Daily Speculations The Web Site of Victor Niederhoffer and Laurel Kenner


Jan. 1-15, 2006


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Patterns of Life and Markets, by Victor Niederhoffer

Of all the things I've learned from Jim Watson, the admirable discover of the structure of DNA and director of Cold Spring Harbor Laboratory, the most important is that the best biology book of all time is "The Way Life Works " by Mahlon Hoagland and Bert Dodson. The former is a eminent molecular biologist and the latter is a illustrator. In one of the greatest collaborations of all time, they combined their talents to illustrate the profound principles that unite all things and yet make them unique.

Amazingly, Hoagland admits he learned much from Dodson about biology in writing the book because the ballroom scenes, dancers, coffee-makers, chains, construction sites, laboratories and card games Dodson used in his illustrations are actually highly informative and realistic models of what goes on inside living things. My favorite picture, for example, is the Chloroplast Ballroom, where jitterbugging electrons at a party show how light energy is converted into chemical energy, setting up the ion shuffle wherein a bouncer grabs each man as he dances threw and throws him into a machine that "reattaches the end phosphate to spent ATP molecules." It's the kind of illustration, reminiscent of Norman Rockwell's best, that you'll remember the rest of your life. The amazing thing is it also teaches important principles of ionization, angular momentum, the conservation of energy and orbits of molecules.

The book starts with 16 patterns and rules of life that tie everything together from the smallest organisms to the most complex. I have waited too long to apply these principles to markets. The only excuse I have is that I knew it would take a lifetime of study and quantification to do a proper job. However, I hope readers will excuse me if I take a stab at applying the 16 patterns to markets, since I've spent 50 years studying market patterns and believe the things that make life go round also make the markets spin. I'll start with these four:

Orson Terrill replies with insights on the similarities between trees and the markets

Thoughts from The Tao of Spycraft, by James Sogi

The Chinese have studied and engaged in the art of warfare, strategy and intelligence for  thousands of years. T'ai Kung wrote Six Secret Teachings, a massive work for deceptively manipulating the enemy in which he discusses counter intelligence tactics" These have applications to trading and to modern politics.

The last one reminds me of the recent contingency table study in which the most buying activity appeared to be in the lower ends of December's range, the opposite end of the flank to be captured and a good place to have done some buying. "If you attack the enemy just after they have formulated their strategy it will ruin their plans and force them to submit. The highest realization of warfare is to attack plans." Sun Tzu.

"One whose thoughts and visible expression are identical will be defeated, one whose thoughts and visible expression differ will be victorious. Warfare is the Tao of deception. When capable, display incapability. When about to employ the army, feign that you are not. Obscure the real, cast suspicion upon the doubtful. Be profound like the Mysterious Origin free of all images, be an abyss like the unfathomable depths of the sea. When you attain this, yin and yang can no longer be employed to calculate your intentions, ghosts and spirit will be unable to know them, techniques and measures will be unable to impoverish them." Sun Tzu, Initial Estimations. (Similar to LACK's 10 Big Lies.)

Some techniques advised to destroy a state from Wu Yueh Chun-chiu:

Of beauty and s#x, the Chinese have their wisdom. Yen-tzu says, "Desire can reverse normality and change nature." Confucius said, "When the average man's emotions follow his desires, he is defeated." The Tao Te Ching states, "The five colors cause the human eyes to be blind. The five notes cause the human ears to be deaf. the five tastes cause human mouths to be numb." "Heaven gave birth to men and causes them to have greed and desire." "Disorder stems from external stimuli that drive men to perverse acts in seeking their unbridled fulfillment," said Liu Hsiang. Traders, keep your minds on business! See Ed Spec, Ch. 11.

Lu-shih Chun-chiu defines wisdom as: "the means by which one compares the past, what is far off, and sees what is nearby. If one thoroughly knows the present he can know the past, if he knows the past he can know later ages. Antiquity and the present, earlier and later, are one. Thus the sage knows a thousand years ahead, a thousand years back. The ancients had a saying: 'If you do not know what is coming, look at what has passed.'"

The Top Ten Daytrading Lies, By Craig Maccagno and James Lackey

  1. "I would be up money this month if it weren't for the commissions."
  2. "All I have to do is make two points a day, on a two-lot, to make a nice living."
  3. "If it weren't for stops I would have been broke a long time ago."
  4. "It traded my price, but I didn't get any fills."
  5. "The Internet went down, so I didn't get any fills."
  6. "My trading software was down, I didn't get filled."
  7. "I knew it, but I didn't trade it, darn it."
  8. "Trading has been great."
  9. "I was right, just too early, my timing was off."
  10. "If it weren't for that one big loss last year I would have made money."

Larry Fletcher adds:

Top trader lie: "I don't daytrade!"

Nathan Stewart extends:

What about these pearls of wisdom?

  1. "I am about even." (Stopped looking at the statements a long time ago.)
  2. "The secret to day trading is: never risk more than two ticks." (Bleeding to death.)
  3. "A chat room run by a true super trader, join now to move from one winning trade to the next." (Does not trade or trades one-lots, moves from one losing trade to the next.)
  4. "When this line crosses below that line and turns up, buy. It is an art though, it must be interpreted not followed blindly." (You'd be better off trading blindly. Random.)
  5. "Always wait for confirmation." (Buying at short term highs, bad fills, losing the edge on most occasions.)
  6. "Trail a tight stop after entry, locking in profits." (Shaken out of any chance for a good trade.)

A Perspicacious Spec Reads the Newspaper, a Continuing Feature


Surprise? Not. But I still have trouble grasping the move from a safe Senate seat in glamorous, babe-rich DC to Trenton. Yes, there's the Albert Jay Nock explanation, that a Governor has more leeway than a Senator to pump taxpayer dollars directly into his friends' pockets. But skimming NJ can't be easier/more fun than working at the GoldMine.

Friday the 13th, from the Assistant Webmaster

Here's a quick and dirty update of the enumeration of stock market moves on Friday the 13ths that's in the DailySpec archives, using INDU data since 1929 (in the fashion of Dr Zussman) to give the broad sweep of history. I whipped up an R script to output a summary by decade of Fri-13th percentage changes on the day in INDU. There are 17'ish observations per decade. Looks as though Friday the 13th is bearish some decades, bullish others. This is why I've never written an Almanac.

Last few observations:

               Y   M   D   W     INDU     %
 9/13/2002  2002   9  13   5   8312.7 -0.80
12/13/2002  2002  12  13   5   8433.7 -1.23
 6/13/2003  2003   6  13   5   9117.1 -0.86
 2/13/2004  2004   2  13   5  10627.9 -0.62
 8/13/2004  2004   8  13   5   9825.4  0.11
 5/13/2005  2005   5  13   5  10140.1 -0.48

Summary by decade:

          N   Avg%  StDev      T
1930s    17   -0.9    1.6   -2.3
1940s    16    0.2    0.5    2.1
1950s    19    0.3    0.5    2.9
1960s    16    0.3    0.5    2.1
1970s    17   -0.5    0.7   -2.8
1980s    18   -0.2    1.9   -0.4
1990s    16    0.5    0.7    2.6
2000s     8   -0.2    0.9   -0.7

Momentum, from Dr. Alex Castaldo

PhysOrg has a brief news item about a paper by Mark Grinblatt and Bing Han, two good academics, called Prospect Theory, Mental Accounting and Momentum. Their hypothesis is that the unrealized capital gains of the typical investor in a particular stock affect its pricing. Basically when a stock has unrealized cap gains, the typical investor is too reluctant to buy more on good news, and when a stock has unrealized capital losses, the typical investor is reluctant to sell on bad news. As a result the former stocks are somewhat undervalued and the latter somewhat overvalued compared to some theoretical ideal value. This mispricing gradually correct itself, resulting in a momentum effect whereby the former stocks gradually drift up and the latter down.

It is an example of behavioral finance being used to try to explain a finding, in this case the momentum effect that other people have written about as a purely empirical phenomenon. However, I realize the Chair is doubtful about the importance/existence of the phenomenon in the first place. The paper is 38 pages long, and apparently will appear in the Journal of Financial Economics, hardly a trash journal. On the negative side, it uses data from 1962 to 1996, so the results are out of date. Also a negative: it uses F#ma-Macbeth regressions.

Dick Sears Weekly Commentary: กก Ay, Toro !!

Juggling, from Laurence Glazier

I like my positions. Once or twice a day, after the bell and sometimes mid-session, I look at the charts, the developing risk profiles, assess if intervention may be needed -- it's like meeting a group of friends. At present there are five positions, though with my strategy it will typically be between six and eight. I can cope with this, and it's fun. But in due course I might increase the number of positions, I'm hoping this won't turn something I look forward to into hard work.

As a chess player develops, some skills become second nature. Simultaneous displays might have more and more participants. A firm trading hundreds or thousands of positions will need a largely automated system, and presumably lose touch with the individual stocks, the developing myths, the brave conquests of Apple and Google, the spirited ploys of Boston Scientific against an adverse tide, in short: the romance of trading.

I'm wondering how many positions to aim for. As an options trader, how many I can I ultimately handle and still enjoy? When does a juggler stop adding another ball? I may decide not to go beyond a dozen, time will tell, I'm in no hurry, just enjoying the ebb and flow.

GM Nigel replies:

Only take trades where you have an edge, as the Chair advised me the first time I met him. No edges, no trades, more edges, more trades. I've also been advised to specialize in a single instrument, which is fine by me because I have more than enough trouble with just one.

As to simultaneous displays, a GM becomes markedly weaker when he plays on lots of boards at one time, I'd estimate around 300-400 Elo points. I think it's better to play at full strength in fewer games.

Lessons and Stories from a NY City Policeman, from Victor Niederhoffer

Whenever I meet or read about someone extremely effective at his day-to-day activities, I try to consider how it throws light on markets and what the lessons for specinvestors are. Yesterday, Laurel and I had dinner with Bill McCarthy, one of the most effective policeman in history, a man who rivals the Palindrome himself in range of experiences and survival and successes in navigating them. Bill is also the best storyteller I've ever met and I hasten to share a few of his lessons and stories with my readers.

First a word about Bill's background. Bill is a principal of Threat Research, Inc., an international security management consulting firm, and a professor of Criminal Justice and Sociology, State University of New York. He was a police officer for 21 years in the New York City Police Department, serving as commander of both the Bomb Squad and the Vice Squad.

A Patented Method:

Bill had a patented method for overcoming resistance to an arrest. He participated in more than 4,000 arrests during his career and executed over 1,400 search warrants. When he entered a bar or other dangerous place and was physically threatened by a perp, he would start punching himself in the stomach and face, and butt his head against the wall. The poor criminals in the bar would see that he was willing to fight, and ready to take no prisoners without a brawl, and they would immediately give up. In the market, a similar strategy is a show of tremendous volume on one side. The poor weak sinners on the other side see that in order for the market to go in their favor, it would take an incredible show of force. And thus they immediately capitulate.


Bill often had to make arrests under violent conditions. One of the things he feared most was having a partner who had no experience in taking a punch a two. Certain non-Irish groups were particularly vulnerable to such lack of training in their youth, mine among them. I hate to get beaten up. And when someone takes a punch at me, I often lose my head. Regrettably, some policeman are like that also. But that can create unpredictable difficulties and escalate the situation such that guns might be pulled and someone seriously hurt. Bill, on the other hand, had been involved in innumerable fistfights in the neighborhood starting at age five, and frankly enjoyed it when someone attempted to exchange blows. He could admire the quality of the punch, the deception of it, and predict the next moves. The situation was quickly resolved in a harmonious arrest with one of his patented techniques, to everyone's ultimate benefit.

I don't have much experience in physical harm. Indeed, I once lost a million bucks when a policeman gave me a one-second Indian burn for talking at a public meeting for longer than three minutes, and I sued for false arrest and interference with my freedom of speech. That's another story. But I am quite experienced at taking tremendous financial harm in the markets. Not only do I not panic in such situations, but I am likely to take out my cane and buy when the light at the end of the tunnel is darkest. Such training in experiencing losses and violence, especially among violent stock market declines, is a great aid to the experienced police officer or specinvestor.

Naive Rookie:

When Bill was a rookie working in Harlem, he would often be assigned the undesirable job of chauffeuring a Division Lieutenant. This Division Lieutenant would often order Bill to drive around to street dice games. They'd pull up in their unmarked but obvious police car to these games and the players would immediately run away, leaving their money there in the process so as not to be caught with evidence, and Bill would chase them. Once he caught a few of them and brought them back in handcuffed to the car. The Lieutenant would looked at him with fire in the eyes, "who told you to catch them?" Bill was so naive as a rookie that he didn't understand what the Lieutenant really intended. The Lieutenant just wanted the money for himself! The situation reminds me of many of the announcements by corporations that they have been notified of a routine query by a regulatory agency and have hired an independent law firm to conduct an investigation of the matter. Such announcements often serve merely to create the semblance of fair play.

Millie and Morse:

Bill's wife Millie's favorite play is The Fantasticks, which she's seen at least a dozen times. One day, five years after he retired from the force, he was walking down Sullivan street to pick her up. All the sudden every social club on the block closed down and emptied out, and the block became deserted. The lookouts had immediately recognized him from five years ago and had concluded that a raid would soon ensue, as this had been the norm all the time when he had been on the job as head of the organized crime squad.

The scene was so reminiscent of the bull forays of Anthony Morse, 100 years ago and a mile south at the NYSE, that I could not refrain from recounting the story. From "The Last Scene in Morse's Career," from Worthington Fowler's 10 Years in Wall Street (1870):

Morse's end spoke to all like a warning voice. He departed from the arena, a stripped, penniless, heartstricken man. Out of the troop of wealthy friends which but lately clustered about him, only one or two still clung to him. He had now only the shadow of a great name. [Vic's note: Why does it hurt so much to recount this?] He was pointed out in the streets as the man who had once set the market in a blaze [in 1996?], but capitalists shrank from him as if he had the leprosy. His attenuated face now and then flitted past the streaming throng in Broadway [always taking care to avoid coming within a square block of even a Th#i restaurant?]. One day, more than a year after his failure, he was seen on the street, and Fort Wayne rose 5 percent. His name still spread alarm among the bears and inspired the bulls with new courage. Then came disease. No longer blithe and gay of mien, but morose and irritable. The vast burden of his debts and losses wore upon him. A gaunt, pallid face, in a notorious gambling hell in 24th Street. Alas, how changed from the Morse who but the the year before had led his dashing ranks to the summits of the market.

