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October 16-31, 2005

10/30/2005
Friday Rallies, by Victor Niederhoffer

Talk about ruining a man's weekend. Here are recent Friday moves in the S&P futures:

Date   Move     Date  Move
 9/9     10     9/16     9
 9/23     1     9/30     3
10/07     3    10/14    12
10/21     4    10/28    17

During this period, the market moved from about 1250 to 1200, so without the Fridays, which went up a cumulative 60 points, the market would be at 1140.

One can only imagine the glee with which the weekly financial columnist starts out his Friday mornings with exuberance like that of Tom Sawyer impersonating a Mississippi steamboat -- and then, by the end of the day, deflation, despondency. "What happened? My good friends who are the sharpest investments minds I know, the ones that called the top in the 1990s --  they were expecting The Big One. How could a rally happen eight times in a row? Dash, the PPT! See if Bob is back from his tennis game for an update on what a reflex rally on a Friday on low volume really means, and if he's still playing, get Charlie off the racquetball court!"

One is reminded of the gentleman who smiles at a beautiful girl at the bar, and gets a smile in return, and then he breaks the ice. "Would you like to join me for a little...?" After being hit with a few karate chops, stomped, elbowed in the head and kicked in the groin, he gets up five minutes later and says, "I trust that some ### would be out of the question?"

An ironic aspect of this is that the person who told me the joke, the best comedian and joke teller I know, is one of the chronic financial columnist's best and most favored sources for bearish scenarios with a 4-in-10 probability. There must be a market connection or at least an ecological reason for this.

10/31/2005
Dept. of Non-Predictive Studies: Prof. Pennington Announces Contest Results

Here are the results of the recent options contest.

Recall that we were considering these possibilities:

  1. BUY CALLS. Starting in 1999, On the last day of each month, buy a nearest to the money call, with expiration date about 1.5 months out, on each of the 500 S&P index components. Hold to expiration.
  2. BUY PUTS
  3. SELL CALLS
  4. SELL PUTS

Contestants were told that the average price paid in A was $2.195, and in B $2.19. The average price received in C was 1.961, and in D 1.953. (The difference between A and C, and between B and D, reflect the bid/ask spread.)

Contestants were asked to give the average price of the options at expiration for cases A, B, C, and D. I then found the answers using historical data (which is not easy to get).

  1. As summarized in the table below, the average final price for case A, in which calls were bought for an average of $2.195, was $1.87. So call buyers lost money.
  2. Put buyers paid $2.19 on average but recovered only $2.09 at expiration. So they lost money too.
  3. Call sellers received on average $1.961. On average they had to buy back at $1.87. So the call sellers made a little money.
  4. Put sellers received on average $1.953, but then had to buy back at $2.09. So put sellers lost money.

What's the message here?

  1. Neither calls nor puts are over or underpriced in any big way. The market is pretty efficient.
  2. The bid/ask spreads in options are big, and tend to prevent everyone from making money except perhaps for the market makers.

There were 8 contestants, and their guesses are listed below. Two contestants, Tom Ryan, Kim Zussman (contestants 1 and 5, respectively), gave answers that were reasonably consistent with the empirical result, and therefore the contest judge has deemed them the winners, in a tie. Contestant 8 was reasonably close also, but not quite as close, and so the judge decided to be an old grouch and just stick with two winners.

Congratulations on all those bold enough to take a guess. I was unable to evoke guesses from the options wizards that I know around here. The answer was not obvious, although it does make sense in retrospect.

                        A       B       C        D
                   Buy Call Buy Puts Sell Call  Sell Puts
       Init Avg Prc    2.195   2.19    1.961    1.953
       Final Price     1.87    2.09    1.87     2.09
Guesses           1*   2.12    2.12    1.98     1.97
                  2    0.40    0.40    1.20     1.20
                  3    0.89    0.95    0.89     0.95
                  4    4.49    0.06    0.14     0.08
       		  5**  1.92    1.91    1.92     1.91
                  6    2.41    0.31    2.41     0.31
                  7    0.50    0.20    0.50     0.20
                  8    1.71    1.50    1.70     1.49

* Ryan
**Zussman

Michael Cohn Responds:

I will admit I was surprised by the results which proves the points of facts on the table.

I approached it from two perspectives:

  1. Grouped selling volatility and buying volatility together and observed that according to Goldman Sachs realized volatility has been about 3% below implied volatility over past 4 years. Accordingly, I was losing money in the long portions as I had paid over the odds. So focus on the shorts. Triumph of the Optimists point you in the direction of making money on the short put and losing on the short call..
  2. Equal Weighting. I have often said that if I could only do one trade it would be to buy an equal weight index and sell its market value weighted equivalent against it. Accordingly, I feared for the short call on this ground as well and favored the short put.

Accordingly, back to the drawing board. I did however receive some nice insights into the Unification of Physics.

Russell Sears Responds:

I can only half way agree with the "efficient" option markets. If you mean that the option writer (C+D)or option seller (A+B) will never make much money, then I can agree.

Though its too much stats to show here, I think it could be shown that: The writer is short volatility, and the option buyer is long. Given that volatilities are fairly predictable, and enough periods (35 in the test), neither one can really deviate too much from the average price. This is only a matter of Black Scholes, "fairly predictable" vols, and flipping the volatility coin enough times.

However, if you mean no one; A, B, C, or D could make money. I must disagree with the conclusions of the option contest. The results do not show the efficiency of the options markets. That all the payoffs were near the original prices was merely a coincidental consequence of the markets during this period.

Rather the results show that buying an equal number of each shares using a 2 month floating rate was only a small loss from 1999 on.

Consider the put-call parity.

Stock ending - strike = call payoff - put payoff

Now ignoring the rule that you took the nearest to the money price and assume they cancel out such that on average you buy strikes at current stock price.

Ending equal weight index -beginning equal wght index = total call payoffs - total put payoffs

Divide both sides by number of stocks and periods you get:

(average stock price at end -average stock price at beginning) / Periods tested = avg call payoff -avg put payoff.

But the left hand side is limited the risk free rate, because it can be replicated by buying each stock equally using borrowed money .

That is for any one stock and one period Cost of call -put must equal interest cost of buying stock on borrowed money

Thus summing each stock up for each period, Charles has shown that investing in an equal weight index has been slightly costlier than simply taking the risk free rate.

If the index had double this would not have been the case. Using the equation above and assume average stock goes from 35 to 70. Then:

(70 - 35) / 35periods = $1.00 = average call -average put

Not -0.21 = 1.87-2.09

Now during my lunch break run, I realized that this equation (change Equal wt index = sum diff calls- puts) has a survivorship bias to it. Which we all know, during the test period, that many companies were removed from S&P due to near or complete bankruptcy not just mergers. Thus why I believe, "puts" beat the "calls" more than my equality suggest.

10/31/2005
Dr Castaldo contributes to the Dept of Finance

A reader writes

I am taking a class on International Financial Markets - What is the motivation for the "Forward Extra" for an American exporter (expects payment in foreign currency) and what are the risks? Also, what is the advantage of the "Forward Extra" relative to a standard forward hedge, and what are the drawbacks?

With a forward contract the exporter can eliminate all FX risk and lock in the forward rate FR that is quoted in the market today (for example 1.253 dollars per EUR).

With a "forward extra" the exporter agrees to take some risk of the euro falling, (for example to take risk of euro falling to 1.245, the so called "worst rate," and be protected below this level).  Note that this rate is worse from the exporter's view than the forward rate.  In return for this the exporter is allowed to speculate to a limited extent on a favorable (upward) move in the euro (for example this "best rate" might be set at 1.3225).  The exporter gains if the euro rises LESS than this threshold during the life of the contract; however if the euro touches this rate at _any time_ during the contract the exporter is stuck once again with the "worst rate" of 1.245.

A "forward extra" can be synthesized as the sale of a barrier option (knock-in EUR call with strike 1.245 and barrier 1.3225) which finances the purchase of a EUR put (with strike 1.245), i.e. it's a zero-credit item.

An important point to remember is that the bank that provides the exporter with this wonderful bit of financial engineering charges the exporter for its services more than on a vanilla forward contract.  This extra profit margin is what makes the "forward extra" attractive to the bank.

10/31/2005
Jim Sogi contributes to the Dept of Changing Cycles

Why do cycles change?  Why does the price go  up, then shift direction and go down, from hours to hour, day to day? Why do memes take hold, spread, fade away? What gives an economy and fiat currency confidence, strength, then later weakness. What starts irrational exuberance, and depression.  How do you know when the cycle has changed? How do you change public opinion? What causes events?  Who knows the answers rules the world. A few  hypotheses to measure markets might help advance the cause. Let's reject the hanging hypothesis from the start and consider a few smaller bits.

Dr. Niederhoffer studied the effect of news on price.  Consider the converse. Price causes news.  Price affects the general level of optimism and doubt which drives events and their reaction.  Last week was notable how price preceded the news. Same for the prior weeks and months before.   Coverage of the political climate this last week was strongly related to price movement, as was Refco story the week before, as was the hurricane last month and the month before. It is worth study.

News is reflective and descriptive, not in terms of factual accuracy, which it is not, but in terms of outlook.  Unfortunately, the public following news are doubly behind the form. Recent discussions of journalists missed the mark.  Journalistic analysis itself is not predictive, it is a reflection of  the current meme and should be regarded as meta news, rather than meaningful analysis.   Media can be manipulated to accomplish hidden agendas, but is a dangerous tool as recently demonstrated.  Media uses itself as self promotion. This needs to be considered.  News is  a barometer. No one criticizes the barometric pressure.  Like news, it is an indicator of conditions and tells you to put on a slicker not to curse the rain. News sways public opinion. There is a reflexive cycle at work.

There is information in news, but following media analysis is not the way to profit.  It is descriptive rather than predictive.  Analysis of news as intelligence information is the better approach, in many layers. One way news seems relevant to price is to discern relative levels. Absolute price itself give little relative value information.  The news puts price in context allowing judgment of value. On Thursday, before the "Leak" announcement, prices crashed. Everyone wanted out before the bad news.  A close look revealed two things. First, only the assistant was a likely target, or the VP at worst. It was not the end of  the world.  Second, the price seems to have built in the news before it was announced.  Quite amazing how it does that.  A second method is the magazine cover contrary indicator method.  Both methods can offer the astute speculator an edge rather than being reactive, head 'em off at the pass.

We should not be so quick to close our minds to these issues until we understand what is happening and what the changing cycles are bringing to the plate as the past few months seem to show. Those who have the answers to the above questions need not worry about such trivia.

10/30/2005
Capitalism the Ahmadinejad Way, from Jean Paul Schmetz

I couldn't resist posting this report from Iran Focus.

"Iran's President says "2 or 3 hangings" could end market woes"
Tehran, Oct. 30 - Iran's hard-line President Mahmoud Ahmadinejad told the latest cabinet meeting in the Iranian capital that "if we were permitted to hang two or three persons, the problems with the stock exchange would be solved for ever", according to a Tehran-based newspaper.
Ahmadinejad was addressing a cabinet meeting held to discuss the rapidly deteriorating situation at the Tehran Stock Exchange, the daily Ruznet reported on Sunday.
Ministers and experts disagreed with all the different views and proposals raised at the meeting, which came to an end without any concrete results. Tempers flew high and participants shouted at each other during the discussion, according to the daily. Frustrated with the inability of his economic advisers and experts to come up with any solution, Ahmadinejad told them that the only way out of the current stock exchange and financial market problems was to "frighten" speculators by hanging two or three of them.
Iran's ultra-Islamist President first sent jitters through the country's markets when he said on the eve of the presidential elections in June that "stock exchange activities are a kind of gambling and we are against them". Gambling is banned in Islam.
Nervous investors have been transferring their capital to other countries, and Dubai has benefited palpably from the flight of capital from Iran. The Tehran Stock Exchange has lost 20 percent of its value in the past four months.

Jason Ruspini Responds:

Prima facie, he seems like a desperate man occupied with maintaining his internal political base. If I were a betting man...

Regarding subjective probabilities/value and sports betting, it's interesting how home teams tend to be overpriced in local markets. To me it would seem that there would be more selling pressure as fans would tend to "subjectively hedge" against their favorite team's fortunes, rather than "levering-up".

Lastly, has anyone heard any updates on Mark Cuban's sports fund announced nearly a year ago?

10/30/2005
The Bush Brain Trust, by Jim Sogi

The end game. Even though normally this scienter type of charge is defendable, Libby has to fall on his own sword and plead guilty. A trial would open the inner workings of the White house, require testimony by the entire White House, VP, and open up the CIA. It's untenable. Prosecutor has White House in a no win - heads I win tails u lose - situation. It's "Check!"

"2 or 3 hangings" could end market woes.* Here is the first.

In order to understand the weaknesses of others and to exploit those weaknesses, your own weaknesses must be understood. This is especially true for the market. To understand your own weakness allows counter-intelligence operation against other market participants' weaknesses and to anticipate and in some cases manipulate them. Market participants have specific weaknesses. They are exploitable.

I have begun a search for books discussing counter-intelligence and intelligence methods for use in market operations. I am not talking about seeking restricted in formation, but rather 'handling' market moves. Typical techniques are use of bribery, sex, extortion, blackmail, money, ideological, greed, revenge, fear, hate. Any recommendations?

* Iranian wisdom.

10/31/2005
Libby in the Polls, forwarded by George Zachar

In a CNN/USA Today/Gallup poll conducted this past weekend, less than half of the American public believes former senior White House aide I. Lewis Libby Jr. did anything illegal...
...Only 38% of Americans say the charges are a sign that "the Bush administration in general has low ethical standards." The majority, 56%, say the charges are "based on an isolated incident."...

10/31/2005
The Libby Affair in Context, by Yossi Ben-Dak

In weighing the media's coverage of Libby's indictment, consider the following:

  1. As the administration's tactical man on a wide range of major issues requiring intense concentration, Libby was carrying a huge weight on his shoulders during 2002-2004.
  2. He apparently was consistent in his statements to journalists intending to hang him and his administration.
  3. The media has a technique of creating a discourse of "fake friendliness" that consists of a reporter's suggestion that he already has obtained the facts from other people and that the source needs only to confirm them, using short answers without clarification. Such discourse can be so easily misrepresented later.
  4. It's possible that Libby was covering for higher-ups on matters that could not and should be discussed in public.
  5. Libby was one of the most erudite, informed and mentally ready officials to talk to analysts, etc., and was therefore not at all likely to lie without a reason. The prosecutor has so far not identified any such reason, critical in my mind for such a serious charge.
  6. Libby is said not to be involved in lying regarding the Wilson spouse.
  7. The compliments from the president on this investigation/investigator set it in a need-to-respond mode, i.e., not the best mental environment to come up with nothing after such a long time.

The public and Princeton are, once more, fully aware what is justice and what is not. Perhaps there is a need to check more closely what illegal machinations produce, other than grief to innocent people and no satisfaction to those who are hurt and violated.

10/31/2005
Dorgan vs. Markets, by Jason Ruspini

Senator Byron Dorgan now has a history of seizing upon ephemeral opportunities for political hay-making at the expense of sane economic policy and financial innovation.

I and many others have, intellectually if not effectively, defended the central concepts of DARPA's ill-fated Policy Analysis Market. PAM's primary function was to price indices of economic and demographic prosperity in the Middle East (to which specific events of violent unrest would most probably be correlated). PAM's secondary function, event-linked-futures, inspired Dorgan to label it a "terrorism market" and led to its demise.

A more robust argument against PAM might simply be that it should not be government-run. In any case, legislation-linked futures markets would not suffer from the same major difficulties of prediction markets linked to events such as terrorism and coup d'etats. I stress this crucial difference: in the latter cases the "insiders" and their proxies are inherently lawless, while legislators are lawful. Um, that is, it would be quite something if legislators argued that they couldn't be trusted as insiders of legislation prediction markets.

If there were a prediction market in place linked to Dorgan's proposed windfall tax, energy companies would have the recourse of insuring part of their potentially affected profits. Senator Dorgan claims there is $7 billion per month in "windfall profit", and wants half of it. Philip Verleger, an economist at the Institute for International Economics, calculates that even with exploration costs offsetting part of any windfall tax, the tax could raise $3 billion to $4 billion a year (over 3 years) from each of the three or four biggest oil companies. I have not vetted these numbers in any way, but this market is potentially far more sizable than anything yet seen on the online prediction exchanges such as Tradesports, and since it is essentially an insurance market, participation/liquidity will be compelled in ways lacking from markets that are more purely "betting" markets, such as the SCOTUS contracts.

Legislation-linked futures will most likely predict suitably general-yet-specific concepts being fully passed into law by a certain date not specific bills being passed in specific houses, under threat of veto, etc. Of course, all of this is contingent on whether LLFMs gain the blessing of the CFTC and whether the specific contracts are deemed to fall under IRC 1256(e)(2) and are officially recognized as hedging instruments (which seems completely reasonable with tax- and subsidy- related legislation).

Although it is currently a somewhat moot issue, another large market could be formed around the permanent repeal of the estate tax.

There are many other complications and obstacles here, and yet I feel these markets will catch-on, somewhere or other.

