ParkTwain's Parlor

Well, I would recommend reading the whole article. It develops the idea of the correlation between the whole person and trading philosophy. Neiderhoffer had become successful at everything he attempted in life. Taleb had grown up in Lebanon, also had gone through an unexpected bout of throat cancer. So he was already sensitive to the idea of "black swans" in his own non-trading experience.

Actually, Taleb's approach is like that of the lead character in a book about playing roulette ("Thirteen Against the Bank") that I read years ago. This was about a team who covered every roulette wheel in a given casino (England, then later in Nice, France) at the same time. There were six team members per table, and each bet only on one of the even-money bets (black, red, high, low, even, odd). They used a particular progressive betting scheme that was based on the idea that at some point in a given extended span of time (say, 12 to 24 hrs) there would be a run of results that, combined with the betting scheme, would result in a big win ($>100K). The betting on the other spots would basically cancel each other out (the betting scheme would direct the player having a losing streak to revert back to making minimum bets, while the winning player was steadily increasing the bet) and therefore, when no one even-money bet developed a good winning run, to a minimal overall loss for the team. They wanted to have all the bases covered so that they could take advantage of any extended run of luck on any of the even-money bets. It's a decent story, and many believe it is entirely fictitious. Of course, they did win some good money in the story. I did the numbers and in each case one of the bets had to go on a winning tear of at least 65% winners. So yeah, it was luck, but the question is, what are the odds of at least a 65% winning streak on an even-money bet for, say, 6 hrs straight?

The story took place at a time and in casinos with no maximum roulette bet. So to combat this approach, the casinos use a maximum bet rule (such as $2K on any number and maybe $1K on any even-money bet) on all roulette wheels. You could say that this tells you the team idea has merit.

[billyjoe]

Park,
That's some interesting stuff. Especially the theory that many winners are just getting the "lucky coin flip" year after year. I've always believed that the greatest successes in the market are unusual individuals that think differently than the crowd. This could also lead to the greatest failures . Something inborn sets them apart. A way of thinking that might be possessed by one in billion . Testing Buffet I'm sure would show more than a person who studies the market more hours than anyone else. The guy is eccentric in many ways having nothing to do with business.

------------billyjoe

Nassim Taleb is the author of Fooled by Randomness

Read the very good reader commentary on the book at Amazon.com:

http://tinyurl.com/ltxl4

Such as this comment:
//
1) There is good advice on avoiding some common mistakes that lead to "blowing up", which will prove useful to inexperienced market practitioners.

2) Taleb's own (claimed) trading methodology (buying OTM options) could easily fall victim to the "black swan" problem. A regime change to persistently higher implied than actual volatility would result in extended losses for his fund (unless he is bluffing us about its methodology).

3) Taleb only focuses on cases where volatility is underpriced - but some of the best opportunities come when it is overpriced, during market panics. Yet according to what he says in the book, one should continue buying such overpriced volatility! As someone whose bread and butter trade is fading market panics, I can confirm that premium selling can be highly profitable - the trick is to sell at the right time, and to employ risk control. Just because some practitioners are incapable of this, does not invalidate the method, any more than OTM options buying is invalidated because many naive speculators buy in a panic just before the VIX is about to collapse.

4) Taleb lumps MBA and businessmen types into the "fool" category. This misses the point. 99% of business is not about risk-assessment, dazzling insight, or grand strategic thought, but about successful *execution* of obvious ideas, and hard work. How many eggheads have had great ideas, but never done anything to put them into action? There is no point knowing that a beach bar in the Bahamas might be destroyed every 10 years by a hurricane, if you aren't even capable of raising capital, employing people, or working 16 hour days getting it off the ground. Good MBAs and CEOs will in any case employ people like Taleb to assess risk for them.

5) Taleb ignores the possiblity of using praxeological analysis (i.e. taking a set of demonstrable a priori truths, then using a logical train of deduction to discover what those truths necessarily imply about reality) to avoid the survivorship bias & noise problems. E.g. you can predict the effect of supply and demand on price without having to test it in the real world. This technique has been used by Murray Rothbard in economics (which has an even greater "non-falsifiability" problem than trading), and Warren Buffett in investing. As an example, you *can* judge if a good track record is "skill" or "luck", by examining the methodology of the trader/investor. If they operated solely during a period favourable to their style, it is probably luck e.g. if they made money buying emerging market bonds from 1994-1998. If they made a bucketload trading a style that was *against* the market regime, then it is almost certainly skill e.g. someone who made good returns as a shortseller of tech stocks from 1997-2000; or someone who has successfully sold premium during market panics. Since Taleb is a follower of Popper, and a hardened quant, it should come as no surprise that he is ignorant of praxeology, but it is a huge oversight all the same.

