Archives June 15-30, 2006 Home Write to us at: (not clickable). Please include your full name, and omit attachments.

30-Jun-2006
Briefly Speaking, by Victor Niederhoffer

The book The Truth About Markets by John Kay contains a modern compilation of numerous examples of central planning gone astray. There is a nice story about Nikita Khrushchev's visiting Iowa and concluding that the source of American prosperity was corn, and that corn was the future for Russia. He imposed it and it led to disaster and his toppling. A similar example shows the destruction and poverty and famine that followed Mao's Great Leap Forward in 1957 where 100 million people were forced to live in communes. Similar examples are given with the disaster that followed England’s nationalization of electricity in 1947, and the fiasco that followed when they attempted to generate electricity with five gas powered nuclear reactors, and the incredible destruction and poverty and crime and ruination that followed the public housing Title 1 programs of the US detailed in Martin Anderson's The Federal Bulldozerozer. Kay attributes these disasters to the attempt to plan by a single voice without feedback from customers. This leads to sluggishness, lack of accountability, misleading information, lack of pluralism, waste, deadweight costs, misallocation of resources, and enormous unintended consequences involving cronyism and perquisites. All these examples played out over years and involved losses in the 10-figure range.

A much better example of the disaster of central planning is the recent month’s destruction of wealth set off by the coordinated set of plans to jawbone the economy and inflation down set off by the Fed Open Market Meeting of May 10, 2006. It started with an attempt to show that inflation was rampant, the public didn’t get it, and the markets needed a dose of tightening to bring things back to proper order. The attempt was imposed from above, based on the vision of a single personage who coordinated a series of staged speeches about how vigilant the Fed was and how concerned about the failures of the knowledge of individuals they were. The loss of wealth that it set off was in the $3 to $4 trillion range as all the emerging markets, Asia, Europe, and Latin America declined 10 to 20% in lockstep from a $45 trillion or so base. By June 29, 2006 it was all over. The last Open Market meeting emphasized how restrained inflation was, how the Fed would be guided by markets in the future, and how the tightening might be near its end. The world markets recovered an average of 5% from their recent lows, and will undoubtedly move back to their former levels in the due course of reasonable time, perhaps a few months. But what deadweight costs, what frictional costs, what individual hardship and poverty was created by it all.

What fools these central planners must think we are. What arrogance of power Khrushchev, Mao, Fred Lee and Ben Bernanke displayed in trying to consolidate power about them. What stooges the media and other bit players in the debacle were as they fanned the flames of total economic Armageddon as if puppets in a performance.

Let the story of this recent disaster in centralized planning, this superposition of the vision of a single leader for the wisdom of the market, this attempt to consolidate power behind a single voice (possibly engendered by the pretty woman transgression), serve as a vivid, and compact episode in the US of why market based solution, and pluralism, and suffering the consequences of failure are so necessary to the common good. And let us learn how to profit from such orchestrated forays in the future.

Mexico's nationalization of the oil industry in 1938 is another example of poor central planning. Pemex is so inefficient that in a few years Mexico will become an oil importer despite its being seated on vast oil reserves in the Gulf of Mexico.

They don't have the technology or the people to drill in deep waters and as outsourcing is forbidden by the law those reserves will remain under the sea.

30-Jun-2006
Celebrating the Fourth of July by Tim Melvin

So here we are once again, the fourth of July Weekend fast upon us. For those of us here in the States it is a celebration of our nation's birth, a unique nation founded on principles that were unheard of at the time, with a belief in individual liberty and independence. While some may argue that we have strayed from that path, it remains true that the US has been the guiding light of freedom in this century and the one past. Those of us from here will this weekend celebrate our nation's birth. I imagine the rest of the world will use the opportunity to remind themselves of how much they hate us but that's not going to stop the party.

With the exception of a brief opening Monday for the markets, it shapes up as a four-day holiday weekend for most of us. Here on the island, it is shaping up as a typical Melvinian bacchanalia with festivities starting tonight and rolling right on through until Tuesday evening. There will be the fermented and distilled beverages, the end product of grains, grapes and juniper berries flowing across the docks, there will be roasted domestic farm animals over the fire, steamed pots of squirming crustaceans, the uniquely American sound of southern fried rock and roll will blast across the docks at both redeye dock bar and the jetty all weekend, the speedboats will growl and rumble and we'll fly across the bay at 70 mph just for the sheer joy of the speed, scantily dressed women all around showing off the end product of endless hours in the gym and tanning booths. There will be laughter and dancing, drinking and dining in the sun, with American flags everywhere flapping in the breeze that swings in off Eastern bay. The whole damn crew will be out and about this weekend with wives, girlfriends (including a new contender for the current incantation of the one true love of my life) the whole shebang. It is just too much fun to miss.

As always, I like to recall why we are celebrating and to toast those who sacrificed for the right to be here this day on this dock with these friends. I have written much in the past of the sacrifice of our military and will mention it here for we all know that without them, there would be no party this day, no cold beers in hand, no burgers on grill. They lived, fought and died that we may be free and I honor and thank them for that. I have written on past fourths to thank the greedy bastards, the capitalists who built this economic engine that sustains us all. This year, in light of the recent tumultuous markets and the blasting that Victor received on several ill conceived chat boards during the upheaval for his risk taking (although in the Bloomberg article he clearly stated that he favored taking large risk for large returns over time), I pause to think of the exceptional risks taken by exceptional men and women over the past 230 years to build this nation we call home. They have risked their lives, their money, and their effort. Many of them failed over and over only to get up and push doggedly on until they met success. The taking of extreme risk to achieve extreme rewards seems to be an inherent characteristic of our nation and I think today we should drink, grill and dance in celebration of these risk takers.

To celebrate the original risk takers, the incredibly brave 56 signers of the American Declaration of Independence. These 56 were committing an act of treason against King George. Affixing their name to the document was a death sentence. Yet they all signed this document with the last paragraph acknowledging the risk they were taking ''And for the support of this Declaration, with a firm Reliance on the Protection of Divine Providence, we mutually pledge to each other our Lives, our Fortunes, and our sacred Honor." Of these 56, nine died in the war. Five were captured. Eighteen of them had their homes burned by the redcoats. Several of them lost their entire fortune and never recovered, dying broke and bankrupt. They had to know the very real possibility of this future, but they also recognized the vast potential of the republic they brought into existence with their signature. So they signed, taking the extreme risk for the extreme reward of liberty.

We celebrate those who left the relative safety of the Eastern seaboard to push into the interior and onward to the Pacific in search of land and opportunity for themselves and their families. Think of Lewis and Clarke setting forth to map the way westward with no real idea of what they would discover. From 1804 to 1808 they traversed the continent, encountering hostile natives, unknown wildlife (they were the first, to their dismay, to describe an encounter with the enormous grizzly bear), fierce weather and unknown hardships. But they went, opening the path for westward expansion of the young nation. We celebrate all the trappers and trackers, as well as the pioneer families who struck out with no knowledge of the outcome but a firm unshakeable belief that they could take the risk, overcome the obstacles and achieve success and prosperity.

We celebrate the risk takers in business, people like Henry Ford, Sam Walton, Andrew Carnegie, Tom Watson, even Bill Gates. These men risked their reputation, their capital and their effort to build lasting companies that changed the face of not just America but the world. Walt Disney who had already gone broke a couple of times but persevered in his vision and changed the world of entertainment forever; Ray Kroc who expanded one little burger stand into a fast food empire; We celebrate all those as well who rise each day to open the bakery, the print shop, the small business that serve us each day, often opened on a string and a prayer along with credit card debt, risking ruin to chase their dream and making our lives easier in the process.

We celebrate those who expanded the frontiers of science and exploration pushing forward into areas no one thought they could succeed. People like the Wright brothers, Thomas Edison and Jonas Salk who pushed the frontiers of their field and changed the world forever by virtue of their courage to push the envelope and their dogged determination to succeed where others had failed. We celebrate the courage of the Apollo astronauts who pushed on to broaden man's knowledge of the universe even though the first of the spacecrafts had exploded resulting in the fiery death of their friends and fellow astronauts; Neil Armstrong taking that great step into uncertainty. We salute the Shuttle astronauts who continue to fly, as well as all those who risk reputation and career to continue to push ahead against the diseases and ailments that have faced man since the dawn of time. They have expanded our knowledge, lengthened our lives and provide light, power and comfort to the world as a result of their taking of great risks to achieve greatness.

It was George Bernard Shaw who said, "The reasonable man adapts himself to the conditions that surround him. The unreasonable man adapts surrounding conditions to himself. All progress depends on the unreasonable man." Although Shaw was Irish, in that statement, he captured the heart and soul of America. It has been our willingness to push the edge, venture into the wilderness and explore the frontier that has made our nation great. I think Victor is quite correct when he said most people today do not take enough risk. It is in the taking of risk that lays the seed of greatness, of discovery and of success. Our nation was birthed by those who took the risk of leaving all they knew to come to a new world full of hope and adventure. It was birthed by men who risk everything to achieve liberty, not just for themselves but also for a whole new nation and those would followed over the next 230 years. It has expanded and prospered by risking it all in business, in science and across all endeavors. We exist as a nation because we have always embraced risk.

So raise your glass of sparkling gin, hoist your beer and pay tribute to those who have gone before; many succeed, many failed but they all knew the exhilaration of being alive and risking it all, be it money or reputation of their very life so they we may enjoy the lives we live here today. Then celebrate as only Americans can, with cold adult beverages, rock and roll, loud boats, fireworks blasting a multi-colored tribute across the early night sky, the freedom and independence we all have to succeed, to fail, to participate in a venture like this site that expands our minds and opportunities and create new friendship with the incredible mix of risk takers that reside here. Happy Fourth of July. If you are in the Mid-Atlantic area, stop in redeye's over the weekend and I'll stand you a drink and a hunk of roasted flesh in honor of our nation and our opportunities.

30-Jun-2006
Timing Duration and Yield Curve Bets by Edward Talisse

Forward rates do not have any predictive power. Researchers have documented that spot rates develop much slower than the forward curve implies. However, forward rates are high in information content. They include expectations and the market price for bearing risk. The market price of risk is a slippery concept in fixed income. In equities, it is simply the expected return over the risk free rate divided by the volatility of the market. In both markets it is time varying. You are supposed to buy when the market price of risk is high and sell when it is low.

Sounds easy, right? So how do we measure the market price of risk in fixed income? There is no right answer, but here is an approximation:

Forward rate = Spot Rate +1/2fr (t) - 1/6 (volatility)2 (t) where fr represents the market price of risk. Lets look at a real example in Japan. At The Money (ATM) forward rate 10y1y = 2.93%, spot 1y = 60 bp, volatility = 26.5% or 81 bp normalized and T =10. Work through the formula and you will get fr = 48 bp. This means the forward rate includes 48 bp compensation for bearing risk. It has nothing to do with expectations. Track the 48 bp over time. Receive 10y1y rates when it goes higher and pay when it goes lower. Why try and out guess the market? Go long when you are paid handsomely to do so. Go short when you are not. This is just a timing strategy for traders. Long-term investors will do better following the deterministic component of stocks and bonds. For stocks, it is of course, the positive drift that the Chair so frequently points out. For bonds, it is mean reversion. By the way, 10y1y represents the 1y rate 10 years from now.

29-Jun-2006
Market Imperfections, from Victor Niederhoffer

The book Market Failure or Success, edited by Tyler Cowen and Eric Crampton, is a collection of articles about when and if markets fail, and the solutions that the market comes up to preclude failure. It deals extensively with the role of prices in providing information. Two contrasting views are tested:

1. Prices are signals that takes account of our imperfect knowledge to balance supply and demand.
2. Prices are set to ration demand so that those with better information will not be induced to purchase at the market price.

The book deals with such topics as credit rationing, price rigidities, path dependence, quality uncertainty, frictional costs, lock-ins, opportunistic behavior, prisoner's dilemmas, loan guarantees, kinked demand curves. Articles presenting the modern idea that government intervention is necessary everywhere because markets don't work, mainly based on the work of Akerlof, David, Samuelson and Williamson, are presented. Next, empirical tests and market-solution articles are presented to show that such market imperfections are solved by the market.

The articles get me thinking about the current moves by the Fed to remedy what they see as a market imperfection. The question is whether individuals are not alert enough to the dangers of inflation, and businessmen are too ready to pass on prices because they mistakenly feel inflation is going to be more likely than it would be with a vigilant Fed. Thus, the dignitaries at the Fed and their counterparts all over have been dispatched to pass on the message that the Fed will prevent inflationary expectations from taking root. The minutes, the statements, and everything else have been coordinated in this direction.

The market solution would be that market prices provide a better signal of what inflationary expectations are then the anecdotal feel and ideas as to the resoluteness and steadiness of the head man at the Fed.

I notice there is a cyclical pattern of moves following Fed meetings, where the signaling effect of one regime, kicked off by a meeting, is followed by an opposite effect following the next meeting. Such a solution would be consistent with a Hayekian view of stock prices, which provide relevant information about the activities of an extended order of sophisticated buyers and sellers of equity capital.

In line with the signaling effects of Fed meetings, I note that when there is a big decline in S&P 500 from one meeting to the next, measured from the close one day before the meeting, there is a tendency for a reversal in conjunction with the next meeting as measured from the close one day before to the close one day after:

Date of Price Change(%) since Price Change(%) from Day Before
Meeting Previous Meeting to Day After Meeting
 10 31 2005 -2.4 1.4
 05 02 2005 -1.4 1.0
 08 09 2004 -6.1 1.1
 03 15 2004 -3.0 1.7
 01 28 2003 -4.1 -1.6
 09 23 2002 -7.7 0.8
 08 12 2002 -7.1 1.8
 06 25 2002 -7.5 1.9
 05 06 2002 -9.6 3.4
 01 29 2002 -3.6 2.6
 10 01 2002 -11.5 3.0
 08 20 2001 -3.1 -0.7
 06 26 2001 -3.1 0.5
 03 19 2001 -14.8 -3.4

As the total correlation between price moves the month prior and the next two days is insignificant and close to zero, this was approved by the Minister of Non-predictive Studies.

29-Jun-2006
Giving Proper Credit for Breakthrough Work by Saurabh Singal

The name of Ito's Lemma has been changed to Ito-Doeblin Lemma. It is a tragic tale that leads to this. Wolfgang Doeblin was a mathematician whose work was in the same exalted league as that of Levy and Kolmogrov. He was born in Germany. His father, a well known author, was on the black list of the Nazis so the family moved to Paris in 1933.

In 1939, Doeblin was called up for the army on the front line. So his career as a mathematician lasted only five years, but he collaborated with Frechet and Paul Levy in that brief time. In 1940, the part of Lorraine where he was fighting fell to the invading German army. To avoid being taken a POW he shot himself. Before doing that, he had filed his recent work in the National Academy of Science in Paris. The packet lay unopened for 60 years, but it was found some years ago and one of his results was almost the same as Ito's well known result, but independent of him. So in the newer publications, the reference is to Ito-Doeblin formula as opposed to only crediting K. Ito.

29-Jun-2006
A Retired Daytrader Reads the Newswire, by James Humbert

Trillium, Schonfeld Fined $490,000 for Improper Nasdaq Quotes

June 29 (Bloomberg) -- Trillium Trading LLC, along with eight of its traders, and Schonfeld & Co. were fined a total of $490,000 by NASD to settle allegations of sending improper quotes to the Nasdaq Stock Market.

NASD, which announced the fines today in an e-mailed statement, said the firms affected the open of trading in over 1,000 stocks over a two-week period in 2004.

The two brokerages and traders agreed to the fines without admitting or denying wrongdoing. Telephone messages left at the two brokerages weren't immediately returned.

Reminds me of the old days. Using small orders and going up a penny at a time, odd lots, to hold up a down market, taking away plus tick bids etc. Well, that's what I am assuming. They're just traders and don't make markets so I don't kno w any other way to send "improper quotes." I did get yelled at one day trading COMS with a 7-share bid refreshing on Island to upset ###### ####### holding on the offer, selling 100 shares every 15 seconds and he was buying on Instinet. Only guy that would and could make a silly ###### ####### trader would be ####### #####, lock a MSCO mumbo offer with a 1000 share bid through his offer, and make him look like an idiot. ####### ##### used us to help him moved stocks up, and as they came back in ####### ##### would buy 'em back and work their order.

For the life of me I still can't figure out the vitriol ###### ####### had against daytraders and how silly they acted. But the gist is, if you're a market maker you can do all sorts of fun things the rest of us can't. But then again, it costs a fortune to make markets and even back in '98, after the '97 order handling rules, many of the small-time market makers gave up and came over and became daytraders themselves.

29-Jun-2006
Cassius Coolidge, from Steve Leslie

C. M. Coolidge is the most famous American artist you've never heard of, even though his paintings occupy a rarefied echelon of artworks with Edward Hopper's Nighthawks, Grant Wood's American Gothic, and Andy Warhol's Campbell Soup Cans. These signature works, for better or worse, are indelibly burned into the subconscious slide library of even the most un-art historically inclined person through their incessant reproduction on all manner of pop ephemera: calendars, t-shirts, coffee mugs, the occasional advertisement. The difference with Coolidge's most famous image and these others, however, is that Coolidge's subjects seem to have gambling problems and, one surmises, doggy breath.

Cassius Marcellus Coolidge (September 18, 1844-January 13, 1934) was a United States painter named after the brother of the famous statesman Henry Clay and best known for a series of nine paintings of anthropomorphized Dogs Playing Poker.

In 1903, Coolidge contracted with the advertising firm of Brown & Bigelow of St. Paul, Minnesota, to create sixteen oil paintings of dogs in various human poses.

Nine of them depict dogs playing poker. On February 15, 2005, two of these much imitated paintings, A Bold Bluff and Waterloo, went on the auction block expecting to fetch between $30,000 and $50,000 but surprisingly sold for $590,400. The auction set an auction record for Coolidge, whose previous top sale was $74,000.

His style inspired American Illustrator Arthur Sarnoff to create his Dogs Playing Pool series. As Yakov Smirnov says "What a country!"

28-Jun-2006
Patterns in Music and Trading, from Laurence Glazier

In music there is an eternal question which is the more important factor, melody or rhythm? I intuitively have always gone for melody, though perhaps rhythm is more accurate, for each pitch is produced by a rhythm happening scores of times per second. The truth is that probably the most important factor is harmony, the third member of this trinity.

