Daily Speculations

The Web Site of Victor Niederhoffer and Laurel Kenner

Dedicated to the scientific method, free markets, ballyhoo deflation, value creation, and laughter. A forum for us to use our meager abilities to make the world of specinvestments a better place.

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June 2005 Posts

6/30/05
Humility, by Julian Rowberry

In real life we need to act on our theories, so it's right or wrong, 1 or 0, good or bad. Pick one, act. Assess it. Repeat.

Recently a young Australian was drafted #1 into the NBA. He declared, among other things, that he is the 'best basketballer to have come from the country', if 'you want to play NBA, play US college basketball, not NBL (Australian basketball league)'. These things are painfully obvious. The Australian media rubbished him for declaring the truth, and not assuming the 'false humility' public relations approach.

Whilst humility is the opposite of arrogance, it lives in the same stead. A misjudgment of value equally as costly. Why it should be encouraged, is beyond me.

Kevin Bryant adds:

Balance is critical in all things. The absence of humility means arrogance. Just when we think we have a hot hand and begin to believe in our omniscience, we get bit by the proverbial snake in the grass because our heads were too high in the clouds.

GM Nigel Davies responds:

The only thing that matters to someone's performance is whether he's objective.

Apparent arrogance can be nothing more than a statement of fact. If someone knows he's good at something, why should he not recognize this fact? The only point at which it becomes dangerous is when self-belief gets ahead of reality, when people believe their own legend.

Excessive humility, if genuine, can lead to underperformance. And false humility is much worse.

Kevin Bryant replies:

Apparent arrogance and true arrogance are two very different things. True arrogance, the state of being overly convinced of one's own importance, is by definition a state not in touch with reality.

6/30/05
A Fine-Looking Bunch

L to R, top: Doc, Tom, Wiz, Chair, Duncan, Professor; bottom: Ace, Susan, Dude

Photo by Ming Vandenberg

6/30/05
Humility, by Julian Rowberry

In real life we need to act on our theories, so it's right or wrong, 1 or 0, good or bad. Pick one, act. Assess it. Repeat.

Recently a young Australian was drafted #1 into the NBA. He declared, among other things, that he is the 'best basketballer to have come from the country', if 'you want to play NBA, play US college basketball, not NBL (Australian basketball league)'. These things are painfully obvious. The Australian media rubbished him for declaring the truth, and not assuming the 'false humility' public relations approach.

Whilst humility is the opposite of arrogance, it lives in the same stead. A misjudgment of value equally as costly. Why it should be encouraged, is beyond me.

Kevin Bryant adds:

Balance is critical in all things. The absence of humility means arrogance. Just when we think we have a hot hand and begin to believe in our omniscience, we get bit by the proverbial snake in the grass because our heads were too high in the clouds.

GM Nigel Davies responds:

The only thing that matters to someone's performance is whether he's objective.

Apparent arrogance can be nothing more than a statement of fact. If someone knows he's good at something, why should he not recognize this fact? The only point at which it becomes dangerous is when self-belief gets ahead of reality, when people believe their own legend.

Excessive humility, if genuine, can lead to underperformance. And false humility is much worse.

Kevin Bryant replies:

Apparent arrogance and true arrogance are two very different things. True arrogance, the state of being overly convinced of one's own importance, is by definition a state not in touch with reality.

6/29/05
Monkey Business, by Tim Hewson

Being a monkey isn't as easy as it used to be: gone are the days of swinging from trees, drinking cups of tea and starring in movies with Clint Eastwood. Now you gotta turn to academia to earn your keep.

Research done at Yale shows monkeys share the same "irrational" tendency to risk aversion as humans, i.e. for two equal outcomes people will prefer the choice of avoiding a loss to making a gain.

On thinking about it, why is this behavior termed "irrational"? In a society and economy based so much on personal relationships and interactions, reliability and consistency ought to be preferred and looked to for guidance over average outcomes, be they "irrational" or not, no?

How does the baker explain to his customers, after they pay, there is no bread today as his flour supplier didn't deliver, but on average, when he does show, he delivers as much flour as the guy who turns up everyday, and next time they come he'll give them twice as much bread, so net net they'll be no better or worse off?

Surely the more rational behavior is that which enables participants in a market to go about their daily business as efficiently as possible, and a precondition to this is having reasonable expectations of the behavior of your counterparties, Those who are reliable and efficient and provide a good service prosper, while those that do the same "on average", but in none of the above ways go belly up.

6/28/05
CBOE Fears Low-Vig Options Trading Will Cause Eyestrain, from the Assistant Webmaster

June 28 (Bloomberg) -- The Pacific Exchange, the fifth- biggest U.S. stock-options market, will reduce the standard gap between the buying and selling prices of all contracts it offers to a penny, from the current minimum of a nickel. 'We worry about our major data vendors' being able to handle something like that,' said Tom Knorring, vice president of trade processing at the CBOE, in an interview last month. 'The exchanges themselves would have trouble gearing up for it. And you are going to run into the unreadable screens: either your screen couldn't keep up or if it could, your eyeballs couldn't.'

6/28/05
A Niederhoffer in History, by Laurel Kenner

In keeping with my practice of reading all I can on the history, economy and art of places I visit, I bought a sun-faded book called The Bull of Minos from a rack outdoors in the small Cretan village of Krista. It's an account, first published half a century ago, of the excavations in Troy, Mycenae and Knossos by Henrich Schliemann and Arthur Evans.

When I reached the passage that appears below, I started to smile. Other readers will recognize in it, if not the denomination and the inebriation, the scholarly bent and catalytic role in others' lives:

[Heinrich Schliemann] had to leave school at the age of fourteen and become an apprentice in a grocer's shop in the small town of Furstenberg. 'I was engaged,' he wrote, 'from five in the morning until eleven at night, and had not a moment's leisure for study. Moreover, I rapidly forgot the little that I had learnt in childhood; but I did not lose the love of learning; indeed I never lost it, and, as long as I live, I shall never forget the evening when a drunken miller came into the shop.' The miller, whose name was Niederhoffer, was a failed Protestant clergyman who had taken to drink, which, however, 'had not made him forget his Homer; for on the evening that he entered the shop he recited to us about a hundred lines of the poet observing the rhythmic cadence of the verses. Although I did not understand a syllable, the melodious sound of the words made a deep impression on me. From that moment I never ceased to pray to God that by His grace I might someday have the happiness of learning Greek.'

Schliemann went on to amass a huge fortune as a trader in Russia, California and elsewhere. By the age of 33, he spoke 15 languages, including modern and ancient Greek.

My opinion is that the miller wasn't drunk, just... exuberant.

6/28/05
Target Shooting, by Andrea Ravano

I have cultivated some intense passions along the course of my years. One of the first and more powerful has been free pistol 50 meters target shooting. Besides the difficulty of the breathing process, controlling the nerves that move your fingers, keeping your shoulder relaxed, the most difficult part is, in my opinion, to lower the arm, saying to yourself not to shoot. In fact, while aiming, your arm and hand are never still. The gun passes from left to right, up and down, with the slowest movement possible, underneath the target. Never completely still. That is why the decision to fire is so complex: you never know if you are in the 10 point region, the 9 or worse. The tough part is to tell yourself you are wrong and must start over again the aiming process. I find many an analogy in the financial markets, where the most difficult part is to recognize a bad trade from a good one. Buy low and sell high, or the opposite, are never a good measure of your judgment as the math and stats of the markets are stirred in a complicated mix of emotions and feelings called a human being. The Japanese hysteria that drove the Nikkei to 42,000 should have stopped much earlier, yet in those days you would have missed a tremendous rally if you sold the market high. The same applies to almost all tradable instruments ranging from the black tulip to the Nasdaq. In the end, though, the real mistake is always not to shoot.

6/28/05
Wearing Two Hats, by Jim Sogi

I work two "jobs", but am lucky in many ways:

  1. In Hawaii the market is open from 3:30am-10am, so by the time my coffee break is over, I can start doing law work during the regular day. I have the luxury of setting my own hours, schedule and workload, so it's manageable. Both are computer and high-speed Internet intensive, so it would not have been possible even 10 years ago.
  2. Trading is flexible, allowing a cash-out whenever other commitments heat up, or it's possible to let a position ride, and it doesn't take "work" to maintain.
  3. Law gives the opportunity for wonderful interpersonal relationships and interaction every day, which make the profession so rewarding.
  4. The constant learning makes the long hours a pleasure. Even the "homework" reading: spec, baseball, biology, science, programming, statistics, economics, martial arts, physics and history books piled up, and a few hours programming in R, are a treasured treat to look forward to.

The main thing is to have the right priorities in life so that life is in balance. That is the key. Health and family first. At the end of the day, nothing else really matters.

6/28/05
Moneyball, by Dan Grossman

Seems to me intuitively, without counting, that a major reason for the Yankees' loss to Baltimore last night was their extreme managerial reluctance to use Rivera, their closer and only reliable reliever, except in "save" situations or when the Yankees are ahead.

With the score tied 4-4, the Yankees brought in Stanton to pitch the bottom of the ninth, who promptly gave up a home run to Baltimore. Rivera had been warming up with Stanton, apparently for use when and if the Yankees scored in the ninth, tenth, etc.

Assume for example:

  1. Rivera's chance of pitching a scoreless inning is 90%
  2. Stanton's chance of pitching a scoreless inning is 60%
  3. Rivera can pitch a maximum of only two innings
  4. Yankees' homerun-heavy lineup has a 50% chance of scoring in any of tenth, eleventh or other innings, especially with Baltimore's best closer's having already pitched two innings in the eighth and ninth

What's an easy way to mathematically calculate whether my intuition is correct?

6/28/05
La Dolce Vita, by George Zachar

BN 10:05 EU Urges Italy to Use `Rigor' to Lower Budget Deficit

No creature with a more complex neural net than a planarian can read this formulation without laughing. Now, since Brussels knows "Italy", "rigor" and "budget" cannot go together, and global political/economic elites know the same, and Brussels knows the elites know this, what's the point in making the statement? They are knowingly lying to people who know they are being lied to. It is a very Soviet phenomenon, and a scary foreshadowing of what may well be Europe's future.

6/28/05
Kazuo Koike and Goseki Kojima's Lone Wolf and Cub, Reviewed by Will Huggins

Short version of the scenario: The main character, an assassin named Ogami Itto, has been hired by the five gunsmiths of the Shogun to kill off another gunsmith working to develop new weapons. During the relative "age of peace" instilled during the Tokugawa Shogunate in the 18th century, guns had moved from being pure instruments of death to being highly decorated, overpriced implements shown off by the Shogun's riflemen. When he realizes he is doomed, the gunsmith gives his parting speech. The parallels to investing seem obvious, along with the omnipresence of ever-changing cycles:

The nation is at peace, strife forgotten. Luxury and pleasure rule the streets, and our people wallow in decadence! Yet the Nanban barbarians prime their cannon and hungrily eye our land. The fires of war already flicker in the south! In times such as these, the true warrior gathers his arms and horses, and does not forget the arts of war! Only a fool would join hands with the gunsmiths of Sakai and have me killed for his own gain.
Weapons have a life of their own. Make one weapon, and a second appears to defeat it! A third one to make the second obsolete. Yet they seek simply steal my designs and copy them! They hasten the day when all are obsolete and our nation lies undefended
The cutting edge isn't the weapon. The cutting edge is skill, the endless effort of the inventor. If this truth is forgotten, our land will lie as tangled as grasses in the wind, and the nation will fall.

6/28/05
Mortgaging Our Future, by George Zachar

The Mortgage Bankers Association reported the adjustable share of applications fell to 30% in the week ended 6/24, exactly as one would expect in a flattening yield curve environment.

LATEST RATES
Fixed 30-year          5.47%
Fixed 15-year          5.06%
Balloon 7-year         5.42%
Balloon 5-year         5.68%
ARM 1-yr Treasury      4.42%

I expect the hysteria about naive borrowers' "getting trapped" in adjustables will be replaced by hysteria about something else.

6/28/05
Forty Fewer for Primal To Scream At, from the Assistant Webmaster

TheStreet.com Shuts Independent Research Brokerage (Update1) June 28 (Bloomberg) -- TheStreet.com Inc., which operates a financial-news Web site, closed its Independent Research Group LLC brokerage unit, citing new regulatory requirements and the slow pace of the unit's growth toward profitability. The brokerage business employs 40 people, mainly at the company's Wall Street headquarters, and accounted for about 13 percent of revenue last year, the company said in a statement today.

6/28/05
Mr. Jefferson, by J. T. Holley

Some say Mr. Jefferson contended that manufacturing would be the death of civil society. Actually Mr. Jefferson had a nail factory that employed 25-30 of his slaves, so he did know a little bit about manufacturing. To go along with his loves of reading and messin' around in his gardens I would assume that he'd rather be doing something else than workin' the second shift at his factory meshing out nails. He also had a unique way of incenting his employees who produced or worked harder at production. He would buy them a red coat or give them select cuts of meat for their effort. I would also argue that we never moved from agriculture to the extent that manufacturing took its place per se. Still to this day through the efforts of farmers we crank out more butter beans, potatoes, corn, tobacco and what not than probably any other country. Manufacturing is something that was added and existing GDP wasn't replaced, and just because India took the lead in cotton production doesn't mean people weren't using cotton gins to produce more than they had before. Wealth to Mr. Jefferson was valued in more ways than just plain coin or currency or how many nails that he sold. He about broke himself equating land to net worth. If he needed to get liquid and create cashflow he just sold a couple of acres or slaves. G-d ain't makin' much more land, and those slaves, well they were literally family. The concept of wealth and money to Southern farmers was something entirely different than that of a Northern industrialist. Plenty of people Mr. Melduke keeps countin' getting laid off regularly in the South in the plants of tobacco, textiles, and such. Do you think they sit on their tails unemployed and just collect checks while laid off and outta jobs? No, they are being productive, sowing seeds and planting gardens to can vegetables come fall harvest to sustain their lives and live for the next wave of whatever plant, business, or idea comes along and be employed again.

6/27/05
Mr. Dow 5000 Pounds the Table, Critiqued by George Zachar

This recovery is different because it was spawned and subsequently nurtured on the back of asset appreciation alone. Greenspan and company have high hopes that investment and then employment will ultimately kick in and work their self-sustaining magic one more time, but jobs and investment these days go to Asia at the margin, and domestic animal spirits have been squelched by the looming inevitability of reduced returns on risk capital in a low interest rate world.
  1. The standard reply to the Japan analogy is that Nippon's financial system is calcified and bank-centric, while America's is dynamic and capital markets-centric.
  2. The American job killing "Yellow Peril" meme has been around since the Dodgers left Brooklyn.
  3. There have been numerous anecdotal reports of China's "losing" jobs to Vietnam, etc., as well as internal bottlenecks/capacity constraints.
  4. In 1949, Orwell forecast (in 1984) that wars would revolve around controlling Asia's labor surplus.
  5. The only perma-doomsters with a positive track record are the terrorism experts who correctly forecast the rise of Islamist asymmetrical warfare. For the past 50 years all economic doomsters have been consistently wrong over spans exceeding a couple of years.

Rick Ackerman rejoins:

I don't sense much table-pounding, only a blunt and unrefuted assessment of an economy that has been growing more sickly and dysfunctional with each passing month. If there is empirical evidence to suggest that the weakest economic recovery since the Great Depression has been catalyzed by something other than rampant asset inflation, then by all means please share it with me.

I'd be most interested in an explanation of why new borrowings approaching $3 trillion in the last six years have failed to engender any meaningful growth in a key macro component, net fixed capital investment; or how, in the complete absence of household income growth, consumer spending has come to represent as much as 86% of claimed GDP growth during certain periods.

To me it seems factually beyond challenge that the economy is being sustained by prodigious borrowing alone, borrowing collateralized by a steroid-fed asset class whose grossly inflated value the Fed chairman would have us construe as wealth.

And keep in mind that Mr. Dow 5000 is a raving bull compared to Mr. Dow 700.

Jim Sogi replies:

Empirical evidence exhibit list of a country running well with prosperity, health, justice, everything a Utopian society and economy could ask:

This is the best of all possible worlds.

The nattering nabobs of negativism have forgotten 1974. When was there a better time economically than now? Not to say it will last forever, but things are good now. The sky is not falling. There is nothing wrong, and in fact many positives. There will always be opportunity for the optimists, while Chicken Littles will be fodder for the wolves.

6/28/05
Summer Interns From Birinyi Associates Visit the Chair

6/27/05
In Vino Vertitas, by Kim Zussman

A small group of specs met for dinner Friday at 94th Aerosquadron Restaurant at Van Nuys Airport, including Jeff Rollert, Steve Ellison, Tyler McClellan, and a handsome, urbane dentist. It was a great evening, fine food, wine, and friendships that included a number of long discussions. Some topics:

A grand evening, with great thanks to the Chair.

6/27/05
Splendid Isolation, a New Essay by Dr. Ross Miller

6/27/05
Shanghai Surprise, by Yishen Kuik

Heard about this from my in-laws in Shanghai:

The official numbers for the salary of a Chinese worker are often misunderstood by Western analysts, because it is customary for the Chinese company to clothe, feed and house its workers. The take home pay is usually savings. Even middle level managers bill most of their living expenses to the company. While this is not enough to close the gap with Western paychecks, it should be noted by the careful analyst.

Adi Schnytzer replies:

To my understanding, this is a special feature of Chinese communism and not Third World practice, but I may be wrong. Further, in many communist or socialist countries, it was/is difficult to make sense of wage data, since workers often had two jobs, some fictitious but paying a salary, for example in academia, or they received extensive benefits of other kinds. Sometimes this "complexity" was deliberate government policy, to keep one group from knowing what another earned and thus to prevent leapfrogging wage claims.

6/27/05
Fascinating?, by GM Nigel Davies

I have one question about Thomas Johansson's book The Fascinating King's Gambit, which is highly acclaimed by club players. Does fascinating help us win our games?

Laurence Glazier replies:

No, it doesn't help us win, and that suggests two aspects of chess, as the beauty of some historical sacrificial King's Gambit games may be important to us as works of art, and though the winner's strategy is subsequently disproved these games stay famous. To my detriment as a player, I used to love exploring new twists in openings I knew at heart were unsound. Now I would seek chess beauty more in problem compositions than by playing the game itself.

GM Nigel responds:

I agree but I'd put it slightly differently. I think fascination helps with immersion but not mastery, and it's the mastery that helps us win. Amateurs remain at the fascination stage through either conscious or subconscious choice. One theory I have about the 'why' is that looking too deeply at any endeavor forces us to look at ourselves as a reflection of our efforts. And most people don't want to do this.

6/27/05
The Elephants Return to the CBOT

6/27/05
A Renaissance Man, by Kim Zussman

Paul Winchell passed away last Friday at 82. A Renaissance man, Paul was known as an inventive entertainer but also entertained invention:

Winchell was also an inventor who held 30 patents, including one for an early artificial heart he built in 1963 and then donated to the University of Utah for research. Dr. Robert Jarvik and other University of Utah researchers later became well-known for the Jarvik-7, which was implanted into patients after 1982. Among Winchell's other inventions were an early disposable razor, a flameless cigarette lighter, an invisible garter belt and an indicator to show when frozen food had gone bad after a power outage.

I was lucky to have known Paul for a number of years, and we always enjoyed his polymathic tales, quick wit, and the occasional book or lamp projected with the life of one of his characters.

6/27/05
The Kelo-Based Land Rush Begins, from George Zachar

With Thursday's Supreme Court decision, Freeport officials instructed attorneys to begin preparing legal documents to seize three pieces of waterfront property along the Old Brazos River from two seafood companies for construction of an $8 million private boat marina.

A Brooklyn Spec adds:

I remember being in 5th and 6th grades and having hours of civics lessons focusing on the concept and virtues of 'eminent domain'. Later I realized that the reason for these lessons was to ease the way for the destruction of a part of our neighborhood to make way for the approach to the Verrazzano Bridge. I remember trying to convince my father that the state had the right to do what they were doing, how it was for the good of all. He told me how Fascism took hold in Italy and how one of the most effective tools was to brainwash the school children.

6/27/2005
Dick Sears Weekly Review It Isn't Fair

6/25/05
Silver Queen, by Tim Melvin

Driving down Route 8 here on the island as I do every Saturday of early summer, I finally saw what I was hoping for: Farmer John's produce stand was filled with buckets showing the green-clad ears I've waited to see since early last fall. The first of the summer sweet corn was in. Farmer John's stand has been here for 30-some years and his kids still come home from their Ivy League schools to work the register and supply Kent Island with the finest of summer eating: melons, tomatoes, cherries, strawberries. If it grows, John has it. He's always first in with the good outdoor grown corn. Hothouse sweet corn is to real Silver Queen as Arch Crawford is to the scientific method. Only one course of action open to a dedicated foodie like me. Now, I like fine foods and elegant dinners but my true expertise lies in serving up platters in the cooking style known around these parts as Chez Redneck.

So, let's see..

It's in the 90s today and sunny, combination that produces sunsets of Technicolor perfection. A feast, a sunset walk along the bay: it is summer at last here on the Chesapeake. If you can be here by 7:00 and aren't afraid of an ill-tempered puppy that weighs as much as you do, come on over.

J. T. Holley replies:

Old Bay seasoning sprinkled on an ear of Silver Queen corn drowned in drawn butter is heaven. I highly recommend this concoction. By the way, a lesson for novices: BBQ sauce isn't a marinade. It's a sin to marinade chicken, beef or pork in BBQ sauce then throw it on the grill. Basting is the proper technique. That's why they call it finger lickin' good.

Mark McNabb adds:

And some food for the ears:

6/24/05
Know Your Enemy, by Nick Marino

My son is a black belt and serious student of karate. At first, he had trouble winning sparring matches, even though he is quite good -- powerful and aggressive.

My advice after studying the game was:

Furthermore:

6/23/05
Fun in the EU, by Laurel Kenner

It's been lots of fun to read the local press coverage of the arguments over the EU redistribution scheme known euphemistically in standard US newspaper jargon as the budget. Here in Greece, the new budget would give olive farmers a subsidy of 1750 euros, about 90% more than what they received now. The catch is, they have to give 1100 euros back if they grow any olives. Most aren't expected to grow any olives.

The farmers are unhappy with their current subsidy and have been embarrassing the politicians by organizing tractor blockades of highways. Meanwhile, olive exports are booming. Extra virgin olive oil, a luxury 20 years ago, is now common in grocery store chains.

In five years, the subsidies will end. Hey, the party has to end sometime -- doesn't it?

6/23/05
Looks Bearish, by Pam Van Giessen

In a town in southern California last night, a bear sighting was called in to the police.

In a village in Holland, a bear warning was issued. Scientists descended to investigate paw prints, and track the elusive animal since there are no bears in Holland. Photographs of said bear were distributed.

And in another town in the U.S. a "bear warning" was posted with photos.

In all three cases the "bears" were actually dogs. Newfoundland dogs, pretty much the most gentle canines to grace this good earth. The photographs distributed were of said dogs, and in the last case it was a 7 month old puppy. In the first case, my friend, out walking her dog, nearly fainted when the police descended on her with spotlights while she was out for her nightly stroll with man's best friend.

Sometimes bears aren't bears, even when photographic evidence is submitted.

6/23/05
Gait Analysis, by Saurabh Singal

A gait is a characteristic limb coordination pattern used in locomotion. And gait analysis is the quantitative study of gaits with direct applications in orthopedics and robotics.

Animals with different number of legs have different types of locomotion. For example, horses have four main types of gait: the walk, trot, canter and gallop. These are characterized by the sequence of movement of different legs and also their timings. In a walk, each of the four feet rises up and falls on ground independently. In the trot, the diagonal foreleg-blackleg combinations rise and fall together. Trot takes two beats, canter takes three beats and galloping and walking take four beats.

Most insects have six legs, and they have two basic gaits: the tripodal gait and the metachronal wave gait. In the metachronal wave, each leg lifts only when the leg behind it is on the ground, giving the appearance as if a wave is spreading. In the tripodal gait, one tripod of either the front right leg, middle back leg and back right leg or the front left, middle right and back left leg are on the ground and the other tripod lifts and moves forward.

There are also research initiatives to use gait analysis for identifying different individuals, in the same way as fingerprints are used. When a foal is only four months old, gait analysis can predict its chances of becoming a champion race horse. At this point the purchase price of the foal would be less than later on, when its potential is more widely known.

