Daily Speculations The Web Site of Victor Niederhoffer and Laurel Kenner


Jan. 16-24, 2006


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Tying Your Shoelaces, by Russell Sears

As the great John Wooden taught his freshmen to put on their socks right, a distance track coach should teach his beginners how to lace up their shoes.

I learned this trick from Nathan Pitner. A kid that graduated from HS at 16 and went on to become a MD. Instead of double tying or triple tying, what really works best is tucking your laces between the tongue and the other laces. It reduces the bouncing. The constant but random vibration is what causes your knot to unravel. I forgot this this Sunday as I tried to do a 15k (9.3 miles) hard (close to 5 flat per mile). Twice I had to stop to lace up my left shoe.

But, most of us are not like Bill Rodgers. If a racer's lace unravels: stopping costs more than time, it is usually disaster after the first 2 miles, let alone after 20 miles like Bill is said to have stopped. On an easy run, stopping is no problem, as you can catch up quickly after a short rest. In fact the rest generally can more than be made up for. Jeff Galloway suggests you walk through your water stop, at least the first few water stops, in a marathon for this reason. A moment's rest refreshes.

Further, if I am running with slow runners I find myself feigning a loose lace so I can stop to stride to catch up. But, while racing this usually causes your system to lose balance and muscles to tighten, often ending the race for you.

I suspect that employee turn-over for a fast growing company is like the bouncing of the laces, it can cause the whole system to grind to a stop, forcing it to regroup and redevelop the competitive drive. AT&T, Lucent even Wal-Mart come to mind. Where as GM, Ford, the unions shops, and slower paced job turnover is like walking through the water stops, not racing.

Russell continues:

A question was posed by David Higgs as to why hasn't there been any improvements on shoelaces over the history of its life, or why hasn't it been replaced altogether. And he says that his daughter is not happy tucking in the laces.

While Nike had tried other things, the laces persist. There are many gadgets that keep the laces tied. But for me while racing, tucking it in the tongue seems to be the best. Specifically tucking it in the bottom part of the weave of lace and the tongue where generally it is not as tight. If it's too tight everywhere, and still doesn't meet your daughter's standard, perhaps it's the shoe. My kids goes through a pair every other month while they are growing. But I will concede I am more concerned about performance than convenience or looks. Plus the oversize lace of running shoes makes this easy to do. Even if they don't come undone the flopping of these big laces are annoying. I have even seen once it trip a kid as the feet get tangled, though not in competition. But for me at least with my skinny narrow feet this is not uncomfortable. Never had a athlete complain. Most love the idea.

A new section, Daytrader's Forum, with posts from J.P. Highland and James Lackey, is out now.

Market Lessons from Verdi's "Rigoletto," by Victor Niederhoffer

After attending a performance of "Rigoletto" conducted by Placido Domingo at the Met, I was charged up with such violent conflicting emotions from the great dramatic and lyrical work, so similar to what I feel after a great emotional roller-coaster of a market day, that I can refrain no longer from sharing some similarities and lessons.

"Rigoletto" is the story of an evil Duke whose main passion is to sleep with the most beautiful girls in his domain. He is aided in this pursuit by his evil jester Rigoletto, who is tricked into helping courtiers abduct his daughter Gilda to become one of the Duke's conquests. (Gilda is sung by Anna Netrebko, a Russian soprano of true greatness.) Rigoletto tries to show Gilda how unworthy the Duke is by taking her to view the Duke's attempted conquest of Maddalena, the beautiful sister of the assassin Sparafucile. Maddalena is in business with her brother to lure men to their death.

Anna Netrebko

There's a quartet in the third act where the Duke tries to convince Maddalena to sleep with him by vowing marriage while at the same time Rigoletto pleads with his daughter to leave the scene and renounce the Duke as her lover, that is generally considered to be musically and emotionally one of the great moments in opera, and it will immediately elicit thoughts in every market participant of the climactic battle that the bulls play with the bears near the end of every market day. The special effects of the opera machine are then brought out with storms, thunder, lightening, lighting, mistaken identities, deception leading to Gilda's sacrificing herself for the Duke, and Rigoletto's slowly coming to the realization in three stages that the assassin he hired to kill the Duke has instead killed Gilda, Rigoletto's own daughter. At the conclusion, the daughter revives from her death throes to sing an apology to her father for deceiving him but says her love for the Duke gave her no choice.

Similar cataclysmic events leading to close at the extreme ordinarily occur at the end of each market day.

The opera includes the most vivid conflicts Verdi ever wrote, animated by the evil role that Rigoletto played for his duke , the retribution that he receives for this, his disloyalty to the Duke when he tries to get him killed, and the tragedy of seeing the formerly innocent daughter sacrificed at the end for a thoroughly evil noblemen. The conflicts are carried forward in vivid sonata form with the Duke's opening the opera with his evil chasing of women, and Rigoletto's doting on his daughter who has never seen been allowed out of the house except to go to church, where she regrettably fell prey to the charming gaze of the Duke.

This same battle occurs at the opening of every day's session in the market. The overnight orders come in and a move ensues, setting up the main theme of the drama. Then comes the secondary theme: a move in the other direction. The middle of the day, like the middle of the opera, is given to development of both themes. Finally, amid climactic activity and singing of high notes, the conflict is joined and ends with great tragedy, as all with tragic weaknesses are punished.

Before putting some statistics on the table I have to note that my favorite vignette in the opera, aside from the aforementioned quartet, is when Maddalena asks her brother the assassin if it wouldn't be cricket to kill Rigoletto instead of the Duke. The assassin is stunned that his sister would think him a common thief, as Willie Sutton was when he was casing out a bank disguised as a cop and a new mother asked him if she could double-park so she could feed the baby some formula.

A regression equation of the move from 9:30 a.m. to 10:00 a.m. in the S&P from 1996 to 2006 as a predictor of the move from 10 a.m. to close gives the equation:

forecasted 10 a.m.-to-close move = -1/20 + 1/4 of the move from 9:30 a.m. to 10 a.m. 

The t-statistic for the regression coefficient is 3.8 with an R-squared of 1/2 of 1%.

Note also that after an up move from 9:30 a.m. to 10 a.m., the expected move from 10 a.m. to the close is 1/5 of a point -- i.e., a move from 1001 to 1001.2 with 55% up compared to a norm of 53% for every day . (No wonder I was able to slip this past the Minister).

And yet, we point out that that we have shown a tendency in the market day to end on the same motif as the original tonic theme of the opening, as is the tradition in all opera, symphonies and dramas of the last 300 years.

Greenspan Keeping Up with the New Economy, brought to our attention by Dan Grossman

Ms. Mitchell, his wife, said he recently started figuring out how to do his own research on the Internet; he is still in the process of getting a personal e-mail address. -- "Greenspan, Another Monument in Washington, Prepares to Leave,"NYT, 1/30/2006

The Commedia dell'Arte (Part 1), by Dr. Alex Castaldo

The Commedia dell'Arte was an improvised form of theatre which flourished in Italy from the 16th to the 18th century. It was based on a limited number of stock characters and a limited number of situations (the servant steals gold coins from his master, the young wife cheats on her elderly husband, two young lovers come together despite obstacles that other people put in their way, etc). The stock characters wore characteristic costumes and masks which allowed the audience to easily identify them. Within this broadly predictable framework the actors were free to develop the details of the plot and dialogue as they saw fit, based on a sketchy scenario outlined to them by the director before the playing began. There were also stunts (lazzi) performed on stage to amaze the audience. The actors were professional actors who traveled from town to town; highly accomplished, they had to have both acting and story-telling skills, as well as some acrobatic abilities for the stunts, and at least some dancing and singing ability.

The Commedia influenced both the traditional theatre and the opera. Many characters in operas are based on stock characters from the Commedia dell'Arte. Since these characters are universal and timeless it is not surprising that many investors of today also resemble characters from the Commedia.

Stock characters:

Pantalone -- an elderly and wealthy merchant. He is very cheap, and so concerned about the value of money to be a slave to it. He wears tight fitting red trousers and a loose white shirt; on his belt he carries a money pouch. He walks in a stooped or arthritic posture because of his age. Fond of good food and pretty women, he is easily duped by the younger characters. He is the butt of many jokes, but ultimately comes off as a decent fellow. Representative investor: Warren Buffett.

Il Dottore (the doctor) -- a pretentious older man who has (or claims to have) a PhD in Philosophy or Medicine. He is an absent-minded pedant, quoting Latin at inappropriate times, and enormously conceited. He is dressed all in black except for white collar and shirt cuffs. The doctor is quite pompous; he has dedicated his life to learning, but he knows nothing and has no common sense. He meddles in other peoples business, and he has the "gift of gab"- he can talk his way out of almost any situation. He falls easily to the pranks of servants and unsuccessfully courts young ladies. Representative investor: Robert Shiller.

Il Capitano (the captain) aka Il Capitan Spavento (Captain Fright) -- a boasting, swashbuckling officer. He is dressed very elegantly in bright colors, with a cape, feathered hat, high boots and always carries a sword. Very boisterous and self-confident, he tells extraordinary tales of his achievements, such as how he and his men beat a whole army of Turks and carried off the beard of the Sultan; but despite these past feats when there is a hint of real danger he is the first to run away. He is popular with the ladies. Representative investor: Tudor Jones.

Arlecchino -- a clown with a slapstick comedy style. He is a master of disguises, agile and acrobatic. For him everything is a game. He is a trickster and enjoys tormenting the old, such as Il Dottore or Pantalone. He wears breeches and a jacket covered with colored patches. Crafty and unprincipled. Representative investor: James Cramer.

These other characters will be fleshed out later: Brighella, Pulcinella, Zanni (the servant), Colombina, Innamorati (the lovers), Smeraldina.

Today's Lunch Room Discussion, from Tom Ryan

Regarding Exxon profits, when will we know the top is in?


  1. Carly becomes CEO of major oil company.
  2. New "sino-go" chinese car is top seller in USA.
  3. New tv show with Larry Hagman.
  4. GE buys an oil company.
  5. Texas and Alaska threaten independence.
  6. Hugo Chavez buys up all Miami Beach.
  7. Vegas styled sand dredge/island building contest between Dubai, Bahrain, Qatar.
  8. Canada offers to buy Alaska from us to help us pay down all of our debt from the invasion of Iran.
  9. Rockefeller ghost sightings on Broad Street.
  10. "Leo says" bumper stickers make a comeback.
  11. While on an airplane grandmother gives me unsolicited tip regarding Schlumberger "sitting at overhead resistance".

Any others?

My vote is numbers 1, 11, and 4 to be most likely.

Eric Keller adds:

You know a top is in when:

  1. A Mexican fast food chain doubles on its IPO.
  2. Every average investor I know is kicking themselves for missing aforementioned IPO.
  3. Google has come out with a plethora of new unproven services in an attempt to maintain its growth. Investors expect earnings to double until 2010.
  4. The phrase: "Google is going to own Microsoft" among IT administrators.
  5. Steve Jobs has become the largest shareholder in the house of mouse.
  6. Consumer confidence is at a 3 year high.
  7. Henry Blodget has begun to re-appear in the news with his new website.
  8. Abby Joseph Cohen is bullish on telecom in the Barron's Roundtable.
  9. "The Screamer" begins his college campus tour, (I wonder how many MBA's will be in attendance?)
  10. Ableson becomes slightly bullish.
  11. New Fed Chair takes office.
  12. Enron is front and center in the news. Again.
  13. Exchanges are looking to buy other exchanges.
  14. Strong earnings and lighter revenues.
  15. Strippers aspire to become mortgage brokers as the quickest way to easy money.
  16. My mom is asking me about investing in Japan.
  17. '06 election year is around the corner.

A Note from The President of The Old Speculators Club

As reported early this month, the unlamented Indomitable I portfolio closed out '05 at -12.89%. To appreciate the breadth, quality, and catholicity of the recent rally, that collection of dreck went into the black as of Friday's close. For the time being it appears safe (though not necessarily advisable) to buy just about anything.

Recent Letters to the Editor on: The Impact of Daily Speculations, Yield Curve, Pitching Strategy Debate, Bearish Mindsets and more.

Dick Sears's Latest Market Commentary: Victor Victorious

On the Senator's Bookshelf: Timothy Egan's "The Worst Hard Time"

"The Worst Hard Time" is one of the most informative books I have read in years. Egan focuses on the Dust Bowl. He presents much evidence as to the cause of the problem and all this with the backdrop of stock and commodity prices a la the wheat bull market that in many ways caused the Dust Bowl and how that in turn played upon stock prices in 1929-1937.

Though he does not raise the parallel to the dot-com bust, it's sure there.

Good history spiked with quotations from the people who experienced the storms that stole 850 million tons of top soil from the prairies and carried much of it to New York City; so much of it that ships would not leave port and the skies were black at noon time.

A wonderfully written book with some great lines, as this observation on marriage posted in a diary:

Verna and I were married 25 years ago today, I would be foolish to say we had never had troubles. One would have troubles even by himself in that length of time...

Who is the Federer of the Financial Markets?, from J. P. Highland

It's miserable weather in Connecticut, nothing better than to watch ESPN and enjoy sports.

It's a pleasure to watch guys like Roger Federer play tennis as he does and win his seventh grand slam tournament, the Swiss is a machine, he is like a Rolex, always accurate in his game. The headline should be that he lost one set not that he won the Down-Under tournament.

I also love watching guys like Michael Schumacher, Kobe Bryant, Barry Bonds, Tiger Woods, Ronaldinho Gaucho, Vince Young (in his glorious night in the Rose Bowl) or Enrique Ponce (for those who like Tauromaquia). They make their sport look easy.

Who is the Roger Federer of the Financial Markets? Who makes it look easy?

Stefan Jovanovich responds:

Until he retired, John Templeton did. Unlike Buffett, he always kept straight books, and he never presumed to lecture the world. He was Christy Mathewson in his prime.

Briefly Speaking: Runs, Davos, et al., by Victor Niederhoffer


Since the beginning of the year, runs in the direction of the S&P move from previous close to current open, are as follows:

Positive run [of length] 2
Negative run 1
Positive run 1
Negative run 2
Positive run 1
Negative run 4
Positive run 1
Negative run 1
Positive run 5+

For example, the open on Monday Jan 23 was 1266.80 and this was up from the 1264.80 close on Friday, Jan 20. The Jan 20 open was 1287.50 and this was down from the close on Thur, Jan 19. Thus, a positive run of length 1 was started on Jan 23, which since Tues, Wed, Thur and Friday (today) also had up opens is now a positive run of length 5 and counting. Is such behavior consistent with randomness and does it provide a caution for day traders to get the joke?


Every last week in January, prime ministers, CEOs, academics and reporters meet in Davos and take a 60-franc bus ride to the ski resort to hear papers designed to create a world state and provide a general backdrop for disseminating thoughts on the smallness of man, the weaknesses of the United States, the coming decline of the dollar, the importance of communitarian goals, and the ravages that mankind's attempts to deploy resources efficiently cause to the environment.

Like Delphi, Davos is a forum designed for rubbing shoulders with the elite and coming up with predictions that will maintain the existing pecking order. It's the kind of function where the Sage might be expected to enumerate the serial numbers of all the private planes that land there for the purposes of holding up the users to ridicule the way he likes to do and has done at such meetings as the Masters, and the Bohemian, but presumably because everyone at this one is a fellow traveler, they're safe this time, and those that use the helicopter because their time is valuable are safe from his scrutiny and exposure. But the question is: does all the dollar bashing that goes on there provide a proper platform for a jumping-off point against at a predictable time after the Delphic self-serving predictions have been made? Inquiring minds wish to know what other ephemeral moves come out of this mountainous area, and how small folks can profit therefrom.

Bond Moves

Very quietly bonds have moved to a one-and-a-half month low, gold has moved to an all-time high, and crude and the stock market are within a gnat's eyelash of respectively all-time and five year highs. Such relations provide a nice backdrop for understanding and predicting the connections and feeding relations between markets, but the problem is that they are always changing.

The Sage's Stock

There is a general tendency for past performance to be very ephemeral and non-predictive. Indeed, I often look for the worst past performers when choosing a adviser to handle my own meager funds on the principle of ever-changing cycles et al. and the "we try harder" factor. However, there is an even worse tendency to remember the vivid successes of an investor many years after he has lost his greatness, especially when fanned by his own claque. Such a tendency I'm afraid might be too prevalent vis-a-vis the Sage and the Palindrome. Since Aug. 31, 1988, when the Sage's stock closed at 78,000, it has risen to its current level of 89,600, for a total return (there are no dividends forthcoming from such an eminent value investor) of 15%. Such a total return compares most unfavorably to Treasury bills during the period. I'll go out on a limb and speculate a la Julian Simon with a counterpart that loves the candymakers and regional furniture marts in declining urban areas of the world that such a relation has a reasonable chance to continue until the future. I abstain from a similar analysis of the Palindrome's past and forecasted performance during these periods on the grounds that he is doubtless in Davos now; and former doubles partners and great benefactors of humanity should always be given the benefit of the doubt. (Note that I chose a retrospective within-year high for my calculation of the Sage's 6 1/2-year total return.)