Rather than use the term melody, in this question, one can more subtly use the notion of shape. A melody does not have to be accurately sung to identify a tune, it merely needs to go up and down where appropriate, and this, the Parsons Code, can be used to look up the piece of music.

Last year some research was done by Peters, Anthony and Schwartz to show that the rhythm, taken by itself without the tune, can likewise often identify a piece of music.

We have in trading a similar challenge to codify and test patterns, removing all that is unnecessary to identification. In the manner of point and figure or Gann swing, it is tempting to apply similar approaches in trading. Perhaps it is necessary to subtract in some way the influence of the grand market wave (S&P) and eddies of the market sector and look for patterns in what is left. There is some math, inevitably, to be done.

28-Jun-2006
Finding New Fields, from Hany Saad

Even as demand rose sharply, crude oil prices were declining. The answer is simple. Petroleum production was increasing at an ever more rapid rate than consumption. Overproduction has been the industry's recurring chronic occupational disease. To understand this, it is necessary to examine briefly the two principal causative factors. The first is the deep seated, obsessive fear of oil famine which has gripped the world ever since Edward Drake brought in his Titusville well. From the very beginning, many people -- experienced oil men and learned scientists, to say nothing of politicians and pundits among them -- have thought and said the world's petroleum supply was limited and would be soon exhausted. Alarmists' predictions of the imminence of critical oil shortage has always been one of the factors which inspired stampedes to locate new oil sources, to find new fields, and drill more wells.

This is an excerpt from J. P. Getty's My Life and Fortunes, written by the man himself in the 1960s. How his wise words ring true today. This is not only a great lesson in supply and demand, but also in how recent events can shape public psychology, forever to its detriment.

The recency of the "bear market" at the turn of the century and the Fed's role in precipitating it by raising interest rates is ingrained in the public's memory the same way the oil shortage was in the 1900s. Now the mere mention of a "Fed meeting" sends shivers down operators' spines as they start liquidating their longs or hedging defensively. Also, the same psychological bias prevented all the operators of 1929 from making a cent in all the prosperous years that followed.

It's the reason astute fund managers, upon sensing a market turn in 1987, fired all their senior staff who experienced the Panic and were scarred for life by it and hired inexperienced kids to avoid this costly psychological bias as the experienced traders shorted every rally while the Dow doubled and tripled.

Now is the best time in history to invest in equities, as this psychological bias has kept stocks at very attractive and unsustainable levels. And yes, I have my money where my mouth is.

28-Jun-2006
Word of the Day, from James Sogi

The term mumbo jumbo comes from the writings of Francis Moore and Mungo Park, eighteenth century explorers of the Niger region of west Africa. Mumbo Jumbo was a fictitious god who was impersonated by men of the tribes he encountered in order to terrify the women and keep them under control. Now mumbo jumbo means incomprehensible nonsense we hear about the markets every day, used to terrify the public.

Dr. Kim Zussman replies:

In preparation for upcoming family trip, we viewed a program on the history of kings of England. There were many kings dating from the time of Arthur (about year 600), and even a greater number of battles and wars. One great difference from the present was the apparent need of people to subject themselves to, and even worship monarchy; possibly in search of physical and psychological security.

Another theme was myriad wars, including the War of the Whiskers and the War of the Rough Wooing, often waged at the behest of royal dictators. Each have historic causes usually attributed to territory, religious, or ethnic disputes.

Studying the War of the Market suggests a common cause to all wars; humans and other animals are programmed to compete and conflict. The causes listed in history books are too varied and random to explain the recurring need to delineate and fight unless the common denominator of biology is at work.

Panics and great sell-offs, as well as galloping bull markets, can be given retrospective battle themes and historical labels, but behind it all are men swinging swords.

28-Jun-2006
Barbecue Pizza, from David Higgs

For you gas burner grillers who tired of the same old fare, you know the stuff that flys, swims or had 4 legs...........try bbq'ing a pizza.........here's how you do it: first get you a box of fire bricks then arrange them in your bbq grill. fire it up real hot at first for aseptic reasons then lower the setting to medium and cook to your desire. I won't suggest the toppings, cheese or sauce, that's to personnel but, bell pepper ( all colors ) olives (green), onions, tomatoes, a veggie affaire a good start for a change and the thinner the better, sorry Chicago! Below is a beginner's dough recipe:

Makes One 15-Inch Pizza Or Two 9-Inch Pizzas:

1 1/2 teaspoons active dry yeast
6 tablespoons warm (110°F) water
6 tablespoons milk
2 tablespoons extra virgin olive oil« -
1 tablespoon fine cornmeal
1/2 teaspoon salt
1 tablespoon rye flour
About 1 3/4 cups unbleached white flour
1 to 3 tablespoons additional flour for rolling the dough

Dissolve the yeast in the warm water and set aside in a warm place for 3 to 4 minutes. Meanwhile, combine the milk, oil, and cornmeal in a 1-quart bowl. Add the yeast mixture, then the salt and rye flour; mix well. Gradually add the white flour, making a soft, workable dough. Turn out onto a lightly floured work surface and knead for about 5 minutes, sprinkling in a little flour as necessary to keep the dough from sticking to the surface. Put the dough into an oiled bowl and turn it once so the surface is coated with oil. Cover the bowl with a kitchen towel or plastic wrap and let the dough rise in a warm place until it has doubled in bulk, about 35 to 40 minutes

28-Jun-2006
Cash and Carry, from Easan Katir

Shortly after the Euro 500 note was issued, the dollar rate of depreciation increased. The theory was that sheiks and apparatchiks could transport five times the cash in the same suitcase using Euro notes. US $500 note on the drawing boards?

George Zachar replies:

I thought the Euro 500 note was introduced right at the start-up of the single currency. Alas, for the sheik or apparatchik who wishes to move or maintain mountains of covert capital, is there really an alternative? Is it possible that the Euro's ECB/London regulatory complex offers greater security?

There's no chance the US Treasury will produce a denomination greater than $100, because as the dollar's purchasing power declines over time, more and more transactions will be forced to go electronic, and hence into the government's database.ase.

28-Jun-2006
Tokyo Observations, by James Tar

My first observation focuses on the so-called "boom" in Japan. Nikkei soaring (recent dump of ~10-20% no bother). Economic recovery. Real estate reflating. Consumers spending (from the mattress account). Hmm. Why then does commuter traffic seem so depressed? Where are all of these hard working people? Why are the shopping malls so empty? Why is there such a lack of the once so obvious glowing neon advertisements?

Train traffic has been light, to say the least. Immigration at Narita, despite nine flights from abroad landing within 30 minutes, was the easiest I have ever been through. Baggage claim roundabouts were empty. If commerce is high and recovery is underway, should I not expect something different? /p>

The Bank of Japan has recently removed more liquidity from the system than ever before and I wonder if this has anything to do with it. Restaurants in Roppongi are empty! Bring on the Sake? Hardly...

I am not drawing any conclusions here, just that I do not know what all the cheer is about for the Japan Miracle when the streets say something different. Perhaps Turkey over the weekend -- the huge raise in rates -- said something clear: it is time to reel in consumption. Has Japan pre-emptively taken notice?

Turkey is ominous for the rest Emerging Market Land. "Let's take rates high enough so we maintain a positive interest rate differential, keep our currency strong, to squelch foreigners' selling our assets -- stocks -- and crush fears of an economic nightmare." You can see what a nasty virtuous cycle this becomes.

28-Jun-2006
David Hillman Reviews Broken Trail

Not much TV watching takes place in my household, but the past couple of nights, the tube was tuned to AMC for Robert Duvall's latest work, Broken Trail. Without giving up too much, this is a story of Print Ritter (Duvall) an old cowboy who inherits his sister's estate. Estranged from his mother, Print's nephew Tom (Thomas Haden Church) is cut out entirely, but in fairness Print proposes a business deal. They go to Oregon from their native Nebraska, purchase a herd of 500 horses and profit by driving them east to Montana for sale to the military. Tom signs on somewhat reluctantly to a 75/25 split and they set off on this great adventure. Along the way, they encounter an inevitable cast of nasty characters and good-hearted souls. At one point, five Chinese girls who had been sold into a life of slavery and prostitution become their wards. They plan to care for them until they can deposit them in the first available safe haven. Nearing a town, Tom is instructed to take the girls in and find someone to care for them. Tom and his fiddle-playing drover Heck (a very likable Scott Cooper) find no there is no civil authority in the rough and tumble mining town, which is more or less run by the saloonkeeper madame to whom the girls were to be delivered originally. She wants 'em back. Tom refuses. He and Heck hurriedly load the girls into the wagon, along with a kindly whore (Greta Scacchi) and a pistol-whipped Chinese man. They're confronted in the street by the madame and her thugs. Tom levels a rifle at the thugs, who back off. As the wagon thunders off, the madame screams "What about my property?" Tom turns his horse, looks back and answers, "That's the price of being a capitalist, lady!"

Some days you get the bear, some days the bear gets you, eh lady?

There are many lessons in this four hours related to business, entrepreneurship, trading, markets, etc. Not the least of these is about taking great risk and using good decision-making to manage that risk. In going for it, Print risks it all and Tom has nothing to lose -- two sides of the same coin. There is something to be learned about the partnership of the wisdom of age and the skill of youth. Fairness and integrity are themes. Mentoring another. Theft, deception, negotiation and luck are involved as well.

While this may not be on the same level as Louis L'Amour's work or the story of Monte Walsh, there are similarities to both, although real students of the Western genre, such as Victor, would be better judges and reviewers. However, the story was inspired by documented tales of the period, the characters are engaging, the performances are very good and there's enough poignancy and pathos here to make for an enjoyable viewing. While violence and the prostitution angle may render this unsuitable for young children, there was nary a four-letter word uttered. While that might not be very realistic, it was welcome.

And for the musical among us, the score was co-composed by the famed and accomplished Van Dyke Parks, so it's quite good and features a suitable western twang. Encore presentation July 6, 8 PM EDT. Enjoy.

27-Jun-2006
Streaking, from Victor Niederhoffer

All streaks except one were broken yesterday. The three S&P down opens in a row, the six S&P down 3:30 to closes, the five S&P down Mondays. The exception: the seven non-updays in bonds in a row, now eight. I turn my counting attention to what happens when such streaks are broken, when the S&P has dropped 50 or so in the previous 30 days, and what happens when the last move around the Fed Open Market Committee meeting was down. On a qualitative level, there is much talk about how Chairman Bernanke is strong-arming his colleagues into maintaining a very vigilant stance against inflation (or when strong-arming fails, easing them into retirement) so that his own image as an inflation fighter can be maintained for the good of all. I have found that a powerful executive, whether at Grace, GE, Tyco or Enron, is usually very effective at gaining compliance with his wishes for his personal empowerment, always spun as for the good of all, but that such maneuvers often backfire and lead to total disgrace and revulsion as hysteresis takes its inevitable toll.

As yesterday marked the ninth consecutive day of rising ten-year yields, some of my contacts have been chattering about what the circumstances were during the last such occurrences.

Ckin responds:

There were two occurrences of nine straight down days in 1975 (July and September). The context of this timeframe was the Whip Inflation Now button.

There were 11 straight down days in April 1974. That was contemporaneous with the release of a collection of audiotapes from a President who was not a crook.

27-Jun-2006
Defensive Driving for Speculators, by GM Nigel Davies

Earlier this week I attended a defensive driving course where I learned a number of things which may be of value to specs. For example, the acronym COAST means the following:

• Concentration
• Observation
• Anticipation
• Space
• Time

Of these five, the most important factors were space and time, the idea of increasing space (by decreasing speed at appropriate moments) between you and the other vehicles gives you more time. My ears pricked up at this point as time and space are two of the major factors in chess.

It also struck me that there was a great analogy with markets here if one substitutes leverage for speed. The inappropriate application of leverage can leave one with little space (adverse excursion) should things go wrong and therefore little time for the trade to work favourably. By anticipating possible hazards, on the other hand, one can manage ones leverage in a way that will avoid the necessity of sudden stops (stop-losses if you use them or running out of margin if you don't). This in turn can produce a smoother and less dangerous drive. ve.

A few other acronyms:

BOB and MIC (Hazards on the either side of the car, BOB meaning 'Boy on Bike' and MIC meaning 'Motorcycle in Center')

OUT (Over, under and through as a means of observing hazards at junctions)

Pitt T. Maner III responds:

Another interesting aspect of defensive driving is that it is very important that all the occupants inside your vehicle are wearing their seat belts. Given the forces involved in an accident (Mass times Acceleration) a person in the backseat without a seat belt can fly forward and injure/kill themselves and you (even if you have a seatbelt on). Babies of course should always be secured properly and those that think they can hold on to a baby in a car when there is an accident have no idea of the forces involved.

With respect to markets one might say it is easy for the investor to underestimate the forces and risks involved.

In my daily driving on a state highway, I typically can easily change lanes for the first mile. After that, however, is a traffic light at which traffic gets clumped together and often becomes bumper-to-bumper from that point on. As I approach this light, I assume it may be my last chance to get in the right lane without needing to drive aggressively (which I would rather not do, since there is a non-negligible risk in my small city that the person I cut off might be a co-worker or a teacher at a child's school).

An impending shrinkage in one's available choices is often a trigger to action. Examples in the markets include approaching expirations of options and futures contracts. Are there other circumstances in which many market participants' choices shrink, possibly driving predictable actions?/p>

Laurence Glazier replies:

Another, slightly different analogy, traffic tends to slow some distance before a road narrows, and then speed up through the narrow part, this may be an example of Bernoulli's principle. Seems very similar to narrowing of daily range.

Can the principles of fluid mechanics be applies to guesstimate the extent of move when daily range expands again? If the likely move can be deduced from option prices, one might be able to derive the appropriate coefficients. Perhaps I am reinventing a model here.

Pitt T. Maner III replies:

And then you have the rubberneckers, who are quite prevalent in south Florida on the interstates who will come to a stop to look at the most insignificant fender bender, construction activity on the side of the road or highway patrol car with a flashing light. It is a strange phenomena that can slow traffic for miles. Complex psychology of vicarious thoughts.

The "moth" effect in which a driver will subconsciously stir towards a vehicle, light source, or object on the shoulder of the road--particularly at night. A great danger to those fixing flat tires or doing car repairs. Driving hypnosis.

The dangers of not paying attention at 70 mph... looking away for a second or two and covering hundreds of feet in the interim. Cellphone accidents about 7 to 1 higher?

Studies in complexity or chaos theory that suggest that leaving gaps between you and the next car and allowing other drivers (particularly trucks) to enter in an orderly fashion can help alleviate traffic congestion...

And again the log increase in forces associated with each 10 mph in velocity. Avoid a head-on collision whenever possible.

Craig Maccagno replies:

Then do it all in Florida on a motorcycle which most would say is less safe, and you'll find quite the contrary. Much easier to avoid accidents due to better stopping power, faster acceleration, and unsurpassed maneuverability. Not to mention there's no being able to chat on your cell phone, or fiddle with a CD player, or any number of other distractions on a bike.

27-Jun-2006
Disclosure

Victor Niederhoffer has no positions in individual stocks mentioned in his posts. He trades futures and options actively for his account and others. At present he has a net long position in stock market index options and net short in futures, but this position can change within and between days, and frequently does.

Mike Long flames:

Disclosure, eh? That's new. Distraction? Deception? Music to my ears. Though I might even go long with you for the end-of-quarter paint job. Maybe.

27-Jun-2006
David Wren-Hardin Inquires: Any Thoughts on "Inside the House of Money"?

27-Jun-2006

OK, we all know that charts are a waste of time, and the current account story that is driving the dollar weaker is all papers seem to focus on these days. For all dollar bears I suggest a trip to Europe where prices in Paris (expensive), Rome (very expensive) and St. Tropez (super expensive) compared to anywhere in the US exist. It is almost impossible to believe that the Dollar can go beyond $1.30/Euro when one is now paying an average of $10 for a beer, $75 per head for a meal $500 for hotel room - where the service is not great and the quality of everything is far behind the average US hotel. I went to a fairly well known club in St. Tropez where any drink (even a water) was $31. So hotel, food and drink are way overpriced compared to New York (which is overpriced compared to the rest of US). What about fashion? Isn't the clothing one of the reasons people visit Italy? This was the most disappointing part of the trip, where all the fashion houses are so globalised that prices in France and Italy are the same everywhere and even the Italian fashion houses are expensive and so homogenous that all the stores have the same products. In fact the most interesting labels are now non-European like Ed Hardy/a>, DSquared, etc. Make no mistake, Europe is a great tourist destination and culturally fantastic but I am going to the Americas on my next vacation it is far cheaper. I wonder how many others feel the same.

26-Jun-2006
Seasonals, by Victor Niederhoffer

It is always good to hear from former students, especially if they have advanced to prominent and successful careers, even if they sometimes try to grab me by the beard. Such a pull came recently from one of the best of my 1970ish class at Berkeley, Dr. William Rafter, now a math investment personage:

In response to Rod Fitzsimmons Frey's June 7, 2006 post on seasonality and Fourier Analysis

The 21-day cyclicality you found is caused by options expiration, there being on average 21 trading days in a month. For an illustration, look at the open interest:

One of the best ways to create a surrogate or smoothed data set is to analyze the data series for cyclic behavior, find the best fitting cycles and put them together. The magenta line below is a composite of the 10 most dominant cycles that can be obtained from the dataset using Fourier Analysis.

This cyclic behavior is an excellent way to fit past data. Furthermore, since one has the formulae for their construction, those formulae can be used to produce a cyclic prediction. But just because you can do something, does not mean that you should do it. Although FA can be used to generate a prediction, that prediction has no reliability. Many other smoothers are not good predictors either; it's just that most people believe that the past cycles will be repetitive. The Chair might have a horse racing parallel. Chiefly, the cyclic values are not stable/constant over time. That is, if you cyclically analyze N days through the most recent Monday, and then analyze an identical number of N days through Tuesday, the entire fit of Tuesday values will be different from the entire fit of Monday values. Thoroughly revisionist history. Contrast that with what happens if you smooth with other tools like (perish the thought) moving averages. -- Bill Rafter

Now Bill knows as well as anyone that I am one of the world's most ardent deflators of seasonality and cyclicality and I don't believe them predictive, but merely descriptive, and so beset by multiple comparisons and changing cycles to be completely destructive of value. Indeed, I have found that almost all who use seasonality as a descriptive tool have stopped trading and if they haven't they have special interests in using a descriptive factoid to help their already ingrained position along, in perhaps the hope that poor followers will further their thinking along.