Champion swing dancers can identify a good dancer quickly. Champion racquet players such as Chair need only watch a follow-through to determine if someone is a good player. Chair has commented that economy of movement and compactness of style characterize world champions in different arenas. Since markets also move in different gaits at different times, sometimes in lethargic listless gaits, sometimes at a canter and at other times in galloping strides or Lobagola stampedes, I wonder if studying the science of gait analysis can help speculators?

6/23/05
Overheard by a Savvy Fed Watcher

At a cocktail party last night, an equity portfolio manager told me:

We use the Fed model, and stocks have never been this cheap relative to interest rates. Then you look at how easy it is for private equity types to borrow real cheap, lever anywhere from 7:1 to 20:1, pay up for a company, tidy it up a bit, and then either pay themselves an enormous cash dividend, or flip it back out.

Is it that easy? Maybe I'm in the wrong business...

6/23/05
Bob and Weave, by Jim Sogi

Our kick boxing teacher always told us to keep moving.

In trading, don't present a fixed target trying to do the same old thing over and over. Bob and weave. Count the different patterns. Change it up. Don't step into a punch and put your stop one tick under the prior low. Don't just stand there. Move your orders. Things moving fast. You should too. After four days of the same price close, do you think it will be the same thing again tomorrow? Will the market just stand there and take it?

6/23/2005
Ask The Senator, a Continuing Series

Q: S&P floortraders calculate actionable trading areas based on a pivot, which equals yesterday's (H+L+C)/3. Are there any predictive qualities to this calculation?

A: That pivot formula is very old. I showed it in my my 1966 book and I lifted it from Owed Taylor's work of the 1930's. The values may have some merit but in a reverse fashion. I have tested it, and I actually use the points on a few occasions, but not at all as they are supposed to be used.

Send queries for the Senator to senator<at>dailyspeculations<dot>com

6/22/05
Pillow Talk, by George Zachar

Bizarre interview with Andrea Mitchell, i.e. Mrs. Alan Greenspan, just now on the Imus morning radio show. She's a NBC reporter, and spent most of the time talking about inside-the-Beltway intrigues, but then she offered this:

No one expected $60 oil to have no impact on the economy. It's a demand shock, and not a supply shock, and people are happy to pay and keep going.

In a zillion years of listening to her on Imus, I have never heard her comment on what is apparently her husband's thinking. One can simplistically read this as saying the Fed has dropped the notion that high energy prices, for now, constitute an inhibiting tax on the consumer/economy.

6/22/2005
Howl, by Roger Arnold

The Road to Riches Is Called K Street: Lobbying Firms Hire More, Pay More, Charge More to Influence Government, By Jeffrey H. Birnbaum, Washington Post Staff Writer, Wednesday, June 22, 2005; Page A01 -- To the great growth industries of America such as health care and home building add one more: influence peddling. The number of registered lobbyists in Washington has more than doubled since 2000 to more than 34,750 while the amount that lobbyists charge their new clients has increased by as much as 100 percent. Only a few other businesses have enjoyed greater prosperity in an otherwise fitful economy.

an oldie and status quo story from the recession proof town
thanks to the us taxpayer
yes the revolving door from public to private sector is booming
while greenspan and snow say let them eat cake
the supremes take away their homes
we can at least claim to not be europe or japan
the refrain in unison is it could be worse
jefferson said people get the government they deserve
all we need to do is look in the mirror

6/21/05
Volatility, by George Zachar

I assume the counters all see the new move lows in VIX, VXO and VXN. Debt marts too are seeing vols scraping along/near recent lows.

Though off their narrows, credit spreads have resumed their inward grind again, and monster-sized mortgage issues, like FNMA 5%, are trading special in the repo/roll market.

This has all the earmarks of a liquidity-driven, cash is trash, wall of money chasing ever-shrinking alpha, environment.

It's a good time to re-think/shock-test positions and the premises behind them, as quarter-end/half-year approaches.

Famous market commentator Han Solo sums it up..

The Senator adds:

Note that the bull markets that followed the crash of 1929 rallied on less and less volatility, as expressed by average weekly or daily ranges. It was not until volatility picked up that the bull markets of 1933-37 and 1942-1946 ended. The same thing was true following the crash of 1987.

6/21/05
Media, Media, Media, by Kim Zussman

Often while driving I listen to KNX, a local AM station which has a Business Hour program. Usually the topics relate to stock sectors, asset allocation, personal finance; likely useful information for most listeners. Recently the emphasis has shifted to "the housing bubble", and today a UCLA economist claimed that California housing is 30% over-priced.

I was less interested in the content than the content of the interest. Perhaps these are the lazy days of summer, with stocks flat for the year and breezes sans anthrax spores. Leaving talking heads and hungry ears worrying about which asset classes are most inflated.

The first foray into counting was 4-years ago when subscribing to Louis Rukeyser's Wall $treet. He claimed journalistic access to the best and brightest analysts and managers, and (for a slight fee) would pass this onto us readers (who would not trust a man who is pictured on 1$ bill). Each issue contained a list of stocks and mutual funds picked previously, along with performance since selection. Only I noticed that with some frequency stocks were dropped for various reasons. Using back issues it became clear that only losers were dropped, and performance including them was worse than indexes of my own.

A second foray was monitoring the dart-throwing contest in WSJ, originally suggested by random walker Burton Malkiel. However it seemed inconsistent with theory that managers were beating the darts. So I emailed the good professor M, who kindly replied that manager out-performance was the announcement effect and it would disappear if performance were measured from a day after publication.

Barron's was better than Rukeyser; with more in-depth econospeak, and favored companies popped nicely on Monday. (Investment thesis: a spy at Dow Jones publications to leak the picks on Friday).

A Semiotic Spec adds:

Every day, pretty much without fail, the first thing I see in the morning is the cnn.com front page, and its primary image and headline are of a bombing in Iraq, with a couple of US deaths.

There is absolutely no doubt in my mind that the motivation for the low-level violence by the anti forces in Iraq is simply to keep bloody images in the US press every day, in the hope the US public will do what it did in Vietnam: leave the innocents to be slaughtered.

I believe this is obvious, upon reflection, and that the US press knows this, and is a willing accomplice. They would willingly, indeed gladly, see a return to mass murder in Iraq, and a ratcheting-up of terror against US targets, to weaken W and bring the Democrats back to power.

This is, of course, widely believed on the right. But, given the death spiral of MSM ratings/circulation, this notion seems to be seeping out into the broader population.

6/21/05
Grandad, If You're Listening, by Nigel Davies

I recently discovered that some relatives of my wife were investing some money for our three year old son. Their choice of instrument? Premium bonds. For the unenlightened this is a bond which pays out a small amount of money in the form of a monthly prize draw. The 'attraction' is that you can win a million pounds.

Premium bonds are not a new thing to the Grandmaster dynasty. My grandfather bought me 8 quid's worth of premium bonds when I was a similar age to my son (early 1960s) which I forgot about until one moment in my chess career when cash was particularly short. I'll never forget phoning up the premium bond center, hopeful that these premium bonds had netted one of the huge unclaimed prizes. Was I in fact a rich man?

How much had they actually won? Nothing. Not a penny. The original investment of 8 quid was still worth 8 quid, less 30 years inflation of course.

There's nothing I can do about my Grandfather, who has long since passed away (though if you're listening Grandad, why didn't you buy me some stocks!?). But is there anything (within reason) to be done about the still living relatives?

6/21/05
Steganography , by Saurabh Singal

Steganography, which literally means "covered writing" differs from encryption in that while encryption uses cipher or code to protect or conceal the contents of a message by scrambling them before transmission, steganography works by concealing the very existence of the message. Clearly, detection of an encrypted communication between an unsavoury party (known terrorist or enemy agent) and a previously unsuspected person is going to put this person under suspicion. This is would be adequate reason for criminals to use steganography tools.

Simon Singh describes some historical methods of steganography in The Code Book. These included shaving the head of a courier, writing the message on his scalp and letting the hair grow; writing a message on a wooden writing tablet and coating it with wax. In later times, people would make pinpricks below certain words in a newspaper cutting and then mail the cutting to the recipient.

But nowadays, electronic methods of hiding information have evolved. At its core, electronic steganography hides or embeds a message inside another file which is called "cover image file" or "cover text". Together, the two are called "stegotext". Encrypting the message and then embedding it is common. Many programs are freely available on the internet that allows one to embed a text message inside a picture. The container file can be a text file, or a picture or audio/video file. Similarly the embedded message can also be a text or picture.

Here is how one common technique of hiding one image inside another image works. First, the image is represented in the RGB format, i.e., each pixel is represented as a (R, G, B) triple and there are three bytes per pixel. Changing the least significant bit has the smallest impact on the value of the 8-bit number (byte). Therefore if we embed an image in the least significant bit of each pixel of the container image, the changed value of each of the three bytes in the (R, G, B) triple will not change too much. Hence, the stego'd image (container image + embedded image) will not be visually too different from the original container image. To recover the hidden image, one performs the reverse operation, i.e., the stego image's least significant bits are used to re-construct the hidden image. The reconstructed image is degraded but sufficiently clear for many purposes.

Detecting the presence of hidden messages has also been the focus of much research. As the insertion percentage increases the statistical nature of the jpeg coefficients differs from usual and this can be basis for detection. For example, it is known that in monochrome images, the entropy is usually between 4 to 6 bits per pixel. An image with an embedded message such that the observed entropy value observed is to have deviated from the usual by chance alone, is the basis of an approach. Some detection systems actual test the properties of least significant bits for departures from usual Other approaches utilize knowledge of the statistical properties of JPEG images certain transforms of an image are taken and chi-square tests on the resulting coefficients are performed. The resulting chi-square statistic indicates the probability of embedding.

What can we learn from a study of steganography? First, the least important places might make good holes to hide stuff. But as in any scheme of deception, once the adversary knows we might go for the least obvious approach, the least obvious will become the first place the adversary will look for. Secondly, what appears innocuous to the eye may actually be important; and we should rely on statistics rather than visual examination to guard against the possibility of deception - looking at charts to make investment decisions is dangerous. Paying attention to measures like entropy or moments can signal departures from the usual. And of course, deception might be particularly effective when its very existence is not suspected.

6/21/05
Book Review by Victor Niedehoffer: Data Driven Investing by Bill Matson and Mitchell Hardy

Data Driven Investing discusses techniques used by the authors to turn approximately $0.6 million into $4 million over the period July 2000 to December 2004 by investing with margin, in the main in nanocap value stocks. The authors' methodology in motivating their results reminds me of a piece of silver I own where a mad painter rides an octopus on top of a squid with sea monsters jumping up at him from a turbulent sea. In more familiar terms, its like what you would end up with if you had a magnet and Googled every academic journal for an anomaly, every issue of the Stock Trader's Almanac for a seasonal, and every technique in every book in the last five years with a system to beat the market, and all of these were made of iron.

Here are just some of the techniques that the authors tested and/or used to select the buys in their portfolio:

  1. Fed funds rate did go down in the subsequent month
  2. Fed was in a easing mode
  3. Low P/E, low P/S, low P/B, and low P/Cashflow
  4. High relative strength
  5. Low capitalization
  6. The ideal years in the presidential cycle
  7. Combinations of the first six, taken two at a time
  8. Good news
  9. Upward revisions of earnings
  10. Spin-offs one month after they begin trading
  11. Buybacks of value companies
  12. Insider trading
  13. Low activity in IPOs and secondaries
  14. Big gap ups at open
  15. Buy Monday morning
  16. Small companies in December; losers in late December

The managers also buy put options when they think the market is likely to go down, especially during June to September, and they sell Friday afternoons.

There are no statistics on the variability of any of the techniques. And the authors rely on Compustat data that assume perfect knowledge of income statement and balance sheet figures as of the end of the year they invest in.

While the authors understand that data have survivorship problems because the small nanocaps that had been added as of 2000 were not selectable prospectively, they apparently don’t realize that using perfect knowledge of earnings is guaranteed to lead to value's beating growth because of the regression bias, and unexpectedly good earnings leading to subsequent price increases when they are announced. The authors also don’t seem to appreciate the principle of everchanging cycles, or numerous other biases that would take longer to enumerate than the previous list of techniques used.

The authors intend to create a video library of information on companies, including plant tours and management discussions of financials, and this is to be applauded. And they intend to schedule 52 fundraising events per year until they've raised $3.25 million, with 5% to be given to Babson College.

I'd recommend this book highly for teachers of investment classes who wish to use it as a take-home exam. "Comment and criticize."

The authors have kindly agreed to comment on this review. And many of the analytical deficiencies I find in the book do not deflect from what may be the practical value of the book. Indeed, I might be tempted to open a trial account with them myself. However, the problem with techniques that are not properly scientific is that it's impossible to separate the wheat from the chaff, the permanent from the transitory, the recurring from the everchanging. That is the great tragedy of this monumental effort so marred by multiple comparisons and look-back biases.

Coauthor Bill Matson replies:

To the extent you found fault in our work, it appears that the problems generally arose from our being insufficiently clear in making our points. We will certainly take your comments to heart in future editions. In particular, we should have been more emphatic in making the point that we only bet on anomalies that are likely to be sustainable. Sustainable anomalies are likely to arise from such things as:

When we backtested with Compustat data, we assumed perfect knowledge of income statement and balance sheet figures as of the beginning (not the end!) of each year whose returns we tested. As we admit, this introduces about one quarter's worth of look-ahead bias; however, we also note that side-by-side comparisons with O'Shaughnessy's lagged data (from What Works On Wall Street) are consistent with our major conclusions.

Coauthor Mitchell Hardy adds:

Data Driven Investing was intended to help individual investors make money in the market, not as a work of scholarly erudition. We're practical men, not theoreticians, hence the "Data Driven Test Portfolio." To the extent our book lacks scientific precision, that was intentional in that we purposely avoided presenting any advanced statistical analysis that might have limited its practical utility to a wider audience.

Also, it should be recognized that it's probably impossible to explain with scientific precision an activity as complex as the management of a real money portfolio encompassing more than 10,000 trades involving hundreds of individual stocks. A lot of different ideas went into the mix, and if we didn't nail down our every assertion with enough analytical rigor to please our most sophisticated critics, so be it. The proof of the pudding, it is said, is in the eating, and we have been dining rather well off our 890% returns. Anyone who reads, understands, and applies the ideas we presented in our book would likely do pretty well.

Regarding value versus growth stocks, there are, of course, numerous analytical and practical difficulties, not the least of which is defining just what is meant by a growth stock. A mechanical approach that might work to define a value stock (e.g. low P/E) tends to break down in picking growth stocks. A high P/E stock might be a growth stock or it might just be an overvalued stock. People who invest in growth stocks tend to think they are smart enough to pick companies whose earnings really will grow fast enough for long enough to justify the high prices those stocks typically command, but "smartness" in this case is hard to define quantitatively. We've made a lot of money by trading on "unexpectedly good earnings" announcements, but the bar of expectations is generally set very high for growth stocks; they really have to perform to create unexpectedly good earnings, but the penalty for unexpectedly poor earnings can be severe. Having said that, the effect of one quarter's worth of look-ahead bias on the significant differences we've observed between the returns for low price ratio (value) stocks and high price ratio (growth) stocks does not materially affect our conclusions.

Lastly, I rather like the image of the mad painter atop the octopus, etc. I've never heard my coauthor described so aptly.

6/21/05
Ten Variations On The Theory of Least Effort, by Victor Niederhoffer

Article: Human Brain Applies Law Of Least Effort When Solving Problems
Old Speculators’ Association Forum: Markets and the Theory of Least Effort

  1. I first heard of the theory of least effort when reading Nock's Memoirs of a Superfluous Man as he used it to explain the tendency of birds and humans to prefer welfare to work, nay I heard of it when my grandfather would always tell me at the age of 13 that "the path of least resistance now would be down in the market" since it was so far above the 1929 levels. Recently I note that two scientists at the Carnegie, Eric Reichie and Patricia Carpenter have shown that the brain uses least effort to solve problems that can be solved alternatively by visual or verbal methods. Whichever way the student is better at, they use to solve the problem and the better they are at a problem the less they have to work to solve that problem. They use MRI's to show that " brain functions associated with a verbal strategy produced relatively more activation in a network of brain areas specialized for language processing, including Broca's area, which governs the ability to talk. The use of visual strategy shifted the activation towards a network of brain areas particularly the parietal cortex ". Perhaps this provides an alternate explanation over and above the mumbo one as to why some use charts and some use counting.
  2. I find the distribution of prices classified by the leading number like 97 equals 9 much too regular for chance. Do prices cluster by levels much more than they should? Here's a rough estimate of the distribution of prices by leading number as of year end 2004:

       Number of 10's        Number of 1's
         in lead digit           in final digit
                10                            4
                9                              8
                8                              2 2 8
                7                              none
                6                              1 2 3 4 6 6 777 9
                5                              00 11 22222 3 5 6666 899
                4                              0 1 222 3 4 5 7777 8 999
                3                              0 0 11 2222 3333 44 5 666666 7 8 999
                2                              0 11 3 0 3 4 5 6 77 88 9
                1                              0 0 3 4 55 6 7 8 999
                0                              4 7

    Why no 7's and why none above 104? And so many thirties.

  3. The explanation for this to me is not splits but the forces that cause the canopies of trees to be so uniform in height. The tree has the choice of growing to get more food versus the difficulty of getting the water up there. When there's more sunlight unbroken above, it's always easier to grow the extra foot, and they choose that option.
  4. It’s so easy to push the opponent over when he's leaning the wrong way. The market mistress always looks to see which way everyone is leaning and then takes the easiest path. Most people lean in the same direction as they recently and most vividly made some money--- and this provides so much grist for the mill.
  5. The same way people develop templates to solve problems via least effort, thus reducing the dichotomy between mind and brain, a la the Carnegie paper, the market develops easy solutions to keeping its infra structure going. And why not keep it simple by using the smallest number of methods of making the public contribute to the upkeep. That's why patterns work. But the problem is that the patterns are always changing.

To be continued. Your suggestions and augmentations appreciated.

Sushil Kedia responds:

The theory of least effort, in all its possible manifestations revolves around the concept of the path of least resistance.

Even revolutions, wherein individuals may endure much more hardship than in the prevailing order, are incited and sustained by mapping individual minds to a collective emotion that appears to be the path of least effort in obtaining a much larger comfort which otherwise is seeming improbable.

Resistance to collective thoughts or collective action which when minimized have produced more lasting and richer outputs. Mark Twain in America or Shakespeare in Britain or Kabir in Indian all have a common characteristic in producing long-lasting literature because their choice of expressions (words and ideas) related to the masses, producing least resistance.

Thoughts, principles and philosophies originating even from the sciences have found resistance of the highest order when the communication was such that was offering a high resistance for the masses to understand. Scientists who could convert their findings into a readily usable 'invention' were embraced and those who let complex-theories hang in there met with proportionate resistance. Needless it might be to illustrate here the example of Copernicus's landing in jail. His thought being right he was still wrong in the theory of least effort.

I assume that the human mind which has evolved through inheritances of wisdom (ability to apply gathered intelligence), has been getting increasingly codified with the evolving perception of the physical reality. So if mankind has seen water finding its level and has considered it to be a law of nature, the mind too is conditioned with these observed laws of nature. The path of least resistance and thus the theory of least effort is at the centre of all perceiving we humans may have been through generations. The brain thus operated by the mind, seeks methods of least effort.

The unending rise in the popularity of P/E ratio is because of its simplification of a much more elaborate discounted cashflow value since the mind on average operates on the theory of least effort.

Let for a moment it be granted here that price is discovered at any given moment of time when the vector sum of all existing and expected bets in the market turns zero; where each of such individual bets is a vector represented by individual willingness & individual ability (classical demand & supply ideas).

If one were to choose what most others have chosen to do or are willing to do, one could hope to be rewarded at best the same as these most others after taking care of the vig. The collective vector sum of willingness (that keeps fluctuating as explained by the idea of reflexivity) and ability (that too keeps moving as per reflexivity) produces a mammoth resistance for the vig to be collected. Hence, the market in turning this vector sum to zero, moves away from the consensus.

Therefore, to get extraordinary rewards one might have to find that point of least resistance where either collective willingness is overstretched and/or collective ability is overstretched.

Trendfollowers as also the contrarians are then both the birds of the same flock since both seek the path of least resistance. The first seeking to profit when majority action is high on ability and low on willingness (read as disbelief or confusion) thus making the trend prevail. The latter seeking to profit when the majority action is high on willingness as compared to the prevailing ability thus starting diffusing yet another consensus while letting the market mistress turn the vector sum of all existing and expected bets into zero.

Tom Ryan responds:

My variation on least effort as it relates to markets is that the path of least effort for the marketmaking ecostructure to extract the maximum level of vig from its participants is to encourage as much turnover in positions and volume as possible. For example I would not be surprised to see by the end of my lifetime an additional set of option expirations at start of month as well as third week. Anyway, the path of least effort to encourage high turnover is to create maximum uncertainty in participants just prior to a calendar effect such as the close of the day, the last hour of the week, the last day of the month, last week of the quarter. And lately with the market so flat in the last week right before earnings announcements and end of quarter this looks like another attempt to sow uncertainty and a set up for a bout of early July volatility.

6/21/05
What a Great Life Story!, from Henry Carstens

6/21/05
Quiddities, by George Zachar

6/21/05
Turn, Turn, Turn, by Jim Sogi

Full moon, summer solstice, highest tides here in memory. As the summer turns, the garden plants all start to seed. Many changing cycles on such a day.

6/20/05
Blackjack and Options, by Rick Ackerman

I went to a seminar a while back, intrigued by the promoter's claim that any idiot could make money using his option system. I've traded puts and calls on and off the floor for nearly thirty years and have always found it quite challenging, particularly as a retail customer, to achieve a positive expectation of just 1-2%. I wrote up the seminar's well-marketed plan in my daily advisory service, soliciting positive comments, but received only negatives from disappointed grads.

The first guys to strike it rich on the options floors were blackjack players: Ken Uston, Doc Reppert, Ed Thorpe, Blair Hull et al. Guys who had wearied of having casino thugs looking over their shoulders all the time. But the options game has gotten much tougher over time, and, casino goons aside, the thought of a steady 3.5% playing Revere High-Opt against a five-deck shoe makes me nostalgic for the Trop, Sands, Riviera and Flamingo.

6/20/05
Primal Scream Stock Screen, by Big Al

Do people still watch CNBC? Evidently, there are a few who are watching between 6-7pm Eastern. I have been one of them more than once. Primal Scream's show has three basic elements:

  1. An interview with a CEO or somebody like James B. Stewart
  2. Primal's responses to viewer call-ins and emails
  3. Primal's own stock picks

The action is in Primal's own stock picks, mostly when they have small market caps. If he picks something the size of a HAL or SLB, there isn't much of a reaction (exception: SHLD). But look at the 10-day charts for BEAS, TIBX, OII, GW, SWKS and MLNM, and you can see quite clearly when Primal recommended them, whether you watch the show or not. You can actually see the stocks pop on the after-market ticker at the bottom of the screen.

Pam Van Giessen replies:

Do people still watch? Sort of, a little. Ratings for Primal's show are the highest ratings CNBC is pulling right now, but at something like 180,000 viewers, that is not much. Consider that 60 million people tuned in for The Beverly Hillbillies in the 1960's. CSI garners about 22 million today and Donald Trump brings in 15+ million. I bet HSN gets more viewers than Primal Scream.

Jeff Sasmor adds:

It's also fun to fade the picks of popular newsletters, some have skillions of subs and proffer picks of low-priced low-float stocks that often move the day after the picks appear via email.

Not as entertaining as watching Primal's veins bulge as he hits the sound effect buttons.

6/20/05
Wooden on Leadership, Reviewed by Jim Sogi

Wooden on Leadership is one of the most profound and insightful books I have read. Though I have never played basketball, this highlights the important lesson that wisdom can come from many different areas, not just your own area of expertise. Wooden lists the basic building blocks of success. Their applicability to trading is clear.

  1. Industriousness. Engaged, focused, absorbed activity.
  2. Enthusiasm. Eagerness and having your heart in the activity.
  3. Self control. Control over emotions and acts.
  4. Intentness. Diligence, determination, fortitude, resolve, persistence, patience.
  5. Initiative. Failure to act is often the worst failure of all.
  6. Alertness. Pay attention. Stay in the game. Be ready for opportunity.
  7. Never be satisfied. Work constantly to improve and adapt to change.
  8. Poise. Never getting rattled, thrown off or unbalanced.
  9. Confidence. The knowledge that your preparation is complete.
  10. Condition. Top physical, mental and moral strength is required.
  11. Skill. Master the basics.
  12. Attention to detail. Small things add up to either success or failure.