A amiable correspondent from Australia writes to me that I should be very careful in spreading good ideas around the Web because he knows of at least two operatives at substantial firms whose main job it is to watch what I do and front-run or imitate me. I would point out that I also have heard of at least three operatives whose job is to ferret out what I am doing and take the opposite side of my trades. Such an activity has even been one of the major themes of a book and is widely recommended on the highly prestigious trading forums. I would put my vote and my money on the wisdom of those who go against rather than those who go with such a poor speculator as I.

Dr. Kim Zussman on Commodity Futures

Henry Kat looks at commodities and finds no reliable risk premium to commodity futures. Though in some periods, such as recent 5-years, commodities futures did out-perform stocks; in general stocks do better.

The paper seems like a good primer on commodity futures, and is clearly reasoned and written. It is quite current in attempting to address the flood of capital which has flattened yield curve as well as average hedge fund returns, and chased up emerging markets and certain commodities.

Two possibilities come to mind, (in no particular order):

  1. There will be a rogue wave in next few years that will make some very rich and others very poor, (big wealth transfer in financial markets and big premium to some as-yet undetermined relationship).
  2. Not (1)

Kim Zussman suggests some sources on CAPM and using the Yield curve to predict GDP.

Because beta varies considerably Ang and Chen conclude that book/market alpha is insigificant. Ang also uses a complex model of yield curve to predict recessions, and finds that short rates are most helpful.

James Lackey on the Screamer

I have had a few friends at the BMX/baseball fields ask me "what do you think of the Screamer". I had to retract my first rude statement and say, well no ... actually the guy was very smart, went to Harvard, achieved a law degree and then made millions for himself in the markets. How he did it is suspect however and please do understand that what he is now is an entertainer. If you want to learn how to trade stocks there are many good books written on the subject.

I have to say that Ken Smith here "got the joke" and mentioned to me the cross marketing of CNBC, MSN, WSJ, and the Street, and how CBS market watch was taken out by the Jones'. Perhaps I would be motivated by guilt to get many out of a big losing trade TSCM and call it a draw if it was sold. Just-maybe he always loved the "news business" and has fond memories of sleeping in his car. Perhaps he does it out of passion.

However, I wouldn't write anything negative about any of them on DailySpec. He is quick draw lawsuit McGraw. Remember the trading clerk that worked for him and his book was blacklisted? It is always nice to have Elliot $p!tZ#r as a cohort. Don't be shocked if he is appointed chief financial bottle washer for the State of NY if ET is elected.

Tom Larsen adds:

After reading your post I looked up the book Tr@ding W!th The Enemy, on Amazon. It is available used through Amazon's wonderful used book service, but I found a copy at my local library. The author simply explains how he came to work on the trading desk at the Screamer's firm and some of the events that happened while he was there. You probably would not get any great trading ideas by reading it. It is really a memoir of a young man's disillusion, a very quick read.

My overall impression is that there seemed to be an anger management problem. Having spent my working career on trading floors and trading desks, I understand that things get a little tense from time to time, and I admit with embarrassment that I myself have smashed phones to smithereens, but according to the book, the destruction went much further than that.

The author claims that the firm kept spare hardware in the trading room because replacements were necessary after monitor-tossing sessions. The language even shocked me, and I have been called every name in the book during my career. There was such hostility and paranoia involved in his trading, that I can't help but think that moving to the TV entertainment mode is bound to extend his life.

The Cost of Schmoozing, by Dan Grossman

Am I the only one to question the appropriateness of charging one's stockholders, let alone deducting as an ordinary and necessary business expense, the cost of attending Davos for the average CEO:

Plus cost of security detail, attendance by VP Corporate Communications and/or other executives, attendance by miscellaneous flunkies to make restaurant reservations, schedule interviews, etc., for a total in the range of $400,000- 500,000.

Of course, as they all point out, it is at the private get-togethers for cocktails after the public conferences where the real networking and important work on behalf of shareholders gets done, not to mention the opportunity to listen to the economic theories of Angelina Jolie. I myself would think a CEO could simply telephone another CEO back in the USA for 3 cents a minute but that's perhaps not as glamorous or personally aggrandizing.

I would be impressed by any CEO or NGO head (Larry Summers?) who paid these expenses personally but I doubt there will be many of those.

Market Waves, by Nigel Davies

Here's something which is beyond my math and computing ability to test, but which I think may have some relevance; do the waves in markets look like a "u" or an "n"? Probably it's just delusion on my part, but I get the impression that "u"s are bullish whereas "n"s are bearish.

Alston Mabry comments:

Currently on Discovery Science there is a show called "Killer Waves," which examines unusually large rogue waves at sea. Once suspected to be only sea lore, these waves have now been confirmed by recording devices on oil drilling platforms, as well as recent incidents with ships that survived.

One of the first successful theories about these waves predicted that very large rogue waves could be generated when normal waves were moving across or against a strong underlying current (Fornberg and White) - a situation which could also be affected by the local bathymetry (measurement of ocean depth - new word for me) and ocean floor topography. Such a situation exists off the coast of South Africa where the Agulhas current flows north to south along the east coast of the continent and meets wave action coming up from the southern ocean. Many rogue waves have been reported in this area and have destroyed several large, modern ships.

The TV show indicates that this theory very satisfactorily identifies dangerous areas off the coast of Norway as well, and shipping has been diverted to avoid incidents. However, it became clear that large waves also appear in the open ocean, where neither bathymetry nor topography appear to play a role.

Alfred Osborne and others showed how large, freak waves can occur in the open ocean. Recent analysis of satellite data indicate there are many more freak waves in the open ocean than was previously thought, and Osborne's analysis seems to have wide acceptance. One interesting part of the theory is that the rogue waves may be taking energy away from the waves in front of and behind them.

It is certainly tempting to conduct a thought experiment in which last Friday's down draft was a rogue wave. Local wave action going against a strong underlying current? Spontaneous creation of freakishly large waves? The physics of this are way over my head, but perhaps the Minister might care to comment.

Bruno Ombreux suggests:

Rogue waves are interesting. I have a friend who is a world renowned specialist of rogue waves. He got onto several TV shows when a rogue wave hit Asia in 2004. He dedicated his life to studying them.

He is also a statistician who learned statistics the hard way several decades ago, by punching cards, and wrote a few FORTRAN routines that are used to this day. And he is also a successful investor. Investor, not trader.

I suggested to him to use his statistical knowledge in his investments and to join the Speclist. Guess what? He is interested in neither!

He even wrote a program to predict rogue waves in the market based on his knowledge of rogue waves in the sea. But he says it was just for fun and doesn't believe this can be used in the markets, nor does he believe in applying his statistical knowledge to the markets.

John Lamberg adds:

Rouge waves have been discussed on the list before. This is an extract from the excellent discussion on rogue waves on BBC radio:

I was flabbergasted, absolutely flabbergasted. It just looked exactly like one of these exotic solutions to the non-linear Schrödinger equation. One of the ones that we threw away over the last 30 years because we said this kind of thing can't happen, this kind of thing is just too strange, yet it just sits there and it looks at you and you have to entertain the possibility that it is a real effect and it might really have something to do with these extreme waves in the ocean...

Secrets of Professional Turf Betting, from J.P. Highland

I finally got it for $39 in EBay, I tried to get in Amazon for a reasonable price, in abebooks.com, lost many auctions in Ebay but finally after 3 weeks of waiting for the turtle express I got the book. Printed in 1961, long before I was born, in reasonably good shape and with that scent that old books have that I like. That scent reminds me my Dad's old books that he collected from which unfortunately I only keep a few.

I'm impressed about the content after only reading the first chapter, I can't believe that Bacon wrote the book only thinking about horses, similitudes with our field of interest seem to be too obvious to be by chance. If I go belly-up in the stock market with stupid trades like FD maybe I can make a career in the Aqueduct with the ponies.

A Great Business Story, forwarded by Easan Katir

"The Go-Getter: A Story That Tells You How to Be One," by Peter B. Kyne, is a favorite of mine. His bio says:

Kyne was a sometimes wealthy Republican, though he ended up squandering much of his wealth on poor investments in the oil industry, schemes of speculation and invention and horseracing.
Highly recommended by the Webmeistress

Could ROE Provide for A Meal for a Lifetime? by Victor Niederhoffer

Fundamental relations. The growth of a company book value is a function of its rate of return on equity (ROE) and its payout ratio. For those companies with high ROE, growth should be higher, holding the payout ratio constant. One would think that over time, differences in the ROE might be translated into returns to stockholders. This relation might be expected to vary over time, industry and stage of the economic cycle. It might determine the prospective returns to stockholders of public offerings . Retailers with high returns on equity might be particularly attractive as their growth could be exponentiated up or down depending on the ease of raising capital and the infrastructure necessary to provide scalable growth.

At a more general level, the relation between ROE and returns to stockholders might be expected to vary over the economic cycle with reasonable leads and lags. It could provide a model for which industries to invest in and which to avoid, or when growth companies are moving into and out of favor versus value companies. I hypothesize that the relation might also be predictive of the overall health and prospective returns of the stock market.

One wonders what other factors besides industry -- for example, the price level of a company, its debt equity ratio, its rate of return on capital or its beta -- might affect the relations posited above. Also, whether the most fruitful avenues of study here are how the rates of return vary for an individual company over time, or how the relations hold on a cross-section of companies at a moment in time. How do predicted returns on equity correlate with performance from standard sources such as Value Line, Zacks and IBES? To what extent should the relations be normalized by the existing price-earnings ratio and interest-rate environment in the economy or the company? How relevant are the finding in the empirical finance literature on this subject, and how out of date are they? The book "No Monkey Business" by Stuart Fowler seems to have some good work on this.

I would not be surprised if my colleagues and I were to drill down on queries similar to the above. Assuming we can slip the results past the Minister, something as difficult as slipping a lamb past a wolf (when he's not on the courts), you will doubtless be hearing from us further on this subject, and I encourage your own insights on this seemingly fruitful subject.

From Prof. Charles Pennington:

The Minister will let this lamb slip by!

One can sort the 500 S&P stocks into quintiles based on their trailing return on capital, updated quarterly (and with the list of S&P components updated annually). Then one can start with $1 invested in each of the 5 quintiles, with quarterly re-allocations.

I'm finding that the $1 would grow to the following values, depending on whether invested in quintile 1 (highest return on capital), quintile 2, 3, 4, or 5 (lowest return on capital):

1 (highest return on capital)    $4.12
2                                $4.33
3                                $3.10
4                                $3.78
5                                $3.65

Totally consistent with randomness, just the way I like it.

The recent book by Greenblatt advocates buying stocks with a combination of high return on capital and high earnings-to-price (or low P/E), and his back tests show that that strategy is a winner. He doesn't say though how much of the effect comes from the return on capital and how much from the earnings-to-price.

So a brute force ranking by return on capital doesn't add much. The Chair's more elaborate ideas on this topic may however have much value, and therefore I don't feel they're suitable for discussion.

Ckin responds:

I would think that the high ROE portfolio would need to be adjusted for leverage of the underlying companies. No point in having the ROE filter include companies capitalized with 99% debt. Even if those firms generate a nice ROE, once the equity builds up, the ROE declines markedly.

One of the Merrill Lyn#h strategists disseminated in the mid '90s a piece of proprietary research showing that a portfolio of high ROE companies outperformed each of the other dozen or so strategies that they followed, including value, revenue growth, price/sales, price/book, etc.

Stern Stewart & Co. has made a nice franchise for themselves using ROE as the main component for their Economic Value Added analysis and research. Essentially, they look at firms whose unlevered ROE (based on unlevered net operating profit after tax, or UNOPAT) compares favorably to their weighted average cost of capital. They claim good historic investment returns, and they also apparently make quite a bit of consulting income to securities issuers as well.

Sushil Kedia responds:

The problems of finding a definable way of inflation accounting as pointed by Prof. Haave and of ignoring leverage undoubtedly add to the randomness observation.

Also, the rates of depreciation admissible under the Taxation laws (which help postponements of taxes really and nothing else) are often more aggressive than rates of depreciation allowed in laws governing Corporate reporting. This creates a set of companies with high / rising capex that add to bloating of reported earnings in nearer time periods on a earnings forecast series, and thus another variable that adds to consistent with randomness observed possibly.

EBITDA based ratios as a surrogate for measuring efficiency of capital usage and specifically EBITDA by Networth ratio provide a better feel, but I would guess it too is likely to be unable to escape definitions of consistent with randomness, even after being adjusted for payout ratios. Markets are pricing in management capability, signalling effects and such other qualitative variables fairly often.

To turn the crystal ball around, I have been playing with plugging in the value of the current prices (market cap) as being equal to the Discounted Cash Flow value of a firm. Simply the market implied growth rate that jumps up on the sheet with each change in prices and its ongoing comparison with the historical growth rates of returns and finding deviations does provide clues to overpricing. [a fairly simple bloomberg plugin sheet that assembled for this objective and containing codes of Indian companies only, modifiable by replacing with codes of stocks you want to check will be mailed off-list upon requests].

Financial stocks where money is the raw material, end-product and yardstick of performance measure seem to provide better feeling numbers when gauged with the reverse dividend discount model as opposed to the reverse DCF for most others.

Just felt like putting up some extenstions to Chair's core theme while good questions are brewing up in stronger minds.

May be, tuning up various permutations of extended ratios as the RoE but applied to specifically similar stocks (not necessarily from similar sectors) would raise the chances of finding workable relationships of ranking stocks.

Severe Shortage of Choreographers, by Ross Miller

One does not have to watch many music videos to see that the U.S. faces a severe shortage of choreographers. Indeed, the dance steps of most rock stars (with a few notable exceptions) appear to be completely unchoreographed. Such a lack of professionalism also extends to the corporate sphere. Steve Ballmer's infamous "monkey dance" would not have been so deleterious to Microsoft's stock had he sought professional help. And even superior hedge fund performance can benefit from the right moves.

One day the ETs will visit in their perfectly choreographed saucers, say "thems humanoids can't dance worth a damn" and zap everyone.

Jungle Travel, by Rod Fitzsimmons Frey

I recently returned from Madagascar. There were many highlights in my month-long trip, but overland travel certainly stands out.

Moving between towns using public transportation requires planning, determination, courage, and flexibility. A trip of roughly 100km begins at 6:00 am. We get the backpacks filled, have a cold shower, and actually get onto the road by 6:45 and are full of self-congratulation at our industriousness and preparation. Until we get to the bus station, that is, where we see hundreds of people more determined, more industrious than us. No matter how early we start to compete for a spot on the bus, we should have started earlier.

Our size and foreign skin play to our advantage, though. We push our way to the front of the swarm of people, and the vendors, pretty sure we'll pay three to four times the going rate, are anxious to serve us first. Our initial politeness and demure behaviour wore off early in the trip, so we take full advantage of the only edge we have. I let Heather negotiate, since her French is much better than mine and I'm better equipped to intimidate those curious about the contents of our backpacks.

Negotiating price, whether for our bus ticket or last night's meal of Zebu steak and infused rum, has always been a strange part of rustic travel. It seems odd and wrong to argue over 25 cents for a $2 item that would cost $40 at home. Indeed, my wife and my first trip together was on our honeymoon, when we backpacked through Peru and Ecuador. Full of the spirit of love and compassion, we rarely paid much less than the asking price for anything: after all, what was $5 to us, compared to its value to the vendor? We ran out of money after three weeks and had to phone home for more.

We learned that negotiation isn't a moral issue, it's a state of mind essential to survival: if one fails to adapt to the local rules of the game one might as well paint "fleece me" on one's forehead. The local vendors are fighting for survival too, and they're better at it than us. We need not feel sorry for them, not on their own arena.

Eventually our seat is purchased and we take our place on the bus, which is actually a 30-year-old 12-passenger van. The original 3 back benches have been removed and replaced by four rows of wooden benches. Eventually 16 adults and nine children fill the back. The van sits lifeless for two hours. There is no reason not to get moving: the van is full (schedules do not exist). But we know that the van has its own master plan, and it is inscrutable. Trying to find a faster ride would be the worst thing we could do: the van would leave while we were arguing with the proprietor and the next one wouldn't go for a week. So we wait.

We entertain ourselves by showing the kids photos of Madagascar from our guidebook. It seems like they've never seen photographs before: maybe it's true. One of them recognizes a street in the town we're in, and there's a flurry of excitement and mayhem as the guide gets passed around. We're heros for about fifteen minutes. We keep a close eye on our backpacks anyway.

When the driver starts the van and pulls out, we are elated. Out of the town, the roads degrade from the merely potholed streets to narrow eggcartons of broken asphalt. The van picks its way along at about 15 km/hour, listing 15 degrees to one side and then the other as the wheels pass over 50 year old chunks of pavement. Seeing my white and drawn face, the mother of one of the kids shows me how you can take the window out of its housing to lean out the side. Heather's stomach is stronger than mine, so she just snaps my photo as I part company from my morning baguette. Fortunately for my pride, the bumping is so bad she only gets a picture of the overhead light.

Eventually the pavement dwindles to nothing and we are driving on what seems to be a track in a wide plateau. We can see some jungle in the east, but nothing in front of us, and soon, nothing behind us. Later, we can't even see the track in front of us. If it were night, we'd guess the driver was navigating by the stars, but it's 4:00 in the afternoon. GPS is not an option. We decide we don't care, since at least we're moving fast -- at least 70 km/h -- and we've been on the van for ten hours.

