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October 1-15, 2005

10/15/2005
Multiple Hypotheses, by Philip J. McDonnell

One of the least recognized abuses of statistical methodology is multiple hypotheses. The classic market based example is the day of the week study. We start off by looking at our data and calculating the average return and standard deviation for each day of the week. Then we pick out the best day of the week and the worst day of the week. Now we call these our hypotheses. We look at their statistical significance using the usual 1 chance in 20 criteria. If either one is statistically significant we accept it as a non-random event. But is this really a scientifically sound and statistically sound procedure?

The answer is an emphatic no. The first mistake is to look at the data in the beginning. A good scientist or statistician forms his hypothesis first without ever looking at the data to be tested so as to avoid bias which may result merely from random oddities in the data. It is acceptable to look at other data not in the test sample to form an hypothesis, but never the test data. For market research this means one can go back to some 1990s data set and data mine ad lib.

Another common mistake is to violate the fundamental assumptions of the statistical test in question. Most test require independent identically distributed variables (usually abbreviated i.i.d). Often normality is assumed. The word independence means that observations are not correlated with each other. If the data are correlated with each other then there is a greatly increased chance of an extreme outcome. Because most tests assume independence they are designed to be fooled in the presence of correlation. Correlation can come in many forms. It can result from the action of gravity so as to form star clusters. Explosions of super novae or other unknown energy sources are known to create expanding shock waves of denser gaseous material which can act as the breeding ground for new stars. Viewed edge on the wave fronts can appear as concentrated lines or arcs of stars. In the market study of day of the week effects the days often show a correlation to each other. In each of the above correlated cases we would expect apparently anomalous behavior in the form of more clustering or more extremes, but it is all due to correlation.

The multiple hypothesis mistake is ubiquitous and insidious. In the day of the week example there are actually five hypotheses for the best day of the week. It could be any one. However there are also five more hypotheses for the worst day of the week. Thus the situation is equivalent to drawing 10 balls out of the proverbial urn where the chances of drawing a "winner" is 1 in 20 (assuming i.i.d!). This is roughly a coin flip. So rather than the desired statement there is only a 1 in 20 chance that this result was a random fluke in the data we, now we can only say maybe it was random and maybe not.

The insidious nature of multiple hypotheses comes from several sources. If you have ever read a book on investing or an academic finance paper or any of the numerous quantitative studies on the spec list then you are guilty of vicariously peeking at someone else's data. No serious student of the markets is immune to this issue. The only way I know to prevent this problem is to treat what is read as an exercise in data mining and thus only as a single hypothesis. So if the book or study was written in 2002 any subsequent testing must be performed using 2003 data or later.

Another aspect of multiple hypotheses comes from the human mind's ability to recognize patterns, similarities and correlations whether they exist or not. My wife's mother passed away on 9/11/02 from illness. On the anniversary of her passing my wife and her sister took their father down to Disneyland with two grand daughters. In the hotel room that night they played cards and the first two cards turned up were both aces. This was immediately proclaimed by all as a message from the dearly departed. Given the first Ace, the odds of the second one (with replacement) are about one in thirteen - not likely but not incredible either. What if it had been two queens? Wouldn't those present have accepted that as an acknowledgement that the two daughters were present? A pair of two's could represent the same interpretation. Three's could be interpreted as recognizing the two daughters and the father, kings the father only, five's the 5 immediate relatives (including grand daughters) and sixes would acknowledge that the sister's husband was there as well and seven's the seven kids the mother had. There are many possible hypotheses in such circumstances. There are so many that it becomes almost certain that one of them will fit if we try hard enough. The only way to avoid the trap is to form the hypothesis before looking at the data.

Yossi continues on data and hypotheses:

The key issue is that when you open yourself to trust foreign sources that are broadly and globally minded, your data and conclusions may be swayed when the bias is not obvious. The problem as I see it has at least two relevant faces. One is the political bending of data released, including their suppression in whole and in part. The second is the relevancy of variables that actually determine the true value of statistics and information used in predictive models.

I find that if you watch national US television news or read the New York Times or Washington Post you know far less about themes like European, African and Asian issues in time or early enough, as compared with the BBC  or French media -- which I do follow almost daily. I find the bias of BBC TV and radio very consistent and virtually predictable (especially -- but not only -- when you cross check) against:

1. anything U.S. or Republican;
2. Israeli initiatives or wishes in the Mideast conflict;
3. top dogs in economics and industry, including a consistent attempt to paint blacker than the devil their interests and leadership (particularly when not British);
4. new types of commerce, financial expansion and local entrepreneurship;
5. demands and suggestions to create productivity and self policing in less developed countries.

The BBC source is refreshingly  very consistent in preferring the stated ideological predisposition in favor of simplicity in reporting bare facts. It is committed to black-and-white, missing shades of gray and colors altogether. And it misses, seemingly accidentally but actually permanently, evidence or need for applying the rules of evidence.

However, I do need to check the BBC, Arabic language media, many terrorist websites around the world and numerous other propaganda sources for three reasons

1. to develop hypotheses
2. to make sure I do not miss an important scene or perspective
3. to consider their alternative explanations and predictions before I come with my own opinion and checks.

It matters not at all where you live in this age of Internet and search engines; you can access sensitive and complete information if you really want to know. If it does matter where one lives, one should prefer to be, no insult or diminution meant, a barber or a fashion director, as the specialty rights and wrongs are, while not less biased on getting valid and reliable causality, faster in reaching targeted practicing professionals.

Having lived in Israel, Japan, Korea, Brazil and Papua New  Guinea I have always found information filetered through cultural prisms to be less accurate but more enriching for analysis. Getting to ask the right questions is where knowledge starts. Getting to have an open mind and an independent pool of greatly informing models and hypotheses is an exercise our chair and many of our specs consider imperative and for good reasons.

There are more serious issues for the student of data patterns: too often we assume that we know the research universe relevant for prediction. For example, Chinese-made cars are sold in Europe -- mainly from a Belgian base of sales -- at about half the price while duplicating original European and Japanese models that are either very prestigious or economical. The numbers are growing at such a rate that this phenomenon will become noticed in less than two years. The overall consumption of energy in China and India is not reported fully, as new manufacturing plants, including those in certain remote areas, do not report their total energy needs in 2006 or 2007. The growth in production of consumer goods in these and other populated countries seem to predict new types of burden on the national and global energy accounts. Very often these data are collected or/and known to the energy giants and analyzed by them before public or external government  is aware of coming changes.

With  these factors in the background, I also use a few search engines that are mathematically  and statistically able to help look for patterns where you find none or only glimpses and, hence, create distal knowledge. Often I find that numbers and quantitative measures taken for granted, are off or wrong at the source or sourcing  by looking for covariance or missing data that should be easy to locate, given what we know about other such studies of the virtually same universes elsewhere. Often enough these are not real issues -- but when this extra care is applied the following, in  particular, require a second look:  energy, food consumptions, agricultural products (especially genetically based), certain financial reporting trends and utilization of related statistics, capital reserve deposits and metal extraction. Then, it appears that very sophisticated analysis using the less-than-optimal sources, particularly  when not comparing a few independent sourcing, results in bigger sins, misleading a researcher or his research consumers. Again it can and does happens almost everywhere, not only in America.

10/15/2005

I wanted so badly to fall in love with a woman I recently met. Perfect height, perfect body, perfect attitude, perfect humor, and perfect drive; in my eyes, perfect everything.

But, when that P&L is deep in the red and you sit in the quiet of a room reliving every aspect of the trade that went wrong, hating yourself for not getting out sooner than you did, wondering how you missed the signs that told you all was wrong with your count, your investigations, your expectations. How do you go out and pretend all is well? How does one sit at the dinner table pretending to listen while all you think about is the trade that set you back? You've just lost a small fortune. How do you keep your temper in check while the supposedly person you love complains to you about the freshness of the salad?

I truly wish I could consign the two, but it seems that I cannot. My trading takes preference. That is all, in the end, that I care about. I suppose that I am doomed to a lifetime of dates.

Russell Sears responds:

Perhaps the good Dr. Brett could say it better, but anxiety has been very counterproductive to my trading and enjoyment of life.

What I find great about running is that I start with the bad call fresh and in the front of my mind. But I end the run with it put neatly away in the back rooms of my mind. If there is a solution, often there is not, I have a much better chance of solving it with my creative sub-conscious. And I have cleared my mind to enjoy life.

In "Something About Mary" the advice was "don't go out on a first date with a loaded gun". I would change this to "don't go out on first date with a racing mind."

10/15/2005
Detritivores and Other Destroyers, by Victor Niederhoffer

1. There's something unholy about the market's reaction to every twist and turn in the Refco death dance. With every bit of news that made the company's death seem more likely, the market dropped 1% in a minute. Yes, they might go under, as did Enron. And Delphi, with \$1 billion in market cap, also went under amid the change in bankruptcy laws. But how does that compare in significance to the many companies that reported 15% earnings growth this week, the three-quarters of the total that reported positive surprises, the decline in energy prices to three-month price lows, the great news from McDonalds and Alcoa, the technology breakthroughs at Apple, the paltry 0.1% rise in the core inflation rate for a fifth straight month, the differential between earnings yield and bond yields of a few percent in stocks' favor, and the fantastic performance of every other market relative to ours so far this year? Are we that bad?
2. It's a major, terrible tendency of market players to feast on the dead. Those who have been around recall how the market went down a fast 10% as the vultures circled around the Long-Term Capital Management collapse. Whenever the firm went in to find a buyer, the prospect couldn't wait to kick them out, to sell in front of them. That's the tradition. The same thing happened with Baring's collapse, and I well remember how the U.S. market stopped dead in its tracks the week of Oct.. 19, 1987, and how it dropped 5% whenever there seemed any likelihood that the British government would hold the U.S. underwriters to their pre-crash commitments on British Petroleum.
3. History abounds with these paralyses caused by death. In Henry Clews's classic books on Wall Street, he describes how Governor Flowers was the leader of the bull claque, and when the homely rustic died, the market ''dropped to zero.'' The reaction to all the rumors planted about ''Doctor'' Greenspan's death or, it is hoped, retirement are another horse from the same shed. And this must be quantified.
4. Detritivores and reducers play a key role in the ecosystem by recycling nutrients and minerals that couldn't otherwise be used by organisms. About 90% of the organic material in the forest is recycled only when it is dead and the bacteria and worms take over. Vultures and crabs are specialized to ingest decaying matter. It's disgusting to see them on the road or shore, the same way it is to have your counterparts watch over you like a hawk or vulture to see if you're near death, try to precipitate it, and then with no risk of their own, eat your fixed remains. Such is so common in markets.
5. The general principle here is that the inflexible and the slow-moving are easy prey for those who are flexible. The principle reaches its ultimate expression and a terrible realization in the case of market death.
6. Among the rumors that constantly swept the floor this week was that this firm or that firm was intimately involved in some way in the Refco debacle and held a current weak hand in the market firmament. The surfacing of such rumors were usually good for a quick quarter-percent decline in the market. When such rumors gave way to others, the market bounced back. Such is the way of markets. And such is the way of those who disseminate such rumors.

10/15/2005
An ode to the site, from Ken Smith

"You cannot recall the spoken word, you cannot wipe out the foot-track, you cannot draw up the ladder, so as to leave no inlet or clew. Some damning circumstance always transpires."

In my experience Emerson is a speaker of truth. If nothing else then in the withering hours of life haunting memories will occupy the mind during the endless minutes of sleepless nights.

10/14/2005
Nobel Prizes, by Yossi Ben-Dak

When it comes to science, medicine and economics, I see in the Nobel institution a tool of progression in cumulative knowledge with true interest in a unified science tools and even -- more and more often -- a subtle ideology of building a multidimensional ideology for comprehension and forecasting. Example: giving the prize to R.J. Aumann now, and previously to Daniel Kahneman. I loved Kahneman's autobiography where he highlights insight into intuitive prediction all the way to consequences of pupil size. His treatment of behavioral economics and his zeal to borrow from any and every discipline becomes, in his concluding observation, his wish for a legacy of efficient procedures for the conduct of controversies. His using the www.nobelprize.org site to remember the 1996 loss of our common friend, Amos Tversky, is also relevant to why I hold the Nobel prize in these areas as a major human compass.

Amos, never to receive a Noble award, was the kind of person who would have real insight into what other scholars said, all too often more than they had themselves to offer. He was concerned with carefully listening in to his fellow scholars and students and drawing always the most from "what the terrain gives" by way of cross-discipline and milking out all that a phenomenon offers, first ideographically in terms of the original explicator and then, nomothetically, for future science. All in all, this is true for both this year's Nobel laureates in economics, and Danny Kahneman and to a degree for all others, particularly the Chicago school. It should be often the perspective to recall in speculation as well.