6/20/05
Down and Out in Paris and London, by George Zachar

Non-financial European observations from my recent trip:

Paris:

London:

6/20/05
Cake Cutting Algorithms, by Saurabh Singal

A and B want to divide a piece of cake into two equal parts; how do they do it so that each is satisfied he got at least a fair share? Cake Cutting Algorithms: Be Fair If You Can by Jack Robertson and William Webb is a book that answers questions such as this and discusses related but more complex problems.

The classic solution to the question posed above is called "cut and choose": one person divides the cake into what he estimates are two equal parts and the other chooses a piece. It is straightforward to see why this works.

But what if there are more than two people? Or instead of equal halves, it is agreed to divide the cake in some other proportion, say a third to A and the rest to B? These are the types of problems that the field of "Fair Division" seeks to answer. Incidentally, this branch of knowledge was started in the 1940's by the famous Polish mathematicians Banach, Steinhaus and Knaster.

The problem of fair division for more than two players is more complicated than one might assume at first sight and the authors present several plausible schemes that fail. After pointing the drawbacks of these, they also present several algorithms that will work. I will describe two of them that I found very elegant.

In the Moving Knife Algorithm, a knife is continuously passed over the cake from left to right and the first person who thinks the portion between the starting position and current position of the knife is 1/N, can shout "stop" and he gets that piece and drops out. This step is repeated on the remaining part of the cake and the remaining N-1 players. When only one person is left he takes what is left.

In the Trimming Algorithm, Player P1 cuts what he estimates to be a 1/N of the cake. This is passed to players P2, P3, Pn successively; any player who thinks he has been passed a piece bigger than 1/N trims it so that the reduced value is exactly 1/N in his estimation. When the piece reaches the last player, he can either accept it or else this piece is given to the last person who trimmed the piece. This person will drop out. The remaining N players will repeat the procedure with the remaining cake and as before, when only one person is left, he takes whatever part of the cake remains.

If two players are to divide the cake in non-equal parts, say 2/5 to A and 3/5 to B, it may be tempting to "clone 2 of A" and "clone 3 of B" and apply the above algorithms, but the authors point out that if the ratio is irrational, say A gets 1/sqrt(2) and B gets the rest, then there are fundamentally different approaches needed.

The book also discusses fair division in settings under disagreement, i.e., scenarios where different players disagree about the value of different pieces of the cake, and the authors show that in these situations there is always a solution where there exists not only a solution such that everyone believes he got a fair share but also there will be some part of the cake left over. As a toy example, if A estimates the value of the two pieces as 40% and 60% whereas B estimates them as 60% and 40%, then giving A the second piece and B the first piece will result in each getting a piece he believes to be bigger.

A more realistic example presented in the book shows the serendipity of disagreement. Suppose N persons have claims to equal shares of a property bounded on the north by a lake (curvilinear, irregular boundary), to the east and west by vertical boundaries and to the south by a horizontal road. They agree to have equal access to road and beach; how does division proceed so everyone is satisfied? The authors suggest (and prove the correctness of) a really interesting algorithm. Each person is given an aerial picture of the real estate and told to divide it into N equal parts. If there is complete agreement, that is, when all the pictures are superimposed, the markings made by each player is identical to that of every other player, then it is trivial. But the more intriguing result is that if there is not complete agreement, it is then possible to give each player a division he estimates to be a fair share and at the same time, still have some land left unassigned.

How this is done employs a fascinating algorithm and is described (as well as proved) in this book, which alone made it a worthwhile read for me.

As in any book of algorithms, there is analysis of the number of steps (or number of cuts) needed for cutting the cake, what is possible or impossible in a given number of cuts.

There are other interesting situations, such as envy-free division where every player gets by his estimate a fair share and also believes no one got a bigger share than he. Also described is the envy-free dirty job division, where N people have to do a dirty job, everyone feels he is allocated no more than 1/N of the dirty job and also that no one got a lesser share than he.

Pareto Optimality is discussed. There is an example where the authors discuss how to make risk free bets, i.e., when there are two players who have different opinions on the possible result of a sport match, how it be possible for a third player to structure bets with both of them so as to assure himself of a riskless profit.

Jim Sogi adds:

M. Osborne in The Stock Market and Finance from a Physicist’s Viewpoint discusses the functions of supply and demand and price. An excerpt is enclosed below on the issue of cake cutting. The point that I have been struggling with is that supply and demand do not seem to apply to price distributions on SP futures on the daily/weekly price distribution. Why if price is lower does not volume go up at the lower price, but rather concentrates in a bunch in the middle values, closer to average or vwap. Some other factor other than the 'law' of supply and demand is at work. These may be functions of time, managerial functions of dnlm, outside issues such as college tuition due, death, closure of markets, and structure of market participants, the globex algorithm... What is the reason that the practice does not follow the economic 'law'? This occurs on a larger time frame as well. The lower price does not always create higher demand. The movement of the inside market does not always appear to be a function of supply and demand in globex, but some other factors are moving price. I will address this issue with tick data later related to this afternoon's breakout from the morning range. Here is what the physicist asks on the cake cutting issue.

6/19/05
Oil Price, by Andrea Ravano

The first time I heard about oil scarcity I was 15 years old, and the Arab/Israeli 1973 war had just ended. The embargo followed and in Europe we experienced the famous car-free Sundays, but mostly consumers started looking for fuel efficient cars, heating systems and industrial production plants. I remember my mother's Fiat 850, a super-compact model, circa 1970, burned the same amount of gasoline as a Mercedes SW 3000cc of 2005. In those days we listened to Cassandra predicting the end of Arab oil reserves by 2010, only perhaps to justify the greed of "oilers" to earn a fast buck. Now, 2005, here we go again with the barrel skyrocketing under the same pressures, and Italians have discovered that most of their diesel engines run on oil of colza! It took oil about 20 years to return to $40 per barrel. The problem is: when are we going to short, $60, $70 or $105 (not $100, mind you) predicted by Goldman Sachs?

6/19/05
Jim Sogi's BBQ Sauce Recipe

3/4 cup soy sauce
3/4 cup sugar
3/4 cup water
3 inches fresh ginger, chopped
1 clove garlic
1 tbsp sesame oil

6/19/05
Korean Barbeque Ribs, by Martin Lindkvist

As I was making the BBQ sauce described by Mr. Sogi, I heard my better half on the phone with one of her friends: "Martin will go to New York in early August, as he is part of this...". She could not find the right word to describe the Spec Party and instead continued, "Well, he is attending a meeting." Then I heard her continue, "Sect? No, I would not call it a sect...", and I chimed in "Yes, it's a BBQ sect!", at which she laughed heartily.

She laughed until she sat down, but when she started eating...

The BBQ was a great success. And to understand my joy one has also has to understand that I am not usually successful in the kitchen. And of course here is where the application to trading comes in. With the right recipe you can be a success both in the kitchen and in the markets. By choosing the right cuisine (market), the right dish (method), carefully noting that the right dish changes depending on a lot of things such as which guests you are having (changing cycles) and following a proven recipe (a method which has stood up to some counting), we stand a better chance of attaining success.

6/19/05
Identifying the "Public," by Ken Smith

Much ado about the public is ubiquitous, here and elsewhere. Who is the public? The guy on the streets with white socks, the gal with the flowered skirt, the bawling child in the stroller?

Not in terms of the market mistress. The mistress, at her commanding heights, considers the public to be all the thousands of mutual fund managers, the hedge fund managers, the insurance company traders, bank traders, pension fund traders. In short, as far as the mistress is concerned the public is an assortment of money managers.

The mistress does not concern herself whether the guy with white socks washed them this week or last. The mistress does not concern herself whether the gal with the flowered skirt is wearing panties. The mistress does not concern herself whether the bawling child needs attention or has dirty drawers.

No. The mistress of the market is intensely focused on money managers, upper level traders, Ivy League employees of white shoe establishments. When sly innuendos, disparaging remarks, comedic repartee, and downright nasty animadversions are said about the public it is not, by any realistic meaning, a reference to the common citizen.

Who's fooling whom? The public doesn't have the kind of cash the mistress requires for her diet, a very, very rich diet. The fooling is of the self. It is money managers. They are the public. They have the people's money. They are the new suckers. Is that a strong term? Well, who is it that the market mistress makes fools of? Traditionally that ignominious word has been applied to the man on the street, the guy with white socks, who always bought and sold at the wrong time, thus feeding the affairs of the market mistress. But here, in this new understanding, we see and come to realize the truth, a new paradigm.

Money managers are the public. That's it. The mistress gets her abundant needs met by money managers, not the public as we traditionally understand the term. To speak of the public is to speak of money managers.

6/19/05
Chess and Trading Opinions, by Nigel Davies

On the subject of opinion there is something strong chess players tend to do which might have an application to trading. The words I stand better are never really uttered in the internal dialogue. It's a statement that carries too much permanence when it is verbalized because a retraction has to be made if the assessment is changed.

I'm having trouble describing my impressions but one of my students recently wrote about it in this way:

Dear Nigel, The ideas were flying last night and that was great. It's interesting the way you look at a deep line in a quiet position, seriously trying to find best moves, but not thinking that it is the truth about the position, just as an experiment to illuminate the nature of the situation. And you call it "just playing with the position".

Translated into trading, one might decide that the market has to be bought and then act on this, but without ever uttering the statement I am bullish. I believe this may make it easier to stay light on the feet.

6/18/05
Backgammon Stop Loss, by James Humbert

I just played two of the most amazing backgammon games I have ever played, and what transpired, back to back, has to be the most excellent example of "never give up", "winners never quit", winning while facing statistical impossibility, you name it.

I was willing to throw in the towel in the first game, yet my opponent and great friend reminded me that "you never know what can happen, you just never know", so we continued on. The board was screaming gammon or backgammon. I removed my stop from the game, and with average dice, came all the way back, and gammoned my friend. What happened in the next game, as you can imagine, was the exact same thing, but I was on the losing side.

Obviously, stop-losses are a way to protect yourself when you make the wrong decisions, or the market is ruthlessly taking your capital from you. This board game instance and market survival are incredibly different situations, but it brings about the question that is never easily answered: "When is time to call it quits in a trade?"

Over the last seven or so years, the professional hedge fund investing community gradually and increasingly has shifted to a "do not lose money" (DNLM) mantra. Events such as LTCM, Julian Robertson's shorting tech in the late 90s, the Russian debt crisis, etc., have forced managers to do monthly, or even biweekly, reporting to their investors. Tight stops are more and more apparent in the market. "Let's not be too wrong, and just survive and boost AUM" is the widespread strategic focus. I believe implementation of such strategies is stripping alpha from the marketplace, or you have to be willing to take on a heck of a lot more risk to capture it, but DNLM prevents you from being rewarded with the ever-more illusive alpha.

I went into April with the most bullish call I've ever made, buy the homebuilders, and with 3-4 to 1 leverage, one bad day was enough to scare the heck out of the powers that be. Being encouraged to get flat, or should I say, forced out, resulted in the obvious: to Friday's close, my beloved Hovnanian ran approximately 40%.. .

A Major Quant replies:

This DNLM mantra observation is dead on, but of course this would imply the lack of stop-loss use. A DNLM mandate requires a (very) left skewed distribution (right skewed would entail losing money often) and clearly these are the stock-in-trade of the hedgefund crowd. Stop-loss implies right-skewed. Prevalence of stops would also create higher vol, of course.

Steve Wisdom adds:

The relationship between the seasoned hedgefund trader and his assorted FoF/MoM/allocator/advisor/private-banker clients is well-analyzed by French fabulist Jean de la Fontaine (1621-1695) in his fable Le Meunier, son Fils, et l'Ane.

One English-language variant is:

A man set out on a trip with his son and their donkey. His son sat on the donkey's back while he walked along beside them.

They passed through a town. People stared at them and said, "Did you see that? That strong, young boy is riding while his aging father has to walk."

Hearing this, the man swung his son off the donkey and got on in his place. On they went.

They passed through another town. People stared at them and said, "Can you believe that? The man rides on the donkey like a king while his little boy grows weary running by his side."

Hearing this, the man got off the donkey, and both father and son walked, leading the donkey by the reins.

They passed through another town. People stared at them and said, "What fools to walk when they have a donkey they could ride!"

Hearing this, the man put his son on the donkey and got up behind him.

They passed through another town. People stared at them and said, "How cruel, to make that poor animal carry the weight of two!"

Hearing this, they dismounted. By this time, the man was very angry. He put his son on the donkey's back. "This is the way I left home, and this is the way I will continue," he said.

6/18/05
Hard Work, by Jim Sogi

Power and grace. Those who have achieved mastery of their craft perform with power and grace, making moves of great difficulty with apparent ease, executed with strength and individual flair. Young tennis champion Henin-Hardenne, sensei aikido master Ueshiba, surfer Shane Dorian: all perform feats of strength and astounding speed with apparent ease that belies years of painful training, many setbacks, losses, doubt and sacrifice. The road to mastery is long and hard. A highly ranked tennis player once said it takes about five years to learn the basic skillset of almost any human endeavor and to perform at journeyman level, whether in sport, carpentry, law, trading or cooking. Surpassing journeyman level requires continuing devotion, love and passion. Each day, continual failure on the road to success is another reason to quit, another reason to make excuses, another reason to rationalize, slack off , blame others, and avoid personal responsibility. Masters continually train, learn, reinvent, re-examine every aspect of their areas of expertise, and the quest becomes not just an examination of a sport, profession or avocation, but a quest to learn who we are as humans, the nature of our existence and purpose. This quest marks the achievement of success. As John Wooden says, it is not the comparison with others' performance, it is doing the best that an individual is capable of. As Batman says,  we are not defined by who we are inside, but by what we do.

6/18/05
Attention Bias, by Kim Zussman

Is the herd of investors too attracted to current attention-grabbing stocks, or by analogy, market moves? Is it human nature, in combination with limitation of search/testing capability, that leads many investors to stocks with spikes in volume and/or price?

Terry Odean looked at this and found that individual investors, in contrast to institutional investors, were more attracted to big volume and price moves. Individuals were net buyers of both large one-day drop and large one-day gain stocks. This is consistent with "attention bias" for both contrarian and momentum investors, which Odean goes on to suggest gives poor results in either case:

We argue that many investors solve this search problem by only considering for purchase those stocks that have recently caught their attention. While they don't buy every stock that catches their attention, they buy far fewer that don't. Within the subset of stocks that do attract their attention, investors are likely to have personal preferences contrarians, for example, may select stocks that are out of favor with others. But whether a contrarian or a trend follower, an investor is less likely to purchase a stock that is out of the limelight. Professional investors are less prone to indulge in attention-based purchases. With more time and resources, professionals are able to continuously monitor a wider range of stocks. They are unlikely to consider only attention-grabbing stocks. Professionals are likely to employ explicit purchase criteria perhaps implemented with computer algorithms that circumvent attention-based buying. Furthermore, many professionals may solve the problem of searching through too many stocks by concentrating on a particular sector or on stocks that have passed an initial screen. We test for attention-based buying by sorting stocks on events that are likely to coincide with catching investors' attention. We sort on abnormal trading volume, since heavily traded stocks must be attracting investors' attention. We sort on extreme one-day returns since whether good or bad these are likely to coincide with attention-grabbing events. And we sort on whether or not a firm is in the news. Consistent with our predictions, we find that individual investors display attention-based buying behavior. They are net buyers on high volume days, net buyers following both extremely negative and extremely positive one-day returns, and net buyers when stocks are in the news. Attention-based buying is similar for large capitalization stocks and for small stocks. The institutional investors in our sample especially the value strategy investors do not display attention-based buying. Our theoretical model, which is based on the assumption that some investor purchase decisions are influenced by attention, predicts that when investors are most influenced by attention, the stocks they buy will subsequently underperform those they sell. We find strong empirical support for this prediction. Not only does attention-based buying not benefit investors, but it appears to also influence subsequent stock returns..... The attention-based buying patterns we document here do not generate superior returns.

Currently, retail investors can access trading platforms such as Tradestation, Metastock and Cybertrader to identify technical patterns in individual stocks. So a contrarian strategy in such an environment would be to eschew attention-grabbers and invest in the unremarkable.

In a world of investing dominated by hedge funds, perhaps there are analogous, but more sophisticated, attention-grabbing stocks, patterns, and anomalies being arbed and leveraged to the point where the only good strategies will be the ones that aren't good historically.

6/18/05
Counting Playboy, by Marion Dreyfus

Here's some counting and compiling on the run of Playboy magazines, from inception in '53 up to today. It may answer some of your questions. Compiling it was instructive -- but is there a deeper pattern evident under these mounds of, ah, flesh? Read on.

6/18/05
Fatherly Advice, by Jim Sogi

On Father's Day I think back to some of the things my father told me. My father was a lawyer on Wall Street and Park Avenue for 40 years. When I first started my career he told me something I've never forgotten: "Don't worry about the money. Work hard. Do your best. The money will come on its own."

He's right. Money is not the goal of a profession or a job. It's a byproduct of hard work, character and integrity. In trading, profits are the byproduct of hard work, enthusiasm, development of personal character and integrity. Doing the right thing in the market is not making the most money; it is doing what is appropriate for the market. Seeking more money can lead to loss or frustration.

Another thing he told me: "Work hard on the small cases at the beginning of your career. The issues are the same and just as important. The only difference between the smaller matters and the big cases is the number of zeros." In trading, the trade of a handful of contracts is the same as one of hundreds. The only difference is the number of zeroes.

6/18/05
Review by Victor Niederhoffer: The Hidden Language of Baseball

I hasten to recommend The Hidden Language of Baseball by Paul Dickson. It's about how signs and deception have influenced the course of baseball. Did you know that there are about a thousand secret signs given in a baseball game?  The infielders signal the outfielders, for example, on where every pitch is going. Umpires signal their colleagues to come to their aid when a manager gets overheated. A squeeze play involves about 10 signs starting with the coach to the batter to the runner, back to the coach and the hitters, and then from the opposing catcher around the merry-go-round to his fielders, and then a pitchout or a strike -- and the whole thing starts over again.

The book leads me to consider the influence of secret signs on markets. Sure, there are the anecdotes about how spotters were paid to wait by the elevator and signal up to the floor when the silver and gold trader for the Hunts was on his way up to buy 1,000. On the IMM, a Nasdaq broker had signals in his shoes so he could front-run any big orders coming in from the public. And there are the white shoe brokerages that apparently make a business of reading signs from their research department and the customer order flow so they can steal the signal.

But what about signs that we can all read. in the first hour of trading on Monday, like the lead-off batter in baseball? Is it significant? Do things in markets occur that can be tested that have analogies to the transmission and stealing and reading of signals in Dickson's excellent book? I declare it open season for such studies and request my colleagues and others to contribute quantitatively and qualitatively to the fray.

Art Cooper replies:

It's more like quarterly window-dressing, in which small purchases are made (though they otherwise would not have been) in order to increase the market value of pre-existing major positions.

6/17/05
Milano Malato, by the Senator

Is there any hope for Europe and the EU?

I just checked into my hotel in Milan, a stone's throw from the Crown Jewel of all the Duomos. I needed to press a shirt and pair of slacks, no iron in the room. was told "it is impossible" to iron in one's room. Darn, I've been leading a dangerous life traveling. Was told housekeeping would be "right up" and I said "good, I have a TV show I have to get to." They arrived... after the third call. My clothes never got back in time so I looked crumpled, as usual, on camera.

Just got back in my room, sputtering about the $120 cab ride from the airport, pondering the fact that a seminar-giving friend of mine says he can't do them in London anymore as the hotel makes more than he does.

Wondering if I've just become an old-man cheapskate, I reflected more on a newspaper story that says the average person in Italy wants to retire at 50. Fifty!... Geez, the fun was just beginning at that age.

Then I saw it, my nicely pressed one shirt and one pair of pants, just pressed, not washed, not dry cleaned... and the bill for $24. Yes, $24. And did I mention the porter who showed me into the room? When asked where the DSL line was, he took my computer and tried to plug it into the thermostat.

This not not just one bad trade. I've seen this over and over, over here. Asia and the US, heck Mexico, will eat these guys alive.

6/17/05
Chair's First Annual Office 9-Ball Championship, Westport, Friday 6/17 8pm

The Championship, with the Assistant Webmaster serving as Host and Referee, was a smashing success, full of drama and excitement.

In the first men's match, Henry, whose father was once billiards champion of East Berlin, showed excellent form, technique and consistency, making short work of Ari and emerging as the man to beat. Next, controversy arose in the match between Chris and Tim when, well into the long, grueling match, Chris needed to use the restroom, and the Host invoked a house rule that the Host can fill in for an unavailable player. When the Host ran off the 7, 8 and 9 balls to seal Chris's victory, Tim appealed to the Referee, but his protest was denied.

Next up, Dude broke without success and handed the stick to Tom, who sank the 1, then comboed the 2 into the 9 for a lightning victory. Dude, who was ousted without taking a shot, bemoaned the single-elimination format to the Referee, but found no succor. Then an overmatched Professor fell to Wil's steady, workmanlike play, and he echoed Dude's complaint about the tourney format.

The winners matched off in a round of four, producing the evening's greatest upset. Henry looked invincible against Chris, running off the 1, 2, 3, 4, 5, 6, 7 and 8 balls, but he scratched on the 9, and when Chris made the free-throw, stunned silence fell over the crowd. Next was Will and Tom. Will's play showed improvement proportionate to beverage consumption, and he wore Tom down in a tough match.

In the men's final, Chris's momentum coming off his shocking win over Henry, and fueled by the crowd, proved too much for Will, and Chris took the men's title.

The women's bracket featured solid play from both Ming and Amanada in a match that could have gone either way. But in the end Ming's steady nerves earned her the women's crown.

Finally, everyone was on the edge of his seat for the long-awaited overall championship between Chris and Ming, a see-saw battle finally decided when Ming carried the day with a long, difficult cut shot on the 9. The crowd erupted in cheers. 

Afterward, by popular demand Henry played the Host in an exhibition match. An exciting battle featuring clever bank play was resolved when the Host rattled out a makeable 8 ball, leaving a clean 8 and 9 ball layout that Henry finished off in style.

Men's

Henry       --\ Henry
Ari         --/         --\ Chris
                        --/
Chris       --\ Chris
Tim         --/                     --\ Chris
                                    --/
Dude        --\ Tom
Tom         --/         --\ Wil
                        --/
Wil         --\ Wil
Professor   --/

Women's

Ming        --\ Ming
Amanada     --/

Championship

Chris       --\ Ming
Ming        --/

6/17/05
Stubborn as a Mule, by Andrea Ravano

In the current discussion on growth versus value stocks and the Sage, I would like to share with you some thoughts about the history of my family. My great-grandfather was a man that would not stop easily in front of obstacles and challenges. He wore big moustaches and was an olive oil producer who lived in and around 1850-1870, great times for people innovative with a strong will to improve their standard of living. He was among the first in the Genoa region to switch from animal-powered mills to steam powered machines. Great-grandfather was extremely successful and managed to get for himself and his family a better economic environment and way of living. But with this success story I always asked myself, without getting an answer of course, what happened to the price of mules, the animals that used to move the oil mills? As all olive oil producers switched to the new machines to match competition, I suppose that the price of mules must have fallen quite sharply. The point is here to understand if, going back to those days with a time machine, you and I would have bought shares at cheap ratios and falling prices of mule producing companies, or would we have preferred to invest in the more expensive-looking steam engine producing companies? And how would statistical analysis have helped us in figuring out going short or long the mules market? Maybe it wouldn't have helped at all. Maybe a simple, straight to the point line of reasoning would have been a better tool for decision making. As someone wiser than I used to say, if I cannot explain my theory to the crowd than it is possibly false.

6/17/05
Recent Gains Can Slim Down, by Allen Gillespie

Bill O'Neil has some quantitative and some qualitative ideas worth testing, so I thought I'd put this on the radar. He defines a climax top, which he says is how 8 out of 10 of the Best of the Best top, with the following characteristics:

There is one hot group coming close to meeting many of these criteria by month end, if not within the week.

6/17/05
A Picaresque Tale, by Bruno Ombreux

I want to tell the tale of my early career. It is very comical but also contains a few lessons.

After graduating, I spent a quick couple years in Africa, but soon decided to get back to France. My first job was as a financial analyst. You have to understand that I had never studied finance, only math and biology. They just hired me. I don't know why. But I ended up making recommendations on companies although I didn't have a clue what I was talking about, from the commanding height of my 25 years.