On the horizon to our left, Heather spots a cloud of dust. We get out the binoculars and discover that it's a van similar to ours, going in the opposite direction. We're on the national highway, and it's 60 km wide. Soon afterwards, we arrive at our destination. It seems that in the jungle, the well-marked paths are the slowest and most treacherous.

A Question for Victor on Inner Tennis and Trading, from Jeff Beckwith

With the spring frostbiting season not far away and my New Years resolution that I would seek to shape my well rounded physique into something more competitive, I picked up a copy of the book Sail Fitter by Dr. Michael Blackburn, BApSc (Hons), PhD. Dr. Blackburn is a Sports Science PhD and a top level international sailor who won a bronze medal in the Laser Class at the 2000 Olympics. The book is very good reference manual for any dinghy sailor looking to bring his fitness level up a few notches. The one item that really struck me in the bibliography, where amongst all the sailing titles appeared:

Gallwey, W.T. (1976). Inner Tennis: Playing the Game. Random House, New York.

A tennis player first confronts the Inner Game when he discovers that there is an opponent inside his own head more formidable than the one across the net. He then realizes that the greatest difficulty in returning a deep backhand lies not in the speed and placement of the ball itself, but in his mind's reaction to that ball: his own thinking makes the shot more difficult than it really is. Further, he becomes aware that these same mental obstacles which keep him from playing his best tennis also prevent him from living his best life.

Dr. Blackburn states that despite its focus on tennis, it is a great book that can help you improve your feel for and mental approach to sailing. Based on the quote from the book I imagine that may help improve the mental approach to trading too! Are any of the racquet aficionados familiar with this book?

Victor enlightens:

The tennis aficionados are indeed familiar with Gallwey's book , especially since he was a year or two ahead of me at school, and Hobo wrote the Inner Guide to Raquetball, an augmentation of Gallwey's book, and Dr. Brett is always trying to write about the inner game of day trading.

Regrettably, there is nothing to the idea that the inner game is important. You need good strokes in tennis to be good, and good athletic ability. Then you need good coaching so that you can fit your strokes and abilities to the game, and proper discipline to apply the previous two factors. Nothing else matters, although someone like Martina Hingis is a natural in knowing where to hit the ball, and someone with a bad temper, and bad character can detract from her abilities and training at the margin. Let's say that ability, strokes and training account for 99%, and your temperament accounts for 1%, that 1% being that you could destroy yourself with cowardice et al.

The same applies to trading. If you have the right niche, if you ask the right questions, if you apply the proper balance regarding the mix of qualitative and quantitative, if you choose a proper reward and risk structure relative to your goals and ruin point, if you choose your spots, if you vary your positions and markets based on the above, if you realize the cycles are always changing, if you take account of the interrelations of markets, if you understand your place in the market eco-structure, if you have your costs to an absolute minimum, if you have no fixed rules that are easy picking for the flexible, if you choose to trade against the ephemerals and not against the true experts like the dealers and the market makers, if you have the wind at your back by always believing Lorie and Fisher, and and Dimson, and if you have the right trainer, then you've achieved 99% of what you can accomplish.

All the inner secrets, all the proper training, all the EEGs, all the good character can't augment the preceding by more than 1%, although like the tennis player that blows up, if you're particularly egregious of character, if you drink or gamble too much, if you spend your time trying to impress the beautiful babes, if you're desirous of financial suicide, then you can override even the best of the 99%..

Now that I've listed the factors necessary for success for the spec investor, I see that it's much harder, and much more varied than for the racket player who if he's fast and strong and agile, and has good strokes, the world is his oyster, whereas comparable attributes for the spec investor, i.e. intelligence, capital, knowledge, study, are just a beginning.

Bo Keely adds:

I hope to clear some readers minds in four paragraphs. I opened Tim Gallwey's "Inner Game of Tennis" right after it was published in 1972 when I was the national paddleball champ and runner-up in racquetball. The contention that the tennis player first confronts the Inner Game when he discovers there is an opponent inside his own head more formidable than the one across the net struck me as bizarre. I still remember putting the paperback aside and meditating a full minute with the closure that the author's implication of an inner game hence an inside player was something I hadn't found on my own and didn't want to.

Fast forward a year to an evening in the mid-70 s when the phone rings. I was living in an unheated garage on a remote lake in Michigan with a Doberman, and we were surprised to hear a fast-talker on the other end remark, "This is Tim Gallwey's agent and he would like you to co-author a book on The Inner Game of Racquetball  with him". We verbally sealed the deal in five minutes, and I hung up elated. Immediately I pulled a thick file of racquet sports psychology clippings and wrote an introduction and table of contents. A day later, the agent rang and I proudly told him what I d done. To my astonishment he scoffed that it was impossible to empty the head with a file of clippings, and if I'd closely read the Inner Game I'd understand Zen athletics. Maybe he heard the Doberman mindlessly fetching in the garage, but in any case the book was stillborn along with my chance at Zen sports stardom.

Incidentally, I read Gallwey's original text from cover to cover to be stunned not by the main precept but by another sports proffer that has had wide implication throughout my life. The author suggests that if you are frightened by any prospect, anything at all in life, then cure it instantly by mental rehearsal of the worst scenario outcome. For example, I am going to lose this match. That's pretty awful, but the worst scenario might be more like I am going to lose the match by an unforced error in front of my parents and fans, my wife will divorce me to run off with the opponent and take the dog that fetches my practice balls. That vision overshadows simple loss.

Buy Inner Game of Tennis but ask yourself before cracking it, if you already have an entity in your head. If not, begin and stay on your toes.

Dr. Brett Steenbarger responds:

The book I'm currently writing reviews all research on human performance, including athletics, chess, performing arts, etc. Hundreds of studies and books are available on these topics, but--oddly--no one has assembled all the data. The bottom line is that psychological fortitude and confidence comes from structured practice/rehearsal, in which performance expectations are progressively raised and frequent, accurate feedback allows for correction of errors and eventual mastery. If the goal is the development of expertise, the pursuit of "positive attitudes", "self esteem", etc. apart from effortful mastery of a performance domain is a waste of time. Psychological difficulties can impede the enactment of skills and the expression of talents, but psychological interventions cannot substitute for those.

J. T. Holley remarks:

Reading Brett's undertaking made me think of Sam Snead's famous quote "practice puts brains into my muscles". This is from a man who could stand in a doorway and kick the top part of the frame in his younger days. The other is ole' Harvey Penick who shunned any use of negativism in his teaching of his pupils e.g. "I am never going to tell you not to swing hard, I'm going to tell you to swing slow". My wife tells me that I make people sick on the stomach I'm so optimistic and positive thinking.

Dean Tidwell adds:

Contemplate yourself in the condition you want to produce.

8 time world champion calf-roper Dean Oliver is a living legend in work ethic. Repetition to the point that nobody could/would do what he did. My father still has the old projector film showing his hours and hours of repetition.

Wasn't it Vic's Ed. Of Spec. that told the story of Rene Lacoste's serving of a ball while the crowd was bowing to the Queen. Of all the world's greatest, at their respective field) I have never studied anyone who created the "Condition" without 1) unbelievable work ethic and 2) Powerful "re-creation" ability.

True Story... In high school, I was a baseball, basketball, and any ball "star." Bolletieri tennis academy helped me to a Singles District Championship and a Regional Semifinalist in tennis as a sophomore. I quit forever after the final loss that year as a new passion in golf was found. After struggling to an 80+ every tournament (my senior year), my father had me read Psycho-Cybernetics. I spent over 3 hours visualizing the entire day. The surroundings, each swing, everything. The next day resulted in a 74, winning my 1st High School Tournament. This was 6 shots better than any round I had played to that point. Was it NAIVETY in an easily manipulated teen that might believe anything if the right person told him so? Or was it psychological fortitude?

James Tar on the Yield Curve

I am likely the world's worst when it comes to understanding the details of fixed income and the bond market. There are a few experts on this, one in particular who focuses on bonds, and another who's name needs no mention. Maybe they will discuss their thoughts with us on the yield curve over the next few days as we have GDP tomorrow and the Fed next week.

To me, the flat or inverted curve concept really does not make any sense. I understand the leading explanations, but I believe those explanations are entirely wrong -- the economy is nowhere near slowing down. I believe part of the bid that has been underneath the long end is similar to the bid that was behind the stock market in the late 90s: Baby Boomers all over the world were in their peak income years in the 90s and they bombarded cash into sexy growth stories. Baby Boomers are now heading into retirement and the US long end is the best way to secure an income in terms of safety and yield on a global basis.

Well, what if the markets are wrong and things really are quite robust? It makes sense to me, mainly because herds get slaughtered. Better to be the wolf I believe. I believe all of these crazy moves we have seen in the foreign markets and commodities are a sign of an extreme amount of liquidity gushing out from all over the place. Considering where the world has been in the last 5 years -- anti-US, corporate fraud galore, terror, war, recession all over the place -- things are remarkably safe, stable, and sound. US stocks finally are benefiting.

But why does the curve remain so flat? Maybe to mop up all of this liquidity? But a flat curve really does not make sense if I am right and things are running full steam ahead.

Bonds are apparently the king instrument of all of the instruments. I think all of the choppy action we have seen in the markets over the last week or so -- from currencies to stocks to commodities - is a pilot fish foreshadowing a massive move in the bond market. Europe is about to move as well. I think today's move, one I was dying to buy, might be the start of something much bigger.

Inside Outside: More on Pitching Strategy from Dr. Phil McDonnell

A baseball batter is taught to "turn" on an inside pitch. This means that he will move his hands in front of the body and throw the fat head of the bat out in front and possibly step toward his power field (left field for a right handed batter). The combined effect of turning on the balls of the feet, turning on the hips and swinging the bat all the way through provides the maximum amount of bat speed and power. The result of meeting the ball in front causes the bat to be at an angle and normally sends the ball to left field for a right handed batter. Another expression for this style of hitting is "pulling" the ball.

Generally speaking batters are coached to try to pull the ball when they have an inside pitch. The inside pitch allows them to see the ball well. It also the best pitch to hit with the bat head out in front. There are two disadvantages to pulling the ball. The first is that you have to move the bat the greatest distance meaning you have to be quick with the bat and quick to decide. The other is the increased risk of a foul ball if you turn too far. It is quite common to see a long foul ball near the foul pole at home run distance. Invariably it was an inside pitch which the batter pulled too far.

Read rest of article

Baroque Music and the Markets, by Victor Niederhoffer

The decline of some 8% in Japan from Friday, Jan. 13 to Wednesday, Jan. 18, followed by a 23-point decline in the S&P 500, its largest one-day fall in three years, seems too imitative and unique to be just chance variation. The cyclical nature of the decline might even be qualitatively related to the fall of Enron in 2001 on improper accounting, which led to the fall of R#fco in October 2005, which made the financial shenanigans of Livedoor in Japan seem that much more significant. To gain perspective on these nexus, I turn to Baroque music, which is more exact and quantitative and regular than Classical or Romantic, where each composer's work bears its own stamp and can be immediately differentiated.

The main principles of Baroque music that seem relevant are taken from Jeffrey Lependorf's Masterpieces of Western Music (a course I find totally uplifting and enjoyable in a deep sense, far above Robert Greenberg's Teaching Company course, which contains one socialist diatribe and biographical detail after another, rather than an appreciation of the music) augmented by the lecture notes of George Weston's Stylistic Awareness in Music of the Baroque.

Lependorf sees the main principles of Baroque music as Imitation, where one instrument imitates the melody of another; Sequencing, where one melody involving certain steps up and down on the scale is repeated in a lower or higher register by the same instrument; Terraced Dynamics, the sudden change from loud to soft or soft to loud; and Ritornello, the repetition of certain sections of music. I augment this with the rhythmic principle that downbeats are key and are always followed by strong beats. Weston summarizes these rules as follows:

Weak to Strong, Short to Long.
Repeated notes, Change of Song.

I am still in the construction-of-hypotheses stage: the asking of good questions. I hypothesize that big moves in Japan early in the week, not accompanied by corresponding US moves, will be followed by subsequent big moves in the same direction in the US. I hypothesize that the intervals of the moves in the early part of a day or week are repeated in the later parts of the day or week. I hypothesize that big down moves are followed by big up moves. I hypothesize that small changes in price during the day are followed by large changes. Finally, I hypothesize that when there is little or no change during a period, it tends to be followed by a change in direction from the preceding move.

All these and other ideas stemming from the beauty, poetry and regularity of Baroque music should be tested and augmented, and doubtless readers will have their own expansions and improvements to offer.

MREITs Meet the Croakers, by David Baccile

In the spirit of Ben Franklin's autobiographical account of the Croaker telling him he should not have gone into the printing business and that same Croaker waiting many years to buy a home at much higher price because Philadelphia "was a sinking place", I always look for sectors that have been left by the trash heap by Croakers and to see if there may be some value left. After watching many MREITs rise to levels I felt unsustainable in 2004/2005, I see now that prices have come way down on NLY and others. In fact, MREITs that specialize in sub-prime mortgages such as ECC Capital (ECR) are trading at 30 - 40% discount to book now. I can't help but think that there are many Croakers out there talking about the easy credit terms being offered, the IO mortgage bubble and totally underestimating the homeowner's drive and ability to manage finances, work hard and find a way to make the payment...oh, if that doesn't work, along comes the Fed!

Execution, by James Sogi

There are many ways to execute a trade. Successful execution is critical, and can make the difference between a profitable trade and a not-so-profitable disaster. Given the narrow razor-thin profit margins and edges, over time execution can be a deciding factor in survival versus extinction. There is the debate between getting the spread and lost opportunity and how that plays out over time. One lost trade can make up for 50 market orders, but 5,000 spreads adds up over the years. There are different schools. Yesterday gave only a few minutes to those who wanted to exit on the high. Take the game where the trader is told, "today the market is going up; whoever makes the most wins" but the trader does not know the price path. Some will lose even though they know the market is going up, which shows the importance of execution.

There is the shotgun school of thought, multiple entries with guaranteed entries and exits. Varying amounts of lead in the target. There is averaging into a trade, averaging out. I have chickens in my yard and we have them for dinner on Sundays. If I can shoot them in the head with a pellet gun, that's cheap, but their heads jerk around and it's hard to get a kill and a head shot is needed. I call it "house hunting"). So when I need to certain dinner, I use the 12-gauge. Then there is the sniper/sharpshooter technique, for example a surgical strike after the market turned in one trade, with a ride up overnight and a sale at a new high next day. There are the automated execution systems that seem so attractive but elusive.

Sailboat racing gives a good analogy. When there is a big gust of wind, the sailboat gets lifted, in other words, the course of the vessel points higher into the wind in relation to the other vessels, and allows the ship to get the weather-vane on the other combatants, an advantage. Also, if there is a big gust, the boat heels over, and if some wind is not spilled out of the sails, the boat might tip, or when the wind stops, the boat will rock back and the boom might smack you in the head. I've found in trading that when the market gives a big gust of wind, and it swoops up, it's sometimes a good time to let a little wind out of the sail to avoid a capsize. There is the market insurance method of buying up, selling down. There is dollar cost averaging. Waiting for confirmation versus buying into the drop or selling into the rise. 50 ways, as the song goes.

Victor gave some excellent advice that has made a big difference for me. I've added a few of my own ideas. These are for S&P futures or SPYs. Individual stocks trade differently and idiosyncratically. Tired market homilies such as the trend is your friend and buy low, sell high are not helpful. If the daily average range is 10 points, it seems better to buy in the lower end of the range than in the upper end. Another subject I is profitable exits. We've talked stops and entries, but when or where is the profit taken? What is best exit criterion given a specific signal and time? Price level? Price action? If the market wants to give you a gift, take it. Never look a gift horse in the mouth.

My approach:

Asking the Right Questions, by Victor Niederhoffer

I am often asked what the essential quality for success as a spec investor is. It usually comes up after someone points out that there are so many smart people in the field, that they sometimes feel that no matter what they do or where they go, there is some expert who has access to larger funds and been there before. Their expertise is registered in the current price, and because each event is unique it's impossible to do better than blind chance. Better not to get out of bed at all they seem to say, or possibly to put all their money into a money market fund. How can one improve? What to do?

I do not have a brilliant answer, but it seems to me that the key is to ask fruitful questions about your investments. What is the essential ingredient that will add to your reward/risk ratio with each new investment? How can study of the phenomenon you are investigating provide information that will help? Does the answer to your question help reduce your uncertainty? Can the answer be evaluated for accuracy? Will the answer help you learn and be more successful?

Here's an example of a situation that arises often where I am always called to provide feedback:

There is much bad news around and fear is rampant. The market has just registered a terrible decline, consider the 23 pointer of Friday 20th January as a benchmark. How do you proceed? Four steps relating to asking the right question seem relevant.