When it comes to peace and literature, the selection system seems to be quite consistent in choosing the wrong people. Arafat and Koffi Anan come to mind. Pinter is a lesser choice than any of the others nominated this year, in my opinion. Of course, there are the cases of Schmuel Yosef Agnon (1966) and Mrs. Shirin Ebadi of Iran (2003) -- so it proves that it is not a tautology altogether and they make "good" mistakes once in a while. The peace award is worse than the literature selection because there are so many great, expressive minds that ought to be rewarded in literature as they often provide rare insights into civilization and its stresses and the quest for human liberty and decency. Yet there are so many people who should be screened out, under a minimalist perception of contribution to mankind, both in the present list of Nobel peace laureates and the future ones that may include, perhaps a Mugabe ["a deeply religious person who is concerned with true equality of his people and punishing white oppressors in Africa...."], given the redundant and uninspiring rationalizations for choice. I kind of expect now a major catastrophe in nuclear blackmailing given this year's choice of IAEA, just like the selection of contributors to peace in the Middle East or Vietnam or constructive reform in the UN system.

It is a pleasure to see the erudite and informed nature of contributors to this Web site when they extend their joy to fairly worthy but not too popular writers whom they not only read but meet in the farthest places . This is a mark of celebration of the human spirit in these, our, quarters.

10/14/2005
A South-of-the-Border Update, from Bo Keely

Sorry, I didn't send an update or we'd have ridden the range. The update is: Two weeks ago, after exiting Mexico and getting nabbed midstream in the Texas Rio Grande by the US. Border Patrol, I wanted to dive back into Latin America. But I required a translator-partner to hobo the underground railroad to fully understand the illegals stories. My Spanish speaking friends have families to keep, one Spec-lister backed out lacking fitness & passport, a Colorado businessman thought it too dicey, a Dumpy Eatsalot from Oakland veered when his mom got ill, and a Guatemalan Santiago decided to bicycle rather than freight train home to Central America.

Anyone who wants to visit me at Scorpion Rancho in California, as did amigo Ken Smith, or to get advice on southwest desert travel can email. If there s no immediate answer, I ll see your note on return from an outing and respond.

10/13/2005
Patterns Vs Stories, by Nigel Davies

A major source of mistakes in chess games is an insistence that matters are clear-cut when in fact they are usually complex and difficult. The way this acts is to lead people towards pursuing a particular idea without assigning enough weight to mitigating factors.

I think this same effect is visible in many other spheres. Clear storylines seem popular with the public when they come to elect a government and markets also tend to pursue a particular theme with great insistence that it is some kind 'ultimate truth'.

What is it in the human condition that produces this tendency? I think it's our insecurity, the fact that our brains are big enough to understand that we have a limited amount of time available to us in a vast and forbidding universe. At the same time we are not smart enough to figure out all the answers. So in order to assuage our natural insecurity we try to clutch hold of elements of clarity (comfort) wherever they make just enough sense to get past our often limited ability to discriminate.

Are these patterns? I would describe them as stories. And the essential difference between a pattern and a story is that the pattern identifies a real effect whereas the story is what we want to hear, something that resonates with our need for security and appears to 'make sense of it all'.

So the essential problem for a trader or chess player is to discriminate between patterns and stories. From the above it would follow that there are two ways to do this; to learn to overcome our insecurities and hone our analytical skills. And even then it is difficult.

10/13/2005
Artifacts of Speculation by Mr. Ckin

This past week presented an opportunity for me to travel to Southern California. Although my main business was hardly illuminating, I did have an opportunity to meet some Spec-Listers as well as to engage in a highly relaxing odyssey of a sort that I try to undertake at least once per year.

Having most of a day free of appointments, I took full advantage of the generous unlimited mileage plan offered by National Rent-a-Car to cruise through the Mojave Desert, a region that I have always associated with some of the most profound ventures and speculations that continue to serve as illustrations today.

The jumping-off point of the desert is a dusty enterprise zone by the name of Barstow. Now known for outlet centers, (for which the developers have undoubtedly seen their land speculation pay off heavily), the town's existence is largely owed to the development of the Calico silver mine in the nearby hills. As those who have been involved in development of mining projects are aware, one key aspect of financing, both in the Nineteenth Century and now, is the ability to induce the public to speculate. The truly successful mining promotion is one in which major economic institutions are induced to speculate. In the case of Calico, the Southern Pacific Railroad saw fit to use borrowed money to invest in a rail connection linking Barstow with Mojave, a 100 mile link. This short line seemed to have been a waste of money when the silver played out in 1892, but in a lesson about never giving up the free option, there was a resurgence in economic activity in 1896 resulting from the expanded mining of borax in the area.

Not far from Barstow is a side road leading to an area identified by one map as Croesus (although my GPS unit showed a name of Crucero.) I believe this place to have once been a station serving the Tidewater and Tonopah Railroad, but there were no apparent remains of any structures save for a large rectangular prism-shaped stone oddly reminiscent of the monolith from 2001. My interest in the town was due to the story of King Croesus (referenced by the Chair) and his audacious Oracle audit.

Heading northwards on I-15 some ways brings one to one of the greatest sources of intrigue along the route. Zzyzx Road beckons, just at the edge of a dry soda lake bed. The name Zzyzx was assigned in the mid 'Forties by a defrocked (if he was ever frocked at all) Methodist minister by the name of Dr. Curtis Howe Springer. Dr. Springer illustrated the financial rewards that can accrue to one who incites speculation. After constructing a primitive (though large) spa and resort complex surrounding an oasis, the good doctor used a radio show, nationally syndicated at one point, to advertise a line of worthless snake oil preparations that were alleged to cure almost any illness. Further, invitations were made to his adherents to investigate whether or not an expensive stay at the Zzyzx compound would lead to better health, Dr. Springer presumably grossed over \$20 million prior to his arrest by Federal Marshals for trespassing (he never actually owned the land) and for fraudulent health claims.

The last stop along well-trafficked roads before entering the heart of the Mojave Desert is the town of Baker. Baker is home to several service stations, a Bureau of Land Mangement information office, a Starbucks, homes for local workers, and little else. Some years back, the town elders (I presume) sought to invest in a display of self promotion which would solidify Baker as the preeminent, best-in-class, stopover point between Los Angeles and Las Vegas. The result was the construction of the world's tallest thermometer. Somewhat garish though it is, I would have liked to see it at night. Whether or not it has led to increased commerce is debatable, but the BLM, I understand, is relocating its store and visitor office to the newly restored Kelso Depot, deep inside the heart of the desert preserve.

I turned Southward into the wilderness, along Kelbaker Road, a sixty mile trek that passes along a filming site of an early Star Trek episode (the one during which Captain Kirk must create gunpowder out of materials he finds on the desert floor.) This road passes along the sites of one-time mining prospects with names such as Oro Fino, Brannigan, Paymaster and Rainy Day. These claims must have been tremendous long-shots for their promoters, as I could find no evidence of abandoned rail beds, access roads, or any indicators of nature ever having been disturbed in the area. Subsequent research showed that mine reclamation projects have been active in the area, turning abandoned mine shafts into habitats for endangered bat species.

The Union Pacific Railroad is nearing the completion of a \$10 million+ project to refurbish Kelso Depot, a one-time water station and rail worker camp running along a flat grade called Kelso Wash. Kelso was once a bustling town of 100 people, lured to the area in hopes of establishing businesses to serve the railroad workers and the passenger traffic. The most notable feature of Kelso (and practically its only feature these days) is, of course, the depot. I might venture to say that Kelso Depot is the most opulent structure in the desert, an artifact of the San Pedro, Los Angeles & Salt Lake Railroad, which was known for its Spanish Mission Revival style buildings. Of all of the unlikely ventures to involve traversing the Mojave, this particular track line is to this day a home run. Consolidated with the UP sometime prior to 1922, the current right-of-way encompasses as many as five sets of track, with trains running through as frequently as four times per hour. At the suggestion of the Office of Homeland Security, specific traffic figures are no longer published for the line, but it is deemed "economically sensitive" given that a substantial portion of all goods imported through the Port of Los Angeles are subsequently shipped though Kelso.

Although the temperature was a relatively pleasant ninety-four degrees, almost all of the sunlight was scattered by the nearly white sand, giving the scenery a fierce glare. One can sympathize with the miserable conditions that were endured by the region's early (and only) settlers. Given the attendant excitement at the announcement of possible mineral discoveries in the past century, it is not hard to envision that the rampant speculation that developed served not only to finance mine development, but also served as a distraction to the locals.

Come to think of it, with the above-mentioned trip fresh in my mind, I find that I must wholeheartedly recommend that anyone with an interest in the mining stock activity of a century ago read a book entitled "My Adventures with your Money," by George Graham Rice. (Dedicated to the American Damphool Speculator.) Mr. Rice wrote his book while incarcerated for mail fraud, following an illustrious but short career in which he financed dozens of desert mines through a masterful series of stock manipulations marketed to a "sucker" mailing list of 65,000 investors. Before his trust company collapsed during the Panic of 1907, shares of Rice's companies enjoyed heavy trading volume for several years, listed on stock exchanges in San Francisco and in Tonopah. Although Rice was sentenced to a year in prison following the panic, some of Rice's business partners met with some later success. One of them, Tex Rickard, later moved to New York and was instrumental in developing the original Madison Square Garden.

The remote territory you drove is familiar at a slow pace as I walked on the Mojave Trail five years ago. It courses over sand and through cactus, with fascinating history, for 200 miles from the Colorado river to Barstow where I hoboed a freight back home. The Trail incorporates your Drive at unspoiled sites including Kelbar Road, ZZyzx, Kelso Depot, the Union Pacific RR, and on to Barstow. Any budding capitalist would profit from studying Dr. Springer's complete history at Zzyzx, where one can now stay with the present-day biologists and study nature. I nearly turned it in on the dry Soda Lake outside that spot with the temp in the 120's and no water. The surrounding desert, as you viewed, is splendid with green washes, Joshua Trees and vultures.

Besides exercise, I thought on the walk to speculate in property for sale, maybe move in with a trailer and solar power, however, the Mojave green rattlesnake stopped me. Twice. I like snakes but not the endemic lime Mojave rattler with its strange neurotoxic venom. My digs, Scorpion Rancho, is scant miles from where you drove, so next time I would happily show myriad other speculative and scenic attractions such as copper mines, Salvation Mt., and the Tuk's giant hog. We would capitalize with a ride in a Road Warrior buggy on the Chocolate Mt. Bombing Range to gather scrap bomb fins to recycle for gas money.

10/13/2005
Pols & Polls, from Shui Kage

A survey carried out by NBC-TV and the Wall Street Journal shows:

Support President Bush? Yes 38%, No 58%.
Country is heading for the right direction? Yes 28%, No 66%.

General sentiment is the most negative in the past few years for President Bush.

Having said that, I have never seen low polls for the President at a market high. Generally, when business is good, poll numbers go up. Can I conclude: the low poll is near a market low?

I think just one little policy change can reverse market sentiment. For instance, if Bush can come up with a brief plan of pulling back the deployed troops in Iraq, this alone will ease many people's minds. I am looking forward to the November 1-year anniversary speech.

10/13/2005

I am absolutely delighted that Bob Aumann has won the Nobel Prize in Economics. Bob is a truly great game theorist as well as a really nice guy. A modest genius who has known personal tragedy and deserves this honor.

Having finally got my economist in after so many years, my pick for literature is Ismael Kadare, perhaps the greatest living novelist and living proof that you can be a Stalinist and great artist at the same time. Want to get an insider's view of Stalinist dictatorship? This man was a hometown (Gjirokaster) friend of Enver Hoxha himself! Check out "The Concert", "The General of the Dead Army", "Spring Flowers, Spring Frost" and, his latest, "The Successor", and don't believe the spin about how he really was a kind of dissident all along. No one but a really close friend of Uncle Enver could have written what he wrote and outlived the system!

10/13/2005
Check Out a New Batch of Wiswell Proverbs!

10/13/2005
Jim Sogi on Strategy

What is the strategy for a small combatant to fight a larger more powerful, better equipped opponent? A head on battle would not succeed. Indirect methods are needed.