Yes, the market, like the crocodile, remembers all the greats who bulled it up, all the ways that easy money was made and is ready to think it will happen again. But for those who believe that repetition and imitation will carry the day again, the crocodile or the gambling house will get them. Fortunately, Bill survived his 4,000 arrests and his undercover career to write one of the best true crime books of all time, Vice Cop, and to head up one of the premier security companies of our day. Those who believe unduly in past glories, whether they be capos or soldiers, speculators or stadium builders, are doomed to failure.

Surveillance Secrets:

When conducting a surveillance one of the common mistakes of a rookie is thinking that you have to hide and not be seen by the subject of the surveillance. And if seen the rookie assumes that he has been made (identified as a police officer). Bill call the syndrome made-itis. An accomplished surveillant is prepared to provide an innocent visual explanation or distraction for his presence to the subject, if his presence comes into question. Talking to yourself, scratching, coughing, walking a dog or minding a child are quite effective. He used his son on several occasions.

Often a company will announce a stock split, or a buyback, or a dividend increase, in conjunction with insider trading or a meeting before a key brokerage house, well before an important product or earnings release. To a highly inordinate extent, the next earnings are going to be a very pleasant surprise.

Ken Smith replies:

The story many folks like to hear would be about the lieutenant without morals who ripped off the dice players. The story about good cops doesn't attract as much interest. I had one cop steal a box of mechanic's tools from me. Yet, other encounters with cops were positive experiences. A state trooper found me in a wayside rest stop locked out of my car with a fierce wind blowing ice cold on a mountain top in winter. He put me in the passenger seat of his vehicle and turned the heat full on and left me there while he went to my car and used a tool to open the door. I was saved from freezing. I had only a dress shirt and slacks to protect me from the elements. I have a couple more stories like that. But my point is made. Cops are good guys.

Dept. of Science: Mirror Neurons, Noticed by Jeff Rollert

Six years ago, Edge published a now-famous essay by neuroscientist V. S. Ramachandran (known to friends and colleagues as "Rama"), entitled "Mirror Neurons and imitation learning as the driving force behind "the great leap forward" in human evolution". This was the first time that many in the Edge community heard of mirror neurons which were discovered by Iaccomo Rizzolati of the University of Parma in 1995. In his essay, Rama made the startling prediction that mirror neurons would do for psychology what DNA did for biology by providing a unifying framework and help explain a host of mental abilities that have hitherto remained mysterious and inaccessible to experiments. He further suggested "that the emergence of a sophisticated mirror neuron system set the stage for the emergence, in early hominids, of a number of uniquely human abilities such as proto-language (facilitated by mapping phonemes on to lip and tongue movements), empathy, 'theory of other minds', and the ability to 'adopt another's point of view'.
In the past few years, mirror neurons have come into their own as the next big thing in neuroscience, and while the jury is still out on Rama's prediction, it's obvious that something important is unfolding. Interesting new research is being conducted in neuroscience labs in the US and Europe and discussed at conferences and in the press.

Look Before You Leap, from James Sogi

Albert Einstein said, "The formulation of a problem is often more essential than its solution which may be merely a matter of mathematical or experimental skill." A common mistake of inexperienced statisticians is to plunge into a convoluted analysis without paying attention to what the objectives are or even to whether the data are appropriate for the proposed analysis. Look before you leap! Qualitative statistical concepts are just as important as quantitative, because they enable us to actually do it rather than just talk about it. Julian Faraway's Practical Regression and Anova Using R is a very nice free ebook on regression and ANOVA.

The Vacuity of Campaign Finance Reform, by Prof. Gordon Haave

In response to the long-standing yet growing problem of special interest influence on the government of the United States, Congress has passed a number of major "reform" packages, and is on the cusp of passing another. The first major package was passed in the years following the Watergate scandal, when, among other things, Congress passed tight limits on individual campaign contributions. More recently, Congress took the significant step of criminalizing political speech when it passed the Bipartisan Campaign Finance Reform bill, signed into law by President Bush.

Now, with the the Jack Abramoff revelations, we can expect further restrictions on the ability of Congressmen to raise money and accept gifts from lobbyists, organizations and individuals. On the surface, all of this makes sense to the average citizen. Why not make it more difficult to buy influence in the government? The media also advocate these measures, as it increases their relative power to influence the government.

When we examine the underlying principles of what the government is doing, however, we find that the idea of expending significant resources trying to clamp down on the buyers of political access is absurd in light of the fact that there is a much easier way to solve the problem.

To break the problem down to its simplest form: There is a market for political favors by the government. The buyers are the 280 million Americans, the sellers are the 535 Congressmen. So which groups behavior should we focus on restricting in order to end this marketplace? The answer is obvious. The problem is that it is the 535 Congressmen that get to write the laws. Therefore, the government will focus on the behavior of the 280 million buyers, and largely ignore the 535 sellers.

This is, of course, the exact opposite of how the government deals with drug dealers. The government largely ignores the buyers, as they are too small and numerous for the government to have much of an effect on them. Instead, the government goes after the relatively small number of manufacturers and major sellers. The government has a difficult time doing so, as there is so much money in the drug trade that new sellers rapidly replace those that the government removes from the marketplace.

Such would not be the case, however, if the government went after political favoritism sellers. Unlike with drug dealers, there is a very limited pool of potential favoritism manufacturers and distributors. There are 535 of them, and we all know who they are. With a fraction of the budget that the Federal Government expends on the war on drugs, it would be very easy to monitor the activities of 535 high-profile individuals.

Dan Grossman replies:

I'd put it a little differently. The main thing to attack is the government's ability to grant special favors. If minor Indian tribes can pay $84 million for lobbying, it shows that the benefits they are lobbying for (i.e., gambling rights) are obscenely valuable. And there is no way money, legally or illegally, is not going to find its way to those who can facilitate and grant the favors. So we need things like a simplified flat tax, and a general prohibition on (or at least an extreme reluctance to grant) special benefits such as gambling rights.

Rational Herds, Reviewed by Victor Niederhoffer

The beautiful and extraordinarily important book Rational Herds: Economic Models of Social Learning by Christophe Chamley treats topics important to decision-makers in life and markets, including how fast, delayed and divergent our learning is, herding, the convergence of beliefs, booms, bubbles and crashes, entries into business, diffusion of innovations, investments in knowledge, searching costs, the cost of information, the value of isolation versus joining (e.g., to stag hunt or not), regime switching, avalanches, variations in prices, limit orders versus market orders, and information delays in financial markets. Each chapter starts out with examples of social learning, simple models that illumine how rational agents might act in comparable situations, and extensions into more realistic and technical models that apply to special cases considered in the literature. The more familiar the reader is with probability theory, simulations, economics of utility, and normal distribution theory, the easier it will be for him to gain knowledge from the book, but a hard-working layman with a pencil and paper can gain insights into many fruitful areas even without this background.

The book begins with an example of social learning among penguins typical of its many suggestive examples for market decision-makers. book. The penguins, after much hard winter work without food, move in a group to the edge of a cliff overlooking an ocean full of food. Possibly lurking in the water are killer sharks, whales and seals. The penguins as a group would be much better served if one of them would test the waters. But for the individual penguin, death might result. Action must be taken or else they'll all starve to death. The penguins solve the problem by pushing a particularly vigorous individual off the cliff. If he survives, they all jump in.

Comparable situations occur whenever danger or discomfort threatens a group and the first person to test the water might risk harm or, worse yet, social disapproval for being a non-conformist. We all face this, for example, when we see a fight and know that we can break it up if only group action can be taken, or when we are in a crowded room where the heating or ventilation isn't proper, or when we're in an establishment where the service is poor. We face this in the market when we have to test the waters before a trend is set, before an announcement has been released, before a new industry or market has come into favor, or before a change in interest rates has occurred. The book will help you decide how long to wait in such situations, and to analyze the attempts of others to substitute for you or coordinate with you.

Many of the basic models in the book start with binary choices such as the identification of a taxi as red or yellow, or the prediction of a market move as up or down. Consider the following situation: 70% of all months are up. Now, a study is made, e.g. of times when interest rates were very high, that shows the market is more likely that other months to decline. However, only 60% of similar predictions are accurate. Now there are two likelihoods that can result:

  1. The prediction applied to the 70% base can be wrong. This combined event has a 70% x 40% = 28% likelihood.
  2. The prediction can be accurately applied to the 30% of months that are declines. This combined event has a 30% x 60% = 18% likelihood.

Thus, the probability of a rise is now 28/46 = 61%, down from the original 70%. But despite the forecast based on interest rates, the correct prediction is still for a rise. No change in decision will be forthcoming. But now, suppose that a second study is made, and it also predicts a decline. But such a study also has only a 60% chance of being accurate. Applying this to the new 61% base probability of a rise, the likelihood of a rise is 61% x 40% = 24% and likelihood of a decline is 39% x 60% = 23%. Now it's about 50 /50 as to whether the market will rise or not. And with a third prediction based on another study forecasting a decline with better than a 50% probability of being accurate, the weights would swing to a decline forecast. Everyone who followed such a decision strategy, or learned of the studies, or believed that others were acting on the basis of correct decision-making, would follow the third forecast and change his action to selling Thus, depending on the delay and decisiveness of action, an avalanche, cascade or crash might occur.

There are hundreds of fascinating examples of group decision making given in Chamley's excellent book that will illuminate all your thinking about social behavior. Some of my favorites involve studies of the value of conformity, when to go out in the rain, when to get out of a booming market, when to follow an expert, the value of the risky market order or the conforming limit order, the value of experience (old-timers versus beginners), when to attack a currency, how much credibility to place on initial reports (the white van problem), the accuracy of group behavior, when it pays to coordinate or go it alone. and the path of truth. The book will change the way you think about groups and will have you rereading to to better appreciate these key areas.

Martin Lindkvist adds:

The site for Financial Economics Workshop, a finance course at NYU, contains lecture notes and research papers pertaining to many of the chapters of Chamley's book.

Dr. Kim Zussman wonders:

There is a card game, at a casino where the dealer, Lo Rates, hands you single cards. They are either green or red (win or lose). The deck he is dealing from is under the table, and he shuffles it out of sight after every deal. You think it is one deck with many cards, and after many tries you notice green 70% of the time.

After dinner you go back to the same table and it is a different dealer, Hy Interest. Hy is still reaching under the table for cards, but after many tries you count green 40% of the time.

You are not sure whether Hy is using a different deck than Lo, or they are both using the same decks and you just got different cards. How do you determine if they were using the same or different decks?

Bronstein's Scoresheets, by GM Nigel Davies

One of the most remarkable sights I've ever witnessed is that of David Bronstein in serious time trouble. Even with 10 moves to make in a minute he was very calm; every move was written down with great care and he played with remarkable accuracy.

One year in Gausdal I learned that Bronstein always carried one of Paul Keres's handwritten scoresheets with him. During the tournament he presented me with one of his own, but when I thanked him too casually he asked for it to be returned.

It was a good lesson. If someone looks after the scores of his games he will also pay attention to the moves that he plays.


Cognitive Dissonance, from George Zachar

I can't think of a macro research piece that hasn't stated as fact that housing/mortgages/cash-out financing will slow in 2006, with various and sundry malevolent effects. Then, I look at the charts of lumber and the S&P home builders, and notice both are up 30% since mid-October. Paging Leon Festinger...

Roger Arnold adds:

Something is occurring in the housing/mortgage market that I did not expect: people are paying up for the higher rates. The rates on purchase money second trusts have increased from an average of 7.5% three months ago to 9.5% today. Sub-prime first trusts are now pushing into double digits for many loans and the borrowers are continuing to borrow and aren't really complaining.

George Zachar replies:

What you're describing is a micro manifestation of the macro decline in risk premia. The standard analytical metaphor usually applied here is the frog in the kettle wherein he gets so comfortable he is unaware of being cooked alive. Our economic denouement remains unclear.

Dr. Bill Egan mentions:

I follow the metro Boston housing market closely after having to move three times since 1998 for new jobs. My town's housing market weakened starting back in August: supply on the market doubled, prices stagnated or dropped, houses sat for much longer. With more stringent loan requirements it should be even worse in 3- 4 months. Lots of longer lags here: house buying season doesn't begin in earnest until April- May and the ARMs adjust yearly. The Boston Globe had a story this morning about homeowners whose ARM-based payments are rising and who have trouble meeting the payments. 35% of San Francisco home loans were interest-only last year, which is nuts. When the easy/stupid loans are gone, the house prices decline because there are fewer buyers. Like the end of another period we saw recently, in 2000. Sounds like the market is saying here are some nice profits, so take them.

Overheard, by James Humbert

Good as Gold, by Kevin Bryant

A factor in gold's favor over the long haul is the lack of credible shills on popular media, even from "credible" institutions. I am often amazed at their inability to put together well constructed arguments for the bullish case. Whether you buy the bullish case or not, coherent, if not provocative, arguments exist. On reflection I recognize that it's a tiny market with a checkered history, especially over the last twenty years, and so doesn't attract as many talented pitchmen as more conventional sectors. Many also appear to wilt under the spotlight, not yet accustomed to the increased attention. It will be fascinating to watch how this changes over the next months and years, provided gold continues its ascent, and how this will attract those able to craft and present more credible, and ultimately fanciful, stories for the "barbarous relic".


