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The Chairman
Victor Niederhoffer

4/11/2005
Daily Speculations Forum: Racing and the Market

The aerodynamics of car racing and bicycle racing are well studied, with the optimum position of cars in a line depending on vertical and horizontal drag. and other factors. Apparently being second in a car race right behind the leader is much more of a wining position than first. I wonder how important such considerations are in human racing in such things as sprints and marathons and relays. I often remark that it is much more bullish for a stock late in the day vis-a-vis the rest of the day if it's just down a little as compared to just up a little (and of course this must be tested over and over again). One wonders also whether the position of a company within an industry in weekly, or monthly performance, shows similar aerodynamic properties and whether this changes with the wind and the past (I look around three times)  "trend." -- Victor Niederhoffer

Russell Sears comments:

A few thoughts on this with perhaps some speculative avenues to pursue.

First, drafting is much more important into a head wind. When the going is tough, nobody wants to be the leader. The largest pack I have ever been in was at the start of Chicago Marathon during a windy day. Even the women were running with the guys. But several mile through once the corner was turned so the wind was at your back the pack thinned immediately. The favorites separated from the crowd.

Late in a race, the wind has much more effect on you as your strength and fight is often gone.

Perhaps some similar effect occurs in the stages of business, e.g., groundbreaking biotech and alternative energy stocks versus mature companies.

Second, leading a chase pack has an adrenaline rush and is heady stuff. Timing this adrenaline rush is very much like giving a diabetic sugar, full tilt until they crash and burn.

But taking the lead from someone can be very demoralizing. My strategy is to take the lead after the hill or after the wind, when doubt is highest. Often a reputation, a name, can be very intimidating. Passing Bill Rodgers or Frank Shorter was very hard when I was just starting, even though their careers were starting to wane and mine was taking off. But once I passed, it gave me newfound energy to ensure I beat them. The idea is to create a mental gap, not just a physical one. The GE-Exxon duel comes to mind. Perhaps sector duels also have this effect.

Watch for the "crash and burn effect" once the battle has clearly been won/lost.

Once the "gap" is created, often both competitors fall off their dueling pace. This itself can cause havoc as your cardiovascular system, which was in equilibrium, slows and lactic acid starts to pool. Slowing the pace due to increased wind drag can also causes havoc because your leg turnover slows, The way the blood returns to the heart is largely through leg motion. Pooling sets in as this motion slow. the Answer is to take smaller steps keep the turnover at a high pace. Unused capital and cash pools comes to mind.

This effect is usually greatest for the person passed, as they often give up. The leader has a newfound motive to try harder. This is especially true of a marathon. The worst thing, and surest way to miss your goal time, or finishing place is to look at the watch and calculate that you can coast in. Anyone who tries to let up a minute in pace will end up giving two or three minutes.

Older leadership wanting to coast in till retirement come to mind. Not all older leadership of course fits this. One example would be the first-generation business with the patriarch ailing but unwilling to cede control.

Drafting is best for longer races. In shorter races such as a mile, being second with a great draft leaves you vulnerable to being boxed in. The third placed guy will work with the first place guy to at least overtake you. In the market, perhaps this corresponds to too many close contenders, leave them battling among themselves.

Taller people fare worse in the wind, as the length of the winds leverage has increase, with your feet being the fulcrum. In the market, you can see volatility's effect on high beta stocks.

Finally, big packs cause a lot of elbows to be thrown and heels to be clipped. There are even shoving matches. Which is why our heavily favored team did not make it to Cross Country nationals, as punches were thrown at our second-best runner. Which brings to mind certain companies being investigated for their earnings and premium smoothing behavior: Unsportsmanlike conduct can shift everything.

Jim Lackey comments:

Drafting with motorcycles in the Grand Prix circuit has separate danger issues of their own. Craig raced and will discuss a street-bike-racer losing traction in front of you under high braking. Those boys run at over 180 mph.