The same year, 1986, I did my first stock trade. This was actually a selling trade. My grandfather had just died, my Mom had inherited stock in his company. She figured that since I was working for a bank, I knew something about the stock market. Wrong guess. She asked me to sell the stock. It took me six months to sell; it was illiquid and I had quite a lot to sell. I just used the same limit order at a round number, 10, for six months. There you have it. Resistance at round numbers. Selling from a major shareholder.

A bit later, I had my first few savings and decided to invest them in mutual funds. The week I decided to invest was the first week of 1987. I was lucky because I had invested in funds with a mix of stocks and bonds. Stocks went down but bonds went up the day of the Crash. I guess I had good reflexes back then, because the day of the Crash, I was at the bank selling the funds I had just bought a few days before. I did the honorable thing and took my losses, which is actually a good thing to do and not obvious when you are inexperienced. And I was lucky because the losses were small thanks to the bonds.

Fast forward three years to 1990. By then I am working in the finance department of a major oil company. I get an internal reputation as a derivatives wiz. They ask me to become an oil trader to help the oil derivatives guys who are losing a lot of money due to rolling in contango. Even though I still don't have a clue about trading, I accept the job, one month before the first Gulf War. The market gets into backwardation immediately after I become a trader. Our book, which was down $15 million the day I joined, ends the year up $120 million.

Management thought this was largely due to my contribution. In their minds, I turned the book over. Wrong guess. But thanks for the special bonus. I can confirm today that I am entirely not responsible for the large profit. You'd have to thank Saddam Hussein. But I took the money anyway. And for the next few years I was considered a superstar within the company. A completely undeserved reputation.

I read Vic's first book and liked it a lot, but since I read so much, it was diluted in the immensity of my readings. Last year, I had a bit of spare cash. I told to myself that I should diversify and try some new things. So I decided to trade sector rotation in a dedicated book. Don't ask me why. One month later, I was down 12% in my sector rotation book. Two months later I was reading Vic's second book which has a chapter about sector rotation and states that it is mean reverting, and that you should test before trading. This made perfect sense too me. That's how I found this site.

6/16/05
Chess Values, by Nigel Davies

One of my personal revelations has been to acquire a greater understanding of how someone's values can affect his thinking. I knew this was the case in chess but never imagined it would also apply to something as "simple" as world finance.

But if the Sage played chess how would I suggest someone try to beat him?

If he didn't have published games, I'd study the man. I think the lunch auction on eBay says a lot about him, that he wants to be seen being doing the right thing (his public persona is important to him) but at the same time isn't motivated by a spirit of generosity (why not just give the money away?). I also sense something darker (why would someone with such apparent respect for 'value' would have someone else pay $200k to have lunch with him?).

Creating a game plan from this information, I'd suggest playing something provocative enough that it would be an embarrassment to him not to win, whilst at the same time obliging him to sacrifice some material (i.e., give up 'value' for the dynamic 'growth' of his position) in order to exploit it. This would nicely drive him nuts if the right vehicle could be found, not easy to bring off in every game but now and then it should be possible.

What would it be best to avoid? Relatively simple positions where you'd be material down. Although he might mis-assess value versus dynamism, I believe he'd play any position with a material advantage with great care and enjoy every minute of it. What's more he'd probably call his friends over to the board.

Summing up, he's a tough old grinder you'd need to tease and confuse. Try to use his bias towards value against him by threatening to take one of his pawns - you can be fairly certain he won't be sacrificing anything at any time unless the win is arithmetically clear.

6/16/05
Pocket Rockets, by Victor Niederhoffer

Don't underestimate the brilliance of Adam Robinson's recent book The Rocket Review Revolution: The Ultimate Guide to the New SAT and the value for a lifetime of teaching kids to focus on bottom line answers and estimates.

All of Adam's books are a perfect realization of the contrarian persona in real life. He shows you how to understand the average test-givers Joe and Pam, what they want you to do so they can ply their trade, and then how to go beyond that to reach the top of the class. Adam inspired me to write a program that applies his techniques to beating the market mistress at her own game, and especially to prevent her from making you always answer the hard questions wrong,. We still use the approach today.

I found Adam's discussion of how to write an essay educational on many planes:

The end result is: you learn how to answer questions, to get to the bottom line, to estimate, to guess, to focus on what counts in tests for admission to college, in the market and in life itself.

6/16/05
Know Your Enemy, by Jim Sogi

A couple of decades ago, when I was getting back into the martial arts, I was working out at a friend's Tojo. A guest was there and we were sparring. In my inexperience and as a lower-level practitioner, I entered the match aggressively. The "guest" was non-aggressive and backed off as I pressed, wildly at times. At a one point during one of my attacks, he let me punch, pull me in as I swung, grabbed my head when I was off balance, and smashed his knee into my face, not hard, but enough to teach me a lesson I have never forgotten since. Know your enemy before you engage. I didn't know him or his skill level and entered aggressively, foolishly. Except for his graciousness, I could have been severely injured. Don't expect the same courtesy in the marketplace.

In the markets, though identities are not shown, participants have footprints. Study them well. Know who your enemies are. Know where they hide, and where they are looking to put you down and catch you off balance. Always maintain balance, in attacks and in defense. Don't get involved over your head. Always protect yourself. When you see an easy opportunity, a sign of the opponent's weakness, when they are off balance, go aggressively for a strong win. Always leave an exit open in case you fall into a trap.

Musashi would deliberately show up an hour or more late to a fencing match. He would wait in secret and watch. Then opponent was already off balance and out of joint. Sometimes showing up late for the match can be to your advantage. Wait, watch. Pick your spot to attack when the opponent is least able to defend.

Nigel Davies replies:

In chess we can look our opponents' games in databases; in markets we can analyze historical data, whilst in fights I guess you should watch the other guy fight or at least move. So when your opponent in this fight was backing off I suspect he was checking you out. I do the same if I don't know my opponent, trying to glean information from everything about him from the moment he sits down at the board.

But here's the question: Was the lesson here a matter of not knowing your opponent's strengths or not knowing yourself? The latter may be more universally applicable; every game is a dynamic in which the opponents vary but we are the common factor. And our errors manifest themselves in different ways against different opponents unless we get to the root cause.

Bruno Ombreux adds:

I practiced some martial arts, although not at the expert level. I have a slightly different experience. From what I've seen, the best moves don't involve analysis at all. You don't really think about them or about your opponent.

In Kendo, there is what they call kitaiken, which is the fusion of ki (spirit), tai (body) and ken (sword). When kitaiken happens, you act automatically.

It is not at all a Zen-like emptiness of the mind. The mind is perfectly aware of what is happening, but it is a spectator of the kitaiken, rather than an actor.

The resulting moves are fast, fluid and beautiful, and the opponent generally is beaten. This state comes from training. After repeating the same move hundreds or thousand of times, it becomes a reflex.

The same thing can happen in short term trading. Sometimes I make kitaiken trades. They come automatically, I find them beautiful and generally these trades are successful.

Ken Smith responds:

Experts in martial arts have learned by experience and that's the best teacher. I do not know martial arts. The only fighting I've had to do was down-and-dirty street fighting, where no one is a gentleman. I never practiced. I am quite certain a practiced martial arts individual would put me out of business in a minute. On the other hand, that's not the kind of individual I fear, in general. Because a philosophy, a way of life, a style of character, comes along with martial arts practice. And they don't go around picking fights. And I don't and never have.

Jim said know your enemy. That is possible if, as in his story of the Master, you can observe the enemy. It is not always possible to know your enemy. Prisons and the streets are full of persons who can be your enemy and you will not know it until you have been struck. A mugger does not give you an opportunity to get to know him, his style, his courage.

The best one can do is be on the alert for signs. Signs are nonverbal most of the time, but not always. Sign reading can save your wallet and your life, can save you a trip to the hospital, can help you avoid a conflict, take defensive measures, maybe even run. If there is no escape, one must be mentally prepare as a way of life. A sign reader may make his own sign, like that of the rattlesnake, e.g., "Danger here, don't tread on me." These signs may be enough to avert trouble.

Chair's friend Bo Keely, a practiced reader of signs, is in supreme physical shape, constantly gives himself near-heroic physical tasks, has experience as a wrestler, is fast on his feet, has a strong punch (as I recall from experience), handles scorpions, and looks cobras in the eye from 12 inches away -- a feat he admitted to me was perhaps foolish.

Sushil Kedia replies:

The ancient Chinese warrior Sun Tzu taught his men to "know your enemy" before going into battle.

For if "you know your enemy and know yourself," he wrote, "you need not fear the result of a hundred battles." But, Sun Tzu warned, "If you know yourself but not the enemy, for every victory gained you will also suffer a defeat."

Finally he reveals, "If you know neither the enemy nor yourself, you will succumb in every battle."

Elaborating further in the Art of War, Sun Tzu has explained the significance of knowing the weather and the terrain and hence is explained origin of the saying, "If you know the enemy and know yourself, your victory will not stand in doubt; if you know Heaven and know Earth, you may make your victory complete."

Without elaborating the entire Art of War here, I would briefly mention that possibly in knowing the enemy, the emphasis has been put in Sun Tzu's doctrines on knowing the strategy of the enemy, for he espouses several times about excellence being in winning a war before fighting it and the objective of war is defeating the strategy of the enemy.

The entire text of Art of War is available freely at Project Gutenberg.

Kevin Bryant Responds

As a fellow martial artist, I have found many lessons in my practice relevant to life in general and life as an investor. Your point here is well taken. Unfortunately, perhaps a comment on my status as a relative outsider (not one of the "big boys", words someone used), knowing the enemy seems exceptionally difficult since it changes from moment to moment, and, in fact, is not one but several thousand. The analogy one might use a kung fu movie where there's one of those mass brawls. you can choose to step in and hope that you're stronger, nimbler quicker than those whose path you cross but as many as you may take out, you are always exposed to the blow from behind or knife to the back. And just as you may have studied the brawl seeking the best point and time of entry, there are several thousand others watching - and they just might bring along an army. Given these dynamics and countless elaborations on the theme, I’m not sure it's possible to know the enemy, except - maybe - one: ourselves.

If only investing were as "simple" as being a good martial artist.

David Wren-Hardin responds

I am a (lapsed for now) martial artist, and I think there is a lot you can do to "know" your unknown enemy, and a lot of that is preparation and addressed by Sun Tzu and friends. I believe Sun Tzu says at some point "If you are at the disadvantage, retreat. If you have the advantage of numbers and position, attack. If the armies are equal, manuever to gain an advantage, or all is chance." I'm sure I've mangled the phrasing, and probably am paraphrasing my own interpretation. But the lesson is clear: Stay out of dangerous situations where you do not have control. If confronted by a sociopath on his own turf, smile nicely and give him your wallet.

6/15/05
Inspirations for Counting, by Victor Niederhoffer

  1. It's nice to be a poster boy for those who get their kicks from wallowing in someone else's misery. During my 1997 disaster, I mentioned that I find it hard to engage in romance when losing. The trendists and their followers had a field day with that one, saying things like, "It must have been a long time between drinks for Victor." It's now been 23 days since a -10 day for the S&P, and 17 since a +10, based on the last eight years of data. After a period of 15 to 20 days without a drink of a +10 day, if you wait for the next +10 day it's an expectation of +7 over a period of 14 days,  which turns out to be quite consistent with chance. After a period of 20 to 30 days without a decline of 10 or more, it's  slightly bullish, with an expectation of +16 over an average of 15 days to the next decline of 10 or more.
  2. The Henin-Hardenne backhand is the most beautiful tennis shot seen in many years. It is characterized by much bouncing on the balls of the feet, a backswing over the head, a drop of the racket head below the wrist, and then an accelerating unbroken follow-through with a firm wrist ending high above the right shoulder. (Here is where a video clip is worth a thousand words.) It reminds me of a week where Monday is down and the closes on Tuesday, Wednesday and Thursday are above Monday's close -- the expectation for Friday is down 0.5. The reverse pattern -- where Monday is up and the Tuesday, Wednesday and Thursday closes are all below Monday's close, is an expectation of down 1 with a Z of -0.6. Completely random in both cases.

6/15/05
Bull and Bear, by Chris Hammond and Charles Pennington

In a study we conducted earlier this year ("Up the Ladder, Down the Chute," May 2005), we broached the naive question that has turned up countless times: Is there any prospective way to identify bull or bear markets? In our ongoing effort to address this issue, we looked at the end-of-month prices for the Dow from January 1949 through December 2004. We defined a six-month high pivot as a month where the price is higher than all of the monthly prices within six month before or after, and a six-month low pivot is defined analogously. A pivot cannot be observed until 6 months after it has occurred, so we have found all six-month pivots and calculated the returns 1, 4, 6, 8, and 12 months after they can be identified in order to make the study prospective.

The first table is a summary of the average changes 1, 4, 6, 8, and 12 months after the pivot is observed. The expected 1 month returns after a high or a low pivot are roughly the same, and they are about 50% larger than the average monthly returns. Over a 4 month holding period, low pivots outperform highs, and the average, by about 50%. They are all comparable over 6 months. Over an 8 month period, returns following a high are substandard, but over the year, they are marginally better. However, by looking at the z-score for the difference between the returns following low pivots and following "normal" months, we see no evidence that they are statistically different. Likewise for returns following high pivots.

Average Returns Following
        High and Low Pivots
           1 Month  4 Months 6 Months 8 Months 1 year
   High    0.010    0.026    0.040    0.034    0.089
    Low    0.011    0.041    0.040    0.054    0.074
    ALL    0.007    0.021    0.035    0.050    0.077

Returns Following Normal Months
1 Month    4 Months 6 Months 8 Months 1 year
Average    0.007    0.021    0.035    0.050   0.077
STD DEV    0.042    0.072    0.095    0.116   0.150
#Trials    659      653      649      644     637

Z-Score for Difference of Returns after
Low Pivots and after "Normal" Months
   1 Month 4 Months 6 Months 8 Months 1 year
   -0.49   -1.23    -0.25    -0.18     0.09

Z-Score for Difference of Returns after
High Pivots and after "Normal" Months
   1 Month 4 Months 6 Months 8 Months 1 year
   -0.27   -0.33    -0.26    0.63     -0.45
   
Returns After a Low Pivot is Observed
  Date     1 Month  4 Months  6 Months  8 Months  1 year
  Oct-52   0.054    0.056    0.021      -0.004    0.024
  Feb-54   0.030    0.132    0.140      0.196     0.398
  Aug-57  -0.058    -0.100   -0.092     -0.059    0.050
  Jun-58   0.052    0.136    0.221      0.262     0.346
  Mar-61   0.003    0.042    0.036      0.066     0.045
  Dec-62   0.047    0.101    0.084      0.118     0.170
  Dec-65   0.015    -0.037   -0.102     -0.187    -0.189
  Mar-67   0.036    0.044    0.070      0.011     -0.029
  Aug-68   0.044    0.053    0.010      0.060     -0.066
  Dec-70   0.035    0.123    0.062      0.071     0.061
  May-72  -0.033    -0.008   0.060      0.040     -0.062
  Mar-75   0.069    0.082    0.033      0.120     0.301
  Aug-78  -0.013    -0.082   -0.078     -0.025    0.012
  Apr-79  -0.038    0.038    -0.046     -0.019    -0.044
  Sep-80  -0.009    0.016    0.077      0.064     -0.088
  Jan-83   0.034    0.116    0.115      0.146     0.135
  Nov-84   0.019    0.065    0.106      0.133     0.238
  Mar-87  -0.008    0.116    0.127      -0.204    -0.137
  May-88   0.054    0.040    0.041      0.153     0.221
  Jul-90   -0.100   -0.119   -0.058     0.003     0.041
  Apr-91   0.048    0.054    0.063      0.097     0.163
  May-92  -0.023    -0.037   -0.027     -0.026    0.038
  Apr-93   0.029    0.065    0.074      0.095     0.074
  Dec-94   0.002    0.127    0.188      0.202     0.335
  Feb-99   0.052    0.179    0.164      0.153     0.088
  Aug-00   -0.050   -0.038   -0.064     -0.043    -0.113
  Mar-02   -0.044   -0.160   -0.270     -0.145    -0.232
  Mar-03   0.061    0.155    0.161      0.224     0.296
  
Average    0.011    0.041    0.04       0.054     0.074
STD DEV    0.043    0.087    0.105      0.118     0.168
#Trials    28       28       28         28        28
STD ERR    0.008    0.016    0.02       0.022     0.032

Returns After a High Pivot is Observed
Date      1 Month  4 Months  6 Months  8 Months  1 year
  Mar-52  -0.044   0.037     0.004     0.053     0.039
  Jun-53  0.027    0.028     0.047     0.098     0.243
  Jan-57  -0.030   0.054     0.061     -0.048    -0.061
  Jan-58  -0.022   0.028     0.118     0.182     0.320
  Jun-60  -0.037   -0.094    -0.039    0.033     0.068
  Jun-62  0.065    0.051     0.162     0.181     0.259
  Jul-66  -0.070   -0.066    0.003     0.022     0.067
  Mar-68  0.085    0.050     0.113     0.172     0.113
  May-69  -0.069   -0.133    -0.134    -0.206    -0.253
  Oct-71  -0.009   0.106     0.137     0.107     0.139
  Jun-73  0.039    0.073     -0.046    -0.035    -0.100
  Apr-74  -0.041   -0.189    -0.205    -0.264    -0.018
  Dec-75  0.144    0.169     0.176     0.142     0.179
  Jun-77  -0.029   -0.107    -0.093    -0.190    -0.106
  Feb-79  0.066    0.041     0.097     0.009     0.067
  Feb-80  -0.090   0.006     0.080     0.071     0.129
  Sep-81  0.003    0.025     -0.032    -0.036    0.054
  May-84  0.025    0.092     0.076     0.165     0.191
  Feb-88  -0.040   0.034     -0.019    0.037     0.090
  Jan-91  0.053    0.106     0.105     0.102     0.178
  Nov-92  -0.001   0.039     0.067     0.071     0.115
  Jul-94  0.040    -0.007    0.021     0.104     0.251
  Jan-98  0.081    0.126     0.124     -0.008    0.184
  Oct-98  0.061    0.083     0.256     0.277     0.249
  Jun-00  0.007    0.050     0.032     0.005     0.005
  Feb-01  -0.059   0.000     -0.052    -0.135    -0.037
  Nov-02  0.017    0.056     0.007     -0.113    -0.097
  Sep-02  0.106    0.061     0.053     0.166     0.222
  
Average   0.010    0.026     0.040     0.034     0.089
STD DEV   0.059    0.080     0.099     0.130     0.137
#Trials   28       28        28        28        28
STD ERR   0.011    0.015     0.019     0.025     0.026 

6/15/05
Adaptations, by Kim Zussman

I have to go to a funeral tomorrow and was thinking about where our matter is before, during, and after life.

Most organisms spend their lives in one of the three phases of earth environment; gas, liquid, or solid. Amphibians are specialized to spend early part in water and later on land.

Plants are very interesting-part of their structure is below ground and part in the atmosphere. So they are physically split between solid and gas phase, exploiting both. Plants above-ground development is specialized for light collection and gas-exchange. Their subterranean root systems for water and mineral absorption, as well as stabilization and anchorage.

We are starting a cactus garden here, and it seemed amazing how all the different sizes and configurations have adapted successfully. Until I remembered that mutations are throws of dice and we only see survivors of these experiments who fit with their environment.

Chair might query whether the adaptive strategy of perfectly exploiting more than one phase translates to business prosperity or survival. In Creating Modern Capitalism the authors discuss Thyssen Steel in Germany, which became hugely successful by growing beyond original business of rolling steel. Eventually they owned good ore mines as well as steel-manufacturing machine factories.

Microsoft once made just DOS but now is the de facto leader in most applications as well as the OS. Of course there are  Tyco and other conglomerates that may be trying to do too much. In trying to create an efficient plant that best uses what's available there is the risk of making a jungle.

6/14/05
A Veteran of the X-Shaped Desk Pays His Respects

6/14/05
Roger Arnold writes of the Sage:

The Sage has claimed to be an investor for 40 years and has increasingly over time become openly critical of everything involving trading, speculating, hedging, the growth of financial engineering, secondary market lending, derivatives, and as far as I can tell anything not associated with his Bretton Woods era mentality toward money, the economy and the political economic state. During the last presidential election he joined the Palindrome and other political crusaders highly critical of US domestic fiscal and monetary policies, without putting them in some global context and reference. He shows no understanding of the concept of US hegemony or that the dollar is the global currency - that US fiscal and monetary policies are by practical application now global in their scope, even if Fed Congressional mandate does not allow for it.

He is bemoaning the changing financial, economic and social environments as he openly wishes for the good old days, not because they were so good, e.g. 1945 - 1974, but because they made sense to him. He doesn't understand the new world and it clearly frustrates him, like the guy who doesn't like having to use a use a cell phone or a computer but who does so begrudgingly and b#tching the entire time. It doesn't matter to him that these changes have been at the heart of a rising standard of living for the entire planet; what matters is his own selfish desire for stasis. I have watched him morph in this direction for 10 years and have discussed this openly on my radio shows. The Sage is the counter economy, the anti-economy, the opposite of hope, desire, growth and dreams. The Sage would prefer to drag the entire world back to a Cold War era because it is his reference time period and and he is comfortable with all the economic and financial rules associated with it. He is as close to the concept of anti-Chr#st as most of us will ever witness, and I do not offer that belligerently. I can tell you first hand there are old, longtime, large Berkshire investors becoming increasingly agitated and concerned about his behavior over the past few years. There is much the world's people, economies, and financial systems gained through the post-Cold War, US-driven, tech revolution that was not voided by the Nasdaq crash.

Further I find his business philosophies and practices to be suspect, predicated less on providing a tangible benefit validating a transaction between two willing and needful parties, and more by business strategy based on riskless insurance transactions that provide income that is then laundered for legitimacy into other old-economy investments, not unlike the a drug dealer using his profits to buy real estate. Through his insurance operations he pushes paper around to provide companies and individuals with insurance products they must have by regulatory mandate in order to be able to provide their stated business service or function in society in general, insurance products that in many cases aren't worth the paper they are written on, but it is the paper that counts. In other words he is a parasite on the back of the new economy, criticizing the new rules of finance and the regulatory environment while simultaneously exploiting them for maximum gain. This is similar to the attitude expressed by Europeans critical about US consumption while it is that consumption of their products that is keeping a roof over their heads and food on their tables, or critical of the US deficits and fiscal and monetary stimulation while simultaneously being the beneficiaries of such stimulus.

Having made money is not the sole, binary measurement of a mans worth, and I'm not critical of his making money. I am critical of the way he has done so, his disingenuous and pious attitude about how he has done so, his arrogant and self important pronouncements about things he has no real understanding of. He is an observer, a user, risk-averse and critical of risk takers. He is not a participant in this economy, he is a sideline distraction, like the fan at a basketball game who sits in the front row and yells obscenities at the players, and gets media attention for doing so. The Sage is not someone to be admired, he is someone to be ignored. But with so many fawning fans around him and so much media attention feeding them, sometimes he is just too much to stomach.

--Roger Arnold, host of the Roger Arnold Show - a show dedicated to helping people understand the world they live in. Anyone wishing to respond or critique is invited to contact Roger at

Kevin Bryant replies:

This kind of invective that only adds to my suspicion about the roots of much of the negative commentary. If the Sage is "frustrated" then we're all suicidal. Comparing his insurance operations to a drug dealer is an odd comparison to say the least. The non-specific "he shows no real understanding of..." sheds only heat, not light.

I don't always agree with the Sage's policy ideas -- his solution for curing the trade deficit seems a bit fanciful -- nor his investment ideas, but how can I not respect his accomplishments as an investor? Surely the scorecard means something. Surely many of his ideas have merit. Writing him off entirely smacks of a mind that might benefit from some opening.

I don't pretend to know the Sage's mind but I would suggest his ideas about technology, derivatives, and trading are more nuanced than his sound bites might have us believe. Evidence: his friendship and business partnership with Gates, his own company's active participation in the derivatives market, and his occasional forays into "special situations." His dollar bet could clearly be called one rather massive speculation. I understand the Sage's comments as intended to highlight perceived excesses, not that any of these things is inherently evil.

No doubt the Sage's folksy, Midwestern modesty is something of a put-on, but I suspect he realizes, much like Donald Trump, that his name has become much more of a brand than Berkshire Hathaway, and comes with the requisite trappings and responsibilities. And of course even a person of the strongest character would fall victim to the sycophancy that surrounds him. But hardly a reason for outright dismissal. What great investors, traders, speculators haven't been prone to flights of ego?