Such is the case for example with some ardent exponents of the January barometer. When January is down, as it was in 2000, and the market drops another 70 points the rest of the year, they're bearish as a thousand devils, but in 2001 when it's up 40 in January, why, that's bearish, also thus justifying the 218-point drop that followed.

Moving to 2003, well, it's down again 25 points in January, and the 260-point rise the rest of the year was an anomaly. In 2004, it did work, up 20 points, with another 80 points the rest of the year, but it wasn't bearish, so forget it for the rest of the year.

In 2005, it's down 20 in January, and that's bearish again, let's shout it from the rooftops. But indeed the market rises 37 points, an anomaly. In 2006, the market's up 32 points in January, but there must be something wrong with its bullish position as it's the second year of a Presidential election cycle and 2002 and 1990 were down years. And if it happens to be up in 2007, why everyone knows that the third year of an election cycle is bearish. That's typical of seasonal indicators. They explain everything, are good for all eventualities in helping a previously engrained prediction, and are changeable as the tides and about as accurate, 50% correct in real life, like the January barometer, which is widely trumpeted as one of the best.

Year January Rest of Year
2000 -75 -74
2001 46  -218
2002 -18  -250
2003 -25 256
2004 20  80
2005 -30 67
22006  32 ?

Thus, when a global macro fund manager recently sent me some seasonals showing that if you look at quarterly options expirations only, and stop well before 2001 (when the week after the September expirations the market rose 75 points), you can come up with numbers showing the market has a tendency to go down the week after quarterly expiration (always the third Friday of the month). It would be amazing indeed if one weren't able to come up with something of that nature, considering you are varying the week (before, during or after), the quarterly or monthly, and the starting point, and if not the options expirations, perhaps the bond auctions, or FOMC meetings, or G8 meetings. With this many degrees of freedom and multiple comparisons, it's well over 99% that you'll be able to pick and choose and find a week that in the last three years has gone down an average of 1% with a 80% chance of a decline. Such is guaranteed to happen, as Jimmy Cannonnnon liked to say.

But in honor of my former student and my friend the fund manager, I thought it would be worthwhile to look at the moves in the second week after quarterly expirations. For example, if the current quarterly expiration was June 16, we would look at the move from the close of Friday, June 23rd, to the close on Friday, June 30th (if a four-day week followed without a Friday close, I looked one day forward to the fifth day, a Monday). Here are results:

Moves in S&P500 the Second Week Following Expiration
 Year-end 2002 to present
 
Date of Close, first week Close, second Week Change
Friday after after Expiration after Expiration 
Expiration
 12 27 02 868 906 +38
 03 28 03 905 922 +17
 06 27 03 968 997 +29
 09 26 03 991 1025 +34
 12 26 03 1091 1118 +27
 03 26 04 1105 1141 +36
 06 25 04 1183 1173 -10
 09 24 04 1113 1135 +22
 12 23 04 1256 1259 + 3
 03 20 05 1216 1218 + 2
 06 24 05 1231 1236 + 5
 09 23 05 1249 1263 +14
 12 23 05 1286 1285 - 1
 03 24 06 1313 1303 -10
 06 23 06 1264 ? ?
Total +206

I have the same degree of confidence for such a seasonal study as I do for the January Barometer, but as they say in Fiddler,

It doesn't matter at all,
But all the same, it's nice to know.

27-Jun-2006
An 1869 View of Passport Control, by Steve Ellison

I am reading Westward by Rail, William Fraser Rae's account of his 1869 trip to and across the United States. In the first chapter, he briefly recounts his transatlantic voyage. Excerpt:

When the voyage was drawing to its end, a notice was posted up outside of the saloon, to the effect that the Government of the United States required every passenger to fill up a form with particulars as to age, occupation, last legal residence, purpose in visiting America, and as to whether or not this was the first visit. Such an intimation took the majority by surprise. If it had emanated from the despotic Government of Russia, or from the Government of the police-ridden kingdom of Prussia, no surprise might have been exhibited. Despots are fond of asking impertinent questions, and are wont to act as if travellers ought to be placed in the same category as the plague, and treated accordingly. While the war lasted, the Government of the United States was justified in resorting to the obnoxious passport system, and treating every stranger as a foe or a spy in disguise. Happily, this excuse cannot be urged now that treason has been extinguished and the Union has triumphed. The Americans on board were as much puzzled and annoyed as the visitors to the land of freedom. They used vigorous terms in characterising what was simply an indefensible demand. They were the more angry because they knew that a similar interference with liberty of action does not take place when a steamer nears the coast of the United Kingdom, and they disliked the comparison which could be drawn to the disadvantage of their own country.

26-Jun-2006
Fed Model Update, by Tom Downing

As of June 26, the S&P was at 1245, expected forward S&P 500 earnings for the next 12 months were 89.22, and the yield on the 10-year T-note was 5.22 percent.

From these numbers, one can calculate a Fair Value of the S&P 500 by dividing expected forward earnings by the yield on the 10-year note, which results in a reading of 1709 (89.22/0.0522)

This implies that the S&P 500 is 37 percent undervalued at these levels (1709/1245-1).

However, one cannot really interpret this as an expected return for the market, because 'equilibrium' may also be brought about through adjustments to interest rates and expected earnings, not just stock prices themselves.

We prefer to base our forecasts on the spread between the forward earnings yield (consensus estimated 12 months earnings divided by the S&P 500 level) on the S&P 500 and the yield on the 10-year Treasury note. The forward earnings yield is currently at a 1.95 percent premium to the 10-year note yield. On the eight occasions when this differential has been greater than 1 percent, the S&P 500 has risen eight out of eight times for an average of 14.8 percent in the subsequent 12 months. Our regression model (which is based on the aforementioned differential) currently forecasts a 18.2 percent return for the next 12 months. See full details.

25-Jun-2006
Capital Allocation, by Dan Grossman

I assume the main reason the Soviet Union collapsed economically, rather suddenly and mysteriously, after decades of supposedly growing faster than, and catching up with, the US, was massive capital misallocation. In the first decades of the Soviet Union, its government-planned (remember "five-year plans" ?) investments to increase production of machine tools, and to basic industries such as steel and hydroelectric power, were probably a reasonably sound economic strategy for a primitive economy to catch up to the US and Europe. But as the Soviet economy and the world economy in general grew more complex, the government investment misallocations became more and more costly and inefficient.

One of the great, if not the greatest, advantage of a free market economy over a government planned one is more efficient capital allocation resulting from the decisions of millions of businesses and individuals. But if this is true, why is China (hardly a free-market economy when it comes to capital) able to grow so much faster than the US for so many years? Are the Chinese numbers masking major misallocations that will sink their economy as well? Are they able to keep things going longer than the Soviet Union simply because they are a little more skillful, and significantly more free market, than the Soviets were? But unless they convert to a true free market, and a bottom-up rather than top-down capital allocation, will the result be the same? If capital allocation is so important, I would think so.

Turning to US public companies, where is the analysis of which companies are allocating their capital better than others? The Sage is, deservedly, much criticized on this site. But his advantage at Berkshire Hathaway seems to be mostly capital allocation. When I went to Lewistown, Pennsylvania, for the birth of Aubrey, Vic took me on my first visit to a Dairy Queen. It was a complete slum. Obviously no capital had been invested in it since the 1950s or 60s.

If Dairy Queen had been a separate public company, or a division of a normal company striving for a high-class image, it would have been allocating investment capital every few years to update, refurbish and freshen its locations. No usual CEO would want to preside over 30,000 dirty, unpleasant ice cream/hamburger parlors. But the Sage is happy to milk Dairy Queen as a cash cow and invest all the cash flow in his insurance operation or in acquiring similarly old-fashioned cash-generating companies of the type the Specs hate. (I realize the Lewistown location may be a franchise. But I believe the analysis of company-owned Dairy Queens would be much the same.)

Public companies use return-on-investment analysis to justify their investments. But anyone who has ever been witness to such an investment analysis knows the numbers are most often unscientific projections used to justify what company management wants to invest in. And companies are supposed to pay higher dividends and buy back stock when they do not have opportunities sufficiently attractive to justify investment of their cash flow. But then a single large acquisition, whether for cash or stock, can override years of supposedly more rational capital allocation.

If capital allocation is important, where and how do we analyze which companies are better at it?

David Baccile replies:

The Quest For Value by Bennett Stewart is a classic in the field of return on investment analysis, and more recently Alfred Rappaport and Michael Mauboussin wrote Expectations Investing. These are excellent texts and I am sure someone of Mr. Grossman's experience in the field is already familiar with them.

Steve Ellison replies:

Microsoft at one point had $56 billion in cash. The company has invested billions in MSN, XBox, and other businesses that have yet to prove themselves to be good returns on investment. Giant corporations often misallocate capital for several reasons. Large "competition-free" zones often exist within these companies, creating complacency among employees and an environment in which ideas are not subjected to the type of brutal competition that an entrepreneur would face. After the entrepreneurial founders depart, hired management is often risk-averse. Large companies also find it much more profitable in the short term to cater to their existing customers than to develop breakthrough innovations that would take years to grow to even $1 billion in revenue, as documented by Clayton Christensen in The Innovator's Dilemma. The focus on existing customers guarantees that breakthrough innovations that create billions of value generally come from smaller companies or start-ups.

26-Jun-2006
The Right Tool for the Job, by James Sogi

Compliance with social norms is encouraged. Kids all have to wear hip huggers. Businessmen wear suits. People want to fit in. Contrary thinkers are shunned. In the markets, people want to be part of the crowd, follow the trend. Few want to buck the trend, disagree, stand out. While this is fine in Cincinnati, it leads to losses in the markets. The market goddess has a way of training operators. She might give you a few tidbits, and get you feeling pretty good. You think, gee, I'm so smart, I'm so good. It must be my skill. So you keep doing the same thing. Then the market changes, and you realize that it was not your skill or how smart you were, but it was luck. What you were doing was lucky to fit what the market was doing. Given the law of everchanging cycles, it has to be like that. What worked in one cycle, cannot work in a different cycle. The question is when is the cycle changing.

My friend Tai has an 8,000 square foot shop filled with hundreds and hundreds of tools. A tool for dados, a tool to snip metal, a tool to sand inside corners, a tool to do every little different job perfectly. The market has a million little jobs to do. Each one requires different tool. What you do not want is a really good hammer. When everything starts looking like a nail, trouble is ahead. There must be many different market tools for each little market job. The question is always: what is the right tool for the right job? The second question is: how do the tools work? You can really mess up a nice table with a big saw or hammer, or even a clumsily wielded piece of sandpaper, or the wrong weight sandpaper. There are dozens of different grades of sandpaper. Each stock must have its own tools. Each market has a whole different set of tools. Each cycle has a different set of tools. It takes time to hone each tool, learn to use it with skill. Whenever I work on a car, I strip the bolts, and its off to the shop to redo double the work. I never have the right tools. I try and use an adjustable wrench and< a vice grip for all the jobs. The results are predicable.

26-Jun-2006
Be Sure to Wear Some Flowers in Your Hair, from Tom Marks

On an empirical and localized note, San Francisco is where spirited ideologues go to learn that the Revolution isn't coming, nor should it. All the hippies from the fabled if foggy 60s have been pushed out by a huge wave of postmodern Bolsheviks, right down to the "make podcasts, not war" bumper stickers on their top-of-the-line BMWs. Hardly the unmistakable seeds of impending anarchy. From my observations, the only politics these folks are truly interested in is how to better jockey for a larger slice of the their tech companies' IPOs. And there's nothing not martial about the tactics employed. San Francisco is the most conservative liberal stronghold I've ever come across. It's a function of the real estate values and the considerable spoils. Everything else is an illusion born of a sense to be fashionably correct.

Stefan Jovanovich responds:

Top-of-the-line BMWs are a distinct minority in San Francisco, and the ideologues are entirely home grown. Even gays have stopped coming in any numbers, now that the ravages of rent control have completely taken hold.

The city's liberalism comes not from tech company IPO money (most of which still resides in the 280 suburbs) but from the sources of employment. The three main employers in San Francisco are government, schools (government) and health care (also government, when you consider how much of the bills are paid by Medicare and Medical). In the 60s the city still had a steel fabrication industry, a printing industry, a garment industry and a shipping industry -- now all gone. Then, we had real live Communists and a Republican mayor. Now we have a "fairness" Socialist who has just budgeted the largest pay raise in the city's history, even as tax revenues continue to stagnate.

San Francisco is not America; it is Brussels with even worse football teams.

26-Jun-2006
Captain of His Own Ship, by Steve Leslie

Ten years ago the greatest modern-day pitcher, and one of the top pitchers in the history of baseball, was diagnosed by his team to be past his prime and not worth it financially to retain his services. He was in the midst of a year of sub-par performance resulting in a losing record for the season. Talks began to circulate that since he was a power pitcher, perhaps it would be best to trade him while he still had some value, or let him sign with another team at the end of the season rather than pay him a large salary. This was fueled in part because of a comment from the General Manager of the team stating that he was in the twilight of his career and after all how long would his arm hold out. All of this at the ripe old age of 33.

So after spending 13 seasons with the same team, providing Herculean results, he signs as a free agent with another team ,and what follows in 1997 is quite remarkable. He leads the league in wins with 21, in strikeouts with 292, and in ERA with 2.05, which was 2.5 runs less than the league average. This is the Triple Crown achievement for pitchers. Naturally he is voted winner of the Cy Young Award, which recognizes the top pitcher of the year. This is the fourth time he receives this prestigious award. Many will suggest that this was the highlight of his career.

He didn't stop there. He goes on to win three more Cy Young Awards, and another Triple Crown in 1998, and is traded to yet another team at the end of the 1998 season, in exchange for three players, Homer Bush, Graeme Lloyd and David Wells. From there he wins two World Series Rings in 1999 and 2000.

Now, at the age of 43, he is back in the Major Leagues pitching for his fourth team. He is currently one of only four pitchers to strike out more than 4000 batters in a career, and has appeared in 673 games, winning 341, with a career ERA of 3.02. His 341 wins is a record for any right-handed pitcher in the live-ball era, post 1920. Only Warren Spahn has more wins of any pitcher at 363. He also struck out 20 batters in a nine inning game. He accomplished that feat twice, the only person to do so.

Who is this illustrious pitcher who was cast aside 10 years ago by a baseball team he loyally served for 13 years? Who refused to accept the criticism and "professional evaluation" of others? Who refused to have anyone other than he write his epitaph and chose instead to captain his own ship?

The pitcher is Roger Clemens. That's right, Roger "The Rocket" Clemens. Greatest modern day pitcher. A true legend in his own time. An icon of the game. Now you know the rest of the story.

25-Jun-2006
On Declines, by Victor Niederhoffer

There is considerable Sturm und Drang concerning the market. The tension rose when the S&P futures declined for a third week in a row, even while Europe and Asia recovered. Investors Intelligence reported a draw between bullish and bearish newsletters at 35.6% apiece, the lowest differential since October 2002 when the S&P was 800.6 and rallied 15% to 936 during the next two months. Just 34.4% of individual investors are bullish, vs. 41.6% bearish. This raging bearishness comes in conjunction with the longest-lived of all gloomy columnists, whose absence at the front of the leading financial weekly has aroused much speculation in recent months, who has been continuously bearish since 1964, when the Dow was 900.

Not since the publication of Practical Speculation in February 2003 when the S&P was preparing for a sustained rally after a three-year nosedive have so many been so bearish with such scorn and hope for disaster for buy-and-holders such as myself. (NB: Laurel and I sent the final proofs of PracSpec to the publisher in October 2002, when the S&P was at a low of 800.6.)

Many streaks of bearishness have blazed like comets against the iron-gray market sky, including runs of down opens, last half hours, down weeks in stocks, and runs without a rise in bonds. Under the circumstances, some proper counting of recent streaks seems in order.

Let's start with the recent spell as of June 23, 2006, of declines from 3:30 p.m. to close. It turns out that such declines as of the close give merely a temporary soporific to the forces of detritivism and are visited by highly bullish activities in the foreseeable futures. Rumors that longs have been forced to liquidate apparently fueled the flames. One turns next to what happens after five consecutive declines on the first day of the week, as follows:

Date Decline
5 22 06 -9
5 30 06 -23
6 05 06 -15
6 12 06 -16
6 19 06 -12

It's only happened 20 or so times that the first day has been down around this many times in the last 6 years, so the expectation of 1% the first day, with more the rest of the week, is just barely at the lines of statistical significance. One can't help note after seeing such a pattern that the run of down Fridays and Mondays has brought back many pleasant memories of my former partner Frank Cross, who jointly discovered the Friday down, Monday down relation with me, with a z of -10 or so, back to 1900 through 1975, with a cumulative loss of following it subsequently of thousands and thousands of times on your futures shorts. I also note a run of exactly three declines in a week in the averages as follows:

 Date of Move next week 2d week 3rd week
4th wk 10 21 05 1.3 1.8 1.3
 0.5 3 20 05 0.2 0.5 -3.3
 1.1 1 21 05 0.5 2.2 0.4
-0.4 0 22 04 3.0 3.2 1.2
-0.1 7 23 04 -0.5 1.4 -3.2
 1.1 5 21 04 2.4 0.3 1.2
-0.2 3 26 04 3.1 -0.2 -0.5
 0.5 2 07 03 -2.7 0.8 1.1
 0.7 9 13 02 -5.3 -1.9 -2.3
-3.9 6 07 02 -1.8 -1.7 -0.2
-7.2 4 23 02 -1.1 1.3 -5.0
 0.1 2 16 01 -4.2 -1.0 -4.2
-0.1 11 24 01 -1.8 1.2 -2.2
 0.1 9 22 01 -1.0 -1.0 -1.7
-2.7 5 19 01 -2.2 6.3 -1.0
 0.2 2 25 00 4.9 0.7 4.6
 4.1 9 24 99 0.3 3.6 -5.9
 3.5 8 06 99 1.7 0.5 0.7
 0.7 5 28 99 2.2 -2.2 3.2
-1.8 8 07 98 -2.4 1.9 -4.2
-4.3 12 26 97 3.2 -4.4 3.3
 0.3 10 31 97 0.6 0.1 3.1
-1.1 3 28 97 -1.2 -2.3 3.1
 0.1 7 19 96 -0.6 -0.3 3.0
-0.4 6 24 94 0.6 0.4 0.6
-0.1 1 08 93 0.9 0.0 0.2
 1.4 10 09 92 1.0 0.4 0.5
-0.1 6 19 92 -0.0 1.1 0.4
-0.1 9 22 90 2.2 -3.6 3.2
-1.9 8 17 90 -4.0 2.6 0.3
-2.1 totals 0 11 0
-12

What can you say with a study like this except that there was a period of eight consecutive times that the next week was a decline, and the rest of the period was reversal-prone?

