Daily Speculations The Web Site of Victor Niederhoffer and Laurel Kenner

Home
 

Dept. of
Evolution & Ecology

Write to us at: (address is not clickable)

 
Victor Niederhoffer was the first to study the applications of ecology to markets. He continues to explore the links through his own studies and in dialogues with members of the Old Speculators' Association.

15-Feb-2006
The Origin of Species and Markets, by Victor Niederhoffer

I often turn to The Origin of Species by Darwin for insights into life, markets and science. I usually start with the last paragraph in the book, which most scientists consider, along with The Principia, one of the two most important and influential books on science ever written.

It is interesting to contemplate an entangled bank, clothed with many plants of many kinds, with birds singing on the bushes, with various insects flitting about, and with worms crawling through the damp earth, and to reflect that these elaborately constructed forms, so different from each other, and dependent on each other in so complex a manner have all been produced by laws acting around us.

The laws that Darwin discovered are:

  1. The great variability of attributes of organisms in nature.
  2. A differential survival value for each of the attributes.
  3. A mechanism for transmission of the attribute.

Subsequent work showed the causes of the variabilities and how they were transmitted.

I have written a book, The Education of a Speculator, about the the tangled market bank, clothed with players of ephemeral and and information-based qualities, with the media and the analysts and the promoters singing, and the market makers crawling about breaking up and consuming much of the public's overplus through the execution process. And I have reflected that the elaborate differentiation between the public, dealers, hedge funds and market makers, all trying to profit, creates markets that move in interdependent ways leading to many highly complex and ever-changing relations and price patterns produced by the attempts to make a living by these feeders.

Dawkins, in the Selfish Gene, applied these concepts to the transmission of ideas and activities that transmit the culture of a society. A nice effort to relate these ideas to the transmission of ideas like how P/E affects prices and the uses of technical analysis by major players is contained in Joshua Frank's article "Applied Memetics to Financial Markets: Do Markets Evolve Toward Efficiency?" in The Journal of Memetics, a very fruitful and intriguing publication that discussions memes in such fields as linguistics, music, mental illness, animal behavior, taboos, suicides, religions, bird song, irrational behavior and chess moves.

I always end my rereading of the Origin by reading, preferably out loud, the conclusion of Chapter 3, "The Struggle For Existence," on the difficulties that we face in dealing with markets, facing competition from so many others of great merit and competence:

All that we can do is to keep steadily in mind that each organic being is striving to increase at a geometrical ratio, that each at some period of its life, during some seasons of the year, during each generation or at intervals has to struggle for life, and to suffer great destruction. When we reflect on this struggle, we may console ourselves with the full belief that the war of nature is not incessant, that no fear is felt, that death is generally prompt, and that the vigorous, the healthy and the happy survive and multiply.

I believe this consoling thought is a good place to throw the discussion open for classification, quantification, prediction and the formulation of good questions by readers.

P.S. To provide a Adam Smithian incentive for readers to augment the above discussion, an anonymous donor has agreed to disseminate $1,000 above and beyond any other prizes to the being that reduces our ignorance in this field the most.

Steve Ellison offers:

The "declining dollar" meme has surprising longevity and resonance. One of the leading websites for free futures quotes runs an advertisement saying, "'Currency Crash!' Is the dollar fall precipitating inflation?"

I looked up the prices of a few currencies and compared them to the year-ago prices:

           Price     Price
        2/14/2005 2/14/2006  Change
Yen        0.9526    0.8544  -10.3%
Euro       1.2966    1.1930   -8.0%
Pound      1.8856    1.7357   -7.9%

Some crash! The declining dollar meme is so deeply ingrained in the collective consciousness that a full year of facts to the contrary in the form of market price action has done little to change perceptions. Advertisers who carefully craft their appeals to trigger the desired responses still believe that touting the "declining dollar" will bring in business -- and it probably will.

A thought from Sushil Kedia:

The arrival of markets, the arrival of exchange markets perhaps 5,000 years later and the development of meticulous record-keeping in exchange markets 100 years after that, and reflexive markets 50 years subsequent, is not just a story of evolution of the markets, but a very important substream of the evolution of "evolution."