1. Use traps such as IEDs  in places where the big opponent travels regularly but cannot see them.
2. Use stealth.  Attack in the dead of night while the enemy sleeps.
3. Lure small contingents of the opponent in to prearranged areas set up for defense where they can be knocked off singly or a  few at a time.
4. Hit, run, hide.
5. Observing the opponent's prior tactics and big movements from prior battles. Act accordingly. Different situations require different tactics.  Using what worked over and over against a different enemy or a different time may be as dangerous as fixed systems.
6. Listen to the opponent's communications, propaganda, and determine what makes the opponent tick. Act accordingly.
7. Always over estimate the opponent. Never become complacent.
8. Don't be diplomatically isolated. Keep strategic alliances in place.
9. Maintain good intelligence.
10. Spend adequate money for weapons, training.
12. Play to the opponent's weakness.
13. If the opponent is slow, utilize speed.  If the opponent is fast, utilize patience.
14. Maintain credibility.
15. Never meet the large opponent head on. Attack from the side, while the opponent retreats, or is at the end of its operation.
17. When there is no advantage, retreat, hide, do nothing, prepare, train.

From my experience a stronger opponent will have knowledge of the most tactics so in a market/game which is fast moving and where moves are not always clear you have two different options:

1. Devise new ones that they cannot know about.
2. Change tactics frequently to keep the opponent guessing, this way they will know what you are doing, but by the time they know it it is already over and a new tactic is being used.

Nigel Davies remarks:

The problem is that a stronger opponent is likely to have a knowledge of all these strategies and will be able to do them better because of his strength and the resources under his command. I think the best chance for a weaker player is to randomize.

I should add that vis a vis markets a weaker player, who we'll assume has no edge, should probably avoid playing for money. If, for some unknown reason, he has to play and he needs to win a certain amount of money, he should make the game as random as possible by taking only one big trade and then calling it a day. Any kind of drawn out conflict will mean he's done for, though as with a chess game he might fantasize that he can win if only finds some special 'tactics' or 'variation'.

This delusion accounts for the industries that have arisen around chess, trading and other activities, the elusive search for 'the weak player's edge'. The reality is that weak players will never have an edge unless they become strong players. Until that time comes they're just different varieties of dinner.

You can hire former Princeton basketball coach Pete Carril as an advisor. He demonstrated that even if your opponent is bigger, stronger, faster, more athletic/physically talented (e.g. Georgetown) you have a chance if you play with a patient, smart, percentages-aware, disciplined, mistake-free style. Even with the introduction of the shot clock his teams were successful. Just an amazing coach. He has a book out, appropriately titled The Smart Take from the Strong.

A weaker basketball team can increase its probability of victory against a stronger opponent by taking many 3-point shots. Since 3-point shots have a higher variance than 2-point shots, 3-point shots stretch out the distribution of the team's point total, increasing the probability of a point total that exceeds the average of the stronger team. Since in basketball, unlike markets, a loss is a loss regardless of the margin, the simultaneous increase in the probability of a lopsided loss is of little concern.

Judo is a philosophy that exploits asymmetries between contenders of different mass and strength. The idea is to manipulate the opponent's superior strength and mass to cause him to lose his mental and physical balance. In face to face combat, judo has developed techniques that are very effective.

If the contender is an invincible machine (say, a superior computer program), the weak will fight the human operating the machine and not the machine. The idea is to get the operator to doubt the machine's performance and cause him to fidget with it or discard it. Fight the man in the tank, as we say here.

Russell Sears counters:

I would suggest the converse is the best strategy. Let the superior team shoot the 3 point shot, protect the middle.  If my recollection/assessment of the NCAA 2004 championship game, the Tarheels against Illinois, is correct, this worked great for the Tarheels.  In my opinion Illinois was superior and the better 3 point shooter, however the Tarheels guarded the middle whilst giving a lot of 3 point shots to Illinois.  It did not take all game of poor shooting, rather only a cluster of bad shots near the start. Instead of attributing it to random cluster,  Illinois lost confidence and became frustrated.

Lose of confidence and frustration can override skill and teamwork/cooperation. Illinois had both superior skill and teamwork, if the pre-game experts are to be believed.

There is an Indiana Hoosier adaptation to the proverbial sword saying, "live by the 3 point shot, die by it."

Volatility can cut deep in games, trading and life.

James Goldcamp responds:

As a small point of contention, Illinois had superior teamwork, but was not even close on the raw talent scale to the UNC team which boasted 4 first round NBA draft picks (including the # 2 draft pick, vs 2 picks I recall for Illinois). To win the game Illinois had to shoot 3's well as they were no match in the interior. Illinois excellence stemmed from their precise execution and ability to play near the top of their potential consistently.

I would contend that strength in basketball or football seeks to grind and extend the game (increase the N and reduce variability). In basketball this means throwing it in to your big men, in football it means running it down the opponent's throat as long as you dominate the lines. This brings to mind one of the dumbest pundit comments I remember hearing in sports when the Patriots beat the Rams in the super bowl some years ago. John Madden urged the then underdog patriots to sit on the ball and play for overtime in the remaining minutes, instead of driving down the field and kicking the eventual game wining field goal. The underdog has to go for the jugular (shoot the three, throw the bomb, and by all means don't go into overtime) and avoid conservatism. Time is not on their side.

In any risky endeavor it pays to know when to use a high variance strategy and when to play it safe.  This is especially true in sports and investing.

In sports the metric is the win.  You either win or lose, or perhaps tie. The size of the victory is irrelevant.  Excess baskets, touchdowns or runs are ignored.  It only matters who won.  In markets it is not always like that.  How much you won or lost is quite relevant.  The quantity of winnings is passed on to the rest of your trading career.

In baseball the concept of the closing pitcher is entirely rooted in the idea of minimizing the variance for the team which is ahead.  Ostensibly the idea originated with a certain PhD in statistics who consulted for the Pittsburgh Pirates.  He recommended only using their hot short inning pitcher Roy Face as a closer.  If the game was close Face would come in the 8th or 9th inning to turn it into a sure thing - thus minimizing the variance.  If the Pirates were behind or the game wasn't even close the precious resource of his arm would not be wasted and a lesser pitcher would enter the game.  The closer concept persists to this day.  The indisputable all time best closer is Mariano Rivera.

However there are some scenarios where the game of investing more closely resembles classic sports competitions.  When a manager invests money for others without incentives the situation is different.  For a mutual fund manager the incentive is to keep one's job.  His mutual fund management company does not earn greater fees for better performance, they simply get a percent of the assets.  The incentive is to not do badly - minimize the variance.  Doing badly is how a manager gets fired.  The strategy for a mutual fund manger who is ahead a little bit for the year is to play it safe.  He disinvests to reduce his variance and the risk of  falling from positive to negative territory.

So the incentive for a manger who is a little bit ahead for the year at the end of September might be to pull in his horns, go to money market and avoid a down year.  One might even suppose that the market would decline in October of such years.  So the hypothesis is if the market is unchanged to slightly up in September does this presage a sub par October.

10/13/2005
Briefly Speaking: Market Moves, by Victor Niederhoffer

1. The market during the last 10 months has gone from a daily close below 1200 to a daily close above 1200 on six separate occasions. It is hard to test whether this is random or not.
2. Of the 220 European stock market indexes listed on my screen, all are up. Of the 85 North American and South American markets on my screen, all except Jamaica and the U.S. are up. Among the 85 Asian markets, the only decliners are China, Taiwan and Malaysia. Ten of the 20 U.S. market indices are up.
3. The S&P has gone down open to close eight days in a row, and is now down a ninth.
4. It is common to think that high oil prices are associated with low stock prices. However, the move up to \$70 oil was in conjunction with S&P well above 1200 and the recent move to five-month lows in oil circa \$60 is in conjunction with the current S&P low. More microscopic testing confirms the relation.
5. Thomson projects third-quarter earnings comparisons for the S&P to be up 15%. The yearly estimated earnings, according to a Zacks survey based on eight estimates, is \$73.50 a share for 2005 and \$78.40 for year-end 2006, based on diluted EPS from continuing operations.

Word of the day -- erythrism: unusual red pigmentation. Example: Since the start of October the market has seemingly developed a severe case of erythrism on my quote screen.

Barry Gitarts remarks:

Since September the S&P has gone lower on a weekly basis. Over the same period the bottom-up earnings estimate for the index has gone higher on a weekly basis.

10/12/2005
The Assistant Webmaster Wonders: How Do You "Hold" a Stock You've Already Sold?

U.S. Stock-Index Futures Are Little Changed; Apple Shares Slide; Oct. 12 (Bloomberg) (.. ) General Motors rose 39 cents to \$26.42 in Germany. Deutsche Bank raised the world's largest automaker to 'hold' from 'sell,' saying the stock's tumble this month already reflects the effect of 'bad news' from Delphi Corp., which owes GM money.

10/11/2005
Bridges, by James Sogi

Mechanical engineers have numerous formulas to determine the forces that act on the structure of a bridge and can use their calculations to predict the points at which the greatest stresses concentrate. The formula help compute the vectors and the angles of the forces. The formula could use radial measure rather than the sines and cosines for measures of direction. There are four forces: tension, compression, dynamic and shear. Computing the forces identifies the amount of and point of possible structural failure to prevent collapse. The main relevant measurements are the stresses on each cable and on the abutment at the end of the structure where the greatest forces act.

On a suspension bridge: "The lines of force are spread sideways and vertically, as if they repel each other. Why do the lines of force not simply run straight along under the bridge? The energy density at a place is proportional to the square of the stress, for elastic material. Therefore the minimum energy state is found when the stress field is diffuse. Halving the stress at a place divides the energy density by four. The distribution of stress and strain is the one that minimizes the total energy. Spreading it or shrinking it would increase the strain energy. The stresses near the anchorages are more complicated, because the cables induce tensions, which are present along with the compressions already described."

In the markets we see bridge-like structures such as the one that appeared at 9/29- 10/4. Unlike the situation with bridges, we know the market structure will collapse; the question is where and when. As we saw, the stress was greatest out at the end of the abutment of the right side of the bridge and focused down on a narrow point at 2:15 pm on Fed day, causing enough stress to cause failure there. A simple computation on the number of bars gives information on the amount of stress and load as does the width of the range as the area under abutment to spread the strain. Put this image next to a 1/2 hour chart of SP 9/28- 8/6.

Discussing this theory at our recent Spec Dinner, the most foremost and well known technical analyst suggested that this is nothing more than a double top. True indeed, but I suggest that this is another way of looking at the same phenomenon with the added advantage of having a readymade mathematical framework built in to give precision and predictive power above the technical visual indicators for those more inclined and might more closely identify the particular bar where structural failure is likely to occur. The amount of the force also might give information as to length of the subsequent drop upon structural collapse.

In James' study of bridges I think he neglected to mention torsional forces. One example of what happens when you do neglect this was the Tacoma Narrows Bridge with the famous video of it doing the twist that is mandatory viewing for most engineering students.

The collapse of this bridge also may add the dimension of critical failures and natural frequencies from outside forces to the discussion on the bridge like characteristics of markets. Photo from Smith, Doug, "A Case Study and Analysis of the Tacoma Narrows Bridge Failure," Carleton University, Ottawa (1974).

If I may add to Mr. Eldon Brown's comment regarding the Tacoma Narrows collapse. Two items which came to light after the post-mortem of the collapse:

1. Hubris: Even after the noted oscillations of the previous 'succesful' bridge designs due to wind (George Washington bridge and a few more) engineers believing that they were calculating more 'accurately' than their predecessors continued with the utmost confidence without looking back. The engineers who designed the bridge were the leaders in their field of specialization.
2. Disregarding recent development in an allied field: The new studies in aerodynamics were completely ignored by the engineers. For those interested in 'bridges' the book-"Engineers of Dreams" by 'list favourite' Henry Pertroski describes this story in detail and many fascinating details of the life and times of the famous bridge engineers and their bridges, (a time before bridges became a commodity).

In addition to the stresses mentioned by Messrs Sogi and Brown, two other type of stresses: - 'Flexural' stresses - and those caused by 'elastic instability' {excessive slenderness) are also to be designed for.

And that is the end of "Structural Analysis-101"

10/11/2005
More Hobo Memoirs, by Bo Keely

A BRIEF HISTORY OF DESERT LAW

I try again and again to explain that certain things differ in Sand Valley. Take sheriffs.

The original sheriff visited my neighbor TJ's one afternoon six years ago, and I happened by as he ran the barrel of his .45 pistol up and down the long neck of Kilroy, the pet turkey.  This tall bird has a disarming habit of standing on the feet of males and staring them in the face.   He likes you and  he's lonely,  said Laura.   He s gonna be soup!  groused the sheriff.  TJ kicked Kilroy who landed near me and pressed a thigh.  I shoved him off, and the rest of us spoke of cactus blowing in the breeze which is the real reason the sheriff comes out here to unwind and take target practice.