10/29/2005
Sports Betting, by Victor Niederhoffer

On a recent visit to the CBOT floor, I browsed through the lobby newsstand to see what the members were reading so I could learn, profit and stay abreast. Only one market weekly was on sale, the Commodity Research Board Chart book. That certainly deserves a review, with its list of computerized winners and losers, prices relative to moving averages, and trends in all commodities. Amazingly, almost all the positions were entered within the week at prices substantially better than the current prices, and if only one had followed it, why what alluring profits would have been made. Also on sale were five monthly trading magazines, including Futures, Active Trader, Stocks & Commodities and so on.

This week might have been a biased sample, because all the members were focused on the movement of the CBOT stock, which opened trading the day before I came at 66, went up to 106 in the next week and has since eased off to 94. Apparently BOT takes its cue from the S&P 500, which has banged up and down below and above its own round number of 1200 nine times so far in the last year, and closed at 1200 exactly last week just to confuse the enemy. To the casual observer, it seems good that BOT is taking such cues, because it sells at 60 or so times earnings, and such an observer sees not much growth ahead in the mainstays such as corn, beans, and the 30-year Treasury bonds, whose pits looked like such a shadow of their former selves.

Apparently, by far the most popular reading material for the members is the sports books. About 10 of them were on sale. I bought five. Winning Points appears representative. It's a 12-page tabloid with best bets 83% winners, 67% top college, four-star best bets for the coming week and two more on top for Sunday, all for $7. The Compumatch section has a predicted score derived from the combined stats of prior games. It recommends you only play Compumatch plays where the predicted score is 2.5-4.5 points better than the line and 5 points is a Compumatch top play. One is warned to check the turnover ration and over-and-unders. Historical trends based on matches against the team, last year classified by the home site are given relative to the line and over-and-unders on each game are also considered relative to survival statistics. "The Titans have scored at least 215 points four of the last five weeks, while Denver is averaging 15 points on the road. And the Packers have gone over 14 in their last 16 on artificial turf."

The analysis of each game is highly sophisticated, with analysis of the road game factor very prominent and changing trends for quarterbacks, and of course the turf, and turnovers. Nice consideration of the regression biases is given "These things tend to even themselves up when you have a defense as good as Baltimore."

The incentive to win is considered and the extent of wear and tear, and the return of key players and the desire to "struggle mightily" is always noted. The duration between games and the numbers of sacks is noted, and how much the defense has given in the two last games and the incentives the coach will have to correct that is noted.

"But the fact remains that McNabb is trying to gut the season out despite suffering from ailments [a list follows], but San Diego is a fantastic 10-0, 2 ATS {whatever that is] in their past 12 road games," and then an adjustment for the special teams and whether the star kicker is expected back again.

Detailed box scores in a table looking like the advance-decline or most-active provided by most financial media is given. It's a little too small for an older Spec like me to read, although I can read the power play rankings, which are the personnel ratings of each of the college team's raw talent, the coaching, the field advances, "If you consider coaching important, you'll profit from this method." (Shades of Jubak with his, "If you are bullish, you'll buy and if you are bearish you'll sell, or if you think it a growth company it deserves a P/E of 25 but if you consider it a value company just 8."

In short, the analysis of the sports betters has many more angles and many more supporting numbers than anything that the speculator is exposed to. It is no wonder that the CBOT members flock to buy these as a relief against the mumbo so often disseminated in our field, and as a guide to the proper quantitative study of the markets in our own playing fields.

Guttersnipes LLC comments:

You are quite correct on your sports betting analysis. ATS= record against the spread, Cover or No, home/away. the floor guys tend to bet on anything, most sports, quite a few cards. Tuesdays were always interesting on the Floor as all the bookies' runners would show up for "clean up" day. It was pretty comical, these guys with visitor passes. One of the best odds makers and traders I knew out of CBOE and PSE used to bet everything, even odds on 2 on 2 basketball games, he was quite good and it led to www.wsex.com . Unfortunately, the Feds frowned upon his hobby and he is now a man without a country.

The floor guys for the most part are adrenaline-rush gamblers. But your insight into truth in numbers is spot on. And most use this type of over information to learn to key out the noise in the stats and get to what matters most consistently, statistically speaking. The upstairs OTC stock guys are just degenerates, and for the value of their handicapping, I would routinely rip up my biotech analysts research reports and sprinkle them on his or her head. Both were top-of-the-line analysts, but I couldn't trade A to Z bio on their BS! Most OTC traders are so conditioned to purchase part of a position to work the balance, that an outright sports bet would be too much of a commitment for them without checking AUTEX first. Ha, ha. Now the fixed-income guys, that's a whole different animal. They'll bet anything, and have propped the other side in advance. and no doubt, one of them wrote the program that generates the numbers for all those sports statistical mags.

To feed my speculation habit here in Property Bubble, Nevada I turned my attentions for systems to sports gaming systems recently. Probably not an intellectually worthwhile pursuit, but that is the degenerate fun of it.

The goal is/was to develop a self sustaining betting system against the parlay and teaser cards. I know these cards are sucker bets, but that also is an attraction, beat the system. The concept is use the teaser cards, with wider point spreads, typically 3-6 points more than a parlay card. I.e., a favorite who is -7 on a parlay card, will be typically -1 or +1 on a teaser card. The idea is to use a smaller amount of capital on easier bets to win, fund the more difficult bets (parlay card) and have capital left for the next week if you lose on the parlay card. (Typically I run approx. 70% against a moneyline, it is hard to get much better because of random events within the game itself, so boredom has sent me in this direction).

After a few weeks of pick and pray, I had enough of a data set to begin meaningful research for what it is worth in an endeavor of this nature.

Statistically Significant Variables or SSVs I call them, I'm sure PhD Quants have a fancy name for all of this, but alas I am a degenerate speculator.

What I did begin to notice in the datasets was a pattern of where the team with the smaller "turnover ratio"; the sum total of fumbles, interceptions lost and recovered, won the game or won the wager a "statistically significant" amount of times. This is in comparison to other available measurable statistics on teams offenses, defenses, average scores home/away, against the spread etc. All these other "statistical variables" appeared to be just noise when measured against the "spread number". Meaning they had no apparent correlation to if the team won/lost or covered the wager. Although I will speak further about this in a moment.

So armed with my apparent pattern I set about sampling the occurrences.

Here are the numbers through the last 4 weeks of 2005

College
lower turnover ratio wins outright or covers .607
85/140 samples as of week ending 10/23/05
up 10% from previous week.

Professional
lower turnover ratio wins outright or covers .718
28/39 samples as of week ending 10/24/05
down 9% from previous week.

Statistically Significant Sub-Variables in data that are emerging. Returning to the previous paragraph, aforementioned Offensive, Defensive, statistics and their sub-sets. After noticing a pattern in winners and turnovers that did not appear within any other given SSVs, a sub-pattern was noticed in looking at the teams with higher turnover ratios that won and went against the statistical probablility of the theory. Although it is still too small a data sample to place any faith, much less capital on this data sub-set, it warrants further investigation. In teams with higher turnover ratio's that won, a few patterns emerged. In college, a team with a higher turnover ratio, but a better offense compared to the opponent seemed to win the game or wager. Thus the SSSV beginning to develop, is a highly productive offense is prone to turn the ball over more but can sustain or cancel the "statistical significance" of a high turnover ratio. In professional football the pattern of winners with a higher turnover ratio than their opponent that won or covered the wager had a better defensive rating than their opponent. Hence being able to withstand the mistake or limit the point damage.

So it would appear on first glance that the turnover ratio has "Statistically Significant Sub-Variables" that can offset the "Statistically Significant Variable". The correlation of the SSSV is higher in professional thus far, and in college the SSSV pattern canceling out the SSV is not strong enough in any one of the 2 emerging patterns yet to develop a bona fide working theory.

Statistical Source: www.covers.com

Jason Ruspini comments:

Regarding subjective probabilities/value and sports betting, it's interesting how home teams tend to be overpriced in local markets. To me it would seem that there would be more selling pressure as fans would tend to "subjectively hedge" against their favorite team's fortunes, rather than "levering-up."

Ari Siegel adds:

Here is the homepage of Winning Points. On the left column in red font on yellow background is a link to Try a Sample Issue. I can't answer your question accurately, but I believe the sports quant creates a set of x factors that he believes crucial to score of a game. these factors are counted in relation to opposite team's totals and a final score is computed. kind of similar to arbitrage pricing theory, and perhaps regressions are used but I am not sure. this answer is solely based on friend who does this sort of thing.

Dr Castaldo asks:

Could someone explain how this sort of calculation is done.  Prof. Schnytzer perhaps?

Adi Schnytzer replies:

It is usually done by running a regression which "explains" the score or the line or the winning probability of a game, respectively. What you explain depends upon what sort of betting you plan to do: eg. back a team to win at given odds or back a team to beat the line. Now each game has its peculiarities and some are easier to model that others. Because basketball has high scoring (ie. the dependant variable is fairly continuous) you can regress the difference between two teams in a game on such variables as (all in differences) defensive rebounds, offensive rebounds, free throw percentage, field throw percentage, three point throw percentage, fouls and steals. This will generally get you an R-squared of around 0.7. Throw in the bookies' line and you do even better! Oh, yes, a dummy variable for home court. A nasty game to model is soccer, because the scoring is so low and decidedly not continuous. Even worse is cricket because no one really knows what represents "output" in a Test Match! (I await a production function from a bright spec!)

If you are betting for the win, you run a McFadden conditional logit regression (available in Stata and Limdep) which "explains" the dummy variable, win or lose and yields the "underlying" winning probabilities constrained so that they sum to one per game. (This is why regular logit, probit is wrong). One can also use the old linear probability model if the explanatory variables are differences. Some reading on the subject:

Dugan, M.  & Levitt, S.D. 2004. Winning isn't everything: corruption in sumo wrestling. American Economic Review 92: 1594-1605.

Dobra, J.L., Cargill, T.F., & Meyer, R.A. 1990. Efficient markets for wagers: the case of professional basketball wagering. In: Goff & Tollison (ed.) Sportometrics. Texas: College Station.

Zuber, R.A., Gandar, J.M., & Bowers, B.D. 1985. Beating the spread: testing the efficiency of the gambling market for national football league games. Journal of Political Economy 93: 800-806.

Sauer, R.D., Brajer, V., Ferris, S.P., & Marr, M.W. 1988. Hold your bets: another look at the efficiency of the gambling market for national football league games. Journal of Political Economy 96: 206-213.

Schnytzer, A. & Weinberg, G. 2004. Is the NBA betting market efficient? In: Papanikos, G.T. (ed.) The economics and management of mega athletic events: Olympic games, professional sports, and other essays. Athens: ATINER.

But this market is a minefield of specification and other problems. For the simplest form of modelling (where only past prices are used) blown up to show just how messy life can be, see:

Schnytzer, A. & Weinberg, G. 2005. The Australian Rules Football Fixed Odds and Line Betting Markets: Econometric Tests for Efficiency and Simulated Betting Systems. Unpublished Manuscript (currently under review in the Journal of Sports Economics).

I will send a copy to anyone interested. Comments would be welcome. All the best. Adi

PS. The reason that there is so little nonsense written in the sports betting markets compared to the stock market is that, in the former, you need only predict the outcome of the next game as a function of the past. In the latter, you need such mystical crap as the net present value of a firm's profits for the rest of its life! Yeh, right! If that isn't an invitation to BS, I don't know what is! That's why I'm a sportometrician and as soon as I figure out how to make money there, I'm out of the stock market forever!

Chris Cooper comments:

I have a close friend and ex-gambling partner who has made his living for the last 15-20 years exclusively by betting on football in Las Vegas. The plan of attack, though, has very little to do with "sportometry" and much more to do with understanding and exploiting bettor psychology. He never bets spreads or over/unders. Instead, he participates in the season-long game-picking contests sponsored by casinos. While the procedure is heavily computerized, it depends much more on game theory than on statistical approaches undertaken by most of us on this list.

For those who would follow in his footsteps, there are by now fairly high barriers to entry combined with diminishing returns should others join the game. Stick with the financial markets -- they are the biggest casino in the world!

Allen Gillespie adds:

The one stat that looks most robust is net turnover margin.  Given that there has only been 1 undefeated NFL team, I think the lesson for traders is that we all lose, but self-inflicted capital losses guarantee a sub-par performance.

Tk/Gv    PPG    Team
 -8      16     49ers
 -1      16.7   Bears
 16      24     Bengals
  8      16     Bills
  7      21.7   Broncos
 -1      13     Browns
  6      19.3   Buccaneers
 -2      19     Cardinals
  0      27.6   Chargers
  4      24.8   Chiefs
  8      27     Colts
  2      21     Cowboys
 -5      19.2   Dolphins
  4      23.7   Eagles
  7      25     Falcons
  9      28.8   Giants
  5      18     Jaguars
 -3      13.1   Jets
  5      17.3   Lions
 -3      24     Packers
  1      24.7   Panthers
 -6      23     Patriots
  0      21.3   Raiders
 -8      26.3   Rams
 -7      11.5   Ravens
 -6      22.5   Redskins
-12      17     Saints
 -3      25.9   Seahawks
  5      24.8   Steelers
 -7      12.3   Texans
 -7      19.4   Titans
 -8      15     Vikings

Pitt Maner Comments:

Further musings on sports betting and having the extra edge on the average gambler/investor:

Dr. Steven Skiena at S.U.N.Y. Stony Brook has written about a gambling system for Jai alai that seems worth mentioning and which some here are perhaps familiar with.  I remember a fronton near Ocala, FL. that U.F. students enjoyed going to. Watching the skill level of players handling potentially dangerous, hard balls moving 120 mph. and up was very impressive. We (amateur bettors) all thought it incredibly frustrating, however, to watch the highest-rated players drop the ball just when a bet was almost in the money (damn Basque separatists).  Many thought at the time that the games were so random or randomly rigged that you might as well guess which player positions would win regardless of the individual player records.  Dr. Skiena's research found patterns.  He has a good personal web page with several other items of interest posted. On the basketball front there is an article in the Nov. 2005 Wired magazine about Dean Oliver a statistical consultant (with Ph.D. in environmental engineering) for the Seattle Supersonics.  Dr. Oliver is a proponent of breaking down the game on a "per-possession" basis and many of the things he uncovers do not relate to the common measures of success--rebounds (remember Moses Malone! 5 re's on one possession not uncommon), points per game, assists, etc.  He has a book out that may lead to more statisticians in the NBA! The new way to look at, evaluate, and optimize your team and get that little extra edge.  You would think with all the millions of NBA dollars on the line over the years that there would be nothing new under the sun.

Gabe Carbone Responds:

I have little if any knowledge of sports betting, but I have read Skiena's book. I feel I can recommend the book to fellow Specs, particularly with the implications for developing and testing (stock) trading "systems", but especially for discussion of limitations, etc. to trading "systems". If I recall correctly, he talks about basic models ( e.g. his NFL handicapping in high school), more complicated models (Monte Carlo simulation), some of the attributes which allow a game to be modeled, and some of the limitations/difficulties in implementing a system. The practical reader would probably draw some conclusions as to the viability of professional Jai-Alai handicapping, noting that Dr. Skiena did not quit his teaching position to do this full tip.

10/29/2005
Secrets of a Modern Professional Turf Bettor

Kevin Depew writes of the fear and optimism on display in the Breeders' Cup.

Each spring in certain parts of the country where people care about such things, hope pushes up through newly thawed horse pastures in sentucky, the thoroughbred capital of the world, they call these threads Bluegrass. Of course, Bluegrass is not really blue, at least as far as blue goes, it's actually green. The word "Bluegrass" is nothing more than a funny mixture of literary conceit and deception. Not coincidentally, money is green, so is envy; two sides of the same coin, but there it is. Read the whole story

10/30/2005Ask the Specs!

A real estate Spec inquires: Has anyone else noticed the rapid deceleration in the rate of growth of real money supply this year? There seems to be no discussion of it in the financial press and fed funds futures appears to be oblivious to it while indicating a Taylor rule implied fed funds target rate of 5-5.5% within a year. Am I missing something here? Is this an indication of market entropy or a market reflection of newtons first law of motion? The financial press is abuzz with expectations of helicopter money coming from Bernanke but this is not reflected in fed funds futures. Does anyone else find this to be an anomaly? Or am I just confused?

George Zachar replies:

One of the oddities of the current monetary policy regime is that money supply itself is absent from ongoing discussion.

FOMCers, when asked about the role of money supply in their analysis, uniformly say it rarely comes up. I am unaware of evidence to the contrary.

The stated reasons for money supply's demotion are pretty simple: The definition of "money" has become blurry, and its global circulation has made its counting/tracking problematic.

Mushrooming leverage, and the use of derivatives to unbundle exposures, render past relationships between "money" and the economy moot.

The few economists still fixated on money have been marginalized, and I've not seen much useful/predictive from them. Counter examples would be appreciated.

It's likely that some relationships can be teased out of the various monetary aggregates and economic/financial variables, but I fear such work will be only retrospective/descriptive.