Victor Niederhoffer reponds:

As to the bottom-line reason why some of us are not favorably inclined toward the wisdom and persona of the Sage, and whether it's sour grapes or jealousy that's at the heart, I can only answer for myself. I feel I have developed a sense of when someone is an imposter, when he's untrue to himself, whether he has a hidden contempt for the intelligence and character of others. I feel the Sage has such contempt, but hides his feelings of superiority behind a veil of fake humility. As a related point, aside from the hundreds of specific points I disagree with him on, starting with his feeling that value beats growth, I believe that his ideas, if followed, would lead to the destruction of the well-being of our society, the reduction of incentives, and the substitution of government mandate for competition. Furthermore, he runs a conglomerate, and my empirical and practical studies show that these are on average flawed. So it's not sour grapes here, and I don't envy him  anything except perhaps the press coverage of his relation with Anika.

Melduke replies:

"The Sage has claimed to be an investor for 40 years..."

The fact is you could have purchased 100 shares of Berkshire Hathaway at 19 exactly 40 years ago. I know. I did. Genius that I am I sold it at 36 not long after.

You might not stomach him, and if you don't, that's unfortunate. Nineteen hundred dollars to 84,000 dollars in 40 years makes him an investor anyone could stomach except for possibly those who never bought the stock in the first place.

If you don't appreciate the way he made the money, then come up with a better idea for the next four decades.

6/14/2005
Nasdaq Options, by Charles Pennington:

Barron's column "The Trader" by Kopin Tan in the May 2 issue (subscription required) gives an informative graph of both the levels and the earnings of the Nasdaq Composite from 1997 to present.

Back in 1997, the Composite was around 1200, with earnings around 20.

Today the Composite is around 2000, with earnings around 80.

So in 8 years, the earnings of the Composite have grown by a factor of 4. That's a growth rate of around 18%. The P/E is about 25. (It was about 60 in 1997 and about 120 near the peak in 2000.) The earnings yield then on the Nasdaq is about 4%, a hair less than the yield on the 30 year Treasury.

So the Nasdaq Composite's earnings have grown at 18% through what I would have guessed would have been a difficult period, which included a big tech meltdown. If the Nasdaq Composite earnings grow by anything like 18% going forward, then in 10 years or so the level that we're at now will be considered very low. How can people still believe that we're in a bubble?

A second point is that long-term Nasdaq call options, as they're priced now, look like very good buys, especially for anyone sharing the bullish view outlined above. To support this, I add a little counting below. (I'll be looking at QQQQ and the Nasdaq 100, rather than the Composite, but that should be close enough.)

Right now QQQQ is at about 38, and you can by January '07 LEAP calls with strike price of 38 for $4.70. They expire in about 18 months. Below are listed the last 13 non-overlapping 18-month returns for the Nasdaq-100. Also shown are the percentage return that you would have made on a 18-month at-the-money leap option for each period assuming that it was priced at about 13% of the strike price, as the options are currently.

PeriodNDX % ReturnHypothetical % call return
12/03-6/05         4             -70
6/02-12/03         39            200
12/00-6/02        -55            -100
6/99-12/00         2             -85
12/97-6/99         132           915
6/96-12/97         46            254
12/94-6/96         67            415
6/93-12/94         10            -23
12/91-6/93         10            -23
6/90-12/91         38            192
12/88-6/90         34            162
6/87-12/88         -6           -100
12/85-6/87         43            231
Average            28%           151%
Stdev44%           283%
Count              13             13

If history is a guide, then on average you'll almost triple your money on these calls. Twice in 13 times will you lose your entire shirt. You lose a sleeve or two on four other occasions. On average though you'll have many shirts in the end.

6/12/2005
Infective Causality, by Kim Zussman

True story: Patient sits up after examination and looks apprehensively at the periodontist.

Patient: "Well?"
Dr: "Knock-knock?"
Patient: "What??"
Dr: "Knock-knock!"
Patient:"Oh. Who's there?"
Dr: "Back!"
Patient: "Back? Back who??"
Dr: "Bacteria!"

Most authorities agree that periodontitis is an infectious disease which occurs in combination with a number of host risk-factors. There has been decades of research aimed at identifying the causative organism(s), and the disease state (active loss of tooth-attachment) is associated with about a dozen bacterial species (and even possibly a virus). Harkening back to the era in medicine when bacterial causality was discovered (Henle and Koch 19th century), "Koch's postulates" were used as the criteria for proof of causality:

1. The specific organism should be shown to be present in all cases of animals suffering from a specific disease but should not be found in healthy animals.

2. The specific microorganism should be isolated from the diseased animal and grown in pure culture on artificial laboratory media.

3. This freshly isolated microorganism, when inoculated into a healthy laboratory animal, should cause the same disease seen in the original animal.

4. The microorganism should be re-isolated in pure culture from the experimental infection. (sometimes another is included which says eliminating the organism from the infected animal eliminates the disease)

As usual there are lots of flaws in this logic: Animal studies may not replicate human, immunocompromise, inability to culture a bug, etc. However it is a good starting point, and many suspected pathogens have not passes this test.

This momentum paper has a component that resembles one of Koch's postulates. To paraphrase:

Winner-Loser momentum is a result of poor credit rating companies. If poor credit-rated companies are removed from the sample, Winner-Loser momentum becomes statistically insignificant.

Such causality criteria could be helpful in more general tests of historic data:

1. When A and B occur then C follows
2. But when only A occurs no C follows
3. And when only B occurs no C follows
4. C requires A and B

6/12/2005
GM Nigel Davies on Doing the Wrong Thing

I'll never forget the day I was called to the headmaster's office for wanting to leave school at 15. And a little smirk crossed his face when he explained that I'd never make a living out of chess. I was too young to understand what he was talking about, I just couldn't stand being in the place for another minute.

After many more years of half-trying to 'do the right thing', I did the wrong thing with gradually increasing commitment. My only regret is that I listened at all, but now I am free.

6/13/2005
Fractals, by Phil McDonnell

In Paul H. Cootner's book The Random Character of Stock Market Prices (1964), there is a paper by Benoit Mandelbrot. The paper discussed the important question of how long is the coast of England? In what may be the only worthwhile result to come out of fractal mathematics, Mandelbrot argued that it depends upon the scale at which you analyze the question. At the very largest scale the length of the coast is the shortest because we are using only a few straight lines to characterize the shape. At increasingly fine granularity we use more lines and thus the total path length must increase. One could argue the coast of England is infinitely long.

The same idea holds for trading. As we increase the granularity from monthly to weekly to day and tick data the path length must necessarily increase. For market makers that is a good thing. They have near zero transaction costs - primarily bookkeeping. They even profit from the spread rather than pay it. For most others high frequency trading involves more commissions, paying the spread and sometimes information lag costs which are difficult to estimate e.g. price quotes might be 1 minute old or even 15-20 minutes delayed for some traders.

So the idea that increasing the frequency of trading will increase the profit potential is true but there is an important tradeoff because it will also increase trading costs as well. There is a third variable which is also important - what timeframe is predictable for you. For a fundamental investor relying on quarterly updates his time frame probably should be on the order of quarters or longer. For some quantitative strategies the time frame is in days or weeks. For other strategies, the anomaly they exploit may only last minutes or hours. The overall best time frame is a tradeoff between frequency, costs and your trading methodology.

6/12/2005
Broadway Review: Victor Niederhoffer on Glengarry Glen Ross

Imagine if Warren Buffett and George Soros were to get together to collaborate on a play about Wall Street and the stock brokerage industry.

Both of them are animated by a holier-than-the-Pope attitude about their own rectitude and morality compared to the sleazy dishonesty of the industry. Both rail against the selfish desire of wealthy people to reduce their estate taxes and both long for a planned order where philosophic benevolent people such as they would stamp out the greed and the excesses that go with speculation.

Educated at a time when Thorsten Veblen's The Leisure Class, Matthew Josephson's The Robber Barrons, C. Wright Mills's The Power Elite and J. K. Galbraith's The Affluent Society were considered the best works on the history and effects of business, neither Buffett nor Soros has since read a book; nor have they kept up with modern developments in the fields of enterprise, Austrian economics, finance or mathematical science. And neither has ever operated a business, aside from the conglomerate of the former and the hedge fund of the latter. Both believe that selling by people other than themselves is a hornet's nest of deception, high-pressure techniques and destructive competition.

Both, however, have their ears tuned to popular culture, and have seen the play Death of a Salesman a few times, and in the former case taken in a touring production in Omaha of The Music Man.

Now suppose they got together to write a play.

The first scene would likely be about a Willy Loman type broker complaining that he can't sell the public any highfliers anymore and collect the old fixed commission rates.

The second scene would probably be about a Henry Blodget or Mary Meeker or Harold Hill type of salesman trying to hype a billion-dollar market value Internet company to the rhythm of the train scene -- "But he doesn't know the territory!" -- from the Music Man.  The scene would include side comments on how terrible the metrics really were, and how they secretly planned to sell companies without any music to them at all.

The third scene would probably be about a whistleblower talking to a friend about splitting the finder's fee for going to Spitzer or some such crusader with tales of excessive executive pay, smoothing of earnings or after-hours trading.

Finally the whole thing could come together in the second act with the company declaring bankruptcy and the Willy Loman type being taken to jail for a crime so much less than those the power elite, the establishment brokers, mutual funds, hedge funds, corporate executives and accountants were guilty of.

Doubtless such a play would win a Pulitzer Prize, receive rave reviews in every mainstream paper because of its accurate depiction of the greed of people trying to get rich or help others get rich, be made into a movie and run on Broadway every few years. If you were to picture such a play not about investments, but about the evils, the cons, the duplicity, the greed, the self-dealingness of the real estate industry, but instead of lowbrow "common folks" language, littered with trash talk, every other word a four letter one, you would have a good overview of David Mamet's Glengarry Glen Ross. It's a hateful play with no insights into the real estate brokerage industry it portrays, the incredible wealth achieved by all the people who actually bought real estate since its 1983 writing, or the valuable services that salesman and brokers provide.

In Mamet's withering indictment of American business, sales tactics, consumer choice and culture, the first act takes place in a Chinese restaurant rather than the Burger King (they don’t sell Coke® or Big Mac® s there) that the Sage might have chosen. The scene shows Shelly Levine as the Willy Loman type complaining about the quality of the leads he gets from his sales manager, and the vicious circle this puts him in. Needless to say the problem is solved by the manager's giving him "capacity" in return for 50% of his production. I felt a sense of deja vu here, recalling the allegations against the great California Bond Trading Fund.

The second scene shows underpaid salesmen suggesting to a mild mannered John Dean type that they burglarize the office by stealing all the leads and selling them to a conveniently culpable competitor. You see in the world of those who hate business, leads are not tracked, they don't relate to specific properties, they don't grow stale after a week or two, and competitors are always willing to steal them without fear of discovery. The third scene shows a star salesman pretending to let down his hair about self realization, relative morality and the joys of s-x, all as a ploy to reach a zone with his mark so that he can sell him some worthless Florida real estate. In this world the stocks and real estate bought in the 70's that are now worth on average of 20 times their original purchase price are all part of a big con, and the salesmen's efforts to close the sale are reprehensible examples of self-dealing.

The first act ended abruptly after half an hour and I wanted to leave, because the author had no understanding or appreciation of the subject he's writing about, failing to understand the information and adjustment and technical functions that all salesmen perform. But because I was with my daughter, dance teaching guest, and first wife, who was my star salesman when I ran a merger business, I stayed.

The second act is improbability upon improbability as the heist has taken place, the leads, folders, and phones have been stolen and the glass broken. the Willie Loman type has completed a fictitious sale, a spineless husband is conned into refusing to cancel a sale. An O. Henry'esque finish leads to the good guy's getting the short end once more.

Only a playwright whose audience consists mainly of salesmen and real estate brokers and normal Janes and Joes who envy all their friends who have made so much money by being "conned " into buying real estate that makes them multi-millionaires could find an ounce of believability in any of these completely incongruous wrong notes that would never occur in a million years in real life. There was a standing ovation at the end for the all male, all TV-star cast, marred by loud booing from an admirer of the American business system who wished to be exposed to more salesman in all walks of life, until I was silenced by Collab's discrete hand over my mouth.

Please, unless you wish to wallow in hateful anecdotes about the one-tenth of one percent of business that is dishonest and can stay in business notwithstanding such unethical practices, stay away from this destructive piece of propaganda.

Read a letter to the editor on this review:

6/13/2005
Abe Dunkelheit responds:

Even if the ratio of dishonesty is only 1/10%, which I very much doubt, the real question is: What is the leverage of the 1/10%? The honesty of a baker in a small village might positively affect 50 - 100 people, while the dishonesty of an Enron type of character negatively affects 10,000s of people. Although only 1/10% of the population might be dishonest by principle I'd assume [based on personal experience] that due to their high intentional energy the effectiveness of the con men is 50%. Or in other words: Although only 1/10% of the people might be dishonest by principle, the likelihood that the person you just met in business is a dishonest con man is 50% and in my personal case that even includes family members.

6/12/2005
Strikeout, by Victor Niederhoffer

With my trading on Friday, I felt like turning myself in the way Willie Sutton did after Bobby Thompson hit that homer. I started out long, it went down, then I sold and it went up, about four times in one day. To add to my penalty, whenever I put in an order that would have been right, the market went just to my limit, didn't go through, and left me shaking my head as I was left holding an empty bag,  like Willie when Newcomb and Branca tired in the stretch. The elites sure had a field day at my expense. Reminds me that summertime is very different in the way the market moves, as there is not enough energy, enough sunlight from the public, coming through to the understory for small folk such as me to ply our trade. I hope that August 5-7 at the Spec Party I won't be scratching as many rich men's backs in complete humility and docility as Willie Sutton and I have done so often in the past.

Jay Pasch responds:

A similar experience, through deep memory, realized that they had me again, and sat on a single trade for the duration of the day, exiting near the close from the long side. Two things I can't stand -- to squander capital and time -- and when I lose the former the latter is there also, attached at the hip. Recurrent dreams last night of inadequacy on different stages: a purchased auto with three wheels, tripping on the dance floor, skipping match point off the court. This job runs deep...

6/9/2005
All Good Things, by Dick Sears

The Gilder Technology Index's winning streak came to an end Friday. Read more...

6/12/2005
Imagine, by Henry Carstens

Imagine
The worst trading day you've ever had.
The seconds ticking by, the disaster scenarios playing vividly out.

Imagine
The blackjack player.
His edge is 1% or 2 hands/100.

Imagine
The pressure.

Imagine
The public speaker.
Stammering, nervous, unpracticed and unprepared.

Imagine
The blackjack player, the public speaker and the trader as one.

Imagine
Once per month being unprepared: 12 hands
Once per quarter succumbing to the pressure: 4 hands
Once per quarter not taking the next trade, not betting the correct size: 4 hands

Imagine
The blackjack player giving up 20 hands to the house: his edge is now -18%

Imagine
The blackjack player and the trader as one.

6/12/2005
White Swans, by Kim Zussman

My forays into options as volatility and risk reduction instruments suggests the costs are too dear. We are getting paid to experience the pain of risk and if you remove risk the pay goes down, with the notable exception of mathematical matadors who've figured out how G-d thinks.

James Tar responds:

It's worth looking at objective versus subjective in regards to what you're trading. Love, religion, emotions, feelings are subjectives you can't have put options on, marriage included. When religion is mentioned, think about how silly it sounds to go long a put on G-d's existence? And marriage is all or nothing, total unconditional love. I don't have reservations on that or religion, either I am winner or I am a loser. Now to the objective: If I enter the process of trading with a way of thinking that involves objectively sussing out speculative trades, then why would I need puts, with significant results in front of me? Is it because I would be injecting subjection into an objective approach? The Senator said that if we trade without stops then we'll end up broke. Look at a doctor's task: he gets a patient who is always going to die. A hearse doesn't have a luggage rack nor a Wells Fargo truck on the ball and hitch behind it. I read a wise man's book once that said "I gather berries in a basket; if they spill out, then I start gathering berries all over again." Risk and reward are in linear proportion. If I take away risk I take away reward. I am married because I asked for the order, kept my mouth shut, and the first one to speak lost. We now have three kids and seven years of experience.

6/12/2005
100-Year-Old Book Watch: Thomas Miller Reviews Babson

I recently bought a copy of "Enduring Investments" by Roger W. Babson, copyright 1922, for just a few dollars at Abebooks.com. It was a very good investment and I recommend it.

Babson was a very religious and successful investor and businessman who is credited with calling market top of 1929, albeit a bit early (a "fault" I have heard Chair express occasionally about his own investments).

The book is a collection of his notes on investing, society and religion. A few examples:

Babson had little patience for investors who lost money to con artists because of their own greed and refusal to do own any work:

A lifetime of work with investors has impressed me with the prodigious losses that result from trying to get something for nothing in the realm of speculation and investment. Everybody is complaining about taxes. Statistics show that by saving the money annually contributed to crooks and incompetents, confidence men and blue sky operators, bunco steerers and business imbeciles - with this huge sum conserved - no other taxation would be necessary. Incidentally, I would recommend to Congress a bill providing that for every dollar which a person loses in get-rich-quick schemes, he should be assessed another dollar as tribute to the government. All other taxes to be abolished.

Babson also appeared to be something of a "counter":

Statistics have taught me a good many things. Statistics have taught me to take care of my health. Statistics have helped me in buying and selling. By statistics I have learned in a small way how to influence others. Recently, statistics have been changing my views as to the relative importance of the different phases of life. Statistics have changed my views on many things, including theology. The Bible now is to me a treatise on economics and psychology as well as a book of spiritual truths.

And being a disgruntled postal worker and unionist, his thoughts on organized labor ring true today:

Labor unions started out with the best of intentions to put a greater value on men than on things. As these unions increased in power, some began to discourage industry, initiative, and even in some instances, integrity. A few put a premium on indolence, indifference, inefficiency and the like. When this point is reached, the labor unions cease to be a factor in the developing of men and actually result in retarding that development.

6/11/2005
Coppering the Copper Market, by Tom Ryan

Recently back from two days spent with Phelps Dodge at their annual confab. Two striking notes:

  1. Insurance companies are even dumber than you think with underwriting even after the Freeport MacMoran disaster and 9/11.
  2. There is simply no appetite for a major new project development or investment despite the ore reserves running off as production ramps up to take full advantage of today's price. Phelps Dodge isn't the only one acting like this.

At the risk of sounding like the world-traveling investment biker, what all this means to me is that the next time copper dips down into the 70s or 80s, and the world is spiraling into recession and the doomsdayers are having their say, I am going to quit stock trading and load up on copper contracts and just roll roll roll them as I am convinced that the next major cyclical low in Cu is going to be substantially above the last (60s) simply because there is no new development being invested in during this cycle and without it, there is going to be a Talebian quality in the copper market of relying on ever increasingly deeper pits and higher risk production profiles which the companies are laying off onto certain insurers. As for the physical metal that is another story

Bingham and Grasberg both will wind down before end of decade and although they will switch to underground, the production won't be matched. In other words there is a natural decay in the future supply curve that is currently not being offset by new investment, I guess the incentives are just not high enough yet.

Jim Rogers responds:

Now this is a smart guy. Sounds like he has read or should read Adventure Capitalist and Hot Commodities.

There is a good chance this commodity bull market will be the biggest ever for a variety of reasons -- including his. The same thing is happening everywhere.

Kim Zussman comments:

Naive question about commodities: shouldn't there be differences in price behavior for those, such as metals, that don't disappear? Assuming a finite amount of oil and copper in the ground, even when most is extracted the oil is burned and gone but copper in some forms can be recycled.

Perhaps the rolling of contracts moots this.

In any case it might behoove investment types to visit a scrap yard. I wonder what might be extractable from that which is already above ground and whether (anecdotal) wealth of recyclable proprietors is diagnostic.

(Countless hours spent as a teen at Apex Electronics, an iconic 1970s San Fernando Valley, Calif., purveyor of unloved and discarded aerospace gears, gyros, transformers, etc. Their products were popular with studios making sci-fi flicks, but were also useful for making contraptions to impress your friends. Nothing was priced. I eventually figured out that the counter-man's ask was based on the look on my face. Never did find plutonium for July 4th, but then again it wasn't Russian surplus.)

The Senator explains:

The difference in commodities is between how natural resource commodities trade versus abstracts (man made) such as bonds, currencies, S&P 500 -- price structures (carrying charges) are different as are COT report data. And valuation models of naturals are different than the abstracts. You need to break commodities down into those two camps to understand (trade more profitably).

From the Webmistress:

(Lyrics in honor of Tom Ryan, to the tune of "Rawhide")

Roll 'em, roll 'em, roll 'em
Keep those contracts rollin'
Think of all that growth in
Shanghai

They'll all want copper
Copper's a whopper,
Ain't enough copper
Supply

Buy 'em up, roll 'em over,
Buy 'em low, sell 'em high,
Move 'em on, sell 'em off, Free Ride!
Buy 'em out, ride 'em in
Roll 'em over, let 'em out,
Cut 'em out, ride 'em in, Free Ride!

Free ride!
Free ride!

6/11/2005
Sherlock and Euro/Gold, by George Zachar

The classic gold/dollar teeter-totter broke down Friday, with the Euro down /Dollar up more than one "big figure" and gold up in dollar terms by more than $3.00.

If time and analytic firepower permitted, I'd look back to see what similar divergences might portend. I've struggled to find a way to communicate what the relationship is "saying", as neither unit is really within my expertise.

Then, it struck me.

This is the opposite of the iconic scene in Silver Blaze where the key clue was the dog's not barking.

Here, had both the Euro and Gold maintained their recent historic positive relationship (not barking) there'd be nothing out of the ordinary vis a vis Euro/Dollar retreating from a retrospectively frothy high.

But Gold is not quietly shadowing the single currency. It is "barking" at the Euro, and that "has information" for canny specs who understand those markets.

I don't have any specific meals here, but I am certain there are buffet tables down this road of inquiry.

Here is a log-scaled graph of gold in Euros:

6/10/2005
More Variations on Chair's Tree Theme, by Will Craft

Why do some trees go tall and straight even when planted in the open, while others branch out? In our continuing search for parallels between trees and stocks, Craft, a dendrologist, draws our attention to an article on the degree to which competition affects shape and comments:

Tree form and productivity can be very different in urban plantings and the more competitive setting of the forest. What matters most is the volume increase of the stem and its quality. Calculate the volume (one way would be in a frustrum), then measure change over time (the formula uses pi). If a tree has a large, long trunk and a small crown, it is an efficient user of light, CO2, spacing and the like. 

An efficient tree would correspond to a small, effective workforce making a valuable product with the best return on investment and growth of sales.

To measure a stock using the parameters of a successful tree would require defining stands of stocks or a broad average (has more variation and randomness). Some have used trend following (a proven random).

Securities can change rapidly between early fast-growers and stodgy stalwarts. But a loblolly pine will never be an oak.

A correct calculation of the "crown efficiency, spread, height, width" comparison would require grouping competitors by the right variable. Would it be VIX for long/shorts, performance vis-a-vis the dollar/euro, best-of-the-best in the industry groups? As Chair has said so often, once a technique or formula is known, it won’t work anymore. Does the "stand structure" of the market continuously change as securities forever cycle between ill-defined regimes?

6/10/2005
Victor Niederhoffer: Briefly Speaking

  1. Nice scandal in New York, where hedgefundist Albert Vilar is in jail for converting money from his tech fund to pay for gifts to charities. He  is accused of robbing $5 million from girlfriend Lily Cates. The technique was allegedly to start a fund, get her to put $5 million into it near inception, and then use that money personally rather than sending it to initial third party institution. Reminds me of an experience that a certain chemist had,where a chronic bear, boastful of his million-dollar forays into shorting S&P futures on such things as employment data which hid the weakness in our economy, apparently planned to start a fund with the chemist, but then after the documents were signed and sealed became "unavailable". This might, and I hope was, purely a coincidence.
  2. Excellent movie "Ladies in Lavender" shows two sisters in their 70s falling desperately in love with a young violinist, ruining their sisterly relation and equilibrium as the universal urge to compete and live through the genes strikes in all such triangles. Reminds me that competition is the main driving force responsible for the high standards of living and superhuman efforts that purveyors of products provide to satisfy our pitiless desires.
  3. The excellent book Practical Biostatistical Methods by Steve Selvin provides a supplementary second statistics course with emphasis on useful and generalizable techniques for ascertaining the incremental fits of models and estimates that are highly appropriate for market applications. Very accessible chapters for layman on regression, analysis of covariance, discriminant analysis, principal components analysis, contingency tables, logit regression, and survival analysis.
  4. The best way to get additional alpha for classes of investments like funds-of-funds where the levels, depths, extent and asymmetries of the fees place the take so high relative to the return, like the martingale systems the casinos all love, is to place less than 100% of your assets, or less than a proportion compared to your bogey, in such funds.
  5. Thank goodness the Sage had Charlie to restrain him from speculating so much more against the dollar than the $22 billion he admitted to being short at Berkshire's last annual meeting. When will the first brave soul write about this terrible investment that since the end of the year may have created a greater loss in magnitude than all the other investments he has made up to that time? And how does he subtly engulf smart people like his surrogate son at the computer software company and get him to talk at Davos about dollar weakness and how the Chinese system is so much superior to ours because they put the really smart people in government positions there, without being too overt or pushy about it? Also, what will happen to the market when word gets out that the possibility or pressure to exit the position might at some time arise?