That sheriff was the empathetic kind we like in Sand Valley, but he got high blood pressure after the neighboring Indian blew off his finger with a .22 rifle for taking an environmentally unsafe tire used as a tree planter.

His replacement soon flagged me with a shinny star on the 10-mile private stretch into the Valley.   I just like to know who's here since my processor's lost his middle finger,  he drawled.  In truth, I believe he was embarrassed along with county law when the 67-year old Indian escaped by foot over open desert from eighty troopers with dogs and choppers.  That sheriff was a stickler whose hefty ulcer no one grieved forced his retirement.

A John Wayne was the next sheriff until another neighbor, Cherokee, grabbed the barrel of his shotgun and threw him against the patrol car for trespassing.  Then he called on the police radio for backup.

The next sheriff threw a feminine weight, though less so according to the oldest gal in the Valley who reported next time she bothers her with petty matters she'll  Rip her balls off.  And  if I can't find them, I ll reach till I do. I noticed that badge disappeared last year.

So Sand Valley held a meeting where a constable was elected by a valley quorum of five.  He is a sag chinned ex-biker neighbor who calls the yearly black fly immigration  niggers.  One day this new sheriff brandished a shotgun to block a convey of U.S. Marines lost along the private road to the adjacent Coco Mt. Bombing Range.  The military responded by machine-gunning his corrugated tin roof from a helicopter.

I thought once of becoming a sheriff or a Marine, but ended up a hermit writing stories from underground that no one seems to understand.

10/14/2005
Life of A Beloved Rebel, Bo Keely

Welcome to the world of rebels. When I moved to Blythe, Ca. six years ago, I hadn't stolen anything yet. I just rode a motorcycle-with-sidecar and wore my pants backwards. In the first year, a man sicked his Doberman on me, my bank called the cops thinking I was a thief, I was banned from the library, and there was regular shortchanging at the registers and crossing streets to evade me. Now it's Halloween 05, and I do customary shopping for a disguise. The town pursues me for chat or for advice, everyone wants to walk at my side, and there's no escape save under a wig. The difference is that I became a substitute teacher in a spot where children are gold to parents. It's terrible, and I hardly go to town any more. People used to be better, still are good in spots in America, but the overall advice is to find a niche, cultivate it, and just let em' call you a worm in the apple. Or move along.

10/11/2005
Thought for the Day: Comparative Advantage, by Steve Wisdom

From Joel On Software blog:

"I read an account of a MIT professor who didn't automatically hire 'straight-A' students, he preferred to see a couple of F's in their grades."

"Why? The idea was that these students had priorities, they passed what mattered to them, and ignored the rest."

"The 'straight-A' students, on the other hand, simply do what is necessary to pass the course."

10/9/2005
Switchbacks, by Allen Gillespie

Football players such as Michael Vick, Barry Sanders and Deion Sanders appear faster than they are because of their ability maintain top speed while switching direction. They increase uncertainty for the opposing team and frequently turn busted plays become big payoffs. I suggest testing whether a market that quickly switches directions a few times (i.e., down, up, down, up) has a tendency to then break into longer than average moves as everyone is thoroughly confused.

10/9/2005
National Temperaments, Earthquakes and Markets, by Pitt Maner

As a geology undergrad I read a paper relating national and regional temperament of citizenry to geologic activity. People living on stable, geologically inactive, granitic, billion-year-old cratons in such places as Canada, Sweden, the central U.S., parts of Australia, appeared to have rather stable, conservative, unemotional personalities (sans aquavit and beer). However, those living on active subduction zone margins (the "Pacific Rim of Fire"), near explosive volcanoes, active faults, and in places such as Indonesia, Italy (think Vesuvius and viscous, explosive lava), California, Iraq/Iran (i.e., Zagros Fault zone) and Central America tended to be more mercurial, hot-blooded, war-like, flaky, and radical. Obviously this idea is a sweeping generalization, but it just seems strange that the current earthquake would be centered near a hotbed of terrorism and in recent years one of the most likely areas for nuclear war to break out (Kashmir).

Victor cites the 1906 San Francisco earthquake and its relationship to a subsequent market crash in 1907 in EdSpec and notes Livermore's graphic description of the Panic's being like watching a mouse in a vacuum jar as the air (liquidity) was sucked out. I ran across work by MIT economist Xavier Gabaix discussing similarities between stock trading patterns and financial "earthquakes" -- a predictive methodology for crashes. Dr. Gabaix discusses the mathematics of natural power laws in several papers, large and small scale effects. I leave it to the experts to discern whether tensions are building along major market fault lines that will soon lead to significant positive or negative temblors.

10/09/2005
Don't Fear, the Numbers are Clear, by Victor Niederhoffer

A recent article on fear in Maclean's talks about the epidemics of fear that have been sweeping through our culture. We worry inordinately about flus and food and deaths. Jeffrey Rosenthal wrote a book Struck by Lightning: The Curious World of Probabilities that quantifies our tendencies to overweight highly improbable but very serious events in our decision making and Frank Furedi has written The Politics of Fear about how societies that are very secure are more likely to worry about safety.

The stock market is an ideal place to study the influence of cultural and psychological biases in a testable arena. Looking through Google I see 95,000 entries on the conjunction of "Fear", "Stock Market" and "Epidemic". All the entries are in the spirit of "The stock market in his dream suffered an eleven thousand point drop" or Paul Krugman's "It's about the epidemic of corruption that spread (and caused) the stock market bubble, and scared by Gore's shrinking lead, the stock market began its plunge". Much talk about Y2K, SARS and anthrax.

The stock market has within it a discount for fear based on the extent to which politicians like to keep us small and redistribute a greater proportion of our wealth than the usual 50%. The changes in the VIX do measure this, and the proportion of books and movies peddling fear of disaster take their hide off the flesh also. I can point to the weekly financial columnist who has never been bullish, and the Sage, as expressions of this pathological tendency with all the opportunities that it provides for the healthy investors.

10/9/2005
In Case You Missed This, from Easan Katir

The event of the week which caused my strangeometer to decalibrate was the announcement that Sir David Frost is going to work for Al Jazeera news.

Laurence Glazier responds:

I don't quite understand what is happening here, but I do know that Al Jazeera was originally set up by former employees of the BBC Arabic Service, and Frost is (now was) a key BBC man.

Cynical and malicious propaganda often comes from the BBC. Over Friday and Saturday they had a field day over Bush's remarks on being told by God to invade Iraq, and they were very slow to mention his denial. They refrained from mentioning that the allegation came in the first place from a BBC documentary, yet to be broadcast.

The dangerous aspect is that the Beeb is autonomous, and spreading ferment internationally. The scary aspect is that the views broadcast are now, in my experience, an accurate reflection of how most educated people in the UK think.

10/09/2005
Yen-Nikkei Heading for Year End, from Shui Kage

I don't know who said it first, but humans have very short memories. Not all, but certainly I think my senior bosses in Tokyo have short memories. If they are reasonably satisfied with the current exchange rate of 113.8 yen = \$1, now it is the time to convert the \$ profit to hedge the profit in yen. Most likely though, they will not take any action till the end of the year. The end of the year, if the yen goes higher, 107 or 106 level, then they panic, "Shui! Wire the dividend back to Tokyo faster! The yen is going higher!" And the Nikkei gets smashed by that market sentiment. Most companies in Japan are doing similar things every year. Not learning from the past. When no one is talking/thinking about something it is often the best time to think about it.

10/9/2005
Dept. of International Trade: The Senator Lauds the Land of the Pampas

While traveling the globe these last few weeks I noted how Shui's price points came into play. The most notable ones were seen on wine and taxi cab fares: the finest bottle of wine I could find in Argentina was 100 pesos (about US\$28) while in the States it would sell for \$100 and in Italy 100 euros. The cab fares were most interesting: a 20-minute ride in Milan was about 30 euros (in the states that would be about \$35) and in Argentina 30 pesos (about US\$9).

Now on to the arbitrage... dining in the wine country there one can have a meal comparable to Napa, with seven courses and four different wines for about US\$20 per person! You can buy a four-bedroom house there for under US\$80,000, a winery for about US\$150,000.

The influence is not Latino, it is European. I saw no kids with bones and such through their noses, no graffiti. The guy who shined my shoes took 15 minutes, for about 60 cents gave me the best shoe shine I have ever had, and he didn't expect a tip. I felt so guilty I broke expectations.

I've been every place once, it seems, and most places twice...of all those this massive country represents the best value and lifestyle I have seen. The wines were awesome, the dining up to par with any place I have been.

Mr. E. Notes:

In April, Argentina opened a Museum of Foreign Debt

The reason Argentina is cheap is because they didn't pay back hundreds of billions they borrowed...and worse than that they have done this 90 times in 100 years. What you have there now is stolen money, and that may be OK to visit, but it's an eventual death sentence to capital just like Venezuela has become. If I didn't pay my debts I could claim to be rich too.

Marion D. S. Dreyfus Relates Her Personal Experience:

The theft of personal capital in Argentina is the usual case. My former spouse had millions (dollar denominated) "borrowed" from him, with a vague promise to repay, and it has never happened. He unwisely kept his cash in local banks, and he has had to generate more funds elsewhere. Now he banks his funds out of country. Others were not so fortunate, and they had heart attacks and more when the government granted them an 'allowance' of some \$150 per week per home, to families that were aristocratic and used to thousands in spending money without a thought. These enforced government handouts of money to the people they illegally 'borrowed' from caused massive dislocation. None of this capital has been returned.

This story is repeated in the millions, so that is why the country can be considered a "bargain," despite contrary prices in comparable countries nearby. My experience of Argentina was it is best to stick with highly accessible country favorites (beef, leather, specialty baubles) and avoid all dealings with government.

10/8/2005
Opening Moves, by Victor Niederhoffer

Today's post on counting is inspired by the large number of board game players who have recently been attracted to our site, known by their revealed preferences for the Wiswell proverbs, the Nigel Davies proverbs and the Collab's persona, as well as the many anomalous moves that have occurred this week. What better thing to do than to get out a manuscript book, start with the openings that usually lead to victories, pay particular attention to the opponents' play when the old faithful opening led to losses, and improve the game for the future?

The landing that is probably best known to players of the market game is that there are times when inflows and outflows of liquidity hit the market, like around the horrible April 15, and the beautiful times that we get paid and can deposit any overplus in our index funds and growth funds, and buy tried-and-true favorites like Western Union, Brunswick and good old General Motors and IBM. One aspect of the inflows is that the first day of the month is well known to be bullish. Indeed, such facts as that the entire gain in the market in the last 10 years came from holding on the first day of the month, and that the average gain is some 0.3 % on such days, are so well advertised and so well known to all market practitioners as to be useless. Our lamented cordial and politically correct seasonalist used to love to tell us how he loved to make money hypothetically by paper trading such seasonals since he never trades his own account And of course the more he loved it, and the more it was published, the less likely it was to occur.

You see, market people don't like to give money away, just as checkers players don't like to lose to old 14 or the Glasgow (or any of the other openings named after the cold British Isles where checkers used to be the only winter entertainment). Thus, they telescope -- yes, they buy the days before, the same way the good board player never falls into a published trap. And indeed, in the week ending Sept. 30, the market anticipated the opening day gambit very well, going up seven days in a row from 1216 on Sept. 21 to 1234 on Sept. 30. All that, as we know, was taken back in one day, Tuesday, Oct. 4, when the market dropped 15 points from 1232 to 1217. And that was just the beginning, as we all know all too well, the same way a board game player knows never to use the same game against a good opponent he beat with it the last time out.

Of course, even the pure seasonalist of any note knows not to blindly play Old Faithfuls. Wiswell always led with a move from his single corner to the middle of the board (c3 to d4). You see, certain first days of the month are quite different from others. Among them are those terrible first days of the month that start on Monday (or Tuesday, if Monday is a holiday). Since the turn of the century, there have been 33 such terrible Mondays. And indeed, you could have lost a cumulative 10% if you had bought every one of them, or 0.3 % a day, by holding on such Mondays.

And what happened after such Mondays as Oct. 3, 2005, when the market dropped 2.5 points? We count 10 such Mondays where the market declined that day and the subsequent four days to the end of the week, including the Sept. 4, 2001, Monday, where the market fell 4 points, then fell another 50 over the next four days before declining 60 points when the exchanges finally reopened in New York. (We'll drop that one since it was obviously well known to the operatives who traded off of it.)