10/30/2005
Book Review by Alex Castaldo: "The Model-Free Implied Volatility and Its Information Content"

George J. Jiang and Y.S. Tian
The Review of Financial Studies, vol 18 #4, Winter 2005, pages 1305-1342

The familiar Implied Vol (IV) that we all know and love is a Model-Based IV. The model being used is of course (in the vast majority of cases) the Black Scholes model. Suppose an option is trading in the market place for a price P_mkt. We plug in different values of volatility into the Black Scholes formula until it produces a price P_model that matches the observed price (i.e P_mkt = P_model). That volatility, by definition, is the implied volatility (at that maturity and strike). This concept goes back to the beginnings of BS option theory.

The old VIX (VXO) was a model based IV. Because an option that is exactly ATM and exactly 1 month to maturity is usually not available, VXO was computed by interpolating the BS IV's of several options close to the desired maturity and strike. A little more complicated but still a model based IV.

In the past 5 or so years, a completely different concept has been discovered, called Model-Free Implied Volatility. The new VIX is a model-free IV and its calculation does not involve the Black Scholes formula at all. It is a completely different calculation (described on the CME web site). How/why does it work? Up to now the only derivation I had seen relied on some obscure passages in a 1998 paper by Emanuel Derman, which was not about IV per se at all (it was about variance swaps and their relation to hedging of a theoretical construct called a 'log contract'). The spec_list had a contest for a clear and straightfoward derivation of the formula, but I never gave out the prize because I was not happy with any of the entries. This new paper by Jiang and Tiang in the RFS (the most high powered of the academic finance journals) starts to clarify some of the mysteries behind model free IV.

Of course you cannot get something for nothing: the model free IV requires more inputs than the model based IV. The price of a single option is not enough to recover a model free IV, you need the prices of all options having the desired maturity. The more strikes available the better (theoretically an infinite number of strikes are required, but in practice there are enough strikes available on the exchange, both above and below the current price, to allow a very decent approximation).

The key result of Jiang/Tian is the following: the expected value of the return variance between now and the maturity date T is equal to the following expression involving the current price of all call options that expire at T:

2 * Integral_from_0_to Infinity (( C_K - max(0,F_0-K)) / K^2) dK

Jiang and Tian derive this expression and show that it holds under a wide variety of assumptions (including diffusion+jumps+stochastic volatility). C_K is the price of a call with strike K. F_0 is the current price of S&P futures. K is the strike price of the option, and the integration takes place with respect to K (that is why you need all (an infinite number!) of options).

The authors then discuss the truncation and discretization errors that you make when you don't have an infinite number of options prices available and show that they are manageable.

In the empirical part of the paper the authors look at CBOE prices of options on the S&P from June 1988 to December 1994. They compute three kinds of vol: the historical vol, the model based (BS) vol and the model free vol, to see how well they forecast the future vol. Their conclusions are:

  1. All three measures (taken separately) contain information about future vol
  2. Both model based and model free IV are greater than historical vol, which they attribute to a positive risk premium for stochastic vol
  3. The model free implied vol contains the most information about future vol (i.e. is the single best predictor), the model based comes next and realized vol comes last.

A very worthwhile paper for all option theorists to read. Speculative potential is limited since the market's own forecast of vol is shown to be a pretty good one.

Prof. Charles Pennington comments:

I took price data from Yahoo for calls on SPY expiring in November, taking the price to be the average of the bid and ask, and used the formula given below to calculate the variance, using numerical integration.

First, let's estimate. For a (1%)^2 mean-square move per trading day, one expects a variance on the order of 15*(1%)^2 for November options, which expire in something like 15 trading days (this is just an estimate), which would give 1.5*10^-3 for the variance and 3.8% for the root-mean-square.

The formula below though, using crude numerical integration, gives a result of 3.7*10^-3 for the variance and 6.1% for the root-mean-square. (I will send the spreadsheet that I used to calculate it to the Listmaster.) Annualized that would be north of 25%. (That makes me wonder about whether that factor of 2 in the formula is really supposed to be there.)

Additionally my calculation makes it seem that the integral does not converge nicely. With SPY trading at 119.80, the Yahoo data shows that the November calls with strike prices between 100 and 75 ALL trade at prices that are 20 cents north of their intrinsic value, and the integrand non-negligible all the way down to 70. I had to truncated it to zero below 70. Therefore I believe this formula is very sensitive to one's assumptions for these very low strikes (e.g. What option price is used for a 50 strike, when the lowest strike that trades is 70?). In physics we would have said that that was "unphysical", so I suppose I find it "unfinancial".

I would guess that the model-dependent formula, which can make do with just the heavily traded nearby strikes, would be more robust, even though this new formula is very elegant.

10/30/2005
Losing a Tail: A Momentum Study by Russell Sears

When you race, the only time you pace -- or maintain momentum -- is when you are going strictly for time. A rabbited race. Then you arrange the pace with the rabbit sacrificing himself for the others to have a fast time.

Clearly, the markets don't usually have such a privilege. Most of the time the strongest cannot find such sacrificial lambs, or orchestrate a string of them.

Rather than time, a race usually, is about competition. If you are confident in your strength, a good strategy is to hammer, ease up, hammer, ease up. It takes the wind out of the tail. (The runner feeding off your efforts, drafting and pacing.)

The mile splits add to this. You hammer and ease before the split but still have a fast split. The fast split and the relaxation will make them think you had to back-off, that you are near the end also, but when you hammer again, the element of surprise, and often confidence is tested.

The following test of months with four-day streaks either positive or negative seem to show this. I looked at calendar months since 1995 and found that investing the month after a positive streak of occurred did seem to be positive. Unfortunately, following this strategy for this for October did not work.

The returns are lognormals to be additive.

Months with streaks of 4, positives and negative streaks on SPX.

                          Both
Type Month         Pos    Pos      Neg    Neither
                  Only    Neg      Only
Count               51     29      26      23
Total Next Month  59.9%   30.9%  -21.2%   22.23%
Average            1.17    1.07%  -0.81%   0.97%

Stdev              3.51%   3.92%   5.37%   5.53%
Z                  2.39    1.47   (0.77)   0.84

The month in which the streak occurs does seem to have the ease of the pace.

Return During Mo. 142.5% 28.1%  -85.8%   13.7%

Return after streak before end month in total for Positive streaks 12.86% for 1013 days in 80 months or 0.01% per day

Return after streak before end month in total for Negatives streaks 86.35% for 677 days in 55 months or 0.13% per day

In short if the market is confident it seems to employ a racers strategy to beat the competition. Perhaps more testing around split markers/monthend dates can show new momentum or lack of momentum strategies.

I will leave it to those counting butterflies to count if certain markets have duped others into leading the pace for them. But as I recall momentum investors shot up all over the place as the dot.com bubble peaked.

10/30/2005
Bernanke's Models and Their Limits, by Jim Sogi

As Doc Rock has said, "The best model is just a guide."

Quantitative analysts take note. The apparent certainty of quantitative models can lead to erroneous interpretation and implementation of trading strategies based on the models. LTCM is the poster child of this pitfall.

Discretion and good judgment are still required in financial and other matters of human involvement and decision making due to its historical existence. The financial time series models that are robust enough to be financially meaningful do not give sufficient micro structural guidance for specific entries and exits. Models giving micro structural cues require infrastructure beyond the average retail participant.

Quantitative models answer the big question: up or down? When reduced to its basic element, financial analysis need answer only one question: up or down? In life there is only one big question: right or wrong? Recession or inflation? Questions of exactly when, how much are best left to discretion. Given a framework and direction, the human mind is quite sophisticated in deciphering discretionary questions of fine shaded complexities.

The big questions are often left unanswered, both in the markets and in life. Default is peril. Witness Libby, Ebbers, Koz, Fastow, LTCM. Loss of a moral compass leaves the ship adrift without a rudder despite the most precise quantitative models. Quantitative studies abrogation of the relationship between the ethical and moral judgments and the statistical is peril. A moral element must be factored into financial decisions as they impact human conditions. Good judgment is necessary for success in markets and life.

10/30/2005
National Hunger Care, a letter from Don Boudreaux to the Editor of The Boston Globe

Dear Editor:

Everyone - such as Sandra Heiler (Letters, Oct. 28) - clamoring for nationalized health care should do the following mental experiment.  Imagine having nationalized hunger care, in which government supplies groceries "free."  Anyone who's hungry is entitled to walk into a supermarket and take whatever food items he or she needs without having to pay a cashier.

Is it conceivable that such a system would not make food much more costly and its distribution more arbitrary?  Too many people will take too many groceries that, in fact, are more highly valued by others.  Inevitably, draconian rules will be imposed to govern access to "free" food - and wealthy Americans will begin traveling to Canada to buy groceries.

Sincerely, Donald J. Boudreaux

10/30/2005
The Fake Energy Shortage, by William Haynes

Hi all:

I believe that I have stumbled across an insight.

I've been wondering (ever since ex-astronaut Phil Chapman educated me on it, and we collaborated on a paper he presented at the recent IAF meeting in Vancouver) why we hear nothing about methane hydrate?

(For a quick explanation of why I'm wondering and what it is all about, Google "methane hydrate")

It seems, as Phil put it, that we have known deposits of methane hydrate that will fulfill world hydrocarbon energy needs at the present rate of consumption for about 400 years!

Now, given that the Canadians are about to bring in their first MH wells in the Canadian outback, why are we not hearing anything about all this?

Well, I believe that it reflects fundamental economic truths, the first of which is always the law of supply and demand.

With oil threatening to go to $70 a barrel, and relatively little new oil apparently expected to be discovered, and the Indian and Chinese economies growing at over 11% per annum, the existing oil reserves are threatening to skyrocket in value.

And we all know who owns those reserves, don't we?

UNLESS ... we were suddenly presented with a vast, alternate source of combustible material that is readily accessible and widely distributed under the Earth's oceans.

That will immediately reduce the value of those Russian, Saudi, Iraqi et al petroleum reserves.

Ultimately, petroleum should be used as feed stock for chemicals, plastics, etc. and never, ever burned as a fuel.

I recall that the Shah of Iran was once quoted as saying that the day would come when we greatly regretted burning petroleum as a fuel instead of reserving it for other uses.

That day is about to come, indeed!

If we tap the methane hydrate bounty, petroleum no longer "wasted" as a fuel, and hybrid autos going 50 to 60 miles per liquified methane gallon, a number of interesting outcomes can be anticipated.

Oil should drop back to a much lower price of say, $10 or $15 a barrel again, at least until there eventually is a real petroleum shortage.

Petroleum discovery investments will plunge, and survival by e.g., Halliburton will depend upon success in accessing, handling and marketing methane hydrate. Methane pipelines from offshore deposits to existing distribution systems built to handle oil will provide much cheaper access to effectively unlimited energy supplies.

The present world petroleum managers will go through very painful and challenging times, while those nations that have been depending upon oil revenues (Iraq, Iran, Saudi Arabia, Libya, Ecuador, Indonesia, and yes, to a lesser extent, the U.K. and Norway) will find themselves very suddenly bereft of their "welfare checks."

That will hit the Arab/Muslim and otherwise economically crippled states with very stark challenges.

I doubt that even the Saudi sheiks will find much loose change to send to al Quida.

All of this is hardly something those who are slurping up largess via traditional petro supplies would want bandied about.

Well, I'm bandying!

Some of you are far better equipped than I to extrapolate the possibilities.

But they are real.

And they will happen.

And soon!

Pamela: Just ponder all the books to be written about this ... beginning with one possibly titled "The End of OPEC, or where did all the Sheiks go?"

10/29/2005
Trade With Your Strengths, by Todd Colbeck

Some recent posts regarding change prompted me to post this. The Gallup Organization has studied world class performers in many professions to understand what makes them tick. Was it education? Was it experience? Was it family? No, no, and no. What makes world-class performers tick is talent! By the time we are in our teens we are all wired to have certain predominant talents or strengths. The secret to performance in Gallups studies of over two million people were they were in roles which matched their strengths. Organizations that use this knowledge when hiring new employees know the strengths of world class performers in that role and then hire people with the same strengths. Great, so how do you make money trading with this knowledge?

If we were to use a top-down approach, we would:

  1. Analyze the strengths of top traders.
  2. Look for consistent strength themes.
  3. If we have similar strengths develop similar trading styles. If not --
  4. Partner with or hire people with these strengths and create a mutually profitable trading relationship.

A bottom-up approach would be:

  1. Analyze our own strengths.
  2. Choose a trading style that meshes with our strengths.
  3. Proceed with caution.

For those of you interested I would be more than happy to collect a list of the strengths of traders on this list. Names are not necessary, just a list of your top five strengths and how you rank yourself as a trader. The book necessary for this analysis is " Now Discover Your Strengths" which is available at Amazon. It has a pin code inside the dust cover and the strength evaluation is online.

For more information.

This is not a new approach and there are other ways to measure strengths besides Gallup's. I use Gallup's approach since I attended their university as part of my MBA program.

10/28/2005
Query of the Day, from Victor Niederhoffer

A certain report on the level of consumer happiness seems to be inordinately initially bearish and negative for the administration. I query whether this is because of the incentives that these academics have to provide numbers that support their political predilections. I also query whether there is an incentive for such reports to be particularly glaringly and starkly interpreted at extremes so that the private subscribers might feel like this is sharp news that's guaranteed to give us an invaluable 15 minute edge. Also, whether a survey relating to consumer happiness is let's say 80% correlated with the moves of the stock market in some exponentially weighted average in the weeks preceding the telephonic survey. Of course this is just a query, and doubtless the academics and others who have written theses about the correlations with the stock market and other surveys and the economy x months in the future could clarify the situation, as they could with other privately financed surveys which might have similar circumstances were they not on a much higher plane of morality and non-monetary incentives than you and I.

10/28/2005
Numerology, by George Zachar

From this morning's GDP report:

Price Indexes             3Q     2Q     1Q
 annualized              2005   2005   2005
=============================================
                         --------------------
Gross domestic purchases  4.0%   3.3%   2.9%
 ex food and energy       2.2%   2.1%   3.0%
PCE price index           3.7%   3.3%   2.3%
 ex food and energy       1.3%   1.7%   2.4%

That bottom series is the one that monetary types fret about, and it looks just fine, so far.

And from the Depart of Professional Cynicism, a table extracted from this morning's Employment Cost Index release:

                   Sept.  June March
 Q/Q                2005  2005  2005

Private Industry
 Compensation       0.8%  0.6%  0.6%
  Wages & salaries  0.6%  0.6%  0.6%
  Benefits          1.3%  0.8%  1.1%
Government
 Compensation       1.1%  0.7%  1.0%
  Wages & salaries  0.7%  0.5%  0.8%
  Benefits          1.7%  1.2%  1.5%

Also, GDP is motoring along nicely as seen in this morning's report:

                           3Q     2Q
q/q annualized            2005   2005
=====================================
                          ------------
GDP                       3.8%   3.3%
Goods                     5.3%   5.0%
Services                  3.4%   1.5%

Yet this morning's Rasmussen consumer confidence release tells us:

Thirty-six percent (36%) of Americans believe the U.S. economy is in a recession. That's little changed from 37% a week ago, 37% a month ago, and 37% a year ago. In the immediate aftermath of Hurricane Katrina, the number who believed the economy was in a recession jumped to 40%.

It seems the doomsters have a consistent and substantial audience believing something that is demonstrably false.

10/28/2005
Near Panic, by Andrea Ravano

All sort of emotions are arising on stock and bond markets alike in Europe this morning. I start seeing investors with bulging eyes looking at their computer screens as if they were hypnotized. Fear starts to surface in their words. They sell sure the big one will rock the foundations of the international financial world. Those doing the selling are the same who were asking me what could be worth buying with the DJ Stoxx 50 at its peak a couple of weeks ago. I'm tempted to look for my cane in the closet...

Adi Schnytzer Responds:

Once I realised that I could not be a day trader but that simple buy and hold was no good for me either, I decided to learn patience and so now, if I'm in the market I say what the hell it's down today it'll be up tomorrow. If it's up I say is it time to sell yet? but I can never get this right so I must learn to fight regret! Recently I bought xlb at 27 and sold at 28 and felt stupid when they went to 29. OK I waited and bought again at 27. This time they got to 28 again and I said ha ha at 29 I sell so of couse from 28 down they went to 26 and now I'm even again and am still no wiser as to to when to sell! But I know they will see 32 again (that being the key word), I just don't know if it will take one month or ten years. But having learnt patience I will learn not to regret as well.

10/28/2005
Department of Sports Speculation, by Alston Mabry

I was wondering how turnovers were relating to win/loss records in the NFL so far this season. You would expect some symmetry in the numbers, because for each win there must be a loss, and every time one team loses the ball, another team gets it. But this seemed unusually nice:

I got the stats for fumbles and interceptions for each team and calculated a net turnover number, (Opposing fumbles recovered + interceptions of Opposing passes) - (fumbles lost + interceptions lost). Then I rank-ordered the teams by winning % and got the average net turnover number for each quartile:

Top quartile: +6.875
2nd quartile: +1.750
3rd quartile: -1.750
4th quartile: -6.875

10/28/2005
Dept of Barbecue, from David Higgs

The outside temperature has dropped below 60 here which beats the 107s we experienced all summer when the market couldn't outstrip July's highs and it has been downhill ever since. So the grill got rusty. But the good news is these low temperatures finally bring out the desire to stock up the old below-grade barbecue pit (a mix of the hard woods is never a bad idea, whether it be apple, mesquite, oak (my favorite) hickory or pecan). And once you think you know your woods, along comes a real expert. So now you can achieve that special diversification of hard wood you always wanted to get you on your way to some fabulous smoke induced, palate pleasing sensations for all occasions.