Speaking of struggles, the worst and the deadliest struggle is the one that is unleashed within a specific species. The most dangerous, the most prolific, the most portentous of all wars that the most evolved species, i.e., we the humans, could have seen was the Cold War turning Hot. However, with the mindnumbing dumping of gigatons of aluminum, petroleum, phosphorous (name a commodity) in the global marketplace at discount for years led finally to the overnight crumbling of the Red Flag. For a moment, please evaluate if such an ongoing sequence of market-originated and market-based blitzkrieg, even if at the centre of which was a very rich man who obtained a historically quizzical pardon, was productive in saving evolution from unbelievable collateral damage and near annihilation.

Could he not be seen as an unsung hero who saved the "world" from regressing a few hundred years if not thousands of years in development? Destruction, even if creative, is destruction; the point well made well in the Shakespearean creativity of "She stooped to conquer" a couple of centuries ago. But then, isn't that anything more than drama? Antibiotics being known widely as such an advance in health care make us forget most of the time that our intestines do need to have some bacteria which do us good as well!

Now at such a point in the story of evolution, if markets seen as significant vehicles of evolution is clearly a thought beyond the bounds of absurdity, drawing applicable inferences from the story of evolution to improve understanding of markets is agreeably a high point of reflexive thinking.

The Chair's announcement of an additional reward of $1,000 USD just geometrically raises my desire to pinch the balloon of a thought process that the wisest man speaks last hoping an immediate bout of bashing getting triggered will prevent the wiser from speaking last.

Maybe the intensity of this thread will make the Chair allow multiple postings, addendums, errata et. al. to ensure the survival of the fittest.

Joe Hughes says:

Do markets evolve toward efficiency?  When left to the customers alone, yes. Markets will move towards efficiency and liquidity.

The most jammed-up bid/ask spreads and general liquidity problems seem to occur where there is a market maker or specialist involved. Generally it seems that they hold the bid/ask spread so wide, it prohibits the speculator working in the middle. I have seen bids blocked, continually sized out. I have seen this in most screen-quoted markets, stocks, options; from high-priced stocks to securities quoted in thousandths. This practice aside, I would have to agree that markets do evolve to efficiency, and only when manipulated by man does their growth stunt.

Gary Rogan adds:

What is often missed is that while biological evolution is based upon propagating one's genes over a very long, from the evolutionary perspective, period of time (if numerous individuals who share the same genetic makeup do not propagate they will disappear as a group thus will lose in this game) the markets evolve on a much faster scale and without any genetic code. This distinction fundamentally changes the game in the following sense: while the best adaptation using randomly selected mutations is what happens in nature, optimizing the subconscious desires of all the participants is what happens in the market to the extent that the participants do not run out of capital.

The behavior of the market, of course, influences the subconscious desires of the participants in a reflexive way near and dear to Palindrome, thus overvaluation bubbles will continue to evolve towards bigger bubbles because:

  1. nobody is running out of capital; and
  2. the subconscious desires of most participants are positively influenced towards lack of fear and overabundance of greed.

Since increasing one's capital is NOT the only thing that increases the overall satisfaction, "animal spirits" of a large portion of the participants will play a bigger and bigger role. This is obviously highly non-profound and almost self-evident, yet many economists continue talking about optimizing economic performance. At any one point, asking oneself,  "What would optimize the overall satisfaction given the zeitgeist and the latest information widely available to all the participants?" is useful in order to "guess" the direction of the market. There is private information available to most of the participants that cannot be easily discovered by any one participant, and it will also make itself felt, but since it's essentially unknowable it's also not useful in guessing the direction of the market. Periodically, given unpredictable external events and well-known dynamics of bubble puncture, the zeitgeist will change. Re-asking the same question about increasing the overall satisfaction at that time will also prove useful.

Jim Sogi comments:

The market is an experimental world in a bottle, modeled on the real world, with fixed rules. Activities are carefully recorded and plotted. Inputs are transmitted from outside actors, and effect changes within. Unlike the elusive and enigmatic meaning of life, the purpose of the market is readily understood: to provide capital to the productive ends of mankind.

Just as the struggle of the individual for existence is the mechanism in evolution for the advancement of the species, the quest for profit is the mechanism for providing capital for productive enterprise. In the market and in evolution, both loss and gain at the individual level is the gain of the organization. The dichotomy is that the needs of the individual differ from the needs of the organization, but in the end the organization is supported even in the failure of individual need.