Counting further, we note some more dates like the recent one as follows:

```           date      move that   move rest of     move next
day         week             week
01 03 03    -18          -06               17
02 04 01    -19          -10               52
09 04 01             skipped
04 01 02     -5          -19              -13
06 03 02    -39          -10              -20
12 05 02     -0.5        -21              -27
03 03 03     -5          - 7                6
07 02 04    -14          -13              -10
01 03 05     -7          -20              - 3
10 03 05     -2          -35```

A mixed bag at best.

Alan Millhone, President of the American Checker Federation, inspired this post.

10/08/2005
A Tale of Two Cities, from Dan Grossman

A nice little medical office near my Boca Raton home specializes in advice and shots for overseas travel. No doctor, run by a registered nurse with a friendly clerk at front desk. (How does the FL medical association ever allow this?)

Called to ask if they had flu shots. They gave me an appointment.

Arrived at appointed time, was in and out in literally four minutes. Charge was 25 bucks, cash. No credit cards, no checks (surprisingly, they said they got too many bad checks when they used to allow them), no forms for insurance.

Nurse said she was also an expert in rabies (advice and shots). Gave me her business card in the form of a refrigerator magnet, invited me to come back the next time I planned an overseas trip.

I'm confident medical experts could come up with a long list of reasons why this service is unfair to other medical offices and dangerous to patients, but I found it an altogether uplifting experience.

On the other hand, two realtors from ########## called me today offering to list my suburban NJ house (ie, give them an exclusive listing), since they saw that the former listing with another firm expired yesterday.

I said I was taking the house off the market until next spring. But, since I knew ########## also owned the large NYC broker ####### #######, I suggested that without an exclusive listing why didn't they promote the house with ####### ####### offices as a favorable alternative to a two-bedroom apartment in NYC (for the same purchase price, a large home and property with swimming pool, best school system in NJ, etc) and I would agree to pay them a commission of, say, \$80,000 if they found a buyer.

They said, You mean spend money on marketing without a listing?

I said, Well not very much money, no newspaper advertising, just a few hundred dollars for a flyer or email or meetings with the ####### ####### offices.

They were very offended, said it would be unethical for them to spend money on marketing without an exclusive listing.

10/07/2005
J.T. Goes Semi-Incunable to Find 5th Year Study

The Senator writes:

Just back from Argentina, Italy and Japan where I noticed the 5 year phenomena, originated by Edgar Lawrence Smith, has certainly been dominant in all the markets of the world this year, except ours. Iraq war impact?

The book is titled "The Tides in the Affairs of Men" by E. L. Smith, 1939. Could be considered a forefather in countin' or at least looking at markets in other non-traditional ways trying to be as empirical to the best of his faculties. The first two paragraphs of the Foreword are in my opinion in the spirit of Daily Spec:

"These studies should be looked upon as preliminary explorations. They present a picture far from complete. The field of inquiry which they outline is of such magnitude that no comprehensive survey of it can be expected in many years.

But in the meantime, additional premises and methods for the appraisal of economic ebb and flow are greatly needed. These incomplete studies are published, therefore, in the hope that they may encourage others to push the exploration further, each within the area of his own specialized knowledge, but perhaps with added appreciation of the need for recording his findings in form appropriate for more general application."

It isn't a 5 year phenom but the later, years ending in 5 that were a part of the greater "Decennial Pattern" that Smith mentions in Part 1 of the text. The period looked at was 1881-1939. The Table produced after price charting the decades was as follows:

Table 1: Months of Rising And Falling Stock Prices, 1881 to 1936

Number of Months
Rising Prices 4029384939254343250
Falling Prices 3142292131331316340
No Change in Price 12224110
Total Mo.’s Reported 7272677272606060600
Number of Months
Excess of Rising Price 69 9288 3027
Excess of Falling Price   13   8  9

Italic = Falling Tendency. Boldface = Rising Tendency

Conclusion made by Mr. Smith regarding years ending in V's: "(Fifth Years) From the early months in the V years, the market has, without exception, shown a strong upward movement, and while the pattern varies somewhat, November and December are without exception higher than January. This rising tendency for the V years we have found in other charts, extends without exception at least as far back as 1855."

Let's certainly hope this V hypothesis ring true this year. My conclusion after reading the book was twofold 1) he was brave and courageous in pursuing other ways of viewing data from the market. He viewed them from Sunspots, Rainfall, Pig Iron, Cotton, and Commodity Prices in general. He did this though without the statistical faculties to do so and this is where he fell short in a lot of ways. 2) He didn't give up even after extreme criticism from publishing his first book titled "Common Stocks As Long Term Investments". This book was released in early 1924 a few years before the Crash began! He follows up in the above text with comment " Common Stocks as Long Term Investments need not be discarded as some have felt, following the drastic declines of 1929 to 1932. There is no evidence as yet, that the level for 1949 will not be above the peak of 1929." , of which makes me conclude that with both of theses texts he had his thumb on the "Drift" and power of the Market but couldn't exactly make those besieged from the Body Snatchers understand.

10/07/2005
A Hemingway Kind of Week, by Tom Ryan

"I kissed her hard and held her tight and tried to open her lips; but they stayed closed tight."

"But man is not made for defeat. A man can be destroyed but not defeated."

"Forget your personal tragedy. We are all b#tched from the start and you especially have to be hurt like h#ll before you can write seriously. But when you get the d#mned hurt, use it -- don't cheat with it."

"There is no rule on how to write. Sometimes it comes easily and perfectly; sometimes it's like drilling rock and then blasting it out with charges."

"Then there is the other secret. There isn't any symbolism. The sea is the sea. The old man is an old man. The boy is a boy and the fish is a fish. The sharks are all sharks and no better and no worse. What goes beyond is what you see beyond."

10/07/2005
Fishing for a Bottom, from Victor Niederhoffer

Perhaps sparked by the up opening in stocks this morning, an erudite former politician I refer to as the Senator has questioned the veracity, verisimilitude, and, might I say, bona fides, of a bottoming in stocks. His studies show that historically bonds tend to bottom before stocks, and notes that no such bottoming has occurred. (Time: 9:15 EST)

It is good that it is easy for the Senator to test whether a turning point in one market is predictive of a turning point in another, as this kind of question has stumped us for 25 years. The number of observations and the definitions are fuzzy, and the time scale to test it is so long relative to recent data, that any conclusions are neither timely nor statistically reliable. Much more useful is the direct approach, which would perhaps have kept me in a job at Merrill, if I had stayed there and used it for 40 years, working for chronic bear Bob Farrell and his successors.

10/07/2005
Musings on Five Down Days in the Dow, by Alston Mabry

When I ranked the 5-down-day moves (498 instances, no adjustment for overlap) according to size/z-score, the average z-scores for the quintiles looked like this:

```-2.53
-2.00
-1.69
-1.36
-0.85```

The -0.85 quintile had consistently the strongest returns over 2- 5- 10- and 20-day periods (with strong meaning z-scores relative to all possible 5-day stretches of between +1.96 and +2.96). In plain English, the best returns came after 5-down-day stretches with the smallest % drops relative to contemporaneous volatility.

In reference to the calculations above, the negative move of the last 5 days of the Dow has a z of -1.72 relative to the mean and stdev of the previous 21 5-day moves.

For the S&P from the 1950s forward, the first 5 days of October are historically up, averaging +.15% per day, compared to +.03% per day for all days (z on that: 1.87). Which analysis I will use to renew my Society for Non-Predictive Studies membership.

Over the weekend I thought to myself (to whom else does one think, anyway?): "It's the beginning of Q4, and people have been playing all sorts of short-term positions around the hurricanes, and oil & gas, and we had terror attacks, and the dollar has surprised everybody, etc etc -- I think many players will reassess. And the first step in a reassessment is to sell. Have to sell before they can buy, so the market should drop."

I wish I had listened to myself. (But why? Nobody else does.) Which reminded me of a section in Mr. Gl#dw#ll's latest where he describes a card game using blue and red cards. The players make bets, thinking it's a fair game. But it turns out the blue cards are better than the red ones. The experimenters want to see how long it takes for people to realize it. Turns out most people "realize" it and start changing their play well before they can articulate why. Non-conscious processing.

However, then he discusses people who have suffered damage to a particular area of the frontal cortex that functions as a prioritizing mechanism, evaluating conscious options and relaying them to behavioral control centers. The strange thing is that when these people play the game with the blue and red cards, they will consciously get to the point where they understand that the blue cards are better and they can state this fact verbally...but it doesn't change the way they play the game.

10/6/2005
An Epic Day in the Market, by Victor Niederhoffer

If an all-seeing eye could write an epic about all the events that influenced the market today, it would be a potboiler that would rival anything ever written. On the counting front, we had new lows in the energies with natural gas down 6%, gasoline down 4% and crude down 2%. We had five-month lows in stocks, a change in state from up to down for the year, the longest losing streak of the year, and the third day in a row with a 15-point intraday decline.

We had avian flu hysteria, a speech by Mayor Bloomberg with some old political news about terrorist arrests timed to aid the bears, the release of meaningless seasonally-adjusted employment claims as more grist for the bears, the breakdown of the German DAX below the round number of 5000 right at the end of the day (how did they know about the mayor's announcement?), the third orchestrated speech by a Fed governor expressing concern about inflation's being near the top of the acceptable range and vowing to never monetize inflation (when will the fake doctor join the Sage in changing jobs to pursue something productive rather than performing his staged self-serving set pieces?)

And then the news of General Electric's upgraded forecast, and good news from a bevy of retailers including Target, American Eagle, Costco and Starbucks that sent their stocks up, to serve as pilot fish leading the way as they led the way down a few weeks ago.

It was a wild, disruptive day, with a 22-point range ending down a measly third of a percent, with margin calls and stops elected galore. It was the kind of day like when I used to work for the Palindrome, when Stan and I would talk at the end of the day with hearts palpitating at twice the normal rate and both utter at the same time "What a day!" And one of us would say, "Please explain it to George. He just said, 'What do you mean it was a crazy day? The market fell just a third of a percent.'"

And it was a day that marked a change of state for the dollar, which started the week close to a 18-month high and then today had one of the five biggest losses for the year. Thus the dollar led all the markets down, and is now ready to lead them up, with added potential energy and friction from those who follow fixed systems.

Of course there's much more, the fortunes made and lost, the hopes dashed with stops, the fear of the sleepless night for the longs carrying positions before the always epic employment release tomorrow, which will start another novel.

10/06/05
Hijacked, by James Lackey

The day started out with a "just like 1918" avian flu warning: "It is not a matter of if, just when, could be two months, two years, or 20 years before the virus mutates."

After a few days of downs the market forgot about 1918 and rallied until the war on terror from Prez Bush's speech followed by "inflation is like a virus and can ruin the blood supply of the U.S." which is "just like 1975" from the daily regional Fed switch hitters.

A new barrage of selling a few before 2 p.m. came in to make it four in a row down days. Then at 3 p.m., a vicious decline ensued. I received an e-mail from an old friend lamenting his profits that turned into losses for the day, but he was relieved as he was stopped out some 10 points higher than the current price of 1186. Before I could cry with my reply, a nice rally back to where it all began to 1197 closed the markets down for four straight days.

After the bell, the smell of gunpowder or 18-wheeler brakes and tire smoke came to my senses after I yelled "HIJACKED" -- that is what you yell when a stock is expected to rise and does, only to give it all back in a few minutes into the close. All you can do is shake you head and say, "Truck driver was hijacked by the mob."

Who knew a few days ago "a credible" incredible threat to NYC by terrorists would be announced after the bell? Everyone but me? The Mayor reported "information about a specific but unconfirmed terrorist threat to the city's transit system," and said "the police presence in the subways would be heightened in coming days."

But the mayor said the city was not raising its color-coded threat level from "orange," "I believe people should live their lives as they always do and have faith in the world's greatest police department."

Police Commissioner Raymond Kelly did suggest that riders not bring backpacks, briefcases, baby carriages and luggage if they can do without them. The city has known about the threat for several days, the mayor said, but decided that making it public too soon "could have jeopardized the lives" of some investigators."

Not to mention the life of this speculator. I am happy for New York information from Iraq to thwart any terror threat. However, why tell anyone? So my wife doesn't t take the kids with their backpacks and child strollers on the subway? Wouldn't the police be there the second they heard the threat a "few days ago"? Of course they would, and wouldn't that news leak out to day traders from well-greased speculators only to hit the rumor mill today at 3 p.m. "An imminent news briefing by Mayor Bloomberg about a specific threat to NYC subways and briefcase bombs following today's OEX close."

Of course I think this is not a random news generator. Well maybe it is because that is what I use, google news. Here is the story I read at 7 a.m. today.