Starbucking the Trend, from Prof. Gordon Haave

Back when the idea of paying three times as much as Dunkin Donuts for the privilege of putting milk and sugar in your coffee yourself was becoming popular, my wife said: "Don't worry, Starbucks is starting to expand in Oklahoma. Whenever a fad hits Oklahoma, it's at its peak." However, Starbucks turned out to be the exception to that rule.

Brokers, from Charles Humbert

The better institutional equity salespeople often migrate to the buy side, but the retail brokers I have met over the years who are the most productive, and have the least turnover among clients, are the old guys who specialize in tax-free bonds. These brokers virtually never get sued, and their clients are almost always satisfied with the job they do.

My experience is that younger brokers often flame out after a few years. The ones who produce the most revenues with the least experience are selling the sizzle instead of the steak. After three months of a down market, half of their clients transfer their accounts out, and the other half stop trading.

Besides, ~5% long-term tax exempt yields are a taxable equivalent of nearly 8% for investors with substantial state and local tax rates, which looks pretty good compared to stocks over the past five years.

Father Time, from GM Nigel Davies

They used to say that chess Grandmasters reached their peak between the ages of 35 and 45, though with information more readily available this appears to have gone down to around 25 to 30. Nothing improves with age; it's just a question of mounting as good a defense as possible against Father Time.

How do you know you're getting old? When, as happened to me this morning, the optician is young enough to be your daughter and enthusiastically congratulates you on not needing reading glasses yet, though with the sympathetic explained caveat that this may no longer be the case in 3- 4 years. And you know you're doomed when you feel yourself glowing with pride at the fact.

LACK replies:

In the bucket shoppes they compared the results of "older traders," 50- 60 year old retired engineers, to the 20-something computer gamers. An anecdote: One of the top daytraders ever from B######y Trading was an ex-computer man retired in his mid-50s who used a time horizon of about a day. Therefore you can call him a daytrader, even though the common meme is daytraders hold for only 10 minutes, never hold overnight and are drunks.

Mr. E. explains:

The bigger your losses, the larger your expenses, the greater your taxes, the size of your pants, the sounds of grandchildren, the monthly Social Security check, the friendly IRS audit: they all mean you're getting older.

Feasting on the Corpse, Noticed by George Zachar

R##co's Goldin May Be Paid $685 an Hour, New York Post Reports
Jan. 9 (Bloomberg) -- R##co Inc., the trading firm that filed for bankruptcy in October, asked a court last week for approval to pay Chief Executive Harrison Goldin $685 an hour to run the company, the New York Post reported. Goldin, who served as Comptroller of New York City for 15 years until 1989, would earn $164,400 a month if he worked 60 hours per week at R##co, the Post reported.

Yellow, Orange and Blue, from Yishen Kuik

As perfect an illustration of cycles in biology as possible: Male lizards have three strategies in the mating game. Conveniently for scientists, males have colorations according to their strategy: yellow for sneaky, orange for strong, blue for cooperative. The dominant strategy rotates every few years.

Year-End Review by Victor Niederhoffer

I came across a heinous self-congratulatory piece wherein the weekly financial columnist who has been bearish continuously for 40 years congratulated himself for being bearish starting at the end of the century, noting the terrible market events, terrorist events, and war events that happened during the new century, patting himself on the back for sticking to his guns, and noting that December 2005 seemed inordinately terrible in that it declined when people expected it to rise.

I found the tone of the piece grotesque, even more so than the usual supercilious mocking and parodying of those fools who are optimistic and don't see the risks, that characterizes 100% of what he writes in his columns. It reminded me of what cult leaders do when they find that their ideas have not been accepted or have been challenged by the facts, although I didn't see any evidence of the frequent calls to action and increase in propaganda that usually accompanies such a violation and challenge to the leader's and followers' self-esteem (as described in Festinger's work memorialized in PracSpec).

And yet, it led to my posting as of year-end the counting piece "Hold the Bubbly," in which I concluded, "In short, the dismal performance in December, which is sure to be crowed over by the bears, is quite bullish from a seasonal standpoint." OK, the market registered four consecutive up days since then and is now at 1285 as of the first Friday close after the year-end, 3% higher than the 1248 close at year-end.

It seemed reasonable to go back to the 13 years during the last 50 that showed December declines and note which of those years showed a rise in the first week of trading of the new year, and look to see whether there was a tendency to reverse or continue in the rest of the month. Of the 13 declining months, three of the next weeks registered a decline: those following declines in 1955, 1968, and 1981. That left us with 10 years in which a December decline was followed by a rise in the first week. An enumeration:

Performance Following a Good First Week of the Year
Preceded by a Decline in December:
Year  Move  Move  Move
      That  Next  Rest of 
      Week  Week  Month
1957    2%    -1%     2%
1966    2      3      3
1969    1     -1     -8
1974    3      4      6
1975    1      4      6
1980    1     -2     -3
1983    3     -2     -3
1986    3      5      5
1996    1      1      3
2002    3      2     -8
Avg     2      1      0
2005    3      ?      ?

I conclude that the week following good first-week rises after bad Decembers is bullish with an average of a further 1% gain, say a 25% chance likelihood by chance.

Also, there is a tendency for the four very good first weeks of 3% or more to be followed by a subsequent good week averaging +2%, which one would have to test by simulation for its chance likelihood, but because I've performed more than 50,000 similar hand calculations I can say is about a 10% chance shot.

I predict that the weekly columnist will have a particularly vitriolic and hateful piece about the mistakes investors are making by buying in 2006, and that his most sagacious friends are even more than usually bearish.

Dave Baccile adds:

I note that the AAII U.S. Investor Bullish Sentiment Index declined to 29.3 last week, matching the low last August and the previous low in May. I observe that the Sentiment Index typically follows the recent performance of the market. If the market had a good week, sentiment improves. But that trend has broken down. Despite the market indices' reaching new 52-week highs, even the bulls are disbelievers right now.

Recent Spec-Library Purchases by Dr. Victor Niederhoffer and Dr. Alex Castaldo

Thoreau on Markets, by Henry Magram

Reading great literature with a eye out for trading wisdom, I found two particular passages in Henry David Thoreau's A Week on the Merrimack and Concord Rivers. In the first passage, Thoreau offers fishing advice and perhaps a trading lesson: a passive angler will never catch the biggest species of fish. Only a spearer, who wades into the river, will take home a prized meal. In the second passage, Thoreau happens upon scraps of newspaper bearing New York commodities prices, and he expresses how prices hold more truth than media commentary. The more I read books that have stood the test of time, the more I, too, disdain public news and commentary.

Henry Magram is a University of Maryland sophomore.

Dr. Marion Dreyfus Reviews Match Point

The theme of this film, as with Crimes and Misdemeanors, Woody Allen's sumum bonum, is the expiation of guilt in a forgiving or oblivious society. His societal wife, Chloe, does not notice much beyond her perfunctorily satisfied needs, Her brother dutifully marries a woman he tolerates for appearances and his mother's regard, and Chris himself affectlessly abandons his sport, tennis, for the sport of leveraging assets in other directions.

One suspects, as Vic indicates, that Woody is expiating his non-U desires for these alluring younger females over the comfortable and sanctioned matches put upon him, a way to slay the beast of illicit connubia with those clearly wrong for many reasons. Soon Yi seems to be a not-very-prepossessing manifestation of this syndrome, as she seems to manifest none of the femme fatale analogues of Scarlet Johansson or Mariel Hemingway (from Manhattan), but she does keep him in line.

In "Crimes and Misdemeanors," Angelika Huston starts out self-possessed and diverting, but quickly descends into a madness of whining and demands that Scarlett exactly parallels, though she starts out much more erotically promising than Martin Landau's inamorata. Johansson's talent seems to be minimal beyond a perverse ability to daze any male nearby with her suggestive erogenicity. The "luck" that forms so strong a role in "Match Point," however, is that of Woody Allen, who has gotten away time and again with glancing scripts that are as much about mockery as they are about cynicism. In the end, invariably, the body-comfort and money-homing device works flawlessly, and he has managed, yet again, to abscond with the ethical right, overturning the old film code that determined that evil not triumph in the end. He has no trouble living an empty shell of intimacy with his unsuspecting spouse. Even the constabulary and MI5 (substitutes for the hounding media) seem unable to pin the dastardly tale on him.

In the event, it seems by its mythic forgiveness and sumptuous privilege to be as much myth, creating as is the more honest Narnia for tots and would-be children. A second moral, if you will: Man cannot comfortably serve two mistresses before (personality) disintegration of the male (and ultimate tolerability in the subsumed female).

Dr. Kim Zussman responds:

Woody Allen's new "Match Point" premiered locally to a full house and evidently caused a stir at Cannes. However one critic there called the film "cynical", which is a pretty complete one-word synopsis.

Instead of his beloved New York, the film is set in London. Chris is a dashing tennis pro turned country club instructor who claims the pro circuit is too much; but we see that for the cunning there are better prospects in social tennis with the rich. He strings himself into a wealthy family via marriage to the patriarch's naive daughter Cloe (the only well acted part), while aggressively serving an affair with his brother in-law's fiancee Nola (Scarlet Johannson) after meeting over table tennis.

It seems that Miss Scarlet is a lot better at looking than acting, and at times it felt like a college play in honor of her sultriness. Allen has made a public sport of canonizing young women, and honors this one with the nickname of his beloved jazz-town ruin.

Chris is promoted at his father in-law's financial company, where he has big losses and there are shots of trading screens and pink Financial Times to make you feel a little dizzy if Nola doesn't. In an un-Galtonian fat tale, charm and luck carry the day, and once again there is the message that money protects the moneyed and the successful are the fortunate.

I looked for a derivatives expert in the credits but was distracted by the people next to me. The lady explained that her genius brother was worried about continuing death of brain cells, and that he must quickly make his contribution before he got too old. They applauded the film so I didn't tell them that I liked Woody more when his cells were still alive.

Victor Niederhoffer's critique:

I found Match Point thoroughly off key. The tennis player can't play tennis. The business doesn't do any business .and the situation isn't one where the executives could rise. The police don't make mistakes because they don't wish to follow up on rich man's gun, or ballistics, or a pregnant mother's lover's obvious fake alibis, and the girl friend and every other character is a loser. The only realistic thing is how Woody must have felt when he lusted after the stepdaughter and had to exchange badinage at home and on the set with the jealous Mia, and the lies he must have had to tell her to deflect her from lowering the boom on him. Thoroughly despicable film about losers and the kind of people and place you never would like to traverse. It's the kind of film that depicts life as it isn't and leaves you worse off when you see it.

Intelligence Analysis, by James Sogi

Intelligence Analysis: A Target Centric Approach, by Robert Clark, looks at the intelligence analysis process and offers a different approach to market analysis. Intelligence is defined as reducing uncertainty during conflict. Openly available sources can reveal information an opponent wishes to conceal. Intelligence can be the process of obtaining meaning from available information by forming models, hypothesis and conclusions and predictions for use in strategic decision making. "Future conflicts will be fought more by networks than by hierarchies and whoever masters the network form will gain major advantages. "

In one sense, market analysis is simple: It focuses on which way and how far the market will go. The sole goal is to make money. This is simpler than deciphering the course of governments, war, society and the world. On the other hand, the market is a complex network itself. It adapts, evolves and changes, sometimes quickly. Chair's network intelligence approach works. Intelligence input from all levels benefits mutually. A network of hedge funds alone, or dealers alone, or small traders alone, (or all experts only) would not work as well as a broad network with views that contrast, differ and are from different perspectives. As such analysis is a social process. By looking at the market as a network analysis of the components of the network can lead to information in addition to viewing merely the end result. Sometimes it is easier to target a weak link in a network to get information better guarded elsewhere. Successful analysts have an inherent inquisitiveness and lifelong interest in learning that may seem to have no relevance to the current subject area. long term historical perspective is essential in making predictions. Intelligence requires teamwork, and the process is social where there are many stakeholders. One of Machiavelli's strengths was to evaluate conduct rather than values. Objectivity and broad perspective are crucial.

Models are essential to analysis, to simplify, and to capture the range of thinking and creativity. Looking at the market using different models from other disciplines has helped creative ideas of profitable speculation. Models are built, analyzed and synthesized into better models in an integrative process. Ethnocentric bias, wishful thinking, parochial interests and premature closure should be avoided. The conceptual model should look at systems. For example the energy system includes not only oil supply, but transportation, infrastructure, distribution and alternate sources of energy. Rayner and Best talked about creating models in Contingency Tables. The next task is figuring out how to fit the data into the model template. Use Occam's Razor: explain observations with the fewest possible hypotheses, the simplest explanation that fits the facts. This is the parsimony principle.

Data collection can be broad. Rather than sit in the office and wait for info to come in, one thing we did when in the government in my youth was to go to the target and look around, talk to people, look at the wheat, feel the dirt. Look at the weather. It's amazing what you can learn by just observing, as Yogi Berra said. Nothing covert, just ask. What might a speculator learn by going to Detroit and talking with a few GM guys and taking the free tour, going to the farm and looking at the corn, to Brazil, China, Iowa, Dubai; walk around.

In weighing analysis by others weigh the testimony as in a court of law. Is the purveyor competent to express an opinion by education or ability. Did the person nave a bias or vested interest? Was the person able to perceive directly or was the information third hand hearsay? Common errors re caused by over weighing vivid experience, overweighing based on the source (name dropping, testimonial), errors of recency, disfavoring the unknown, hearsay, experts. Weighing evidence may utilize Bayesian analysis or Dempster-Shafer approach using ratios which can be manipulated arithmetically. There is of course a fascinating section on deception and counter espionage.

Analysis entails breaking down a large problem into smaller pieces. Nobel Laureate Enrico Fermi posed the question, how many piano tuners are there in Chicago? The answer was to determine the number of families, the number with pianos, and then how many pianos can a piano tuner tune? The problem of the US interest rates and the analysis of the wrong data recently in the Daily Spec is a good example of the need to properly deconstruct a problem. A bigger view of collateral models may be needed to get a better grasp on the domestic interest rate problems, and a wider global view including commodities may hold the key to the 'conundrum'. This the 'gap' analysis that needs to be done to understand the issue. Clark calls the conundrum an 'enigma'.