6) Taleb's scorning of Buffett as a lucky fool is ignorant in the extreme. Buffett clearly did *not* use naive analysis of past data to make his investment decisions, or rely on luck (he did well from 1969-82, a terrible period for equities). Rather he deduced highly probably consequences from demonstrable truths about investment (i.e. firms with pricing power, high barriers to entry, and low working capital requirements are likely to perform very well), and then saw that the market was not pricing these factors efficiently. Anyone reading his writings can see this. And Buffett's approach is ironically more rigorous and less dependent on luck than Taleb's professed trading methods. To elaborate - Taleb is relying on "black swan" events happening more often than people think. Therefore EITHER a reduction in the frequency of these events, OR an increase in people's expectation of them, would be enough to invalidate Taleb's approach - clearly neither can be ruled out. Taleb thinks he is betting on black swan events occuring, whilst ignoring the possibility of the "black swan" of major regime change making his own system unprofitable. Whereas with Buffet, the laws of supply and demand, and basic investment/economics, ensure that certain business methods will *always* work better than others.

To conclude - Taleb thinks he has a great idea, but it was already well known by most experienced market practitioners (see the Market Wizards books etc where multiple traders continually bang on about rare event risk and fat tailed probability distributions). He then goes on as if this idea is the only important thing, which is clearly not the case. Finally, he critiques some people, such as Buffett, who use totally rigorous methodologies, whilst himself employing a strategy that is by no means foolproof, and relies largely on past observation (data-mining!) to form its conclusions. All I can say is that he better watch out for the black swan of long-term declining volatility over the next decade!
//

Very cool article about Nassim Taleb, the anti-Neiderhoffer

http://www.gladwell.com/2002/2002_04_29_a_blowingup.htm

//
How Nassim Taleb turned the inevitability of disaster into an investment strategy

... The truest thing about [George] Soros seemed to be what his son Robert had once said:

"My father will sit down and give you theories to explain why he does this or that. But I remember seeing it as a kid and thinking, Jesus Christ, at least half of this is bullshit. I mean, you know the reason he changes his position on the market or whatever is because his back starts killing him. It has nothing to do with reason. He literally goes into a spasm, and it's his early warning sign."

For Taleb, then, the question why someone was a success in the financial marketplace was vexing. Taleb could do the arithmetic in his head. Suppose that there were ten thousand investment managers out there, which is not an outlandish number, and that every year half of them, entirely by chance, made money and half of them, entirely by chance, lost money. And suppose that every year the losers were tossed out, and the game replayed with those who remained. At the end of five years, there would be three hundred and thirteen people who had made money in every one of those years, and after ten years there would be nine people who had made money every single year in a row, all out of pure luck. [Victor] Niederhoffer, like Buffett and Soros, was a brilliant man. He had a Ph.D. in economics from the University of Chicago. He had pioneered the idea that through close mathematical analysis of patterns in the market an investor could identify profitable anomalies. But who was to say that he wasn't one of those lucky nine? And who was to say that in the eleventh year Niederhoffer would be one of the unlucky ones, who suddenly lost it all, who suddenly, as they say on Wall Street, "blew up"?

... Nassim Taleb and his team at Empirica are quants. But they reject the quant orthodoxy, because they don't believe that things like the stock market behave in the way that physical phenomena like mortality statistics do. Physical events, whether death rates or poker games, are the predictable function of a limited and stable set of factors, and tend to follow what statisticians call a "normal distribution," a bell curve. But do the ups and downs of the market follow a bell curve? The economist Eugene Fama once studied stock prices and pointed out that if they followed a normal distribution you'd expect a really big jump, what he specified as a movement five standard deviations from the mean, once every seven thousand years. In fact, jumps of that magnitude happen in the stock market every three or four years, because investors don't behave with any kind of statistical orderliness. They change their mind. They do stupid things. They copy each other. They panic. Fama concluded that if you charted the ups and downs of the stock market the graph would have a "fat tail,"meaning that at the upper and lower ends of the distribution there would be many more outlying events than statisticians used to modelling the physical world would have imagined.