  1. Firstly, by classification. Let us start out the way Darwin or Linnaeus would have done, with a classification of the decline. How big was it? Has it happened before? Did it occur in conjunction with a recurring announcement or was it a nebulous kind of thing like last Friday's decline? Had it been preceded by widespread declines in the market, like those of 9/11 or summer 2002, or did it occur after a big rise?
  2. Counting. What occurred during these events? A complete enumeration is helpful for rare events, but summary measures such as the mean and average absolute deviation are appropriate for more common events. Particular attention should be paid to the times that great gains or losses, including ruinous ones, occurred in the past. Is the most recent event different in terms of the market action that preceded it, with particular reference to whether it came after a market rise or decline, and how long has it been since the last similar event? Did this one occur near a holiday or the beginning or end of a period?
  3. Next, try to learn from the situation. How could you avoid declines such as Friday's in the future? Perhaps by getting off the tiger you are riding at the beginning of a period. Perhaps by coppering the market moves preceding 4 day weeks? How should you change your activities in the future now that the decline has occurred?
  4. Relations. Why did the decline occur? Was it related to some underlying problem in another market or to a particular aspect of the economy? Was it an imitation of something that occurred in another market? Did it occur as part of a repeating sequence?

The four steps to asking the right questions; classifying, counting, learning and relating, are certainly going to lead to humility. There are so many factors to consider and so many unique things that went into the particular phenomenon you are observing that you know you are uncovering only a small part of the situation.

The uncertainty surrounding last Friday was great, that is a given, but imagine how much more difficult it will be now that everyone has learned and listened to this one.

P.S. Before asking a question, it's important to do some homework. Consider who else has studied the phenomenon, and what has been learned. Consult your data base for preliminary answers so that you will have a foundation for evaluating your own. As a second post script, I started this study by researching how to ask good questions. I found this article for teachers on the essential questions for learning to be the best.

I am unsure if what I have written above is useful or not, but I do know that the inability to ask the right questions has wasted more time and money in our field than anything else.

Variations on Victor's "Asking the Right Questions," from Russell Sears

It has been said that Einstein was a slacker prior to 1905, although perhaps to justify why the great minds did not recognize his brilliance. I would suggest that Einstein did not change, and he always had a knack for asking the right questions. Nobody, however, asked him anything before 1905.

Even then it took an almost accidental stumbling onto him before his genius was recognized and while he awaited discovery he continued his meager life. There are excuses after excuses as to why his genius was not recognized; he was a Jew in pre World War I Europe, he lacked well rounded genius in other areas, he was a slacker -- preferring to do his thought experiments rather than study. The truth is that, even for perhaps one of the greatest men ever, nobody thought much of him while he was 'asking the right questions.'

If I ever get the privilege of asking Bill Gates a personal question I think it would be this, "Why did you quit Harvard? Did nobody believing in your genius to ask the right questions have anything to do with it?" The professors now will probably tell you how annoying he was, or some such excuse, (imagine a young Harvard student being too brash, must be rare), rather than admit that they did not see his genius.

Victor's love of the history of Charles Darwin suggests that he admires a man who can ask the right questions. Darwin was at least accepted by his peers, but again, Darwin's genius was not recognized at first. Many would argue that the Church and its doctrine blinded the great minds of Darwin's time to his genius. Perhaps there is more truth to this than the Church would be happy to admit, but I find laying blame at the feet of the religious zealots too easy a scapegoat for the great minds of the time. People like to flatter current society by simplifying the past. Chronocentricity.

Another great mind that "asked the right questions" and did not get recognized early on for his genius.

Each of these people have changed the world by asking the right questions. In hindsight, this is easy to see, but in each instance, nobody, at least nobody within the establishment, would initially recognize their genius.

Perhaps wasting society more money than not "asking the right question" is not recognizing or asking the right person the right question.

This has lead me to wonder why people do not recognize the ability to ask the right questions early on as genius. You could argue that 'questioning' is a learned skill, not developed early on, but I do not believe that this would stand up to scientific observation. I believe the above examples show that this is a gift, a gift to be developed, but a gift none the less.

The only time I have meet Victor was at his birthday party in which he asked me how I came up with my observation and post. I began to answer him, but as there were many others there we both got pulled in different directions at the time.

To conclude I have some thoughts about those who are good at asking the right questions.

  1. They enjoy being alone to think. Einstein walked, Darwin went on the Beagle, Gates spens time programming. Perhaps this means that shutting people out is part to blame for the lack of early recognition? Going off the beaten path is easy for these people.
  2. Once their ideas come out they seem so simple as to be common sense. It is like in those old sitcoms where Mom has the great idea but Dad always thinks that it is his. Many people honestly believe someone else's idea was their idea all along.

  3. Asking the right question often is not really recognized as a skill but is seen as an annoyance, until you prove its the right question.
  4. Victor seems to be an expert at asking the right questions, well beyond me. Study his posts. Study those that have asked the right questions, and ask yourself why?

Finally, a relevant idea to test. While CEOs with high class sheepskin do not overperform or under perform. Do companies that only hire top executives from ivy league schools underperform or overperform?

Andrea Ravano adds:

I am not sure if it is the right question, but I am puzzled by the dilemma; was Friday the first movement of a large and new sequence of events according to the law of ever changing cycles, or is it quantifiable in terms of possibilities, which, I understand, depend on past occurrences?

Are not the two factors opposing each other, leaving us with a zero sum answer? I am inclined to ask myself which amount of information is discounted in the prices more than counting probabilities? But considering the success of counting probabilities, I may want to change back soon.

Andrew Moe adds:

After forwarding the Hobo's latest tale to my brother, who is a Chicago city cop, I began to ask myself how good policemen analyze a crime scene. Not in the glorified CSI sense, but in reality. It seems to me that they must perform a similar action to us as traders, where we analyze the clues left by the prior day to determine causes and future action.

In looking at the carnage scattered about on Friday, one might observe the bodies of GE and C, both shot at close range. Ah, yes, GOOG down 8% with multiple stab wounds and lacerations indicating a struggle and perhaps torture. All on options expiration day ...

A little research also uncovered this gem on crime reconstruction which echoes the words of the Chair on asking the right questions.

Bo Keely Responds:

Interesting. a good thinker is as hard to find as a good cop, and each should be prized.

I entered a big mid-west paddleball singles tourney this weekend in Chicago. The lefty wallpaper shots were effective to handle a B player, play even with an open player, and lose badly to a young A player. Back to the drawing board. The formulation of sports strategy is similar to the scientific method for crime scene investigation as outlined by the writer below- from hypothesis to testing to conclusion.

My hypothesis is that I need better killshots to end rallies quick to get off the court fast because in long tournaments the least expended player is the winner rather than the best. There will be different paddle angles to try this afternoon to get the killshot down while retaining the wallpaper shots. I'll test these against local Michigan players and draw the best conclusion.

The Chicago tourney was a breath of the old court days. Drove five hours in a snowstorm to arrive at the club twenty-minutes before the first 10am match. It was the wrong facility. Found the right club and the marathon began on Saturday morning. Matches were best 2-of-3 to 21 and lasted up to 1.5 hours each. We walked off one court and onto the next usually with zero rest. Some players had five matches in 7 hours, and by early evening they dropped like flies with cramps. The most fit specimen was a 35-yr. old female pro (#8 in the world) racquetball convert with serious legs who got to the A s and B s finals before pulling a calf, and played on.

Paddleball players are cavemen standing next to squash or racquetball. They re held together with pads, braces and duct tape, and the event resembled a mummy reunion. I felt at home playing in clown shorts and a tie-died tank top. The Chicago club is abandoned and opened for the winter weekend tourney. There was no heat and players walked to matches in coats and gloves muttering about shoveling show. The finals should have been held in the only warm spot, the sauna, in consideration of the dozen spectators.

A good time is had by all. Those are the good old days.

Big Al comments:

One is justifiably embarrassed to post about a crime drama, but it bears on the thread. If you like a good cop show and you want a realistic antidote to the CSI - super sleuth approach, check out Da Vinci's Inquest, a Vancouver-based show just recently in syndication on a couple channels in the US (WGN, for one). Da Vinci's Inquest portrays crime scene work in a much more pedestrian manner than CSI, a bunch of people standing around scratching their heads and trying to figure it out. Plus you get a good dose of decent Canadian socialism to go with it, though the recent election results may alter the spin a little.

Henry Carstens suggests different Perspective:

What does trading look like from the computer's point of view?

From The Day Traders Forum: Music in the Market, by J.P. Highland

So as the future Hall of Famer, Mariano Rivera has his own song (Metallica's "Enter Sandman") prior to enter the ninth inning, I decided that AC/DC's "For those about to rock (We salute you)" should be the song I would use every morning prior to begin my trading.

This morning, as every morning, I woke up expecting the best from the markets, it doesn't matter if the previous day was miserable, I always begin the trading day expecting the best. Everything was going fine this morning, the S&P Futures in green and above the pivot range, Crude Oil in red, earnings from two of my dogs in Briefing.com looking good, I still miss Mark Haines but Becky Quick is better looking, so everything was fine. But my mood changed when the NY Mets appeared on the Opening Bell Ceremony of the NYSE, I can't explained why but I didn't like the feel.

As soon as the trading begins I plug myself to my IPod, I usually listen to diverse forms of Electronic music,  Trance being my favorite. The speed of the bids and asks seems to be perfectly synchronized to the high-quality mixes of Nick Warren or the Evil Beats of James Lavelle.

But today was one of those days in which nothing works, my trading style doesn't look for stocks to move 1 point to be successful, for me 5 cents is good enough, but today nothing was working. I always try to trade "a la" Larry Brown (Detroit Pistons), always playing strong defense but I was wiped 3 times in a row badly by a stock I should have not been trading and the churning was terrible.

When things are going my way I usually play something like "Oh, that's I like it, uh-uh-uh-uh" from KC & The Sunshine Band, I know is not very "classy" but I like it. But today "Highway to Hell" from AC/DC was more appropriate.

But tomorrow will be a beautiful day.

Another Theory on the Sage, by Roger Arnold

Has the Sage ever discussed:

  1. What the US alternative to recent trade/budget deficits and fiscal/monetary stimulus is?
  2. The demographic/political/economic and social structural/institutional problems in western Europe or Japan versus the US?
  3. Now that the US deficits have been realized, what the domestic and foreign policy options are for the US?
  4. Exactly why the deficits are a prelude to domestic crisis?
  5. As he believes there will be a flight from the dollar, where will the money flee to?

It was evident about six months ago that there was something wrong with Ariel Sharon. Even a casual observer of Israeli politics would have noticed his abrupt change of stance with respect to the Palestinians; almost schizophrenic.

Is the Sage beginning to show signs of disorientation?

He increasingly sounds like a college coed, ivory tower professor or religious end-timer, spouting off about some personal, kumbaya, political or social belief without consideration of practicality or logic.

I have learned over the years of watching the Sage that he sees every other being or organization on the planet as some cardboard cutout or pawn, a means to a personal goal, and nothing more.

His born-again style pontificating about the dollar and US policy is very suspect

Assuming he still has his faculties intact, I must assume he is either concerned about mishedging at his conglomerate, or has succumbed to political pressure to take his current stance publicly as a quid pro quo for the government's not pursuing the nefarious maneuvers of his insurance operations.

Not a conspiracy theory; just a thought.

A Horn of Plenty of Bearishness, by Victor Niederhoffer

A fount, nay, a horn of plenty, of info reports that the current meme is that if it goes down in January, it always goes down the rest of year, but if it goes up in January, it doesn't necessarily go up. Goodness forbid one should look at 2005, where it was down 2.5% in January and up 6% the rest of year, or 2003, where it was down 3% in January and up 30% rest of year. But isn't it perfect how the Abelprudflecorosetts can make 100 mistakes in one sentence, and doesn't that provide so much opportunity for those that don't hate life itself?

George Zachar responds:

I would like to add that the emerging theme for the upcoming spate of "au revoir Greenspan" articles is that he's left Bernanke a poisoned chalice/ticking time bomb of bubbles and imbalances.

Ambush, by J.P. Highland

Few things are more suspicious than get filled at a better price than the requested one. This morning I was trading one of my dogs on the long side, I was holding a small position and placed a bid at x.35 trying to up-tick the stock, but I got filled at x.32. I have traded this stock several times in the past I am aware that the Specialist is a gangster and never gives something for free, a hidden seller must be preparing an ambush so as soon as I got filled I covered my position against an unaware ECN.

Sometimes I can be be very paranoid, but I'm a small player and I have to protect myself. Dead men don't trade.

Stefan Jovanovich comments:

Citing Clausewitz, Jeremy responsed to J.P with:

During a classic ambush those being ambushed only have two options. Die, or advance towards the attacking force quickly with a maximum expenditure of force.

Not so. In ambushes, as in all combat, people die, whether they retreat, stand fast or advance. What a platoon or a brigade should NOT do in a meeting engagement is advance towards the enemy "quickly with a maximum expenditure of force". The reason is rather simple: you do not know how large the enemy force is. Without that knowledge, advancing "towards the attacking force" can literally be suicidal. It was for Major General Kawaguchi's troops when they ran into the Marine 1st Raider and 1st Parachute Battalions south of Henderson Field, and it was for Custer at the Little Big Horn. (The conventional view of Custer was that he was "arrogant" - a kinder explanation is that he simply did not stop to make an accurate assessment of the size of the force he was up against.)

The proper tactical response to a meeting engagement is "the fan": the point holds and the column behind splits left and right to form an arc. That allows you to bring maximum firepower to bear. It also allows you to assess the size of the enemy's front.

As for Baron von Clausewitz, I am afraid his reputation is highest among those farthest from the battlefield. He is - like Machiavelli - an undoubtedly a brilliant figure, but he is also the guy not to ask how to destroy an attacking French column. The Baron's actual war experience was that of a 2-time loser: once against the French Revolutionary Army and once against Napoleon. That is an embarrassing detail (like the actual combat citations for John Murtha's purple hearts) that is always omitted from any discussion of his military words of wisdom.

Peter C. Earle adds:

I Hope that these recollections help flesh to out the issues, philosophical and otherwise. As a former light infantryman I can offer:

The safest place when ambushed is within the enemy ambush line. For that reason, small unit tactics usually specify two types of ambushes: the near ambush and the far ambush. The difference is defined by whether the enemy line is within grenade throwing distance. In the event of a near ambush, the reaction drill is to drop, return fire, and coordinate the simultaneous throwing of grenades, upon the detonation of which the enemy ambush line is rushed. In the event of a far ambush, the reaction drill is to drop, return fire, and begin retrograde movement under cover of smoke and M60s on cyclical fire, (550 rounds per minute, if memory serves).

How does one avoid being ambushed? Three elements of fieldcraft come to mind:

Firstly, avoid prominent terrain features and 'lines of drift' in movement - stay off of trails, dry streambeds, low points of valleys, pronounced ridgelines, and the like. Look on your map at what you think would be great, ambush channeling positions ... and then avoid them.

Secondly, pay attention to detail, spending a few minutes throughout each day and night with helmet off, familiarizing yourself with and absorbing the smells, sights and sounds of the environs. The enemy, over time, will betray himself with tobacco use, irresponsible disposal of waste or clumsy movement, (leaving footprints, broken and trampled flora, etc). It can indeed, as Chair says, be "too quiet."

Thirdly, and simply, exercise 100% noise and light discipline at all times past the line of departure.

Defending Against Attacks and Trading, by Tom Ryan

With respect to Kobe Bryant's 81 point scoring effort Sunday, my daughter's soccer team has the same problem as the Lakers, as they have one dominant offensive player who tends to score 1- 2 goals each game in the first half. However, in the second half the opposing team adjusts so she has a much harder time scoring although some of the other girls get more opportunity to score.

I didn't see the game with Kobe Bryant although I once saw Jordan score in the 60s. In that game the opposing team could not seem to stop Jordan from scoring, even when they adjusted and double teamed him.

It's an idea applicable to trading, the time required to sense a pattern of attack and make an adjustment in your defense. For example, last year we had several long runs where stocks were down open-close day after day, to the point where we were all shaking our heads and throwing pencils across the trading room. At what point do traders adjust to a repeated pattern of attack?

Several years ago I saw a paper on team defense where there was a study of lacrosse, soccer and water polo that showed defenses collectively began to adjust after 6- 7 continuous attacks by the same players in the same portion of the field. How they counted was questionable and unclear, but the magic number seemed to be about seven. I find that noteworthy that we see very few runs in the market on the smaller time scales (intraday, day to day) that go much beyond seven in a row.

James Sogi comments:

This discussion about continuous attacks, runs of 7 or more, and 3 pointers in basketball reminds me of record sessions in three-line break charts. Steve Nison describes this in Beyond Candlesticks, chapter 6. Being a Missourian in spirit, and following Chair's admonition, I like to test everything now, and with all due humility, even the stuff Chair criticizes as pure mumbo, like candlesticks--see Practical Speculation Ch. 3, pg 85. The old time Japanese rice traders probably painted their charts with a calligraphy brush as they traded their rice warehouse receipts for future delivery. They called 8-10 record sessions "the bones of Sakata's body". Nison claims 8-10 record sessions up is bearish. Testing same reveals some merit to 8 record sessions up being 'overbought'. Scientifically speaking, I hypothesize that it is not pure mumbo. 8 new highs in the market, as in basketball, is an amazing event and might be considered as oishi bento for the current cycle as it was for the last 100 occurrences. Oishi mean tastes good.

GM Nigel Davies adds:

I would have thought that adjustments would start to be made as soon as a pattern is observed. But perhaps a 'critical mass' of observers is required for the pattern to start to disintegrate. Perhaps the adjustment to 'known' patterns is much quicker than those that are obscure. It will be interesting, for example, to see what happens around February 1st after the last two firsts.

