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Kim Zussman

10/18/2005
Perverse Diversity, by Kim Zussman

1. If markets always followed definable statistical laws, would those who understand the laws converge on 100% market wealth?
2. Since that doesn't appear to be true, market participants might rank on a continuum of risk; those who believe risk is unknowable, and those who believe risk is knowable. At one extreme are those who lose consistently but have occasional huge gains, and the other who profit consistently with occasional ruin. How can there be risk if you know what the risk is (e.g., if you could calculate the exact effects of the next Gulf storm on oil).
3. Diversification. Markowitz called it the only free lunch in finance, but is it really free? A portfolio of 20 stocks has zero return on a volatile day, due in part to one stock which falls 10% countered by one that gains 10%. The investor should feel smart that he was diversified, but instead is upset because the 10% drop spoiled what should have been an up day. The cost of diversification is the asymmetric relationship between pain of loss and pleasure of gain.
4. Since markets parameterize life, it could be helpful to characterize other forms of diversification. Like the pistons of a V8 engine, having a harem almost guarantees that while some wives are down, others are up (making the large assumption that multiple wives are uncorrelated) and life is continuous happiness. However if it is human nature to focus more on the problems than the successes, such fine ideas must end in the evolutionary waste-heap of future genome diversification strategies.

Marting Lindkvist adds:

According to this paper, there might be some correlation, at least in one sense, between women who are spending time together, and this is said to be due to pheromones. Perhaps like in the market where the smellier a situation is for a certain stock, other stocks that spend time together with it (in the same industry) becomes more correlated with it when its under pressure and thus gets dragged down. This must be tested though.

T. M. Ryan comments

If markets always followed definable statistical laws, would those who understand the laws converge on 100% market wealth?

Neglecting the principle of ever changing cycles, even if the statistical distribution of say the daily change for many future market days was definable and known in advance the answer is no, because knowing the distribution of the population of days tells you nothing of the sequential timing of the individual events.  This is the problem with all of the Mandelbrot/power law/fractal/log periodic descriptive approaches. In other words a statistical distribution is descriptive, not necessarily predictive.

Dave W. adds:

Remind me some day to describe how I built the holed rabbit portfolio to show that there is nothing random in the market....nothing at all. My conclusion is that it is about dominance and the proof is authored everyday by my own stalemate with the trade.

Positions are always calibrated to retain the same (+ or - 2%) buying power by my host broker. If something goes up 2 bucks the rest of the portfolio gets an accumulated 2 buck loss. Make no mistake these markets are a sham, if you're on the outside looking in ... you're meat, i.e. a rabbit in a hole. I have now 16 months of waging a stalemate with the trade in a specifically designed portfolio which  leverages my amateur ways squared off against all the systems tools of the hunt. Anyone wanting to really test their skills should use a portfolio that gives them every advantage. See how long you last. The experience will give you the edge in everything else you do.

P.S. here is the scorecard on Cramer, the number one Sell side guy in America.

More by Kim Zussman