In motocross drafting is very dangerous. The rear tire throws up rocks, clay, sand debris into your face. My first encounter, my cousin and I were training, racing 80cc motocross bikes when we were 11 years old. A rock came off my cousin rear tire and we were 5th gear pinned down the back strait away at over 60-mph. I remember this as clear as day-today, I tipped my head, like a tip of a cap. The rock took off the top of my helmet. A huge chunk of fiberglass was carved out, ruined a Bell Moto-III helmet.

Next, is racing in the mud. We must draft or run in single file due to ruts in the clay. There is usually 3 good lines or paths to race on the track in good conditions. In a mud race, either you run through massive puddles or you play follow the ruts, where everyone ran and you can achieve traction. On a jump, airborne you take you hand off the bars and tear off a lens off your goggles to see.

I remember getting hit so hard in my chest protector, a plastic gladiator type chest gear, the mud cakes hit me so hard it was a complete "knock the wind out of me" situation. Crashing falling flat on your back is the worst. You have the wind knocked out of you every time. You cant move, you feel like you are going to die, you cant breathe.

That is what scares the Hades out of guys racing and riding dirt bikes, crashing. That is the same as trading, fear of losses, money management, placing stop loss orders. However, anyone that has ever won a trophy loves to win. Sure we never like to lose, yet we are good sportsman. What we hate is not winning.

I am having flashbacks to racing pro class. trading the S&P futures is like racing any type of professional class. If you are not "on it" psyched, trained by a scientific tested program, and a bit lucky you have no shot what so ever at making the main event, the money round or being very profitable overall. Being a pro, paying for your races or making just enough to maintain the class is not a business, not winning, not profiting is losing.

Of course the top pros all went through these losing or not profitable times in their career. Certainly that is what separates the AA pros vs. the A pro riders is the fact the never gave up. The worked through their injuries and never took the easy way out, a salaried job for a brother in law.

I just saw an interview with a drummer in an alternative rock band. He tattooed himself from head to toe. They asked him about the art and why he chose the tattoos. I was about to drop the report when this caught my eye. The point of the tattoos was so that he could never be employable at a regular job. His idea was he was forced to either become a great rock and roll drummer or much worse, so when the chips were down his alternatives were worse than the alternative music scene.

I never really wondered why guys left Vic's trading and went on their own to do other things. I always just assumed these guys were smart and knew thy had connections and would be successful in life. I figured they just didn't have the passion for trading. The ones that left, and stated their own firms a direct copy of Vic's programs I guess were just pure hubris. They figured that sooner or later they were smart enough to figure out what Vic taught them on their own. I gather that as no real "thank yous" were offered and some offense was taken.

Then of course there is the old Mr-e experiment when he he calls Ivy boys stupid and they grenade in place. It is funny to me and a few of my friends. Our claim to fame is we have blown up more racing engines, relationships with women and cars (2 close loves) than we can count. In short we are wrong so often that it is quite simple to accept in our trading.

To draft a guy that knows how to profit off the markets is easier said than done. Dale Earnhardt died trying to help his team mate win the Daytona race years ago. he was just trying to help the poor bastard get his first big win, his team mate and would share in the profits.

I get the biggest kick when people tell me I would be broke if Vic didn't bail me out. There are many reasons I laugh. One, I have admitted that 57 times right here on the list. Second many kicked Vic when he was down in 97 and again in 2002 and I was right there. There is no one in the world happier than me to see Vic succeed. He deserves it for his life's work, that is profitable. especially after so many used him to market their own sham businesses.

Yet, the markets are one of the most competitive games in the world. I had a BMX buddy ask me the other day about trading Forex. I said oh no way. Forex, futures on the S&P options is like racing AA pro class. Nazz futures are the A pro ranks with big cap or S&P 100 stocks. Vet pro or expert class is Midcap and all other stocks. Small caps, penny stocks is the rookie class. I asked him what class do you want to race?

Craig comments:

Okay well I wouldn't consider myself an expert on this subject I have done my share of time at/on the racetrack with a superbike so at Lack's request will throw in my two cents.