Scott Brooks says:

I believe this simply goes beyond pattern recognition and adjusting to it. Skill and ability can and will overcome adjustments made by lesser opponents.

When I was in grade school I got into playing chess. A kid named Mark was the president of the chess club and reigning champ. I beat him and thought I was hot stuff. Soon there after another kid (nicknamed Elmo) came to play. Elmo was a smart kid but smoked to much dope, got suspended for fighting a lot and when he was in school, got bad grades. He played chess one day because we had chess club in the detention room (where Elmo spent a lot of time). Elmo, who had never played before, caught on very quickly and went on the beat everyone. He beat everyone at every school he played against.

I could adjust my play to Elmo all day long. It didn't matter. He was simply better than me. If I played Nigel, the same thing would happen. How could I hope to adjust to Nigel? How could the NHL adjust to Gretzky?

A great player is simply one who sees things that others do not. Like Gretzky said, "I don't skate to where the puck is, I skate to where it's going to be" (or something like that).

Same thing is true when I played poker my Junior and Senior year of college. I made a lot of money (I estimate I made $35k - $45k my senior year). I discovered that I could really play poker well. I played against some very good players who knew how to adjust. They couldn't beat me (I'll have to do a post sometime on some of my poker story's). When I played poker, I went into a zone.

These analogies apply to trading:

Victor Niederhoffer adds:

One could not help but think of the irony of some pseudo academics like the Tversky twins studying basketball scores and concluding that the hot hand does not exist and that Kobe Bryant's 81 points was completely consistent with randomness. In similar fashion, Cootner and Fama and others of the 1960's concluded that markets were completely efficient until the opportunity to profit from anomalies they found that in actuality due to their faulty abilities were truly random retrospectively as well as of course prospectively thru the Bacon effect.

A Note on Friday's Decline, by Victor Niederhoffer

Our readers know that when a big decline occurs, like the 23-pointer last Friday, it's generally time to take out the canes. Such declines have been incredibly bullish for all foreseeable periods of the future since 1850.

For example, seven of the last eight times a 20-pointer has occurred, the market was up by three days later, with the one decline's being 1% and the modal rise of 2% occurring three times. I enumerate the dates so that those with a pencil and envelope can quietly study the anthills:


What is striking about Friday's decline is that it came out of the clear blue sky. It was the biggest drop since March 10, 2003. I studied such events for insight, and my studies did not stop with Laplace's methods of estimating probabilities of such "out-of-clear-blue-sky events" or the myth of Icarus. I believe this a worthy area to contemplate.

The Minister of Non-Predictive Studies is looking over my shoulder now, so all I can add is that the large declines tend to cluster. And once they cluster, as in 1907, the 1930s and 2001- 2002, the reward risk/ratio is changed. However, before his hook reaches me, I point out that everything stated above has been tested.

Jack Tierney comments:

What is striking about Friday is that we have gone over two years with only one other 2% or more downward one-day adjustment. When I read the numerous posts on DailySpec kvetching about bearish sentiment during this same period it's amazing that we have not had numerous similar days. Unless of course, there has been a disconnect between perception and reality.

We went through 2004 without the AAII marking a single week of majority bearish sentiment. This has happened on seven occasions prior to 2005; the following years were always down. Recently this same measure has been at its highest, or second highest, level ever.

The remaining seasonal bears (as opposed to permabears) are so few that, were they a species, they could apply for endangered status. The optimists continue to triumph, and try as they might to create a wall of worry, the only impediments are the occasional stumbling block.

For those who have given up on CNBC, you ought to check out their late night programs CNBC Asia and CNBC Europe. They're totally different animals with legitimate analysis and little or no cheerleading. And Louisa has the greatest widow's peak since Morticia Adams.

GM Nigel Davies adds:

'Unexpected combinations' are quite an important facet of chess. But usually they are only 'unexpected' from the point of view of conventional chess understanding, thus they offer us the possibility of improvement, if an explanation can be found.

Dr. Kim Zussman comments:

Using historical S&P 500 data, I counted weeks with returns below -2%. I then regressed each year's count versus all calendar years from 1950-2005:

Coefficients 0.0735
Standard Error 0.0326
t Stat 2.2556
P-value 0.0282

Over this period the number of -2% weeks per year generally increased and the relationship is significant. I suspect going back further to the 1920's might change this, but that may not be relevant.

The average number of 2% down weeks per year was 5.8, but the last two years were below average:

1950   3   1960   6   1970   9   1980   8   1990  14  2000   9
1951   5   1961   1   1971   4   1981   9   1991   3  2001  11
1952   2   1962   9   1972   2   1982  11   1992   2  2002  16
1953   3   1963   2   1973  13   1983   3   1993   2  2003   6
1954   1   1964   0   1974  18   1984   8   1994   5  2004   3
1955   5   1965   2   1975   8   1985   2   1995   0  2005   4 
1956   5   1966   8   1976   3   1986   8   1996   5  2006   1
1957   9   1967   2   1977   7   1987   9   1997   7
1958   0   1968   2   1978   8   1988   7   1998   7
1959   1   1969   8   1979   4   1989   4   1999  11

The Artful Simulator Releases Our Latest Fed Model Numbers

Fifteen Tech Concepts for 2006 from Popular Mechanics Magazine, summarized by Vince Fulco

  1. Driver Monitoring System: A built-in camera in the car gauges the driver's attentiveness and warns of waning concentration with an audible signal. If the potentially dangerous activity persists, the brakes will be tapped periodically.
  2. Body Area Network: Chips and transmitters embedded in implantable devices such as pacemakers can report a patient's condition and change treatment regimens administered by the devices if necessary.
  3. Internet Protocol Television: Similar to VoIP, a device allows programming one's digital video recorder from afar over the net.
  4. Metadata: Programs are increasingly collecting data about data. Traditionally captured in flat files, the data is "tagged" with more detailed info providing users the ability to sift, sort and find by multiple criteria quickly.
  5. NAND Flash Memory: Already in the marketplace, flash memory capacity will increase manyfold. The technology is superior to hard drives since it is smaller, uses less power and has fewer moving parts.
  6. Nanoparticle Batteries: Toshiba is in the process of manufacturing and miniaturizing batteries which will have remarkably quick recharge times; on the order of 80% capacity within 1 minute.
  7. Spam over Internet Telephony: Due to the rapid adoption of internet based telephony, the marriage of Spam and VoIP will create new and highly virulent threats to one's communications system. Potent and rapidly evolving antidotes will be needed.
  8. Micro Fuel Cells: After years of promise, 2006 is the first year when practically sized fuel cell devices find their way into notebook computers. With twice the energy density of existing lithium-ion batteries, by next year, they'll be found in cell phones.
  9. Electronic Medical Records: Found in less than one third of the nation's hospitals, digitized records will provide disaster recovery capabilities, access by authorized caregivers and better analysis of national disease trends.
  10. Coal Gasification: New technology is stripping coal of its pollutants and breaking it down into a cleaner burning fuel. Power plants in Ohio, Indiana and Illinois will be online with the process by the fall.
  11. Perpendendicular Storage: By changing the orientation of data storage on a hard disk from horizontal to vertical, manufacturers estimate the media will hold 10x its current capacity.
  12. Presolar Interstellar Grains: Recently returned to earth, NASA's Stardust Probe has scientists enthusiastic over the potential that this cosmic dust collector holds. The sample of particles brought back to earth were preserved in the frigid atmosphere of space before our solar system was created.
  13. Crime-Lab-On-A-Chip: Shrinking computer controlled valves, switches and pumps embedded on a chip are leading to the development of fluid based microprocessors and greater in-the-field analytics.
  14. Fiber-To-The-Home: The telecoms answer to the cable industries all in one offering, service is currently being rolled out for 30Mbps delivery of telephone, internet and HDTV on demand.
  15. Blind Spot Detection: Miniature radar sensors built into rear bumpers of cars will allow drivers to "see" objects in their blind spot. With both visual and audible warnings, hidden dangers should be a thing of the past.

Dick Sears Weekly Commentary: Power Outage

The Senator Comments on a New York Times Article on Dividend-Paying Stocks in Last Third of a Bull Market

This excerpt captures essence of story:

A study of bull markets going back to 1900 by Ned Davis Research, an investment research and advisory firm in Venice, Fla., seems to bear this out. An index constructed for the study showed that in the first third of bull markets, stocks that pay dividends tend to trail those that don't pay them. In the middle third, the dividend payers lead slightly, but in the final third, dividend payers, on average, win handily.

To which I would reply:

I have researched this and it is bullish for low price stocks to be very strong when stocks have been in a bear market--smart money sign of buying, whereas low price stock strength later on is public buying close to a top.

Power Skating, by Steve Ellison

One way to store potential energy is in a coiled spring. I was coaching my son at hockey practice last week on how to skate more powerfully, and he said I sounded like a physics teacher. To skate for speed, the technique is to use the legs like coiled springs. With the knees deeply bent, 90 degrees or more, one angles a blade edge into the ice and forcefully pushes the leg to full extension while gliding on the other skate. The gliding leg remains bent because, as soon as the skater retracts the extended leg, he will switch legs and push off hard with the other skate. If one skates with the legs bent only slightly, he cannot go nearly as fast.

An interesting corollary is that, because the force of the leg extension curves the gliding blade slightly outward, the fastest path between two points on a hockey rink is not quite a straight line; it's a bit of an S curve.

Sprinters similarly compress their bodies against the starting blocks to get a fast start. There must be many applications in which one can store potential energy by movement in one direction to increase force in the opposite direction.

Rob Wincapaw Reports on the Australian Open

The magician, as one commentator dubbed him, is the Tahitian-born Fabrice Santoro. At 33, Fabrice is the oldest man left in the Australian Open draw. He can't move like the youngsters, nor does he have the big forehand or the monster serve. But, what he lacks in physical strengths and weapons ubiquitous to most of the field, he makes up in creativity and deception.

Fabrice is deceptive in appearance as well. He's listed at 5' 10", but on the expanse of the big green court he looked more like Bilbo Baggins. Despite this he outlasted the 8th seed Gaudio with a mixture of drop shots, lobs, slice two-handed forehands, cut drop shot return-of-serves and a mixture of other creative shots including the two-handed back hand volley (a-la, one very steady player on team Niederhoffer).

Wrong-footed and frustrated into submission, another big hitter disappeared at the hands of the magician. Unlike Brad Gilbert from the 70's, who drove opponents crazy with junk balls and intelligent but ugly play, Fabrice's use of trickery and deception is more fun to for the spectators. It is equally frustrating to the opponent though, as best shown by this quote from Safin, "being told I would play Santoro was being told I was to die".

I don't know that he'll get by his next opponent, the 11th seed, David Ferrer, but just making it to the round of 16 in a sport this competitive, relying mainly on guile and determination, is quite the feat. Go Santoro!

On another court Martina Hingis continued her comeback, beating Iveta Benesova of the Russian battalion. From the onset it seemed Benesova was too strong for the 26 year old Hingis, who hasn't played for 4 or so years because of injury. Benesova went up 3-1, pounding Hingis' slow loopy shots. Hingis however, much like Federer, is a good all-round player and she kept moving the ball around, whittling away until she found a chink in the Russian's armor. The chink was that once Benesova missed a few shots she quickly and progressively lost her confidence. Hingis just kept the ball deep and moved it around in unpredictable patterns. Benesova became unnerved and never regained her rhythm from the first 4 games, with Hingis winning easily, 6-4, 6-1. Like many great champions, Hingis found a way to win, and to impose her game on her opponent despite her opponent having a potentially stronger and better game.

One badminton legend was extolling the virtues of his game when he said that he basically didn't do anything fancy, he just "almost always hit the correct shot", if the situation called for a drop, he would hit a very well executed drop, etc, etc. I remember Bo was quite adept at detecting a weakness and then zeroing in on it; Vic's not too shabby at this either.

Hingis plays very intelligently and economically, usually making the right shot, and she has the ability to impose her game and her will on the opponent. At 26 years old, and after a big layoff, she too may not advance much further, but it's great to see a master taking to the canvas again. Her Swiss counterpart in the men's draw embodies all of these very attributes, plus he has tremendous physical skills.

In market terms, be creative and on the alert for deception. Also, be intelligent and pragmatic, make the appropriate move at the appropriate time, (easier said then done), and try to impose your game on the mistress, not the reverse.

Tea Benefits, from Pitt Maner

There are a lot of studies on the benefits of tea drinking. Over the past couple of years Fuding White Treasure, Rooibos, Ceylon Select Earl gray and Hoji Cha Kamakura from Upton Tea Imports and the local grocery store have found their way into my kitchen. Some say that tea is going to overtake coffee in popularity - perhaps like wine over beer. Antioxidants and the aging population. Coffee is evidently supplying a major portion of the antioxidants in the American diet at the moment, will Starbucks be able to go with the flow?

The South Alabama, world motorcyclist-investor mentioned purchasing tea plantations many years ago for the young at heart entrepreneurs. Was it a good call? Others in the know will have to say.

At any rate, given a receding hairline, the following 'hair raising' study caught my eye, and the white and green tea has been steeping around here quite a lot lately!

Briefly Speaking: The 2006 Jump Ball Bet, Binion, Linnaeus, by Victor Niederhoffer

2006: A Door-Opener Bet

Bookies in Vegas frequently offer special door-opener bets like the following on any basketball game. The team that wins the jump ball at the start of a game is 6 1/2 -7 1/2 to 5 to win the game. I found that the first blow was half the battle in my racquets career and often put everything I had into the opening, starting out with my "hard serve" right at the beginning rather than following the tradition of waiting for the end of the game. Of course, we know that the market version of this known as the January Barometer is most likely complete mumbo, having been wrong so much more often in the most recent years than would be consistent with a true regularity (we will print the Almanatarian's diatribe and critique that the most recent years shouldn't be considered because of the Lame Duck amendment, the war in Iraq, or the cycle at the Fed et al., when he sends it).

However, the time has come to test the insights of the Vegas boys. What are the chances that the market will be up in the last 50 weeks of the year given that they were up in the first two the way they were this year (up 2%)?

The chances that the market would be up the next 50 weeks based on 1981-2005 data were 75%, with an average of 75 points for those 50 weeks. This must be compared to the chances that the market would be up in any 50-week period conditional on the previous two weeks being up. That chance is 80%; However, the expectation for these 50 weeks is a mere 49 points.

The results can be summarized as follows:

               Move the Next 50 Weeks
                      #        % up     Avg chg
First two weeks up    12       75        75
Any two weeks up     718       80        50

As the standard deviations for the last 50 weeks are of the order of 110 points, the results are completely consistent with randomness. However, the 75% to 80% probabilities of a rise might be good to take into consideration.

A Smart Operator

I had dinner with a good dealer friend the other day, and he told me some stories about the smartest operator in the gambling business. It's Jack Binion of the Horseshoe. He was smart enough to move his gambling operations out of the downtown Vegas area some 10 years ago, and find a more desirable location--- the Mississippi riverboat business. Location, location, location -- and timing, timing, timing. He sold out the business for a reasonable approximation to 10 figures a bit before Hurricane Katrina hit.

Jack was the Wal-Mart of the business. The rooms at the hotel were always of the quality of the Motel 6 but the prices were as low as Wal-Mart's. He was as a consequence always able to give the best odds on dice or roulette or poker, and the most confirmed gamblers came there because of this. He was always ready to accept a fair bet of any amount on any game in which he had the slightest of edge whether it was the SuperBowl, dice or roulette for seven figures or more. After all this was his business. But he hated to take a bet for $750,000. If he lost a million, it was great publicity and the handle would increase enough to offset the 49% of the time he lost. But if he lost $750,000 that was just another loss so he didn't get the advertising mileage out of it.

I have always thought that it would be good for the investment banks and dealers and other top feeders in the chain of markets to advertise how much their customers made off of trades because this would be great for business. The British Navy of Thomas Cochrane and Horatio Nelson and Patrick O'Brian was always good at this, ready to fire a chivalrous salute to a enemy ship at the end of a well-fought engagement that ended in a draw. However, I am afraid that the investment banks and dealers are much too like most Vegas dealers, who seem to hate it when you walk away a winner . They at least have an excuse because the dealers have to explain to the pit bosses that they really lost it fair and square and were not in collusion with the players, and this takes time. The dealers always seem disgruntled on the rare occasions you beat them out of a tick or two, from that same malevolence that so often characterizes those that could not fare well in an evenly fought game. I encourage operatives in my shop to follow a trick I learned from The Godfather and my own 12,000-plus competitive refereed matches, and now from the excellent book Buzz Marketing: Always make the adversary underestimate your wins, as this will lower his guard and make him overconfident.