Other interesting counting questions are the run of seven days in a row without a rise in the bond futures, and the run of three consecutive down opens in stocks.

Perhaps such counting will be of interest to those who wish to build a foundation for meals for a lifetime.

25-Jun-2006
Quote of the Day, from Dale Irwin:

The weak are the most treacherous of us all. They come to the strong and drain them. They are bottomless. They are insatiable. They are always parched and bitter. They are everyone's concern, and like vampires they suck out life's blood.

Do you think this is true? Do you know who said it?

25-Jun-2006
Hedge Funds: Corruptors of Youth?, by Dr. Kim Zussman

While not surprising, it is possibly diagnostic that many of the best/brightest are chemotactically attracted to recent financial fad-hedge funds. Back in the 1980's, I knew a number of lads trained in astronomy, astrophysics, or physics who accelerated toward the glamour and panache of star-wars research in lieu of observatory work.

Further back it was the Manhattan Project.

The problem with this approach is that the demand fuelling the attraction eventually subsides. The wall fell, and Japan surrendered. Is it possible that scientists usually deployed in weapons research, now lieutenants in financial wars, speaks not only about the nature of fads, but also the changing nature of warfare?

24-Jun-2006
Applications of the Bass Diffusion Model, by Victor Niederhoffer

One of the hot topics in marketing these days is applications of diffusion models to help in predicting and stocking new products. The Bass diffusion model, developed by F. M. Bass in 1969, is used especially for products such as videos and new electronics, where the customers can be segmented meaningfully into two groups, one who like new things and are called the innovators, and the other who like to watch what others do and buy based on how many other people are buying.  This paper by Philip Hans Franses (200k pdf) is a good review. The practical solution to the Bass model is to estimate a hazard rate for the chances of the target audience buying the products, similar to the SSRN model used in epidemics and discussed here before, as equal to two parameters one based on the hazard rate for innovators, and one for the imitators. In practice this is estimated by a regression of the expected number of adopters in one period based on the cumulative level of adoptions and its square up to that period. An alternate method is to estimate the two hazard rates with simulation and see which fits the observed sales level best.

An obvious application of the Bass model to markets is to predict the growth of IPOs, and rapidly growing companies thru applications of the Bass model. What strikes me as perhaps more intriguing is to look at the movements of prices from one level to another as the outcome of the activities of innovators and imitators. How long does it take for the innovators to get from one price level to another. And then what add-on effect is produced by the imitators. What is the likely level at which the usual sigmoid curve of growth could be expected to reach an asymptote. The time unit of consideration could be days in a week or time to reach each price during say a day.

This is a good project for someone wishing to look at movements in prices in a way that's not standard, and I will report a few results on this subject in the near future I encourage all to consider the application of new product diffusion models to markets and recommend the paper An Examination of New Product Diffusion Models by Jean-Pierre Van de Capelle and study of this graph of the last two days' intraday prices in the averages as grist for the mill.

24-Jun-20062006
Dr. Kim Zussman: FDR

FDR stands for "False Discovery Rate", a statistical method to adjust for the role of luck in genetics and sports team streaks. In this paper, FDR is used to look for true alpha beyond lucky streaks in stock mutual funds:

They find that luck severely influences historic performance (whereas 8% of growth and income funds have positive conventional alpha, adjusting for FDR changes this to 0%), and that removing effects of luck most severely effects the lower performance tail (many more funds have truly negative alpha than truly positive, which might be expected in light of fund fees). Using FDR, 20% of funds have negative alpha, and 1.9% are positive, and the authors conclude that historic poor performance of active management is attributable to the negative alpha group.

Another way to look at this is from the perspective of an individual investor: Indexing in its many forms proved superior in the past due to negative active alpha and management fees, and the effect is even worse when adjusting for luck. What is the chance that individuals can pick stocks even as well as highly incentivized pros, who on average blow it completely?

Of course another interesting application of FDR would be hedge funds and CTAs.

24-Jun-2006
Models in Finance, from Vince Fulco

There is a beautiful mention of the raison detre for models grounded in the scientific method  in the article "Making Money From Mathematical Models" by David Harding (pp. 61-65) found in Mathematical Models in Finance edited by Howison, Kelly & Wilmot:

I have stressed that a theory or model is scientifically valueless unless it is capable of making empirically falsifiable predictions. In economics and the study of markets there can be no more incorruptible measure of utility than profit accrued by arbitraging predictions of a model against the common view (the market). The quest to "beat the market" is thus more than a venal desire for money or an egotistical desire to win, it is also a means of obtaining the most ruthlessly honest evaluation of the scientific utility of a model and method.

24-Jun-2006
Goats, from Dan Grossman

Here"s an interesting company that produces therapeutic human proteins (i.e., biotech drugs) through the expression of the human gene in the milk of goats. The appropriate human gene is spliced into the fertilized egg of the goat so that the protein is produced in the adult"s milk. The protein in then separated out of the milk for therapeutic use. This turns out to be more efficient and cheaper than the usual biotech methods of producing the protein.

24-Jun-2006
Timing Commodities, by Dr. Kim Zussman

The paper here use information in the the Committment of Traders (COT) report to create "dynamically managed strategies" which  "exhibit superior out-of-sample performance".

Alston Mabry responds:

This article grabs one's attention because (1) it's relatively short, and (2) the authors make intriguing assertions about the predictive abilities of their model.

From the paper:

We focus on the information contained in the "Commitment of Traders (COT)" report, published by the CFTC. This report summarizes the size and direction of the positions taken by different types of traders in different markets. Our findings indicate that there is indeed significant informational content in this report, which can be exploited by an active portfolio manager. Our dynamically managed strategies exhibit superior out-of-sample performance, achieving Sharpe ratios in excess of 1.0 and annualized alphas relative to the S&P 500 of around 15%.

The authors develop a model that creates a portfolio which is a time-varying mix of the S&P 500, a 1-month CD rate (as the risk-free asset), and the commodities, oil and copper. They then test this model "out of sample" over a period and sub-period: May 2000 - May 2006, in which the S&P was essentially flat, and May 2002 - May 2006, when the S&P was marginally up ("marginally" compared to the big moves in oil and copper). During both periods oil and copper saw very large gains. The authors" conclusion is that their model beat the S&P.

Perhaps the Sharpe ratio in excess of 1 is the key issue here, because it seems obvious to say that over time period T, during which index S was essentially flat, a mix of S plus booming assets O & C beat S alone. In fact, for the overall period May 2000 - May 2006, the CD-rate beat the S&P all by itself (though with a Sharpe ratio of zero or less).

In Figure 3, Panel A, the authors show the graph of their portfolio against the S&P during the period May 2002 - May 2006. It appears the model portfolio returned about 100% over this time period. If one creates an alternative portfolio that is long 25% S&P, 25% oil, 25% copper and 25% "risk-free" CD (at approx .02% per week), this alternative portfolio returned 120% over the same time period,

However, the authors state that the question is not simply whether money could be made by investing in commodities during the time period under study:

Our results imply that the CFTC data can be used to construct reliable signals that tell a portfolio manager when to switch from equities into commodities and vice-versa. In particular, even when we estimate our model only until early 2000, the resulting strategy successfully exits the equity market in mid-2000 (just before the collapse of the dot.com bubble), and increases its exposure to commodities. Similarly, while our strategies ride part of the commodities boom, they remain conservative, and in particular trade out of commodities before the crash of May 2006. In summary, the question we address here is not, "could you have made money if you had been invested in commodities in the period from 2002 until the end of 2005?" but rather "could you have known when to get into commodities and when to get out?" With the benefit of hindsight, the answer to the former question is of course "yes," our results provide an affirmative answer even to the second question.

The first claim is that the model gives signals "that tell a portfolio manager when to switch from equities into commodities and vice-versa". The supporting instance given is that "the resulting strategy successfully exits the equity market in mid-2000". Looking at the Figure 3, Panel B1, one sees that for the 2002-2006 time period, the model allocated to the S&P only during (approximately) Q2 2003, Q4 2004, Q2 2005 and Q4 2005-Q1 2006.

So, the model did not like being in the S&P, and missed large moves in H2 2002 and also H2 2003-H1 2004, when the S&P was up over 20%. In its defense, the model weighted oil and copper heavily during the period H2 2003-H1 2004, and that period is when the model had its steepest increase.

The authors state, "while our strategies ride part of the commodities boom, they remain conservative, and in particular trade out of commodities before the "crash" of May 2006." Well, yes, in a sense: The model drops out of copper almost entirely by mid-2004, and decreases the oil position to nil by mid-2005. From May 2004 through May 2006, oil was up about 90% and copper about 240%, so the model misses the biggest part of the commodities boom. And to say that the model avoids the May 2006 "crash" by pulling out of commodities 1-2 years ahead of time might be considered a stretch.

The central claim of the authors is that the model generates "signals that tell a portfolio manager when to switch from equities into commodities and vice-versa". One could argue that the model provided such signals in 2002 to early-2004, but failed significantly mid-2004 to 2006. (Perhaps the form moved away from the model some time in 2004.)

Also, one could argue that the S&P is not an appropriate benchmark, compared to a long 25%/25%/25%/25% allocation among the four assets. Such an allocation produced a return greater than the model, though possibly with more volatility and a lower Sharpe ratio.

24-Jun-2006
The Mother Tongue, from GM Nigel Davies

The comedy Clockwise with John Cleese features a headmaster who turned his life around by learning not to be late. But under pressure (and on the verge of his greatest achievement) his rigid discipline (and life) starts to fall apart.

I think there's an important lesson here. Observation has led me to believe that abilities learned relatively late in life are vulnerabilities, just waiting for pressure to appear before they become brittle. On the other hand our 'innate' strengths tend to persist through thick and thin.

There are many examples of this in chess. The openings we learn first are always the most natural and it's known that players who learn the moves early tend to make fewer blunders. Chess is their mother tongue and they're never at a loss for an appropriate expression.

For this reason I think it's important that we tailor our game plan in whichever endeavor we pursue, to fit with our 'innate' (early learned) strengths rather than the ones acquired with great effort. And the same thought increases the importance of starting our kids on the right track.

24-Jun-2006

Found around 1900 in shipwreck off Grease, the "Antikythera Mechanism" is being analyzed with help of micro CT scanning .

Presumably these images can be used as blueprints to make a working model, in order to decipher what the ancients were attempting to model. The mechanism's complexity speaks of an enduring quest to replicate and understand the universe, even at a time when there were only unenlightened pagans.

George Zachar responds:

What I found interesting about this discovery is that it calls into question the the standard historical narrative of Copernicus'  "discovery" of the heliocentric nature of the solar system.

That parallels the now-accepted notion that the first Europeans to "discover" the Americas were not Spaniards led by Columbus in 1492,  but were Vikings ruled by Eric the Red or his contemporaries around 1000.

Henry McGilton responds:

Interesting comments in Cod by Mark Kurlansky (somewhat paraphrased):

Giovanni Caboto (John Cabot) found land, though it wasn't Asia...a vast rocky coastline ideal for drying fish, by a sea teeming with cod...Cabot reported the wealth of this New Found Land, which he claimed for England. Thirty-seven years later, Jacques Cartier was credited with 'discovering' the St. Lawrence, and claimed it for France. Cartier also noted the presence of 1,000 Basque fishing vessels...But the Basques, wanting to keep a good secret, never claimed it for anyone...

23-Jun-2006
Poker, Trading and Patience, by Steve Leslie

You must learn to allow patience and stillness to take over from anxiety and frantic activity. The good player is patient. He is observant controlling his patience and organizing his composure. When he see an opportunity he explodes -- martial artist Jim Lau quoted by Joe Hyams in Zen in the Martial Arts.

Inaction at the poker table is one of the greatest, most powerful tools that a poker player can possess. It is also one of the most difficult to develop. This is the skill that the best poker players work the hardest at as it is critical to success at the game.

Very few games events or sports work this way with the winner being the one who withdraws from the activity at the appropriate time. Nobody goes to a casino and says I am only going to play a few hands, or I am going to get into a card game so I can fold for three or four hours. We never think of a Mississippi gambler as sitting at a table for a whole evening and winning one big hand. But in order to be successful, that is exactly what you will have to do to win at the game.

It is this activity or inactivity that will become your greatest weapon. You judge your involvement by the hands that you choose to play. If the hand does not start out right or you miss your flop, then you throw it away. If you have thrown away the last 40 hands and the next hand is a pair of rags you throw those away also. There just aren't that many hands that are profitable in the long run. Understand this before you sit down at the game. Constantly remind yourself this rule. You are there not to play hands but to win money. The one who at the end of the evening or the end of the tournament has the chips is the winner. It is not winning pots that is your objective, it is winning the right ones. Your job is to be observant. To wait and wait and wait for that one moment when you will explode, and capture the chips.

There will be times when others get to play and you don't. And seemingly they are winning a lot of pots. Although it appears on the surface that nothing is going your way , realize that beneath the surface activity is bubbling. Like lava in a dormant volcano. It is only a matter of time, until the cards get sorted out, and then you can explode and take down the big hand. It will happen it just takes time./p>

TThe same can be said of trading. Inaction can be your weapon of choice here. Most of trading should be observing . Watching and waiting. Reading and researching. Counting and charting. until you find that proper position to enter. The one in your view that has the greatest opportunity for success. Most of the traits that are critical for success but run contra-trend to that of a trader.

Traders are action players. They are the alpha males. They like to move money. They constantly are in a struggle between good and evil. In this respect they are like the Neanderthals, but instead of clubs, they like to fight by using money as a weapon. If they are not in a battle they think that they should be.

Unfortunately, the events that give you the greatest chance for success are rare there just aren't that many great stocks, or events that you can exploit. And there can be great spaces in between events. Understand this and embrace this and work at doing nothing. Come prepared and relaxed and alert./p>

When things do happen and everything aligns in your favor, you will have the capital rested and at hand ready to exploit the situation. Believe me it will pay off handsomely in the long run. Which is what all traders should be about and that is the long run.

GM Nigel Davies responds:

There are some nice parallels with chess here. One of the distinguishing features of professional chess players is that they often seem to do very little, keeping their position flexible until there's a good opportunity to strike. Weaker players tend to rush in with a one-sided plan, even if it's unsound.

Bronstein opined that the goal in chess was to 'make a combination', but implicit in this view is the idea that it usually isn't easy to find the right moment! He'd probably say that the goal in trading was to 'place a trade'. Tarrasch meanwhile advised that you should 'sit on your hands'.

Marlowe Cassetti adds:

On the topic of wagering, or, the euphemistic gaming, for many years I have followed political forecasting via the TradeSports site. Somehow the people who put their money where their mouth is are pretty good at picking election results. The current line is Republicans keeping control of the Senate 80.4/81.7 (bid/ask) and control of the House 51.1/51.5 (bid/ask). Stay tuned to see how the results change as the open interest expands.

23-Jun-2006
I Want Two Menschen, from Dr. Mark Goulston

A jerk is a know-it-all who doesn't know what he is talking about. They are able to carve a wide path through the serenity in your lives, because you are so aghast, dumbfounded, and appalled by their outrageous behavior.

Recognizing a jerk is the first step to removing them from your life.

Instead of reacting assertively, you stand transfixed, like a deer in the headlights of a car. It takes almost all your self-restraint to keep your cool in the face of their audacity, which is why it is so difficult to "just say no" to jerks. They are the opposite of a mensch.

The Jerk Checklist:

1. They interrupt.
2. They don't take turns.
3. They take advantage of people who are down.
4. They gloat in victory.
5. They are sullen in defeat.
6. They are not fair.
7. They lack integrity.
8. They are the people you hope you won't grow up to be like.
9. They are the kind of person you wouldn't want your sister (or brother or child) to marry.
10. They are the kind of person you'll avoid, if you can break free of them.

A mensch is an everyday saint. These are the people most of us wish we could be. If you're lucky, you may have one grace your life.

A mensch is not just a human being, but a humane being. Without being a Pollyanna, these people manage to be positive, optimistic, and generous in their thoughts and deeds towards others. Menschen leave the world better than they found it, whereas jerks leave the world better by leaving it.

The Mensch Checklist:

1. They don't interrupt.
2. They take turns.
3. They don't take advantage of people who are down.
4. They are gracious in victory.
5. They are noble in defeat.
6. They are consummately fair.
7. They have integrity.
8. They are the people you want to grow up to be like.
9. They are the kind of person you'd want your sister (or brother or child) to marry.
10. They are the kind of person you'll cherish, if you're lucky enough to have one in your life.

23-Jun-2006
Improving Your Home Network, from Jay Pasch

See Lifehacker for the full article. An excerpt:

[This project involves] converting a regular old $60 router into a powerful, highly configurable $600 router. The router has an interesting history, but all you really need to know is that the special sauce lies in embedding Linux in your router. I found this project especially attractive because: 1) It's easy, and 2) it's totally free. After a relatively simple firmware upgrade, you can boost your wireless signal, prioritize what programs get your precious bandwidth, and do lots of other simple or potentially much more complicated things to improve your computing experience.

23-Jun-2006
Counting at McDonald's, by PProf. Charles Pennington

I've always thought that my McDonald's in Norwalk, CT (340 Main Street) was exceptional, with very professional employees. Elide, the morning manager, always recognizes my voice when I'm ordering and automatically puts some strawberry jam in with my Egg McMuffin.