Would seem to me that the major difference from the cars to the bikes is that a "bump" from another car coming off the draft into the turn or at any point won't put them on the ground, and one thing you try to avoid in motorcycle racing is the inevitable "road testing" of your leathers. All it takes for you to go down is for you to be focusing on the man in front of you too much and for him to go down, if you are watching someone go off the track at high speed then you better prepare for the fact that when you take your attention from him you will most likely be in the position of going down yourself, a great example of the old axiom, "you go where you look", the easiest solution to this is to never watch a falling rider which I would say is akin to "don't focus too much on the current price of the market, while you're in that trade", be aware but not fixated.

So drafting with bikes is certainly most common down the longer straights and often you see more of a dispersal going into the turns, this is where I go off on the tangent, bikes have a bit more room to adjust their lines through the turns so you will quickly see that most riders approach their line based on what they consider their strengths and weaknesses (sounds just like approaching a trade doesn't it?). A rider's line is basically his plan for going through a turn, for example, a rider that likes to use the maximum amount of lean angle typically designs his lines to use lean angle to his advantage so his line often is tight to the inside of the turn, while in contrast a rider who does not prefer to use all of the ground clearance available will likely have a line that limits his maximum lean time, so he will finish steering as soon as possible, straighten the bike and move from the turn as vertically as he can. So riders, much like traders will design their turns (trades) around the strong points they believe they have.

Now to watch the best of the best in MOTO GP is truly a beautiful thing, the current list of greats that are racing now would include, Valentino Rossi, Sete Gibernau, Loris Capirossi, Troy Bayliss just for a few that often battle up front. All speculators should indeed watch a GP race and consider the number of strategies involved to truly appreciate all that is happening since they do make it appear effortless and fluid. Rossi is the current master in my opinion, when he's not in the lead he's merely stalking the man in his way, examining their lines and braking habits while staying a foot or two off their rear tire, it does not take him long to recognize where the rider in front of him will begin braking and what their line through the turn will likely be and once he has that info , he simply waits for the proper time/turn to overtake them. If he knows where you begin braking in turn x, and he also knows that he go deeper in that turn before he needs to brake, then likely he'll late brake them and the next thing they see is his rear wheel, then it's a matter of can they keep up and do the same right back to him. This world is full of trading analogies, much as the everyday life of each speculator, one must simply open their eyes so that they may see.

Don Van comments:

Craig I agree with all your points and can add some that may apply to trading. I raced open wheel single seater formula cars until 1994.

It is certainly true any rubbing can be dangerous for bikes however it was equally dangerous with open wheel racers if not done with extreme care and with someone you could trust with your life. A wheel to wheel rub was OK but getting a wheel inside another usually led to disaster and end over end multi car crashes. I was involved in many mostly on starts and into turn one.

There are many subtle and specific techniques to drafting besides the obvious of the hole in the air advantage. It starts with knowing your competition and who you can work with to take max advantage. In each race I always knew who was my competition for the win usually 3-5 drivers in the field the rest were of no concern. In any race the idea is to eliminate as much as the competition as you can quickly. After a successful start and making it through turn one intact I always looked to see who I was running with, if it was someone as fast as me we would attempt to "hook up" and "work together" to separate from the rest of the front pack. Two or more drivers working together can go much faster then a group that is fighting it out under braking at each turn.

The best technique is to use the "leap frog" strategy which simply means on the longest straight you take turns passing each other to take advantage of the draft and never pass under braking which only slows you down. The end result if executed correctly is an insurmountable lead on the rest of the field that increases lap after lap leaving the race in the hands of only 2-3 drivers with a few laps to go. The ideal situation is to be left with only 2, you want to be the #2 car on the final lap, make your pass on the long straight utilizing the draft and come out of that last turn in the lead. Of course with about 3 laps to go the #1 car is thinking the same thing and trying to sucker you in to taking the lead. It is important on that final lap not to make the pass too soon and risk a re-pass into the final turn, best to drop back prior to the turn before the long straight so you can take the turn at max speed but not end up directly behind the lead car and be forced to take the pass too early on the straight. Experience, patience, confidence, discipline all become important in this final move. Many drivers will choke in this situation where one move is for all the marbles no second chances.