This dichotomy is illustrated in other systems. The adversarial structure of the legal system pitting parties against each other, which while creating strife and struggle for the individual, brings out the best result from the competition. The mouse about to be eaten by the lion does not say, "Ah, I sacrifice myself gladly for the good of the whole." The losing litigant does not say, "I sacrifice myself for the good of the system." The trader does not say, "I give up my profit and capital for the good of the system." In each case, the individual viewpoint and the system view differ, but the system serves a higher function. Viewing occurrences from the system level works better in marriage and in legal matters. This key dichotomy can be applied profitably to the markets.

Darwin theorized, "If under changed conditions of life, structure, before useful, becomes less useful, its diminution will be favored, for it will profit the individual not to have its nutriment wasted in building up useless structure. Thus I believe natural selection will tend in the long run to reduce a part of the organization, as soon as it becomes, through changed habit, superfluous, without by any means causing some other part to be largely developed in a corresponding degree. And conversely, that natural selection may perfectly well succeed in largely developing an organ without requiring as necessary compensation the reduction of some adjoining part."

Through these processes, the whole improves and survives, though a trail of individual tears follows. Look at the system's purpose to maximize transferal of capital, maximize liquidity for the maximum productive use rather than focusing on individual needs. The idea that "I am what I am, and do what I can" leads to extinction or diminution. As conditions of life; change, adapt, learn new things, change. The system is not there to reward the individual, it is there to maximize its transferal of capital. For the reason Darwin theorized, each system has a life cycle that fits some curve. Two weeks ago the markets closed down for the week, this week the closes were up. The systems that worked last week don't work this week. Are you going to be the dinosaur or the crocodile? See your place in the firmament. The trader inside the market system can transcend the evolutionary forces by seeing above the individual transaction.

A Word, or Two, from the President of The Old Speculator's Club:

For those who enjoy parallels between "descent with modification" and the market, let's start with this fact: over 99% of all species that have ever existed are now extinct. If you are married to the Darwin/ Dow analogy, this could prove troublesome. But let's assume you can remain solvent until the lottery of life calls your number. In that scenario, Darwin provides some insights that can enhance and, perhaps, lengthen your survival. Especially if we appreciate that there is a critical difference between our standing in nature and in the market. In the former, we are participants whether we like it or not and it's an irrevocable "until death do us part." In the latter, we are there willfully and may withdraw at any time.

It's an important difference since it affords us the opportunity to choose to play and, if so, to choose our "biosphere". The sea, like the entangled bank, offers abundant life forms; but the system is an extraordinarily complex (and extraordinarily dangerous) ecosystem. Of course, the greater abundance offers greater potential rewards. If the sea were our chosen milieu, most would prefer to be a shark and a demented handful would opt for the angelfish. However, neither birth nor the market is fair, and we must play with the chips we have accumulated. With that in mind, and cognizant that the market is no less cruel than the sea does the angelfish choose to sup with the sharks? Incredibly, yes.

The day trading coral atoll is notoriously lethal but as long as movies are made and books are written glamorizing the pursuit and making it appear simple, fresh fish will keep the sharks well fed. The option reflection pool is another popular starting point for many of those who have read, and believed, any one of several hundred newsletter writers claiming expertise in this field. Few people are put off by the prospect of modest profit or the promise of a good meal at a reasonable price. More desirable is Archimedes Lever and the potential for a huge profit and a free banquet. Major brokerages promise to keep the initiate safe and comfy in their highly capitalized, well-protected, deep-water grotto.

Unfortunately, our angelfish aren't aware that they're represented by the anglerfish. Found only at the deepest, darkest depths, the female anglerfish possesses a huge mouth and an expandable stomach; not surprisingly it can consume a fish as large as itself. The male anglerfish, only 1/10th the size of the female, lives its life attached to the female and totally dependent on it for food and safety. (However, because it requires oxygen just as much as many other organisms, but lives so far beneath the surface, the anglerfish has very thin skin - and must be handled with care.)

If any of these situations mimic real life, it might be time to reassess your investment approach. Nature and the market offer a large number of less abundant and less attractive niches. The dessert seemingly offers very few attractions; but, anyone who has ever seen Disney's "The Living Dessert" can attest, if you are patient and in the right place and the right time, the rewards can be breathtaking. Mountainsides and tundra are equally dreary - but the former occasionally lie atop tons of valuable minerals and the latter serves as a drab cover for oceans of gas and oil. Rarely, however, do these venues offer extraordinary rewards - more often, the rewards are in line with 7-10% expectations that have characterized the market for decades.