Their speed and efficiency isn't a coincidence. When I reach the pick-up window, I can see their whiteboard inside, where they post statistics on the speed of their drive-through service, and often the results of contests that they hold to set drive-through speed records. Today the whiteboard was celebrating a new record: 139 cars during the noon to 1pm lunch hour rush. That's an average of 25.9 seconds per car, and yes, they probably do track the decimal.

I was thinking about what this kind of speed means. It doesn't mean that it would take just 25.9 seconds if I were the only car there, because part of their speed results from their parallel processing of cars. There's an order window, a window to pay, and a window to collect food, and at any given time, all three windows are occupied. It does mean, though, that if I arrive at McDonald's and see that I'm the 5'th car in line, then the waiting time that I should expect is 5*26 = 130 seconds. Not too shabby! I think they've made 1 mistake out of literally hundreds of my morning visits; in that case they misheard me, and I was probably mumbling (I'm a former professor).

22-Jun-2006
IIHOP Insanity, from Scott Brooks

If you want a good breakfast value then I recommend the Cowboy Cafe in Mercer, MO.

You get three eggs (any way you want them), three pieces of meat (I get three sausage patties), a 1/2 order of biscuits and gravy, an order of hash browns, two pieces of toast, and a big glass of orange juice (which they'll gladly re-fill at no charge) for $6.95. I simply can't eat it all. I get a "to-go" box and finish up the other half of the meal for lunch!/p>

With tax and tip, you get out of there for nine dollars, for what works out to be, essentially, two meals! Some things are still pretty inexpensive in small town America! But the effects of inflation are there in other ways. These small towns are literally dying. The best and the brightest leave for greener pastures. The farmers are being choked out because you simply can't make a living on a 500 acre farm (and that's a big farm in that area).

The ones who stay are the ones who simply don't have many other choices. So you end up with an area of that has an overabundance of people that are simply not "capable". Not capable to do much so solve their plight in life. Not capable enough to see that their way of life is dying. And even if they could, they are not capable enough to come up with a solution to solving that problem. That capable people are all out buying their food at IHOP (in the cities) or they're buying up the land that the farmers can no longer make a living off of.

Greetings from the heartland, Highmore SD. The post by Scott Brooks was so well written and tells a tale of our life in rural communities and small towns. Our heritage is a culture within a culture. Of course, there is more to the story. Visiting our area is a treat, just like visiting New York, Kansas City, Omaha, or Las Vegas is for us. You are moved back in time to a slower, richer pace. Some of our best and brightest do move to brighter lights. Not true of all. Many of our farmers and ranchers are college grads and run operations that rival the financing and net worth of many mid-size businesses. There are those in our midst that invest in the stock market or trade a good number of futures contracts, hedging their grain and livestock or buying for their needs. Our middle school and high schoolers attend classes in brand new school house. We are presently raising money to refurbish our local swimming pool. Some of our streets are not paved, but we are charmed by gravel roads! Other truths are self-evident. This is the greatest place in the world to raise children. Having said that, we have our own problems with drugs and alcohol. There is precious little new building in this area, so the old is maintained and repaired. We boast about the same number of bars as we have places of worship! Our towns are just barely holding their own, like the bottom of any chart. Maybe we are just on the edge of a big, new surge of growth that is hidden from view. Come visit sometime, our homes and hearts are always open.

Dr. Kim Zussman says:

Investment thesis would be to send daughters to college in Midwest so they hook up and marry there. Once the grandbabies come poppin', sell pricey coast-state homes and businesses and equity emigrate to Branson, MO to live like a Tsar. (two-bedroom condos around here recently going for $500k)

And, speaking of rare treats, anyone know where to get some bear meat?

David Higgs replies:

Jeff Guimeny's Howard's Grove Meat Market, 211 South Wisconsin Dr., Sheboygan, WI 53083. Jeff's makes bear sausage for Ted Nugent. Hmmmm, Hmmmm... Good!

22-Jun-2006
Easy as 1-2-3, from Dr. Mark Goulston

When you feel under attack, be it from outside, or from your insecurity inside, try counting to three as follows:

Think of the first thing you want to say and don't say it, pause and then think of second thing you want to say and don't say that, pause again and finally think of the third thing you want to say and do say that. The first thing you want to say is about defending yourself. The second thing is about retaliating. The third thing is about finding a solution.

22-Jun-2006
Hysteresis, from Victor Niederhoffer

Hysteresis: Sir James Alfred Ewing has given the name of Hysteresis to the subject of the lag of magnetic effects behind their causes. He has shown that under constant magnetizing force the magnetism will go on slowly and slightly increasing for a long time: this is called magnetic creeping or viscous hysteresis. "There is a good deal of hysteresis, that is a time lag between the cooling and the setting to be expected of the jelly." A simple electronic circuit that displays hysteresis is the Schmitt trigger.

A hysteresis loop, a graph showing how the value of some property of a hysteretic system varies as the agent causing it is varied from one value to another and back again, having the form of a closed curve. -- OED (A good graph for all market people to have handy at all times.)

II first came across the concept of hysteresis when I did something very good or very bad as a little boy and it took a long time for the consequences of that behavior to eventually manifest itself in the result. I next got some physical manifestation of it when I spent many years as an electronics hobbyist constructing all sorts of op amp circuits that had triggers and buffers that led to a delayed but inevitable reaction of the output dampened by negative feedback from the input. The enclosed link to Schmitt triggers is one that I found particular pleasure with and helped me and my friend, Leon Foreman, on the road to designing an automatic toilet lid opener.

Indeed, hysteresis is one of those universal concepts that comes up in all aspects of psychic, physical and market life. The most vivid times I came across it in markets are the delayed but inevitable reactions of markets to movements in interest rates. It used to be that the stock market and the bond market almost invariably went in the same direction during the year. This relation trumped all others, including the good earnings good stock market relation (which doesn't exist) and helped explain and predict many a market movement. Indeed, the work of Tom Downing and the Spec Duo on the Fed Model is an excellent example of a modern update of that work. It's one of the reasons that, even more than usual, the triumphalists have the wind at their back these days, although the extreme negativity of stock market sentiment, at a 30-month low, and the hoped for Dow 5000 of all those who hate enterprise is another highly bullish factor, (this latter always engendered for the next 10 years after a market crash as we had in 2000-2002).

TThe hysteresical effect of the interest rates on stock markets is a bit more subtle now. It was all changed by the 1987 crash when stocks went down 30% or so in two days and interest rates dropped by a comparable amount. Since that time, the reaction has been much more convoluted and delayed. And the movement of bonds yields in mid May to above 5.0 % from 4.7 %, in conjunction with the gold and energy moves up was the Schmitt trigger that led to the delayed reaction of the 10% stock market decline.

All that is a given. But I would like to focus more on another aspect of the hysteresical effect. That is the movement of the Arab markets which was a concurrent circuit that helped to trigger the whole hysteresical effect. It started in Feb with such things as the Saudi Arabian market above 20000 in Feb month end up steadily over the previous six years from 3000. It fell to below 10000 on May 13, 2006. That was the trigger, along with the interest rates for the effects that followed with accompanying accidentals relating to the CPI, the changing of guard at the Fed, and the unfortunate dinner meeting which sparked the need to gain credibility. Since that time, every market in the world has had a mini crash ranging from 10% to 25% Japan moves down from 17000ish in mid May to 14200 on June 13. The Dax moved down from 6143 on May 13 to 5294 on June 14. Since that time, things have become normalized. The hysteresical effect is in reverse. The Sasftdx has moves up steadily from 1000 to 12729. The Nikkei has moved above 15000 to 15135. The Dow from 10700 on June 13 to 11100 at today's open. The Dax is pushing 6000 again.

Date Dax Nikkei SP Saudi Date Dax Nikkei SP Saudi
28-Apr 6,009 16,906 1,326 13,043 26-May 5,788 15,970 1,293 10,385
1-May 6,009 16,925 1,318 13,417 29-May 5,755 15,915 1,293 10,519
2-May 6,051 17,153 1,328 13,000 30-May 5,622 15,859 1,270 10,832
3-May 5,968 17,153 1,323 13,053 31-May 5,692 15,467 1,282 11,201
4-May 6,039 17,153 1,327 12,751 1-Jun 5,707 15,503 1,296 11,610
5-May 6,113 17,153 1,339 12,751 2-Jun 5,687 15,789 1,298 11,610
8-May 6,127 17,291 1,337 11,376 5-Jun 5,621 15,668 1,280 12,181
9-May 6,140 17,190 1,340 10,598 6-Jun 5,502 15,384 1,276 12,423
10-May 6,118 16,951 1,338 10,074 7-Jun 5,543 15,096 1,266 11,408
11-May 6,054 16,862 1,322 10,046 8-Jun 5,383 14,633 1,266 11,994
12-May 5,916 16,601 1,305 10,046 9-Jun 5,464 14,750 1,261 11,994
15-May 5,857 16,486 1,307 11,859 12-Jun 5,395 14,833 1,246 12,078
16-May 5,851 16,158 1,305 10,764 13-Jun 5,292 14,218 1,232 11,936
17-May 5,652 16,307 1,279 10,692 14-Jun 5,305 14,309 1,241 12,046
18-May 5,666 16,087 1,273 11,046 15-Jun 5,422 14,879 1,267 12,046
19-May 5,672 16,155 1,281 11,046 16-Jun 5,376 14,879 1,260 12,046
22-May 5,546 15,857 1,272 10,147 19-Jun 5,439 14,860 1,248 12,610
23-May 5,678 15,599 1,263 10,367 20-Jun 5,493 14,648 1,252 12,633
24-May 5,587 15,907 1,271 10,341 21-Jun 5,503 14,644 1,261 12,729
25-May 5,706 15,693 1,286 10,385

The hysteresisal effects are almost as inevitable as the circuits I played with with my op amps and I recommend going to your local electronics store, and buying a couple of 8-volt batteries, a good op amp or two, some resistors and a capacitor or two for a good hands on ( Montessori like ) rendition of what's happening today as first Europe goes up, then Asia stumbles, then the US fails, then Asia goes up, then Europe goes up, then finally the hysteresic effect of a nice rise in the US inevitably follows.

Henry Gifford adds:

In the heating and cooling industry, "Hysteresis" is sometimes used to describe steadiness of a system, or fluctuation around a temperature set point. (Or price point).

When a thermostat on the wall is set to 74 degrees, what happens in the winter when the room cools to 74? The heat comes on. Okay. At what temperature does the heat turn back off? That depends on the equipment used, much of which has a variable "differential" between on and off points. (Usually a sliding or rotating part of the thermostat)

Setting the equipment for a small differential can, in theory, make for more accurate control, but it can also lead to "hunting" for the correct temperature, resulting in overshooting and undershooting the setpoint. Too wide a differential can make for clumsy control too. The trick, as with many things, is to get it just right.

The analogy to trading is too obvious for me to go on about.

Henry McGilton notes:

The "laws" of hysteresis were derived by Charles Steinmetz in the 1890s. These "laws" were really "rules of thumb," derived by Steinmetz from tens of thousands of empirical observations.

While we all agree that Francis Galton and Francis Bacon are historical role models of those who observe and count, I have long felt that Steinmetz goes unrecognized as a first-class empiricist. At the time he derived the rules of thumb for hysteresis, there were no mechanisms to even come close to explaining the effect -- from a practical engineering perspective, Steinmetz had derived equations to model the behavior of magnetic materials in varying electric fields, but with no theory to explain why magnetic materials behaved the way they did.

A coherent explanation of hysteresis had to wait for the emergence of magnetic domain theory sometime in the 1970s. So I vote to place Steinmetz high in the ranks of the greatest empiricists.

John Lamberg mentions:

While the original query relates to magnetic effects, it brought to mind some interesting properties of Teflon that electrical and mechanical engineers learn the hard way. A quick search didn't uncover the information I was looking for, but I found something better:

...It just goes to show that if you have the best materials, and the finest concept, and you misapply things just a little, you can get some terrible results...

Steve Ellison comments:

In the physical movement of goods, lags occur because moving goods takes time. In many manufacturing situations, dozens of parts must be on site in order to build a product. If any one part is not present, the build will be delayed. Therefore, any unexpected change in demand results in material being in the wrong place relative to plans. This effect occurs most obviously and dramatically when demand unexpectedly goes up, but can also occur with stable demand when the mix of product options or features shifts.

Lags also occur because of prior imbalances and filtering of information as it is disseminated. Firms that do not ship to end users are at an information disadvantage because their perception of demand is shaped primarily by their suppliers. Information from suppliers is often biased by the suppliers' own needs. For example, if consumer demand turns up for a product, but a firm has excess inventory of the product, the firm's initial reaction is likely to be relief that it might avoid an inventory write-off -- it will probably not communicate the increased demand to its suppliers. When it finally does communicate a persistent upturn, the delay combined with the need to reverse tactics will magnify the increase of supply it requests. A 10% increase in end user demand may result in a 30% increase in orders to suppliers. The suppliers may do the same to their suppliers, resulting in increasing oscillations that Hau Lee of Stanford calls the bullwhip effect.

Gary Rogan offers:

By far the biggest use of hysteresis in electronics today is to protect inputs of digital chip from switching multiple times in the presence of noise. Essentially all modern chips, such as microprocessors, have this protection built in. Once the chip "decides" that it needs to switch in a particular direction, a small noise spike will not cause it to switch back, thanks to hysteresis, thus providing some measure of noise immunity. This contrasts with the state of affairs at the dawn of the computer age when the dominant application was in "core" memories that relied on the magnetic hysteresis to remember 1's and 0's in each of the tiny magnetic toroidal rings called "cores".

Addendum:

Hysteresis is everywhere. Once a politician announces a position on some issue, if he immediately reverses himself based on some minute amount of new information he will be perceived as unstable and unreliable. Arguably, Kerry lost to Bush becasue he was successfully portrayed as lacking hysteresis in his decision-making. You don't want to vote for something and than vote against it too soon if you're a politician.

Hysteresis is essentially shifting the decision point towards the decision once the decision has been made. It's a well-understood psychological phenomenon that human beings will tend to look for support for their decision once it's been made more than pure neutrality would call for. Hysteresis doesn't have to be symmetrical. Decisions made out of fear tend to shift the decision point more than decisions made out of hope. Perhaps that's why it's easier to kill an economy with interest rates than to restart it.

22-Jun-2006
Compression and Expansion, by Victor Niederhoffer

An interesting discussion of compression and expansion appears in Chance in Biology by Mark Denny and Steven Gaines. They point out how compression and expansion assist the flapping of an insect's wing. Compression of the insect wing as it flaps is stored in a tendon made of a protein rubber called resilin, which stores the elastic energy created by the flapping of wings. A similar mechanism is found in bivalves, where a protein called abductin is stored in a pad called resilium. The hearts of vertebrates have similar rubbery materials that store energy. Dennis remarks, "A consideration of the energetics of flow in pipes, however, shows that it costs less to move blood through the body's plumbing if the flow is steady rather than pulsatile." Such a consideration should be written in stone at the door of all trading rooms.

It leads me to look at compression and expansion in monthly moves. Inspired by resilium and Dennis, I felt it might be apt to clear the decks by doing a little counting to see if anything of relevance might arise. I have done such counting since 1980 to ascertain what happens in months following declines of 1.5 % or more in the S&P, when that decline was preceded by a rise. Here's an enumeration:

	Next Next 
 Month Month Month Month 
 Date %Chg %Chg Date %Chg %Chg
 ----- ----- ----- ----- ----- -----
 02/79 -3.6 5.5 06/94 -2.7 3.1
 05/79 -2.7 3.8 09/94 -2.7 2.1
 10/79 -7.0 4.3 11/94 -4.0 1.2
 12/80 -6.0 -4.5 07/96 -4.6 1.9
 04/81 -3.0 -2.3 12/96 -2.1 6.1
 12/81 -3.0 -1.8 03/97 -4.2 5.8
 05/82 -3.9 -2.0 10/97 -3.4 4.5
 07/83 -3.3 1.1 05/98 -1.9 3.9
 10/83 -1.5 1.7 02/99 -3.2 3.9
 05/84 -5.9 1.8 05/99 -2.5 5.4
 07/84 -1.6 10.6 07/99 -3.2 -0.6
 07/86 -6.0 7.0 01/00 -5.0 -2.0
 09/86 -8.0 5.4 04/00 -3.0 -2.2
 12/86 -2.8 13.0 07/00 -1.6 6.1
 09/87 -2.4 -22.0 09/00 -5.4 -0.5
 03/88 -3.3 0.9 02/01 -9.2 -6.4
 11/88 -1.9 1.5 06/01 -2.5 -1.0
 02/89 -2.9 2.0 01/02 -1.5 -2.0
 01/90 -7.0 9.2 09/02 -11.0 8.6
 06/91 -4.8 4.5 12/02 -6.0 -2.7
 09/91 -1.9 1.2 03/04 -1.6 -1.7
 11/91 -4.4 11.0 07/04 -3.4 0.2
 01/92 -2.0 1.0 01/05 -2.5 1.9
 03/92 -2.2 2.8 03/05 -1.9 -2.0
 08/92 -2.4 0.9 10/05 -1.8 3.5
 04/93 -2.5 2.3 05/06 -3.1 0.0
 02/94 -3.0 -4.6

What conclusions can one draw? During the months following a first decline of 1.5% or more, the chances of a rise are 72% and the average change is 1.3% including the 22% decline which followed the Sept. 1987 decline of 2.4 %. During the 90's there were about two such initial declines of 1.5 % or more a year, and 35 of 37 were followed by rises. During the current decade of the naughties, there was a run of negative results with six of eight negative from 2000 to 2002. I see some market analogies to strategies employed by bivalves in clamming up during such periods.

Dr. Kim Zussman adds:

In addition, from a longer-term perspective, the mid '90s was a period of expansion of volatility moving to the late '90s. Though the short-term correlation of stock return with volatility is strongly negative, this was certainly not the case through the course of the '90s.

Of course that was back before little Al was inventing global warming and still putting finishing touches on ARPANET. Which inventor can we turn to now to fire up hopeless investors about new new new possibilities? Perhaps Mackey's conversion of wind to groceries? Even this post proves such resources exist outside Arab lands.