Strategic vs. Tactical Analysis. Tactical analysis answers which way the tanks are going, and when. Strategic is long term and looks at SWOT (strengths, weaknesses, opportunities, threats). Collection of I&W (indicators and warnings) were used by analysis to predict the Iraq attack against Kuwait a week before the invasion. True analysis is predictive. The problem is convergent and divergent evidence. One is cause and effect, the other is more difficult along the lines of chaos theory where a meme grows rapidly from small beginnings. An example is the aborted meeting Gates set up with IBM of CP/M Gary Kildall who went flying his plane instead of meeting IBM. IBM, miffed, told Gates to write his own system. Scenarios are constructed and as situations develop the analyst determines which scenario is unfolding and understand which driving force or which branch was central in the development. One of the triumphal trio's main contributions has been the idea of drift. The analyst always must understand that the predictions will always be wrong, in detail. The value lies in the assessment of forces shaping events and markets. Old predictions can be entertaining so far off base and so wrong. In the markets, the bright future scenario shaped by the upward drift, the resourcefulness of man and the market makes the prediction easier. The question becomes solely the path to riches without going bust on the way, i.e., how much leverage to use. The gloom and doom scenario is much more complicated and problematical from a trading perspective.

Of the forces, Newton first named inertia. Things tend to continue. Institutions resist change. All forces meet resistance. No country can expand unopposed, as we are now seeing with Russia opposing US action in the Mideast. We are defined by who opposes us. In Dante's Inferno, Etheriel asks G-d if the adversary is his servant. The reply: "For what is Good but the eternal fight against Evil?"

Steve Ellison says:

I found the article in the May 2005 Harvard Business Review by Vijay Govindarajan and Chris Trimble, "Building Breakthrough Businesses Within Established Organizations", highly educational. The authors' recipe for success is for the new venture to forget, borrow, and learn. In discussing learning, they say "the crucial learning step .. is analyzing disparities between predictions and outcomes".

Going into more detail:

At the outset, predictions are always wild guesses. It is not uncommon for revenue forecasts for three years out to be off by a factor of ten. But as the management team learns, wild guesses become informed estimates, and informed estimates become reliable forecasts. Reliable forecasts are the best indicators that a new business is learning.
Because predictions are bound to be wrong, especially early on, it is tempting to put little effort into them or quickly discard them. This is a trap. You cannot get better at making predictions by avoiding them. Predictions are important not because of their accuracy but because of the learning opportunities they present.

The Mountains of Truth, by Dr. Brett Steenbarger

While writing The Psychology of Trading: Tools and Techniques, I encountered a quote that immediately reminded me of the frustrations and ultimate benefits of counting:

On the mountains of truth you can never climb in vain: either you will reach a point higher up today, or you will be training your powers so that you will be able to climb higher tomorrow. -- Friedrich Nietzsche

Perhaps the quote that I've encountered that I like best, however, is from Viktor Frankl:

Ultimately, man should not ask what the meaning of his life is, but rather must recognize that it is he who is asked. In a word, each man is questioned by life; and he can only answer to life by answering for his own life.

I suspect the greats answer for their own lives by climbing those mountains of truth.

Film Review by Yishen Kuik: "Grizzly Man"

"Grizzly Man" is a documentary about a self-styled eco-warrior documentarian Tim Treadwell, who spent 13 summers living more or less alone with the grizzly bears in Alaska only to be eventually killed and eaten by a bear.

There are many fascinating angles in the film, but I'll focus on a few that might have spec interest.

Treadwell flew into Alaska from summer to autumn, following the bears as they fed and mated in the early season before retreating to a heavily vegetated area Treadwell called the Grizzly Maze where the bears would find hiding places to hibernate for the winter. Amazingly, Treadwell came close enough to touch and swim with the bears in front of an unmanned camera. Over time, he appeared to be accepted by the group of bears that he followed.

On his 13th summer, after quarreling with a travel agent over his return ticket, Treadwell decided inexplicably to stay longer than usual. All of the bears that he normally followed had gone into hibernation and his last videos caught an unfamiliar older lone bear diving deep for salmon carcasses. The narrator offers the analysis that such a bear hunting so late in the season likely had not sufficiently eaten enough to hibernate and would be exceptionally dangerous. Additionally, such a lone bear might have been hunting in poorer areas before, moving into better territory during the off-season when the local bears, sufficiently fed have retreated from the scene.

Ironically, Treadwell also pointed out that older lone male bears are often the most dangerous. It is suggested that this is the bear that killed Treadwell.

Can we observe late season foraging by those bears in the market having difficulty producing enough returns to make it through the winter? When we observe bears in the market moving to new territory, should we draw conclusions about the prospects of their traditional stomping grounds?

Finally, do long track records of survival in an environment, such as Treadwell's, encourage one to venture into apparently not dissimilar territory (late season vs. normal season bear country) that hides fatal nuances (appearance of lone hungry bears)?

Dr. Kim Zussman comments:

  1. Twelve-foot carnivores that are mostly docile and predictable will occasionally break you in two with one bite.
  2. The audio portion of the video was recorded while the bear killed Treadwell and his girlfriend. Treadwell's ex was given the tape but warned not to listen to it, and his family did not want the audio played in the movie. So director Herzog listened to it using headphones, with his back to the camera but facing Treadwell's ex. He describes the horror as his invisible face is reflected in the woman.
  3. Post-mortem vaccination. Have you ever noticed people's reaction to another's untimely death? Typically, we look for reasons it could not happen to us, e.g., did he smoke? Was she overweight? Did he have diabetes? Does he play with bears? 1929 couldn't happen to us because... 1987? 911? LTCM? I posit that the Monday morning quarterbacking about LTCM (overleverage, wrong options model, not enough Nobels) falls under the rubric of platitudinous autovaccination with everything else that catches us unawares.

Risk, s#x, money, death, as usual.

Repetitions and Crocodiles, by Victor Niederhoffer

The performance of the S&P surrounding year-end 2004 and year-end 2005 has been inordinately opposite. The S&P closed in December 2004 within 1 point of its high of 1213 and 35 points above its December 2004 low. During the next four days, the S&P registered a continuous decline of 25 points to 1187. In December 2005 the market closed at 1248, at the low for the month, down 25 points from its December 2005 high of 1273. During the first four days of 2006, the S&P has risen 35 points to 1283.

The behavior of crocodiles can provide insight into these stylized facts:

Year-end 2004:             Year-end 2005:
35 points above low        25 points below high
First 4 days down 25       First 4 days up 35

The crocodile has the largest brain among reptiles. It uses that brain to remember how to eat by taking account of the repetitive behavior of its prey. I first learned of this when I heard Crocodile Hunter Steve talk during a visit to the Western Australia Zoo in 2004. Steve mentioned during his talk that the keepers like to jump over a certain low point in the fence completely out of the area where the crocs normally congregate, to feed them each day. But they have to count the crocs before they do so, because the crocs remember where the keeper jumps the fence and lay in ambush for them.

I had been sensitized to this information because Alex Elder had once told me that experienced fisherman in Australia learn never to fish in the same place near a bank twice because the crocs remember where they fish and wait at the same time and place, completely camouflaged below the bank to hurtle out of the water to catch the overly repetitive fisherman. He added that the crocs particularly hate Steve because he was the one who captured them all, and they remember that and hold a grudge.

I subsequently found verification of this behavior in the Nova report Outlasting the Dinosaurs, where croc researcher Dr. James Ross said crocs "particularly learn to avoid dangerous situations very quickly. For research purposes, we find that we often have to change capture techniques, because it's very hard to catch them with the same trick twice."

Study of croc life shows that there is much to learn from them. All researchers agree that they are the greatest survivors among all reptiles, having existed in unchanged form for 200 million years, outlasting the dinosaurs by 65 million years, and often living currently over 100 years, actively reproducing the entire time.

The basic design of the crocodile, very thin and long, a large perimeter relative to surface area seems to have great survival value. Heat loss is proportionate to surface area, and thus energy required to keep a croc going is less than for any other form. To see this, consider the various rectangles that could be constructed with integer sides that have an area of 16. They could be 16 and 1, looking like a crocodile; 4 and 4 , looking like an oak tree; or 2 and 8 in intermediate form.

The 16 and 1 rectangle has the biggest perimeter to surface area ratio (34 to 16), and the square has the lowest perimeter to surface area ratio (16 to 16). The square will always have the shortest perimeter for a rectangle of a given area. A natural extension is that the circle is the two-dimensional form that minimizes perimeter for a given surface area.

The applications of these two basic characteristics of crocs to markets are clear. I call on readers for proof, extensions, and profitable applications.

Steve Leslie replies:

First thing crocodiles do is observe the characteristics of their prey: nuances, habits, tendencies. Second they plan and develop a strategy to capture the prey: location, time of day, wind, deception. Third they lie in wait for the right opportunity: patience, discipline, economy of motion. Fourth, when timely, they attack with full fury. One major assault. An explosion of energy with one goal and expectation in mind. A singleness of purpose. Finally, they fill themselves with the conquest of the victim, relax and live sumptuously for some time.

If crocodiles can stalk and kill man, who supposedly stands atop the food chain, what does that say about man?

Victor adds:

From Nightmares of Nature by Richard Matthews:

On the night of 19th February, 1945, Japanese troops were trying to escape from the Island of Ramree, off the coast of Burma. Bruce Wright, a member of the British forces, was trapped on the island and wrote of what then happened.

"That night was the most horrible that any member of the Marine launch crews ever experienced. The scattered rifle shots in the pitch-black swamp punctuated by the screams of wounded men crushed in the jaws of huge reptiles and the blurred worrying sound of the spinning crocodiles made a cacophony of hell that has rarely been duplicated on earth. At dawn, the vultures arrived to clean up what the crocodiles had left. Of about 1,000 Japanese soldiers that entered the swamps of Ramree, only about 20 were found alive."

I am not familiar with the incident but I shed a real tear, not a crocodile tear, at the deaths and will refrain from comparing the incident to any market events.

A Las Vegas Whale extends:

The problem with stock picking in this day and age lies in a massive structural problem deeply embedded in the US stock markets: long/short and "market neutral" equity strategies. The herding of money into these strategies has stripped all of the available alpha completely out of the market. With so many wizards out there in the market with so much ammunition, they have shot everything in sight long long ago. The smell of burnt gun powder has gotten every shooter high, and the smoke, always making lines of sight more cloudy, continues to stream from the gun barrels. The landscape is so confusing, shooters are shooting each other every which way. Like Ramree all over again.

The key is to be the crocodile. Like the continuous rolling and twisting of the crocodile, you look for the shooters' overcrowded fire, and you wait for them to shoot all of their ammo, then you bite, and bite hard, and never let go!

George Eastman must have been there at Ramree taking pictures of the massacre. Today he demonstrated what he must have learned there by the way his stock began to bite into the shorts like a crocodile. It may be just the beginning. Hint: Just because a stock has 100mm shares in the float doesn't mean they are for rent. And the US Stock Market is a renters' market these days, and hedge funds are the ones leasing everything in sight. It is the owners that will win in the long run.

Stefan Jovanovich offers:

The foundation of the Morgan fortune was the hotel business. J.P. Morgan Sr.'s grandfather, Joseph, bought the Exchange Coffee House in Hartford with money gained from selling his share of the family farm. He later traded the Exchange Tavern for the City Hotel. The cash flow from the hotel was invested in common stock in Aetna Insurance and the Hartford & New Haven Railroad. Operating a profitable hotel requires the skills of a crocodile. Most of the profits come from the relatively brief periods when the hotel owner (read: trader) can predict that all the rooms will soon be booked. Relatively steady if smaller profits come from being able to assess what a walk-in customer's price point will be. During the slow periods the ability to live on a near starvation diet is the difference between success and extinction. None of the Morgan biographies pays much attention to the nature of Joseph Morgan's business and its legacies for son Junius and grandson John Pierpont. They tend to look from wide end of the telescope and view the Morgan's success as a matter of "investing" rather than trading. I wish it were so. Those of us who have been successful investors know that the traders are the people who make the money in any business whose profits come from the margins on "turns". The difficulty for investors is in finding a trader whom you can fully trust to simply "buy 'em and sell 'em". The problems come when the traders decide to "invest" -- i.e. make large unhedged bets where the positions cannot be squared. In our radio business that has come several times from having the traders fall in love with a particular type of equipment or be seduced into making a large inventory purchase in advance of any actual orders.

Morgan Senior was a ferocious trader. His father's letters to their partner George Peabody complain about the risks J.P. took. Peabody is more sanguine. He is happy to have the firm's "idle" capital put to use. Most of the time, the "idle" capital is a large sum because the firm's biggest allocation is to "money" itself - i.e. gold. Peabody's only caution for the junior partner is that he not lay on a trade that he cannot as quickly reverse. Since he trusts J.P. Morgan's character, Peabody reassures the elder Morgan that the firm has the right "crocodile" for the trading post. J.P. Morgan never stopped being a crocodile at heart. What his biographers described as investing - the railroad recapitalizations, the formation of U.S. Steel - were, in fact, large trades - using cash to turn bad old paper into good new paper. Sometimes, as with the maritime trust International Mercantile Marine, the trade failed. Only then did the paper become an "investment".

The only investments Morgan actually bought and held were art objects. When he died, he gave those away.

Yishen Kuik diverges:

In online first person shooters (like Quake, Doom, Counterstrike et al), 30 or so human players run around trying to kill each other. Scores are kept as a ratio of kills to deaths. In a WW2 game that I play, Day of Defeat, Allies and Axis platoons fight over a ruined European city much like in the movie "The Longest Day".