Such after-the-factness by me is as bad as "sell programs hit, housing and the 'energy complex' and a sector, seasonal rotation is selling the S&P 500 and buying the OEX. Yet no one could understand why, when the Fed spoke of inflation, the S&P dropped 12 handles a day, every day this week, while bonds didn't move but a few ticks on inflation contagion.

This reminds me of when I was a 12-year-old kid racing dirt bikes. After I crashed in my first moto, I threw my helmet into the van. My father threatened my existence and any future racing or sitting on my backside. When I protested to him that I was "t-boned and taken out in the first berm" by the same dirty rider, many weeks in a row, Dad said, "Son if you are far enough in the lead, no one can ever take you out."

That thought came to me after the bell. My buddy called me and jokingly said, "You OK, Lack? Were you long today? You know those unemployment reports are always bearish." I wanted to throw my cell phone onto the garage floor and break it into a zillion pieces. Yet out of the corner of my eye I saw a motocross helmet on the handlebars of my old dirt bike. I burst out laughing. My buddy said," I thought you'd laugh at that." Awe man, we were hijacked today. However if I was a much better trader and had a big lead ... or who knew?

I watched the entire "Godfather" series this weekend. Perhaps if Mr. E was here he would have told us 1197 was a critical number. All week, a blizzard of posts would have came back: "Why 1197?" Earlier, when Bush said that many terrorist attempts on American soil have been thwarted, I would have been more careful today after a rise to 1207.

In no way did I see this coming, an imminent threat to NYC today after the close when hours earlier, the president also said, "The U.S. and its partners have stopped at least five more efforts by al-Qaeda to case targets or infiltrate operatives in the United States."

Very funny jokes, huh? Maybe I can be a fiction writer one day. If I don't start trading better, I can assure you, it will be too soon. I protest, got hijacked today. LACK

Letters to the Editor Competition

A note from the editors: The material on this Web site is provided free by us and our readers. Because incentives work better than no incentives, each month we have been rewarding the best letter to the editor with \$1,000 to encourage good thinking about the market and augment the mutual benefits of participating in the Daily Speculations forum. This has worked so well that starting this month, we are expanding the field of candidates to include all contributions to Daily Speculations. Prizes are awarded at the end of each month by the Chair and the Collab.

This month, we had more than one winner:

10/06/2005
Department of Hubris, from Kim Zussman

That's big -- about an acre and a half for the house!

Maybe when he's done with it, he can donate it to California as The Museum of Survivorship Bias. It can display thousands of artifacts of those who tried and failed, from all coasts and countries. I could volunteer as a docent.

10/05/2005
Nebraska Chronicles: Sage Pilloried in Baltimore Sun, from Steve Ellison

One of the most negative pieces of media coverage I've seen on the Sage. An excerpt:

Warren Buffett's digestion is threatened these days by more than T-bone steaks and Dairy Queen ice cream. Often as not recently, the world's foremost dollar doubter has been waking up to find the greenback gaining in value, shaming its critics and costing him and his shareholders millions... Not long after boss Buffett decided he was not just a stock-picker but an applied macroeconomist, competent to bet on global fund flows, Berkshire began lagging behind the stock market... If the greenback continues to rise or at least maintains most of its recent gains ... many scary stories you've heard about the future U.S. economy won't come true.

10/5/2005
Polar Coordinates, Revisited by Geologist Tom Ryan

I routinely use polar coordinates in my work and would be remiss if I did not comment on this subject. Polar coordinates are very useful for visualization of data where you have three to four dimensions. For example, while in Montana several weeks ago, I conducted mapping to determine the three-dimensional geometry of a vein of ore cut by several faults. By using polar coordinates, and a compass, one can quickly measure the attitude of the vein using two measures; the strike of the vein which is the angular measurement from the north pole of the line that the vein makes when crossing the horizontal plane, and the dip of the vein which is the measurement of the angle between the vein and the horizontal plane in a direction that is orthogonal to the line of strike. These two angular measurements are all that is needed to describe the three dimensional planar body in a polar coordinate system. Similarly, two angular measurements can be used to describe a line in three dimensional space (trend angle and plunge angle) by projecting the line onto the horizontal plane. In this case it was obvious even with just a few measurements that the faults were indeed changing the orientation of the vein from block to block and therefore this needed to be taken into consideration of any projection of where the vein was going. Read the whole post

10/05/2005
Statistically Insignificant, by Russell Sears

Perhaps the common man does not truly overestimate the probability of a statistically insignificant event's happening to him. Rather, he recognizes the impossibility of its happening, and then when it does happen to him, considers it validation or divine intervention. When it happens to you, it does not seem random. Those who feel lucky all try to replicate that moment when the Gods smiled on them. I believe the elderly are particularly vulnerable to this type of thinking since the odds are stacked against them. Death is certain; a miracle is needed. This of course is nonsense when we are talking about lotteries, casinos, coin flipping, or other events designed to be random. Chance, not divinity, rules. In these events there will probably be a winner; it just won't be you.

But perhaps the converse is true with the Expert, who clearly understands the scale of the infinitely small, but cannot see how something seemingly random is built on a foundation of non-random legal rights and the progressive spirit of mankind. When a human system has a highly insignificant random event you must first question the system's integrity. Coin flippers die in mid-flip, casinos are rigged, and governments change overnight. Rules can be broken after the fact.

In other words, a crash of 20 sigma or 40 sigma is most likely to be caused by the Devil's visiting us all. For everyone to give up his right to ownership of stock so freely implies that either money or property rights has little value. So what payout is to be expected of a derivative contract of the underlying? Further, in such a world of chaos, many of those young with a bright future will find the odds now stacked against them, if they're not already dead. Thus as the Expert says knowing the probability means we know nothing, but I would add that this includes that we do not know whether there will be a payoff, never mind the magnitude.

10/05/2005
Broken Trends, by Victor Niederhoffer

Many trends seem to have been broken this week. On Monday, bonds fell to a two month low at 113.24, just a few ticks above its 5 month low of 113 1/2 and the Eurodollar fell below 1.20 to \$1.19 for the first time since since July, reaching its lowest level since December of 2003.

Crude oil fell to 63 before closing at 63.90, the lowest level since Aug 5. On Tuesday, November soybeans closed at 562,  down 19.5 cents, and within striking distance of their February 2005 low. Corn is in similar 1 3/4 year-low territory.

Stocks have shown a beautiful symmetry, going up from 1216 on Sept. 21 to 1232 on Oct. 3, and then down to 1216 again in one day -- today. The decline in S&P today from 1232 at 230 to 1224 at 3 pm was one of those disruptive large moves that happens very rarely. Indeed, only 13 this big since the new century.

However, it's not chance that all these down moves occurred in conjunction with each other. They signal, they lead, they pilot fish. Nor is it chance that the market would go down on Dallas Fed Richard Fisher's remark that the inflation rate is at the upper end of the Fed's tolerance zone on a day when all these deflationary lows were being set. Talk about being behind the form.

Of course it's always so much easier to describe than to predict. But we can count.

10/04/2005
Dept. of Chronic Bears "Abelfleckprecettoros": by A. Bear

The yield curve is very close to inverted, telling us that we are lurching toward a recession. Evidence is showing a peaking in home prices. The US is no longer competitive at producing steel without trade barriers/tariffs. See the WSJ article this morning on Chinese steel capacity and how they are taking it up significantly for export.

Of course the US steel companies are not happy. The point is that forward 'E' in the P/E equation becomes unachievable. Industries that are economically less sensitive to rates and GDP slowdown, such as unique tech/biotech/telecom equipment, are where all the money is flowing. Correct or not, investors believe there is less risk there in the 'E' going off track. I do not believe the Fed has stopped hiking rates. I totally disagree with them, but that isn't the point. Besides, steel and other deep cyclicals are traditionally good investments when the historical normalized P/E is high not low.

10/05/2005
For Chronic Bear Dept, from Another Bear

I still get that eerie feeling that something bad is going to happen... can't quite tell what but there sure feels like volatility is about to become a feature. Equities feels like either an upside melt up or a crash... you know which one I think has the higher chance. Not sure if you read the stuff I sent you yesterday but it look s very much like 1973... upside head fake in ISM, oil prices go  higher, Fed raising rates, yield curve going negative, equities crash along with the economy.... maybe I'm dead worn g but something feels amiss. On the other hand the upside melt is possible true. Either way something is about to happen.

10/04/2005
Don't Worry, Be Happy, by Jeff Sasmor

My dad used to say "Life's expensive, then you die." Maybe my generation (boomers) don't t'ink dat way! It's a lot of pluses and minuses in a nice balance like a nice meal with a tasty sauce.

• My real estate taxes have gone up by 50% in nine years
• The last few years I have to pay AMT (for those outside of the USA, it's egregious; Google it...)
• I got a speeding ticket in 2001 and am still paying for it on my car insurance. Ticket = \$75; Insurance += \$2000
• I have to pay for two bat mitzvahs and two weddings and two college educations
• I have to use premium gas in my car
• It costs a minimum of \$40-\$50 for a family of four to eat out in a decent restaurant
• My 14-year old daughter has lately become a clothes fanatic, togs have a two-week rotation then they're passe
• Both major political parties are spending the country to oblivion. Do the new bankruptcy laws apply to an entire country?
• There's a traffic jam in Harlem that's backed up to Jackson Heights

But don't worry, be happy...

• My home is worth 3x what I paid for it nine years ago
• With lots of pills my blood pressure and cholesterol are normal
• I have 10 Mbit/sec Internet access
• I can afford a nice car
• Two reasonably nice kids (so far...)
• Trustworthy and rabidly loyal spouse
• I only have to commute intra-house
• I gotta iPod Nano!
• I get to stare at red and green flashing numbers all day!

10/3/2005
Dept. of Improvement; forwarded by John Lamberg

Sometimes a story or two seems to help at the end of the day. Recently I've been exploring the archives at Gaslight (Stories from 1800 - 1919). Click on the Chronological List of Texts for a look at the etext offerings:

10/03/2005
The Economic and Investment Implications of Delay, by Victor Niederhoffer

A key question in decision-making in all areas is how much delay is good. Delay reduces uncertainty and mistakes, but it costs time. The question arises in markets on numerous fronts -- most recently when the S&P rose from 1216 at the close on Sept. 21 to 1223 on Sept. 28 with five small daily gains in a row. That was a historic kind of delayed move that has typically been somewhat short-term bullish, and as it turned out, it continued up to 1234 in the next two days.

Areas in investments where decisions on optimal delay are important are legion. Here are just a few examples. Before an important economic announcement such as the monthly employment numbers, when do we step up to the plate? What about the optimal timing relative to the release of an earnings report or guidance by a company? When do you take a position in a stock after receiving a tip? How many analysts and research reports do you study before pulling the trigger? More generally, how do you weigh events that are likely to occur at different proximities to the present?

Major efforts to come up with frameworks for deciding on the proper amount of delay have come from economics, psychology, statistics, electronics and sports. The economic approach is to note that information is an economic good that has an opportunity cost. To get more information, you have to give up time, money and effort. Proper decision-making involves waiting until the cost of acquiring more information is greater than the anticipated benefits that the information provides.

A related economic framework is the analysis of how consumers decide between current and future consumption. The analysis depends on how impatient they are, what the rate of interest is, the availability of borrowing and the path of expected future income. A simple analysis of this is contained in Price Theory and Applications by Jack and David Hirshleifer. They show that for impatient people, current consumption will be high and savings low, and the rate of interest that they will pay will be high. The reverse is true for patient people. They apply this to historic events by considering how farsighted (patient) and family-oriented a person is. "The later years of the Roman Empire were characterized by a decline in such puritanical attitudes and a shift towards impatience, and interest rates accordingly rose."

In a surprising extension for economists they relate it also to biological factors such as average lifespan and size of families. "In recent times, these considerations have operated in opposite directions. Rising lifespans have encouraged saving while smaller family sizes have discouraged it." A more extensive and wide-ranging consideration of time preferences and their influence on economic behavior is contained in Chapter 16, "Consumer and Supplier Behavior Over Time," in Pashigian's Price Theory and Applications.

The statistical approach to the proper amount of delay, is based on George Stigler's classic article "The Economics of Information," JPE 1961. The information gained from searching is constantly decreasing. For simple models of finding the best price when the distribution of prices is uniform, the searcher gains 87% of the total information after three quotations from purveyors so it makes sense  for most people with reasonable alternate uses for their time to stop searching after three or four such quotations.