I have been in these situations many times as #1,2 or 3 and it is possible to win in any position but different techniques are used in each case much of it depends on the action-reaction of the other drivers, lots of feints, mind games, jockeying going on in that last lap. If in the #2 or #3 position observation of the driver ahead is also important, is he checking his mirrors, getting tired, sloppy, sliding the car, missing brake points, wide in the turns, missing down shifts these are all signs you may be able to pressure him into a mistake that he can't recover from, in racing all it takes is a few 10ths of a second advantage on the last lap to win without doing anything at all.

George Zachar comments:

Anecdotally, when Trump was solicited to propose a plan for New York harbor's governor's island, he reportedly said that the "first guy" investing in such a scheme "always goes broke. I want to be the second guy." In most other modern property ventures I am familiar with, first is best. In capital markets underwriting, where reverse engineering is rampant, it often pays to invest in distribution, letting the other guy pay for the research and development. MSFT shows that both quality and seniority can take second place to marketing/distribution. The value of "place in line" is likely in flux across industries and time.

Charles Pennington comments:

Oddly enough, not only does the car in second place benefit from "drafting" the car in front of him, but also the car in front benefits from the car behind. (I learned this from a big NASCAR fan. Apparently it's very well known among fans. Yet I don't have a simple picture of how the physics works. Here's a website that discusses this: "The lead car benefits from a drop in air resistance that comes when the slight vacuum at its rear wheels is filled.")

So by analogy maybe all the stocks in a leading sector will benefit.

Tom Marks comments:

The NASCAR drafting phenomenon might have applications for interpersonal relationships as well. If a young man is interested in marriage, his chances are probably improved if he starts dating a woman who just broke up with a long-term boyfriend, sort of a dating drafting phenomenon with the initial suitor breaking the nubile's coquettish resistance to commitment. Studies would probably bear this out. (The anecdotal evidence certainly does.)

This, of course, raises the possibility of strategic drafting wherein a guy purposely introduces a charming yet caddish friend to a desirable woman knowing full well that eventually the thing will blow up, whereupon the calculating swain then swoops in with more sensitivity than a Dr. Phil show and walks off with the prize.

The whole human mating ritual is just a cotillion with wolves.

Janice Dorn comments:

And did the second mouse get the cheese or not?

So there were these two flies, flyin' around above a lake. And the one fly says to the other fly, "Ya see that lake? I'm gonna drop down onto the surface of that lake." And the second fly asks, "Well why ya gonna do that?" And the first fly says, "Well ya see that storm? It's a-brewin'. And when that storm hits, the wind's gonna blow pretty fierce and it's gonna blow us all around, and I'm gonna drop down onto the surface of the lake to get out of the wind." And the second fly says, "Well that's a good idea."

Well there were these two trout, swimmin' in the lake. And the one trout says to the other trout, "Ya see dem two flies? I'm gonna get me one-a-dem flies!" And the second trout says, "Well how ya gonna do that?" And the first trout says, "Well ya see that storm? It's a-brewin'. And when that storm hits, the wind's gonna blow and those flies are gonna drop down onto the surface of the water. And that's when I'm gonna swim on up and get me one-a-dem flies." And the second trout says, "Well that's a good idea."

Well there were these two bears, walkin' through the woods. And the one bear says to the other bear, "Ya see dem two trout? I'm gonna get me one-a-dem trout!" And the second bear says, "Well how ya gonna do that?" And the first bear says, "Well ya see that storm? It's a-brewin'. And when that storm hits, the wind's gonna blow and those flies are gonna drop down onto the surface of the water and the trout are gonna swim up to get the flies, and that's when I'm gonna reach in the water and grab me one-a-dem trout!" And the second bear says, "Well that's a good idea."