10/28/2005
An Earnings Analysis, by Victor Niederhoffer

The following table is from a daily summary of earnings reports of S&P 500 companies that Bloomberg publishes each day.

POSITIVE SURPRISES:    218/331 = 65.9%
% of Surprises:                        EPS Differences (Actual-Estimate):
     (0% to 10%):     154             (1 cent):                     58
    (10% to 20%):      33             (2 cents):                    31
    (20% to 30%):      11             (3 to 4 cents):               52
    (30% to 40%):      11             (5 to 9 cents):               36
    (40% to 50%):       3             (10 to 19 cents):             25
0% SURPRISES:           44/331 = 13.3%

NEGATIVE SURPRISES:     69/331 = 20.8%
% of Surprises:                        EPS Differences (Actual-Estimate):
      (-10% to 0%):    47             (-1 cent):                    15
    (-20% to -10%):    12             (-2 cents):                   14
    (-30% to -20%):     4             (-3 to -4 cents):             10
    (-40% to -30%):     1             (-5 to -9 cents):             13
    (-50% to -40%):     0             (-10 to -19 cents):            8
  (less than -50%):     5             (-20 to -49 cents):            5
        % chg n/a       0             (-50 cents or less):           4

Source: Bloomberg LP

One of the amazing things each quarter is to see the market go down overnight when a company misses its earnings estimates or gives a warning, and every commentator says, "Stocks down on earnings shortfall in this one or that one." It's as if the public really expects a 1,000% batting average for companies. Yet earnings of the companies in the S&P 500 are up about 18% this quarter, 80% showed increases, and two-thirds beat estimates. Eight-nine beat estimates by 1 or 2 cents a share, and 29 were below estimates by 1 or 2 cents.

I do admire the ability of companies to eke out those accruals on the positive side versus their inability to do so on the negative side to an inordinate degree. Along these lines note that for companies reporting more than 10 cents above estimates, about 1.5 times as many beat the estimate as fell below (25 who beat versus 17 that fell). But among the companies that just beat or just missed earnings by 1 to 4 cents, the ratio of companies beating to losing was 3.6 to 1 (141 beating versus 39 that missed).

I can only express amazement at such a nonrandom and asymmetric distribution. Along these lines, various articles have come down the pike that show earnings statements this year are very much better than ever before. Actual GAAP earnings are apparently only 15% worse than pro forma earnings this year, whereas in previous years the GAAP earnings have been about 40 % worse. And yet, the animal spirits, the ability to guide propitiously and to squeeze would not seem to be dead. What kind of world would it be if it were dead.

Perhaps, in view of everything, our readers will excuse me for doing something unmentionable and truly uncharacteristic. What I'd like to do is to pat myself on the back. You see, about 35 years ago, in an article with Pat Regan, I analyzed the influence of earnings surprises and earnings changes on stock prices. The results are on p. 272 of my 1997 book, "The Education of a Speculator". The key step that cleared the way for everything else was to measure the movements in earnings as earnings change per dollar of price rather than percentage earnings change. For example, if a company is at $10 and it increases its earnings to $1.10 from $1.00 a share, that's a 1-cent increase per dollar of price. This paves the way for actually using earnings declines and earnings changes from a base close to plus or minus zero, instead of throwing out these observations as do 95% of the retrospective studies of the value practitioners and the academics of this persuasion. It also opens up some very meaningful regressions that separate out the influence of actual magnitude of change and surprise on future returns.

Estimated EPS for the S&P 500 for 2005 is $77 a share, which corresponds to a 6.5% yield. With a 6% increase predicted for 2006, that would make a 6.85% estimated earnings yield for next year, compared with a 4.54% yield on the 10-year Treasury note. That 2.31% differential will and has figured more prominently in the decisions of investors than the individual woes or triumphs of this or that shooting star. A detailed analysis of the predictive properties of earnings yields versus 10-year yields is contained in the joint continued work of Vic, Collab and the artful simulator Tom Downing.

I wish to praise Bloomberg for providing this sophisticated, analytical and practical summary. The founder, now a politician, once complimented me for continuing to be a customer despite my grievances against certain parties there, and the company's ability to come up with a detailed Baedeker on things like earnings, corporate actions and returns of the individual aspects of indexes (with retrospection) between any two dates prevents me from cutting off my nose to spite my face. One sometimes must live to fight another day.

10/28/2005
Hubris, by James Sogi

An essential ingredient of human nature is the belief in the ability to survive.

Human self-perception of ability diverges from the reality. The least able often have think themselves the most superior. The divergence is least in those with the highest ability.

The degrees of divergence changes in cycles. The Greeks and Shakespeare considered this divergence to be hubris. Hubris is a flaw that can lead to downfall. The danger of hubris is it that leads to attempts that are beyond the ability to perform or to inappropriate acts.

The other side of the coin of hubris is man's inability to see his own faults and limitations. Few see their own faults. It is nearly impossible for all but the enlightened few to do so for reasons that only a psychologist could explain. Many mighty titans of industry, finance and politics have taken the big fall in recent memory and news brews tomorrow. A few wins, a few up months can lead to blinding hubris in the market.

Humility alone is not the cure, but it is a start. The lonely and empty road to self-introspection and enlightenment is long and hard. Ah, to be able to see and understand!

10/27/2005
George Zachar on Benny Bernanke

Ben Bernanke's appointment to succeed Sir Alan has afforded the markets yet another inkblot test. The politically-oriented deduced weakness on the part of the president in the circumstances, and timing of the announcement.

The economics community, from Laffer and Kudlow on the right, to Brad DeLong on the left, is unanimous in its praise. No doubt the elevation of a nearly pure academic to the pinnacle of monetary policy goes a long way towards validating their field.

The Street, me included, recalled Bernanke's invocation of the "money helicopter" metaphor, and his aggressive anti-deflation rhetoric of 2003. The professional cynics, like the elegant James Grant, used the announcement as a news peg to review all that is wrong with discretionary fiat money schemes.

Mr. E. has had the benefit of having spent time with Dr. Bernanke, and reminds us all that we don't know what we don't know. Taking the recent press puff pieces at face value, Bernanke's was a "boy genius" ascent from small town kosher household to Harvard/MIT/Stanford/Princeton and now, on to the great stage of global finance. We can all read Bernanke's ample paper trail, and draw our own conclusions about what it portends for interest rate policy.

What we cannot know is how he will fit into Washington's political culture - an environment Greenspan archly observed revels in public executions. A New Jersey school board and ivy league faculty politics is scant preparation for the 24/7/365 shark tank of Washington's permanent government. Greenspan had a lengthy apprenticeship in DC before assuming the stage. Bernanke, from a political angle, is relatively untested.

I watched Bernanke's CEA hearing testimony, and he was almost comically obsequious and deferential toward the poobahs grilling him. It was uncomfortable watching a very bright guy saying things you know he thought were idiotic, just so the senator from where ever wouldn't have an excuse to be difficult.

In addition to all the economic and financial unknowns, we must take into account the unknown duration of Bernanke's upcoming honeymoon in Washington. It would be naive to assume the knives won't be out for him. 2006 will mark not only the House/Senate elections, but also the kick-off of the 2008 Presidential election cycle. It is easy to spin scenarios where a failure at the Fed can be spun to work in favor of one faction or another.

Continued discussion on Benny Bernanke

10/27/2005
With cane in hand... , from John Lamberg

...I stood before the bond market and paid the price

While the captain of the USS Minnow surveyed the waves:

"The weather started getting rough, the tiny ship was tossed."

Looked at the radar screen with the following verse playing in his head:

"If not for the courage of the fearless crew, The Minnow would be lost."

Decided against it and wrote the following message on a piece of paper, placed it in a bottle, and offered it up:

Capitulate before the Minnow capsizes.

Then went back to swabbing the deck.

10/27/2005
A Love Affair with Uncertainty, by Tom Ryan

I love uncertainty. Science is always uncertain. We have uncertainty with our measurements (precision), and uncertainty with our estimates/models (accuracy). Trading is similarly always uncertain. Without uncertainty we would not be able to make profits. To me the world is one big dispute -- I see it on my trading screen every minute of the trading day. Without the dispute there would be no profit because there would be no one on the other side from me when I trade. Without profitable dispute there would be no incentive, no desire to innovate. I think dispute is a darn good thing, as it keeps us all on our toes and thinking and studying trying to better ourselves and the wheels of innovation greased and moving. Its when I hear people say that something is not in dispute when I start to worry that we are headed for a surprise or two. I have learned from the trader school of hard knocks that placing a trade in html with bold and caps does not ensure a profitable trade. But then again I don't know anything with certainty. Maybe my experience suffers from the small sample (accuracy) problem.

10/27/2005
Victor Niederhoffer reviews 'Just What I Said' by Caroline Baum

Every now and then you read a book like this that makes you want to stand up and cheer, and tell all your friends that this is the real McCoy, that Emerson or Emily Dickinson or Samuel Johnson is alive. That's the feeling I had while reading "Just What I Said.". To see what I mean, consider this. The middle-of-the-road, mediocre, eponymous tennis player and economist Robert Samuelson says in a sap-filled send-up to his kids: "You've got to care more about the election, because it goes to the heart of who we are as a nation. The greatness of the United States is not McDonald's or Microsoft. It's our basic beliefs on how we should govern ourselves."

From long experience reading her columns I shudder when she quotes someone like this, especially the fake Dr. and poseur at the head of the Fed. She never lets them off easily though, and writes, " The greatness of the US, Mr. Samuelson, is precisely McDonald's and Microsoft. They are the product of how we govern ourselves. They are symbols of liberty and democracy. If you tell that to your kids, they actually might come around. These companies identify a consumer need, conceive a product or service to satisfy it, and compete with other producers to deliver the best quality at the lowest price."

My goodness, she sounds like... one of my favorite personages.

The book is replete with poetic and poignant ways of looking at such important things as the yield curve, the Fed influence, the doomsdayist take on the stock market, first principles of economics, bureaucratic snafus in business and government and homely analogies of the kind that you'd expect a sagacious all-knowing columnist to make. Some of my favorites in this regard are the lessons she learns from birds at her bird feeder about crowding and mobbing, the chapter that could have been entitled "I, Mop" about the nitty-gritty of what a mop should do, the unhelpful help desks of the technology firms (never sell her a bad product if you don't want to be pantsed in front of the most knowing audience in the world).

One of my favorite examples of her insights is her use of the word McGuffin in order to ridicule "Dr." Greenspan's attempts to make Congress think he's much smarter than they by trotting out one new indicator after another that one of his boys has developed and or researched for him recently.

The list of the great things she illuminates and the insights that you can get from this book is endless. Its a masterpiece that belongs in everyone's library. I have bought dozens of copies for my friends, and plan to buy more.

10/27/2005
Revised R Code, from Steve Wisdom

Verbose code, such as this sample Doc Castaldo passes along from the University of Illinois, causes me psychic pain. "Omit needless words," said Strunk & White.

Below is a re-worked version, roughly half as long, with my notes as to why I excised the commented-out bits :

# Simple version of the Granger-Newbold spurious regression simulation
# Revised & streamlined, 26 Oct 05

n<-100; u<- rnorm(n); v<- rnorm(n)

# y<-rep(0,n)
# x<-rep(0,n)
# for(i in 2:n){
# x[i] <- x[i-1] + u[i]
# y[i] <- y[i-1] + v[i]
# }
# .. replace with :
x<- cumsum(u); y<- cumsum(v)

par(mfrow=c(1,2))

# t <- 1:n
# plot(c(t,t),c(x,y),type="n")
# lines(t,x,col="red")
# lines(t,y,col="blue")
# .. replace with :
matplot(cbind(x,y),type='l',lty=1,col=c('red','blue'))

plot(x,y); fit<- lm(y~x); abline(fit)
title(paste("t=",format(round(summary(fit)$coef["x","t value"],2))))

10/27/2005
Chaos in Asia Tonight, from Mr. E.

When Asia read that General Motors was subpoenaed last night by the SEC over various accounting issues with Delphi, the re-translations into various languages had GM going into Chapter 11. While this was denied, nonetheless 2-year Treasuries rose 13/32s at one point.

Credit issues have a way of shaking up the world from time to time.

10/26/2005
Dangerous Curves Ahead, from George Zachar

Flattening curve = slowing economy signal, doom.
Inverted curve = negative carry, doom.
Steepening curve = market fears inflation, doom.

10/26/2005
Buzzword Bingo, from Steve Wisdom

This is the first sentence of JDSU's Letter to Shareholders, sent out with the annual report:

Dear Stockholder,
Fiscal 2005 was a year of heavy-lifting as we embarked on major activities to reengineer our business model to focus on those products and markets that make best use of our core competencies to meet our growth and profitability targets.

10/26/2005
Briefly Speaking, by Victor Niederhoffer

  1. For more than the 16th time in the last year the S&P 500 moved from above 1200 to below, or the reverse, on a daily close basis. Today's move was particularly gravitational as the market moved above and below the 1200 mark six times during the course of the day. Of course such frequent reversals lure the easily deceived by first level deception into great difficulties, so be even more careful than usual. As Louis L'Amour reiterates throughout the Sackett series: "Wherever and whenever the ambush is most likely, be careful. But be doubly careful when the ambush is not expected."
  2. Today was a time for gravitational attraction in theS&P but not in many other markets. Oil futures moved up sharply, with December contracts on the NYMEX rising $1.93 to $62.25 by 3 p.m. The dollar also moved sharply away from its base level over the last few weeks of $1.20 to $1.21. Since all markets are connected, albeit the connections are always changing, one speculates as to which other markets are ready to move awayfrom home.
  3. The yield curve rises in a steady slope from 3.83% on three-month Treasury bills to 4.73% for 30-year Treasury bonds.. The same upward tilt as usual, but now doomsdayists cannot say that the slope of the yield curve is the key to imminent worldwide collapse -- so now it is something else. Perhaps the misrepresentations, wholesale corruption, liquidation of positions and spillover effects of the big commodity brokerage, thus proving the frustration/aggression theory of Dollard, Miller et al., is alive and well in the hearts of stock market players as well as the Skinner box.
  4. It is hard to measure negative sentiment and to figure out what levels or changes in level are predictive. However, if articles that I have read attributing yesterday's 0.2% decline in theS&P and 0.1% decline in the Dow are typical, then there is gloom and doom all over. Consumer confidence is at an all-time low; Texas Instruments and Amazon both reported disappointing profits; the S&P 500's earnings growth is expected to drop to 6% from 11% next year; higher energy prices are putting consumers under a lot of pressure going into the holiday season. There's a heavy overload of negative sentiment overhanging the market, the bears say; yesterday's rise was just a reflex rally that will be stalled by the same. It has been a month since the market has managed to rise for two consecutive days. The market's terrible state is shown by the fact that we are on target, according to the doomsdayists, for the worst October in recent times and the worst monthly performance since July 2004. Such were just some of the bearish factors cited by my favorite wire service (the Collab's former employer). This was on a seven point drop in the Dow; just imagine what would have been said if the average had declined its normal 50 points. Such is the chronic pessimism from which the phoenix soars.

10/26/2005
Non-Predictive Studies Minister Charles Pennington Announces a Contest!

Looking back over the period from 1999 to now, with the benefit of hindsight, do you wish that you had done any of the following four options A, B, C, or D?

  1. BUY CALLS. On the last day of each month, buy an at-the-money call on every individual stock in the S&P index, a call that expires two calendar months away (typically about 50 or so days). Buy at market, paying the ask price. Hold to expiration.
  2. BUY PUTS. On the last day of each month, buy an at-the-money put on every individual stock in the S&P index, a put that expires two calendar months away (typically about 50 or so days). Buy at market, paying the ask price. Hold to expiration.
  3. SELL CALLS. On the last day of each month, sell (write) an at-the-money call on every individual stock in the S&P index, a call that expires two calendar months away (typically about 50 or so days). Sell at market, getting the bid price. Hold to expiration.
  4. SELL PUTS. On the last day of each month, sell an at-the-money put on every individual stock in the S&P index, a put that expires two calendar months away (typically about 50 or so days). Sell at market, getting the bid price. Hold to expiration.

There is an answer to this question! The Ministry of Non-Predictive Studies has data.

Kindly submit your answers following the Procrustean formatting rules given below:

Please give numbers that best complete the following 4 statements:

  1. The calls, which on average were bought for $2.195, were worth $_______________ on average when they expired, yielding an average profit of $______________.
  2. The puts, which on average were bought for $2.190, were worth $_________________ on average when they expired, yielding an average profit of $_________________.
  3. The calls, which on average were sold for $1.961, were worth $_____________ on average when they expired, yielding an average profit of $______________________.
  4. The puts, which on average were sold for $1.953, were worth $______________ on average when they expired, yielding an average profit of $____________________.