Whenever I find an advantageous spot to mount my MG42, racking up an impressive array of kills. I often find that staying at the same spot after such good fortune is a sure way to be at the receiving end of a soon-to-come barrage of grenades, sniper bullets and bazookas. Whether my spot is on a tower overlooking a plaza or at the end of an alleyway, my MG42 racks up the kills because of the careless behavior of my opponents who run clear across the plaza or right down an alley. I profit from those in my opponent's platoon with careless or fixed behavior.

However, their deaths at my hand are surely educational to them, and the next time they are at the alley, they will dart from doorway to doorway, just as they will stay clear of running clear across the plaza. Not only will my kills degrade because of the lessons they have learnt from being hurt, I can also be sure that they will seek revenge and pass my position onto their teammates. Soon, crosshairs will gather at my position, and a canny player knows it is best to be gone before then. Take 3 or 4 kills and then move on.

Perhaps the same is true in markets - when one has a strongly profitable strategy going, at the receiving end of one's strategy are a group of people nursing their wounds, cursing their suffering at the hands of an unseen opponent. They sit around thinking about what they did wrong and their behavior changes accordingly, depleting the profit opportunities for one's strategy. If one is big enough that one's opponents knows where to put those cross hairs, such as perhaps LTCM, then one's positions will surely be marked against one. Like the futures markets and poker, the scoring system of kills in first person shooters is a zero sum game.

Steven Ellison says:

Brains, particularly large brains, are energy-intensive. The human brain, comprising 2% of the mass of the body, consumes 20% of the body's energy. The return on investment of this seemingly excessive energy consumption is quite good, judging by the 6+ billion human population.

The survival of crocodiles during the mass extinction at the end of the Cretaceous period, 65 million years ago, is a mystery to many paleontologists. Crocodiles' cold-bloodedness and intolerance to cold present difficulties for any who would hypothesize that those characteristics doomed dinosaurs at a time of super-volcanic eruptions and/or asteroid impact.

James Sogi continues:

  1. Crocs are shy and reclusive.
  2. The croc is nocturnal and feeds primarily on crabs, fish, snakes, turtles, birds and small mammals, rarely anything larger than a raccoon or rabbit. Repetitive hunting 20 point trades can be hazardous.
  3. As is the case for many reptiles (and traders?), the mortality for hatchlings is high--90 to 95 percent.
  4. The croc does not have to eat for months at a time.
  5. Crocodiles can float or sink at will, finely tuning their buoyancy.
  6. Crocodiles are capable of breathtaking speed. Nile crocodiles have been known to reach speeds of up to 29 mph.
  7. Over a lifetime under a tropical sun, they may grow 4,000 times bigger. I hope your net worth does the same. (not your weight)
  8. Crocodiles have a variety of hunting techniques, ranging from simple, savage rushes to complex entrapment behaviors.
  9. Their exceptional sense of smell enables them quickly to capitalize on the demise of others.

Consider Trading like a crocodile. Look for repetitive action by the unsuspecting. Remember with good data. Make a science out of studying repetitive actions as quantitative traders. Consider hiding unseen in the water below the surface and when those lonely bars come wandering down below the surface as they do with regularity like at year end and day to day, the crocodile trader can grab on to a leg or arm and chew away. An example are break down failure bars and reversal. Another is in the daily/weekly range or trend, a lone low bar or two will drop and reverse, just like the recent 82 handles. Nice meal. If the mid point of any bar is like the surface of the water, on the entries, its good to buy under the half way mark of a bar and save exposure to the predators and hunters above. Why buy above the surface? Consider the mature trader who can wait months for a trade, then gorge on the 80+ points then wait has low vig and spare time. Its good to float or sink with the market and trade at low levels or high levels, whatever. Don't get confused with absolute values as its all relative. After the recent rally if one thought price was too high to buy...wrong... big 6 point gap up. Move fast, but be sluggish in between. Crocs have some good techniques for outlasting the dinosaurs. So should Crocodile traders.

Rich Bubb considers:

The shape of the alligator reminds me of that of an airplane wing--the bottom is much flatter than the top of the wing. Maybe natural selection was at play for a couple of reasons:

  1. Legs can be shorter due to less stomach-protrusion;
  2. Large contact when on 'resting-surfaces' (wet/underwater and on land/beach/stream banks);
  3. Aerodynamic principles at work when moving through watery medium where lift is created due to shape of object moving through medium provides economic energy saving movement-cost. all in all, a pretty efficient critter. not to mention deceptively dangerous.

From the Speculative Files

In 1989, when the reputation of traders in general was at a low amid a cheating scandal at the Chicago commodities exchanges, CBOT and CME seatholder Victor Niederhoffer wrote a piece called "The Speculator as Hero" for The Wall Street Journal. Until now, Daily Speculations has had only an edited version of the piece. We are now pleased to republish the unabridged article, discovered this week in the cavernous filing cabinets of the Webmistress. As politicians are once again in a flurry over oil prices, the defense of speculation outlined in the article is as relevant today as then.

Lord Byron, from A Las Vegas Whale

What I read today only confirmed what I have always known: This beloved strategist, formerly at a leading Wall Street investment bank, and the "surprises" he puts out every year are nothing more than a representation of how even the most ignorant and undeserving get to places and positions of so-called "prestige" and "dignity". What kind of strategist would speculate that society and the markets will be surprised by an Asian-born USA pandemic, or that there will be a major terrorist act in the USA, killing at least 100 people? What an embarrassment. And a shame. Not only are such events a possibility that would likely not be taken as a surprise, they are an insult to our great nation's efforts to diminish such risks.

My Top Three Predictions for 2006:

  1. No widespread illness that spooks the markets.
  2. No terrorist activity in the United States.
  3. Dow 12,000.

In Fond Memory of Lou Rawls, from Karaokist Charles Pennington

You know, there was a time when, if someone told you to do somethin', you did it. Bam! Right on! No questions asked. It was "Yes, sir" and "Yes, ma'am." You never said no. You know? Huh. But, you know, things are changing nowadays. It's a new day, babies. Folks want to take their own lives into their hands and make their own choices. No longer do they wanna go along with the program 'cause everybody say it's right. You know what I mean? Let me tell ya what I'm talkin' about, ya see, 'cause...
From A Natural Man, 1971

22 Years as a Gym Rat, by Craig Maccagno

Having attempted since age 18 to keep fit through multitudinous methods, I have spent countless hours at the gym. Come January, a similar pattern occurs every year. Scores of resolutes show up, clad in the latest fitness gear emblazoned with logos of this fitness company or that. Fresh-faced and eager to embark on their quest for "the new them," they pour in and begin their workout regimen. Once the real workout is under way and the sweat begins to drip, you can almost see the chinks form in the armor of their resolve. As the days go by and the soreness sets in, you can read their thoughts in their faces as plainly as if they were written on their shirts: "Boy, this is harder than I thought"; "I really don't feel like being here"; "I didn't think it would be like this." After a few weeks, the herd begins to thin. By early March, only a small percentile remains. Those who've passed that gauntlet usually become "regulars." All that said, I can't help but think how akin that is to the new traders armed with the latest charting program, a fresh Wizards book under the arm and a newly paid guru site subscription, ready to trade their undercapitalized accounts to riches, much like this trader in his early years. After countless drawdowns, losses, miseries, self-doubts and lamentations, I must assume that tenacity counts for something and wish them all the best.

Let's Vary Piracy with a Little Burglary, by Victor Niederhoffer

Come, friends, who plow the markets
Truce to speculation, take another relation
Let's vary piracy with a little burglary

10 burglary tips for speculators

  1. Track Records. Don't take them at face value. They often contain great rates of return. Often these are made with great results at the beginning with small amounts of money and house-generated trades. Pay strict attention to inflows and outflows. Often the "manager" can show 30% a year returns and still lose dollars overall. Beware especially of funds where the managers end up owning a large proportion of the assets. The only constant is fees, and that's the explanation. Same goes for the Sharpe ratio. A good rule of thumb: the higher the past Sharpe, the worse the subsequent expectation. Remember, the only way to get a high Sharpe is by Martingaling it. That's what casinos love. The only one who can grind is the house.
  2. Protect the entry. Just as many doors are hollow and easy prey for burglars, many entries are based on ephemeral factors with no foundation. Have a reason for all trades. Secure the trade with adequate capital so that a dealer will not be able to squeeze you out of your position without undue hardship. Remember that most squeezes are opportunistic: They follow the rule of least effort. If you're an easy target, with inadequate margin, a fixed time to get out -- "beware, oh you day traders" -- they'll squeeze you without even having to force the entry.
  3. Have adequate escape routes. You don't want to confront the enemy head on. He might be young and nervous and create a life-threatening situation. Be flexible in how you can get out. Never get cornered with just one way of getting out as this could lead to disaster. If it doesn't go your way in the expected time, will it still be good? If not, do get out.
  4. Viewing. Try to figure out who's on the other side of the door or trade. If you're trading with a bank for example, with foreign exchange do realize they make about $100 billion a year on their trades. Are you really that much smarter than they are? Of course not. Is there really going to be that much money left for you to profit from the total pool after they take theirs out? Same goes for the guys named "Doc" among the handful who still trade commodities such as rice or flax. They've been around for 75 years each, on average. In a zero-sum game, who's more likely to end up the winner? Think of the survival test popularized by Stigler, which shows that the most efficient companies and individuals are those who are most numerous and live the longest. Much better to trade on the opposite side of the ephemeral traders, the public, who invariably lose money.
  5. Vary your routines. Be sure to specinvest at different times of the day. Your adversaries are like crocodiles: They remember what you did last time, and they're not going to let you get away twice. Neither always a buyer or a seller be, except in markets where there's a drift.
  6. Don't leave clues. Don't leave newspapers or trade slips around that tell the adversary what you're going to do. Never telegraph the other side that you are a buyer or seller before entering the trade. And whatever you do, make sure that your positions are fungible so you can get out with any other counterparty -- not the original one you have the position on with, like you have to do most of the time in foreign exchange or options where the other sides know what your positions are at all times. Just as it's good to have neighbor park in your driveway when you're away, it's good to place other trades through your account so that the other side won't know at all times which way you're going and what you're planning to do.
  7. Create the illusion of security. Always remember that the adversary is guided by opportunism and least effort. If he thinks just a few ticks or few million bucks will cause you to exit, or be tripped on such things as a barrier option, you're gone. Send money to the clearing firms promptly, and always take the calls of your counterparties even when you're in the hole, of they'll know you're on a trip to ruin.
  8. Keep a routine mien. Just as the homeowner should always keep some shades and blinds up, the specinvestor should always have a semblance of activity even when petrified with a terrible position. Call for a quote in normal everyday routine. And whatever you do, never leave a message on your answering machine that you're out of town (or can't meet a call).
  9. Lock the door to attached trades. A cascading series of losses can do you in just as surely as poor security on your main positions. I heard of a trader who could have made a fortune on options and U.S. stocks in 1997 if he hadn't been hit with a cascading loss when the enemy broke into his positions in southeast Asia. Burglars often enter through garages; the positions you're not as concerned about are much worse secured than the main ones.
  10. What to do after the burglary. No matter what I say, let's face it: We are going to be victimized. After the specdectomy has occurred, don't rush right back into the market. The adversary might still be there. And they are better armed and prepared than you. Once burned is enough. Take a break. Go to a neighboring house and call the Specbusters for advice.
Thanks to the Burglary Detection Council

J. T. Holley comments:

One of the greatest tricks the Devil plays is convincing everybody he doesn't exist. Think of the guy who robs you, knows he's taken from you, then devotes time afterward to trying to "help" you find what you've thought you lost. While in college in dormitories I was victimized a couple of times with CDs, bikes and such coming up missing. I always suspected the guys who were overly sympathetic and "Johnny on the Spot" to help me look for what I thought I lost. They really do come back to the scene of the crime! I imagine they do in markets as well. I've been set up in poker games by more skillful players using the same principle. They don't take me down with "one big theft," they take the chips over and over before I know I've been robbed -- sucked in on emotions thinking the pot owes me something.

One suggestion that was handed down to me, of course after the fact, is to photocopy all the contents of your wallet. Make copies of debit cards, credit cards, driver's license and such. Once you've been robbed, then you have an immediate record to go back and start calling all accounts to inform them of the mishap. I learned the hard way after being mugged in New Orleans after, ironically, getting directions from a police officer on horseback.

James Sogi remarks:

Look at burglary from the other side, not the home owner, the guy in the mansion, but from the crook's view. Some of us are probably closer to the small time criminal in the markets than we are to the homeowners. There has been a spate of burglaries in our neighborhood. It was the guy up the street, probably a crack addict. His girlfriend drove him around and he would run on foot in the middle of the day when he knew most people are at work and run in, grab a few easy things like a laptop and run out. The car wasn't in the driveway for people to easily see. The cops staked him out and nabbed him because he kept doing the same trade over and over. His mistake. What he did do that was smart was to work fast where no one was home. Just knock, or look, and if no one home, hit and run. Most houses are unlocked around here. This is a good modus operandi for a trade. Take the trades where it looks like no one is around. Why fight GS? Pick up the easy stuff, hit and run. Be wary. It s no use ever getting caught. Even if you give up gold hidden, its not worth the one time getting caught and ending your career. Don't hang around the house, fall asleep, watch a movie, or starting eating food. One, you'll leave evidence, and leave your modus operandi around for them to track you. Two, it increases your profile, your window of getting busted. Don't try to haul away Fort Knox. Switch neighborhoods. Go to a different town. For the private trader, depending on the account's risk profile, how much leverage do you really need on your retirement plan? Don't increase your chance of getting caught one day and going up the river for an all expense vacation at Sing Sing breaking big rocks into little rocks, and getting an new sledge hammer for Christmas.