Jun-22-2006
Small Traders, from Vinh Tu

In case anyone should feel that they are "pikers," there are much smaller fish in the ocean of the world's markets. An article in WSJ talks about Indian day traders who work in internet cafes where you pay 25c an hour for web access. One guy has a profit target of $10 a day. I would like to know what the transaction costs are, what brokers they use, etc. (and whether I can sign up for an account)

21-Jun-2006
The Forgotten Art of Adjournment Analysis, by GM Nigel Davies

BBefore the advent of computers and a single playing session, games were adjourned after 40 moves so the players could go for dinner. Sometimes they'd be continued on a separate day, so tournaments could last three weeks or more after the normal rounds, rest days and days set aside for adjournments.

Despite the importance of adjournment analysis only Paul Keres devoted much attention to the matter, writing a chapter about it in The Art of the Middle Game. As you read this chapter it becomes clear that the process of falsifying ones ideas increases greatly in intensity.

The early part of my career came at the back end of the times when we still had adjournments, and I remember the care with which positions had to be analyzed. One had to expect that one's opponent would find the most unpleasant moves with which to test you, even more so than during the course of a normal game. Cooperation was really the last thing to be expected, or even a normal distribution of mistakes.

Does this thinking have an application to markets? Perhaps it does in terms of risk control. We continually deal with 'expected outcomes', but what if we turn this around and consider the "worst" that the market can do to us. Imagine it is a malevolent beast designed to exploit every point of vulnerability in our game. Can one still win, get a draw or even just survive? And what moves will one play to keep the game going as the beast sets about taking our position apart?

Perhaps my background in chess makes me rather too paranoid to play markets in an optimal fashion, I go into every game expecting a deadly, conscious and adaptable opponent. There again, maybe there is some merit in this way of looking at things from this perspective, if only to be ready for the worst.

21-Jun-2006
Deception, by David Lamb

I recently re-read chapter 10 of Victor's book Education of a Speculator. Under the heading is a quote that I feel is pertinent to recent market movement and subsequent rhetoric.

Speaking of Stonewall Jackson:

A favorite device with him was to institute inquiries in the presence of the crowd around him as to roads and watercourses in a direction which he did not intend to take; even to order maps to be prepared, and roads laid down, as though for instant use. Having thus set every gossip talking and predicting his intentions, he would calmly march directly in the opposite direction. Mystery, mystery, is the secret of success!

Over 20 pages are devoted to this subject of deception. The use of this tactic has been, and still is, constantly used by many, but is effectively used by only a few. In my opinion, one of the many reasons why Dr. Niederhoffer has been successful in trading is his use of this device.

I recently visited an "elite" financial markets chat site and read a rather lengthy thread about Victor. Both sides fought it out for hours it seemed. My question is: How in the world can anyone (with exception of he who is sitting across the room from him) know how he is trading?

In email conversations with Victor,  he has graciously answered all of my ignorant and uneducated questions, which visibly demonstrated his charitable character. With this said, what makes me think that he would show me his hand? It is rather presumptuous of anyone to assume that he would. What I am trying to say is that Victor is sitting where he is because he is a master of his art. I would be wise to sit and listen -- really try to listen -- to what he is saying.

21-Jun-2006
Soccer, Penalty Shots, and Markets, by Hany Saad

Unlike poker, chess and even tennis, soccer is a game one hardly uses in analogy to markets. But, since the World Cup in soccer is on, I gave myself the liberty to study soccer and try to draw some analogies with markets. In this case, I will analyze a small segment of the game, namely the penalty shootouts.

I'll use France vs. Switzerland and France vs. Korea to illustrate my point. I picked these two games since the French players are said to be the most talented, most expensive in the soccer world next to the Brazilians, and since they are playing against what you could safely label much inferior teams in these two cases. At any rate, the French ended a very sterile game with a 0-0 tie against the Swiss who, although lacking in talent and experience, played a very good defensive game. They also tied last week with Korea 1-1. All the top teams in this World Cup displayed very disappointing performances. Even when they won, they won by very narrow margins as in Brazil's 1-0 win over Croatia. It is unusual, since the teams should be more cautious during the advanced stages of the Cup, not the preliminary ones.

This made me think that a team with a very strong defense and a bit of luck could make the finals and easily win with a good penalty shootout strategy, i.e. the chance that the weaker will score a win against the better team is higher than you might think as demonstrated by the final scores so far. In other words, many big matches can and will come down to a penalty shootout and that's where the weaker team has a perfect opportunity to heighten its chances.

Given the importance of the shootouts, it is almost painful to realize most coaches don't spend much time with their players to perfect their technique and design elaborate strategies to win them. It's not unusual to watch the coach caught totally off-guard after a tied game and wondering whom to pick for the shoot-outs, and in extreme cases wandering around asking for volunteers amongst the players.

Skeptics might ask, is there such a thing as a penalty shootout strategy? It's all luck, right? In fact, it is not. Penalty shoot-outs occur when the game is still tied after final time. There has been a lot of cases where the better team lost with the penalty shots.. One very vivid (and painful) example is France Vs Germany in 1982 where France was the better team all around yet lost to the Germans by the penalty kicks after a 3-3 tie. I remember this one in particular as I had a substantial bet riding on it. I made all the calculation possible to make the bet and was right throughout the whole game as France was leading during the game, then again by 3-1 till the last 5 minutes of the extra time. The one thing I left open in my elaborate calculations is the penalty shots. So, like the coach above, I was not prepared for the penalty shots as they are the exception not the rule in most games. In the markets as the chair puts it: "as usual, the unusual". It is the little extra effort and preparation that can make all the difference in the soccer matches as well as in the markets. What are the unusual events that the traders (like the coach above) need to prepare for? In a market with an average annual drift of 10% year over year how can a trader be prepared for adversity similar to the recent beating we are experiencing now.

Back to the penalty shots: Five players must take a kick (only one kick / player). The coach has to decide which five players to choose and which order to put the players in. Knowing that, statistically, one in every four shots is missed, should the coach start with his best player out of the five? In fact the correct answer is to put them in reverse order of ability. So you actually save your best player to the final kick since the stakes rise with every shoot-out.

A study shows a lower success rate with the fourth and fifth penalties than with the first three. Since players have to deal with stress and since stress rises with every penalty kick, the correct answer is to leave your best players till last as they are usually more able to deal with stress. Yet, from watching most of the games that ended in penalty shoot-outs, the coaches always start with their best players which is the wrong answer.

I argue that it is more important to be prepared to manage your open positions than to just open a position. Any fool can press a certain sequence of keys and open a position. What differentiates the experienced from the amateurs is how well they manage the position whether a losing or a winning one. Should one buy puts to hedge his longs in down markets? should stops be used? Should you sell calendar and credit spreads instead of outright naked positions to avoid total wipe-outs? ts?

A (not entirely scientific) study by British researches suggests that heart attacks increased shortly after an England/ Argentina match that ended in a penalty shoot-out. they conclude that in the interest of public health penalty shoots should be abandoned. Do you feel the same kind of rush when your long positions gap down right at the open. Researchers blaming public health on penalty shoot outs are like Malaysian prime minister Mahatir's blaming the ruin of the economy on those darn speculators.

A field simulation of penalty shoots was designed. It investigated the relative merits of approaching the penalty kick with either a keeper-independent or keeper-dependent strategy. In the keeper-independent strategy, the shooter selects a target location in advance and disregards the goalkeeper's actions during the run-up. In the keeper-dependent strategy, the shooter makes a decision resting on the anticipation of the goalkeeper's movements during the run-up. Ten intermediate-level soccer players shot at one of two visually specified targets to the right and left side of the goal. In the keeper-independent strategy condition, participants were told that the visually specified target would not change. In the keeper-dependent strategy condition, participants were told that in half of the trials the visually specified target would change side at different times before ball contact, indicating that the direction of the kick needed to be altered. The results showed that penalty-taking performance was apt to be less than perfect in the keeper-dependent strategy condition. A decrease in the time available to alter kick direction resulted in a higher risk of not only an incorrect but also inaccurate shot placement. It is concluded that anticipating the goalkeeper's movements may degrade penalty kick performance, mainly due to insufficient time to modify the kicking action.

Is it more advisable to buy a market regardless of which way the media pundits and the permabears want you to lean? Is one more prone to make judgment mistakes reading the newspapers and listening to the so called "experts" than buying and selling strictly based on science?

This said, I believe the role of the speculator should be more likened to the goalkeeper rather than the shooter. First, as in speculation, the goalkeeper is starting off with a negative expectation since most shooters score with penalty shots. The same as the trader. However like the speculator, there are a lot of tricks the goal keeper can use to enhance his odds.

The shooter often give away some clues to which way he will shoot the ball. The eyes, the approach, the movement of the hip, the head, etc... The trader, like the goal keeper would do better off studying correlation between different markets for clues. How a spike in gold can give a warning signal for the stock market? What does a gap down mean? Is it better to buy on up days or down days? Is the Nikkei a pilot fish for the Dow? what about the Tadawul index? do they have private information about natural resources that the rest of the world doesn't have access to etc..?

Much more importantly, it's been well researched and proved that almost 70 to 80 % of the kicks taken went to the opposite side from the kicker's dominant foot according to the DiCicco 2000, yet the keepers choose to ignore all these clues over the years and jump randomly one side or the other.

In Triumph of the Optimists, the authors proved without leaving a shadow of doubt that the markets have an upward drift over the years. Yet, speculators still choose to short the stock market in the face of this overwhelming upward drift disregarding the odds. The most important lesson one learned from the chair is that markets have an upward drift year in and year out and that the odds favor the long side even (and specially) during unfavorable times like the last few days.

Ryan Carlson adds:

Due to the increase in volatility and the greater emphasis on certain economic releases, I've felt that attempting to capture the immediate post-release move presents itself much like a penalty kick situation in soccer. In the reading stack for my upcoming vacation is the following paper "Testing Mixed-Strategy Equilibria When Players are Hereongeneous: The Case of Penalty Kicks in Soccer." Perhaps others here might find some interest in it as well. Of course, trading data announcements is extremely risky but technology has made it easier to capture trades and add safeguards to limit risk.

24-Jun-2006
Goats, from Dan Grossman

Here's an interesting company that produces therapeutic human proteins (i.e., biotech drugs) through the expression of the human gene in the milk of goats. The appropriate human gene is spliced into the fertilized egg of the goat so that the protein is produced in the adult's milk. The protein in then separated out of the milk for therapeutic use. This turns out to be more efficient and cheaper than the usual biotech methods of producing the protein.

24-Jun-2006
Timing Commodities, by Dr. Kim Zussman

The paper here use information in the the Committment of Traders (COT) report to create "dynamically managed strategies" which  "exhibit superior out-of-sample performance".

Alston Mabry responds:

This article grabs one's attention because (1) it's relatively short, and (2) the authors make intriguing assertions about the predictive abilities of their model.

From the paper:

We focus on the information contained in the `Commitment of Traders (COT)' report, published by the CFTC. This report summarizes the size and direction of the positions taken by different types of traders in different markets. Our findings indicate that there is indeed significant informational content in this report, which can be exploited by an active portfolio manager. Our dynamically managed strategies exhibit superior out-of-sample performance, achieving Sharpe ratios in excess of 1.0 and annualized alphas relative to the S&P 500 of around 15%.

The authors develop a model that creates a portfolio which is a time-varying mix of the S&P 500, a 1-month CD rate (as the risk-free asset), and the commodities, oil and copper. They then test this model "out of sample" over a period and sub-period: May 2000 - May 2006, in which the S&P was essentially flat, and May 2002 - May 2006, when the S&P was marginally up ("marginally" compared to the big moves in oil and copper). During both periods oil and copper saw very large gains. The authors' conclusion is that their model beat the S&P.

Perhaps the Sharpe ratio in excess of 1 is the key issue here, because it seems obvious to say that over time period T, during which index S was essentially flat, a mix of S plus booming assets O & C beat S alone. In fact, for the overall period May 2000 - May 2006, the CD-rate beat the S&P all by itself (though with a Sharpe ratio of zero or less).

In Figure 3, Panel A, the authors show the graph of their portfolio against the S&P during the period May 2002 - May 2006. It appears the model portfolio returned about 100% over this time period. If one creates an alternative portfolio that is long 25% S&P, 25% oil, 25% copper and 25% "risk-free" CD (at approx .02% per week), this alternative portfolio returned 120% over the same time period,

However, the authors state that the question is not simply whether money could be made by investing in commodities during the time period under study:

Our results imply that the CFTC data can be used to construct reliable signals that tell a portfolio manager when to switch from equities into commodities and vice-versa. In particular, even when we estimate our model only until early 2000, the resulting strategy successfully exits the equity market in mid-2000 (just before the collapse of the `dot.com' bubble), and increases its exposure to commodities. Similarly, while our strategies `ride' part of the commodities boom, they remain conservative, and in particular trade out of commodities before the `crash' of May 2006. In summary, the question we address here is not, `could you have made money if you had been invested in commodities in the period from 2002 until the end of 2005?', but rather `could you have known when to get into commodities and when to get out?'. With the benefit of hindsight, the answer to the former question is of course `yes', our results provide an affirmative answer even to the second question.

The first claim is that the model gives signals "that tell a portfolio manager when to switch from equities into commodities and vice-versa". The supporting instance given is that "the resulting strategy successfully exits the equity market in mid-2000". Looking at the Figure 3, Panel B1, one sees that for the 2002-2006 time period, the model allocated to the S&P only during (approximately) Q2 2003, Q4 2004, Q2 2005 and Q4 2005-Q1 2006.

So, the model did not like being in the S&P, and missed large moves in H2 2002 and also H2 2003-H1 2004, when the S&P was up over 20%. In it's defense, the model weighted oil and copper heavily during the period H2 2003-H1 2004, and that period is when the model had it's steepest increase.

The authors state, "while our strategies `ride' part of the commodities boom, they remain conservative, and in particular trade out of commodities before the `crash' of May 2006". Well, yes, in a sense: The model drops out of copper almost entirely by mid-2004, and decreases the oil position to nil by mid-2005. From May 2004 through May 2006, oil was up about 90% and copper about 240%, so the model misses the biggest part of the commodities boom. And to say that the model avoids the May 2006 "crash" by pulling out of commodities 1-2 years ahead of time might be considered a stretch.

The authors' central claim is that the model generates "signals that tell a portfolio manager when to switch from equities into commodities and vice-versa". One could argue that the model provided such signals in 2002 to early-2004, but failed significantly mid-2004 to 2006. (Perhaps the form moved away from the model some time in 2004.)

Also, one could argue that the S&P is not an appropriate benchmark, compared to a long 25%/25%/25%/25% allocation among the four assets. Such an allocation produced a return greater than the model, though possibly with more volatility and a lower Sharpe ratio.

24-Jun-2006
The Mother Tongue, from GM Nigel Davies

The comedy 'Clockwise' with John Cleese features a headmaster who turned his life around by learning not to be late. But under pressure (and on the verge of his greatest achievement) his rigid discipline (and life) starts to fall apart.

I think there's an important lesson here. Observation has led me to believe that abilities learned relatively late in life are vulnerabilities, just waiting for pressure to appear before they become brittle. On the other hand our 'innate' strengths tend to persist through thick and thin.

There are many examples of this in chess. The openings we learn first are always the most natural and it's known that players who learn the moves early tend to make fewer blunders. Chess is their mother tongue and they're never at a loss for an appropriate expression.

For this reason I think it's important that we tailor our game plan in whichever endeavor we pursue, to fit with our 'innate' (early learned) strengths rather than the ones acquired with great effort. And the same thought increases the importance of starting our kids on the right track.

24-Jun-2006

Found around 1900 in shipwreck off Grease, the "Antikythera Mechanism" is being analyzed with help of micro CT scanning .

Presumably these images can be used as blueprints to make a working model, in order to decipher what the ancients were attempting to model. The mechanism's complexity speaks of an enduring quest to replicate and understand the universe, even at a time when there were only unenlightened pagans.

George Zachar responds:

What I found interesting about this discovery is that it calls into question the the standard historical narrative of Copernicus'  "discovery" of the heliocentric nature of the solar system.

That parallels the now-accepted notion that the first Europeans to "discover" the Americas were not Spaniards led by Columbus in 1492,  but were Vikings ruled by Eric the Red or his contemporaries around 1000.

Henry McGilton responds:

Interesting comments in Cod by Mark Kurlansky (somewhat paraphrased):

Giovanni Caboto (John Cabot) found land, though it wasn't Asia...a vast rocky coastline ideal for drying fish, by a sea teeming with cod...Cabot reported the wealth of this New Found Land, which he claimed for England. Thirty-seven years later, Jacques Cartier was credited with 'discovering' the St. Lawrence, and claimed it for France. Cartier also noted the presence of 1,000 Basque fishing vessels...But the Basques, wanting to keep a good secret, never claimed it for anyone...

23-Jun-2006
Poker, Trading and Patience, by Steve Leslie

You must learn to allow patience and stillness to take over from anxiety and frantic activity. The good player is patient. He is observant controlling his patience and organizing his composure. When he see an opportunity he explodes -- martial artist Jim Lau quoted by Joe Hyams in Zen in the Martial Arts.

Inaction at the poker table is one of the greatest, most powerful tools that a poker player can possess. It is also one of the most difficult to develop. This is the skill that the best poker players work the hardest at as it is critical to success at the game.

Very few games events or sports work this way with the winner being the one who withdraws from the activity at the appropriate time. Nobody goes to a casino and says I am only going to play a few hands, or I am going to get into a card game so I can fold for three or four hours. We never think of a Mississippi gambler as sitting at a table for a whole evening and winning one big hand. But in order to be successful, that is exactly what you will have to do to win at the game.

It is this activity or inactivity that will become your greatest weapon. You judge your involvement by the hands that you choose to play. If the hand does not start out right or you miss your flop, then you throw it away. If you have thrown away the last 40 hands and the next hand is a pair of rags you throw those away also. There just aren't that many hands that are profitable in the long run. Understand this before you sit down at the game. Constantly remind yourself this rule. You are there not to play hands but to win money. The one who at the end of the evening or the end of the tournament has the chips is the winner. It is not winning pots that is your objective, it is winning the right ones. Your job is to be observant. To wait and wait and wait for that one moment when you will explode, and capture the chips.