Well there were these two hunters, huntin' in the woods. And the one hunter says to the other hunter, "Ya seem dem two bears? I'm gonna bag me one-a-dem bears!" And the second hunter says, "Well how ya gonna do that?" And the first hunter says, "Well ya see that storm? It's a-brewin'. And when that storm hits, the wind's gonna blow and those flies are gonna drop down onto the surface of the water and the trout are gonna swim up to get the flies and the bears are gonna reach into the water to grab the trout, and that's when I'm gonna lower my rifle and bag me one-a-dem bears!" And the second hunter says, "Well that's a good idea."

Well there were these two mice, scurryin' through the woods. And the one mouse says to the other mouse, "Ya seen dem two hunters? I'm gonna get me one-a-dem hunter's cheese sandwiches!" And the second mouse says, "Well how you gonna do that?" And the first mouse says, "Well ya see that storm? It's a brewin'. And when that storm hits, the wind's gonna blow and the flies are gonna drop down onto the surface of the water and the trout are gonna swim up to get the flies and the bears are gonna reach into the water to grab the trout and the hunters are gonna lower their rifles to bag the bears and when they do they're gonna drop their cheese sandwiches, and that's when I'm gonna scurry on out and grab me one-a-dem cheese sandwiches!" And the second mouse says, "Well that's a good idea."

Well there were these two cats, stalkin' through the woods. And the one cat says to the other cat, "Ya see dem two mice? I'm gonna catch me one-a-dem mice!" And the second cat says, "Well how ya gonna do that?" And the first cat says, "Well ya see that storm? It's a-brewin'. And when that storm hits, the wind's gonna blow and the flies are gonna drop down onto the surface of the water and the trout are gonna swim up to get the flies and the bears are gonna reach into the water to grab the trout and the hunters are gonna lower their rifles to bag the bears and when they do they're gonna drop their cheese sandwiches and the mice are gonna scurry out to grab the cheese sandwiches, and that's when I'm pounce and catch me one-a-dem mice!" And the second cat says, "Well that's a good idea."

Well you know that storm, that's been a-brewin'? It hit. And it hit BIG. And the wind blew and the flies dropped down onto the surface of the water and the trout swam up to get the flies and the bears reached into the water to grab the trout and the hunters lowered their rifles to bag the bears and they dropped their cheese sandwiches and the mice scurried out to get the cheese sandwiches and the cat jumped out to pounce on the mouse.

James Sogi comments:

Dr. Pennngton's NASCAR article refers to game theory. Chair mentioned game theory being an exception to foraging theory. A few other posts recently have referred to game theory.

Game Theory was invented by physicist John von Neumann. Von Neumann and Morgenstern wrote the Theory of Games and Economic Behavior. Game theory says that the true source of uncertainty lies in the intentions of others and represents a dramatic break from prior efforts such as Galton, Bernoulli and Laplace, to incorporate mathematics into decision making. Almost every decision is based on a series of negotiations, but unlike poker and chess, there is seldom a winner. Alan Blinder, former Fed Vice chair, wrote in a 1982 paper that the likely outcome between politicians and the Fed would be tight monetary policy and expansionary fiscal policy, similar to what we have now. It is the result of what is known as the Nash Equilibrium, named after John Nash where the outcome is less than optimal for each side, but stable. This a a typical result of mediation, where neither party feels that the result is favorable.

A controversial aspect of game theory applied to economics is that the participant can get the most winnings if he behaves rationally. The winnings can be increased if the other participants do not act rationally. An example of irrational behavior in an auction such as the stock market is the "winner's curse" where the buyers dog-pile in at the top of the market and over pay. See Bernstein, "Against the Gods."

Have any here pursued game theory applied to speculation? Seems like an interesting avenue to pursue. Perhaps some of you might have some good recommended reading on its applicability to the market.

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