Can you beat the market? Why do you care? The key question is "How much do you need to survive and leave heirs?" Anything beyond that demonstrates an over-riding concern with what others think - that's easy:  They don't think about you, they're too concerned pondering what you think of them. Angelfish with greater appetites are forgetting one of nature's great truisms: for 99% of all existing creatures, every day is a battle to get just enough food and proper shelter to get through until the following day. In nature obesity is a chimera, vacations non-existent, and sympathy non-productive.

Like the lowly and vulnerable angelfish, investors should content themselves with modest expectations and a limited field of interests. One might argue that even a few fields is too many and one is more than sufficient. Maybe, maybe not. With a 99% fatality rate, is it not more than likely too many species became too specialized - and subsequently, when the sharks moved in, were unable to adapt to a different diet? The secret here is "preadaptation". Though relatively comfortable and protected in their current environment, our angelfish (according to Ridley) spend some of their spare time bouncing across the muddy bottom with their lower fins. One of these days they may have to hop along the mud flats as Jaws closes in.

But few of these niches (and water, by the way, is a very nice niche) offer huge short term returns. And this is contrary to Joshua Franks' observation that "there is much more desire to make large gains quickly than to invest for the long-term." Therefore, and you're given this freely, you must invest for the long-term and your expectations must be modest; with the miracle of compounding even modesty can achieve an immodest stature.

For those few who heed the word, expect to be lectured repeatedly on "opportunity costs". Individuals who embrace the opportunity-cost argument, dream of a mythical world where all of one's capital is always invested at a rate of maximum return. Some worry about "dead money". Better they should worry about no money. If they're insistent, demand to know precisely where you should place your money and for how long it should remain. Mark it down and compare 10-20 years later.

Never forget that the success of any given market area is a function of reproduction or, in Franks' terminology, "interpersonal reproduction (where the meme is transferred between individuals)". Call it news, call it gossip, call it a rumor, call it a lie - whatever it may be, it becomes so prevalent in every day discourse, that it becomes a "must own" or a "must short". But again harkening back to Franks, "a meme's interpersonal reproductive fitness may have nothing at all to do with its economic reproductive fitness." In short, the latest hot stock may be the biggest lemon on the market (can you say Lucent?).

Undoubtedly a few words should be expended on mutual funds. Nature provides similarities in both the predator (lions, wolves) and prey (zebra, buffalo) categories. Generally speaking, if you follow the rules (and they're not negotiable) you'll live a hard life hunting with the predators and, unless you're an alpha (and if you're thinking mutual funds, you're not), with only enough food to keep you healthy and no sex and no offspring. If you're prey, the rules are pretty much the same - the only solace to be found is in the large numbers. Unless you're very young, very old, or crippled, the odds overwhelmingly favor your survival should the herd come under attack. It may not seem like much of a life, but if it's a no-load fund you'll find contentment in starving the anglerfish.

Steve Ellison rejoins:

An excellent book on the application of evolution and other scientific principles to business is "The Power Laws of Business: The Science of Success" by Richard Koch. Below are a few key points from the book, with some thoughts on how we might classify or quantify them.

  1. The "struggle for existence" makes the few survivors stronger. The struggle is more intense at some times than others. Measures of competition might include the number of mutual funds, the number of hedge funds, and the prices of exchange seats.
  2. Variations in both organisms and environment result in fitter organisms and a richer ecosystem.
  3. Ed. Spec. likens the public to producers, dealers to herbivores, large speculators and hedge funds to carnivores, and locals and vulture investors to decomposers. Environments include bull markets, bear markets, trading ranges, recessions, recoveries, rising interest rates, and falling interest rates. Ed Spec classifies markets into open and closed markets. Competition is an important part of the environment. Questions to ask might be:
  4. As complexity increases, niches increase. Lawrence Harris identifies several types of information advantage: order flow, non-randomness of price movement, value analysis, and news. What niches within these categories are opening?
  5. Reproduction is as at least as important as survival. However, most offspring will not survive. New market players might be classified into new mutual funds, new day traders, new brokers, and new 401K investors. The nature and level of sales of market best-sellers would provide clues to what market memes are reproducing fastest.

