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Patterns of Life and Markets, by Victor Niederhoffer
Of all the things I've learned from Jim Watson, the admirable discover of the structure of DNA and director of Cold Spring Harbor Laboratory, the most important is that the best biology book of all time is "The Way Life Works " by Mahlon Hoagland and Bert Dodson. The former is a eminent molecular biologist and the latter is a illustrator. In one of the greatest collaborations of all time, they combined their talents to illustrate the profound principles that unite all things and yet make them unique.
Amazingly, Hoagland admits he learned much from Dodson about biology in writing the book because the ballroom scenes, dancers, coffee-makers, chains, construction sites, laboratories and card games Dodson used in his illustrations are actually highly informative and realistic models of what goes on inside living things. My favorite picture, for example, is the Chloroplast Ballroom, where jitterbugging electrons at a party show how light energy is converted into chemical energy, setting up the ion shuffle wherein a bouncer grabs each man as he dances threw and throws him into a machine that "reattaches the end phosphate to spent ATP molecules." It's the kind of illustration, reminiscent of Norman Rockwell's best, that you'll remember the rest of your life. The amazing thing is it also teaches important principles of ionization, angular momentum, the conservation of energy and orbits of molecules.
The book starts with 16 patterns and rules of life that tie everything together from the smallest organisms to the most complex. I have waited too long to apply these principles to markets. The only excuse I have is that I knew it would take a lifetime of study and quantification to do a proper job. However, I hope readers will excuse me if I take a stab at applying the 16 patterns to markets, since I've spent 50 years studying market patterns and believe the things that make life go round also make the markets spin. I'll start with these four:
- Life Builds from the Bottom Up.
Before a single plant appeared on the planet, bacteria invented all of life's essential chemical systems. They transformed the earth's atmosphere, developed a way to get energy from the sun, devised the first bioelectrical systems, invented s#x and locomotion, worked out the genetic machinery, and learned how to merge and organize into new and higher collectives.
The everyday life of the Greeks and Romans of antiquity involved land development syndicates much like our LLCs of today. The risky and highly profitable explorations for treasure and spices of the Middle Ages gave rise to the system of stock ownership that the Dutch perfected with such companies as the Dutch East India Company in the 17th century. Every enterprise must start with a basic unit -- a profitable transaction between customer and purveyor. Ideally, these can be repeated and put in a silo; GE is around the corner.
- Life Assembles Itself from Chains.
Life has adopted the chain as the organizing principle. Chains are made up of simple units linked together in long, flexible strands. Chain molecules fall into two main classes: information chains which store and transmit information, and working chains which carry out the business of living.
All successful entities must survive on repeated transactions, repeated stores, repeated factories, repeated methods for making a profit, repeated reasons for the customer to continue purchasing. The most successful firms have a profitable plan and a product, and they provide the information necessary for their satellites to reproduce this plan profitably. Always remember that the price today is the sum of all the changes from transactions since the last closing price. The series of buys and sells that you make creates your portfolio. DNA molecules twist into a double helix for "easy access and duplication." You must plan your transactions so that the resulting portfolio protects you from the strains that prevent success. Not extending yourself too far on the long side or short side, shifting back and forth between one side and the other (except for those that have a drift), moving from one industry that temporarily has the world in its grip to another, all provide protection and flexibility. Over time, those elementary transactions can add up to some very large changes in wealth. If you wish to survive, you're going to know how to make those transactions profitable, as well as how those transactions link with others that they enhance or preclude.
- Life Needs an Inside and an Outside.
When danger threatens, oxen gather in a circle -- heads and horns to the outside, tails to the inside -- sheltering their vulnerable calves in the center, thus illustrating life's crucial organizing principle: the difference between inside and out. The differences are maintained by a protective barrier, a clam shell, a membrane.
Let's start with how you manage your portfolio when you're beset by danger. I believe it's a rule of thumb among survivors to sell off the weak ones and keep the strong ones. Without a strong inside, you aren't likely to prosper. But the problem is that you realize it only when danger threatens. A rule I enforce in our organization is to keep all the "ephemerals" out of our trading room so that the inside and outside are separated. I believe it is also helpful to separate business from personal, the futures trades from the options, the individual stock trades from the index ones.
- Life Uses a Few Themes to Generate Many Variations.
Life hangs on to what works. At the same time, it explores and tinkers. This restless combination leads to a vast array of unique living creatures based on a considerable smaller number of underlying patterns and rules. New cells can form concentric rings, as in snail's shells and ram's horns, radials as in flowers or starfish, or branches as in bushes, lungs, and blood vessels. The scale can vary but for all life's diversity -- few other growth patterns exist.
Many entities, many markets, form S-shaped growth curves, circular growth curves or branching, tree-like growth patterns. The ability to predict which one you're going to end up with given a reasonable history is the key attribute of the analyst. I hypothesize that these tendencies are not consistent with random walks. Finding similarities and gaining insights from different fields can lead to a deeper level of understanding, or to mumbo-jumbo. The pencil and paper must be taken out so that I can prove that there are certain kinds of early stages of growth that are predictive of subsequent stages above and beyond chance. As Beethoven said to his nephew's headmistress, "You will be hearing from me shortly."
Orson Terrill replies with insights on the similarities between trees and the markets