The Importance of Being a Classifier

The book Linnaeus; The Complete Naturalist, by Wilfred Blunt is an excellent book for the speculator to read. In addition to providing a glimpse into the life of a doctor and true lover of nature, it shows you the importance of classification. His classification schemes provided a framework and necessary link for many of the discoveries of Darwin, the entire advancement of botany in the 19th and 20th century, the classification of diseases, and much spicy interest in the sciences from the public. The scientist himself was likeable, lively and romantic in the style of Jim Watson. I liked this letter he wrote to the attractive botanist Lady Anne at the age of 57, whom he had never met:

Nature has never produced a woman who is your equal -- you who are a phoenix among women. Those who fall in love are wont to ingratiate themselves by precious gifts. I enclose a few rare and genuine pearls (seeds) which I have recently collected. Sow them in a flowerpot and place it in your window where it will get the sun. Should I be so happy as to find my love for you reciprocated, then I ask but one favor of you: that I may be permitted to join with you in the procreation of just one little daughter to bear witness of our love -- a little Monsonia, through which your fame would live for ever in the Kingdom of Flora." [The Monsania are geraniums.]

I believe that Jim Lorie and Lawrence Fisher, through their establishment of The Center for Research in Security Prices and their papers on rates of return, played the same role in the classification and codification of security returns that Linnaeus did in botany, and that the explosion of subsequent work in finance; the development of index funds; and a large part of the increase in wealth, the diffusion of stock ownership and standards of living throughout the the world came from their classification schemes. It's one of the reasons that I always recommend starting a study of any market phenomenon with a nice classification scheme, and a good quantitative exploratory description of the data.

Martin Lindkvist adds:

Linnaeus made good use of "apostles" as he called them. Men under his mentorship were sent out across the world to help him explore and collect plants for classification. Of 15 apostles, 5 died during their travels. The others returned in fame. One of the apostles, Daniel Solander, was onboard the Endeavour during 1768 to 1771. This started a tradition, that all British naval ships for exploration should carry a naturalist for biological collection and observation (Solander had by that time though, after having been sent to England by Linnaeus, changed "shops", to another naturalist; Joseph Banks.)

Pitt Maner comments:

Is it better to be a 'lumper' or a 'splitter' when it comes to these taxonomic, financial, or life questions?

It is interesting to note that some of the amazing and never to be seen again life forms, Burgess shale fossils, (the "Cambrian explosion"), were initially classified under Vermes, (worms), and then over time and with further investigation moved into unique categories. The reverse has been true when 2 distinct species actually turned out to be the same animal. The point being that time, experience, and the scientific method play their role in these categorical decisions.

Cop Talk, by Bo Keely

Like a lot of other kids who read comic books, I wanted to be a policeman when I grew up. Now however, I fear that being stopped by police about 100 times while traveling will not ease the hiring process.

A good street cop is a specialist who reads me as fast as I him. I think it is correct that it is better to respond with a milk toast, "No sir, I don't want to be arrested" rather than an honest repartee with a straighter spine. This is because 90% of cops I've met want the perp, (citizen), to say something stupid, (honest), to jack, (escalate), the scene and break the tedium of his work that you're paying for. I've tried as many lines on policemen as are in a pickup book for women and it boils down to telling the truth or kowtowing.

If the officer is respectful, then of course I return it, but as stated, that occurs about 10% of the time. State troopers are better than sheriffs who are better than city police. The three times in the past decade that I've looked a cop in the eye and spoken honestly; "I didn't rob the bank so get lost", "I didn't trespass in the park, and if one of my students acted that way I d send him to the principal" and "No, those are not drugs in the Excedrin bottle as evidenced by the E on each of the tablets". I went respectively to the L.A. county jail, Broward County Jail and San Bernardino jail.

You may enjoy the book You Can't Win by Jack Black. My arrests don't amount to a hill beans. The bottom line after 100 confrontations is that personal habits and ruts develop if you don't watch out.

I've discovered that the "Yes sir, I was wrong but please don't give me a ticket" response, if repeated, brings on a terrible habit of cowering through life. Most people don't have my problem of sheer numbers, but if there are others then they may use my new, (past decade), Method of Ratios. Once in every five incidences with inept policemen, (explaining the three trips to jail), I try to embarrass the man, or jack him. This is usually easy, employing polysyllable words and telling him to repeat himself when he repeatedly barks at you the same order. Bad cops also hate it when you insist their superior be called to the scene, while holding your hands limply out for the other option, handcuffs. The one-in-five ratio is reminder enough of my place in America. And 36 hours in the county jail is a terrific seminar.

I quickly prize other stellar cops, the 10% with active military duty or enough years on the beat not to have to gratify themselves by bullying. There are thousands of diamonds across the country who should be taken off the streets and into the police academies to teach green troopers respect.

Like a lot of other grownups, I still want to be a cop, but now its for different reasons.

Pitching Strategy, by Phil McDonnell

The days of Little League coaching are gone but the memories linger. Early in the season we would discuss all of the different types of pitches - fastballs, curves, knuckleballs, change-ups, split-finger fastballs, sliders, screwballs and all the rest. The question I always posed to the team was which is the easiest pitch to hit? There is one clear answer to this question. The correct answer is a "strike".

Obviously the emphasis is on judgment and knowledge of the strike zone. The point for a batter is that he doesn't have to chase a bad pitch. He can wait for his pitch. The lesson for a trader is clear. Wait for your trade. There is no need to chase bad trades.

As a player I was a pitcher. There is quite a bit of strategy to pitching, and consequently just as much to batting. The pitcher and batter are continually trying to outthink each other. Most pitchers have mastery of about three pitches. Almost every pitcher considers his fastball to be his bread and butter pitch and the pitch which he can control the best. When he needs a strike or needs an accurate location pitch he will probably go to the fastball.

The curve is the most difficult to hit. A major league curve ball can curve at least 17 inches. That is the width of home plate. The ball can literally appear to be headed inside to a batter and wind up outside the strike zone. What most people don't realize is that the curve ball accelerates in its curvature. The spin on the ball induces an acceleration which causes the ball to move at ever increasing velocity in the direction of the curvature. The movement the batter saw in the last hundredth of a second will only increase in the next interval. The usual linear extrapolation of the human brain simply does not work with the curve ball. Thus it is deservedly the most difficult pitch to hit.

From the pitcher's standpoint the curve is also the most difficult to control. To deliver my curve into the LOWER strike zone I had to aim for just behind the batter's ear. To be a good pitcher one must overcome any silly squeamishness about hitting the opponents with 90 mile an hour lethal projectiles.

The change-up is usually relatively easy to control and usually thrown right down the middle of the strike zone. It relies on its slow speed and deceptiveness for its effect. Most batters time the fast ball and key their swing off that. The key to a good change is to throw it just like a fastball but with a grip which reduces its velocity. Like so many things in the market it relies on deception for its efficacy. Otherwise a change-up is just like a slow fastball. It is no better than a batting practice meatball.

Pitch selection depends on the count and the situation. One of the simplest strategies is for the pitcher to start the batter off with fastballs thrown for strikes. The batter has not timed the fast ball yet so the pitcher has the advantage. The goal of the pitcher is to get to two strikes before getting to three balls. At two strikes the pitcher can use his curve ball if he has less than 3 balls. If the pitcher reaches three balls the curve ball is very risky because it is a difficult pitch to control.

Batters know this. In fact good batting coaches will teach that hitters counts are: 1-0, 2-0, 3-0, 2-1, 3-1. In each case the pitcher is behind in the count and will undoubtedly rely on his fastball for control. When a pitcher gets to three balls he will probably tend to go to his fastball to get the control and not walk the batter. Good hitters will anticipate the fastball and wait for a pitch in the middle of the strike zone as long as they don't have two strikes. The saying is that the strike zone shrinks on the hitters counts.

Conversely the strike zone expands with two strikes. The batter must now "guard the plate" and not let the pitcher sneak a corner strike by him. There is no longer any opportunity to wait for the juicy pitch right down the middle. Now the batter's goal is simply to make contact, put the ball in play and see what happens. Given the expanded strike zone this is the optimal time for the pitcher to pull out the curve ball. The batter is most likely to chase a pitch which looks like it might be a strike and later winds up outside of the zone.

The batter's position is analogous to the trader who is full extended and is beginning to suffer losses. He enters a stop loss orders to limit his losses. The market is fully aware of this and gratuitously responds with an excursion through his stop and back again. The market has thrown the hapless trader a curve and he is forced to protect his capital "zone" and strikes out.

Stefan Jovanovich adds

After he retired from baseball, Hank Greenberg explained how he had been able to hit Bob Feller. Rule 1 was 'Never Swing At His Fastball' and rule 2 was 'Wait until Feller has two strikes on you, then stand flatfooted and hit the curve to right field'.

When the reporters asked him what he did when Feller threw a 3rd fastball for a strike, Greenberg said he put his bat back in the rack and prayed that next time he would throw a curve.

When someone asked him why Feller ever threw anything but fastballs, Greenberg replied, "He probably gets bored".

An O. Henry Tale for Speculators, forwarded by Laurel Kenner

Who knew that O. Henry was a great observer of the financial markets? "The Gift of the Magi" has long been one of our favorites, but we had not run across The Romance of a Busy Broker until this week. As O. Henry writes:

He who has been denied the spectacle of a busy Manhattan broker during a rush of business is handicapped for the profession of anthropology. The poet sings of the "crowded hour of glorious life." The broker's hour is not only crowded, but the minutes and seconds are hanging to all the straps and packing both front and rear platforms.


Shakeout, by Victor Niederhoffer

Every end of quarter, there is an opportunity to be shaken out of all good positions by ephemeral factors. First there are the earnings warnings. "Oh, my goodness, Kodak or some such company is reducing its guidance. That means every other company is going to do just as badly. Earnings will be much below expectations". Yes, of course, the companies that issue a negative guidance are going to be the worst. Similarly, for the ball-players the coach gives a bus ticket and meal money to everyone, even the worst players, but that doesn't mean the rest of team is that bad.

Well, if the warnings aren't generalized and you can't force the market down, let's try the negative correlation game. Now, if last quarter, the earnings seasons were good, then there's the negative correlation between the price performance during earnings seasons. And if you don't like quantifying, then you can always talk about how good the earnings were last year, and how this quarter is going to cool down. On the other hand if expectations are very high, then there's always the likelihood that the company's will miss expectations because random factors will negatively affect the company's ability to meet expectations.

 Of course, once earnings are reported, there's always the company like Intel that misses forecasts and comes in 2 cents below. Worse yet, it might try to guide you down for the next quarters so it can have an easier target for the next quarter just so that they can get all the weak hands out. All these things came together the last few days. First, Intel, then Apple, then Ebay, all below expectations. 4 big down opens in a row. The largest sum of the last four down opens in the last 200 days. My goodness, sell, sell, sell, it's going to open down again like it did yesterday on Intel.

What fools these publics be. The current Zacks forecast is for S&P 500 earnings to be 10% above 2005. Bloomberg reports that 100 of the S&P 500 companies have reported fourth quarter earnings so far, and 75% of them have beat forecast. A diffusion index of the number of companies reporting earnings increases per dollar of price, as well as a rereading of Bacon would save so many of the public from losing so much more money than they have a right to lose.

What a Card, by Victor Niederhoffer

The Sage of Nebraska gave an 11 page talk to the students of the Harvard Business School (HBS) on December 22, 2005. It contains one untested, detrimental, or loaded, partial but misleading truth and shibboleth after another. The highlight occurs when he starts off by telling how the secret of his success is buying great companies like Nebraska Furniture Mart, and See's Candy. You would have thought that one of the professors or students would ask him what the rate of return on these companies might have been, or how a company that produces or retails a product in a declining market segment in a declining region in the most competitive of all businesses could have an above average rate of return going forward, but no.

The audience eats up such sayings as "take care of thy shop and it will take care of thee." and " we've bought business after business like the mart" and "reading Ben Graham's book The Intelligent Investor is the most important attribute that has contributed to my success" and "there is a very high probability that a major nuclear biological or chemical incident will happen somewhere," and "markets everywhere follow three stages--- innovators, imitators, and swarming incompetents ( that 's where the hedge funds are now)" and "find people you like and are capable, and things will work out" and "look for businesses that an idiot can run ". "The reasons Berkshire can do so well is that they can buy businesses and leave the owners alone" and "he never buys a business at auction", and "two of the five businesses he bought last year had higher bids from private equity shops, but Berkshire has the an advantage in buying from people who don't want to auction off their business." "The Sage met FlightSafety for a hamburger and cherry coke at Skadden's offices. They had a deal in about an hour. You see, Al believes in producing safer pilots ".

There were dozens of these statements contained in the lecture and you would think that a Professor there would have said that "Hundreds of other conglomerates have said that the key to their success is that they leave the companies alone. And, can you really make money by buying a business that an idiot can run or is it doing something so repetitive that it doesn't have to worry about competition and aren't these factors taken into consideration in the price?  More importantly, Mr. Sage doesn't everything that we teach our students here say that our economy is very competitive, and it's becoming even more competitive with increasing free trade and free enterprise around the world and aren't the businesses that any idiot can run that do humdrum things within everyone's sphere of competence, the ones that are guaranteed to have the most competition, with the rate of return on them being driven down to the risk free rate? Isn't that the lesson that Charlie taught you? Are the returns on the humdrum businesses you bought taking every thing into consideration before your credits with and deferrals from the Service so different from the risk free rate of return? And, doesn't every seller tell you that they're taking less money to sell out to you than they could with someone else just to get you to raise the price?"  ( 99% of the thousands of companies that I sold or tried to sell during my 25 years in the merger business were instructed to use this tried and true mantra of the old maid. )

But what really is the key, the one thing that confirms my theory that the sage is the old snarling lion fighting to keep the younger ones from mating, is the frequent use of the sexual allusion. Here are two samples after his staple "It always seems there's one dance left." The sage "used to go to sleep counting legs but now he doesn't do it any more because it's not so good for sleep" and "the Wall Street analyst said we could save money by your cooking so we could fire the cook, and the wife said we could save money if you learned to make love and we could fire the gardener."

What naive patsies they must have at HBS to let all these untested, and anti economic theoretic statements go without challenge? Worse yet, because Warren is so tight, and he has a great savings succession plan with his charitable foundation, there is probably very little chance that the school will get a major donor gift from him. All in all, a very dismal moment in the history of investments and the integrity of the academic environment. 

But it's an ill wind that blows no good, as the chronic bear would say. The fact that people like the Sage and the Chronic and the other abelflecprudsortles exist and spread the damaging message that has the world in its grip through their second-hand levelers in the wholesaling-of-info game does open up some nice niches for those who believe in enterprise, can count, or read the work of the Triumphal Trio, or those of my colleagues above.

Stefan Jovanovich remarks:

Whatever J.P. Morgan, Sr.'s faults, he was never "doddering" and the response to his remarks about "character" before the Zagora committee were anything but approving. No one believed him. Morgan's own opinions about Jews were equally puzzling to his contemporaries on Wall Street. In an age where Gentiles' attitudes ranged from wariness at best to outright paranoia, Morgan, Sr. had no fear of Jews - either privately or in business. Many of his art dealers and "scouts" were Jews, and there is no record of his having ever said anything anti-Semitic. His firm did not hire Jews, but they also did not hire Baptists or Catholics. As for the Ivy League, Morgan, Sr. was a skeptic, not a believer. He thought Harvard had made his son into something of a prig, and Yale was not one of his charities. (I have to check, but I do not think that the college is mentioned in his will.)

The Sage of Omaha is a genius. So was Colonel Parker. Buffett knows that Berkshire's valuation is not sustainable, if measured by "mere" financial criteria, so he is busily creating a legacy that makes his company into the ultimate "social responsibility" investment. Selling the Berkshire Hathaway stock will become as unthinkable as doubting the wisdom of the Kyoto Protocol (or whatever its successor will be in virtuous certainties about our sinful world). If you want to become the Saint of Omaha, that is the only way to go; and that is the road that the Buffett carnival show has been traveling for the past decade. Reading from Graham and Dodd, the "bible" of investing, is part of the act. It is truly a masterful performance.

Prof. Gordon Haave comments:

Ultimately, HBS is a business. The business depends on customer satisfaction:

1. Good job placement after graduation, and, less importantly:
2. Being able to instill in the students a sense of superiority

Harvard is aided in both #1 and #2 by a long history of success (or at least perceived success). However, the top 5-10 business schools are in fierce competition to get the top ranking in U.S. News and World Report. Thus, on the margin, #1 and #2 are very important vis-a-vis competition with Stanford, Wharton, Columbia, etc.

What is the last thing that a smart business manager would do in this situation? Telling the customers that the world changes every day, that the cycles are ever-changing, and that no amount of money or text-book education can guarantee success. Therefore, they all work very, very hard to get people like Buffet to come in and make them feel special, and more importantly lead them to believe that their book-smarts along with a few trite platitudes will guarantee success.

This false sense of security is self-fulfilling because self-confidence is a very important trait in hiring and promotion decisions in most industries. HBS, by allowing the "anti economic theoretic statements" to go unchallenged, is thus successfully guaranteeing the success of its business. This should come as no surprise. What is interesting is that a man of such wealth and fame would allow himself to be a part of the charade.

Ken Smith continues:

Our lives could be construed as a series of charades. Fantasy is everything for us, we humans. Harvard dwells in fantasy when books and classes are waved around like patriotic flags. For connections and prestige and background get most Harvard grads into top entry positions in American corporations and in U.S. bureaucracies. It has little to do with academic symbols and meanings.

A brother-in-law played football as a star running back for the University of Washington. Of course Harvard wanted him. The prestige of Harvard Law School got him a slot in a notable legal firm as soon as he graduated. Of course, he had brights too, not to diminish his intellectual credibility. However, hundreds of Harvard students have brights, but they don't have star-level football history.