Look at Kevin Mitnick, The Art of Deception, Controlling the Human Element of Security, who was a famous hacker turned security consultant. He uses what he calls 'social engineering' to con people by analyzing the weaknesses of the soft human side of crime as the vulnerable part. He preys on natural human tendencies and his innate skill to take advantage to gain trust and access to otherwise secure sites, through the front door rather than breaking an entering. He has several techniques. Use innocuous information to use later to gain confidence from gate keepers to gain access. Innocuous information like the name of a supervisor, or the number of the branch store. Use sympathy, guilt to gain information from entry level employees. He impersonates repairmen, supervisors, employees, police, investigators, using innocuous information he got before to convince inside employees to grant him access. Another source of information is on line where manuals and inside information is unsecured and available to outside parties. As applied to finances, it looks like a certain bankrupt broker did a certain amount of social engineering in going public. It looks like Enron social engineering to the public and their various brokers to make the private deals. But for the the regular trader, the knowledge of social engineering is used for understanding the doorkeepers of the citadel and the participants. Even relations with the broker need some engineering at times to keep the accounts correct and keep the broker moving along with you. The market itself, and the participants have traits and weaknesses that can and should be engineered to profit. As an security adviser, Mitnick tells the clients to think on both sides, and see how the attacker thinks.

The key here is to be able not to only think defensively and hunker lock down mode, but to understand both sides of the human element that is integral to the markets.

Steve Leslie adds:

The Captain Hook principle: Understand how an alligator eats its prey.

I learned this from Vic Sperandeo's book Methods of a Wall Street Master. He mentions this on pg 15. "The more the victim struggles the more the alligator gets. Imagine an alligator has you by the leg: it clamps your leg in its mouth and waits while you struggle. If you put one of your arms in the vicinity of its mouth while fighting to get your leg free, it lunges and then has your arm and leg in its clutches. The more you struggle, the more the alligator takes you in. So if an alligator ever gets you by the leg, remember that your only chance is to sacrifice the leg and drag yourself away. Translated to market terms, the principle is when you know you are wrong, close your position!"

Aron Ralston describes in his book Between a Rock and a Hard Place how he broke his radius and ulna bone in his right arm and then self amputated his hand at the wrist after being pinned under a rock for 6 days in Utah's Canyonlands National Park.

This illustrates clearly what happens when you are in a bad trade. Be an adult, don't rationalize, don't pout, don't freeze, don't call your mom, admit you were wrong and sacrifice the hand to save the life. Most importantly live to fight another day. Accept your humanity. Look rather as a bad trade as suspension of success. Vince Lombardi said "We never lost a game we just ran out of time."

And in the timeless words of John Maynard Keynes "the markets can remain irrational much longer than you can remain solvent."

J. P. Highland recalls:

In a previous mail I mentioned that among my trading rules is one that prevents me from trading Dow Jones stocks, famous Nasdaq stocks and oil related stocks among others. The reason I chose not to trade stocks like GOOG, XOM or INTC is high competition, I suspect that institutions like Merrill Lynch or Goldman place their best traders in these stocks and I also considered the fact that the best Specialists and Market Makers are behind them. And not to forget computer programs ("Nintendo Vegas" as Marty Schwartz says) who produce funny movements.

The stocks I trade are not glamorous, s#xy or appealing, I would never buy them and hold them overnight, they just stink! But they've been good to me so I have nothing but to wish them the best.

Intelligence, Discipline and Success, by GM Nigel Davies

This article reminds me of a discussion I once heard between some US chess players. They were trying to tack bits of different players together to create an overpowering Frankenstein's monster, with Fischer's early middlegame, Reshevsky's endgame, Christiansen in the attack, etc. "You can press the clock, Fed," I quipped to John Fedorowicz, which he found a lot funnier than some of the others did.

Amongst the many problems with this kind of analysis is the need for synergy between the different aspects of someone's game. Masters develop a way of compensating for any weaknesses they might have with habits and thinking routines. Put these in another player and they might well confuse the heck out of him.

Vis a vis intelligence, three of the smartest and most talented chess players I've come across are Anand, Har Zvi and Rudd. Rudd? You've probably heard of the first, maybe the second, but I doubt you've heard of the third. Do brains matter? Yes, of course. But the proof of the pudding is in the eating.

Here then is my magic formula for knowing the good players from the bad:

And it doesn't matter if he's a self-disciplined genius if all he can do is lose.

Changing Cycles, by Jason Shapiro

OK, home gamers, here we are at the start of another new year, and while it's just another turn of the calendar, let's see who can make some accurate predictions. The asset we will focus on today is the 10-year yield, since I'm told this is where fundamentals play out the best and since this is the market that affects all other markets. Just to make it more interesting, I am looking for a forecast for 10-year yields going out three years. The yield right now is 4.25%. I will make the game a bit easier by giving a few hints:

In the next three years the following will happen:

  • Oil will go up 130%
  • Natural gas will more than triple
  • Unleaded gas prices will rise 150%
  • Copper will go up 190%
  • Gold will go up 45%
  • Silver will double
  • GDP growth will exceed 3% for 10 quarters in a row
  • The CRB Index will be up 40% and finish the period on its highs
  • The Fed will raise rates 12 times in this period

    If you guessed 10-year yields will be the same in three years as they are now, I have some good news and some bad news. The bad news: you are fired from your job because you obviously have no idea about economics or markets. The good news: you were 100% correct because this information was given to you on Jan. 1, 2003, and in the ensuing three years all of these things happened and 10-year yields were unchanged over the period.

    The point is, many of us are focusing on the wrong information. Our job is to make money in the markets, not predict future events. These data show that you can accurately predict future events like nobody on earth yet still be totally wrong on the market. The markets are not about the underlying fundamentals, they are about discounting -- over-discounting and under-discounting, just like any endeavor that involves gambling.

    Now, let's go ahead and look forward. The main thing I hear is that there is a major shortage of oil going forward. I do not doubt this, in particular because I know very little about the supply of oil since I have never visited a Saudi oil field, but what I don't doubt is that suddenly everyone is an expert on oil supply. It was only a few short years ago that I got laughed at for paying attention at my desk each Tuesday (yes, it was on Tuesdays back in the old days, home gamers) when the oil statistics were released. Now this release brings a hush over hedge fund desks and is broadcast live from the pits on CNBC. What this tells me is that we are in the midst of a very frustrating time for those trading oil. Too many participants watching too many data leads to whippy markets that get net nowhere. Oil may very well be the least supplied commodity on earth and the Chinese may quadruple the number of cars they own, the Saudi oil fields my be left with nothing but air, and oil may be on its way to $300 a barrel, but none of this means that for the next 12 months oil won't trade in a big trading range, thus frustrating all those who partake enough to get them out of the market before the next leg up.

    The next thing I hear about is emerging markets. Surprisingly, what I hear after these markets have had historical moves up over the past 24 months is that they are once again due for a large correction, just as they have always done in the past. Anyone who knows anything about these markets (read: those who have traded them for the past 10-15 years) knows that these markets always have large run-ups and then come crashing down. Only when these crashes happen, so goes the logic, is it time to step in and load up. This helps explain why so many emerging market hedge funds spent last year earning single-digit to low-teen returns while markets in South America, Eastern Europe, and Asia were up anywhere from 30%-70%. As I have said many times before, there is nothing more powerful then a trend that most participants are fading. Here is where that case is in play.

    The next asset to concentrate on this year is gold, and by extension silver. While the energy markets have stolen the headlines the past two years, these metals have been climbing steadily, much to detractors' dismay. Markets have a way of surpassing previous bull-market highs, and in the case of silver we are looking at $41, and even if you take the 1980 spike high away, still around $22. For gold, the historical high is around $870, and $720 without the 1980 spike. There is a long way to go to these points from the current price of $9 in silver and $520 in gold. Do yourself a favor and forget about dollar moves when looking at these because that relationship, like all relationships when they get over-watched, established itself as dead last year. I hear a lot of pseudo-contrarians arguing with the metals call, saying it's moved too much and there are people everywhere talking about it. I have to disagree. From a retail standpoint there has always been a contingent of gold buyers waiting for the end of the world. The fact that retail trade in gold coin dealers is up recently tells me these people are finally selling their coins after waiting 20 years to get their money back. From an institutional standpoint I think the important thing to remember is that trend-following systems have no been very successful trading these markets for the past 20 years. The same was true for energy markets up until two years ago, which is why these systems were very underweight energy markets during the run-up and had paltry returns during that period. While trend-following systems may be long these markets, the weighting is still very low compared to the historical trending markets such as interest rates and currencies, which of course have not seen a trend in years. Of course the last major participant, the central banks, sold their gold on the lows back in the late nineties when they decided gold was a poor store of wealth. Who can forget the Bank of England's monthly auctions for their gold reserves? Maybe these banks start buying this gold back now, or maybe they wait for $800 an ounce; either way, it's going up.

    Last is the bond market. As I have said for the past two years, bond rates will rise as soon as the Fed stops raising rates or, in the current market environment, indicates it will stop raising rates. The bond market, and particularly the long end of the yield curve, is a discounting mechanism for future inflation. As long as the Fed is raising rates and containing inflation, bonds won't go down. As soon as they stop doing this bonds can begin to discount the possible error. I think it's important to remember that just because the Fed stops raising every meeting it doesn't mean the next move is a cut, which is most likely what the market will start to believe at some point. The Fed will pause, rates will start to rise as the metals and other inflation benchmarks rise, and soon the Fed will resume rate raises, again thus stopping the fall in bonds. My best advice for this market is short it when they stop, and buy it when they start again, in particular if they start by going 50 bps at a time. This idea is just as counterintuitive as it was two years ago and will perhaps be just as good.

    Jason Shapiro is principal of AST Capital in Westport, Connecticut.

    Stock Research from Down Under, Noticed by the Senator

    A researcher at the University of New South Wales (UNSW) has made headway in explaining one of the enduring mysteries of the financial markets - and it could change the way we invest.

    UNSW School of Banking and Finance Professor Peter Swan has investigated why equity investments, like shares or units in a managed fund, on average outperform the bond market by an annual six to eight per cent. This phenomenon is known as the equity premium puzzle. Australia has a high equity premium and even lower return on government debt, he said. Professor Swan suggests his model can help identify illiquid equities, that is, stocks that do not trade very often but have the right trading characteristics.

    "This is important because those stocks that investors want to trade, but choose not to because of trading frictions such as high transaction costs, are likely to command higher returns," he said. "If you don't want to trade much then you would be better off with such a portfolio."

    In a working paper titled, "Can Illiquidity Explain the Equity Premium Puzzle?", Prof Swan said that equity markets are highly illiquid compared to government securities such as bonds. "My contribution to (the puzzle) is that we can't just look at the direct impact of transaction costs on returns," he said. "We have to look at the indirect impact in terms of interfering with our ability to achieve desirable risk minimizing portfolios." Prof Swan added: "When you take into account indirect effects it would appear that even in small transaction costs do seem explain much of the equity premium puzzle, and a variety of other puzzles as well."

    His model illustrates that the equity premium is no more than compensation to equity holders for the adverse effects of illiquidity. Prof Swan's work also helps account for the term "irrational exuberance", a phrase coined by the US Federal Reserve chairman Alan Greenspan.

    According to Robert Shiller, of the Cowles Foundation for Research in Economics and International Center for Finance at Yale University, the term "irrational exuberance" is often used to describe a heightened state of speculative fever. "What this is referring to is the high volatility observed in asset prices ... the big booms and the crashes we see in stock prices which are not nearly as prevalent in government securities," said Prof Swan. "This is not easily explained within the standard finance paradigm, which states that the price of any stock depends on its expected dividends or earnings." Prof Swan provides a theory for why stock prices are so volatile when dividends are stable and earnings are relatively stable. "The biggest benefit of all is from the security that is associated with volatility in the returns and prices for the stock," he said. "We no longer need the new field of behavioural finance to explain excess volatility."

    A Visit to the Chemist Stirs Galtonesque Ponderings, by Sushil Kedia

    Each time that I walk down to the nearby chemist to pick up toiletries, routine medicines and supplies, accompanied by my seven year old daughter, the same question arises:

    "How does this fellow remember exactly where which medicine with a tongue-twister of a name is stored in his shop?"

    Additionally, one starts one wondering at the alacrity with which instantaneous answers pop up as to the available quantity, expected time for fresh stocks to come and alternative brand recommendations for the same drug. No other professional or merchant I have seen to have as a class the same expertise in recalling quickly stacks of information from their minds about the storage patterns of their merchandise.

    I wonder, what rules of the thumb, memory mechanisms and back of the envelope ideas one could enlist for the price structures that one routinely faces in the market?

    I checked with several of the chemists of late and found each has his own way of organizing medicine: sachets, ampoules, packets, vials. No one particular method offered clues worth reporting. But still I wonder, what is it that the profession of retailing medicines has in it for us those of us handling prices?

    J. T. Holley adds:

    Librarians have that Dewey Decimal System? Ever seen a mechanic and his tools? It is amazing though to see this in action and watch one at his trade that demonstrates efficiency through classification. Speculation must be enhanced or improved if this were done. One would argue that it is almost an extension of the scientific method. The downside I guess is that in an ever changing realm it might lead to being to rigid or robotic.

    Russell Sears responds:

    My wife is a pharmacist. Often she subs, she tells me that the top 200 drugs are all she has to know where to find. This would be an impossible task for me, but for her, a master organizer, she has this in a day at a new place. Local Doctors often are the key, in why this is limited, as most are limited in what they can or will master, in drugs. A pharmacist can often recommend a better regiment than a doctor, because they master why two drugs that do the same thing differ. Doctors will often listen to a pharmacist's recommendations. A lesson in where you get your advice from, it's not always the smartest richest guy, as he is too busy to worry about the small details, you.

    Another lesson is, "execution is paramount" we lose money they lose lives. Double check, and then hand it to a tech to check again. Repetition of the same order of events is important. Filing and record keeping are also paramount, knowing  reactions to each drug and interactions between drugs. Again some poorer doctors often let you worry about the details here. Patients often don't tell their doctor or pharmacist everything such as taking herbal cures that react to your meds. Responsibility for all your positions, not pigeon holing some assets as "special" and how they interact.