The psychological approach to the proper amount of delay is probably the most fruitful for decision-makers. A classic and highly fruitful article in this regard is by George Lowenstein and Ted O' Donoghue, "Animal Spirits: Affective and Deliberative Processes in Economic Behavior." The authors divide decision-making into a balance between two parts of the brain: the deliberative or patient part, and the affective or impatient part. The balance between them is determined by willpower, which they view as "a resource expended by the deliberative system to exert influence over the affective system." Their approach enables them to explain most of the seemingly irrational behavior that behavioral finance has uncovered, such as loss aversion, the vividness effect and the excessive weighting of improbable outcomes like winning a lottery.

The approach to decision-making about the proper amount of delay that most of us have the greatest degree of familiarity with comes from sports. The best players seem to be the most patient. However, among average players, often the impulsive and action-oriented player takes home the prize. I had personal experience with the former approach as the great coach Jack Barnaby would often sit behind me during a game and bellow before I was ready to strike, "Waaait," thereby making my opponent commit himself. Tom Wiswell, undefeated checker champion for 25 years, often emphasized a similar strategy in checkers; he pointed out the importance of first developing a good "base of operations" in your game and then employing good "waiting moves" as a key to victory. On the other hand, Art Bisguier in chess liked to concentrate on the importance of seizing the initiative when the main chance was there. However, I believe that Art would be the first to acknowledge that at the top levels, the more patient players who develop a good foundation are the most likely to win.

As to how to apply these insights to markets, the situation is complicated by the principle that investors get paid for assuming risk. The more they wait, the lower the risk and uncertainty, and therefore the less likely they are to achieve above-average returns. The Collab and I, when we wrote Practical Speculation at the bottom of the market in February 2003, were roundly criticized and or ignored because we emphasized the value of buy-and-hold and the likely above-average returns from seizing the initiative from the bears circs S&P 800. Yes, it would have reduced chances of mistake to wait until all the companies and analysts were prohibited from releasing or doing anything unique. But the benefits of additional waiting and searching seemed orders of magnitude lower than the opportunity cost of eschewing the 1.5 million percent-a-century return documented by the Triumphal Trio.

Perhaps the best approach is to prepare a proper foundation well in advance with scientific study of the impact of waiting for various events, and then to take action when the benefits of accepting uncertainty are greater than the future information to be obtained. (This is a work in progress, and I solicit insights of readers from their own fields of expertise and interest.)

James Sogi Analyzes "Delay":

Swoosh theories: Pondering the room cleaning/paint drying elevator phenomenon here are some possible ideas on comparable mechanisms of push/pull equilibrium then swoosh, or processing then swoosh, critical mass then swoosh/boom. The same effect may be at work over years as hours.

1. Tug o-war.
2. Earthquake tectonic shifts.
3. Spread of disease and epidemics
4. Football without passing.
5. War of attrition.
6. Micro structure. Globex need for food.
7. Atomic bombs. (Critical mass)
8. Water boiling.
9. Sand castles falling, Pick up sticks, House of cards.
10. Survival of equilibrium states.
11. Stock breakouts vs. breakout failures.

Analysis of delay:

1. Attempts to control emotions tire people out emotionally and physically. No wonder a big trade can be tiring.
2. The deliberative system can often override affective responses (at least partially). The mind, like in meditation clearing thoughts and like clarinet practice, can be trained with practice, Hours, over and over. Few can sit and play a piece of music the first time with ease or stand in public and speak. It takes experience and realistic practice often only comes only with the performance.
3. The general finding is that exerting willpower in one situation tends to undermine people's propensity to use it in a subsequent situation. Good reason to take a break after a trade.
4. Assess current willpower strength before entering trade. Increased stress or higher cognitive load both move behavior further from the deliberative optimum. Don't trade during times of personal stress, family illness or problems.

Fat-tail conundrum:

Pondering the conundrum of fat tails, consider that the curve is an artifact of the interpolation of the distribution. Often, and whether significantly so is the issue, the fatness of the tail is not always a result of the occurrences in the shoulder/tail range, but as the as result of an outlier. The outlier is not caused by the same functions as the middles, but rather as a result of some sort of mechanical breakdown in the systems, circuit breakers, limit moves, Soes or Arca, Globex shut down as on August 29, 2005 or an act of war such as 9/11.