There will be times when others get to play and you don't. And seemingly they are winning a lot of pots. Although it appears on the surface that nothing is going your way , realize that beneath the surface activity is bubbling. Like lava in a dormant volcano. It is only a matter of time, until the cards get sorted out, and then you can explode and take down the big hand. It will happen it just takes time./p>

TThe same can be said of trading. Inaction can be your weapon of choice here. Most of trading should be observing . Watching and waiting. Reading and researching. Counting and charting. until you find that proper position to enter. The one in your view that has the greatest opportunity for success. Most of the traits that are critical for success but run contra-trend to that of a trader.

Traders are action players. They are the alpha males. They like to move money. They constantly are in a struggle between good and evil. In this respect they are like the Neanderthals, but instead of clubs, they like to fight by using money as a weapon. If they are not in a battle they think that they should be.

Unfortunately, the events that give you the greatest chance for success are rare there just aren't that many great stocks, or events that you can exploit. And there can be great spaces in between events. Understand this and embrace this and work at doing nothing. Come prepared and relaxed and alert./p>

When things do happen and everything aligns in your favor, you will have the capital rested and at hand ready to exploit the situation. Believe me it will pay off handsomely in the long run. Which is what all traders should be about and that is the long run.

GM Nigel Davies responds:

There are some nice parallels with chess here. One of the distinguishing features of professional chess players is that they often seem to do very little, keeping their position flexible until there's a good opportunity to strike. Weaker players tend to rush in with a one-sided plan, even if it's unsound.

Bronstein opined that the goal in chess was to 'make a combination', but implicit in this view is the idea that it usually isn't easy to find the right moment! He'd probably say that the goal in trading was to 'place a trade'. Tarrasch meanwhile advised that you should 'sit on your hands'.

Marlowe Cassetti adds:

On the topic of wagering, or, the euphemistic gaming, for many years I have followed political forecasting via the TradeSports site. Somehow the people who put their money where their mouth is are pretty good at picking election results. The current line is Republicans keeping control of the Senate 80.4/81.7 (bid/ask) and control of the House 51.1/51.5 (bid/ask). Stay tuned to see how the results change as the open interest expands.

23-Jun-2006
I Want Two Menschen, from Dr. Mark Goulston

A jerk is a know-it-all who doesn't know what he is talking about. They are able to carve a wide path through the serenity in your lives, because you are so aghast, dumbfounded, and appalled by their outrageous behavior.

Recognizing a jerk is the first step to removing them from your life.

Instead of reacting assertively, you stand transfixed, like a deer in the headlights of a car. It takes almost all your self-restraint to keep your cool in the face of their audacity, which is why it is so difficult to "just say no" to jerks. They are the opposite of a mensch.

The Jerk Checklist:

1. They interrupt.
2. They don't take turns.
3. They take advantage of people who are down.
4. They gloat in victory.
5. They are sullen in defeat.
6. They are not fair.
7. They lack integrity.
8. They are the people you hope you won't grow up to be like.
9. They are the kind of person you wouldn't want your sister (or brother or child) to marry.
10. They are the kind of person you'll avoid, if you can break free of them.

A mensch is an everyday saint. These are the people most of us wish we could be. If you're lucky, you may have one grace your life.

A mensch is not just a human being, but a humane being. Without being a Pollyanna, these people manage to be positive, optimistic, and generous in their thoughts and deeds towards others. Menschen leave the world better than they found it, whereas jerks leave the world better by leaving it.

The Mensch Checklist:

1. They don't interrupt.
2. They take turns.
3. They don't take advantage of people who are down.
4. They are gracious in victory.
5. They are noble in defeat.
6. They are consummately fair.
7. They have integrity.
8. They are the people you want to grow up to be like.
9. They are the kind of person you'd want your sister (or brother or child) to marry.
10. They are the kind of person you'll cherish, if you're lucky enough to have one in your life.

23-Jun-2006
Improving Your Home Network, from Jay Pasch

See Lifehacker for the full article. An excerpt:

[This project involves] converting a regular old $60 router into a powerful, highly configurable $600 router. The router has an interesting history, but all you really need to know is that the special sauce lies in embedding Linux in your router. I found this project especially attractive because: 1) It's easy, and 2) it's totally free. After a relatively simple firmware upgrade, you can boost your wireless signal, prioritize what programs get your precious bandwidth, and do lots of other simple or potentially much more complicated things to improve your computing experience.

23-Jun-2006
Counting at McDonald's, by PProf. Charles Pennington

I've always thought that my McDonald's in Norwalk, CT (340 Main Street) was exceptional, with very professional employees. Elide, the morning manager, always recognizes my voice when I'm ordering and automatically puts some strawberry jam in with my Egg McMuffin.

Their speed and efficiency isn't a coincidence. When I reach the pick-up window, I can see their whiteboard inside, where they post statistics on the speed of their drive-through service, and often the results of contests that they hold to set drive-through speed records. Today the whiteboard was celebrating a new record: 139 cars during the noon to 1pm lunch hour rush. That's an average of 25.9 seconds per car, and yes, they probably do track the decimal.

I was thinking about what this kind of speed means. It doesn't mean that it would take just 25.9 seconds if I were the only car there, because part of their speed results from their parallel processing of cars. There's an order window, a window to pay, and a window to collect food, and at any given time, all three windows are occupied. It does mean, though, that if I arrive at McDonald's and see that I'm the 5'th car in line, then the waiting time that I should expect is 5*26 = 130 seconds. Not too shabby! I think they've made 1 mistake out of literally hundreds of my morning visits; in that case they misheard me, and I was probably mumbling (I'm a former professor).

22-Jun-2006
IIHOP Insanity, from Scott Brooks

If you want a good breakfast value then I recommend the Cowboy Cafe in Mercer, MO.

You get three eggs (any way you want them), three pieces of meat (I get three sausage patties), a 1/2 order of biscuits and gravy, an order of hash browns, two pieces of toast, and a big glass of orange juice (which they'll gladly re-fill at no charge) for $6.95. I simply can't eat it all. I get a "to-go" box and finish up the other half of the meal for lunch!/p>

With tax and tip, you get out of there for nine dollars, for what works out to be, essentially, two meals! Some things are still pretty inexpensive in small town America! But the effects of inflation are there in other ways. These small towns are literally dying. The best and the brightest leave for greener pastures. The farmers are being choked out because you simply can't make a living on a 500 acre farm (and that's a big farm in that area).

The ones who stay are the ones who simply don't have many other choices. So you end up with an area of that has an overabundance of people that are simply not "capable". Not capable to do much so solve their plight in life. Not capable enough to see that their way of life is dying. And even if they could, they are not capable enough to come up with a solution to solving that problem. That capable people are all out buying their food at IHOP (in the cities) or they're buying up the land that the farmers can no longer make a living off of.

Greetings from the heartland, Highmore SD. The post by Scott Brooks was so well written and tells a tale of our life in rural communities and small towns. Our heritage is a culture within a culture. Of course, there is more to the story. Visiting our area is a treat, just like visiting New York, Kansas City, Omaha, or Las Vegas is for us. You are moved back in time to a slower, richer pace. Some of our best and brightest do move to brighter lights. Not true of all. Many of our farmers and ranchers are college grads and run operations that rival the financing and net worth of many mid-size businesses. There are those in our midst that invest in the stock market or trade a good number of futures contracts, hedging their grain and livestock or buying for their needs. Our middle school and high schoolers attend classes in brand new school house. We are presently raising money to refurbish our local swimming pool. Some of our streets are not paved, but we are charmed by gravel roads! Other truths are self-evident. This is the greatest place in the world to raise children. Having said that, we have our own problems with drugs and alcohol. There is precious little new building in this area, so the old is maintained and repaired. We boast about the same number of bars as we have places of worship! Our towns are just barely holding their own, like the bottom of any chart. Maybe we are just on the edge of a big, new surge of growth that is hidden from view. Come visit sometime, our homes and hearts are always open.

Dr. Kim Zussman says:

Investment thesis would be to send daughters to college in Midwest so they hook up and marry there. Once the grandbabies come poppin', sell pricey coast-state homes and businesses and equity emigrate to Branson, MO to live like a Tsar. (two-bedroom condos around here recently going for $500k)

And, speaking of rare treats, anyone know where to get some bear meat?

David Higgs replies:

Jeff Guimeny's Howard's Grove Meat Market, 211 South Wisconsin Dr., Sheboygan, WI 53083. Jeff's makes bear sausage for Ted Nugent. Hmmmm, Hmmmm... Good!

22-Jun-2006
Easy as 1-2-3, from Dr. Mark Goulston

When you feel under attack, be it from outside, or from your insecurity inside, try counting to three as follows:

Think of the first thing you want to say and don't say it, pause and then think of second thing you want to say and don't say that, pause again and finally think of the third thing you want to say and do say that. The first thing you want to say is about defending yourself. The second thing is about retaliating. The third thing is about finding a solution.

22-Jun-2006
Hysteresis, from Victor Niederhoffer

Hysteresis: Sir James Alfred Ewing has given the name of Hysteresis to the subject of the lag of magnetic effects behind their causes. He has shown that under constant magnetizing force the magnetism will go on slowly and slightly increasing for a long time: this is called magnetic creeping or viscous hysteresis. "There is a good deal of hysteresis, that is a time lag between the cooling and the setting to be expected of the jelly." A simple electronic circuit that displays hysteresis is the Schmitt trigger.

A hysteresis loop, a graph showing how the value of some property of a hysteretic system varies as the agent causing it is varied from one value to another and back again, having the form of a closed curve. -- OED (A good graph for all market people to have handy at all times.)

II first came across the concept of hysteresis when I did something very good or very bad as a little boy and it took a long time for the consequences of that behavior to eventually manifest itself in the result. I next got some physical manifestation of it when I spent many years as an electronics hobbyist constructing all sorts of op amp circuits that had triggers and buffers that led to a delayed but inevitable reaction of the output dampened by negative feedback from the input. The enclosed link to Schmitt triggers is one that I found particular pleasure with and helped me and my friend, Leon Foreman, on the road to designing an automatic toilet lid opener.

Indeed, hysteresis is one of those universal concepts that comes up in all aspects of psychic, physical and market life. The most vivid times I came across it in markets are the delayed but inevitable reactions of markets to movements in interest rates. It used to be that the stock market and the bond market almost invariably went in the same direction during the year. This relation trumped all others, including the good earnings good stock market relation (which doesn't exist) and helped explain and predict many a market movement. Indeed, the work of Tom Downing and the Spec Duo on the Fed Model is an excellent example of a modern update of that work. It's one of the reasons that, even more than usual, the triumphalists have the wind at their back these days, although the extreme negativity of stock market sentiment, at a 30-month low, and the hoped for Dow 5000 of all those who hate enterprise is another highly bullish factor, (this latter always engendered for the next 10 years after a market crash as we had in 2000-2002).

TThe hysteresical effect of the interest rates on stock markets is a bit more subtle now. It was all changed by the 1987 crash when stocks went down 30% or so in two days and interest rates dropped by a comparable amount. Since that time, the reaction has been much more convoluted and delayed. And the movement of bonds yields in mid May to above 5.0 % from 4.7 %, in conjunction with the gold and energy moves up was the Schmitt trigger that led to the delayed reaction of the 10% stock market decline.

All that is a given. But I would like to focus more on another aspect of the hysteresical effect. That is the movement of the Arab markets which was a concurrent circuit that helped to trigger the whole hysteresical effect. It started in Feb with such things as the Saudi Arabian market above 20000 in Feb month end up steadily over the previous six years from 3000. It fell to below 10000 on May 13, 2006. That was the trigger, along with the interest rates for the effects that followed with accompanying accidentals relating to the CPI, the changing of guard at the Fed, and the unfortunate dinner meeting which sparked the need to gain credibility. Since that time, every market in the world has had a mini crash ranging from 10% to 25% Japan moves down from 17000ish in mid May to 14200 on June 13. The Dax moved down from 6143 on May 13 to 5294 on June 14. Since that time, things have become normalized. The hysteresical effect is in reverse. The Sasftdx has moves up steadily from 1000 to 12729. The Nikkei has moved above 15000 to 15135. The Dow from 10700 on June 13 to 11100 at today's open. The Dax is pushing 6000 again.

Date Dax Nikkei SP Saudi Date Dax Nikkei SP Saudi
28-Apr 6,009 16,906 1,326 13,043 26-May 5,788 15,970 1,293 10,385
1-May 6,009 16,925 1,318 13,417 29-May 5,755 15,915 1,293 10,519
2-May 6,051 17,153 1,328 13,000 30-May 5,622 15,859 1,270 10,832
3-May 5,968 17,153 1,323 13,053 31-May 5,692 15,467 1,282 11,201
4-May 6,039 17,153 1,327 12,751 1-Jun 5,707 15,503 1,296 11,610
5-May 6,113 17,153 1,339 12,751 2-Jun 5,687 15,789 1,298 11,610
8-May 6,127 17,291 1,337 11,376 5-Jun 5,621 15,668 1,280 12,181
9-May 6,140 17,190 1,340 10,598 6-Jun 5,502 15,384 1,276 12,423
10-May 6,118 16,951 1,338 10,074 7-Jun 5,543 15,096 1,266 11,408
11-May 6,054 16,862 1,322 10,046 8-Jun 5,383 14,633 1,266 11,994
12-May 5,916 16,601 1,305 10,046 9-Jun 5,464 14,750 1,261 11,994
15-May 5,857 16,486 1,307 11,859 12-Jun 5,395 14,833 1,246 12,078
16-May 5,851 16,158 1,305 10,764 13-Jun 5,292 14,218 1,232 11,936
17-May 5,652 16,307 1,279 10,692 14-Jun 5,305 14,309 1,241 12,046
18-May 5,666 16,087 1,273 11,046 15-Jun 5,422 14,879 1,267 12,046
19-May 5,672 16,155 1,281 11,046 16-Jun 5,376 14,879 1,260 12,046
22-May 5,546 15,857 1,272 10,147 19-Jun 5,439 14,860 1,248 12,610
23-May 5,678 15,599 1,263 10,367 20-Jun 5,493 14,648 1,252 12,633
24-May 5,587 15,907 1,271 10,341 21-Jun 5,503 14,644 1,261 12,729
25-May 5,706 15,693 1,286 10,385

The hysteresisal effects are almost as inevitable as the circuits I played with with my op amps and I recommend going to your local electronics store, and buying a couple of 8-volt batteries, a good op amp or two, some resistors and a capacitor or two for a good hands on ( Montessori like ) rendition of what's happening today as first Europe goes up, then Asia stumbles, then the US fails, then Asia goes up, then Europe goes up, then finally the hysteresic effect of a nice rise in the US inevitably follows.

Henry Gifford adds:

In the heating and cooling industry, "Hysteresis" is sometimes used to describe steadiness of a system, or fluctuation around a temperature set point. (Or price point).

When a thermostat on the wall is set to 74 degrees, what happens in the winter when the room cools to 74? The heat comes on. Okay. At what temperature does the heat turn back off? That depends on the equipment used, much of which has a variable "differential" between on and off points. (Usually a sliding or rotating part of the thermostat)

Setting the equipment for a small differential can, in theory, make for more accurate control, but it can also lead to "hunting" for the correct temperature, resulting in overshooting and undershooting the setpoint. Too wide a differential can make for clumsy control too. The trick, as with many things, is to get it just right.

The analogy to trading is too obvious for me to go on about.

Henry McGilton notes:

The "laws" of hysteresis were derived by Charles Steinmetz in the 1890s. These "laws" were really "rules of thumb," derived by Steinmetz from tens of thousands of empirical observations.

While we all agree that Francis Galton and Francis Bacon are historical role models of those who observe and count, I have long felt that Steinmetz goes unrecognized as a first-class empiricist. At the time he derived the rules of thumb for hysteresis, there were no mechanisms to even come close to explaining the effect -- from a practical engineering perspective, Steinmetz had derived equations to model the behavior of magnetic materials in varying electric fields, but with no theory to explain why magnetic materials behaved the way they did.

A coherent explanation of hysteresis had to wait for the emergence of magnetic domain theory sometime in the 1970s. So I vote to place Steinmetz high in the ranks of the greatest empiricists.

John Lamberg mentions:

While the original query relates to magnetic effects, it brought to mind some interesting properties of Teflon that electrical and mechanical engineers learn the hard way. A quick search didn't uncover the information I was looking for, but I found something better:

...It just goes to show that if you have the best materials, and the finest concept, and you misapply things just a little, you can get some terrible results...

Steve Ellison comments:

In the physical movement of goods, lags occur because moving goods takes time. In many manufacturing situations, dozens of parts must be on site in order to build a product. If any one part is not present, the build will be delayed. Therefore, any unexpected change in demand results in material being in the wrong place relative to plans. This effect occurs most obviously and dramatically when demand unexpectedly goes up, but can also occur with stable demand when the mix of product options or features shifts.

Lags also occur because of prior imbalances and filtering of information as it is disseminated. Firms that do not ship to end users are at an information disadvantage because their perception of demand is shaped primarily by their suppliers. Information from suppliers is often biased by the suppliers' own needs. For example, if consumer demand turns up for a product, but a firm has excess inventory of the product, the firm's initial reaction is likely to be relief that it might avoid an inventory write-off -- it will probably not communicate the increased demand to its suppliers. When it finally does communicate a persistent upturn, the delay combined with the need to reverse tactics will magnify the increase of supply it requests. A 10% increase in end user demand may result in a 30% increase in orders to suppliers. The suppliers may do the same to their suppliers, resulting in increasing oscillations that Hau Lee of Stanford calls the bullwhip effect.

Gary Rogan offers:

By far the biggest use of hysteresis in electronics today is to protect inputs of digital chip from switching multiple times in the presence of noise. Essentially all modern chips, such as microprocessors, have this protection built in. Once the chip "decides" that it needs to switch in a particular direction, a small noise spike will not cause it to switch back, thanks to hysteresis, thus providing some measure of noise immunity. This contrasts with the state of affairs at the dawn of the computer age when the dominant application was in "core" memories that relied on the magnetic hysteresis to remember 1's and 0's in each of the tiny magnetic toroidal rings called "cores".

Addendum:

Hysteresis is everywhere. Once a politician announces a position on some issue, if he immediately reverses himself based on some minute amount of new information he will be perceived as unstable and unreliable. Arguably, Kerry lost to Bush becasue he was successfully portrayed as lacking hysteresis in his decision-making. You don't want to vote for something and than vote against it too soon if you're a politician.