6/10/2005
Books on Market Makers by Philip J. McDonnell

The Stock Market and Finance from a Physicist's Viewpoint by M.F.M. Osborne is actually his class notes from a graduate business seminar which he gave at Berkeley in the early 1970's. Roughly the first half of the book is about market makers, how they operate and their strategies. It is more than a theoretical discussion, rather it stems from research of actual specialists books on a trade by trade basis done by Osborne and Niederhoffer. My understanding is that the Chair still has some of this original data from the 1960's. Osborne also cites the Chair's influence in obtaining his teaching position at Berkeley. He was previously a physicist at the US Naval Observatory even when his paper was published in The Random Character of Stock Prices edited by Cootner. That probably explains why he was wasn't recognized by the mainstream academic community as the originator of the random walk theory.

The second half of Osborne's book deals with various seasonal and other anomalies. He also presaged the predictability of volatility in his observation that the squared differences of price changes were serially correlated even though the first differences were not. The book also has a section on Fourier analysis.

The only other books on market makers I would recommend would be by Richard Ney. The Wall Street Jungle and The Wall Street Gang  are both excellent.

One warning is in order - the tone and demeanor of Mr. Ney's books should be obvious from the titles. He believes the Wall Street specialist system is a corrupt monopoly which exists to exploit the public. Conspiracy theories aside the book is a very practical analysis of how the market makers work and how to use that knowledge to profit on a short term and intermediate term basis. Most of the factual insights in the book are based on the 1962 SEC study of the specialist system and how much money they make (100%/yr average). Although it is 43 years old this study is still the final word on the subject for the SEC has never done another study. Thus Ney's books published in the 1970's remain timely as well.

6/9/2005
Victor Niederhoffer: Review of Forecasting with Dynamic Regression Models

Forecasting with Dynamic Regression Models by Alan Pankrantz, Wiley, 1991, is a statistics books that shows you the ideas behind the widely-used programs for forecasting with Box Jenkins models and distributed lags. Written in 1991, before the field had developed all the special notation, techniques, higher mathematics, and mumbo that makes such books accessible only to a mathematics consultant, pure mathematician or modern econometrician, this book is designed for all those with just an elementary statistics background.

The chapters include practical and theoretical reasons for using autoregressive and moving average models, an integration of these with regression forecasting, discussions of how to tell when a shift in the model has occurred, a series of diagnostics for telling which model is best, and worked examples of how to forecast, including one using stock prices to forecast industrial production. The last chapter on vector models shows how to put all these together in the context of simultaneous equations where the inputs and outputs of each equation have feedback relations with each other.

The author uses the technique of backshift notation , e.g. B(y(t)) = y(t-1), to show how you can use simple models for dependence in residuals independent of normal regression forecasts where one variable such as industrial production is used to forecast something like stock prices. Practical electronics hobbyists will find that a familiarity with circuit analysis for such components as operation amplifiers, with output feeding back to the positive and negative nodes of the input, is a helpful foundation for gaining an intuitive feel for many of the concepts used.

I like the author's idea of using simple models for the effect of one variable on another, where the impact of each lagged independent variable exponentially decays, or oscillates around 1 in its impact on the dependent after a period of rest or delay before it has an impact. The author finds it very rare in practice that a model with more than a 2 period impact of the residuals from a regression is useful for forecasting.

The book leads me to focus on such variables as the joint impact of the correlation between two variables, and how far away from their normal affect they are on each other now and in the previous period. For example, stock prices in the US are normally up a little bit more than German stocks, but what happens when for the last two periods the relation is much greater or less than normal, or such departures are getting much bigger or smaller than usual. It leads to looking at such relations as comparing the current change of a variable to previous changes in other related ones, and then using the departure during the most recent two periods as a forecasting tool.

The book is recommended for those who find practical forecasting with moving averages, regressions, and serially correlated variables fascinating and wish to get some ideas as to how to combine them.

P.S. Normally, I don’t read a book 15 years out of date for such a topic, and I am confident that more up to date, technical, and useful treatments of the subject are available, perhaps even in the manuals accompanying the widely used statistical software packages, but I was induced to do it in honor of William Cochran, the teacher in my second statistics class 45 years ago. He was very amiable and talented and his query on our first exam as to the standard error of the constant term in a regression equation had me looking through my old statistics book, which led me to finding this one.

6/9/2005
Rolling Dreams of a Poor Mechanic, by Kim Zussman

Chair's discussion of regressions could be coupled with recent topic of "nonlinearity" of marketime:

If X=some recent past condition and Y=position taken in relation to X

Regression of Y=aX + b over time might lead to significance in slope and/or intercept.

If the conditions occur frequently it is possible that magnitude and significance of slope and/or intercept would exhibit periodicity. That is, the thing intermittently works and stops working (or even reverses) in a way which could be estimated by determining the wavelength and amplitude. (charts or FFT?)

Like a light wave with orthogonal waves of electrical and magnetic field. Or a roller coaster in the dark with the direction of passenger's flailing arms indicating the cycles of dips and turns. The more you ride the better you understand the thoughts of the creator.

Probably the undaunted 8000 ride this everyday.

6/9/2005
A Savvy Fed-Watcher Tunes in CNBC

I am a long-time student of Greenspan's appearances.

Congresswoman (cough) Sanchez is on TV now bantering with him. She's among the complete economic illiterate dolts who seem to have one idee fixee: looting.

And I have never ever seen Greenspan toy distractedly with anything on his desk while delivering an Econ 101 rebuke to someone, till he did it a few minutes ago with my Congresswoman, Carolyn Maloney, who's scary-stupid.

Now that I think about it, I've never seen anyone show that kind of casual disrespect when testifying.

I'm now visualizing Clarence Thomas undergoing hearings for elevation to the Chief Justice's chair.. suggestively sliding his finger around the rim of a Coke can.

6/9/2005
Bearish Outlook, by Tom Ryan

I should have known not to buy yesterday, what with the bears prowling around my neighborhood and all. Bears getting hungry, I guess.

Paul Nelson adds:

And the Geologist has revised his predictions. He's also predicting a peak in house prices in the middle of next year.

6/9/2005
Different Smarts, by James Sogi

When I was younger, I knew a heck of a lot more than I know now. In fact, how little I know appears to me over and over in a many many places.

Last weekend I was privileged to be aboard the Hokualakai, a beautiful and powerful 57 foot traditional Hawaiian sailing double canoe and had a chance to talk story with the Captain, designer and the first mate. The first mate has no formal education but has over thirty years experience learning from master navigator Mau Pialug, the native navigator chronicled in Lewis's We the Navigators. He was the master lasher who tied all the lashings that bind the entire canoe together without metal fasteners. There are hundreds of different knots, lashings, bindings and ties keeping the nets, rigging and wooden beams together. Each knot has a purpose, as a rope railing, a net, a stay, a fiddlehead, a diamond lashing, a cross lashing, binding the steering sweep, the running rigging, the mast lashing, the figure-eight. He taught me the angles on the canoe match the angles of the star patterns, the time the half moon is on the bottom and tracks the same path as the sun allowing night shots for navigation, the time to head west on the way to the Marquesas, the color of the ocean half way to Tahiti, rigging a sea head, the way the spirit of life fills the body the way water fills and empty gourd. He told me how Mau can call the porpoise and the birds to help him navigate.

Many words of wisdom in unexpected places about things to be learned nowhere else. Handy things to know for those whose life is surrounded by the sea. There is so much to learn but so little time and I know so little about so much.

6/8/2005
See our Buyback Study Update

New on Daily Spec: Letters to the Editor

6/9/2005
Who's Better?, by GM Nigel Davies

Two residents of Kharkov asked just two questions, who stands better and why? Their names were Mikhail Gurevich and Alexander Chernin, and this was just prior to their becoming super-GMs.

6/8/2005
Tech's Great Secular Tailwind, by George Zachar

The just-updated NY Fed "Tech Pulse Index" data show enormous strength.

Interestingly, at least one wire is spinning the report thus:

Tech is really slowing, as the April's 12 month growth rate dropped to 31.7% from March's 32.8%.

6/8/2005
Why Strong Players Prefer Clarity, by GM Nigel Davies

There are many chess positions arising from logical series of moves which fall outside a Grandmaster's ability to decipher what's going on. What do we do about them? Generally speaking we try to steer clear of them, the reason being that the thinking mechanisms which give us an edge will not be so easy to apply.

I think this idea lies at the root of what the Daily Spec site is about. It doesn't matter if certain ideas and techniques are good, or being "open minded," etc, etc. It's a question of whether we can achieve mastery over them and in that way can use them as an extension of our being. When there are too many "ifs," "buts" and "maybes," such mastery is impossible to achieve.

The Assistant Webmaster adds:

GM Bisguier likes to remark about messy, chaotic, hard to analyze positions: "Both sides are busted".

6/8/2005
Dendrologist Will Craft on Chair's Tree Variations:

One way to view the forest or a tree either up close or at a (Bette Midler) distance is as vertical structure no matter how short or tall. Fish, tourists and investors do it. I think this may explain the attraction to white shoe brokers: hey, look at the flashing sign, people say; the market is up.

Everything thrives at the edges of vertical structure and begs to look up or down at trees, canyons, buildings.

More important to me is why the structure is there in its present form. We all try to explain it our own way. How one views his "structure" is not a uniform science or response.

You look out the back window to old stone walls that kept in cows or corn (they had to do something with the rocks) and I see terraces of a red clay B horizon that once was an underlay for a sandy clay loam. I believe the Prez has some gullies in Tennessee!

The truth is usually hidden by a bias. Get the joke! And still the market has gone up a kazillion! Take a look at this perspective of history from 1491. It's long but well worth the read.

And, what would I be doing if the chestnut trees were still here?

6/8/2005
Stop Signs, by James Tar

It's of the utmost importance to know for certain where all of the stop orders are within the markets one trades (or at least to have an idea as to where they may lie - either on the books or in market participants' minds and risk management).

Some unreal moves in the forex arena today between 11:45am and 12:45pm, as well as the dump in stocks yesterday, and the spike in NDM5.

6/8/2005
IO, IO, It's Off to Work I Go, by George Zachar

With all the FUD being generated about IO mortgages in the Golden State, the following table of IOs by state is good for a chuckle.

Yes, I know California is critical because of its size, but still..

Via Bloomberg, "the percent of mortgages that are interest-only as reported by Loan Performance. The data for 2005 are for the first three months of the year. The data are sorted by state and 2005 total %.":

                    Purc.   Refin.  Total
                    2005    2005    2005
========================================
National           22.9%   16.0%   19.1%
----------------------------------------
Dist. of Columbia  54.3%   25.8%   40.1%
Arizona            39.2%   27.3%   33.9%
Colorado           30.6%   31.6%   31.2%
California         39.1%   24.7%   29.9%

6/8/2005
Hot Stories, by Victor Niederhoffer

"A Taxonomy of Barnacles," by Galt Niederhoffer, due out in January 2006, leads me to consider the interview of Bryan Gindoff in the book Bulls, Bears and Millionaires by Robert Koppell. Gindoff is a screenwriter who had been a floor trader and hedgefundist.  He wrote Hard Times and produced Losin' It. He believes good screenwriters and good stock pickers (and market pickers) are cut from the same cloth. You have to have a big story that overrides everything else

"In both writing and in the stock market, the great success comes from identifying a strong story or a strong theme. If your story is strong enough ( in Hollywood), it will tend to transcend poor execution." He uses the stories of Tom Clancy as an example where the characters are poorly developed. I would use Louis L'Amour, who has sold more Westerns than all other Western writers of all time combined, whose characters are lame with automatic and shallow emotions, and whose women are single-dimensional objects of virtue and worship. But his stories are gripping, and the settings are thrilling.

I ask, what are the stories of today's markets and stocks that will override poor executions? Which are the stocks with innovations that will withstand competition and poor execution, with niches that have been carved out where no one else will be able to whittle away at them?

James Tar comments:

Health care is a good place to start.

  1. Health-care firms have balance sheets that are superior to all other industry groups. They are loaded with dry powder and are debtors to none.
  2. They have outstanding innovation, and a free market system will always reward those who continuously aid its advancement.
  3. We are am ever-growing and ever-aging population, and health care naturally will improve the life expectancy and the size of its market.

Laurel Kenner adds:

This ties in with the study of earth's hot spots -- part of the revolution in knowledge about the earth since the ''70s -- specifically concerning tectonic plates, volcanoes and earthquakes.

In Hawaii, the Pacific plate is slowly sliding over a giant hot spot of magma. As the plate passes over the hot spot, a volcano emerges and builds an island. Every few hundred thousand years, the plate moves on enough to create a new volcano and a new island is born. The newest island in the chain is Hawaii.

The plate's direction has been determined, and predictions can be made. And it turns out there's another volcano/island ready to emerge under the surface of the waves, called Loihi.

In the market, investments move but the heat lasts. The best story would be what people's desires are moving the market toward.

Story stocks:

1993: Biotech was the story. Then it got killed, and came back again in 1999 and got killed again.

Mid-1990s: Consumer stocks were the story, because growth in international markets was going to make everybody rich. The Chinese would buy U.S. brands: Coke, Gillette. The first Internet stocks emerged: Iomega and Netscape astonished everybody with mega-bagger gains. Semiconductors and computers ramped up. Home Depot was huge. Gold stock frauds were big.

Late 1990s: Tech was the story, as this Y2K column by the Spec Duo records. Look at the "Down 35" list of stocks at end. Everybody loved stocks, if they were internet/telecom/fiberoptics. Conversations in Manhattan cafes all included "I am making so much money in JDS Uniphase!" In 1999, Y2K angst made Internet security stocks like Verisign a story.

Early Millennium: Value was the story.

Post 9/11: Defense was the story. Lockheed. Northrop. General Dynamics.

2002: There was no story. Practically everybody wanted out of stocks. Real estate and REITs were the story. 

2003: Disaster was imminent. People hated stocks. Naturally, the market recovered starting in March 2003, the month Practical Speculation came out. Prechter's latest "Crash" book outsold it by several orders of magnitude.

Russell Sears adds:

Every stock has a story; life and death decisions, battles and victories are everyday occurrences. I would suggest, however, that not every stock has the audience's ear. Like a forest where many juvenile trees await their turn in the sun. Many will grow too fast too quickly without getting a chance at the sun. Further, not every plant that grows after the canopy is opened will grow to be a tree.

But I would suggest that the audience has grown tired of the "character" novels of the 90's. The celebrity CEOs of Microsoft, Cisco, GE et al. Further, the audience no longer accepts the autobiographies or ghostwritten biographies of the Enron, the dotcom, or the stock analyst. The canopy has opened.

However, due to innumeracy, many are turning to other storytellers with an even more obvious bias: investors telling why they are taking a position. The Sage, the World Traveler, the syndicate and other hypetheinvestors.coms, all seem to be getting their voices reflected on the tape. These plants will have their day, without reaching the canopy.

I agree that healthcare will be a tree. But other players will also be critical for the demographic shifts. Wealth managers appear to be well positioned. Which companies' strategies will capture the hearts and minds of the baby boomers long-term is hard to tell. Currently it appears they are rushing to every door that promises a sure way to get rich quick.

6/7/2005
Practical Microeconomics, by Victor Niederhoffer

In his book Mangerial Economics Hirschey gives four sources of above-average profits:

  1. Frictional profits from the unanticipated shocks that lead to bottlenecks to entry. The drug companies with the $1 billion average cost for a approved drug are a good example here. "Over time, barring impassable barriers to entry and exit, resources flow into the field and profits return back to normal levels." But during interim profits might be above because of frictional factors that prevent instantaneous adjustment.
  2. Monopoly profits, high barriers to entry through economies of scale, patents and import protection. Fannie and Freddie would be examples.
  3. Innovation profits. coming when a company successfully develops a superior product. Microsoft and McDonald's are examples.
  4. Compensatory profits for firms that are good at executing, and maintaining efficient operations. Presumably Dell or Toyota or UPS.

I was interested in applying this to the heroic icon of the Sage and the companies he buys and whether they could be seen to have a place, on average, in the Pantheon of above average profits. Since he likes to buy companies at book or below, there is prima facie evidence against this because such companies invariably return less than the competitive rate of return or else they wouldn't sell below cost. Charlie talked him out of this vis-a-vis the farm equipment companies and regional department stores that he liked to buy. It would seem that about half of the first 20 companies he bought were such companies.

As for innovative profits, they don't exist in companies that don't innovate, and usually innovation is closely related to technology, or patents of the kind that the Sage avoids.

I'm left with compensatory and frictional profits. But consider whether the ability of the Sage to buy companies from a quick look at their balance sheets, at hoped-for bargain prices relative to net assets, i.e., the half of liquidation value favored by his mentor, the Father of Securities Analysis, would put him on the right track for bargain purchases of companies with superior profits, thus confirming Professor Hirschey's appellation of the Sage as "the greatest practical microeconomist alive."

Jim Sogi adds:

One of the valuation metrics in the estate litigation area is the Key Man discount. When the Key Man dies, the company is not worth as much. This will be an issue until 2011 when the estate tax ends. The converse is that a source of profits is the Key Man: charisma, vision, innovation, leadership, risk-taking at the early stages, luck. Think Edison, Ford, Sage, Gates, Dell, Rockefeller. Some businesses are one man industries: Michael Jordan, Tiger Woods, Bill Cosby, Paul McCartney. Consider the role of the Key Man as a source of above average profits.

6/7/2005
Letters to the Editor: Finops Noygobi Responds to the Lizard Brain Posts

GM Nigel Davies has adumbrated a crucial theme of late that deserves further elaboration. Earlier, he wrote about the Moscow Rules, "I think that we've been missing something here, and that the gut of a master craftsman (honed on  massive experience) is a very different thing to the untrained instincts of a rat or lizard brain. Perhaps a psychologist can explain this!? Of course, then there's a problem in identifying which  is which, is it your rat brain working or the gradually awakening instincts of an apprentice craftsman?"

Michael Oakeshott takes up just this issue in  "Rationalism in Politics." The full text of the essay  is available online and a collection of essays by the same name is  available from Liberty Press, a collection that certainly deserves a space on the "Liberty Reading  List."

Here is an excerpt:  

Technical knowledge can be learned from a book; it can be learned in a correspondence course. Moreover, much of it can be learned by heart, repeated by rote, and applied mechanically: the logic of the syllogism is a technique of this kind. Technical knowledge, in short, can be both taught and learned in the simplest meanings of these words. On the other hand, practical knowledge can neither be taught nor learned, but only imparted and acquired. It exists only in practice, and the only way to acquire it is by apprenticeship to a master--not because the master can teach it (he cannot), but because it can be acquired only by continuous contact with one who is perpetually practising it. In the arts and in natural science what normally happens is that the pupil, in being taught and in learning the technique from his master, discovers himself to have acquired also another sort of knowledge than merely technical knowledge, without it ever having been precisely imparted and often without being able to say precisely what it is. Thus a pianist acquires artistry as well as technique, a chess-player style and insight into the game as well as a knowledge of the moves, and a scientist acquires (among other things) the sort of judgment which tells him when his technique is leading him astray and the connoisseurship which enables him to distinguish the profitable from the unprofitable directions to explore.

What is called "counting" here on this page, then, while beyond the purview of many would-be specs, is but the vestibule to a "natural philosopher's" approach to the markets. I for one do not simply turn on programs I have written and run off to play tennis! Those same programs stand alongside experience in support of judgments.

6/7/2005
In Over My Head, from a California Spec

The bond market resembles a pool (in the literal sense) of surplus liquidity to me at the moment.

If I were to metaphorically treat it like water, how could I estimate the the evaporation rate increase as I increase the vibration I apply (which should easily expand the surface area). Wind and temperature are assumed to be constant. Wavelength and amplitude are what I'd like to build an algorithm to estimate.

It's been too long since I tried something like this....

Philip McDonnell responds:

If we assume the "water" is flat with one dimensional surface of length s then the arc length (1d surface area) of a sinusoidal wave of amplitude 1 and period 2 pi is simply 2 * pi * s. If amplitude is A and wavelength is W then the ultimate pathlength is given by 2* pi * s * A / W. Note that 1/W is the frequency which is the inverse of the wavelength.

The rigorous proof involves showing that the lower limit and the upper limit both converge to the above formula as sufficiently refined approximations are performed (e -> 0). This is left as an exercise for the reader :).

6/7/2005
Lasker and his Contemporaries, by GM Nigel Davies

One of the main differences between Lasker and his contemporaries was the universal nature of the ideas he proposed. So whilst Tarrasch claimed that a knight on Kt3 was always badly placed, Lasker waxed lyrical about flexibility and the like.

Naturally it was claimed that he left no school and his victories were put down to chemical warfare (cigars). But the problem wasn't so much with the teacher as with the students.

6/6/2005
Victor Niederhoffer: Wooden and Welch

What a contrast between the leadership books of John Wooden, the legendary basketball coach, and those of Jack Welch, the former CEO of General Electric. Wooden’s most famous technique is the pyramid of success, memorialized in his book of the same name. The basics:

  1. Never try to be better than someone else;
  2. Learn from others; and
  3. Always do your best.

At his first key meeting with players, he is likely to say the three most important things are:

  1. Put your socks on properly;
  2. Keep your nails clean; and
  3. Tuck your shirt into your pants.

I would say to traders that the most important things are:

  1. Count out your trades in advance;
  2. Take account of the balance between expectation and total disastrous ruin (not the standard deviation); and
  3. Always be ready to adjust away from recent success.

Wooden had a monopoly on national championships and kept a diary of all his lessons, thoughts and forecasts. Hundreds of valuable things, tested under competitive conditions when he had the tallest and shortest teams are in the books of this humble man, exactly the opposite of the vainglorious Jack Welch who could never understand why his employees wanted to be home with their families on Saturday rather than drink beer and talk about broads with him at the GE office on Saturday, and whose wisdom and persona decreases from that. A nice interview with Bill Walton on the concepts ofhow to learn patience, planning and humility with John Wooden can be found here.

Ari Siegel comments:

I wish someone had tried to hammer this into me 10 years ago...but of course I wouldn't have believed him then. I am working to rectify:

John Wooden represents the conquest of substance over hype, the triumph of achievement over erratic flailing, the conquest of discipline over gambling and the triumph of executing an organized plan over hoping that you'll be lucky, hot or in the zone. John Wooden also represents the conquest of sacrifice, hard work and commitment to achievement over the pipe dream that some one will just give you something or that you can take a pill or turn a key to get what you want.

6/3/2005
Dick Sears Weekly Review

Dick notes that the Gilder Technology Index has been up five weeks in a row, beating the Nasdaq each week. Read more.

6/6/2005
Penumbra numba mumba, by James Sogi

June 1 high 1207 - 1200 = +7
June 6 low 1193 - 1200 = -7

Nice symmetry - kind of like tetherball we used play at summer camp where the ball winds around the pole.

6/6/2005
The Problem With Explaining, by GM Nigel Davies

There are two interesting phenomena that have gone unexplained: Strong players have immense difficulty in really saying how they decided on a move and weak players always want things expressed in "words." Is it any wonder there are so few books of any merit?

I think the reason is something like this. The attempt to turn chessboard thinking into words loses the dynamic essence of what a player "sees" and "feels" at the board. Words have a permanence about them whereas the patterns in a player's mind are dynamic, ever-changing and subject to revision by the tiniest nuances.

6/6/2005
Risky Business, by George Zachar

The "Goldmine"/hedgefund piece in this morning's WSJ, talking about their prop desk next to the trading desk:

The firm took away the Risk Unit's access to client orders in October 2003, a year after giving it access. .. Several months later, in 2004, it closed the Risk Unit altogether. Mr. Evans says this was because "it wasn't making money."

Interesting how once there was actual "risk" involved -- not having "access" to customer information -- the "risk unit" stopped "making money". I literally laughed out loud.

