A LoBagola, as described in The Education of A Speculator by Dr. Niederhoffer, is a phenomenon whereby a market makes an historically large run in one direction, usually up, and then at some unpredictable point begins an equally extreme run back to where it started.

Some recent cases in point would include virtually every asset class there is. Most certainly oil and other commodities have retraced much of their spectacular run ups. Stocks have now retraced the last 12 years of gains with no bottom in sight. Real estate is another prominent example.

To understand LoBagolas we need to understand how they start. They start with some early optimism. Things start improving for a certain stock or asset class. Some early profits are made as more investment dollars chase the emerging bull market. These profits add to account equity and can be used to compound returns through increase margin borrowing. In futures there is not really borrowing but the effect is the same - investors can take larger positions as prices rise. In effect there is a feedback mechanism. Higher prices result in even higher prices as more leverage is added.

But when the price finally cracks the effect is reversed. The first selling causes some short term holders to exit resulting in a further decline. At some point the decline reaches the level where the latest thin margin players are forced out. This results in another round of feedback selling. As prices come down it almost seems like they break in waves. Each successive wave forces another round of margin calls and forced selling. Finally the entire bull run is retraced. All the new holders who were enticed in by the lure of quick profits have been forced out as the whole bubble unravels. That is a LoBagola.

Dr. McDonnell is the author of Optimal Portfolio Modeling, Wiley, 2008

Victor Niederhoffer writes:

The question about LoBagola, especially since he was a charlatan, is whether the migrations that he described with an exact retracing of the path but variable in time exist to a non-random extent. How can this be tested, and what predictive value does it have? The picture of me in the WSJ with Lobogola overlaid did give James Lorie the biggest belly laugh of his life and for that it is undeniably valuable.


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