Dan Grossman adds

I admire the Chair's energy and feistiness in still going after the Sage. Do you have the accurate cite for the HBS reviews of his speech because I would love to look at them.

I can't imagine what it is in Graham's book that he still thumbs through and finds relevant in this day and age.

On the other hand, the Sage at HBS is sort of a ceremonial appearance like Eleanor Roosevelt visiting Quincy House when we were there. If the Sage really had some treasured technique, such as running the cash flow of See's or Furniture Mart through the insurance companies so that under foreign controlled tax regulations he could avoid taxes forever, then that is the last thing he would talk about.

Its sort of like the doddering JP Morgan saying you didn't need to look at financials, the most important thing in lending to someone was his character, (meaning probably that the borrower went to Yale and wasn't Jewish or anything), and everyone nodding and saying 'how brilliant'.

George Zachar contributes to the Dept of Fixed Income

I occasionally get off-list requests for technical bond math material. Here is a paper I just "stumbled across" that presents an overview of relevant quantitative approaches.

Count This! from GM Nigel Davies

Those who can play chess might like to take a look at the position arising from the following sequence of moves:

1.e4 c5 2.Nf3 Nc6 3.Bb5 g6 4.Bxc6 dxc6 5.d3 Bg7 6.h3 Nf6 7.Nc3 0-0 8.Be3 b6 9.Qd2 e5 10.Bh6 Qd6 11.g4 Be6 12.0-0-0 Rad8 13.Bxg7 Kxg7 14.Kb1 a5 15.Qg5 Rfe8 16.Ne2 a4 17.Ng3 h6 18.Qe3 Nd7 19.Rdg1 Kh7 20.Nf5

This position was reached in Davies - Grkinic, Correspondence 2003. What is interesting is the computer's, (Fritz 8), assessments of the position after 20...Qf8 21.Ng5+ (clear advantage to Black) 21...hxg5 22.h4 Kg8 23.hxg5 gxf5 (clear advantage to Black) 24.gxf5 (approximately equal).

Actually Black is completely lost after 24.gxf5 as any grandmaster will understand almost immediately. The computer counts the material but is unable to perceive the matrix of threats to Black's king and his inability to defend.

Can the position after 24.gxf5 be analysed statistically, to see if White scored more than x points from y games? No, the position was unique to this game.

Then how does a grandmaster know Black is lost when it can't be programmed into a computer? Through a knowledge of similar positional types, reconstructed something like a photofit picture.

So why can't this be programmed into a computer? Because it is too subtle for simple number crunching; it requires a synthesis of information which appears to be the domain of organic rather than silicon brains.

Yes, Vulnavia, it appears that the human mind does have its advantages...

Adi Schnytzer adds:

With all due respect to your expertise in chess Nigel, you are completely wrong and I will prove it. Firstly, according to game theory, chess is a game of complete information, which means that uncertainty and statistics do not enter into the theoretical problem of winning it at all. The problem is that in order to win with certainty, (if that is possible from any given position in a game), I must know how to calculate your every possible response to every possible move that I have from this position, (I'm assuming it's my move), and then to calculate every possible response I may make to your response to my move. I have to look at every single possibility.

If I have definitely won the game, then there exist paths of moves for me which give me a win regardless of which moves you make in response to mine. Note that the only thing that prevents me from programming this into the computer is that no one is willing to donate a chain of Crays to spend some weeks solving your game from position 20 onwards without any access to statistics. The fact that one feeble IBM computer was sufficient to beat the World Champion should provide sufficient support for my argument. So, why does your program get it so wrong? Quite simple. It isn't a bank of Crays and thus must model the game in order to simplify the task. The quality of this model is a function of the expertise of those who wrote the program and the level of complexity permitted by the computer on which we run the program. Chess is - at the end of the day - nothing but number crunching. The reason it is such a great game is that the possibilities are almost endless and so it will probably never be solved completely. Note that the opening for 10 or so moves has already been pretty much solved. All grandmasters agree on the losing lines in most openings. When a grandmaster comes along who thinks he spots a way to win from what is considered a losing line, he plays it and if he wins, the new variation is named after him and the book changes. But this only happens because someone took the time or trouble to follow a seemingly lost cause in order to find what others had overlooked. The ending was solved long ago. So we are left with the mid-game which is the messy part.

The Grandmaster responds:

With all due respect to your expertise in theories, as a practitioner I must point out that there are actually an infinite number of possible chess games from the starting position. I will wait for you to tell me I'm wrong before proving it.

Computers have to rely on primitive positional assessment heuristics to supplement their, (admittedly great), calculating abilities. They are unable to calculate to the end, which makes any claim of 'complete information' quite irrelevant from a practical point of view.

Anyway, to prove my point I'd be happy to play you in a computer assisted match - we both get a bank of Crays, (or the best thing available), to assist in choosing the move. IF you are right you should be able to draw every game. If, on the other hand, I can supply extra value in this 'game of complete information', I might be able to beat you.

What about a 10 game match in which you win in the event of a 5-5 draw? And please let me know how much money you would like to play for, maybe you can get some game theory institution to sponsor you!?

Peter Grieve adds:

The mathematical issue, (but not the practical one), does seem to turn on the finiteness or infiniteness of the game. It is, (by the mathematical definition), a game of perfect information. Here it is important to note that mathematics sometimes uses common words in a very precise and often subtly different way than ordinary speech.

If the game is infinite, then the payoff of a given move is not computable. Computability is defined as whether a certain kind of mathematical construct called a Turing machine can come up with an answer in a finite time. All practical computers try to model Turing machines.

If the game is finite, and if every proton in the universe was a Cray, and if they all worked together for enough time, they could really exhaust all of the possibilities in any position, and it would be solved beyond all argument. This however is about as practical a consideration as your dog sprouting wings and flying. The quantum mechanical amplitude, (probability), of your dog flying is non-zero, and quite computable. :o)

Mathematics doesn't give a fig about practicalities, your dog flying and your dog walking are just two more functions with little to distinguish them. One a bit smaller in amplitude than the other.

And before you accept a computer-assisted match with Nigel, be aware that his approach to chess supplies exactly what the practical computers are missing, that is, shrewd judgment and street fighting ability.

Nigel asks:

Can I not persuade you even to try a match with both of us having Hydra on our side, (the one that beat Michael Adams heavily)? Say for $50k a side?

Of the mathematicians who attempted to estimate the 'finiteness of chess', Hardy, incidentally, is quite wrong as could be very simply demonstrated by any clever child who actually plays and knows the rules. The number of possible games is infinite.

The number of possible positions must be, of course, 'finite', but I compute, with my organic brain, that this won't help you in our match.

Even with your fantasy machine I believe I'd beat you if we both had one, but I'd want a much longer match. Why? Because there'd be a bug or a power cut or some other glitch caused by the Hardys of computer programming.

One thing that Hardy must have overlooked is that chess games can actually go on for ever unless a claim for a draw is made. This could have been simply remedied had he bothered to examine and understand the rules before doing his calculations. Or even ask a chess player...

I think a better approach might be to try and establish a database of positions that are 'known' and then work backwards until every single position has been assessed. Of course when that happens, say in 1000 years time, we'll have to add a new piece or two and send them back to the drawing board!

In any case, thoughts of a 'solution' to chess seem to me to be purely hypothetical and nothing more than titillation for academics. As things stand it is as vague and uncertain as life itself.

Absolute Price and Tape Reading, by James Sogi

When my brother-in-law goes to the store and he sees beer on sale, he buys a bunch of beer and says, "Just think how much money I saved!" Today while surfing after an exciting session in the markets I wondered if plain absolute price isn't a good thing to focus on. Instead of looking at a thousand different combinations of patterns, times, just when a good price level comes along, buy as such as you can afford. Why if you think it is a good deal, why not? Think how much money you'll save. There were some recent good deals and blue light specials for special shoppers. Then the specials came on again in the afternoon. I guess they really wanted to get rid of them.

Before there were live charts, just the ticker, the price and tape were the things to watch. The old timers talked about the speed or sound of the ticker, and that was significant to them. The way the orders got snatched up was significant to them also and the tape signified these things to them. Astute tape readers could tell who was buying and selling. Did big orders get gobbled in a single gulp, or did they get nibbled and the bait get stolen. I have not seen modern analysts talk about the rate of transactions except in terms of volume, but the tape sound would be a function of the rate or number of transactions. The time and sales show large number of big blocks hitting when things heat up. The Tokyo stock exchange asked traders to consolidate their orders to reduce the number of transactions, but did not mention the volume of shares. It was the number of transactions that broke the camel's back and shut down the exchange. The goal of CME as market maker is to set the price where the maximum transactions will occur so they make the most fees. How would an algorithm ration volume against number of orders to maximize the rate of transactions. Why does the price swoosh up and vacuum up all the sparse orders and swoosh right back down Lobogola style.

Consider the TSE news and the impact of the number of orders and executions. (no mention of volume.) The approximate number of orders and executions as of 14:32 p.m. today is as follows:

Orders: 6,400,000
Executions: 3,500,000

For the time being, Tokyo Stock Exchange will make an announcement regarding the approximate number of orders and executions at the following times: 10:00, 11:00, 14:00, 15:00

Gordon Haave adds

An interesting application of this concept would be to apply it to the shopping habits of my wife. What she does is she buys the dress that was priced at $600 one day and then immediately marked down to $100. She then says "I bought a $600 dress for $100". I say "You bought at $100 dress for $100".

The application would be to buy any stock that is down off of its highs with no deterioration in the fundamentals.

She also sometimes buys the dresses with the slight imperfections that are marked down. That would be like buying a company when it is down because it just barely misses earnings projections.

And, of course, she buys more dresses then she could possibly ever wear, and puts them all on each store's charge card. That would be like applying all three of the above strategies in a highly leveraged manner.

J.T. Holley comments

This reminds me of Nick Murray. He wrote a book titled "Excellent Investment Advisor" in the late 1990s. He is definitely a good salesman, empirically figured out the financial services industry on the sales side, and has a wonderful way of detailing how one in the practice can help others. He is an equity zealot as well.

To paraphrase, he talks about investing as if "you were buying Tuna fish". To him, most investors are wired backwards. The masses are the just like Mr. Sogi's brother-in-law. He explains that most who buy Tuna fish on a regular basis will go in expecting to see it as 85 cents a can. When they go in to shop the next time they see that it is $1.15 they will more than likely buy less cans. Then they go in and see that it is 35 cents a can so double up on it and create every dish they can out of Tuna fish.

Nick explains that investing is the opposite to the masses. If we've seen a stock that we've been following trade regularly around the number 50 suddenly drop to 25 then we automatically think more often than not "what's wrong?", "is there bad earnings?", "what did the CEO do?", "what's on the news about them?", "darn, I was going to buy a round lot". We don't buy some or more. The Body Snatchers have taught us those stupid fixed rules:

  1. Don't try to catch falling knives
  2. Averaging down is for losers
  3. The trend will continue and then throw a million and one justifications for it.

But, if we have been watching our favorite stock trade at 50 and then one morning it gaps up to 65 and it is more expensive, then the average person, according to Nick, says "get me in", "it's going to 100", "buy, buy, buy", "earnings are going to explode", "it's gotta sky rocket and split at least a dozen times", "what did they announce?", "did they say on CNBC what the reason was?", "buy, buy, buy."

We are wired backwards in most cases according to Mr. Murray, but others like our Mr. Melvin love to buy Tuna fish cans by the dozen when they are 35 cents vs. the usual 85 cents as long as there is nothing wrong with the contents. Hey, we can even live with dented cans as long as they have not been punctured and will spoil!

Think tuna fish when looking at Absolute Price and reading the tape. You will be at least 2 deviations away from the masses.

Thoughts on Markets Inspired by On the Origin of Species, by Victor Niederhoffer

  1. While acknowledging that everything Stephen Gould or Niles Eldredge have ever written about evolution was a disguised attempt at egalitarianism, cultural relativism, and liberal ballyhoo, they are considered the main current leaders of the theory of punctuated equilibrium, the idea that the change in species and the earth was due to a series of cataclysmic changes, such as earthquakes and large meteorites hitting the earth. This neotech version of creationism attributes any current findings of fossils or life at a time to "a temporarily static result of deep seated, intense and episodically constant violent wrenchings of sediments quietly deposited on the sea floor and transformed into the slopes of prodigious mountains". A more technical discussion of it is contained in Wesley Elsberry's discussion.

    The theory has always seemed to describe everything and predict nothing like so much of the mumbo in our field. Nevertheless, there would seem to be some cardinal events that created completely different kinds of atmospheres and regularities. Key events included the 1987 crash, the collapse of Long-Term Capital Management in 1988, the 9/11 bombing, the two Iraq wars, the fall of Enron, the public offering of Google, and the cuts in taxes on dividends and capital gains.

    Any poor specinvestors who don't change their counting and cycles a la Bacon in the light of these events are doomed to failure.

  2. Doing small things: Eldredge reports that Jesse Brodie, the Darwin children's nurse and a former employee of Thackeray, once saw Darwin just looking for an hour at an anthill. She said "What a pity it is that Darwin unlike Thackeray had nothing to do." This brings to mind Nock's essay Snoring as a Fine Art and the patter song in the movie version of Showboat "I don't do nothing." I often stare at the screen the way Darwin looked at the anthill. And then I make observations on the back of an envelope until such time as the observations might be tested with a theory and a prediction.

George Zachar responds:

Not only is there a long and growing list of metaphorical asteroids striking the global capital markets, but the rate of such impacts is increasing.

This accelerated bombardment of cycle-altering events is taking place concurrent with a dramatic expansion of the speculative playing field, perhaps reminiscent of the vistas opened to European capital with the discovery of the New World. The new horizons are geographic (China et. al), technological (nanotech, etc.), and financial (such as credit swaps).

One could make the case that no greater speculative opportunity matrix has ever existed.

Prof. Gordon Haave replies:

Some possible additions:

  1. The deregulation of brokerage commissions and the resulting rise of the discount broker.
  2. The launch of Vanguard and the rise of index funds.
  3. The widespread use of the internet, making information gathering and trading more efficient.

Alston Mabry responds:

Retrospective, but nonetheless:

In November 1999, the Vanguard S&P 500 Index fund topped $100B in assets. The average investor had indeed gotten wise to the whole "active management" game.

adj close Nov 99: 116.80
Jan 13, 2006:  118.62

VL Arithmetic
adj close Nov 99: 985.58
Jan 13, 2006:  1993.50

What was it Robert Bacon said about the form moving away from the public?

Steven Leslie responds:

Your point number two reminds me how Jerry Kramer described Lombardi's attention to detail in running the famous Green Bay sweep. How they would practice it so exhaustively that it became so natural and second nature that opponents said they saw it coming but they still could not stop it.

How Ted Williams would lift his bat and knew that it was an ounce off in weight. Or how James Joyce labored all day over where he would place a comma in a sentence. Or how Vic Niederhoffer said that his greatest skill was his ability to concentrate and focus on the screen in front of him one time for 52 straight hours without sleep.

Mark M McNabb on IBM and DB plans

A question put to my class was the significance of IBM ending generous pension contributions and the national shift to DC over DB plans due to globalization's competitive pressures:

Answers are, (in the form of Late Show):

#8 Less capital entering the market
#7 Less investment oriented to longer horizons
#6 Less allocation to alternative investments
#5 Less management by pros, more market irrationality and fad investment styles
#4 Change in volatility, (although the direction is unclear, but likely to be less as trading is lower)
#3 Change in return paths and correlations as momentum strategies more profitable
#2 Coupled with boomers hitting 65 in 2011, market enters a distribution stage

and Number 1 on tonight's list

#1 Less $ for those 6000 hedge funds to fight over....

I thought higher Social Security/Medicare taxes would make the list but students don't link private-public impacts to markets.

A story on Beauty and the Beast, and a trip to the Beach, by Tim Melvin

Livedoor Shock, from Shui Kage

Last year the Japanese created the term "Printer Shock" due to poor earnings reports from Epson and Canon. This year, 2006, it's "Livedoor Shock". What an amazing morning trade session it has been here in Asia. The Nikkei is down 2.6% from the previous day and it seems virtually every single trader is rushing to sell.

Due to Livedoor's possible fraud account manipulation case, now The Emotional Tokyo Stock exchange commission even announced a possible delisting Livedoor's stock.

Whoa, cool down guys! You can delist Livedoor, but have you considered the impact of delisting a  $7.8 billion market cap stock for a small fraud case? One of frauds was to transfer the group's son's company's profit to the parent company to show Livedoor was in the black. To me this seems quite common and not a big deal. You can easily do that by manipulating transfer pricing etc. Yesterday alone, the market cap of Livedoor went down by $1.3 billion!

Some other remarkable declines are such as Softbank, -12% in a single morning trade session today, and Mitsubishi Motors, which has nothing to do with Livedoor, - 5%. Takafumi Horie, President of Livedoor, wrote on his blog today that he wants to cry.

I once thought wider availability of information, the modern internet generation, would change the behavior of people around the world, but it really proved basic human behavior and mass psychology have not changed at all. And that is why most of the good investors and traders are seniors in their 50s and 60s: they have seen all these and experienced much, with some pain also. Carboy investors, 20s and 30s, are dangerous in that respect.