6/4/2005
The Value of Enemies, by Andrew Moe

Throughout history, great heroes have always been countenanced by great enemies. Galt had the looters, Patton had Rommel, Superman had Lex Luthor. Today Chair has the Sage. Enemies ignite the passion that fuels the desire for victory.

In the markets, we all have enemies. No matter how sure your analysis, someone always takes the other side. There is no free run from the foxhole.

Enemies are agile. Allies quickly become adversaries when the pros shift gears. The true danger is stepping into battle behind a tank, only to find that the tank has turned a corner while you have gone straight. Your enemies will be waiting.

Enemies expose areas of weakness. They deliberately seek out soft spots. In nature, the slow, the sick, the old and the young are all at risk. We find that we must become stronger to survive. Our enemies keep us lean and mean. Improvement in the predator drives improvement in the prey - and vice versa.

Enemies offer opportunity. Our enemies have weak spots as well. Probing them, we find areas where we may advance. Properly delivered counterattacks can be more devastating than the original advance. When enemies push, we can push back.

The struggle defines equilibrium. Battle lines are drawn daily. Like the Yin-Yang, we often see ourselves as a result of our enemies. Price is the dynamic equilibrium that separates friend and foe.

You will always have enemies. Like the hydra, when one head is defeated, another grows in its place. No matter how bullish it gets, new bears always step in. Many are slaughtered along the way, but the few that catch the top can become legends. As in war, the survivors tell the story.

Find new enemies or they will find you. "When Alexander saw the breadth of his domain, he wept for there were no more worlds to conquer." And so he marked the beginning of the end. Beware the world that offers no obstacle. It is during these times that enemies consolidate. When they are strong enough, they will move against you.

Be glad to find the razor's edge for on it, you find survival.

Famous Quotes Regarding Enemies:

Jim Sogi adds:

The adversarial process defines excellence. As difficult as the adversarial model of our judicial system can be to the participants, as a systemic model it winnows out the weak, it exposes weakness, uncovers lies and forces the best to come out for survival. In the market as in the law, it exposes truth to the bright light of day, and replaces it as time changes.

6/3/2005
Kenny Sogi's Valediction: Ephemeral Beauty

Kenny Sogi, a new graduate of the Hawaii Preparatory Academy, is the son of James Sogi. He will attend the University of Southern California's Asian Studies program next year.

The Japanese use the idiom “mono-no-a-war-e,” which cannot be directly translated into English. “/A-war-e,/” is the awareness of the ephemeral beauty in our lives. It is the poignant sensation that our lives are passing, and that this time will never come again. “A-war-e,” is the vaguely poetic feeling you get around dusk, watching the rain fall on our window panes, watching the sunset fade to night. "Mono-no-a-war-e" is no more and no less than appreciating the sadness of existence. The Japanese have their love for the cherry blossom, not just for its radiant beauty, but because they appreciate, so sadly, that soon the blossoms will all be gone.

It’s funny, that when it comes time to say everything, I find myself at a loss for words. Somehow we expect ourselves to be able to say goodbye to the people sitting next to us, the people that have been there through it all. But sadly, a goodbye will never sum up all those wins, the… few losses, the late nights, the early mornings, the inside jokes, the long talks, the times we spent just killing time, and all the unforgettable memories.

We cannot find closure to our time here. And yet, it’s time to move on. It’s time to grow up and become different people. We will walk across this stage and say goodbye to this day, to our friends, and to this part of our life.

Above all, be conscious of your existence. Be conscious that this is change, and that indeed our lives are indeed passing. Do not wait to say goodbye to make something of your relationships or of your life, because goodbye is too late… goodbye is not enough. In every way, we are like the cherry blossoms, ephemeral, and all beautiful.

Because I have no other way to say this, Goodbye. And from the bottom of my heart, I love you all so much. Thank you.

(3 minutes)

Kevin Depew comments:

I only have one moment of Mono-no-a-wa-re to share, and only because Father's Day is rapidly approaching...

There is nothing at all, no clues, no signposts, no wind shifts, nothing at all to say that this day is going to be different from any that preceded it. My routine is precisely the same as it was yesterday and the day before that. I wake up, make coffee, have a bagel, or toast, or a piece of fruit, sit down with the newspaper and wait to greet my son as he mopes into the room. Like me, he's not a morning person. But we get through the earliest part of the day the best we can, with monosyllabic greetings, a nod or two, and a mutual respect for silence.

No, nothing at all to say this day will be any different than the 2,000 or so that came before, to put it into my nearly six-year-old son's terms. After a bit of breakfast we both begin to emerge from our morning fog. Questions begin to form. Answers and yet more questions float back and forth between us with effortless grace. But this day will be different. I don't yet know it, sitting across from him at our breakfast table, watching his mind work, admiring his curiosity, same as every other day.

Unguarded, unprepared, the difference arriving this day is but a single syllable, a clip of a word, shortened, stuffed, lost. He says, simply, "Dad." I wait for the rest of it, the child's attachment to his father's name, the syllable, the E that ends the word; da-dE.

But on this day, this different day, it never comes. I feel like something has left me, been snatched away, a piece of who I am that I never fully and properly greeted. That 'something lost' is quickly replaced, however, by something heavier, like a stone. Not mine alone, mind you. This stone, we share it, my son and I, at least I think we do. It means different things to us. He's moving on a different curve than I; so much to do, so much to see, so many dangers to confront, avoid, tame, escape, create. All I can do is watch. Mono-no-a-wa-re.

The Chairman adds, in Honor of Kenny:

Fifteen areas of mono-no-a-war-e in my markets career:

  1. The retirement of Alan Abelson.
  2. The times I exited positions right before an announcement that would have made me a very wealthy man if I had just had the guts to hold through it.
  3. The beautiful women I bought seats on the floor for, especially Susan.
  4. The wonderful partners that have joined the firm, left, and then come back, especially Wiz.
  5. The many times that my friend and surrogate brother Dan has enlightened me as to what's going on in the world for things not in the Enquirer.
  6. The Collab, and the 850 articles we wrote together.
  7. The bearishness of the Sage and his inability to find a stock that he likes especially in technology over a period when the stock market has doubled at its usual pace.
  8. The image of the fake Dr. at the Fed pretending he can plan the world economy based on production statistics and meaningless seasonal indicators that he studies in his bathtub.
  9. The trend followers and their constant assurances that they will inevitably bounce back whenever they have a drawdown in one of their past, present or future funds.
  10. The computer programs I co-wrote where I created beautiful output and merged with the mind of a beautiful person at the same time, especially Susan.
  11. All the times that someone told me something bad about my trading or activities and I laughed and the mistress of markets or Mr. Lack told me, "No one but you would find that funny".
  12. The spectacle of the many employees I had in the past who at one time or another were not properly chivalrous to my romantic interest.
  13. The professors and retired engineers from the military who have come through these portals with systems that were guaranteed to make us profits and the papers they wrote about them or the marketing brochure they developed based on them that were delivered at holiday meetings of economic societies.
  14. The good books that I have read from 100 years ago that put in perspective everything that is happening today.
  15. Jim Lorie and a few of my other best friends coming to watch us trade in the office and, after a few hours, sheepishly saying, "Vic, would you mind if I took just 1% of your action for the rest of the day?"

6/3/2005
A Different Kind of Valedictory, forwarded by Kim Zussman

An American Soldier: 'I want to be remembered for the things I accomplished'

BY MICHAEL C. CARLSON (Wall Street Journal, Monday, May 30, 2005)

(Editor's note: Sgt. Carlson, of St. Paul, Minn., was killed on Jan. 24, 2005, when his Bradley fighting vehicle overturned in Mohammed Sacran, Iraq. He was 22 This is adapted from a "credo paper" he wrote in 12th grade, on May 11, 2000.)

I was born in Wisconsin. We lived in a town called Webster, on a road called Lavern Lane. Since then many things have changed, but many more remain the same. We no longer live in the country, we only go to church once or twice a year, and we no longer struggle to make ends meet. Today we live in the city, but we still have a junkyard, my dad still works 16 hours a day, every day. Today I am a man, not a 7-year-old child. There are still cars everywhere. We own over 90 About 20 of them still run and 12 of those we store in the city. No, we don't have a parking lot. What we do is borrow our neighbors' unused stalls for fixing their cars and doing other little things for them.

I admire my father more than any other person on this planet, not for being a mechanic, not for being a tough guy. I admire my father for his ambition. For 30 years he has gone to work every day, for 30 years he has come home, gone to the garage and worked 10 more hours. I don't know how he does it, but I do know why. He does it for us. He wants my brother and me to have everything we need and most of what we want. Lots of people say that the best way to learn is by the example of others. Well, then I have one of the best teachers there is on how to be a man, how to treat others, and the work ethic. I mean he is not perfect by any means, but is anyone really perfect! I think that he is pretty close.

Sometimes I wonder if my dad ever thought of college. I wonder if he's happy. I sometimes even feel sorry for him. What I mean by that is that I look at him and see a guy that has spent his entire life working. That is what he does. He works. If my mom never brought up the idea of a vacation he would never think twice. He would work to the day he died. I love hard work, but how do you go to the same dead end job everyday knowing that you will be doing it forever.

Every now and then someone that had my dad fix their car will stop by and need something, and every time I talk to them they start talking about my dad's work. They compliment him on paint jobs he did 20 years ago that still look like they are brand new. That reminds me of another trait I have taken from my dad besides my hard work ethic. "If you are going to do a job, do it right the first time, because a job not done well is a job not worth doing," so the saying goes I take that personally. If someone has an honest complaint about my workmanship, I will bend over backwards to make it right. If people are going to pay you good money to do something then you had better do a darn good job. That is why I usually work alone, then, if there is a problem I know whom I can blame.

My dad hasn't taught me everything though, a lot of it I have learned on my own too. I still got a lot to learn still, but I have figured out things like how to deal with people you don't like or those that don't like you. I also learned why when cutting a frozen bagel you cut away from yourself, I got the scar to prove it. My dad calls this type of learning "the school of hard knocks." Some of the knocks are harder than others.

I love sports. I love football, wrestling, weight lifting, skiing and hockey. I love the thrill of competition, the roar of the crowds, the agony on the faces of your opponents as the final seconds tick off the clock. However, I don't want to do it as a profession. I think it would be fun for a while then it would get boring. I guess the point that I am trying to make is that when I am on my deathbed what am I going to look back on? Will it be 30 years of playing a game that in reality means nothing, or will it be 30 years of fighting crime and protecting the country from all enemies, foreign and domestic.

I want my life to account for something more than just a game. In life there are no winners, everyone eventually loses their life. I only have so much time; I can't waste it with a game. I don't want those close to me to look at me and tell me that I was good at a game. I want to be good at life; I want to be known as the best of the best at my job. I want people to need me, to count on me. I am never late; I am either on time or early. I want to help people. I want to fight for something, be part of something that is greater than myself. I want to be a soldier or something of that caliber, maybe a cop or a secret service agent. I want to live forever; the only way that one could possibly achieve it in this day and age is to live on in those you have affected. I want to carve out a niche for myself in the history books. I want to be remembered for the things I accomplished. I sometimes dream of being a soldier in a war. In this war I am helping to liberate people from oppression. In the end there is a big parade and a monument built to immortalize us in stone. Other times I envision being a man you see out of the corner of your eye, dressed in black fatigues, entering a building full of terrorists. After everything is completed I slip out the back only to repeat this the next time l am called. I might not be remembered in that scenario, but I will have helped people.

I guess what I want most of all is to be a part of the real world, not an entertainer. I want to have an essential role in the big picture. I want adventure, challenge, danger, and most of all I don't want to be behind a counter or desk. Maybe when I am a 100 years old I will slow down and relax. Till then, I have better things to do.

6/3/2005
From the Grandmaster

Capablanca had a way of knowing what was important in a position and would exchange off pieces that weren't needed. I think there's a good lesson about life in his methods: rather than straining for an advantage on many fronts it's better to identify the essentials and focus on those.

6/3/2005
Dept. of Doomsday: A Timeline of Gloom & Doom, by Mark Mahorney

What follows is a compilation of books / authors predicting economic and financial collapse, depression, worldwide disaster, the end of the world, etc. The list is primarily focused on the markets, barely touching on apocalyptic prophecy, millennial fears, Y2K and things of that nature.

I had hoped and expected to find a book predicting disaster for every year in recent history. They've probably been written, but many of the works in this list, not surprisingly, are now long out of print.

A trend that did expose itself is the fact that the greatest frequencies were in 1993 and 2003, presumably these were written during the recessions that preceded publication and not surprisingly these titles hit the book market just as the financial markets and economy were coming out of their funk.

Robert Prechter and Doug Casey are noteworthy for having made the list more than once.

Prechter forecast "The Great Bear Market" in 1997 at the start of the great bull market. He then proceeds to tell investors how to handle a deflationary depression in 2003. Do you think he was surprised when we started fighting inflation at the beginning of 2004? Give it up, Prechter. Your timing couldn't be more off.

Casey, whom I met at an event in Aspen a few years ago, belongs to an informal group that includes Bill Bonner (also on the list) who reproach American life. Bonner resides in France.

I dined with a gentleman who took Casey's 1979 book The international man: The complete guidebook to the world's last frontiers: for freedom seekers, investors, adventurers, speculators, and expatriates literally having moved to a small South American country. He was quite verbally bitter that so few of his cohorts had actually made the leap. Casey himself found freedom on a large ranch near Aspen writing books predicting economic depression in the '80s and again in the '90s.

The list:

6/2/2005
Variations on Tree Form, by Victor Niederhoffer

1. Trees often can be visually separated by how wide the branches reach versus how how high they go. A typical classification is between the cones such as the firs, pines, and spruce, called a decurrent form, and the deciduous species such as the oaks and maples where the form is circular, and the lateral branches often grow almost as far as the height. A big factor that must also be considered is how narrow the spreading form is because the elm is so compact they are planted to line the streets in cities like Reverse Horn of Plentington. Stock price movement should be characterized by horizontal and vertical components, and the result should be used to predict subsequent movements in direction and volatility. A good way to characterize horizontal moves in a stock versus the vertical is to take the total absolute variation and compare that to the total algebraic variations. For example, if the moves in a stock during a week were +1, -1, +3, -2, +4,the total algebraic move was +5 and the total absolute move was 11.

Thus, 5 /11 or 45% of the total variation was positive. A little calculation shows that the statistic 4/5 x the % of total variation about the mean that is positive (x the square root of n) is approximately normally distributed with a mean of 0 and stand deviation of 1, i.e.,is a unit normal statistic. Thus, the chances are 5% that that this statistic will be above 1.65 and 2.5% that it will be above 2 due to random factors alone. Here are some results for individual Dow stocks.

Sushil Kedia comments:

Might this not be also a very useful way to comprehend and compare volatility, the way our brains are wired to understand numbers and comparisons, instead of resorting to obtaining square root of a sum of squares:

Say for example :

+1, -1, +3, -2, +4 provides an algebraic move of +5 (net movement) while the absolute move of 11 is the total movement and the ratio 5/11 is net movement / total movement in price and thus a relative measure of volatility is 1 - 5/11 = 6/11 = .5454

+1, +1, +1, +1, +1 gives +5 and 5 thus 5/5 = 1, a perfect trend and zero volatility is given as 1-1 = 0

Simple to comprehend: more volatile moves produce more fluctuation and less volatile moves produce less fluctuation away from the regression of the trend.

So Net Change in Price divided by Sum of Absolute Deviations = trending component

Add to that

Volatility = Certainty

Comes in a similar form of thought as Probability + Uncertainty = Certainty

6/2/2005
The Information Content of Jackson Trial Contracts, by S. Jack Fan

Many of you know that the outcome of the Jackson trial can and is be traded as binary contracts. Now, I haven't followed up on the trial because the subject matter doesn't interest me, but the idea of pricing this contract is somewhat instructive from a Bayesian setting. While the analysis borders on obvious, it may be interesting for those of you who asked about Bayesian analysis in the past.

Assuming that you know nothing about the trial, do not follow the reports and arguments, could you still put an expected value on the contract different from 50/50? Perhaps.

Let's first consider our prior belief: we are neutral on whether Jackson is guilty or not, but we aren't sure. This can be stated differently as: we are completely unsure as to whether there is enough evidence to convict him.

With that prior, we see that the prosecutors are bringing charges against him after getting grand jury indictment. The bar of "beyond reasonable doubt" is a rather large hurdle that if we dogmatically believe in our prior, we do not expect to see the charges being brought. So given our prior, and seeing the charges, Jackson is more likely guilty.

Now we consider the action of his defense. We can consider two settings: (1) the defense is rational and will plea out if it considers a guilty verdict highly likely, or (2) the defense is irrational, Jackson is risk-seeking (in the financial theory sense), and rather take their chances despite being an actuarially unfair gamble.

If our prior belief is that Jackson's defense is rational, then seeing them in court gives us a further posterior that the chances of Jackson being convicted is greater than 50% (after all, they had a chance to respond to the action of the prosecutors and are privy to the discovery). However, if we believe dogmatically that he is risk seeking, then we conviction remains below 50%.

Thus, a trading strategy can be formed from this Bayesian analysis: if one were to trade this contract, one could do so by forming a belief over Jackson' risk seeking personality (which is more observable than trial matters - but there might be a selection bias problem - the media loves weirdos);

6/3/2005
Law of Diminishing Returns, by Tyler McClellan

A unique application to food from Thomas Keller, owner/chef of The French Laundry in Yountville and Per Se in the Time Warner Building. I've eaten at the former and can say it was an incredible experience.

He has even written a declaration of intent for his staff describing the philosophy behind the myriad tasting menus. 'With each course we want to strike quick, mean and leave without getting caught,' he writes, like some Norman Mailer of the stove. 'All menus at the French Laundry revolve around the law of diminishing returns. That is the more you have of something the less you enjoy it.' So lots of tiny courses and lots of intense flavors. 'Imagine one carrot's having as much sweet, earthy and fresh characteristic as a pound of carrots or a spoonful of pea soup with the impact of a thousand peas.' I don't need to imagine. I've tried it.

6/3/2005
Four Chess Books, by Grandmaster Nigel Davies

I would say that these four books summarize my own understanding of chess. I guess a measure of the extent to which others share my views can be summed up by the fact that two of them are out of print and the other two are done on the cheap by Dover! Nigel

Lasker's Manual of Chess by Emanuel Lasker (Philosophy of the struggle, theory of Steinitz, timeless principles)

Zoom 001: Zero Hour for Operative Opening Models by Stephan Zeuthen and Bent Larsen (The only book that is explicitly built around the idea that chess mastery involves pattern recognition)

Pawn Power in Chess by Hans Kmoch (Devoted to structural matters and pawn levers, which are two of the most difficult aspects of chess for improving players to master)

Dynamic Chess Strategy by Mikhail Suba (The best explanation of the inherent dynamism in chess, going beyond Lasker in this respect)

6/3/2005
A Graduation Speech, from James Sogi

The Japanese use the idiom mono-no-a-war-e, which cannot be directly translated into English. /A-war-e,/ is the awareness of the ephemeral beauty in our lives. It is the poignant sensation that our lives are passing, and that this time will never come again. A-war-e, is the vaguely poetic feeling you get around dusk, watching the rain fall on our window panes, watching the sunset fade to night. "Mono-no-a-war-e" is no more and no less than appreciating the sadness of existence. The Japanese have their love for the cherry blossom, not just for it s radiant beauty, but because they appreciate, so sadly, that soon the blossoms will all be gone.

It s funny, that when it comes time to say everything, I find myself at a loss for words. Somehow we expect ourselves to be able to say goodbye to the people sitting next to us, the people that have been there through it all. But sadly, a goodbye will never sum up all those wins, the few losses, the late nights, the early mornings, the inside jokes, the long talks, the times we spent just killing time, and all the unforgettable memories.

We cannot find closure to our time here. And yet, it's time to move on. It s time to grow up and become different people. We will walk across this stage and say goodbye to this day, to our friends, and to this part of our life.

Above all, be conscious of your existence. Be conscious that this is change, and that indeed our lives are indeed passing. Do not wait to say goodbye to make something of your relationships or of your life, because goodbye is too late goodbye is not enough. In every way, we are like the cherry blossoms, ephemeral, and all beautiful.

Because I have no other way to say this, Goodbye. And from the bottom of my heart, I love you all so much. Thank you.

Kenny Sogi
Graduation Speech
Hawaii Preparatory Academy 2005
3 minutes

6/3/2005
More from Suba's Dynamic Chess Strategy, by Grandmaster Nigel Davies

A new strategy imposes itself. It has no pretensions to be a perfect science searching for absolute truth. Science, or philosophy, or whatever it is, it should be adaptable to actual and present needs. We call it dynamic strategy.
The main goal of dynamic strategy is to develop the the personality of a player, to discover and turn to good account everybody's uniqueness. Social dynamism and the human personality are two assets of our day and this is reflected in chess. Tactics and dynamics are becoming predominant in chess. This favors young players and there is no mystery about the increasing number of child prodigies in chess. This is because they are not slaves of a rigid system of rules and dogmas, and their personalities express themselves naturally. Chess strategy must lose some if its grandness and sententiality, come back to earth, and become practical, so that we can make it work for us move by move.

6/3/2005
Redundancy, by Tom Ryan

From 'Information Theory', S. Goldman, 1953 picked up at library sale for $1

Chapters. Foundations of information & the 2 basic laws Exponential law of choice Intersymbol influence Information Entropy Information energy Noise Negative information Redundancy Reliability and probability Attention span Bandwidth Dimensionality

Redundancy. In counting, it is found that the average information per symbol in a language is always considerably less than its maximum theoretical value stipulated by L to the n power where L is the total number of letters in an alphabet and n is the length of the symbol (in letters). In effect this means that parts of messages usually tell things to the receiver that is already partly known, that is there is some repetition built into the structure of language. The partial or complete repetition of message content which occurs in language is a form of redundancy. It is likely that redundancy, has developed over time thru trial and error with feedback in order to maximize the rate of transfer of knowledge and minimize interpretation error on the part of the receiver and is therefore a fundamental property of all language (and music), .

By coding messages with some redundancy, there is a loss in the maximum rate of transfer of information. However, redundancy is a very useful property of language, for it allows individual errors in the transmission of messages to be easily identified and corrected. Redundancy, in effect, is the primary "noise reducing" mechanism in all languages. In its simplest form, redundancy employs a simple repetition of information over time. Various permutations of redundancy are also common, such as embedding a key piece of information into repeated context or the referral to a previously transmitted message in the subsequent message, which is the basis for all logic. Logic imposes structure within a stream of messages in order to constrain interpretation.

If market prices are information, and I think they are, one could expect that the messages that the market sends to have some redundancy buried within the stream.

To test this simply I looked at a market message that I follow, that is a series of price changes that lead to a 20 day low. I then rolled the tape forward from each 20 day low and looked at the time expired since the previous 20 day low. It has been noted already that the standard deviation of 1,3, and 5 day returns immediately after a new 20 day low are substantially wider than average. This volatility effect diminishes with time expired since the 20 day low, in particular volatility in the past decade has tended to return to longer run averages after about 20 days has expired from the 20 day low. So I looked for repeated messages in the period of time of t=+3 to t=+20 from the last 20 day low. Specifically, I looked at the 1, 3, and 5 day returns during that t+3....20 day period whenever the previous 3 day return was less than 90% (arbitrary) of the 3 day return that had transpired when the 20 day low was set. In other words the market goes down and sets a 20 day low. I noted the 3 day return (obviously quite negative) on that day. Then for the period of 3 to 20 days afterwards I screened for times when the three day return dropped near or below that previously noted negative 3 day return that had occurred when the 20 day low was set.

1997- present, S&P cash

Average 1 day return all days .03% stdev 1.22% Average 1 day return when redundant message received .30% stdev 1.3%

Average 3 day return all 3 day periods (overlapping) .09% stdev 2.1% Average 3 day return when redundant message received .65% stdev 2.2%

Average 5 day return all 5 day periods (overlapping) .15% stdev 2.6% Average 5 day return when redundant message received .87% stdev 2.9%

Maybe I just haven't been listening to the market although like most of the systems I test, there are quite a few knobs to turn and tune on this.

Andrew Moe responds:

Some relevant quotes from Shannon's Mathematical Theory of Communication (1948) follow:

"The redundancy of ordinary English, not considering statistical structure over greater distances than about 8 letters, is roughly 50% ... This has the advantage of allowing considerable noise in the channel. A sizable fraction of the letters can be received incorrectly and still be reconstructed by the context. In fact, this is probably not a bad approximation to the ideal in many cases, since the statistical structure of English is rather involved and the reasonable English sequences are not too far from a random selection."
"An approximation to the ideal would have the property that if the signal is altered in a reasonable way by the noise, the original can still be recovered ... This is accomplished at the cost of a certain amount of redundancy in the coding. The redundancy must be introduced in the proper way to combat the particular noise structure involved. However, any redundancy in the source will usually help if it is utilized by the receiving point. In particular, if the source already has a certain redundancy and no attempt is made to eliminate it (in encoding), the redundancy will help combat noise."

