make investments in there securities contrary to their own judgment, by Mr. Clews

    Clews also never liked the State of Georgia. He was their fiscal agent, bought the entire issue of their bonds, and when Georgia repudiated that debt, Clews was wiped out. He bounced back however, and he and James Keene are distinguished in Wall Street Annals as perhaps the only two men who ever rose above such great disaster and regained their fortunes. It is good to know that Clews was a also great society man, always at the balls of the Union League Club, and the treasurer of the Society for the Prevention of Cruelty to Animals.

    Some other highlights of lions of the day. Frank Sturgis, President of the Exchange, was known in Delmonico's uptown as Hamlet's Ghost. He used to eat at a table alone and was never known to speak to anybody on his daily visits to their fifth avenue and 14th street location. There are many references to Delmonico's in the article, and the fortunes of the restaurant waxes and wanes with the frequent booms and panics that occurred, it seems, at least once or twice a year.

    One of these panics hit, amongst others, Stephem 'Deacon' White (all the greats had nicknames). White was called a Deacon not for any religious reason but because of his learnedness. He was an orator, poet, philanthropist, classics scholar, translator, lawyer, accountant, editor, astronomer, schoolmaster, ex-plough-boy and trapper, congressman, and church trustee. Regretfully, these abilities did not keep him from being

    ... suspended four times, but happily no disaster can keep him under water in the state where he is tramping about in a baggy flannel suit without a scarf, and with the most rumpled of slouch hats.

    Definitely not in a state of wealth to dine at one of the two Delmonicos' emporia.

    One of the most interesting characters of the Exchange was Addison Commack, who had piratical tastes, having made his fortune by running the blockade and delivering arms to the South during the War of Secession. He became

    ... the great bear of Wall Street. He never owned slaves but ... as to the blockade, I did it, and am proud of it for I was highly successful. I went into it myself and backed up my opinion, not only by the risk of my life, but by my money too, and that is more than many a man can say.

    Commack could have been a good model for Rhett Butler in Gone with the Wind, being the boldest of all the operators in the ring. Known as the Twenty Third Party, it was rumored that he was a broker for the Soros, Gates and Buffet of those days; the Commodore Vanderbilts, and the Goulds, who controlled the Missouri Pacific Railroad, and Western Union.

    Finally I offer a fleeting tribute to Russell Sage, the old man of the street, about whom there is this quote.

    Not one in a million that could had had the dynamite bomb flung at him, and escape instant death, with only the loss of his hearing.

    18-Aug-2006
    GM Nigel Davies on the British Chess Championships

    With the last round coming up I am already packing. I need a win today for a chance of a small prize, so maybe I can get out of Swansea early. It is a mere five hours back to Southport from here.

    Some initial thoughts about my performance:

    1. As my first major tournament since 2003 I was not 'match fit'. Probably this showed in the amount of effort I used during the games - easy living produces a tendency to coast. The errors that showed up (vs. Palliser, Ashton and below vs. Palliser) might well have been due to this rather than age-related deteriorating calculating ability.
    2. Writing books on openings you play ('Play 1...e5') can cause a loss of confidence in one's openings, as opponents just have to find a single flaw to put you in trouble. So if I had to write such a book I should at least have prepared good alternatives or continued working on this lines to go further in my analysis. I believe this was the backdrop to my loss against Jones where I met the Scotch with the unscheduled 4 ... Bb4 + and obtained a very difficult position from the opening.
    3. It is all very well showing off with 5 different opening moves in 5 games with White, but the strategy of hit and run has its limitations.

    Summing up, the recipe for improving would seem to be to study and play - not stunningly unexpected. So then the only problem is to find the time.

    18-Aug-2006
    Mastery, from J. T. Holley

    "Everyone wants to be on a winning team, but nobody wants to practice."

    I love that quote and have it imprinted in my noggin'. The things in my life I have a passion for and am devoted to I practice over and over again. I am always seeking to improve myself in whatever way possible.

    I heard on the radio this morning on my way in to work that Phil Mickelson is not really a lefty. He is a righty that stood opposite his father and learned to swing a golf club. Through years of practice he became a lefty. The thing that amazes me is that when he plays right handed he has a +1 handicap. Vijay Singh is similar, when he plays left handed he is a +2.

    Guys, I will not embarrass myself by stating my double digit handicap, but I will share with you that for years I have hit 500 golf balls a day in some fashion, all up until 3 years ago. Never would I have contemplated trying to swing a set of clubs with the opposite hand, but probably because I could not afford to buy the other set!

    Hearing this gave me a deep appreciation of their Mastery of the game. They had to put in a ton of practice even with their abilities to be able to play so well from each side of the ball when addressing it.

    I would also love to see Tiger "left handed" vs. Phil "right handed" for a round.

    18-Aug-2006
    Thoughts on Impulse Responses, Spreads and Depths, from Ken Smith

    The better skilled and attractive prostitutes use their ability to read clients when they gauge how much to ask for services.

    Reading non-verbal responses, body language, dress, speech, mannerism, these highly desirable women of the night increase profits by continually developing and honing their analytic skills.

    A major component of analysis for them is to access the strength of desire in a potential client. A randy person is a setup for a higher tag on price. A nonchalant person, out for a casual experience, will not accept price out of proportion to his wallet. The randy guy, however, is setup by his own desire to accept price out of reason compared to his financial status.

    Women of the night are traders. We can learn from their practices, from their skills in trading services for cash and benefits.

    A trader anxious to make a killing a minute is comparable to the randy guy, will accept a price just to satisfy his desire to trade.

    The laid-back, nonchalant trader accessing his ability to pay and valuing that against a potential satisfaction that may be ephemeral will not accept any price, but will wait for the other side to meet his financial ability or value assessment.