THERE IS NO PENALTY FOR INCORRECT ANSWERS, and GUESSING IS PERMITTED!
Answers will be judged based on both how accurate they are and how precise/detailed/quantitative they are. The judging will be arbitrary, capricious, and final, and the Chair has hinted that some cash prize might be in order.

Peter Earle Takes a Stab at it:

  1. The calls, which on average were bought for $2.195, were worth $4.49 on average when they expired, yielding an average profit of $229.50/contract.
  2. The puts, which on average were bought for $2.190, were worth $0.06 on average when they expired, yielding an average loss of -$213.00/contract.
  3. The calls, which on average were sold for $1.961, were worth $0.14 on average when they expired, yielding an average loss of -$181.30/contract.
  4. The puts, which on average were sold for $1.953, were worth $0.08 on average when they expired, yielding an average profit of $188.10/contract.

Mr. Ckin replies:

Going out on a limb with an answer...

Since this scenario seems to indicate a new holding period every two months, I presume that expiration of in-the-money options would be settled in cash, instead of in shares.  A scan of the VIX index shows that the bulk of the time from 1999 through early 2003 at levels between 20 and 30 implied volatility on index options, whereas the S&P 500 index showed an average (absolute value) annual percentage change of 15.4%.

This would tilt my thinking towards being an option seller.  Since we are using hindsight, we see that the major discreet market "shocks" were skewed toward share price declines for the broad markets.  Thus my instinct is to select the short calls choice,  option C.

Since we are restricting our choices to as-the-money options, our positions will have just a moderate level of gamma (meaning that delta wouldn't change all that much with a moderate move in equity prices), but a good amount of theta (lots of time decay, especially in the early years of the study.)

Additionally, the option seller would benefit from the investment of premiums in a money market vehicle, which would have added a couple of hundred basis points of performance per year during the study.

As for the expected return, that answer cannot be calculated without a determination of the level of risk to be incurred by the investor.  I am not familiar with all of the rules for naked call margins; I understand they vary a bit from broker to broker.  I believe that you can get effective leverage of any arbitrary amount up to 3 or 4 to 1, though.  As this strategy would appear to be successful in the early years, the cash position would build up nicely, putting the investor at risk for a big drawdown in 2003 if the position sizes grow in proportion to the equity.

Also interesting to study whether or not short at-the-money straddles would have been more lucrative.  Also, selling one month options would seem to have had a more favorable theta with a negligible increase in risk.

Rob Fotheringham adds:

Buying options and holding to maturity will always produce a loss.  As the S&P was several hundred points higher in 1999 than it is today, I would expect selling calls to have been more profitable, on average, than selling puts.  I’d guess you could sell such a call for about $20 (on the S&P).

Mark Spitznagel tries:

Over period, vol component net lower.
a-d linear to vol. so c-d clearly best.
c = short 1 atm strddle + short 100 shares.
d = short 1 atm strddle + long 100 shares.
so only diff is mean return on 100 shares for each stock.

We are not S&P weighting, so the question is do we prefer overweight in small cap over period? Which makes me think D is probably best, (although I just worked it out on a napkin)

10/26/2005
On the Melbourne Cup

Just to mention that the Melbourne Cup Horse Race is on in Australia next Tuesday, and as mentioned in an article by Victor the Aussie Equity market was up again last year on the day, which makes it 17 out of 20 years. Fingers crossed for this time

10/26/2005
Inordinate Returns and the Australian Equity Index, by Andrew McCauley

While testing to see whether Tabcorp (TAH) and some other listed Australian wagering companies had an inclination to rally into Australia's most famous racing day, The Melbourne Cup, I stumbled across some price data with respect to the S&P ASX 200 that is worth highlighting.

Looking at all the 4 Day % Returns Pre & Including The 1st Tuesday of November (Melbourne Cup Day) from 1992 onwards (sample 13, daily data for S&P ASX 200 only available from 1992), I found that the S&P ASX 200 had a tendency to produce inordinate gains with an average move of 1.86%. This return is substantially more than the average 4 day rolling market drift of 0.15%. It should also be noted that 12 out of the 13 sample periods were positive.

Intuitively I think this inordinate gain occurs due to perceived investor relief that October is over, 1st day and 1st week of the month positive bias, November through to the end of January marking the beginning of an historically positive period and thin markets around Melbourne Cup Day. However my intuition needs to be tested. Neglecting the ever changing moods of the market it would appear that a short term upward bias is probable.

S&P ASX 200
4 Day % Returns Pre & Including The 1st Tues of Nov (Melbourne Cup Day)
28th Oct 1992 - 26th Oct 2005

Average - 4 Day % Return Pre & Including The 1st Tues of Nov (Melbourne Cup Day)       1.86%
Average - 4 Day Rolling % Return 28th Oct 1992 - 26th Oct 2005 (4 Day Drift)     0.15%
Differential     1.72%

Standard Deviation     1.35%
Maximum     4.44%
Median     1.53%
Minimum     -0.23%

# Positive - 4 Day % Returns Pre & Including The 1st Tues of Nov (Melbourne Cup Day)       12
# Unchanged - 4 Day % Returns Pre & Including The 1st Tues of Nov (Melbourne Cup Day)       0
# Negative - 4 Day % Returns Pre & Including The 1st Tues of Nov (Melbourne Cup Day)       1

10/26/2005
An Update from the Dept. of Asian Studies, by Shui Kage

The normal wage structure of Japanese companies including mine are that of a 12 times monthly salary plus bonus twice a year (July summer bonus and December winter bonus). Each bonus is approximately 2 - 2.5 times the monthly salary. Unlike Western companies, Japanese companies give bonuses no matter how they perform, except the amount fluctuates a little in accordance to this.

The 2005 winter bonuses for major companies have just been announced and this winter's is an average 860,3577 yen,  (US$7,509) - up 5.08% compared with a year ago. This means three years of consecutive increases, with the biggest increases in the metal industry (average US$8,695, a 35% increase from last year) and the motor industry (US$8,782, a 2.5% increase). The non-manufacturing sector is down 0.28%, to US$7,260.

Now my observations start.

  1. When the Japanese economy is doing well usually the yen goes as the end of the fiscal year in February approaches, like a scoring system or handicap system.
  2. The opposite is also true: The yen usually goes lower toward the end of the year when the economy is depressed.
  3. This year's major money-earner is Japanese manufacturing, which makes money selling abroad, not to the domestic markets; hence, plenty of US$ are piled up among these companies waiting for exchanging into yen.
  4. Nikkei has been up most of year 2005 and yet the yen is down -- i.e., . there is strong divergence.

My conclusion: The yen is bullish, Nikkei is bearish (for the next few months). Any objections or different observation would be highly appreciated.

10/26/2005
London Underground and Magic Numbers, From Shui Kage

I'm not sure if people recall when I mentioned world pricing and magic numbers. I have repeated some calculations, this time including Britain.

Underground ride:
150 yen in Japan
$2 in the US
£2 in England

Next year they will be:
150 yen  in Japan
$2 in the US
£3 in England

Britain is always unique, but this does not end here. In US dollars the underground short rides will become $1.56 in Japan, $2 in the US but $5.34 in England! $5.34 is a heck of a lot of money for one short underground ride. Especially on such old trains.
for people yet to try London underground, I guarantee, it is not like an oriental express type of train. The London Underground must have considered the average income of commuters before coming up with that sky rocket £3 ride. I suspect, £3 for a British is like the feel of $3 for American, 300 yen for the Japanese or 3 euro for Europeans.

So the question becomes How does Britain manage, (or manipulate), to keep its currency at such a high value over other currencies? This is a question I have been asking since the day I landed in Britain back in 1988 for high school and university education. It is not that the manufacturing industry so strong? It is questionable that the service industry so strong? I don't see many of the US scale of brands, coke or McDonalds, equivalent in the UK. Their educational industry I believe is one of the best in the world but that does not earn so much. Is it the trade surplus? I don't think so. It seems Britain is importing more than exporting. Is it the British central bank? In 1992 they lost against George Soros.

With all these reasons, I wonder, how does Britain maintain its currency at such strong buying power over other currencies? If there is no reason, why are speculators not attacking?

I love to receive my salary in British Pounds.

10/26/2005
Is the Weather Changing? from Kim Zussman

Satellite imaging of the arctic ice shows large decline in area (there is even a nice plot with a trend-line). Of course there is debate whether current global warming signifies a trend or is noise consistent with long-term stability. However measurements of greenhouse gasses show increasing concentrations.

This site and this site record historical global temperature data. Celsius temp is reported monthly and annually, (with various caveats listed on the site).

Laurence Glazier adds:

I would be cautious about temperature record sources from British academia, where no-one who questioned the global warming hypothesis would keep their job.

Some years ago I did manage to download from the Net some hundreds of years of temperature data (the source is no longer available to us plebs) - and charted it in Access. There seemed to be a sixty year cycle and we were just retreating from the peak of the 30 year warming. I am sure I can find this file if it is useful.

Now this most recent cyclical warming is higher than the previous few though it would be jumping the gun to say that we have moved to a trend. I have no doubt that come January we will be told 2005 was the warmest year ever, but these annual announcements recall the old Soviet record harvests, and the fact is we have had two coldish summers and winters despite reports to the contrary (this summer I am not even sure we got above 90 degrees).

10/26/2005
Jason Ruspini on Round Numbers

I had developed a theory of price gravitation a couple of years ago, but later abandoned it because it couldn't be falsified. (More importantly, it didn't seem to make money, although perhaps just a bit more cultivation/time was needed.) The theory grew out of the anecdotal tendency of prices to gravitate to option strikes, particularly high open-interest strikes during expiration.  Your recent posts reminded me of this, especially where you noted the exception in rates, since their gravitation would be determined by the bond strikes.  I have not examined recent open interest levels to see if it corroborates my statements here, but I was compelled to write you and send my regards.

10/26/2005
Food for Thought, from Vincent Fulco

I happened to attend a NYC meeting last night of QWAFAFEW. One of the presenters, Brooke Allen of MANE Fund Management (a stat arb shop) addressed the issue of strategy survivability. He started off by saying that what happens to the person/entity on the other side of the trade is important to understand.

He hypothesizes that those strategies which, a) do something for someone, i.e. adding market liquidity, will recover from hard times and persist whilst those strategies which, b) do something to someone else; think index arb front running or married puts a few years back, will go away due to being found out or being legislated out of existence.  If the strategy is doing something to someone, how long till they figure it out and stop putting up with it?

An important question to ask a HFM would be is the track record based on doing something to someone or for someone?

Other questions asked in the meeting announcement bulletin which were not answered completely for lack of time included:

  1. What makes a business or strategy profitable when it is profitable?
  2. What makes a business or strategy unprofitable when it is unprofitable?
  3. Who benefits during good times?
  4. Who benefits during bad times?
  5. Who is helped and who is hurt during both good and bad times?
  6. Is the world better off if this business or strategy succeeds, or is the world better off if it fails?

10/26/2005
Mr. Ckin comments on the Council of Economic Advisers

As is described on the CEA page of the President's website:

"Ben S. Bernanke is Chairman of the Council of Economic Advisers (CEA). Two positions on the council are currently vacant. The CEA was established by the Employment Act of 1946 to provide the President with objective economic analysis and advice on the development and implementation of a wide range of domestic and international economic policy issues.  The CEA includes three members who are appointed by the President, by and with the advice and consent of the Senate."

Since it seems unlikely that any economists will be nominated and approved anytime soon, it seems a safe bet that with Bernanke being elevated, there is no in-house source of economic guidance available to the president.  I shared this sentiment with a list-member, who intimated that the CEA is more of a jawboning-policy tool where favorable political appointees may be deposited.  Nevertheless, it calls into question whether or not  any economic initiatives that may interest the president would go forward "rudderless," if at all.

Perhaps this is symptomatic of a broader problem, in which the president is having substantial difficulty in attracting competent (and clean) employees to join his cabinet.

10/25/2005
On Round Numbers, by Victor Niederhoffer

It is interesting to contemplate the many round numbers broken with what would seem to be inordinate frequency on almost a daily basis these days. For example, the actively traded 150 billion a day of trading volume S&P 500 futures has now broken on a daily close basis from below to above the round number on 8 separate occasions, (and now below at the open) in the last year, twice in the last week, corn price has broken below $2 a bushel, and oil flirts above and below $60 a barrel almost every day. The one thing missing from the puzzle is some stickiness or attraction of fixed income yields to a 4.5% 10 year yield (not 4.4%), and a Treasury bill yield of 4.0 ( now 3.95%). I started out my stock market studies at the University of Chicago by counting every time a common stock broke above 10 or 100 and calculating subsequent returns. They were enormous, but the statistical treatment of the results was confounded by the many clustering of such events in years like 1935 or the '50s (and now the '80s) when stocks were going through the roof.

It was natural at the time to conclude that there were limit orders that clustered at the round and when these acted as barriers. When they were broken, batten the hatches if you're on the other side. But I quickly learned from study of the futures markets that these rounds tended to be broken over and over again as if an all seeing force, which I have subsequently labeled the market mistress in honor of a certain fixed income columnist (who has written an excellent book on the forces that affect fixed income that I will review soon), liked to run the stops and limit orders that slow moving members of the public place at such levels. I then changed my mantra to "a round never holds" and made some good money by following it.  But I often trade based on it, by allowing myself to take a little bit less than the round knowing that everyone else is waiting for the breakthrough to occur and a stampede will develop. This seemed to have merit also.

I was never sure whether such profits were an example of Tom Wiswell's rule, "It's better to have a system than no system, even if its a bad system."  Yes. the tendency to do the wrong thing is so ingrained that I agree with Wiswell's proverb, one of some 10,000 he authored (and which we memorialize  for our firm in the 20 years he graced our office with his weekly checker lessons.

My views on the matter have gone through another permutation. I believe that the tendency to be attracted to the round is an example of the law of universal gravitation. One market will be attracted to levels of price or another market according to the weight of the public's current or prospective inclination to provide energy to the market at these levels, and inversely to the square of the distance between them (or some such).

I now believe the situation vis a vis round numbers at a practical level resembles more the death throes of many animals as they writhe about. But it's most similar like the possum's dance, as often the seeming passivity and lack of movement to new space, is part of a deception so that it can escape when the prey's guard is open.

The movements up and down now with my favorite ratio of the running absolute deviation for a week relative to the absolute deviation for a day, running at unprecedented low levels seems to me part of such a deception now, and I am positioning myself accordingly.

10/25/2005
Allen Gillespie on Palindromic Symbols

Are stocks with Palindromic symbols different from the rest?  It would appear that a few are commodity and cyclically related. DD , GG, AA, BAB, MAM and others back from, at, or near death's door. XRX , EE, HH, PAP, (in the old days), and of course ENE, while others are new, GOOG, which suggests this may be worth testing.

10/25/2005
The Professor of Non-Predictive Studies comments on the GTI

The Chair has called my attention to, and asked me to comment on the website gtindex.com, authored by prominent Spec-Lister Mr. Dick Sears, and the site's recent finding that:

"One day up, one day down, the next day up. That's how the ice breaks up, that's how a rally starts. All we need are good earnings reports."

First of all, the website is not to be missed.  It has great data on the historical performance of the tech-stock recommendations from George Gilder's newsletter.  Mr. Sears actually turns Mr. Gilder's historical recommendations into a survivorship bias-free index.  He documents the index's rise and harrowing fall, in which it lost as much as 95% of its peak value, as well as its subsequent recovery of about 300% from the lows, which still couldn't make the victim whole. There's also a lot of amusing stuff on Mr. Sears' other interests.

Now, about the "One day up.." finding.  I think Mr. Sears is contemplating a down market, which then displays this up/down/up pattern, so I tested the following pattern for the S&P futures, going back to 1996:

--Today is up
--Yesterday was down
--Two days ago was up
--The 30-day return ending 3 days ago was down at least 50 S&P points
--Results? 48 trades, some of them overlapping.

Here are the returns, (measured in S&P futures points), going out 1, 5, 10, 20, 30, and 50 trading days:

 1  day:    avg 2.9    stdev 19.8    t-score 1.0
 5 days:    avg -7.5   stdev 40.8    t-score -1.3
10 days:    avg -5.9   stdev 50.3    t-score -0.8
20 days:    avg 3.6    stdev 65.3    t-score 0.4
30 days:    avg 17.2   stdev 86.8    t-score 1.4
50 days:    avg 8.8    stdev 89.6    t-score 1.0

So this interpretation of Mr. Sears' pattern does have some positive expectation going out a couple of months, though it's not inconsistent with the possibility that it resulted from chance alone.

It would be interesting to hear the theory behind the prediction.  My specific implementation of the idea may not have been what was intended.  For example, perhaps the 50 point decline was not envisioned, and/or perhaps the up/down/up pattern needs some magnitude thresholds.

In any case, check out the gtindex.com website for some original work and ideas, and to share a few laughs.

10/25/2005
Low N of Long Term Boys, by Kim Zussman

Somehow still interested in the long-term, I turned to Professor Shiller's site. It contains monthly data on "S&P composite" from 1871-present, including price, dividends, real price, and real dividends (adjusted for CPI). Using this longer data set (veracity unproved but ostensibly well scrutinized), looked at return patterns.