Take for example the following distribution after a panic:

```-6 | 1
-5 |
-5 |
-4 |
-4 | 4
-3 |
-3 | 21
-2 | 66
-2 | 311
-1 | 998777666555
-1 | 4443333321111111000000
-0 | 99999888888877777777776666666665555555555555555
-0 | 44444444444444443333333333333333333222222222222222222222222211111111+20
0 | 00000001111111111111111111111111111111112222222222222222222222222222+52
0 | 55555555555555555555555555556666666666666666666677777777777778888888+5
1 | 0000000001111111122223334444444
1 | 5557777799
2 | 1234
2 | 56```

Note that the big losers causing the fat tail gaps away in an isolated move. It is a different mechanism. Assuming that the same function is related to all occurrences leads to difficulty reconciling the outliers.

To define the issue as fat tails may be misleading when the study should be of that of system breakdown, outliers, 10 sigma, rogue wave theory Rather than assume smoothness, a study of the structural break mechanism might be productive, or time between failures. Perhaps this is the same mechanism that causes the break from a range during everyday action.

Some chess players can't wait to play a good move if they see one (Heikki Westerinen for example), others like to hold them in reserve. There are also sharp/direct openings vs. those in which there is a longer build-up. The former feature a quick dissipation of energy which often burns out to a draw; the latter often feature prolonged tension and can explode much later.

Scott Brooks ponders:

What techniques do you employ to help you be patient on making a purchase? Many of the losses I have experienced in my career came from being impatient on both the buy and sell side. In a very small nut shell, I basically do all the research I can, figure out what I think is the best price, then wait for it to happen.

I was doing some thinking over the last few days in my favorite place in the world to think: My tree stand with my bow and arrows in hand. Even though this is R&R time, thinking about work in this setting is very relaxing to me (because I simply love what I do). I was pondering all the good and bad trades I made I've made this year and equating them to patience. Was I patient in waiting for the right price or did pull the trigger to soon? Or said another way, was my research right. Did I pick the right price.

I was drawing in my mind an analogy of success in the markets and deer hunting. I've deer hunting for 20 years. Early in my career, my goal was to just "get a deer". Just like early in my financial career my goal was to just buy a stock as soon as the money came in. As time progressed and I matured as a hunter, I stopped looking for "just a deer" and started looking for "the deer". The same can be said of my professional practice; I stopped looking to just a buy a stock, and started looking for the right stock. Then as I got better at deer hunting, as only you can through time and experience (most of the experience being watching the whitetail of the deer as it ran away), things started to click. I've become pretty successful at getting "the deer".

As a matter of fact, each year my house on my farm is a gathering place for local hunters to drop by just to see if I got my deer yet and how big a buck I got. I am invariably asked (usually numerous times a year) how I get such a big buck year in and year out. I used to give long winded complicated answers involving all the intricate details of all the many many hours of scouting, cultivating fields, research studying etc. etc. etc. that I do to get that deer. (I've discovered that people don't really want to hear that. They want me to tell them about some "magic pill" or secret location, or they assume that something nefarious on my part has had to occur for me to consistently year in and year out get that wall hanger).

I've given up on the big long explanations. I now give a simple explanation. I tell them, "I don't shot the first buck I see. I pass up on every single deer until I see the one that I want". Believe it or not, they are not even satisfied with that answer. But since they want the "easy way" answer, the answer that involves no extra work to strive toward excellence on their part. Since no matter I say will leave them unsatisfied, I now just save myself some time and give the short answer.

This does tie back into my original point. I am successful at bow hunting deer because I am patient. If I wasn't patient, none of my other preparation would amount to a hill of beans. That's the way it is with investing. I can have all the book knowledge in the world, I could understand everything single thing that is written on the spec-list (which I don't), but if I don't execute properly, if I don't exhibit patience, none of it matters.

So, what are some techniques that you all use? What do you look for before you pull the trigger (buy or sell side)? I know this is a broad question, but I hope it generates some nuggets of wisdom.

As an aside: I got out into my tree stand for the first time this year on Thursday. Thursday morning I saw a parade of deer come by my stand, but I did not see the buck . That evening, a mere 20 minutes into the hunt, I arrowed the buck a very nice 10 point buck. He'll score around 145 P&Y. As a basically impatient person, I prefer to get my wall hanger in 20 minutes or less. Now if we could just get the markets to be that cooperative!

Tom Ryan offers:

In our mineral property evaluations there are mainly two types of uncertainty that we deal with, problems in characterization (accuracy) and problems in estimation (precision). These have different decay functions with time and data. The characterization problem tends to have the classic power law decay function; as more data is obtained the uncertainty drops off asymptotically approaching zero with varying exponents depending on the complexity of the situation.

On the other hand the measurement/estimation problem tends to have a s-shaped curve where uncertainty decreases only slightly with the initial measurements, then drops off steeply with more data and finally the curve shallows again with diminishing returns as ever more data is obtained. Hence the total uncertainty is a function of both problems. This is why grade is so important in exploration. If high grade is encountered early on, the decision to commit is easy although you may not know how large the project may become, you know you have great odds of making money no matter the eventual size. Whereas it is always difficult to commit to the low grade deposit no matter how big the definition drilling shows it to be. In other words the high quality payoff (as opposed to high quantity) requires more decisive action than the easily replaceable or low quality payoff.

I found this very interesting, but was hard-pressed to think of any ecological examples that seemed especially relevant. Behavioral ecology seems like the right realm. Lots of interesting examples of delay in making decisions, but they're usually potential life-and-death decisions, which wouldn't be relevant to investing unless you had all of your assets in a single security (e.g. a herd of wildebee

10/03/2005
A Perspicacious Spec Reads the Newspaper, a Continuing Feature

Insured Hedge Fund CDs Mired in Details: John Wasik
Oct. 3 (Bloomberg) -- Suppose you wanted to invest in hedge funds and your principal was guaranteed by the Federal Deposit Insurance Corp.? At first blush, this sounds like an easy way to anchor a risky investment within a safe vehicle. Two federally insured certificates of deposit (CDs) are being sold that are linked to the return of a hedge fund index maintained by Hedge Fund Research, Inc. of Chicago. One is offered by HSBC Securities USA, a unit of Europe's largest bank. The other is sold by Bear Stearns Cos., the New York-based securities firm. (..) There are a few catches with the principal guarantees on both CDs. Although Bear Stearns says it intends to maintain a secondary market for the CD, early redeemers would receive the lower amount in a bid-ask spread. The guarantee is only good up to \$100,000 and only if you hold seven years to maturity. There's no minimum interest with either product. Both certificates only pay if the return of the underlying index --the HFR U.S. Global Hedge Fund Index (HFRXGL) -- is above an ``initial index level equal to the closing price of the index on the month the CD is issued,'' according to the Bear Stearns CD's terms. Then there are the expenses. Unlike a standard CD sold by a bank, Bear Stearns investors are charged a monthly fee called an ``adjustment factor'' that reduces the return of the index by 1.8 percent annually. (..) Mike Dubis, a certified financial planner with Touchstone Financial in Madison, Wisconsin, said he was troubled by the fact that neither certificate pays interest or dividends annually. ``I do not like what I'm seeing,'' he said. ``It's expensive, confusing, illiquid, no dividend inclusion, tied to a poorly managed index and psychologically confusing to investors. I would not allow any of my clients to buy this product.'' (.. )

Expensive, confusing, illiquid, no dividend inclusion, tied to a poorly managed index and psychologically confusing...

Sounds like they've created the perfect retail product!

10/3/2005
Home Run Totals Dropping Off, from Kevin Elian

From an ESPN article:

"...An average of 2.06 homers per game were hit through Monday, according to the Elias Sports Bureau, down 8 1/2 percent from last season's final average of 2.25. The figure hasn't been so low since it dipped to 2.05 in 1997."

We hit a low in homeruns in '97. If we all remember our history, that was folllowed up by one of the most exciting spectacles in baseball in 1998. I, of course, speak of the McGwire/Sosa battle royale for the title of new single season homerun king. McGwire beat Sosa to 62, thus displacing Roger Maris' so called unbeatable record. McGwire went on to hit 70 homers that year and Sosa had, I believe, 66. A very good year for baseball indeed.

Shortly thereafter, Barry Bonds hit 73 homers. Something that he had never even come close to before or close to since. Was it Barry or was it steroids? (For that matter, was it Big Mac and Sosa hitting those homeruns or was it steroids?) If they were taking steroids, then it was akin to Enron, Worldcom, et. al. cooking there books. And when you cheat, a big fall usually follows. Big Mac is out of baseball, his body just gave out. If you look at picture of him now, he looks like a shadow of his former self. Sosa is way on the downside of his career and Barry Bonds...well who knows.

The potential analogies to investing just abound. The one that sticks out in my mind is that great rises are usually followed by greater falls. Ah, but it is fun to reminisce about the halcyon days of '98 when the balls were flying out of the park and our tech stocks were soaring thru the stratosphere.

10/1/2005
Getting Ready for a New Day, a New Week, a New Month, by Alston Mabry

In early Roman history (circa 387-386 BC), Roman allies in the Po Valley, the Clusines, faced encroachment by the Gauls. The Romans sent envoys to negotiate a settlement:

Although we are hearing the name of Romans for the first time, we believe nevertheless that you are brave men, since the Clusines are imploring your assistance in their time of danger. Since you prefer to protect your allies against us by negotiation rather than by armed force, we on our side do not reject the peace you offer, on condition that the Clusines cede to us Gauls, who are in need of land, a portion of that territory which they possess to a greater extent than they can cultivate. On any other conditions peace cannot be granted. We wish to receive their reply in your presence, and if territory is refused us we shall fight, whilst you are still here, that you may report to those at home how far the Gauls surpass all other men in courage." The Romans asked them what right they had to demand, under threat of war, territory from those who were its owners, and what business the Gauls had in Etruria. The haughty answer was returned that they carried their right in their weapons: "To the brave belong all things."

10/2/2005
Book Preview, 2nd Installment: How to Buy Companies, by Daniel V. Grossman

Note from the editors: Dan Grossman, Esq., Victor Niederhoffer's business partner for four decades, has been working on a book about his acquisitions, other business transactions, and some deals of others that he has liked. "My general theme is how an ordinary guy, without sizable capital or the backing of a well-known financial institution, can accomplish deals with large public companies," Dan says. We are pleased to provide this second preview chapter exclusively to readers of Daily Speculations. The first chapter, "Deals I Wish I Had Done," appeared in September. Dan would appreciate comments and suggestions at dan <at> dailyspeculations <dot> com.

Chapter Y: "The Perfect Deal" [Read the whole chapter]

On August 28, 2000, I sold my company, Indiana Precision, Inc., to the NYSE firm Kaydon Corporation for \$10,300,000. Based on an original investment of \$1,000, this was a gain of more than 1,000,000%.
These numbers would perhaps not be particularly impressive in Silicon Valley and other breeding grounds of the New Economy, where hundred million dollar or even billion dollar gains have become common (at least until recently). But \$10,000,000 and a 1,000,000% gain on sale of an Old Economy machine shop in Crawfordsville, Indiana, may be considered, even in this New Economy age, worthy of some note and explanation.
In early April we were notified by Alcoa that we were among the bidders selected for the second round. New bids were due on May 15. Alcoa hinted to us that it needed a somewhat higher price than our original bid in order for it to avoid having to report a loss from the values at which it carried the West Plant and machinery on its books, although in keeping with its customary secretiveness Alcoa refused to reveal what its book values were. It also supplied a proposed form of Acquisition Agreement and Supply Agreement (covering Alcoa’s purchase of forming pins and prototypes), and we were asked as part of our bid to indicate any required changes. The agreements were for the most part devoid of legal commitment on Alcoa’s part, and read as if they had been prepared by a secretary copying haphazardly from other agreements in Alcoa’s legal files.
Now things were getting serious and I discussed the transaction with Victor, my 50-50 partner in Tridan. Victor is a speculator in stock futures contracts who sits in front of a trading screen all day (and most of the night). Although we were close friends since college, I rarely bothered Victor with transactions I was undertaking at Tridan. He actually would have preferred that I sell the entire company since he felt he could earn a far higher return on the money in his futures trading. But he did know a lot about acquisitions, having started his career as a leading business broker.
“That’s the stupidest acquisition I ever heard,” Victor commented amiably. “If Alcoa’s selling, they must be planning to phase those things out.”
“No, no, I looked into that. The next technology down the road is EDM, electronic discharge machining. I’m getting Alcoa to commit to buy the EDM pins from us if they switch over from the current forming pins.”
“You won’t make any money selling to them. They must know their costs.”
“I don’t think they do. There’s 50% Alcoa overhead in everything they manufacture. Paul O’Neill, their Chairman, has ordered them to save a billion dollars in costs and this is how Crawfordsville is complying. We’ll have practically no overhead, and we’ll make the 50% as profit.”
You would think an occasional attempt at levity would help, but this was not necessarily the case. During one frustrating negotiating session I finally said, “Okay, okay, Alcoa’s the 800-pound gorilla. Just tell me what you want here and I will do my best to accept.”
Having thought it over for a few minutes, one of the Alcoa participants then complained in a very hurt tone, “You called us a gorilla!”
“I meant a friendly gorilla. A lovable, friendly gorilla,” I said, realizing that even \$100 billion companies have their sensitivities.

10/2/2005
Breath, by James Sogi

Breath is the stuff of life. Yin and yang. The steady in and out each minute, hour, year of life. The study of breath is the key to health and enlightenment in the practice of hatha yoga and transcendental meditation. Wind training is key to sports. The earth breathes with the diurnal wind cycle. The market is the same. It has life. It breathes in and out each minute, hour, day, week, month. The study of the market breath is key to profits.

Musicians and singers breathe from the diaphragm. The breathing from the diaphragm is stronger, deeper. My grade school tuba teacher taught me to breathe from the diaphragm. When we were kids we would play a game: Who could sing a note the longest? Of course everyone has to breath in at some time. And so does the market. It never goes straight up or down without a breath. Even the fastest panic, there are stops for a breath before the terrible fall. In dog piles to get aboard there are breathers at key points. No matter how much air you suck in, you can only hold your breath for so long. The market can only go down for so long or up for so long, before it reverses to breathe. The market breathes in and out and regular advances and contractions. Be sure to have enough breath to stay above water.

Boxers are taught to breathe in through the nose and out the mouth to prevent hyperventilation, dry mouth, panic and panting, and to make oxygen absorption more efficient. When training for black belt fights, we trained three-minute intervals, max breath, 10 rounds. How many times coach yelled at the fighters, Breathe!

Transcendental meditators and yogis are taught to breath through the nose and be mindful of the breath to achieve health and nirvana. The breath is central to life and the spirit. One technique is to sit quietly, breath in and out through the nose. Be mindful of the breath and the air passing through the nasal area while not thinking for 20 minutes. It's very difficult without practice and training the mind to quiet down and stop the thoughts that crowd in on the pure state. Another technique is to focus on the space between the breaths, that pause between inhaling and exhaling. This is the important time for speculators to focus on in the market as well, as the market turns from inhale to exhale. It pays to train the mind there to stop crowding thoughts and ideas, but focus on the market breath. Those who cannot train the mind are doomed to suffer.

When training for the big wave Fiji surf trip, I trained wrong. I trained for wind endurance, 20-40 minutes @120 heart beats per minute. Wrong. Better training for the surf was intervals, 150 heart beats per minute and recovery to under 110 bpm and back up again 3x-5x. When catching the wave its top exertion to catch it, big exertion to ride it for 30-40 seconds, then having extra wind for the big wipeout and the four waves breaking on your head washing you up on the razor sharp coral, while struggling to stay afloat and get back out of the impact zone when out of breath and winded. Got to have that wind and be able to breath to stay out of trouble. Trading is like that. Maximum effort, then recovery period. After a trade, a bit of rest is good. It's hard to think straight or give maximum effort when out of breath.

The trader and the market cannot only breath in without hyperventilating. The trade needs some room to breathe to cover some distance. You can only go so far on one breath. He market breathes in, breathes out. Focus and be mindful. Study well and train the mind.

Mitchell Jones, author of The Dogs of Capitalism, debates trader Hany Z. Saad on whether the U.S. government secretly intervenes in the stock market.

A Daily Spec discussion on why more people don't use debit cards, prompted by an Oct. 1, 2005, article in The Tampa Tribune on how some gas station owners are refusing credit cards. The retailers, who make a fixed 6 cents a gallon, say they're losing money as more consumers use credit to pay for increasingly costly gasoline. Financial institutions charge the station owners 3% a gallon for credit card sales.

10/2/2005
Film Review by Kevin Depew: "A History of Violence"

Today we saw a film about love. "A History of Violence" may be one of the most realistic and beautiful depictions of love between a husband and a wife that I've ever seen. And to think, some people are calling it a film about "America," or "rural suburbia," or worse, a film about "violence."

It is none of those things. It is about marriage, and about love. It is about the very essence of love, the secret reward promised for the very serious risks involved in reluctantly revealing that which we prefer to keep hidden; the part that true love unconditionally accepts no matter how hideous, or reprehensible, or disfiguring, or damaging it may be. That is what this film is about.

```"And maybe there's a God above
But all I've ever learned from love
Was how to shoot somebody who outdrew ya
Well it's not a cry that you hear at night
It's not somebody who's seen the light
It's a cold and it's a broken hallelujah,"```

goes the Jeff Buckley addition to the Leonard Cohen song, "Hallelujah," itself one of the most beautiful love songs ever written.

Although the screenplay for "A History of Violence" was adapted from a graphic novel by John Wagner and Vince Locke, I would like to think the graphic novel may have been adapted from the Leonard Cohen song, because having seen the film, that song is all I can think about.

Love is violent; looking for it even more so. That is why we talk about broken hearts, shattered dreams, destroyed relationships. Have you ever tried falling in love? Might as well try and get the hiccups. I remember mistaking romance for love; two different things, not mutually exclusive, mind you, just different. Talk about crossing thresholds? The traditional first step toward marriage consummation? "A History of Violence" is about crossing the threshold of the threshold. Romance is easy to depict in film, and in life, but true love? Not so easy. If you value true love, I hope you go see this film.

Kevin Bryant responds:

My wife and I saw the movie this weekend and enjoyed it; however, I'm not sure the director, David Cronenberg, was as focused on a depiction of love between husband and wife as you suggest. Indeed it was a film about violence. Cronenberg clearly relished filming and lingering over the images of blood and disfigurement, the results of often gratuitous acts of violence. Some of these depictions particularly when sprinkled with humor were reminiscent of Cronenberg's past exploits as a director of horror films. The fight scenes were well choreographed and entertaining though not terribly realistic. The son's conflict in the school made an important statement about retribution and genetics or generational violence, but had nothing to do with the husband and wife's relationship. The scene of the husband and wife making love on the staircase, had little to do with love but everything to do with violence as an aphrodisiac.

As an aside, the husband, wife, and son were the only characters with depth and nuance. All the rest were comic book caricatures.

The film had is moments and I found myself at points thrilled by the action and touched by the scenes of tenderness, but it appeared Cronenberg had difficulty giving up his fascination with blood and gore in the interest of the softer tones of human relationships.

10/01/2005
Fly Fishing, Big Sky, by Tom Ryan

The Sun-Baked Speculator visits his favorite fishing holes in Dillon, Montana, for some good rainbows and reflection on the markets. Excerpts:

Although I was fishing rather late in the day, and could not get the fish to take to a well presented dry fly, the smaller rainbows were hitting rather aggressively on a golden stone fly fished just under the surface at the head of each pool I trekked and waded to. The technique is to cast to one side with some slack and float the fly downstream below you at a slight angle off your fall line and then swing the fly into the current and retrieve briefly against the current with the idea that the flash of the lure swinging in front of the fish will bring a strike. It's a bit like the market intraday lollygagging around and then suddenly dropping 3,4 ticks in a brief moment to entice you to buy it. Of course, like in the market, that only works on the naive and smaller fish. But it does work if you want to catch rainbows, especially late in the day. You start by dropping the fly two ticks below you, then add some more line and try 3 ticks below, then some more line and 4 ticks below progressively working your way down the pool until you have too much line out or have worked thru all of the prospective buyers for your lure then its on the next big pool.
Like daytrading the stock futures most days on the river you often can get the sense of when the climax has been reached for the day but, at least in my case I can never stop myself from continuing to try to catch an even bigger fish right up until the end. And of course you never know decisively that the top has been put in until the end of the day. And there is always that memory of the big brown trout caught just a couple of miles downstream near Pennington bridge right at dusk (or the irrational exuberance speech by the chairman of the money temple which drops the market 2% in the last hour before close). IN this case however, the 18 inch rainbow was the fish of the day, although I went on to catch over 15 more. I lost count of the total because the whitefish were so aggressive and so hungry. I caught a total of 6 trout and if I still lived in Montana I would have been getting out the smoker to smoke those whitefish they are a good fish for smoking whereas the trout are good for pan frying or baking.