As we are all too well aware, the signals and patterns generated by the markets are rife with noise. Dr. Ryan shows us that repetition can help eliminate some of the noise. I have always considered redundancy to mean confirmation in the form of several different patterns telling me the same thing simultaneously. Perhaps bonds have spiked higher as stocks reach 20 day lows (see late April). We know from Chair's work in thermodynamics that the moves between stocks and bonds are correlated on a weekly basis. Thus, we have confirmation or redundancy from different signals telling us to be bullish.

6/3/2005
Escaping Flatland, Part III, by James Sogi

Synthesize with interesting results.

Market Delta breaks each bar into a box for each price tick level and each box shows the number of bids and offers, the number of strikes at the bid or offer, and the difference between the number of bids and offers at any one time for stocks or futures, and records them in numerical display and by color code. Dark dark to light for hi to low volume, and blue if strikes at offer or offers outnumber bid volume or strikes at bid or red if bid volume or strikes at bid outnumber number of offers or strikes at ask. The point and figure structure makes market structure easy to visualize if so inclined.

A few notes and thoughts:

  1. The top few ticks of each bar were almost always blue, where strikes at ask outnumbered strikes at the bid, which is the exact wrong time to buy at the top tick. Likewise, the bottom ticks of each bar were almost always uniformly red, showing that the majority of market participants were hitting the bid at the worst possible moment and selling the bottom tick. The assumption is that a seller hits the bid. This was fascinating to see.
  2. Breaking the bars into to price tick levels and showing the numbers of transactions cumulatively and displaying color adds additional information to the same screen space without chart junk or clutter.
  3. It is said on the SL that volume itself contains no predictive information. I have not seen convincing tests of that hypothesis that volume does or does not contain predictive information. The number of trades may have information and may reflect liquidity. The Globex algorithm would have to take into account the number and volume of strikes at either bid or ask to set the inside market. Even if it is purely descriptive, the numbers and colors convey more digestible information in a usable manner than the T&S window and a bar chart. There's something here, but its not real clear, yet, what it is. Testing is difficult when Market Delta does not allow download of the data into table form, and is a real weakness of the program. Ability to stream data for analysis like the DDE links would be a great thing. Charts in general are so limited to descriptive or archival purposes.
  4. The chart relationships displayed as color or numerals are fixed as described above, but would much better if they allowed the user to define what ratios to display and stream data to spreadsheet or R. I wish I could design my own color 3d chart system and on the fly data analysis, but R won't take streaming data, yet. Existing technology is behind the form.

6/1/2005
The Ant and the Grasshopper: Two Versions from Jonathan Rogoff

The Ant & the Grasshopper.

An ant and a grasshopper lived in the same field.

During the summer the ant works all day and night bringing in supplies for the winter, and he prepares his home to keep him warm during the cold months ahead.

Mean while, the grasshopper hops and sings, eats all the grass he wants and procreates.

Come winter, it gets bitterly cold and the grass dies. The ant is well fed and warm in his house, but the grasshopper has not prepared for the winter, so he dies, leaving a whole horde of little grasshoppers without food or shelter.

The moral of the story is that one should work hard to ensure that you can take care of yourself.

The African Version.

The first part of this story is the same, but because it now happens in Africa, there are a few complications of course.

The starving offspring of the grasshopper demanded to know why the ant should be allowed to be warm and well fed, while next door they are living in terrible conditions without food and proper clothing.

A TV crew promptly shows up and broadcasts footage of the poor grasshoppers, contrasting this with footage of the ant, snug in his comfortable home with a pantry full of food. The public in the neighboring fields are stunned at what they see.

How can it be, in this beautiful field, that the poor grasshoppers are allowed to suffer so, while the ant lives in the lap of luxury?

In the blink of an eye, the AGU (African Grasshopper's Union ) is formed. They charge the ant with "species bias" and claim that grasshoppers are the victims of 30 million years of green oppression.

They stage a protest in front of the ant's house and trash the street.

When interviewed by the TV crews, they state that if their demands are not met, they will be forced into a life of crime. Just for practice, they loot the TV crew's luggage and hijack their van.

The TRC (Take & Redistribute Commission) justifies their behavior by saying that this is the legacy of the ant's discrimination and oppression of the grasshoppers.

They demand that the ant apologizes to the grasshoppers for what he has done, and that he makes amends for all the other ants in history that have done the same thing to grasshoppers.

PAGAD (People Against Grasshopper Abuse & Distress) states that they are starting a holy war against ants.

The President appears on the 8 o'clock news and says that he will do everything he can for the grasshoppers that have been denied the prosperity they deserve by those who have benefited unfairly during the summer.

The government drafts the EEGAD (Economic Equity for Greens and Disadvantaged) act, retroactive to the beginning of the summer.

The ant is fined for failing to employ a proportionate number of green insects, and, having nothing left to pay his back taxes, his home is confiscated by the government for redistribution.

The story ends as we see the grasshoppers finishing off the last of the ant's food while living in their new government house (Which just happens to be the ant's old house) and also the house end up crumbling down around them because they are too lazy and incompetent to maintain it.

Showing on the TV (which a grasshopper and a couple of friends stole from another ant), the President is standing before a group of wildly singing and dancing grasshoppers, announcing that a new era of "equality" has dawned on the field.

The ant, meanwhile, is not allowed to work because he has historically benefited from the field. In his place, ten grasshoppers, who only work two hours a day, steal half of what they actually harvest.

When winter comes again and not enough food has been harvested, they strike and demand a 150% increase in their wages so that they can buy more food, which now has to be imported because the grasshoppers were not productive enough to produce enough food.

The ant packs his things and migrates to another field, where he starts a highly successful food company again and becomes a millionaire by selling food to the grasshoppers in the field from where he came.

6/2/2005
An Interesting Hypothesis, by Victor Niederhoffer

An interesting hypothesis in the otherwise highly flawed (he believes in charts and Fibonacci) book Bible of Option Strategies by Guy Cohen. He says that whenever he gets a tip, he likes to buy straddles , i.e. buy a call and buy a put at the money with 3 or 4 months duration. He says either the tip will turn out to be wrong and it will do down, right, and it will go up, or nothing will happen and it will go down. The idea might be systematized and generalized in some way and then tested. I don't think it would work for earnings announcements but other extensions might be of interest.

6/2/2005
Ask a Bond Maven, featuring George Zachar

Q: If I remember briefly from my Investment 101 classes, duration is a measurement of how long it takes in years for the price of a bond to be repaid by its internal cash flows.

A: It's the present value weighted date of the arrival of the mean cash flow dollar.

Q: Durations change as coupons are paid to the bondholder - a bond's duration decreases continuously as the the bond gets closer to maturity. Bonds with low yields and coupon rates generally have higher durations because the price paid for the bond is being repaid at a slower rate.

A: Since most of the cash flow from a low coupon bond is in the final principal payment, it makes sense that the arrival date of the security's "mean dollar" would be very close to its maturity, and the principal payment.

Q: Bonds with higher durations are more risky and have higher price volatility that bonds with lower durations. This got me thinking - I wonder what correlation (if any) there is on the 10-year U.S. Treasury Note yield to the forward earnings yield + dividend yield for the S&P 500?

A: I don't have access to that equity data, so I can't comment intelligently.

Q: My guess here (call it a hypothesis) is that, as the yield on the 10 year note goes lower, stock prices move higher due to the bond volatility in pricing and thus, lowers the earnings and dividend yields on an index like the S&P 500 through stock purchases.

A: The correlation between debt and stock prices is often high for many interrelated reasons. As I am at home and a little time stressed (between kiddie school activities) , I don't have the time right now to lay them out, but they're well-discussed in both the professional literature and the regular press.

Q: Thus, a negative correlation would occur since bonds with low yields or coupon rates have higher durations and thus, their prices would fluctuate lower and at a greater rate than stock prices (i.e., volatility).

A: I would not take relative volatility arguments seriously. These have been tested and found wanting many times across many different asset classes.

Q: I could be wrong but I think it's an interesting theory to test. The other issue that got me thinking is: why would portfolio managers buy bonds as duration goes lower? Anticipation of lower bond prices and higher yields, leading to higher durations?

A: No. Many portfolios have assigned point or range benchmarks for the duration of their assets. In the case of mortgages, which is a huge sector, the duration of the paper is unknown and fluctuates. So when rates decline and paper is called away, shortening portfolio duration, managers must re-balance by purchasing enough longer duration paper to compensate.

6/2/2005
A Splendid Example of the Alacrity of the Invisible Hand, by Steve Wisdom

In the new FIA magazine, the Adventurer gives a (mostly pro-forma) interview, but adds a new (?) rationale as to why he predicts the commodity bull market will last for decades (perhaps an hommage to Chair's critique?). His gist of his claim is it takes a really long time for supply/demand to adjust to price changes. He uses the example of opening new lead mines, think of all the NIMBY problems & etc.

On the other side of the coin, here's an example of the marketplace quietly, invisibly reducing demand for a costly commodity, fuel: Volvo has a new propulsion system called IPS out for large'ish boats that's essentially a stern-drive with the lower unit "turned around" so the prop end is forward. It's mounted like an inboard, but runs much more fuel-efficiently than a normal inboard, because the prop is in front, "biting on clean water" rather than on aerated water already disturbed by the lower-unit. So it grabs better and transfers power more effectively.

But anyone with a boat is thinking: "Whoa, what about prop-dings! With the prop in front of the lower-unit, it's undefended. Holy cow!" And this is true. But.. with gasoline expensive, it's worth enduring more smashed props each season in return for burning much less fuel. The economics "work" with expensive gas. (Add also, perhaps, the capital expense of extra motor(s) for limp-home use, given the more vulnerable prop).

Prize Package - Tiara Sovran 4000

Built explicitly for Volvo Penta's revolutionary new IPS proplusion system (.. )

My curiosity was intense because this boat had been built entirely around Volvo Penta's radically new Inboard Performance System (IPS) - a diesel propulsion package whose drives mount beneath the boat, rather than on its transom, and whose four Duoprop propellers face forward rather than aft. The concept is revolutionary. I was about to witness the application.

Volvo's IPS pulls a boat rather than pushing it. It attacks the water head-on, at the most efficient angle possible. Turning the wheel rotates the drives (16 degrees each way), eliminating the need for rudders and providing exceptional maneuverability. IPS drives deliver more speed, more miles per gallon and cleaner, quieter operation than conventional diesel inboards. (.. )

6/2/2005
The Tendency to Categorize Impedes Memory, by Tom Ryan

Recently I have been working with my son Andrew, age five, on reading. I am not against phonics, I think it is a useful skill for children at his age however, several weeks ago I bought him a Lego set of the Harry potter train and was having a bit of difficulty putting it together. Twice Andrew corrected me by his ability to view the diagrams and immediately grok the situation of what piece went where. This led me to think he had strong visual orientation so I started him with a pile of homemade flashcards with two and three letter words and suddenly his reading took off on an exponential growth curve. His ability to imprint the group of letters visually and memorize their meaning helped him get up on the track so to speak.

Although not directly related I found this study interesting as it also pertains to visual memory, detail vs categorization, and how children have this incredible ability to remember detail simply because they don't have an overriding need to fit everything into a context which makes me wonder what price I might be paying as a daytrader to constantly have a view on whether the latest move is bearish/bullish

Sloutsky and Fisher did a series of studies that found children have better recognition memory than adults. The reason has to do with how people learn to categorize and classify groups, he said. "Verbatim memory is often a property of being a novice," said Sloutsky, who is also associate dean of research at the university's College of Human Ecology . "As people become smarter, they start to put things into categories, and one of the costs they pay is lower memory accuracy for individual differences."

Sloutsky said adults are flexible and can pay attention to and remember details if they are asked. However, the key is for people to know when to "turn on" their ability to remember details and when the ability to categorize is more important

6/2/2005
Fishing for Substitutes, by Mark Mahorney

Speaking of lead substituting one good for another, it reminds me how as a boy I spent very much time fishing from the banks of the Ohio River. If you're picturing a barefoot Huckleberry holding a string of catfish, then you're seeing it right.

If we ran out of lead sinkers, in no time at all we'd come up with a workable substitute. Nuts, bolts, funny shaped rocks or rocks with holes in them all worked just fine. Store bought bait was a luxury too. Hot dogs, dug up worms, insects, crawdads, cut up fish all worked fine. We didn't even need poles nor fishing line, just any length of decent string that we could tie off to branch of an overhanging willow tree would do. Left baited overnight there would usually be a nice cat on the line in the morning. Those of you up on rural fishing technique know I'm referring to a trot line.

I laugh to myself at the way the marketing of technology has imposed itself on fishing like Valentine's Day. Many times I've fished with people who have turned their nose up to me for not having the right or expensive enough equipment yet I've always had just as much success.

In that regard I think there is an analogy to the markets. How much should one spend on tools and overhead to be a successful trader? Does technology and the blind disillusionment of untested technical indicators get in the way of common sense and an innate understanding of market action? I think it does. I think the person using logic, reason, and knowing how to manipulate and examine raw data can do perform just as well if not better than most people using high tech tools without the application of logic.

If you know how to use both then all the better.

James Sogi responds:

Hawaiian shoreline fishing technique: When the wind is blowing offshore, take a black garbage bag and blow it up and tie it off. Tie your leader to the bag, bait three hooks on 3 hook rig, and let out into the water and let the wind blow the bag offshore into the deep water where the big fish are carrying your line and hooks out to sea. The bag gives the hooks just the right jiggle action as it blows across the water. Set pole on holder with bell to ring as strike alarm. Enjoy cool one while you wait in chair under the shade.

6/1/2005
Made in America, from Rich Bubb

About a month ago some Iraqi buyers' reps came all the way to our facility in Indiana to go over specifications for the orders of their business and commercial water treatment systems we were going to start to make for them. The Iraqi rep pointedly asked that we not prime the system's treatment tanks in our standard red primer color. When we started to explain that the primer helped reduce the possibility of the metal tanks' rusting after installation at his customers' sites, he politely but adamantly refused the standard red primer.

Instead he requested we prime all the equipment we could with US Military Grey, and to stencil on the outside of the larger pieces of the systems 'MADE IN THE USA', because everything his people (his words, not mine) have seen and experienced about the equipment that the US sends them is that it's so much superior to what they'd been used to putting up with that any type of 'Made in the USA' system is seen as the best available.

I have never seen ECN [Engineering Change Notice] paperwork go through as fast as that one did. The plant manager personally walked it through each and every step required. He had that ECN's i's dotted and t's crossed before the Iraqi rep got back to the airport later that afternoon. As a frame of reference, any single ECN's making it through the Sign-off and Approval stages as that one did [to borrow a phrase I particularly like] "has about the same probability of happening as a junkyard's spontaneously assembling itself into a McDonald's restaurant".

And of course, Everybody made sure it was done at "no charge."

I suggested in a meeting shortly after that that we start putting similarly large-lettered notices stenciled 'military-style' on our larger units. You know, just to dispel any confusion. And that we should start applying American flag decal/stickers for the benefit of our international customers, you know, just to dispel any confusion about whom they're dealing with.

Art Cooper adds:

John Ratzenberger, who played the postman "Cliff" on the sit-com "Cheers", hosts a weekly show on The Travel Channel titled Made in America. Ratzenberger travels throughout the country visiting American manufacturers of various items, many of them household names. He explains the historical background of each of these companies and gives a guided explanation of their manufacturing process. I find the show both enjoyable and educational.

6/1/2005
Pixelated, by George Zachar

Very very early in my trading career, I was trying to sell some gnarly paper. When I told a customer that my offer was lower than the bids on a broker screen, the salesman sneeringly parroted the reply: "He says sell it to the ####ing screen, you chump."

A quote is pixels on a screen. A trade is money.

6/1/2005
Eureka!, by Grandmaster Nigel Davies

From Mikhail Suba's Dynamic Chess Strategy, perhaps the best book on investments prior to Ed Spec:

There is one thing that cannot be explained without the help of potential. This is the 'advantage'.
The advantage in chess does not seem to obey the rules of simple logic. Two good moves do not necessarily make a good pair. An attacking move which forces a retreating move in reply does not always give any advantage or increase an existing one.
Sometimes such 'ply' may even do damage to a favorable balance of the initiative or some other sort of advantage.
Tartakover, master of the chess quibble, once said: "the owner of an advanced pawn has his initiative to defend".
How do we explain all this? There is a sort of coil-spring defensive potential which must be considered as a factor. It is a form of dynamic potential and shows that, paradoxically, the latter can sometimes be improved by a retreating move.

The most useful concept for me from Dynamic Chess Strategy was the idea that 'ideal' positions sometimes cannot be improved (Suba makes special reference to 'hedgehog' formations) but they're very attractive to people visually (like charts showing supposed trends). This is clearly highly applicable to markets and I already 'knew' it, but it helped me to be able to make such a vivid link between chess and markets.

6/1/2005
...And Durations are Collapsing, by George Zachar

Not satisfied with b0rking everyone by inverting the forward curve, the debt market mistress is now wrong-footing complacent mortgage holders by threatening to call their paper away even as we await another Fed tightening.

The chart below shows a daily log-scale bar chart of FNMA 5.5% 30-year fixed coupon duration. This coupon represents the core of outstanding conventional mortgage paper.

Further rate declines would likely trigger a self-reinforcing duration-buying panic as portfolio managers try to stay within the same time-zone (metaphorically speaking) as their duration mandates/bogeys.

All this, plus the seasonal increase in mortgage turnover for the homebuying season, payrolls on Friday, and Greenspan's penultimate economic testimony on Capitol Hill on the 9th.

Who could ask for anything more?

6/1/2005
Dan Soubliere writes regarding continued Euro/$ weakness

I copied this from your website back in March. I think it deserves Top Left!!

3/23/2005 The Coming Demise of the Euro?, by a Tennis Playing Speculator

I still hold to my qualitative reasons for dollar strength and I think you know them, but there really is something interesting that I want to put on the record: The EU, its ECB, and its pathetic currency will fail, period. Throughout history Europe has never been a place that could hold a union. Anyone trying to conquer Europe has failed. I do not need to name periods or names. Though this current regime was formed with open arms, hugs, and kisses, like all love affairs that split, the outcome will be nasty. The political dissention on the tape in recent weeks is more than significant. You heard it here first. Euro to Par, then EU to blow up.

LW Comments:

Maybe its just that I'm long dollars, or just returned from Europe...or that I'm blind... or a Burger King hamburger cost $8.50, no Coke or fries but I see no reason for the EU to exist let alone last.

JB Comments:

I've just returned from Euroland too. Of course it is absurdly expensive, but the interesting thing for me is that even the suggestion that the Euro could fail or the EU collapse is anathema--it is simply not a subject that can be discussed. In my experience when something can't be discussed, you end up discussing it at length.

The Chairman Comments:

Will someone tell me why when a man is short the dollar by an admitted $25 billion and has been talking down the U.S. stock market since 1998 circa SP 850, he is not held up to ridicule and cross examination....

6/1/2005
Context, by Grandmaster Nigel Davies

In Lasker's Manual of Chess the former World Champion expounds the theory of Steinitz in a way that Steinitz never did. Something that I've been thinking about today is the guideline that 'He who has the advantage must attack', and indeed attacking moves work much better when we have 'the advantage'.

But how do we know we have the advantage?

James Sogi responds:

Musashi Miyamoto wrote in The Book of Five Rings that there are three types of strategy:

  1. Attacking while moving forward
  2. Retreating
  3. Attacking while retreating

The third is interesting because the opponent thinks it has the advantage and presses attack. While pressing, the opponent may become overextended, off balance, guard down. Strategist can cut while running, or do a quick stop, harry, retreat, each time killing one or more pursuers. The dynamic is different than other two strategies. When pursued by multiple attackers, this is a good strategy to isolate them so that they can be killed one by one rather than faced en mass.

In a famous Persian battle against the Romans where 50,000 Romans were killed in one day. The strategy was to allow the center of the Persian line to fall back, retreat, and the Roman army advanced through the center. The Persian flanks held. Soon the exhausted Roman army was in the middle, surrounded by the flanks. The Romans were small-statured, carried heavy arms and soon tired. The phalanx was not effective against the flanks, and they were slaughtered. Attacking, while retreating.

Here, the advantage is not defined in terms of momentum,, but of strategy with the opponent in a relative sense, moment to moment.

Grandmaster Nigel Davies responds:

I would define number 3 as attacking an opponent who believes he has the advantage. Lasker was a great specialist in this.

6/1/2005
Thinking like a Tree, by Grandmaster Nigel Davies

"I don't think like a tree. Do you think like a tree?"

This was Grandmaster Anatoly Lein's comment on Kotov's idea model for a chess player's thinking process. In 'Think Like a Grandmaster' Kotov laid out the stages very clearly, that one assessed the position, found candidate moves based on this assessment and then extended ones calculations forward in the shape of a tree.

Yet my own experience and that of many colleagues suggests that this is neither a true picture of how chess players think, nor is it very efficient.

What I believe is missing is the element of feedback, the acquisition of new information as you study a position. The process of considering the next move brings to mind new and superior candidate moves which means that the continued and systematic calculation of the inferior ones would be a waste of time. So after looking at the first move you think of, the best thing to do is often to go back to square one.

I think there are two main qualities a player must have to find good moves, intuition with which to hone in on candidate moves/ assess positions and good calculating ability to test these things. Bobby Fischer was exceptionally gifted in both these departments but other players have favored one over the other (Smyslov had wonderful intuition but was less strong in calculation, for Korchnoi it was the reverse of this).

Good intuition is developed by studying the games of the masters, analyzing your own games and play itself. Good calculating ability is largely a gift of nature though it can be developed through study, practice and things like blindfold chess. And that's basically all there is to it.

6/1/2005
A Wry Spec Brings to the Chair's Attention:

T### central banker ordered to repay $4.6bn
By Amy Kazmin in B###kok
Published: May 31 2005 19:51 | Last updated: May 31 2005 19:51

Former T### central bank governor Rerngchai Marakanond, who oversaw the country's failed attempt to protect its fixed exchange rate regime on the eve of the 1997 Asian financial crisis, was ordered on Tuesday to pay back the Bt186bn (US$4.57bn) spent in the futile defence of the currency.

Ruling in the only prosecution brought in connection with a national fiasco that involved T### politicians, policymakers and businessmen, a local court chastised Mr Rerngchai for "grave negligence" for exhausting T### foreign exchange reserves (.. )

6/1/2005
Roachstradamus, by George Zachar

The likelihood of a China slowdown now looks compelling — as domestic policies are taking aim at a property bubble and foreign policies are targeting Chinese exports. This could reduce world GDP growth by as much as 0.7 percentage point within the next year and impart further downward pressures on global commodity prices.

I can't decide what's the most bizarre aspect of the above passage.

That China's central planners are sincere in their desire to stem the property bubble? That they'll succeed? That the never-ending screeching from Western old-economy firms will now result in effective trade barriers? That it is possible to calculate the effects of such intangible efforts on China's comically mis-reported economy? That it is possible to then calculate the impact of same on the planetary economy? Measured in units of a tenth of a percent?

Wow.

6/1/2005
A Book Recommendation from a Southern Spec:

I read Letters from a Self Made Merchant to his Son while flying yesterday - a great read, maybe more usable content in contents than Reminiscences of a Stock Operator about Jesse Livermore for speculators. Save you from the favorite parts, I'll just mention that if I ever error in not counting is when I take a short cut by trusting that the person I am "counting on" has done his math to come to his conclusions. Lorimer is one in which I feel comfortable making this error. His advice given in the form of John Graham are ones in which seem well tested and should objectively be followed! Darn shame I didn't read it when I was 21 years old. Glad I had a Dad and Pa Pa like ol' John Graham though.

Also worth mentioning is Lorimer's use of "alliteration" in his writings and using it to stress the negative parts of the salesman selling ointments, salve and yanking button hooks out of a boy's throat. That is one more sample of alliteration being a pilot fish for bad to come.

6/1/2005
Web Ad Bucks Rival Prime Time TV, by George Zachar

This year, predicts Advertising Age, the combined advertising revenues of Google and Yahoo! will rival the combined prime-time ad revenues of America s three big television networks, ABC, CBS and NBC.