Sushil Kedia adds:

With all the due respect to the President of the Old Speculators' Club, a few queries emanate from his observations:

Is our standing in nature and in the markets really very different? Not having a position at points of time is different from not being in the market. I mean ,is a market pro ever really out of the market? Likewise, until death do us part, people do withdraw from the zig of life, either to escape to temporary temporal leisure or withdraw inwards. What happens if a withdrawn anxious or depressed soul refuses to brush his teeth twice daily, ignores the required exercises or ignores keeping regular track of expenses? Please correct my belief that a career in markets or for that matter any career and the targeted quality of life existence are both like riding a tiger, which you would rather never dismount from. Taking a respite in not kicking the tiger to run faster is different maybe.

From the focus of the evolutionary perspectives even those who do not engage in a specific market could be highly impacted by unknown or untracked markets. A cricket player who may not be participating in legal or illegal betting syndicates could very well be part of a losing side even while setting up a world record shattering performance in a particular match. A Red Indian never interested in the global spice trade could very well have come in touch with Columbus who had set out to find a sea-route to India.

It is an interconnected world where economics and markets are facilitations for improvising interdependence.

Now if markets are about interdependence and have grown to a point of being highly reflexive, causing events to happen or not happen which have in the previous 5000 years of economic history have been seen as driving the markets, one arrives at an angle to think closely about whether markets evolve to efficiency?

In answering the central question of this thread, one starts and stops soon in asking which efficiency are we concerned with? The type of efficiency defined in the earlier models of Financial Theory or what it is actually supposed to be? If markets are adapting constantly, continuously and perpetually then they are not efficient yet but moving towards efficiency, right? Well no, since the purpose of markets is to enable us to collectively as a race move towards more efficient adaptation. Well then markets are already efficient since they are achieving their purpose. The mechanisms of the market-place evolving each moment further is then nothing but the evolution of markets. The question is similar to asking if we as a race are evolving towards better efficiency? It indeed is different from asking whether markets are evolving efficiently?

There is one serious difference though between the evolution of life and the evolution of markets or arriving at an understanding of the propagation of markets through the evolutionary framework of memes. In nature there is no periodically appointed regulator, who is often limited in its role by the compulsion to be politically correct, while in markets there is. In markets however much of a strong shade of freeness there may be, the purpose of the regulator is to ensure a fair game and a level playing field. In life, nature is assumed to be fair and winning is the only option to level with the field. In markets the process of 'natural selection' has to be modified with suitable quantification, if and when possible, of the (ir)rationality of regulatory action. Now, if it could be answered unambiguously whether the purpose of markets is to allocate capital and risk adjusted returns on such capital efficiently, but not ensure that the trusting will be protected from the cynical, then the markets are trying to move to efficiency. However, if the purpose of markets is focused on a fair way of allocation of matching returns for risks they are obviously efficient since they are mutating forward further, and propagating.

I think that with such a wide bandwidth chewed up already, I have still not been able to get anywhere close to the central question: Are market memes leading the markets to be more efficient? Markets, as one has tried establishing in my earlier paragraphs, are already efficient. The compression of returns, the reduction in size of the percentage moves we are able to capture in the major markets in the world today has not taken any of those markets closer to efficiency; it is just a variation in the game. When the crowds lurched into finding bigger fish the better hunters shifted game to newer shores, and while the crowd keeps hurting itself becoming small fish itself, the better hunters are happy catching these smaller fish.

To pause and organise my thoughts further, I submit for the moment two more question:

Is nature evolving to efficiency? The answer is no, since it is already efficiently facilitating evolution. So the question is, Do markets sound similar to what nature is doing?

Because (al)most whatever we humans have been accomplishing in our contribution to the pathways of evolution is drawing upon our ability to observe, gain perspectives on and respond to the challenges of the natural environment we operate in, are markets not a human response mechanisms to the vagaries of nature? No, this question does not derive motivation from noticing the growing market in weather futures or carbon credit alone. The entire chronicle of every invention and every discovery is a creative replication of our observations of the prevalent phenomena in nature. So, the second question is, are markets not a reflection in our observing minds of the picture of evolution we see in nature?