    Piracy and Markets, by Victor Niederhoffer

    I have been inspired by rereading the quintessential pirate story Treasure Island by Robert Louis Stevenson to consider the lessons that pirates can teach traders. The beauty of Treasure Island is that it describes men at work, trying to make a living under difficult constraints, limited by money, time and provisions, and inspired to take risks by the hope of finding a treasure of gold. The goal of achieving treasure, amid the uncertainties of the weather, money, loyalties and knowledge, forms the backdrop for conflict between the pirates and the merchants described in Treasure Island. It's similar to the conflict between floor brokers and the public in the markets. Here are some of the useful lessons:

    1. Flexibility is key. The pirates were always on the move. They constantly changed their strategy as the distance from expiration of their quest for gold varied. They were quiet, competent, and peaceful at the beg inning of their journey but quite ready to take risks near the end. Long John was a master at changing his plans as the balance of risk of dying and reward from the gold changed. Long John changed allegiances on a dime, depending on reward versus risk of long or short the gold. Pirates were always on the move in those days, never hitting the same place twice. For example the Vikings as described by Juan Cabal in Piracy of the North "After seizing all the goods of any value they would set fire to the polace, and take to sea again with their booty, carrying off in addition a large number of women" for example changing allegiance from pirates to treasure hunters on a dime.
    2. Importance of escape hatches. The pirates always had ample escape hatches: keeping the boy as hostage, and holding the escape boats on Treasure Island to get away in a pinch. They were ready to go back with Captain Smollett if worst came to worst if only he would use his charts to navigate them back to safety. If all else failed, they were ready with the Hail Mary defense of begging for clemency should their escape be impossible.
    3. Emphasis on short term planning but lack of long term planning so typical of the day trader as they get drunk every night and don't keep good watch and go berserk when the nearness of the treasure chest beckons.
    4. Expert use of duplicity at all times, pretending to be cooks and ordinary seaman and getting hired as able seaman on just the right treasure boat, thereby front running the squire and his party in a fashion so similar to that described by Harris. There are more double crosses and false signals given in Treasure Island than in a typical day of trying to fathom what the next big announcement is going to be, and the market's attempt to fake you out of a good position that you might have luckily put on.
    5. The ability of the uneducated man. All the pirates were former mutineers from merchant men or men of war, and the Stevenson pirates were all carefully modeled from the very competent crew of Black Beard who performed much good work in supplying South Carolina with Spanish and English goods during trade embargoes. All were extraordinarily competent at their jobs. They could navigate, cook, fight, sail, and see through a man at first glance . They could survive on a desert island for many years as Ben Gun, a Robinson Crusoe like character, did in Treasure Island. They remember landmarks and entrances and shoals almost as well as Jack Aubrey himself. I am reminded by this that the common sense of the traders on the floor is far superior to that of the average upstairs trader despite the disparity in education levels. To underestimate such pirates or traders is the kiss of death as it was to so many of the Treasure Hunting party. My mentor Irving Redel, a 50 year floor trader on the COMEX, didn't know anything about computer models for arbitrage pricing but he regularly took on the greatest mathematical model teams from upstairs and made mince meat of them with a good head, an instinct for survival, and inexhaustible common sense.
    6. Division of labor is critical. There was a strict division of labor among the pirates with the cook being especially competent at economical, tasteful, creative and sanitary handing of the provisions. There was honor among thieves: no one could dispose of the captain until he was given a fair trial and no stealing allowed from each other. How similar this is to the pirates we meet with in our trading whose word is their bond and would rather go broke than dishonor a commitment to another member but would take no prisoners vis-a-vis the trades with the public.
    7. Take no prisoners. Except for Long John, all the pirates adhered to this view. When they had an edge, they went for the kill. Otherwise, the victim might come back to make mischief for them in their careers as tradesman in the end.
    8. The deadly role of superstition. The pirates were afraid of spirits, shadows, and ghosts. Ultimately, the fear of the ghost of Flint, allowed the treasure hunters to regroup and defeat the pirates in battle just when they were on the point of finding what they thought was the treasure.

    Prof. Gordon Haave replies:

    Pirates knew how to motivate even the lowliest of their crewman, with every member of the crew sharing in the bounty. This is similar to the structure of successful trading firms.

    Similarly, they knew how to motivate their adversaries, the merchantmen that they attacked. Pirates treated the crew of merchantmen that they attacked relatively well, and often offered them positions on their ships. Thus, the crewmen of an attacked merchantman really had no incentive to put up much of a fight. This is similar to the incentives that buy-side firms set up with sell-side analysts. If sell side analysts do favors for buy side firms for a while, they can often jump over and get good jobs.

    Jason Ruspini offers:

    Be wary of narrow straits that see a lot of commodity traffic like Malacca and localities where oil or gold might trade. It is nice to rename loot as "tax" or "slippage".

    J. P. Highland adds:

    I have a long list of rules that I follow religiously and that has kept me alive in the dangerous game of Day-Trading.

    My list of day-trading rules is diverse, it includes things like "Don't drink anything that might contain alcohol from Sunday afternoon to Friday afternoon" or "Don't touch Dow Jones stocks, oil related stocks, home builders, Nasdaq stocks, ADRs or ETFs," or "If you can't pronounce the name of the stock, don't trade it," but the the most important rule, the one that I have in golden letters is "Don't lose money!"

    I suffer from anxiety so for me holding a position for more than 30 seconds is an eternity and I also hate to lose money, that's why I scalp, scalping is a method that fits my personality and you can't have a trade that is different from your nature, that's something I learned from Marty Schwartz's book Pitbull.

    Do I have a plan for the long-term?  Yes I do, but I won't reveal it now. It is midnight and I like to turn on my trading station no later than 8:00am.

    Mr. E. says:

    Modern piracy still exists--the use of bots on the internet to hide identity, knockouts used in electronic piracy, using chat rooms by evils to lure unsuspecting boys while claiming innocence, liquefying cocaine and shipping it as wine, mafia setting up dummy companies to ramp in schemes, using derivatives by Enron to protect the CFOs larceny, and the Malacca Straits.  The list is endless as the relatives of Black Bart still have his genes.

    Andrew Moe remembers:

    Captain Blood is trapped in a port sealed off by a mighty fort and the Spanish Armada.

    "'Don Miguel, the Spanish Admiral, have offer' us safe passage to sea if we will depart at once, do no damage to the town, release our prisoners, and surrender all that we took at Gibraltar.'

    ... A smile irradiated the face and eyes of Captain Blood.

    'I have answered him that unless within four-and-twenty hours we have his parole to stand out to sea, ceasing to dispute our passage or hinder our departure, and a ransom of fifty thousand pieces of eight for Maracaybo, we shall reduce this beautiful city to ashes, and thereafter go out and destroy his fleet.'

    The impudence of it left Cahusac speechless. But among the English buccaneers in the square there were many who savored the audacious humour of the trapped dictating terms to the trappers. Laughter broke from them. It spread to a roar of acclimation; for bluff is a weapon dear to every adventurer."

    Rob Fotheringham adds:

    Regarding piratical changes of strategy, according to David Cordingly in Under The Black Flag: The Romance and the Reality of Life Among the Pirates, their often zigzag courses between destinations, as well as their frequent changes in intended destination, were due to the frequent changes in collective mindset among the crew, not to overt strategic manipulations by the Captain. In fact, the Captain was typically given unilateral decision-making authority only in battle, when quick and decisive pronouncements were considered tactically necessary. While democratically chosen and thus replaceable at any time, the Captain did earn five or six shares of booty to a single share for the average crewman.

    One "change" pirates used to gain strategic advantage was the flying of legitimate country flags to get close to their intended prey before hoisting their own pirate flag. Black, and sometimes red, flags with some symbol of death were common: skulls, swords, pistols and flaming balls. They were intended to inspire dread and quick capitulation by the victim ship. Some flags bore images of hourglasses to reiterate this point. Mercy seems to have been displayed more frequently toward the captured crew when they gave up without a fight. Also, pirates tended to significantly outman the merchant ships upon which they preyed, since the merchants kept crews small to maximize profits, so after disabling the victim ship by shooting away a mast or wedging the rudder, and then boarding, the game was essentially over.

    Likenesses to the world of speculation? In 1999 I attended an "Auditing Derivatives" conference in Florida where I happened upon several poor fellows tasked with exerting financial control over the trading environments at various energy companies. After dispensing with formalities, it became abundantly clear that the traders, emboldened by recent successes, had been given the green light to run roughshod over anybody who stood in their way. In the parlance of Liar's Poker, they were BSDs, and no green-eyeshade in management, or energy buyer in California, for that matter, was going to stand in their way. Also, when the margin call cometh, is it not accompanied by stern assurances that quick capitulation will make things easier for all?

    Consider another parallel between pirate ships and trading floors; the paucity of women. Typically Articles signed by all crew members prohibited bringing women on board due to the resultant jealousy and strife, with violation punishable by death. A few exceptions describe women who were notably tough. They could perform any task on the ship and were more motivated to demonstrate their worth than the average crewman, and, according to those captured, even more foul-mouthed than the other vile dogs.

    Thievery among thieves was not always punished as severely as one might think. Sometimes first-time offenders got off with as little as a nose or ear slitting. Marooning was a common punishment, and they were often given a sword and pistol to increase their chances of survival. Do not the wraiths of the bowery suffer a similar fate?

    The golden age of piracy, which Cordingly identifies as 1650 to 1725, was kick started by the legalized plundering of the privateers. In addition to virtually increasing the size of the British navy, the Crown had a specific financial interest in granting letters of marque; in addition to the government vig on every take, the Queen was known to make direct investment in privateering ventures. After paying back investors and the government, the average privateer might be left with as little as 10% of the original haul.

    The Crown rewarded its faithful privateers with titles, e.g. Sir Francis Drake, and positions, e.g. Captain Henry Morgan in the Caribbean, and at times tapped their knowledge to protect British merchants. To the Spanish, those men were the vilest of pirates and worthy only of a painful death.

    Bring in the New Year with some fresh BBQ Ideas from Our BBQ Section!

    Texan tips for a Mexican feast.. Alston Mabry's cornbread recipe.. Learn how Pam van Giessen ate five pounds of fudge and still lost 10 pounds in three weeks.. Get the buzz about the best coffees in the world and how to make a Turkish cuppa.. Tea recommendations from the Chair.. Chai secrets from all over the world.. And much more on good eating and drinking from our far-flung correspondents.

    Venceremos!, from Bruno Ombreux

    Che Guevara wrote the book on guerilla warfare, "La Guerra de Guerrillas". There is so much in this book that can be applied to speculation, particularly by small guys like me fighting the big institutions, which is what guerilla is all about. For instance, the first chapter, "Essence of Guerilla Warfare", starts with this summary:

    Consideramos que tres aportaciones fundamentales hizo la Revolucion cubana a la mecanica de los movimientos revolucionarios en America, son ellas:

    We can adapt it for the small trader, loosely translating as:

    We consider that the Cuban revolution brought three fundamental principles to the mechanism for speculation in America:

    The Savings Rate, from Kim Zussman

    The personal savings rate is negative, which is too low, according to San Francisco Fed economist:

    The article suggests consumer's low savings and increasing debt are result of asset-price appreciation in holdings of stocks and real estate. Why save more if stocks increase 10% per year, and the house doubles in value every 5 years?

    George Zachar finds:

    A dissent on the savings rate:

    There are many reasons to discount these statistics. For example, when a car, home appliance, or computer is purchased, the entire expenditure is immediately subtracted from income, even if it is paid for over time. Spending on education also counts as consumption. But, these expenditures are investments and on a set of corporate books would be treated much differently.

    While 401ks, IRAs, and other savings plans are accounted for, capital gains on these assets or on a home do not count as income. However, taxes paid on capital gains subtract from disposable income, a downward bias.

    As our population ages, a growing number of retirees spend out of savings, which also biases the statistics downwardly. In addition, the government has a difficult time separating business spending from personal spending because so many small (and large) businesses buy office supplies and construction materials at retail outlets (such as Office Depot, Staples, Home Depot and Lowes). To the extent that government counts business spending as consumption, savings will be undercounted.

    Read full story.

    Gregory van Kipnis adds:

    Savings = Personal income less personal consumption expenditures Over time there have been downward biases in measuring income and upward biases in measuring expenditures. We may have the best economic data in the world, but it is still weak in many areas and the agencies don't get much budget increases to fund better data gathering efforts.

    Income is underestimated and expenditures are likely overstated. For example: underground income (street vendors, cash contractors) are not included in income, yet those folks buy food and cars, items which are picked up in the expenditures data. Expenditures, however, are easily over stated. eBay is a marketplace for selling previously bought items. If they are counted twice (once when the Coach bag was bought and again when it is re-sold) expenditures are overstated. Another example is Costco. Much of what is sold is not to the final purchaser. Mom and pop business and restaurants re-sell what they buy.

    Last year Barrons estimated the underground economy at $300 billion. Others who include gambling and other 'illegal' activities, think it is much higher. Then there are all the other points made about capital gains and the taxes associated with them. Capital gains are NOT included in personal income, but the taxes paid on cap gains ARE subtractions from income. Then there is savings in the form of wealth increments from savings plans, retirement plans, etc. Americans aren't stupid. They are not dissavers, as a whole. Our market economy keeps us all humming along looking for ways to make a buck and avoid taxes and save for a rainy day.

    The Friendly Skies, by James Sogi

    On my way to the beach for a surfing/camp trip over New Years I had to drop off a package on the way at the airport and was astounded at the traffic jam of private jets lined up at the airport. In the DailySpec tradition, I counted 51 private jets lined up at the airport, surpassing the previous highest year 2003 count by seven. Of those, only three were the small private jets; the rest were 737s and shiny 16+ passenger models. If this is a leading indicator, then next year portends well. If it is a lagging indicator it shows why last year was good for business. I tend to go with the leading indicator theory based on 2003 results and knowing who some of these folks are.

    George Zachar replies:

    I do the same counting at the Aspen airport, and this year not only were there ~40% more private aircraft than in recent years, but the landing slots available were inadequate to meet the demand, forcing many diversions to nearby fields. History indicates such spurts are coincident indicators of wealth creation, according to my two decade history of visiting Aspen.