Especially in the earlier years dividends were a big part of returns. These were added in
ret=(this yrs close+div)/last yrs close], and annual returns including dividends were calculated Dec-Dec for 1871-2004:

Nominal annual return:
average 1.106 (10.56%)
sdev 0.181
count 133 (yrs)
average 1871-1997 1.1081
average 1982-1997 1.1801

The returns 1871-1997 were checked against Siegel's "Stocks for the Long Run", and appeared close enough (his were 10.7% and 17.4% respectively).

Looking at nest year's return if this year's was negative: average 1.113556878 (11.4%) sdev 0.216101434 count 37 Notice (like Dow post previously), annual returns were higher if last year was down.

And next year's return if the cumulative return of the past 5-yr was negative (product of rolling 5-year annual ret less than 1): average 1.202106691 (20.2%) sdev 0.19628682 count 12 If prior 5-year cumulative is down, next year is quite a bit higher.

Turned next to real returns (adjusted for inflation), in that investor behavior might relate not only to prior stock movements but also standard of living:

Annual real return 1871-2004:
avg 1.066 (6.6%)
sdev 0.169
count 132

If last year's real return was negative, this year's return: avg 1.080 (8.1%) sdev 0.206 count 45yrs. Like nominal, real returns are better the year after down years, but since inflation lowers nominal returns there are more down years in real terms and the returns were riskier.

And for the (24) 5-year periods with cumulative negative real returns, the next year's real return: avg 1.092 sdev 0.194 count 24 Like nominal, years following 5-down cumulative were higher and more frequent (again due to inflation eating return).

James E. Birk, of Morrisville, Pa., observes:

It strikes me that the article title "Low N of Long Term Boys" by Kim Zussman is a play on the Traffic song "Low Spark of High Heeled Boys." The lyrics of the song are oddly market-related: "The percentage you're paying is too high priced ...."

10/25/2005
Magnetic Currency Markets, by Allen Gillespie

The USDJPY and EURUSD are fast approaching the mid point of the USDJPY (101.67) low and the EURUSD (1.3666) high which also happens to be in the same area of the USDJPY (135.13 high) midpoint for the range from 2002 to 2005. I suspect like magnets this might cause a forceful move, the question, of course what is the nature of the charge.

The Latest Commentary From Dick Sears, Inventor of the GTI

10/24/2005
Dow Moves, by Victor Niederhoffer

A Spec writes that the market has a natural four-year cycle to bear markets, plus or minus seven years or so, as believed and doubtless charted by his Australian market guru. This is the type of thing that we don't accept on face value around here. Indeed, the idea that there are such things as bear and bull markets, except retrospectively vis-a-vis the retrospective performance of the market in the last x months, is antithetical to the facts.

A famed analyst had a similar take on this question, showing turning points in the market over the last 20 years, with hypothetical buy and sell points a few months or years apart that made a similar tabular case. We tested it, found that the turning points were completely consistent with randomness, and extended it by looking at the future distribution of changes that occurs in the DJIA, conditional on the extent of the decline in the previous x months. As we wrote in our analysis:

To test it, the Professor, his student Chris Hammond, the master simulator Tom Downing and I looked at all those months in the last 100 years when the closing price was below the year end four years earlier. For example the Dow price at October month end 1907 was 57.7. This was lower than the price at the end of 1902, which was 64. That's four years and 10 months without a profit.
During the period from 1900 to date [May 2005] there were 1,264 months examined. Two hundred seventy, or 22%, of them showed such a loss( the dry years). The average one-month price appreciation the next month was 0.8% -- a standard deviation of 7%. This compares to a return of 0.5% a month with a standard deviation of 5% on all other months. Such a difference is merely a 1-in-10 shot to have arisen if indeed there was no difference between the months. In the usual terms, the difference was not significant. The question arises if the price appreciation over bigger periods was more significant. For example, in the year following the dry months, the average price appreciation was 14%, versus 5% in the bountiful months.
Because of the clustering of dry months, without a gain, it was necessary to do some relatively sophisticated simulation to determine the likelihood of such differences arising by chance. We chose to do it by assuming that the distribution of intervals between dry months was our total sample. We chose a random price from the full 105 years, and then classified it as to whether it was a dry or bountiful year. Then we chose the next 12 months, skipping an appropriate number of months based on the distribution of intervals between consecutive months of dryness in the sample. The results show that the difference is about 1 in 40 to have arisen by chance. Thus, there is some support for the idea that dollar averaging works and the idea that buying is best when the doomsday scenarists are gloating the most.

We found the most significant result that when the market is down over the last three to five years, then its expectation is considerably higher than when it's up. That, and the Fed model, are by far the best ways we have come up with, and indeed the only scientific methods that we have ever found, of making a long-range prediction in the market that seems of relevance today.

 Note that the DJIA is currently in an current position relative to these results. Here are some relevant prices:

Date              DJIA Price
10/23/1998        8452.29
10/23/1999        10470.20
10/23/2000        10271.72
10/23/2001        9340.08 
10/23/2002        8494.27
10/23/2003        9613.13
10/23/2004        9757.81
10/23/2005        10215.22

Thus, the average is up over the comparisons with prices one, two, three and four years ago, but down relative to where it was five and six years ago. It would seem to be most similar to where it was in the early 1980s or the mid-1930s. Such comparisons would tend to be interesting but certainly not scientific.

Kim Zussman adds:

Just as a review of history, checked Dow annual returns (Yahoo data adjusted for splits and dividends) Dec-04/Dec-28.  The mean annual return was 6.02% with SD 18.69%.  In other words, though Dow was up significantly over the past 76 years, it achieved this through great variability (presumably that's why it gains).

Here are % annual returns ranked from worst to best.

Also, If last year's return <1 (ie, negative), next year's return:

avg = 1.074 (+7.4%),  stdev = 0.26

If cumulative return of past 5-years <1 (derived as product of each year's return over overlapping 5-year periods), next year's return:

avg = 1.129 (+12.9%),  stdev = 0.22

This last group overlaps since stepping forward by single years includes all contained 5-year down periods.  In other words the five-year priors overlap. I will see if I can fix it but for now we are out the door for some family activities!

The Minister of Non-Predictive Studies adds:

Starting in year 1933...

One year Dow returns following 5-year declines: avg 10.7%; stdev 18.6%; count 14; t-score 2.2

One year Dow returns following 5-year increases: avg 7.2%; stdev 15.8%; count 57; t-score 3.4

A table showing trailing 5 year and 1 year returns

Also, here are the gains/losses that one would have had if he had bought on the first year-end when the 5-year return became negative and then held until the next year end for which the 5-year return was positive:

Buy year-end 1934, sell year-end 1937; gain 72%
Buy year-end 1941; sell year-end 1942; gain 1%
Buy year-end 1944; sell year-end 1945; gain 11%
Buy year-end 1970; sell year-end 1972; gain 21%
Buy year-end 1974; sell year-end 1976; gain 14%
Buy year-end 1978; sell year-end 1980; gain 14%
Buy year-end 1981; sell year-end 1983; gain 13%

A Review of Divine Proportions, by Jim Sogi

Six New Traveling Tales from Bo Keeley

10/24/2005
Shui Mitsuda on the London Underground fare hike

The world's oldest and most expensive Underground System, London Underground, raises its fares even higher next year. The new starting fare is £3 sterling, (US$5.3/ride), a 50% increase from this year. This is just more proof that monopoly is bad. This is how the British motor industry diminished, while having some of the best technology in the world. F1 is also living proof of this. Williams, Maclaren, Jordan to name a few are all from Britain and they are alive and well because of competition.

Healthy competition is good - Shui

Nigel Davies adds:

.. and commuters are caught in a pincer movement between this and the huge increase in the 'congestion charge'. Maybe it's time to buy shares in companies that make bicycles!

10/24/2005
The Alert Circle, by Andrew Moe

A recent visit to Chicago offered the opportunity to visit the SP pit at the Merc.  The Mistress was kind enough to slow the wheels of commerce to a grind for careful observation on a historically low range day.  But even in slow-mo, one thing was clear.  No matter where you stand in the pit, you'd better be watching everyone else.  In an instant, a single signal can trigger a stampede.  Interestingly, this is a common predator defense mechanism in herding species that rely on stampedes for survival.

The Wild Animal Park in San Diego features several large enclosures where a wide variety of animals coexist in a fashion similar to nature.  Rhinos, zebras, giraffes and gazelles roam wild over an open plain.  Steep walls with high fences border the enclosure and occasionally snake across the middle to delineate species from different parts of the world.  Guests skim along the outer edges on a guided monorail tour, stopping periodically for narrated, photogenic points of interest.

Guides frequently point out herds sitting in "alert circles" where individual members are scattered seemingly randomly across the plain.  Closer observation reveals that the individuals are looking across each other's backs, maintaining a complete circle of vigilance against predators.  If one animal stands in alert, the rest move almost simultaneously.  Every herding species in the park exhibits this behavior.

That we should see this in the markets is not surprising.  High frequency traders depend on volatility and thus stampedes for survival.  In fact, it has been argued in this forum that the markets themselves encourage stampedes as a way to winnow out the weak, reward the strong and recycle the ecosystem in general.  So I say to all speculators, whether you hunt, gather, forage or farm, always maintain an alert circle against stampedes for nature has shown us that they can trigger from any direction.

I leave you with a quote - Andrew Moe

"In Vegas, everybody's gotta watch everybody else. Since the players are looking to beat the casino, the dealers are watching the players. The box men are watching the dealers. The floor men are watching the box men. The pit bosses are watching the floor men. The shift bosses are watching the pit bosses. The casino manager is watching the shift bosses. I'm watching the casino manager. And the eye-in-the-sky is watching us all."

Casino - [DeNiro as Ace Rothstein]

10/22/2005
Startling Behavior, by Victor Niederhoffer

A visit to the animal exhibit at Chicago's Field Museum of Natural History, particularly the section on defenses, is helpful in putting the market's moves over the past week in perspective.

To avoid confrontation, animals use mimicry, chemicals, camouflage and signaling to one another. When those measures fail, they seek to startle their predator into leaving them alone. Squids change color, moths change their size, cats hiss, squirrels and birds mob, salamanders writhe and secrete toxic chemicals, cones stick you with poison darts, lizards give up their tails, starfish give up their arms, butterflies bring out fake heads.

It's just so in the market. Note that the sum of the daily close-to-closes in the S&P futures last week was 62, versus a recent norm of 30. The sum of the high-low ranges (with two days of 25 or more) was 84, way out of the ball park, unprecedented since the terrible days of the first three years of the century, and 1998 and 1997.

Amid the havoc, this disruptive behavior was good for a cumulative decline of 0.5 %, in the S&P and a rise of 1.5% in the Nasdaq 100.

My former mentor from the COMEX remarked that when they want to keep you in, they move gradually, and when they want to get you out they move with great alacrity to scare the Hades out of you until the family members circle round and crowd you out. He liked to use the analogy of the frog jumping out of boiling water, but remaining placid if the water were gradually boiled. He referred to this as an example of "the law of least observable differences," and the Collab and I have written about this often citing the works of the Gestalt psychologists as background for further understanding.

That leads of course to the seventh time that the S&P futures crossed from below to above and now below the round number of 1200 in the last year. Such changes of state are analogous to the energy transfers that occur when heat is added to evaporate a liquid , thereby cooling the liquid,, and the converse warming process that occurs when the gas is turned back into a liquid by condensation. The steam burned very heavily near the end of the week as the S&P moved from above to below the round on Thursday.

All this must be put in the perspective of the third week in a row that the S&P has declined, and the nice 1 1/4-point rise in bonds this week, with concomitant shifts down in the yield curve.

Under ordinary circumstances, I would have quantified the predictive significance of all this, suggested some statistical techniques to attack the problems and recommended one of the best references for further meals for a day. However, amid the memorial services and self-interested attempts to fool and deflect the prey into attacking the wrong predator, perhaps I will be excused for tending to my own knitting to a little greater extent than usual.

10/23/2005
Ask the Chair!

A reader writes that the returns from the S&P 500 over time documented in the studies by Dimson, Lorie, Goetzmann et al. suffer from survivor bias, and that value is thus the place to go, "if you're foolhardy enough to go anywhere.

A reasonably open-minded person will think of the trillions of dollars of great fortunes made in companies like Microsoft, eBay, Yahoo, Google, Apple, Wal-Mart, Amazon, Electronic Arts, Starbucks, Dell, Genzyme, Amgen and Qualcomm (all in the Nasdaq 100) and Autodesk, Symantec, Centex, Gilead, Paccar, Office Depot, NAVTEQ (all in the S&P 500), and Urban Outfitters, GTECH Holdings, Cognizant, Harman International and Whole Foods (all in the S&P 400 MidCap Index), and note that hardly any of these companies appear at early stages in the growth versus value studies, and balance these against the growth companies that fell down by the wayside, and the compare the situation with value stocks, and note that the only prospective study of value versus growth is the Value Line study showing a 10-fold cumulative appreciation for growth over the last 20 years or so. Then they quickly give up thinking that survivor bias explains the big returns that individuals get from stocks, and that value beats growth.

Quantifying the magnitudes of dollars gained in these stocks in these last five years, as I did above, and then analyzing their performance in the previous five years while they were in their takeoff phase, thinking about the returns of venture capitalists, and adjusting for those that fell down the primrose would be a much more fruitful and educational exercise than those commonly reported in the literature.

Ask the Chair: Part II

Dear Chairman,

Should in that case, I abandon thoughts about survivorship bias in its standard portrayal as being a nice fit to historical data and one which is illusory to replicate on a prospective basis and focus on hunting for growth at the right price in my endeavors to build my big returns?

Would it be more meaningful for me to abandon imagining circumstances in which it would extinguish itself and focus upon GARP?

10/23/2005
Case for Cosmic Dark Matter Darkens, from George Zachar

The current Economist has an interesting, accessible piece on the hunt for presumed missing matter in the universe. Two things commend the article to specs. First, the concept of non-linearity, as described below, would seem to have applications in market analysis. Second, and more important, is the idea that seemingly obvious solutions to knotty problems may have been overlooked and therefore bear scrutiny.

10/22/2005
For Mideast Peace Solutions, Look to the U.S. Constitution, by Yossi Ben-Dak

10/21/2005
The Usual Suspects, by Jim Sogi

Why do price patterns tend to repeat and why does price action appear similar from day to day? One standard explanation is based on behavioral psychology, but this may be too broad an explanation when a simpler one would suffice. Recent days' market action leads to the hypothesis that it is the very same actors involved for the most part that are driving prices by their usual systems and beliefs and habits. The same small group of locals is there every day. The same big players are there every day. You and I are there every day. And that's really not many people. Sure, some come and some go, but it's the usual suspects at work here. As the poker players say, you've got to play the players, not just the hand. What are they thinking? What are their needs, fears, desires? Understand this, and you'll understand the markets. When in doubt, round up the usual suspects. In law school we read cases. Like price data, dull as dishwater, until the actors' motivations, circumstances, needs, backgrounds, fears, greeds, influencers, wives, are taken into consideration and a rich tapestry emerges. Its not just prices we watch here. Every tick is worth a thousand words with intrigue, suspense, deception.

10/21/2005
A Corn Pattern, from Steve Ellison

Corn has had nearly identical lows each of the last five days: 201.25, 201.25, 201.75, 201.25, and 201.25. Today, it has gone all the way down to 201.00.

There have been nine previous occasions in the last 13 years on which the lows in a 5-day period were within a range of 0.50. This condition appears to be bullish for several days going forward.

                      Last 5 days' lows        Next
Date         Close   Max     Min    Max-Min  3 days
01/13/1993  218.50   218.50  218.00  0.5      -0.2%
11/04/1994  215.75   215.50  215.00  0.5       1.5%
11/07/1994  216.50   215.50  215.00  0.5       1.5%
03/02/1995  242.25   241.50  241.00  0.5       1.1%
03/20/1995  246.50   246.75  246.25  0.5       0.3%
12/14/1998  223.50   222.00  221.50  0.5      -1.2%
11/16/2001  218.75   217.50  217.00  0.5       0.8%
01/28/2003  238.50   234.75  234.25  0.5      -0.1%
02/09/2005  195.00   194.75  194.25  0.5       2.8%
10/20/2005  202.75   201.75  201.25  0.5

Average                                        0.7%
Standard deviation                             1.2%
N                                                 9
T-score                                        1.82

10/21/2005
Are Some Stocks More Important to the General List? by Allen Gillespie

The Chair has in the past contemplated whether moves in a major stock like IBM foretell the market's next move. Maybe it became a special stock with a certain Tuesday buyback. I have always preferred studying stocks like GOOG. Before it went public, the general list was languishing on its lows last August. When the market was at its March highs, GOOG had been moving away from its high for 22 days. GOOG found its highs again a mere two days after the April low and now it finds itself up $22 on a day when the S&P lost a similar amount. Could this information help a speculator?

10/21/2005
Very Superstitious, by Jim Sogi

It was a dark and stormy night, and with Halloween coming up market participants exhibited superstitious behavior on the anniversary of the big crash of October 19, 1987.  No one wanted to hold overnight. What kind of superstitious behavior occurs on days like Friday the 13th, 9/11, 3/11? Silly, isn't it? But there it is. How many still knock on wood, toss salt, avoid ladders? Superstitious? The writing is on the wall.