Vinh Tu adds:

The market is distinct from the state of nature because the market embodies certain rules and ideals. We can forget this when we think of the market as a Darwinian struggle for survival. Mr. Sogi points out, however, that the purpose of the market is to produce wealth and transfer resources. I'd like to expand on that theme, and contribute my own ruminations.

The market depends on certain conventions such as respect of private property and respect for contracts. We sometimes speak of "levelers" who seek to bring down those who generate value and possess value and sometimes are tempted to think of them as strange unnatural beings driven by warped beliefs. Yet the "leveling" drive is also present in the realm of international relations, where it is sometimes called "balance of power", and involves ganging up to attack the strongest. I would not be surprised if similar behavior could be found in monkey tribes. Therefore, it may be better to regard the leveling drive as not some aberration of nature, but simply as a primitive tendency that must be taken into account and managed if one wishes to build towards something higher than a jungle free-for-all. The more noble force which enables us to overcome the levelers is the convention of reciprocal respect for our fellow man's labors and accomplishments. Respect for private property enables trade, and trade creates markets, and this enables the mistress of the market to come to life. In one sense, then, it is possible for a person to withdraw from the market. Playing the market game means respecting people's private property, and attempting to acquire property for oneself by following the rules of trade. It is fierce competition, but competition in accordance with certain beliefs regarding fairness and regarding the betterment of oneself and one's position and the right of others to better themselves and their position. One could refuse to play the game, for example, by violating the rules of the markets, by expropriating companies, and by inciting and unleashing the leveling desires in the population.

What distinguishes the market from collectivism is that although market participants must share certain values such as the pursuit of good things, and the right to enjoy the fruits of one's accomplishments, participants agree to disagree as to the specifics of how to carry out this pursuit. This area of disagreement provides the battleground for ideas. This is the entangled bank. One might be tempted to look at individual people, traders, as the elements acted upon by natural selection. However, I prefer to think of the memes that occupy the traders minds. Some minds provide a permanent home for bearish memes. Others may only provide a temporary resting space, and pain in the back of this trader is enough to eject the present meme in favor of the next. One thinks next of the pathways, or vectors, along which these memes travel: news, tv, analysis, reports. Each provide varying amounts of bandwidth. Then there's price. Price can be considered either a meme in its own right, or a message that conveys a portion of a meme. A meme (such as Hubbert's peak) cannot be conveyed by price alone. On the other hand, the memes can be supported or undermined by price action. Rising oil prices give vigor to the Hubbert's peak meme. Falling prices damages the meme's ability to spread or survive. The general population can hang onto some memes despite price movements (and so we have the websites that continue to proclaim the falling dollar.) However, for entrepreneurs and speculators, price is one of the sharpest knives for cutting away a meme. When the selling price of a product drops below the cost of inputs, the businessman is forced to abandon the meme despite what protestations other sources of "information" may trumpet. While a speculator may not change his ideas in response to a particular price movement, he will notice it nonetheless. As a channel of information, it is ubiquitous.

The query, then, is not only whether memes lead the market to efficiency, but whether the reverse might be true, that the market leads to more efficient memes. As we are all allowed to have our own ideas, we have a rich ecosystem of memes. The memes proliferate through the media, personal communications, government publications, and so forth. Contradictory memes can fight it out in debates or can compete for mindshare and eyeballs. One particularly useful tool for culling memes, though, is the law of one price. When the law of one price holds, when one has liquid and efficient markets, then memes associated with high-price cannot easily coexist with memes associated with low-price (except in a minority of specially configured perma-minds). Various meme-complexes relating to various prices must sort themselves out. In a sense, the law of one price acts on memes in a similar way to the philosophical Principle of Non-Contradiction. Self-inconsistent belief systems become undermined. Insofar as several internally consistent outcomes are sometimes possible, reflexive effects arise and perceptions cause one outcome to dominate the others. The result of the culling process is that fewer memes survive, but these are now more compatible with one another than previously.

Direct culling affects the business-plan memes that are rendered unprofitable. "Now," you say, "this is simply standard econ -- we need not be talking about memes." However, I want to talk about memes, and I will. Now, surrounding each business plan we have the related meme complex: memes about strategy, trends, society, paradigm shifts, etc. A new price level can decimate whole meme complexes while speeding the growth of whole new meme complexes.

And so, I picture the mistress of the market constantly using her mesh of moving prices to cull some memes and promote others, while generating energy from order flow and commercial activity.