Hysteresis is essentially shifting the decision point towards the decision once the decision has been made. It's a well-understood psychological phenomenon that human beings will tend to look for support for their decision once it's been made more than pure neutrality would call for. Hysteresis doesn't have to be symmetrical. Decisions made out of fear tend to shift the decision point more than decisions made out of hope. Perhaps that's why it's easier to kill an economy with interest rates than to restart it.

22-Jun-2006
Compression and Expansion, by Victor Niederhoffer

An interesting discussion of compression and expansion appears in Chance in Biology by Mark Denny and Steven Gaines. They point out how compression and expansion assist the flapping of an insect's wing. Compression of the insect wing as it flaps is stored in a tendon made of a protein rubber called resilin, which stores the elastic energy created by the flapping of wings. A similar mechanism is found in bivalves, where a protein called abductin is stored in a pad called resilium. The hearts of vertebrates have similar rubbery materials that store energy. Dennis remarks, "A consideration of the energetics of flow in pipes, however, shows that it costs less to move blood through the body's plumbing if the flow is steady rather than pulsatile." Such a consideration should be written in stone at the door of all trading rooms.

It leads me to look at compression and expansion in monthly moves. Inspired by resilium and Dennis, I felt it might be apt to clear the decks by doing a little counting to see if anything of relevance might arise. I have done such counting since 1980 to ascertain what happens in months following declines of 1.5 % or more in the S&P, when that decline was preceded by a rise. Here's an enumeration:

	Next Next 
 Month Month Month Month 
 Date %Chg %Chg Date %Chg %Chg
 ----- ----- ----- ----- ----- -----
 02/79 -3.6 5.5 06/94 -2.7 3.1
 05/79 -2.7 3.8 09/94 -2.7 2.1
 10/79 -7.0 4.3 11/94 -4.0 1.2
 12/80 -6.0 -4.5 07/96 -4.6 1.9
 04/81 -3.0 -2.3 12/96 -2.1 6.1
 12/81 -3.0 -1.8 03/97 -4.2 5.8
 05/82 -3.9 -2.0 10/97 -3.4 4.5
 07/83 -3.3 1.1 05/98 -1.9 3.9
 10/83 -1.5 1.7 02/99 -3.2 3.9
 05/84 -5.9 1.8 05/99 -2.5 5.4
 07/84 -1.6 10.6 07/99 -3.2 -0.6
 07/86 -6.0 7.0 01/00 -5.0 -2.0
 09/86 -8.0 5.4 04/00 -3.0 -2.2
 12/86 -2.8 13.0 07/00 -1.6 6.1
 09/87 -2.4 -22.0 09/00 -5.4 -0.5
 03/88 -3.3 0.9 02/01 -9.2 -6.4
 11/88 -1.9 1.5 06/01 -2.5 -1.0
 02/89 -2.9 2.0 01/02 -1.5 -2.0
 01/90 -7.0 9.2 09/02 -11.0 8.6
 06/91 -4.8 4.5 12/02 -6.0 -2.7
 09/91 -1.9 1.2 03/04 -1.6 -1.7
 11/91 -4.4 11.0 07/04 -3.4 0.2
 01/92 -2.0 1.0 01/05 -2.5 1.9
 03/92 -2.2 2.8 03/05 -1.9 -2.0
 08/92 -2.4 0.9 10/05 -1.8 3.5
 04/93 -2.5 2.3 05/06 -3.1 0.0
 02/94 -3.0 -4.6

What conclusions can one draw? During the months following a first decline of 1.5% or more, the chances of a rise are 72% and the average change is 1.3% including the 22% decline which followed the Sept. 1987 decline of 2.4 %. During the 90's there were about two such initial declines of 1.5 % or more a year, and 35 of 37 were followed by rises. During the current decade of the naughties, there was a run of negative results with six of eight negative from 2000 to 2002. I see some market analogies to strategies employed by bivalves in clamming up during such periods.

Dr. Kim Zussman adds:

In addition, from a longer-term perspective, the mid '90s was a period of expansion of volatility moving to the late '90s. Though the short-term correlation of stock return with volatility is strongly negative, this was certainly not the case through the course of the '90s.

Of course that was back before little Al was inventing global warming and still putting finishing touches on ARPANET. Which inventor can we turn to now to fire up hopeless investors about new new new possibilities? Perhaps Mackey's conversion of wind to groceries? Even this post proves such resources exist outside Arab lands.

Jun-22-2006
Small Traders, from Vinh Tu

In case anyone should feel that they are "pikers," there are much smaller fish in the ocean of the world's markets. An article in WSJ talks about Indian day traders who work in internet cafes where you pay 25c an hour for web access. One guy has a profit target of $10 a day. I would like to know what the transaction costs are, what brokers they use, etc. (and whether I can sign up for an account)

21-Jun-2006
The Forgotten Art of Adjournment Analysis, by GM Nigel Davies

BBefore the advent of computers and a single playing session, games were adjourned after 40 moves so the players could go for dinner. Sometimes they'd be continued on a separate day, so tournaments could last three weeks or more after the normal rounds, rest days and days set aside for adjournments.

Despite the importance of adjournment analysis only Paul Keres devoted much attention to the matter, writing a chapter about it in The Art of the Middle Game. As you read this chapter it becomes clear that the process of falsifying ones ideas increases greatly in intensity.

The early part of my career came at the back end of the times when we still had adjournments, and I remember the care with which positions had to be analyzed. One had to expect that one's opponent would find the most unpleasant moves with which to test you, even more so than during the course of a normal game. Cooperation was really the last thing to be expected, or even a normal distribution of mistakes.

Does this thinking have an application to markets? Perhaps it does in terms of risk control. We continually deal with 'expected outcomes', but what if we turn this around and consider the "worst" that the market can do to us. Imagine it is a malevolent beast designed to exploit every point of vulnerability in our game. Can one still win, get a draw or even just survive? And what moves will one play to keep the game going as the beast sets about taking our position apart?

Perhaps my background in chess makes me rather too paranoid to play markets in an optimal fashion, I go into every game expecting a deadly, conscious and adaptable opponent. There again, maybe there is some merit in this way of looking at things from this perspective, if only to be ready for the worst.

21-Jun-2006
Deception, by David Lamb

I recently re-read chapter 10 of Victor's book Education of a Speculator. Under the heading is a quote that I feel is pertinent to recent market movement and subsequent rhetoric.

Speaking of Stonewall Jackson:

A favorite device with him was to institute inquiries in the presence of the crowd around him as to roads and watercourses in a direction which he did not intend to take; even to order maps to be prepared, and roads laid down, as though for instant use. Having thus set every gossip talking and predicting his intentions, he would calmly march directly in the opposite direction. Mystery, mystery, is the secret of success!

Over 20 pages are devoted to this subject of deception. The use of this tactic has been, and still is, constantly used by many, but is effectively used by only a few. In my opinion, one of the many reasons why Dr. Niederhoffer has been successful in trading is his use of this device.

I recently visited an "elite" financial markets chat site and read a rather lengthy thread about Victor. Both sides fought it out for hours it seemed. My question is: How in the world can anyone (with exception of he who is sitting across the room from him) know how he is trading?

In email conversations with Victor,  he has graciously answered all of my ignorant and uneducated questions, which visibly demonstrated his charitable character. With this said, what makes me think that he would show me his hand? It is rather presumptuous of anyone to assume that he would. What I am trying to say is that Victor is sitting where he is because he is a master of his art. I would be wise to sit and listen -- really try to listen -- to what he is saying.

21-Jun-2006
Soccer, Penalty Shots, and Markets, by Hany Saad

Unlike poker, chess and even tennis, soccer is a game one hardly uses in analogy to markets. But, since the World Cup in soccer is on, I gave myself the liberty to study soccer and try to draw some analogies with markets. In this case, I will analyze a small segment of the game, namely the penalty shootouts.

I'll use France vs. Switzerland and France vs. Korea to illustrate my point. I picked these two games since the French players are said to be the most talented, most expensive in the soccer world next to the Brazilians, and since they are playing against what you could safely label much inferior teams in these two cases. At any rate, the French ended a very sterile game with a 0-0 tie against the Swiss who, although lacking in talent and experience, played a very good defensive game. They also tied last week with Korea 1-1. All the top teams in this World Cup displayed very disappointing performances. Even when they won, they won by very narrow margins as in Brazil's 1-0 win over Croatia. It is unusual, since the teams should be more cautious during the advanced stages of the Cup, not the preliminary ones.

This made me think that a team with a very strong defense and a bit of luck could make the finals and easily win with a good penalty shootout strategy, i.e. the chance that the weaker will score a win against the better team is higher than you might think as demonstrated by the final scores so far. In other words, many big matches can and will come down to a penalty shootout and that's where the weaker team has a perfect opportunity to heighten its chances.

Given the importance of the shootouts, it is almost painful to realize most coaches don't spend much time with their players to perfect their technique and design elaborate strategies to win them. It's not unusual to watch the coach caught totally off-guard after a tied game and wondering whom to pick for the shoot-outs, and in extreme cases wandering around asking for volunteers amongst the players.

Skeptics might ask, is there such a thing as a penalty shootout strategy? It's all luck, right? In fact, it is not. Penalty shoot-outs occur when the game is still tied after final time. There has been a lot of cases where the better team lost with the penalty shots.. One very vivid (and painful) example is France Vs Germany in 1982 where France was the better team all around yet lost to the Germans by the penalty kicks after a 3-3 tie. I remember this one in particular as I had a substantial bet riding on it. I made all the calculation possible to make the bet and was right throughout the whole game as France was leading during the game, then again by 3-1 till the last 5 minutes of the extra time. The one thing I left open in my elaborate calculations is the penalty shots. So, like the coach above, I was not prepared for the penalty shots as they are the exception not the rule in most games. In the markets as the chair puts it: "as usual, the unusual". It is the little extra effort and preparation that can make all the difference in the soccer matches as well as in the markets. What are the unusual events that the traders (like the coach above) need to prepare for? In a market with an average annual drift of 10% year over year how can a trader be prepared for adversity similar to the recent beating we are experiencing now.

Back to the penalty shots: Five players must take a kick (only one kick / player). The coach has to decide which five players to choose and which order to put the players in. Knowing that, statistically, one in every four shots is missed, should the coach start with his best player out of the five? In fact the correct answer is to put them in reverse order of ability. So you actually save your best player to the final kick since the stakes rise with every shoot-out.

A study shows a lower success rate with the fourth and fifth penalties than with the first three. Since players have to deal with stress and since stress rises with every penalty kick, the correct answer is to leave your best players till last as they are usually more able to deal with stress. Yet, from watching most of the games that ended in penalty shoot-outs, the coaches always start with their best players which is the wrong answer.

I argue that it is more important to be prepared to manage your open positions than to just open a position. Any fool can press a certain sequence of keys and open a position. What differentiates the experienced from the amateurs is how well they manage the position whether a losing or a winning one. Should one buy puts to hedge his longs in down markets? should stops be used? Should you sell calendar and credit spreads instead of outright naked positions to avoid total wipe-outs? ts?

A (not entirely scientific) study by British researches suggests that heart attacks increased shortly after an England/ Argentina match that ended in a penalty shoot-out. they conclude that in the interest of public health penalty shoots should be abandoned. Do you feel the same kind of rush when your long positions gap down right at the open. Researchers blaming public health on penalty shoot outs are like Malaysian prime minister Mahatir's blaming the ruin of the economy on those darn speculators.

A field simulation of penalty shoots was designed. It investigated the relative merits of approaching the penalty kick with either a keeper-independent or keeper-dependent strategy. In the keeper-independent strategy, the shooter selects a target location in advance and disregards the goalkeeper's actions during the run-up. In the keeper-dependent strategy, the shooter makes a decision resting on the anticipation of the goalkeeper's movements during the run-up. Ten intermediate-level soccer players shot at one of two visually specified targets to the right and left side of the goal. In the keeper-independent strategy condition, participants were told that the visually specified target would not change. In the keeper-dependent strategy condition, participants were told that in half of the trials the visually specified target would change side at different times before ball contact, indicating that the direction of the kick needed to be altered. The results showed that penalty-taking performance was apt to be less than perfect in the keeper-dependent strategy condition. A decrease in the time available to alter kick direction resulted in a higher risk of not only an incorrect but also inaccurate shot placement. It is concluded that anticipating the goalkeeper's movements may degrade penalty kick performance, mainly due to insufficient time to modify the kicking action.

Is it more advisable to buy a market regardless of which way the media pundits and the permabears want you to lean? Is one more prone to make judgment mistakes reading the newspapers and listening to the so called "experts" than buying and selling strictly based on science?

This said, I believe the role of the speculator should be more likened to the goalkeeper rather than the shooter. First, as in speculation, the goalkeeper is starting off with a negative expectation since most shooters score with penalty shots. The same as the trader. However like the speculator, there are a lot of tricks the goal keeper can use to enhance his odds.

The shooter often give away some clues to which way he will shoot the ball. The eyes, the approach, the movement of the hip, the head, etc... The trader, like the goal keeper would do better off studying correlation between different markets for clues. How a spike in gold can give a warning signal for the stock market? What does a gap down mean? Is it better to buy on up days or down days? Is the Nikkei a pilot fish for the Dow? what about the Tadawul index? do they have private information about natural resources that the rest of the world doesn't have access to etc..?

Much more importantly, it's been well researched and proved that almost 70 to 80 % of the kicks taken went to the opposite side from the kicker's dominant foot according to the DiCicco 2000, yet the keepers choose to ignore all these clues over the years and jump randomly one side or the other.

In Triumph of the Optimists, the authors proved without leaving a shadow of doubt that the markets have an upward drift over the years. Yet, speculators still choose to short the stock market in the face of this overwhelming upward drift disregarding the odds. The most important lesson one learned from the chair is that markets have an upward drift year in and year out and that the odds favor the long side even (and specially) during unfavorable times like the last few days.

Ryan Carlson adds:

Due to the increase in volatility and the greater emphasis on certain economic releases, I've felt that attempting to capture the immediate post-release move presents itself much like a penalty kick situation in soccer. In the reading stack for my upcoming vacation is the following paper "Testing Mixed-Strategy Equilibria When Players are Hereongeneous: The Case of Penalty Kicks in Soccer." Perhaps others here might find some interest in it as well. Of course, trading data announcements is extremely risky but technology has made it easier to capture trades and add safeguards to limit risk.

[Event "FICGS__CHESS__CLASS_SM__000001"]
[Site "FICGS"]
[Date "2006.5.30"]
[Round "1"]
[White "Davies,Nigel"]
[Black "de Vassal,Thibault"]
[Result "1/2-1/2"]
[WhiteElo "2521"]
[BlackElo "2407"]

1.e4 c5 2.Nf3 d6 3.c3 Nf6 4.d3 Nc6 5.g3 g6 6.Bg2 Bg7 7.O-O O-O 8.Re1 e5 
9.a3 h6 10.b4 Be6 11.Bb2 Qb6 12.Qe2 Nd7 13.Nbd2 a5 14.b5 Qxb5 15.Nc4 Bxc4 
16.dxc4 Qb6 17.a4 Ne7 18.Bc1 Qc7 19.Bd2 Nb6 20.Reb1 Ra6 21.Ne1 Qd7
22.Qd1 Nxc4 23.Bc1 Nb6 24.Bf1 c4 25.Rb5 f5 26.Rab1 Qc6 27.Be3 Nbc8 
28.exf5 Nxf5 29.Nc2 Kh7 30.Bg2 d5 31.Bxd5 Qf6 32.Qe1 Ncd6 33.R5b2 Nxe3 
34.Nxe3 e4 35.Nxc4 Qxc3 36.Qxc3 Bxc3 37.Re2 Rb8 38.Nxd6 1/2-1/2

Year First 9-months move Last 3-months move
2002 -30% 8%
1998 +6% 21%
1994 -1% -1%
1990 -14% 8%
1986 ... ...

=================================================================
 Current % of Year Ago MOM YOY
 ($ Billion) Total ($ Billion) % %br>=================================================================
Worldwide ** $4,455.46 100.0% $3,849.29 1.9% 15.7%
=================================================================
China $875.07 19.6% $659.14 2.5% 32.8%
Japan $842.80 18.9% $823.86 0.4% 2.3%
Taiwan $260.94 5.9% $253.17 0.7% 3.1%
Russia $247.90 5.6% $146.50 7.3% 69.2%
Korea $224.69 5.0% $206.10 0.8% 9.0%
Eurosystem * $168.16 3.8% $179.16 1.9% -6.1%
India $156.74 3.5% $133.95 2.0% 17.0%
Singapore $128.86 2.9% $116.00 0.7% 11.1%
Hong Kong $126.50 2.8% $122.40 -0.4% 3.3%
Mexico $76.05 1.7% $60.70 5.7% 25.3%
Malaysia $74.95 1.7% $72.49 2.8% 3.4%
Algeria $65.91 1.5% $46.18 5.7% 42.7%
Brazil $63.51 1.4% $60.39 14.7% 5.2%
Turkey $59.02 1.3% $37.12 1.4% 59.0%
Thailand $57.00 1.3% $48.40 -0.3% 17.8%
Norway $48.38 1.1% $40.62 7.9% 19.1%
Australia $46.05 1.0% $37.55 9.5% 22.6%
Indonesia $44.17 1.0% $34.61 3.2% 27.6%
United Kingdom $42.71 1.0% $39.97 4.6% 6.9%
Poland $42.09 0.9% $36.06 -3.1% 16.7%
United States $40.09 0.9% $39.93 -0.8% 0.4%
Libya $37.90 0.9% $26.41 -6.1% 43.5%
ECB * $37.21 0.8% $37.05 5.2% 0.4%
Germany * $37.16 0.8% $40.33 -4.7% -7.8%
Switzerland $34.34 0.8% $35.12 -1.6% -2.2%
Canada $33.66 0.8% $31.46 -1.1% 7.0%
Nigeria $32.98 0.7% $22.28 -8.6% 48.0%
Israel $32.31 0.7% $26.47 15.8% 22.1%

(S&P next month return %)=0.18+0.21*("CPI")
R=5%; N=205

(S&P next month return %)=0.79+0.41*("CPI"-"CPI 12 months ago")
R=11%; N=205