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

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

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

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

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

Dr. Kim Zussman adds:

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

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

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