    A Las Vegas Whale adds:

    The number of, and even more importantly, the access to, private jets has gone up approximately ten-fold in the last five years. And the idea or representation of being a private jet owner is tres chic. Despite public opinion, the price trend and costs associated with private chartered flights to Las Vegas and the Bahamas have diminished in recent years. Competition, you name it.. More of a fad that has become more visible than ever before than a sign of a hidden boom in net worths.

    George Zachar replies:

    The cost of flying private from NYC to Aspen in a smallish (8 seat) jet is ~$1,200/seat/hour. That's a large multiple of even 1st class airfare. The proliferation of NetJets-like fractional ownerships and charter opportunities has made such transport cheaper, yes, but it is still an option for only the uber-rich, of which, apparently, there are more these days.

    The Assistant Webmaster mentions:

    A new generation of ultra-cheap private jets is just appearing on the market, which, by simple supply/demand logic, will cause a substitution from public to private transport, regardless of wealth creation or other macro considerations. An everchanging cycle.

    Grassy Knowledge, from Prof. Bud Conrad

    It is unlikely that Castro was behind the JFK assassination.

    But Johnson could. The key question in mysteries is: Cui Bono? Castro didn't get much. Johnson got the Presidency. So where is this story coming from?

    Hold the Bubbly, by Victor Niederhoffer

    That was the thought fizzling through the world as the market declined from 1276 to 1255 last week (Dec. 23-30) and December ended down one-third of a percent for the month. As the chronic pessimist -- bearish in print continuously since Dow 800 circa 1966 -- put it: "The markets, shaken in the final days of '05 by premonitions of woe induced by the coming of the infamous inversion of the yield curve..." thereby increasing his normal bearishness to fever pitch. He indulged in a bit of slapping himself on the back:  "Our friends, all two of them, warned us we'd be sorry if we insisted on continuing to be bearish. We continued to be bearish and look what happened... a stock market crash, recession, 9/11, and Iraq.... Boy, are we sorry!"

    But, but, but. The last big decline we had in December was the -6% in 2002, and the market went up 25% in 2003.  Conversely , the last big rise we had in December was the 5% rise in '99 and the market fell 17% in 2000. Perhaps a bad December is not as bad as the chronics would have it. Indeed, perhaps it sets them and their fellow travelers up with uncertainty and doubt, and leads on average to good tidings in the next periods.

    Let's do something that's completely alien to mumboists and cultists: a little counting with pencil and paper. A good start is to look at every December S&P close from 1949 to the present and look at the relations between December moves and subsequent changes. One notes immediately that December is a bullish month. Indeed, the number of declines for December by decade is:

           # of Dec
    Decade Declines
    1950s     2
    1960s     3
    1970s     2
    1980s     4
    1990s     1
    2000s     1

    The average change is 2.2%, with a mere 13 declines out of 57, a 22% batting average. This is 4 standard errors away from a 50% expectation and 2.5 standard errors away from a 40% expectation.

    A stem-and-leaf of the moves shows a nice clustering around +4% and 5% with an avoidance of 3%, with two rises of 11% and the largest decline of the last 56 years, -6%, in 2002.

    Stem and Leaf of Dec Moves (%)
     -0  0 0 0 1 1 2 2 2 3 3 3 4 6
     +0  1 1 1 1 1 1 2 2 2 2 2 2 2 2 3 4 4 4 4 5 5 5 5 5 5 5 5 5 6 6 6 6 7 
    +10  1 1

    An enumeration of the 13 declines shows a tendency for bad Decembers to be followed by rises:

                Next  Next  
         Dec%   Jan%  Year%
    1955   -0     -4      2
    1957   -4      4     38
    1966   -0      8     22
    1968   -4     -1    -11
    1969   -2     -7      0
    1974   -2     12     32
    1975   -1     12     19
    1980   -3     -5    -11
    1981   -3     -2     15
    1983   -1     -1      2
    1986   -3     13      2
    1996   -2      6     31
    2002   -6     -3     25
    Average     +2.5  +12.8

    Thus, the average move in January following these dismal Decembers is +2.5%, with a range of -7 to three moves in the 12%-13% up area.

    Similarly, we note two bad years of -11%, one in 1969 after a December decline of -4% and another in 1981 following a December decline of -3%. These are counterbalanced by the five rises of 20% and above.

    In short, the dismal performance in December, which is sure to be crowed over by the bears, is quite bullish from a seasonal standpoint. But please, no one remind me that I don't believe in seasonals!

    Yale Hirsch replies:

    Shouldn't Decembers be analyzed differently from other months, rather than counting?

                Next  Next  
         Dec%   Jan%  Year%   Comment
    1955   -0     -4      2   Lost only a smidgen
    1957   -4      4     38   End of bear (dumping losses)
    1966   -0      8     22   Lost only a smidgen 
    1968   -4     -1    -11   Preceded bear
    1969   -2     -7      0   Continued bear
    1974   -2     12     32   End of bear (dumping losses)
    1975   -1     12     19
    1980   -3     -5    -11   Preceded bear
    1981   -3     -2     15   Preceded continuing bear
    1983   -1     -1      2   Preceded losing year till December
    1986   -3     13      2   Preceded 1987 Crash 
    1996   -2      6     31   Profit taking in last two days of month
    2002   -6     -3     25   Anticipation of Iraq invasion

    Ode to a Rally, by James Sogi

    (Sung to Bob Dylan's Desolation Row)

    Sometimes it's best to do nothing
    and allow the trade to go
    up to the higher prices,
    where they were a week ago,
    then sit there enjoy the profits
    with your hands beneath your seat
    to keep you from getting in the way
    and turning vict'ry into defeat
    Icarus was not afraid to fly too high
    but he ended up quite low
    Remember to count the numbers
    on Desolation Row

    Copper Canyon, by Bo Keely

    I took a (1.5meg jpg) photo at 35 mph atop a grain hopper freight car on our Copper Canyon hobo trip through Mexico. The Central Americans on the roof grate of the grain car celebrate with smiles and a dangerous dance the near-end of the 30 hour freight ride from the Pacific to Chihuahua in the Mexican interior. They'll deboard with Tom Dyson (seated fourth from the front with glasses) and me in Chihuahua to catch another freight north to the Mexico-USA border where we'll all cross illegally. Dyson and I rode Mexican freights for two weeks and were caught swimming across the Rio Grande by the US Border Patrol and detained for some hours. We don't know what became of the Central Americans, who had been traveling for over a month with nothing more than you see them wearing. The sage fellow sitting foremost is the Elder (as told in 'Latin Like Me', the leader of the younger Guatemalans next in line on the roof who are headed on to Denver). The two dancers behind Tom Dyson are Mexican itinerant workers.

    Amazing What One Martini Can Do (1.4meg jpg), from Prof. Pennington

    The Wallpaper Ball, by Bo Keely

    A significant event in the rise of my left-hand in paddleball took place deep in the Connecticut woods. I spent the summer of 1995 with Vic Niederhoffer, perhaps the best all-around racquet player of the last century. The key to his racquetball, squash, tennis and paddleball games was the wallpaper ball on both the forehand and backhand sides. This shot is a plaster-clinging pass, kill or lob that courses from paddle to front wall and reflects sliding along the side wall. It chews up more opponents' paddles than any other. I knew at Niederhoffer's court if I could nail this shot I would phoenix my paddles career.

    Vic's compound had an outdoor 4-wall court with a glass back wall, night lights and no ceiling. I studied his down-line shots for weeks. There was little else to do there except play court sports, and my paddleball practice sessions often extended into the wee hours. Once I practiced the wallpaper ball alone from before sunset till after sunrise. Another time I drilled barefoot so long on the concrete court floor that I didn't notice that the calluses wore off my feet until they leaked blood from the court to the house door.

    Night practice sessions were an entomologist's delight as the bright court lights attracted thousands of moths of dozens of species from the dark woods. They fluttered and darted and hundreds settled on the floor and walls. Hence I also practiced footwork around them and accuracy to keep from hitting them. I practiced closed-mouthed to keep from choking.

    The wallpaper shot finally became mine. The ball spin, shape, center of gravity and rubber stretch synergized to propel a straight down-line forehand or backhand, staying in its lane and kissing the side to back wall. The shot looks like a moving nose along a clown flat face. It also makes an effective serve.

    The secret to the wallpaper shot is a blood trade secret. However, knowing that the shot can be hit is half the battle to owning it. Analysis of the combinations of ball spin, shape, center of gravity and rubber distribution is another 25% of the secret, and practice is the final 25%.

    Fear, Control and Regulation, by GM Nigel Davies

    The best chess players are quite happy to break the rules of 'sound play'. Reducing the degrees of freedom of a trading system makes it less profitable. And a high degree of regulation in a country makes it less efficient.

    It seems to me there is a common thread here; in every case greater efficiency comes from reducing the rules to a minimum. And hypothesizing that the origin of regulation is fear (and a desire to control outcomes) then the first step towards destroying an opponent is to increase his level of fear.

    Dress for Success, by Bo Keely

    Last night an Okie stopped me in a sleetstorm at a Lansing, MI bus stop. 'You big goose!' she yelled. She was peeking at my Bermuda shorts. The pretty thing got off at Sparrow Hospital, which houses the nut ward before my stop. I continued on the bus to unfamiliar downtown Lansing, and disembarked at the wrong stop into a snowstorm. I walked wrong turns for 45 minutes into the ghetto. Men with pity in their eyes insisted I get on the #3 bus to Fish-and-Loaves. So I rode 30 minutes to the odd joint that panned out to be a shelter for the mentally impaired. I also discovered Fishes-and-Loaves lies a minute's walk to the Lansing place where I'm staying. So, the next trip I know how to dress to get safely home on the bus.

    Lessons from Buster, by Stefan Jovanovich

    My father-in-law, Jonathan Douglas Turner, more commonly known as "Buster", spent his entire adult life in the oil business. When he was a boy living in Santa Ana, Texas, he helped his father and older brothers load oak barrels of oil onto horse-drawn wagons and drove them from the well head to the railroad depot. He studied geology both as an undergraduate at the University of Texas and as a graduate student at the University of Oklahoma and worked as a roughneck each summer to earn his tuition.

    He was a lifelong speculator and trader - in oil leases and stocks - but I never once heard him predict the price of crude. He said that was something to be left to the people who had tenure - they could afford to be unhedged. He also said that the people who were most confident about predicting the world's future petroleum reserves were usually the ones who had the least direct experience with actually looking for and finding the stuff. That may have been the pride of someone who spend half a century buying drill pipe in December and selling it in January to roll over his tax liabilities, but it was also the wisdom of someone who could know the industry's latest rig count before the numbers were published.

    He thought we would get an accurate survey of the world's petroleum resources only when the rest of the planet had been surveyed, explored and drilled as thoroughly as the lower 48 states had been by 1980. Until that time, there was simply no way to know how much oil and gas remained to be found, and there was no way to use past experience in one part of the world to predict future discoveries in another. You could use the exploration and production science learned from past experience, but that E&P science would not tell you what you were going to find.

    It may be that the world has been so thoroughly explored over the past 25 years that everyone in the oil business now has all the charts they are ever going to need. Somehow, I doubt it.

    Bruno Ombreux comments:

    I agree with your father-in-law that oil prices are impossible to predict. Oil prices are formed at the intersection of supply and demand. Most apocalyptic predictions are based on a study of supply, without considering what impact high prices could have on demand.

    However, when it comes to forecasting oil reserves and production, not prices, I think there is enough geological evidence to state that "peak oil" has already happened, or will happen very soon. See for instance the paper Estimates of Oil Reserves, written in 2001 by Jean Laherrere, a geologist who spent his life in the field drilling for oil, rather than in an academic or Wall Street ivory tower. His English is even worse than mine, but his work is excellent:

    The icing on the cake is Figure 79, a nice chart showing the precision of price forecasters. In 2000, nine major organizations were giving forecasts for 2005 ranging from a low of $15bbl to a high of $26bbl. Needless to say, no one got it right!

    Stefan Jovanovich responds:

    If my father-in-law were here to comment, I think he would point to the 3rd paragraph on page 91: "Good estimates of oil reserves need good data, which are almost impossible to obtain even where records are in the public domain...". No estimates of future production are possible without geologic survey data, and for most of the world the data does not exist for the simple reason that it has not been worth paying for the surveys.

    For the integrated producers of energy the logistical costs of storage, transportation, refining and distribution far outweigh those of exploration and production. My father-in-law had capped wells throughout his exploration area because it was not worth the expense of laying pipe from the wellhead to a distribution connection point. Finding oil and gas in the smaller volumes that he explored for was a secondary problem. Finding it in locations where it was profitable to take it out of the ground and sell it to Ashland or Conoco or Kerr McGee was the real challenge.

    It is for this same reason that oil and gas exploration tends to cluster in the same geographic areas where "known" reserves already exist - the infrastructure for moving the hydrocarbons to market is already there. It takes a lasting increase in prices for both the e&p companies and the integrated producers to be willing to shift their attention to truly unexplored territories. The e&p folks don't want to commit until they are certain there will be a way for them to sell what they find; the integrated producers don't want to build infrastructure until they are assured that the oil & gas reserves are there.

    $50 oil is enough of price increase for both the e&p and integrated companies to take risks on finding and selling oil and gas from new places, if  the price lasts for at least another two to three years and "everyone" then agrees that the new, higher price will be here for several more decades. If enough people believe that a peak in production has been reached, that will help make this scenario come true -- and thereby prove the forecasts of peak production false.

    Down on the Dow, from Prof. Gordon Haave

    I always found it silly the people presume that the purpose of an index is to go up, rather than serve as a measurement tool or an investment opportunity set. That being said, the DJIA is the worst index ever constructed, and that is is still tracked by anyone is testimony to either the skill of the Dow marketers or the general stupidity of market participants.