Regarding speculators, I suppose the meme model supports trend following, since a continued move strengthens the meme. However, memes don't exist in a vacuum, nor do prices. Actual producers and consumers force prices to fit the constraints of the real physical world. So we learn what we already knew: that trends continue until they don't. Furthermore, as a trend develops, a whole meme complex may develop--any one of which should sooner of later run up against reality.

Regarding a different aspect of this debate, the question of whether we (or our memes) serve the market or whether we are individuals in a pure Darwinian struggle could be examined as a debate between group selection and individual selection. From the vantage point of group selection, one remarks all the situations in which individuals sacrifice themselves for the sake of the group, where traits can spread which benefit the group at the expense of the individual who posseses that trait. We can think of those who buy at the top, or who build excess fiberoptic capacity and then fade away. Or, in terms of memes, we can think of well-formulated scientific theories with clear, falsifiable hypotheses. Group selection theory proposes to explain these in terms of the benefit to the group: i.e. the group that contains these elements will dominate the group that lacks them. On the other hand, individual selection theory seeks to show why the trait is in fact a selfish trait, and why it is in fact well-suited to making copies of itself. For instance, the trend-following meme's fitness could depend on it being easy to learn and promote, and the commissions generated by it, as well as atavistic copying and herding tendencies. To be a good meme, a scientific theory needs to be falsifiable otherwise it is rejected by scientists and cannot propagate itself through the many channels available to scientific theories.

For related books, I like Dawkin's Extended Phenotype, which explores the way in which genes, and complexes of many genes, interact and produce long-range effects. There are extremely interesting examples, including genes inside parasites which influence the behavior of the victim... in such a way as to help spread those genes, of course. Really, I think individual selection's got it all. Not that I dismiss everything about Edward O. Wilson's sociobiology. There is a good case for group selection existing. Only, I think group selection can really be reduced to individual selection. And I mean that in the same way chemistry can be reduced to physics. A fun book is Howard Bloom's Global Brain, which contains some interesting ideas and many great examples of group dynamics and complex systems; unfortunately I find that the main thesis of the book is to attack a straw man version of the individual selection theory. In fact, the selfish gene theory encompasses extended phenotypes and complex systems.

But let's return to the levelers, and the mistress. A group selection theorist might say that market participants might sacrifice themselves to protect the mistress against external threats. An individual selection theorist might say that the participants behave in a way that maximizes their fitness, and in the process of ensuring their own survival, help the market to survive. Both theories are correct, or rather, the individual selection theory is the correct general theory and the group selection theory is the applicable special case.

If one looks at the market as an organism, it must have a defense mechanism against the levelers, which endanger the market through rule violations. Being a meme, the market gets its "energy" from the belief people have in it. When people are made happy by the market, the market gains energy. When people profit by the market, the market gains energy. And when people take a loss gracefully and attempt to better themselves, the market does not lose energy, but rather gains energy later when those same people come back as better traders. We look at the market and see first the sharks, the angelfish, etc. In addition, there are the photosynthesizers, the algae and the phytoplankton: these are the hamburgers and widgets. Every time a widget is made, or a hamburger is eaten, the market gains energy. A meme that undermines the root source of the market's energy is therefore one that is harmful to the market. One such harmful meme is the one that says one has a right to any hamburger or widget, regardless of who has made it, how it was made, and the conditions necessary to ensure the ongoing production of goods.

I wonder whether it is a reasonable hypothesis that the mistress of the markets is an organism equipped with self-preservation instincts. She's done well so far. Markets have emerged many times in many places throughout history, each time stronger. Perhaps she's evolving. If so, one has to believe in her having the means to defend against her enemies. Yet it seems strange to say the market is evolving, since evolution presupposes units that can be subjected to natural selection. Are there a many mistresses of the market constantly struggling and dying and multiplying? In the form of parallel memes, parallel market mistresses, parallel sets of market-oriented values and conventions, constantly being born and dying in the consciousness of each and every participant? But these thoughts now seem to lead me back to mythology, and to Utgard.