When you believe in things that you don’t understand, then you suffer. Superstition ain’t the way.

10/20/2005
A Fitting Tribute, by Victor Niederhoffer

The S&P 500 paid Jim Lorie a fitting tribute today, the day of his memorial service, by breaking from below 1200 to above 1200 for the sixth time this year. Whenever the market was down and doomsdayists came to him with yet another crackpot theory about how bad the economy was, and how dishonest corporations were, Jim would always shrug and say something to the effect of, "It may not be tomorrow, but the market will rise like the sun at its normal rate in most long-term periods."

The Dimson-Marsh-Staunton estimate of a 10,500-fold gain per century seemed reasonable to Jim when I updated him with the Triumphal Trio’s great book, “Triumph of the Optimists.” One of the highlights of Jim’s memorial came when Erika Bartlestein, his stepdaughter, said that Jim was a great father but was very sparing in his advice, as he felt that the lessons best learned were those that came from within rather than without. Rule No. 1 was to put most of your money in the stock market.

It was a fitting tribute also to the day that wiped out so many of us in 1987, as noted in a very useful letter from Andrew Humbert, that on its 18th anniversary the market would register one of its greatest gains in the last three years – 1.6% in the S&P and 1.7% in the Nasdaq. The combination of a vivid event like the 1987 crash and the fear that it engenders with the backdrop of terrible memories elicited by comparisons to other crashes like those of Drexel Burnham Lambert and Long Term Capital Management should have been enough to put anyone in the bullish camp. As Gann loved to say, holidays and anniversaries of significant market crashes and booms, are always ripe for a turning point. As with most of his statements and those of his fellow travelers, who recently have become much less numerous on the Street, he fails to tell us whether those turning points are bullish or bearish. But Jim’s children and the readers of these missives were in no such quandary. I admit that when the DAX registered a 3% decline at 8 a.m., and with the woes of Intel and Refco front-page banner headlines across the land, it took more than the usual amount of courage to take the canes out of the closet.

The key turning point had to be when New York Fed President Geithner, for the fifth time, tried to bear the market down by giving us a litany of economic woes that could have come right out of the columns of the perpetually bearish financial weekly’s venerable star columnist. Finally, for the fifth time, the average man must have said to himself, “They’re trying to beat it down again! At a time like this, with a major firm failing! What contempt these governors must have for the public, to beat us over and over again with the same facts!” Finally, the collective public must have said, “We’re not going to let them treat us like fools any longer.” Presumably the Beige Book release was grist to turn that mill.

10/20/2005
Space Rock on Collision Course, from Shui Kage

An asteroid discovered just weeks ago has become the most threatening object yet detected in space. A preliminary orbit suggests that 2002 NT7 is on an impact course with Earth and could strike the planet on 1 February, 2019 -- although the uncertainties are large.

If this is true, we should shift the entire defense budget to this. Let's fight the big stone, not each other!

Readers' input would be appreciated.

George Zachar Replies:

  1. Search for companies with debt maturing in 2020 or later.
  2. Do not take out a mortgage with 15 year or under maturity.
  3. Hire quant jocks to determine impact point. Avoid counterparties within 500 km radius.
  4. Recall the first Superman movie. Purchase soon-to-be beachfront property in Nevada, Nepal, etc.
  5. Acquire hillary2016.com domain.

10/20/2005
It Was the Best of Times, It Was the Worst of Times, by Kim Zussman

Using SPY (adjusted closes) since 1993, I defined large declines as 5-day returns below -5%. By month (the following notation was used in lieu of month number so double digit months don't exaggerate):

JJJJJJ
FF
MMMMMM
AAAAA
M
J
JJJJJJJ
AAAA
SSSSSSSSSSSSSS
OOOOOOOOOOOO
NN
DD

Looks pretty bad for September and October.. until one checks months with 5-day return >+5%:

JJJ
MMMMMMMMMM
AAAAAAA
MMM
JJJ
JJJJ
AAAAA
SSS
OOOOOOOOOOOOOO
NNNNN
DDD

10/19/2005
Jim Lorie, R.I.P.

A memorial service for Victor's mentor at the University of Chicago, Jim Lorie (1922-2005), was held today in Chicago. Jim's achievements included helping found the first index funds, creating the first systematic database of stock prices (the still-authoritative Center for Research in Securities Prices), recruiting the brightest stars in the U.S. to build Chicago's business school and setting many young students -- including, 40 years ago, Victor Niederhoffer -- on the road to success. Here is one of Jim's collaborations with Vic:

James Lorie and Victor Niederhoffer: Predictive and Statistical Properties of Insider Trading.

10/19/2005
Ask The Senator, a Continuing Series

Q: What are the root causes of crime?

A: Michael Crichton, in a wonderful read, "The Great Train Robbery" writes: "The ordinary Western urban man still clings to the belief that crime results from poverty, injustice and poor education." Crime is not a consequence of poverty. In the words of Barnes and Teeters (1949), "Most offenses are committed through greed, not need".

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

 

 

 

10/19/2005
The Doomster at the NY Fed, by George Zachar

Tim Geithner lays out the standard litany of fiscal "imbalances":

The inevitable process of adjustment will bring with it the risk of large movements in relative prices, greater volatility in asset prices and slower growth in the United States and in the rest of the world.
The rest of the world does not appear likely, even over the medium term, to be in a position to provide a sufficiently strong offsetting source of demand growth to compensate for the necessary slowing in U.S. domestic demand.

Necessary slowing in US domestic demand? I'd add a pithy riposte, but my brain congealed. For those joining this program in progress, the NY Fed President is extremely powerful by dint of his role in managing the Fed's trading operations and his position as the Fed's day-to-day face to the New York banking community.

10/19/2005
Intermarket Relations, by Steve Ellison

R-squared of daily percentage changes since June 10, 2005:

           10-Year Bond       Oil       Euro
S&P 500          0.0054    0.0062     0.0033
10-Year Bond               0.0269     0.0641
Oil                                   0.0000

Despite all the news accounts such as "Stocks fell as oil prices rose," the correlation between stocks and oil has been weak, much weaker than the positive correlation between U.S. bonds and the euro. The correlation between bonds and oil is also positive. Why is a falling dollar good for bonds? Because foreigners are the main buyers? Is deflation the answer to Gr##nspan's conundrum?

30 New Wiswell Proverbs

The Hobo's Latest Adventure

10/18/2005
Momentum Versus Randomness, from Victor Niederhoffer

The question often arise as to whether the stocks are random. To test this, I propose to use the average absolute deviation. Let's take the week from 8/5/2005 to 8/12/2005, where the consecutive prices of the S&P futures were 1236, 1234, 1241, 1240, 1245, 1238. The absolute changes are 2, 7, 1, 5 and 7, summing to 22. Thus, the average absolute deviation is 4. The absolute deviation is always computed around the mean change, but in this case, the mean was 0.

It turns out the average absolute daily move during the last 9 years, from year-end 1995 to 10/15/2005, was 9.6. Indeed the actual average absolute moves for the market are as follows:

Number of Days  Average Absolute Move  Lower 2.5% Bound
             1                    9.6
             2                   13.7              13.9
             3                   16.5              17.3
             5                   21.0              22.1
            10                   28.0              30.7
            20                   39.7              42.2

Note that the 5-day average absolute change of 21.0 is just 2.18 times as great as the average absolute change for the 1-day. It turns out that if we repeatedly take random samples with replacement from the distribution of actual daily price changes, only 2.5% of the time will the actual change be less than 22.1. Thus, the 21.0 average absolute change for the 5-day interval is non-randomly less than would be expected by change. Similarly the 2-day, 3-day , 5-day, 10-day and 20-day changes are less than would occur by chance in 97.5% of all samples.

Another way of putting this is that empirically in real life markets, the 2-day absolute change turns out to be 1.43 times greater than the 1-day absolute change, the 3-day 1.70 times, the 5-day 2.18 times, and the 10-day 2.90 times, and so on. The random ratios from simulation would be as low as 1.45, 1.79, 2.30, 3.20, and so on, by chance alone just 2.5 times out of 100. Thus, I conclude there is a inordinate tendency to reversal in the daily moves for all intervals up to 20 in daily prices. This conclusion was confirmed using the variance ratio, with virtually identical results.

Thanks to Tom Downing for his excellent artful simulation.

10/18/2005
Quote of The Day, from Victor Niederhoffer

In discussing the rash of consumer protection intervention and regulation by the government in the 1960's, James Lorie wrote in Government and Advertising: the Heavy Hand of Benevolence:

The view that the consumer is helpless and needs protection by a benevolent government is expressed, (by the consumer advisory council). The view, once widely accepted in this country that competition forces business to serve the public is not even give a token nod. The Constitution of the United States was based in part on the belief that people needed protection , primarily from the government, and that free, competitive enterprise was the most efficient engine for promoting the public good.

I will be reading an excerpt or two from Lorie's characteristically elegant defense of free markets at his memorial service tomorrow.

10/18/2005
Perverse Diversity, by Kim Zussman

  1. If markets always followed definable statistical laws, would those who understand the laws converge on 100% market wealth?
  2. Since that doesn't appear to be true, market participants might rank on a continuum of risk; those who believe risk is unknowable, and those who believe risk is knowable. At one extreme are those who lose consistently but have occasional huge gains, and the other who profit consistently with occasional ruin. How can there be risk if you know what the risk is (e.g., if you could calculate the exact effects of the next Gulf storm on oil).
  3. Diversification. Markowitz called it the only free lunch in finance, but is it really free? A portfolio of 20 stocks has zero return on a volatile day, due in part to one stock which falls 10% countered by one that gains 10%. The investor should feel smart that he was diversified, but instead is upset because the 10% drop spoiled what should have been an up day. The cost of diversification is the asymmetric relationship between pain of loss and pleasure of gain.
  4. Since markets parameterize life, it could be helpful to characterize other forms of diversification. Like the pistons of a V8 engine, having a harem almost guarantees that while some wives are down, others are up (making the large assumption that multiple wives are uncorrelated) and life is continuous happiness. However if it is human nature to focus more on the problems than the successes, such fine ideas must end in the evolutionary waste-heap of future genome diversification strategies.

Marting Lindkvist adds:

According to this paper, there might be some correlation, at least in one sense, between women who are spending time together, and this is said to be due to pheromones. Perhaps like in the market where the smellier a situation is for a certain stock, other stocks that spend time together with it (in the same industry) becomes more correlated with it when its under pressure and thus gets dragged down. This must be tested though.

T. M. Ryan comments

If markets always followed definable statistical laws, would those who understand the laws converge on 100% market wealth?

Neglecting the principle of ever changing cycles, even if the statistical distribution of say the daily change for many future market days was definable and known in advance the answer is no, because knowing the distribution of the population of days tells you nothing of the sequential timing of the individual events.  This is the problem with all of the Mandelbrot/power law/fractal/log periodic descriptive approaches. In other words a statistical distribution is descriptive, not necessarily predictive.

Dave W. adds:

Remind me some day to describe how I built the holed rabbit portfolio to show that there is nothing random in the market....nothing at all. My conclusion is that it is about dominance and the proof is authored everyday by my own stalemate with the trade.

Positions are always calibrated to retain the same (+ or - 2%) buying power by my host broker. If something goes up 2 bucks the rest of the portfolio gets an accumulated 2 buck loss. Make no mistake these markets are a sham, if you're on the outside looking in ... you're meat, i.e. a rabbit in a hole. I have now 16 months of waging a stalemate with the trade in a specifically designed portfolio which  leverages my amateur ways squared off against all the systems tools of the hunt. Anyone wanting to really test their skills should use a portfolio that gives them every advantage. See how long you last. The experience will give you the edge in everything else you do.

P.S. here is the scorecard on Cramer, the number one Sell side guy in America.

10/18/2005
Dr. Castaldo Reviews Academic Paper on Price Discovery

Price discovery in a market under stress: the U.S. Treasury market in fall 1998 Craig H. Furfine and Eli M. Remolona Federal Reserve Bank of Chicago

This is a "market microstructure" study of the US T Bond (spot, not futures) market in the Fall of 1998 when LTCM had its troubles. It documents that the market behaved differently (lower liquidity/bigger price impact of trades) on days when LTCM's problems were more acute than on other days. This was to some extent known already (both anecdotally and empirically), but this paper is very detailed.

The data are a complete record ("tick by tick") of all trades and quotes; the direction of the trade (whether buyer initiated or seller initiated) is also known. Equations (vector auto-regression) are estimated with dependent variable the change in price/quotes from one trade to another and independent variables the characteristics of each trade. In this way (as is standard in microstructure empirical studies) the impact of trades on price can be estimated. The results show a bigger impact on those days identified (in various objective ways) to be affected by LTCM's problems.

Two observations:

  1. This is the first micro study I have seen of the bond market.
  2. The behaviors examined in this paper (and in the microstructure literature generally) are extremely short term. For example the diagrams on page 40 document a price effect of a trade on the next 8 trades (after which the curves flatten out); since the time between trades of 5-Year Notes is 51 seconds on average, these curves represent an effect lasting 6 minutes (and most of it is over well before that).

10/18/2005
Victor Niederhoffer on Average Absolute Deviation

I have been ruminating briefly about average absolute deviation on some ideas I am fleshing out concerning a fast and simple way to measure momentum versus reversal during a given period. The usual method is the variance ratio. I came across an article suggesting the benefits of diversification have been decreasing lately. Another way of saying this is that it takes more stocks to achieve a given level of diversification.

The article shows, for example, that one stock gave an average of 12% off an equally weighted average in 2001, versus  8% in 1973, and 30 stocks were off by 2.7% average in 2001 versus 1.6% in 1973.

Here is my own update.

I use the dispersion in the  individual companies in the S&P 500 as a benchmark and look at the difference  in % return between the companies ranked in the  20th and 80th percentiles as the measure of how much spread there is per year.      

Year    20th percent    80th percent   Difference

2000       53.3            -22.6          75.9          
2001       31.5            -21.5          53.0
2002        5.0            -36.8          41.8    
2003       62.0             10.4          51.6          
2004       33.9             -3.2          37.1          
2005*      20.1            -18.4          38.5*

* the 2005 table is based on the performance from 12/31/04 to 10/17/05.   

The results show that there has been less of a dispersion of the average stock during the most recent years than in the beginning of the period, thereby refuting the tendency that all the academic studies have found and are basing their decisions upon. Of course this is predicted by the law of ever changing cycles.

An interesting byproduct of this study was the preliminary discovery that the dispersion of the ensemble of stocks is greater as of mid October than as of the end of year. This means the difference between 20th and 80th percent performance as of the first 9 1/2 months of 2003 was 66% but the difference at the end of the year was 51.6%. Similar results held for the other years. If this discovery is born out, then one can say that the time  from October 15th to the end of the year is a time for companies to revert to mediocrity. This would not be a candidate for the Minister of non-predictive studies, (a minister with a very dour look recently, due to his inability to play tennis during the last 8 days because of rain, losses and romance).

Such are the unintended consequences, the fruits of very preliminary ruminations on fast and simple methods for determining non-randomness with the average absolute deviation.

Kim Zussman Comments on Average Absolute Deviation:

  1. If the distribution of returns in a given period has smaller variance than in another period, and one randomly chooses, (say), 20 points from each distribution to sample,  isn't the mean still the same?  If the purpose of diversification is to reduce the chances of not tracking the mean, I would think the higher variance distribution requires more points to be sure of getting the mean right.
  2. Was the interquartile range compression at year end due to losses in prior gainers or gains in prior losers? Lots of papers suggest accelerating year-end losses for YTD losers (and January bounce) as a result of tax-selling, but tax effects might be different in years following down and up markets

10/18/2005
Did Emerging Market Debt Foreshadow R#fco?, by George Zachar

From today's Wall Street Journal:

R#fco has begun slowly unwinding a large Latin American debt position controlled by its unregulated Capital Markets unit, whose off-exchange trading activity was frozen by the firm last week.

I'd been wondering what accounted for this slide in emerging market debt prices:

Dow Jones CDX Emerging Markets Index
30-Sep-05  101.05  
 3-Oct-05  101.00
 4-Oct-05  100.66
 5-Oct-05  100.29
 6-Oct-05   99.46
 7-Oct-05   99.87
11-Oct-05   99.74
12-Oct-05   99.09
13-Oct-05   98.51
14-Oct-05   98.27

10/18/2005
Work is Victory, from Jim Sogi

My father advised me: "Work hard. Do the best you can. Don't worry about the money. It will follow."  Emerson spoke this truth 100 years before:

I look on that man as happy, who, when there is question of success, looks into his work for a reply, not into the market, not into opinion, not into patronage. In every variety of human employment, in the mechanical and in fine arts, in navigation, in farming, in legislating, there are among  the numbers who do their task perfunctorily, as we say, or just to  pass, and as badly as they dare,-there are the workingmen on whom the burden of the business falls,-those who love work and  love to see it rightly done, who finish their task for its own sake; and the state and the world is happy, that has the most of finishers. The world will always do justice at last to such finishers:  it cannot otherwise. He who has acquired the ability, may wait securely the occasion of making it felt and appreciated, and know that it will not loiter. Men talk as if victory were something fortunate. Work is victory. Wherever work is done, victory is obtained. There is no chance, and no blanks. You want but one verdict: if you have your own, you are secure of the rest.
Ralph Waldo Emerson Worship, 1860

10/17/2005
Briefly Speaking: Leaks and Announcement Effects, by Victor Niederhoffer

Owen Wilson comments:

The Presentation of Self in Everyday Life looks at the processes and meanings in day to day interactions between individuals and teams. The writer Erving Goffman analyses his encounters as if taking place in a theatre, and as such his emphasis is on the mode of presentation used, its intent and effect.