Well, my long positions are in negative territory now, but I am quite enjoying this astonishing market behavior and I think we will see a "Pinocchio Bar" on the weekly candlestick chart in the near future.

Livedoor Quote, from Mr. Csork

Those that know me are aware of my fascination with the history and dynamics of financial frauds and fiascos. Irrespective of the size and scope of the Livedoor situation, I've never before heard anything like the following quote from the company's architect:

"People responsible are out of town..." according to 33-year old Takafumi Horie.

Perhaps those people were enjoying a long weekend with that rogue Chinese copper trader. I suppose the goings on related to the trading halt are in part due to the mandated daily trading limits on the exchange. I always thought that one of the key lessons of the October 1998 liquidity crisis in the US was that when investors can't sell what they want to sell, they sell what they can sell.

Zzzzpeculation, by GM Nigel Davies

A nice demonstration by Morozzzevich (formerly Morozevich) of grandmasterly sleeping abilities highlighted the importance of little mentioned attribute, even if it cost him a game. Without a talent for sleep how on earth can one survive the stress of an important tournament? And actually I suspect that this is one of the most important qualities for a speculator as well.

Several Grandmasters (Andersson, Timman, Lalic) have also spent the early part of their careers sleeping in cars, which leads me to mention this website for those who wish to conserve trading capital by cutting unnecessary expenses.

Statisticians Please Advise! from Dan Grossman

Would be interested in what statisticians think of application to evolution, and life in general, of the principle Stephen Jay Gould describes: as a complex system matures, "it equilibrates and variation decreases." That is, as system moves closer to limiting wall of attainable achievement, deviations from the norm decrease. This is claimed to explain such things as the absence of a second Einstein (so many brilliant physicists today that harder for any individual to stand out), Beethoven, .400 hitter, 100-point game in basketball. Also, the increasing number of drawn games in chess (GM Nigel?), the closeness of presidential elections (due to increasing expertise in campaign strategy).

Doesn't sound exactly like an accurate explanation to me. Thoughts?

Renowned statistician Steven Stigler responds:

One of Galton's triumphs was to note that regression toward the mean did not require any decrease in variation. This is not to say that there is necessarily no decrease, but that such decrease does not necessarily follow from real or apparent convergence in mean.

Dr. Kim Zussman adds:

During frequent hikes in the local Santa Monica mountains, I often notice how monotonous the coloration of wildlife is, even across species. Deer, coyote, rabbits, squirrels, rats, mice, and even most birds vary little from a dusky grey-brown that blends in well with the scenery.

In a field with plentiful rain, vegetation, and insect life, the rodent population explodes as result. In the absence of selective pressure and the presence of spontaneous mutation rate, over time there would be many coat color variations (similar to domesticated and lab mice). However in nature there is selective pressure; in the form of predation by bobcats, coyotes, hawks, owls, etc, which selectively shorten the life spans and reproductive potential of contrasting mutations. So everyone turns brown.

In a field with plentiful liquidity, competition, and insect life, the hedge hog population explodes, and everyone turns brown.

Iceland, by Yishen Kuik

Just returned from a long weekend spent in Iceland. A few spec-related travel notes:

  1. Iceland is extraordinarily tiny. The population crossed 300,000 just a few days ago. Everyone knows everyone and consequently crime is almost zero.
  2. Like Saudi Arabia, Iceland has plenty of cheaply extractable energy under the earth. Unfortunately it can't load it on a VLCC. As the hydrocarbon-geothermal spread increases, it seems likely that more energy hungry manufacturing processes like aluminium might migrate to Iceland.
  3. Iceland has very high tariffs (30%) on agriculture. I don't know whether this was meant to protect local farmers or reduce corporate/income taxes, but the result is that a bowl of soup at a highway gas station will cost $10 (600 ISK) and a chicken entree at a regular restaurant in Reykjavik will cost $50 (3200 ISK). However, basic math tells me a $50 chicken cutlet isn't fully explained by a 30% tarrif.
  4. You can pay with plastic anywhere in Iceland - even the hot dog guy will accept plastic.
  5. Fishing is still the major export business and it is a protected industry. Some quick work at Statistics Iceland tells me about 1,000 people were responsible for $1bn worth of fish in 2004, or about $100,000 per person. Anecdotally, my guide told me that the best jobs were in fishing.
  6. Iceland has extraordinary population records. Statistics Iceland's database starts at 1703.
  7. The Icelandic stock market made a new all time high today at 6253.4. The ICEX 15 index was 1000 in 12/31/1997 (presumably the calibration date) and 371.1 on 12/31/1992 (earliest time series data).  This gives us an IRR of 21.9% over the first 5 years, 25.6% over the next 8.05 years and 24.2% over the entire 13 year period, excluding dividends. If Iceland were a hedge fund!
  8. Oh yes, it's a beautiful country.


Against the Housing Doomsters, from George Zachar

This Bank for International Settlements report has lots of data and charts allowing ready comparisons of housing finance in many nations. The US data series don't appear out of line relative to peers. But I did notice a clear increase in "housing prices are falling!" stories over the weekend in US papers.

Do CEOs from Ivy League Schools Outperform?, Noticed by Art Cooper

Aron Gottesman and Matthew Morey (reported at p B3 of the Jan 14-15 WSJ) studied the correlation of NYSE-listed corporate performance to entrance scores of the CEOs' alma maters. They found no correlation between the prestige of CEOs' schools and corporate performance, though CEOs from more prestigious schools were better paid.

GM Nigel Davies Reports on His Travels Throughout the United Kingdom

Highs and Lows, by Victor Niederhoffer

Whenever I have spent a few days of qualitative thinking, I feel like I am going to knock the hat off the next macro theorist I meet unless I take out the pencil and paper. I have spent too much time looking at the undue pessimism engendered by the weakness last December to look at the moves in the rest of the year after a strong first two weeks, as well as the tendencies to reversal or continuation in performance of the strong and weak performers among individual stocks, other than noting that the best 10 in the S&P 500 the first two weeks of 2006 are Engelhard, Corning, JDS, PMC, Broadway, Apple, Network Appliance, Marathon Oil, Gateway and Janus Capital, and the worst 10 are Maytag, Dupont, Amazon, Navistar, Tyco, Wellpoint, Apollo, McGraw-Hill, Dollar General and Compuware. Okay, it doesn't look too good for the value stocks so far this year, but do the early winners tend to wax or wane?

I wanted to try something new. Something I don't like to look at because it's usually mumbo in the sense that you can't tell it happened until after it happened. And then it's descriptive and not predictive. And it's based on ephemeral rather than stable numbers. Nevertheless, I thought I'd look at The Predictive Properties of New Highs and New Lows, just because it's so alien to anything I have considered or encouraged.

I looked at the runs in new highs and new lows during the six months ended 01/15/06. I thought it apt to start by considering the distribution of the number of runs in higher highs and lower lows, considered separately. For example, the lows in S&P futures for the 10 trading days beginning 12/23/2005 were: 1273.10, 1262.70, 1263.40, 1258.50, 1251.50, 1251.70, 1274.20, 1276.00, 1281.50, 1290.80. Disregarding the days where the lows weren't lower than the previous, there was a run of length 1 ending at 1262.70, and a run of length 2 ending at 1251.50. I performed the same calculations for runs of higher highs. Here is the distribution:

Length of  Runs of  Chance of     Runs of  Chance of  
Run        Highs    Continuation  Lows     Continuation

1          13       60%           12       58%
2          13       38%            5       64%
3           2       70%            6       33%
4           1       75%            3        0%
5           3        0%            0      N/A

I note a tendency for positive runs to stop at 2, for negative runs to stop at 3 or more, and for runs of 1 either way to continue.

Many questions emerge. On the first day of a higher high or higher low, are the expectations positive for fixed intervals following long trades at the close and short trades at the close? What about trades entered when a run of highs or lows is started, and held until the run is broken? How do different periods work out? What are the joint predictive properties of highs and lows when considered together rather than separately? What happens when a long run of highs or lows is broken? How do magnitudes of the changes in lows and highs enter into the picture? What is the best way to incorporate information on the days that there is not a run of length 1 or more in lower lows, i.e. when the current low is higher than the previous? What's the best forecasting equation, using a multiple regression with independent variables the lengths of the runs of higher highs and lower lows, and dependent variable the next day's price change? What moving average autoregressive predictive scheme might work? How do the cycles change when the system sellers uncover a seeming regularity in the past data? Such questions are only the beginning and I believe that certain fish might be eaten for many days with such a study.

James Sogi comments:

Being from Hilo, Hawaii, I was interested in Chair's post when he asked, "What are the joint predictive properties of highs and lows when considered together rather than separately."

The Senator's book Long Term Secrets to Short Term Trading, page 16, describes a three-day "ringed high" as "a high with lower highs on either side," derived from Henry Wheeler Chase's work in the 1930s. I would add Chair s query and add the qualification of lower lows on either side. Looking at this on intraday bars portrays the much maligned head and shoulders formation. December 10-12 SP CME shows the general idea as it bounced off the round number, but did not qualify for the following test. Testing for the last 10 years shows the next several days significantly bearish after 36 occurrences satisfying a variant of the head and shoulders. Stats after 2 days N=36, average -8.60,down 64.8%, T= -3.31. Oddly, the reversed bottom formation is significantly bearish as well.

From "Minister" Kim Zussman:

Looking at intra-day highs and lows of SPY from 1993 non-overlapping
10day periods:

1. If the high of the last 10 days > high of prior 10 days, comparing
return (cl/cl) of next 10days to all non-overlapping 10 day returns:


t-Test: Two-Sample Assuming Equal Variances

10d ret after H>H    all 10d
Mean 1.005338111 1.00436805
Variance 0.000616324 0.000922253
Observations 200 326
Pooled Variance 0.00080607
Hypothesized Mean Difference 0
df 524
t Stat 0.380402873
P(T<=t) one-tail 0.351900267
t Critical one-tail 1.647766763
P(T<=t) two-tail 0.703800534
t Critical two-tail 1.964501432

The 10 day periods following higher highs were higher (sounds like
1969), but the difference wasn't significant.

2. If the low of the last 10 days < low of prior 10 days, comparing
return (cl/cl) of next 10days to all non-overlapping 10 day returns:

t-Test: Two-Sample Assuming Equal Variances

10d ret after L<L    all 10d
Mean 1.003910496 1.00436805
Variance 0.001278941 0.000922253
Observations 130 326
Pooled Variance 0.001023603
Hypothesized Mean Difference 0
df 454
t Stat -0.137871583
P(T<=t) one-tail 0.445201518
t Critical one-tail 1.648216848
P(T<=t) two-tail 0.890403036
t Critical two-tail 1.965202892

Returns were a tad lower but also not significant.

3. What if the high of the last 10d > high of the prior 10d, AND the
low of the last 10d < low of the prior?


t-Test: Two-Sample Assuming Equal Variances

10d ret L<L+H>H    all 10d
Mean 1.006847546 1.00436805
Variance 0.000972999 0.000922253
Observations 35 326
Pooled Variance 0.000927059
Hypothesized Mean Difference 0
df 359
t Stat 0.457824484
P(T<=t) one-tail 0.323677757
t Critical one-tail 1.649109151
P(T<=t) two-tail 0.647355514
t Critical two-tail 1.966593866

These 35 cases were slightly higher than the mean 10d returns, and the
highest of the three, but again the difference wasn't significant.

From Russell Sears:

The problem with working with higher highs, and lower lows, in streaks is that I suspect it changes the distribution to non-normal. It seems to me that: Highs and Lows are a type measures of second moment, "Higher highs" and "lower lows" are a measure of when this is extreme, therefore a type measure of 3 moment and finally streaks would be a type of 4th moment measure.

While going beyond the 2nd moment is intimidating to my scant knowledge of stats. With all this it is not likely that the normal distribution assumption will hold. Rather, I would suggest that you must look at the distribution, to catch these fish.

Further, I would suggest you need more data. and because you are trying to measure skew and such. This is also why, I used the LN return from close to close. While using such long term data may not give to accurate picture of where the fish currently are, perhaps such a survey will tell you what you can expect to catch.

Defining a higher high as a high greater than the prior 10 days high and likewise for the lower low on the SPY Then I looked at the next days return:

All days 3265, next day positive 1694, average 0.03%, stdev 1.10%

Lower Lows   Count Next Day Average Stdev.
in a row     positive % %
1   224 135 0.06 1.29
2   119 74 0.04 1.46
3   46 30 0.04 1.4
4   23 12 0.06 2.25
Higher Highs   Count Next Day Average Stdev.
in a row     positive % %
1   339 156 0.03 0.86
2   180 83 0.02 0.71
3   93 39 0.02 0.73
4   43 19 0.02 0.68

The averages do not appear to be statistically significant. However, the distributions show some interesting frequencies. I will leave it to the reader to piece together the frequency distributions. But for the 2nd day in row of days lower lows total 119:

frequency of "0 to + 1stdev" = 60
frequency of "0 to -1 stdev" = 32

Also, 1 day higher high have fat tails.

Perhaps, the catch is better if the fish are fresh, but the day old fish appear to be small fries.

The Character of a Hedgefundist, by Neil Humbert

In a business, especially a small business -- like most hedgefunds -- hiring is one of the biggest decisions that needs to be made. Why, pray tell, does Jim Simons hire most of his people from off-Wall Street? This I want to know. It is the only thing different about them that I can tell. I wonder, do inferior minds go to Wall Street?

No doubt, hedgefunds hire smart people, but do they hire true geniuses? I mean, people who not only have very high IQs, but who also create and innovate? What do geniuses dream of? Revolutionizing an industry by making a key invention, or making huge sums of money in a hedgefund?

Do brilliant people go to research, academia? To Google, where working is truly fun and you get to spend 20% of your time on your own projects?

  1. Competitiveness is a key characteristic in a hedgefundist. Perhaps it is the key ingredient, since, with drive and competitiveness, one can pick up most of the key skills. Robertson, one of the greatest hedgefund trainers to exist, emphasized a sports background as a visible sign of competitiveness.
  2. The ability to analyze math and code. Yes, its all math and coding, and if you don't have this place you'll just not succeed.
  3. Creativity, something that is usually not explored in a hedge fund. While few have time for it, it is key.

Peter Gardiner Comments on Chamley's Rational Herds

It is no surprise at all that Chamley's book should be valuable after the Chair's recommendation. But that it should be so incandescently stimulative (and corroborative) at the same time counts as one of the great intellectual treats in memory. I can't help cast out, like a kettle full of boiling oil and popping kernels, a few newly formed questions:

  1. Are there actually 'discrete limits' to 'history' as defined?
  2. If so, is there any periodicity to them?
  3. Does the 'state of nature' change with them?
  4. Are there private signals, which, in aggregate, systematically convey information about an imminent state (of nature) change?
  5. How does the option value associated with defecting (i.e. waiting to invest) change with time as a function of the distance form the last period at which all private signals convey no information?
  6. Are these rates (of option value change) constant or variable?
  7. If the conclusions of the simple BHW model and of other learning models convincingly show that social learning is (by definition or axiom) 'self defeating...when individuals use public information rationally,' [p 61] and that (Propostion 4.3) 'When agents have a binary signal, an information cascade occurs after some finite date, almost surely,' then what unit of time should a state of nature (with normal distribution) be chosen for, especially if E (theta) = - var?
  8. Since herding is certain, and when herding occurs the value of private signal 's' is negligible, if we suppose that history is discrete (closes and opens) and periodic (daily, plus event dates, plus sub periods) , then what measure shall indicate the existence of a herd and the elimination of social learning?
  9. Since the variance (precision) provides an index of Expectation, shall we then take it that as variance decreases in any period, we have, ipso facto, a herd, and therefore a potential for a future 'cascade'? (e.g. when VIC is low)
  10. If so, how can we measure the extent of such a cascade from the signature of its 'mother' herd?

I could go on and on. This book is a volcano.

Memoirs of a Geisha, Reviewed by Steven Leslie

I recently viewed Memoirs of a Geisha, the epic film based on Arthur Golden's bestselling novel, produced by Steven Spielberg, directed by Rob Marshall and scored by John Williams. I found the movie to be a remarkably enjoyable and overwhelming display of cinemagraphic excellence and appeal. It is a visual feast, a stunning view of color and culture. It is an adventure into a lost world that Westerners can imagine but never visit.

It weaves a story of a young poverty-stricken girl sold to a Geisha house owner by her father, beneath the breath of his dying wife. Through the tutelage of an accomplished Geisha, the young girl blossoms into one of the most notable Geisha of her time. She eventually finds true love after many years with a man whom she first meets as a young urchin in Kyoto.

The greatest attribute of the film is the musical score, written by the incomparable John Williams and with melodic yet haunting performances by Yo-Yo Ma on cello and Yitzhak Perlman on violin. Rarely does one find such a collaboration of geniuses. How John Williams does what he does with such consistency and magnificence is beyond me. I would find it impossible not to be moved by the tapestry of music.

If you truly wish to treat yourself to an incredible film, I highly recommend. Be prepared for a full 2:15 of a sight and sound experience that few movies can ever approach. I give it an unapologetic five stars.