14-Feb-2006
The Story of Thor, Utgard, and Bernanke, by Victor Niederhoffer

The Norse myths are particularly rich in timeless folk wisdom that served the Scandinavians in dealing with the unknown and maintaining the feeding relations necessary for the survival of that rough, seafaring society. Thor was particularly revered by the Norse because of his power, symbolized by his hammer and belt, but was easy prey for deception. Such a deception was practiced by the Giant Utgard, who met Thor and Loki in the forest. Angered by Utgard's husbanding and the poor provisions that resulted from pooling food with him, Thor took his hammer and banged it on Utgard's head. Utgard asked if a leaf had fallen. Next the snoring angered Thor, and this time when he banged it, Utgard asked if an acorn had fallen on him. Finally, Thor dealt a blow with all his might, and Utgard only asked if the birds above in the tree might have been disrespectful. After further adventures where Thor mistakenly is tricked into trying to drain the ocean and move the earth, Utgard reveals that he had tricked Thor over and over. Thor had been hammering the wrong thing, a mountain, well after Utgard had disappeared.

The myth might provide a lesson for Ben Bernanke. Never has there been such a decline in inflationary expectations in recent year. Let's look at the commodities once considered bellwethers of inflation because they were used by industry and consumers so extensively. Natural gas is down 50% over the past three months to $8 per million BTU, heating oil is down 45% at 1.38 per gallon at a 9 month low, gasoline is down some 50% over the past 3 months to $1.38 a gal, an 8 month low and crude oil is down 13% in the last month, breaking below $60 a barrel before closing at $60.10, about its average price for the last year. The Goldman Sachs Commodity Index futures is at 414 down some 86 points from the October levels, near a nine month low. Except for a brief dip from October 2001 to Dec 2001,which registered some 20% in the GSCI, these representative declines may be the greatest declines in inflationary expectations in history. No wonder the Dow broke 11000 today for the second time this year, and this time up up and away. Needless to say, this decline in inflationary expectations has not been noticed by those who would try to make the economy seem much worse than it is, so as to level and weaken. That's understandable, given the nature of things. But what's difficult to grasp is how people at the Fed could proudly be talking about continuing to knock all the inflation out of the economy with further interest increases. A lesson in Norse mythology would be good for the powers that be there. There's been far too much looking at the retrospective production statistics that was "Doc Greenspan's" specialty used as a guide to their actions in the past. But it's an ill wind that blows no good.

Eventually, someone at the Fed will realize what every economics student and every trader knows - that the market looks forward and captures the balance of expected supply and demand in its price signals. At that time, the economy will be able to fight off the drag of all this retromingent thinking from the central bank planners, and it will not be long before anticipations of such activities and reflections will be registered in the always forward looking stock markets.

Steve Ellison adds:

Of the top 10 physical commodities by open interest, 5 are up and 5 are down so far in 2006, with the average year-to-date change being -3.3%. The bull case for the biggest gainer is that it is an energy substitute.

               Price     Price
            12/30/2005 2/14/2006 Change
Crude oil      61.90     59.57   -3.8%
Corn          215.75    218.75    1.4%
Natural gas   11.359     7.114  -37.4%
Sugar          14.68     17.72   20.7%
Gold           523.4     545.3    4.2%
Wheat         339.25    347.25    2.4%
Soybeans      613.50    583.25   -4.9%
Live Cattle    95.05     89.10   -6.3%
Soybean Oil    219.0     220.4    0.6%
Heating Oil   179.13    161.00  -10.1%

23-March-2006
How the Brain Works, from Steve Ellison

The way the brain works is that shortly before birth, the brain neurons begin trying to communicate with one another. In doing so, they create paths called synapses. From age 0 to 3 trillions of these synapses are created. After age 3, few new synapses are created; indeed, about half the existing synapses deteriorate and become non-functional because of lack of use. However, connections that are used frequently become stronger and stronger. The pattern of these powerful connections is unique to each individual and is the basis of natural talent (Buckingham & Clifton, 2001). I was thinking of the uniqueness of each person's strengths when I said earlier that everybody can be a star.

It is extremely difficult for the brain to develop any new paths after age 16. My organizational behavior teacher was very enthusiastic about a technique called neurolinguistic programming to try to blaze new pathways in the brain. The most dramatic success stories in this regard have been among amputees who had to relearn many basic body functions (Buckingham & Clifton, 2001). For most of us, however, it is simply not worth the tremendous energy required to develop new paths. Applying the same amount of energy to developing the natural strengths we already have would pay off much better.