In almost all interactions the aim of the presenter is to influence the definition of a situation that the others come to formulate, and to express oneself in a way that leads others to act in accordance to your wishes. Even if there is no conscious desire to mould an interaction, forms of this manipulation will be present - even in wanting someone to entirely make up their own mind a presenter is selling a particular root of inference.

When we express ourselves we give purposeful signals and we give off signals that we cannot control. On the receiving end of this, when we are filtering signals in order to infer information we all try to differentiate between these two types and to process them in different ways. Dependant on how much previous information we bring to an encounter, we often place more value on those signals that we perceive to be uncontrollable as, in most situations, a less manipulated signal will bring us closer to the truth than a manipulated one.

What is the properness of feigning signals?

To a certain extent relations involve feigned signals all of the time, and this is an accepted part of the Cat and Mouse game of interaction. In almost all interactions lying is seen as unacceptable, however people are expected to fake certain 'unconscious' signals at times in order to be polite or to get on. The extent that this is accepted/necessary this varies from culture to culture. Television adverts are a clear example of a minefield of faked signals that are essential in the role of media, whilst at the same time not fooling anybody.

An harder example is of the manipulation of signals whilst dating. For someone with very conscious control over their, for example, body language, tonality and indirect speech, there is not only the choice to block negative signals they may be giving, but also to create false positive ones. These will have a much greater effect than signals that are clearly chosen, such as a compliment, as they do not come under the same critical scrutiny and are seen as more honest by the receiver. They can also bypass the need to be 'proper' as they are not processed as a chosen output. Feigning signals for me becomes improper when the other is unable to tell that the signals are being feigned and the feigning itself is contrary to the stage and characteristics which the signaller has set for themselves. 

As little as I know about central banks, it seems analogous that a central bank, through its monetary policy and monopoly over certain types of information, has the sort of control over markets that would give it the ability to effectively manipulate its current situation. It also seems analogous that a central bank has the amount of reserves and opaqueness that it can choose to hide and manipulate signals that smaller market actors could not, in order to control others' inference of a situation.

Implicit in most of our society is the idea that certain characteristics deserve to be respected with like treatment and second to this, that a person should have the characteristics which they claim to have. For Central Banks, their position of power over the markets, is accepted partly because of the idea that they protect norms that are essential to the markets and society and these norms are inherently connected to social ethics. Although many market actors feel that the power of the central banks is unnecessary, they are entered into this contract of respect for the banks'. This is what makes the 'stagecraft' of leaking information unacceptable from this perspective.

As Goffman reflects, the structure of the self is reflected in how we arrange for our performances to be viewed, in how we stage ourselves. For central banks to choose to 'leak' announcements early shows a level of staging and manipulation that does not reflect well on their ethics, and would be looked down upon in a personal field of interaction. In this way it seems to break the social/economic contract that they are entered into. It shows too great a manipulation of stage and inference. It does not show 'like treatment'.

10/17/05
Occupational Blinkers, by Yishen Kuik

As participants trying to eke out a living in the markets, we often fall into the "don't copy my homework" mindset and cover our work with our arms lest someone peek at our answers from across the desk.

But is the world out there really waiting to pounce on us in order to pry our secrets and insights from us?

Recently I was at breakfast with other market participants. One was into value, another was into distressed, another was into factors and another was into relative value in mortgages. As we shared our perspectives over coffee and pastries, it became clear that each person was only peripherally interested in what the other did.

The factor person believed corporate idiosyncrasies cancel out with sufficient diversification. The value person believed that the whole point was to look into the idiosyncrasies. The relative value person was only interested in the world seen through the lens of his valuation models.

I think it was Anaïs Nin who said, "We see things not as they are but as we are". I realize that we might as well have been talking a babble of different languages around the breakfast table. If one of us had a deep insight specific to his line of work, it seemed unlikely that group interest in that conversation would have been sustained long enough for that insight to be discussed. This is a pity since such insights often have unexpected applications in our own work.

Perhaps that is a good argument for why we should show great interest in others who are in a different line of work. Since most people tend to have occupational blinkers, insights do not travel easily across fields of study. Thus the harvest is rich for those with the intellectual curiosity to traipse across the invisible fences we put up between occupations.

Kedrick Brown adds

Well spoken Yishen:

Yes, it takes a unique person to look outside of his own worldview, but I think this is where many dramatic, occasionally paradigm shifting, discoveries occur.  In physics this is especially true - the parallels that Einstein drew between gravity and geometry, the individual observations that led to the unification of electric and magnetic phenomena, etc.

I'm sure you've heard of the anecdote about the 9 dots in a square pattern that a subject is asked to connect with four straight lines.  The problem can of course only be solved by drawing some lines beyond the perceived boundaries of the box (i.e. by connecting the lines to points that are not immediately obvious to most people).  To me, this is the ultimate use of our pattern recognition ability - finding and studying parallels between phenomena that have been previously thought to be unrelated.

Some years ago, I skimmed through Simon Singh's book about how Fermat's last theorem was finally proved after centuries of labor.  Browsing the web again, I find that the key was in a conjecture by Taniyama and Shimura about a relationship between "elliptic curves" and "modular forms".  For those who venture to draw parallels between seemingly unrelated areas, the harvest can indeed be rich - lots of new math was created in the quest to solve this particular problem.

There's sometimes resistance to ideas garnered from thinking outside of the box in this manner, especially if one is venturing outside of his main area of expertise - but isn't this part of the definition of being a contrarian?

Kim Zussman adds:

Long before Gore's internet was even a glimmer in Monica's eyes, there was English 303, advanced exposition, at a state college.  Though hormonal intoxication hoped for naked shorts; alas, it was about writing.  Worse, it was "taught" by an artsy septuagenarian sporting a skullet, who justified his staccato vulgarity as sovereignty of language's full dynamic range.

In these sweetly innocent days before art had learned to be a sex game, and long before people turned away from brilliance for fear of mailbox clutter, the few A's stayed in the XX corral.  (Demerits for a Wiener dog and B was for Boy).

But in gerontological biology who can't look past a last grab?

One thing professor Graves did impart: Write dialogue as two separate monologues spliced together. Because when people converse, they don't. Everyone talks their book.

10/17/05
Flexibility in Nature - an extract from ScienceNow, sent in by George Zachar

Don't be distracted by the headline:

Great Tits Pass Down Good Habits

Like commuters who switch to public transportation when gas prices rise, birds that display behavioral flexibility have the edge when faced with changing environments. Now researchers studying great tits have evidence that this flexibility, called phenotypic plasticity, runs in families and helps the species cope with changes in its food supply.

10/17/05
Yossi Ben-Dak: The Importance of Network Analysis Systems to Security Issues and Speculation

We increasingly need capabilities of a network analysis inference system in high level intelligence applications for when large data sets must be analyzed by a speculator and insufficient meaningful patterns emerge for predictions... Read More...

10/17/05
A Letter to the Editor from Lucy Genis:

Can you please tell me if Victor has a model portfolio or specific recommendations on the web site?

Victor Responds:

Regrettably, it would create too many problems if we were to divulge our portfolio and it wouldn't be that helpful either because I'm not very good at individual stock picking. However, I'm always long. Period. That looks bad at a time like this, but I've been doing it for at least 25 years, and the market goes up about 10 fold each 25 year period.

10/17/05
Katrina -- Chinese Imports: What's the Difference Really?

To the Editor, Christian Science Monitor:

You wisely endorse free trade (Opinion, Oct. 17).  Your argument, however, is weakened by your use of loaded protectionist language.

In particular, you write about the "flood of Chinese textile imports."  Floods kill people and destroy property.  No one wants them; they are unambiguously undesirable natural disasters.  Imports, in stark contrast, are goods and services that consumers choose to buy.  Imports improve consumers' lives and free domestic resources to produce yet other valuable goods and services that otherwise would be too costly to produce.

Floods devastate lives.  Imports enrich lives.

Sincerely,

Donald J. Boudreaux
Chairman, Department of Economics
George Mason University

10/16/05
What I Know About Fat Tails, by Andrew Moe

The madman clutches a bloody knife above his head, gathering strength for a strike on your throat. Pure rage pours down the edge of the blade as it slices your skin before you have a chance to react. Taking his time, the fiend hacks away at your life, sure of purpose until the bitter end. As the vultures circle, you are surprised to be unsurprised by the unlikelihood of it all. For in our society, you have been preconditioned to accept the black swan.

If you've ever owned a motorcycle, you know that everyone knows someone else who has died from a terrible crash. Even people who don't have a real story adopt a particularly gruesome one as their own. The same is true of natural disasters, market crashes, corporate collapses, sudden illness and all other improbable anomalies. When lightning strikes, people take notice. And people love to tell a good story.

These stories cause others to overreact. Heightened prospective retrospection frightens us to the point of monetary engagement. Insurance exists for any kind of risk. You can be insured 2 or 3 times over, reinsured and partially insured in a variety of complicated structures. J Lo has booty insurance. Yet despite our exhaustive preparations, it's different under the knife. When a perfect storm of abhorrent magnitude bears down on your position, risk takes on new meaning.

With natural disaster fresh in our minds, economic disaster struck these past two weeks. Screens across the country dripped red with losses, driving many to the exits in a frenzy. Mr. E long ago led a discussion on panic, pedestrian arches and mice running for their lives*. I suspect the vigilantes were active this past week, perhaps even joining the plunge protection team on Friday -- if only for a day.

* Self-organized queuing and scale-free behavior in real escape panic: "Numerical investigations of escape panic of confined pedestrians have revealed interesting dynamical features such as pedestrian arch formation around an exit, disruptive interference, self-organized queuing, and scale-free behavior. ... For mice escaping out of a water pool, we found that for a critical sampling rate the escape behavior exhibits the predicted features even at short observation times."

10/16/2005
Book Review by Jeff Sasmor: Humphrey B. Neill, Tape Reading and Market Tactics

It’s always interesting to pick up stock market books that were written long ago; many people like the books written by Jesse Livermore. I picked up a reprint of a 1931 book called “Tape Reading and Market Tactics” by Humphrey B. Neill. An interesting book, if only for some of the factoids:

There are also some great quotes that are either just great sayings or show how little things have changed:

The stock market is a great cauldron of the hopes, desires, and despairs of speculators, or traders. If it were not for the speculators, there would be no active stock market. If it were not for the speculators, America would not stand where she does, as the leading industrial country in the world. We may deplore speculation, but if it were not for this outpouring of money for stocks, you and I should not enjoy a fraction of the comforts and luxuries which we accept as necessities”
“Do not be discouraged if you have lost money in the market. Nearly everybody did during 1929 and 1930.”
“Use charts; employ every aid you can think of. But remember that your charts are records only of past human action. Your charts are pictures of the results of financial strategy.”
“This counsel may be the most important I can suggest: trade alone. Close your mind to the opinions of others; pay no attention to outside influences. Disregard reports, rumors, and idle boardroom chatter. If you are going to trade actively, and are going to employ your own judgment, them for heaven’s sake, stand or fall by your own opinions.”

Lots more, but you get the gist.

10/16/2005
Strategy, Part II, by Jim Sogi

See Part I

Bruce Lee, Jeet Kune Do, Edited by John Little, supplements and contrasts Wiswell's Proverbs. Parenthetical comments added. The market is life-and-death combat. Entering and exiting is "execution." Ruthlessness rules.

  1. "Focus on movement, greater speed -- in other words, subjectively in time for the signal, don't focus full attention on signal, though necessary. This way one can time the rhythm of the signal, or the starter's pattern, so that he can start with the signal, not react to the signal."
  2. "An animal jumps at every sound...a leaf responds to every push of air ... but an enlightened man in combat moves only when he chooses -- only when necessary -- actually, the movement before it is necessary. He is not tensed but ready, he is never set but flexible."
  3. "True observation begins when one is devoid of set patterns."
  4. "Different schools create fixed systems. Combine what works. Adapt different systems to your individual needs.*
  5. Use attack as defense.*
  6. "It is generally fatal to start a bout with a set plan."
  7. "Don't simply rely on what comes easiest to you. There is a great temptation to exploit favorite strokes to the neglect of most others. While this may bring initial success, it is unlikely to enable one to gain regular results in the highest-class competition. All too soon one's opponents will find the answer to a limited game; a routine system of defense, for instance plays into the hand of an observant opponent."
  8. "Variation of cadence and distance are excellent tactics of fighting -- for example, deliberate slowing down of some movements so as to deliver an indirect or compound attack or riposte in broken time can be an effective tool or tactical move, especially against an opponent who is superior in speed to oneself."
  9. "To be successful, you must have a very exact choice of distance and careful timing. Of course, sharp awareness is the foundation."
  10. "Don't just charge in blindly; you've got to listen -- listen!"
  11. "Attack on preparation is one of the best forms of attack."
  12. "Our eyes should not stare at one point. See your enemy in whole and anticipate his action, so that you can evade his attacks and carry out counter attacks."**
  13. "As a matter of generalship you should try to fight a type of contest which least suits the fighting abilities of your opponent."
  14. "Attack by drawing." (Draw the opponent in, and when he is off balance and in close, counter attack. Move to hit the attacker's extension. Advance as opponent pulls back. (Bear squeeze)
  15. "It is wise not to launch an offensive without having come to some conclusion regarding the probable reaction on the part of the opponent."
  16. "Many people make a big mistake in fighting against an enemy by thinking too much about winning or losing. Practically speaking, they should allow none of these sentiments to invade their mind. They need only to act as circumstances demand."
  17. "No plan of attack can be put into execution without first of all having taken the probable system of defense into consideration."
*Paraphrase
**E would say, "The pros are looking at x number."

Alan Gillespie comments on strategy in basketball:

Based on the stats from CNNSI.com, just looking at the averages for the past season, the average NBA team shot 44.7% from the 2 point area versus .356% from the arc, thus on a 100 shots one would expect to make 89.4 points on 2s v. 106.8 on 3s, but on average NBA teams shoot 4x as many 2s as 3s.  There is some adjustment for foul shots as more 3s led to fewer free throws. The average points per shot then are 1.07 for a 3, 894 for a 2, and 1.512 for 2 (as the average was 75.6%).  Thus, while Shaq may not be a good foul shooter, a shooter need only shoot 53.5% from the line to be as good an expectation as a three point guy for that trip down the floor.

The most interesting thing is running a multi-regression, the offensive stat most correlated with Wins was number of shots and the relationship was inverse (more shots correlated with fewer wins).  This may be because the teams are giving up points too quickly on the defensive end of the court or they are not selective enough in there shot selection.  I think the lesson for traders would be to be selective and play great defense.

Scott Brooks comments:

As I've said for years, and drilled into my clients' heads, "Losses hurt you more than gains help you., The playing of good defense is crucial to any endeavor. All the coffee break genius' of the late '90's who were bragging about their 50% returns on their online stock portfolio's (playing a great offense) are strangely missing today.

It's like my favorite (and hometown) team, the St. Louis Rams from '99 - '01 putting up eyepopping numbers on the scoreboard and going to 2 Superbowls in 3 years, only to be beaten by a team that simply personified great teamwork (and investing for that matter), the New England Patriots. The Rams lived and died by the all or nothing play, while the Patriots simply kept grinding away making little gains here and there.

The Rams turned the ball over a lot. The Patriots simply decided to keep the Rams in front of them, prevent them from making the big play, and waited for them to make a mistake. At the same time, the Patriots simply made high percentage plays with low downside risk.

I guess I'm indirectly confessing that I'm not much of a speculator. Even though speculation doesn't scare me (goodness knows I love the Rams and that style of play), I prefer to be the tortoise rather than the hare. I'm happy with grinding out little gains on a consistent basis on trades that have low downside risk.

Oh don't get me wrong, I've had a few big losses in my day, but each one of the big losses seems to be offset by the same amount of big gains (I'll bet that my "big" losses and "big" gains, in terms of a percentage swing, are pretty benign and boring to most true speculators). In the end, its the majority of the portfolio that is grinding it out that accounts for my returns and not the "big" moves (whichever direction the "big" moves go). My clients like boring, tortoise like consistency. I like sleeping at night. It's a marriage made in heaven.

As far as excitement goes...Hopefully I'll talk my wife into doing a family trip to Africa next year, the first 10 days of which will be a safari. My goal is to get a Cape Buffalo with my bow. On that day, I won't want to be the tortoise or the hare. I'll want to be a Bear (as in Fred Bear) and shot straight and true. Now that's real speculation!