In the summer of 1997, Taleb predicted that hedge funds like Long Term Capital Management were headed for trouble, because they did not understand this notion of fat tails. Just a year later, L.T.C.M. sold an extraordinary number of options, because its computer models told it that the markets ought to be calming down. And what happened? The Russian government defaulted on its bonds; the markets went crazy; and in a matter of weeks L.T.C.M. was finished.

... Taleb, by contrast, has constructed a trading philosophy predicated entirely on the existence of black swans. on the possibility of some random, unexpected event sweeping the markets. He never sells options, then. He only buys them. He's never the one who can lose a great deal of money if G.M. stock suddenly plunges. Nor does he ever bet on the market moving in one direction or another. That would require Taleb to assume that he understands the market, and he doesn't. He hasn't Warren Buffett's confidence. So he buys options on both sides, on the possibility of the market moving both up and down. And he doesn't bet on minor fluctuations in the market. Why bother? If everyone else is vastly underestimating the possibility of rare events, then an option on G.M. at, say, forty dollars is going to be undervalued. So Taleb buys out-of-the-money options by the truckload. He buys them for hundreds of different stocks, and if they expire before he gets to use them he simply buys more. Taleb doesn't even invest in stocks, not for Empirica and not for his own personal account. Buying a stock, unlike buying an option, is a gamble that the future will represent an improved version of the past. And who knows whether that will be true? So all of Taleb's personal wealth, and the hundreds of millions that Empirica has in reserve, is in Treasury bills. Few on Wall Street have taken the practice of buying options to such extremes. But if anything completely out of the ordinary happens to the stock market, if some random event sends a jolt through all of Wall Street and pushes G.M. to, say, twenty dollars, Nassim Taleb will not end up in a dowdy apartment in Athens. He will be rich.

... A year after Nassim Taleb came to visit him, Victor Niederhoffer blew up. He sold a very large number of options on the S. & P. index, taking millions of dollars from other traders in exchange for promising to buy a basket of stocks from them at current prices, if the market ever fell. It was an unhedged bet, or what was called on Wall Street a "naked put," meaning that he bet everyone on one outcome: he bet in favor of the large probability of making a small amount of money, and against the small probability of losing a large amount of money-and he lost. On October 27, 1997, the market plummeted eight per cent, and all of the many, many people who had bought those options from Niederhoffer came calling all at once, demanding that he buy back their stocks at pre-crash prices. He ran through a hundred and thirty million dollars -- his cash reserves, his savings, his other stocks -- and when his broker came and asked for still more he didn't have it. In a day, one of the most successful hedge funds in America was wiped out.
//

1st edition by Darvas

"How I Made $2 Million in the Stock Market"

My copy (list price on jacket of $4.95 in hardcover, publ. 1960, 1st ed., 4th printing w/ all 4 printings in June 1960) arrived a few days ago. It has a great dust jacket graphic, like a 1950s horror movie poster. I'm looking for an image of it on the WWW, but haven't found it yet. I will post a photo of it if I can't otherwise find one.

Wikipedia entry on Nicolas Darvas

http://en.wikipedia.org/wiki/Nicolas_Darvas

This entry includes an interesting list of stock market books that Darvas supposedly read:

//
During his off hours as a dancer, he had read some 200 books on the market and the great speculators. He began his studies by reading:

* ABC of Investing, by R. C. Effinger [publ. 1947].
* The Stock Market, by Dice & Eiteman [publ. 1941].
* The Securities Market: And How It Works, by B [Birl]. E. Schultz [publ. 1942].
* Your Investments, by Leo Barnes [publ. 1959, pb].
* Profit In The Stock Market, by H. M. Gartley [publ. 1935].
* Consistent Profits In The Stock Market, by Curtis Dahl [publ. 1951].
* You Can Make Money In The Stock Market, by E. J. Mann [publ. 1955].

His top 2 books which he had read almost every week were:

* The Battle for Investment Survival, by Gerald M. Loeb. Published in 1935.
* Tape Reading and Market Tactics, by Humphrey Bancroft Neill. Published in 1931.
//

Loeb's book is well known. I have read it and reported on it in earlier in this thread. The other books listed above are unknown to me. Stay tuned.

Research results from this weekend, Aug 20th

Quite a few nice new long candidates involving new all-time high (ATH) breakout possibilities. All the "best candidates" have the most positive technicals (RSI, ADX +DI and -DI, and volume trends) for producing good near-term gains. These are not pure momentum plays, but rather "strength" plays with support. See my most recent posts on this thread for explanations.

Best candidates:

BBV - (Spain, banking) recent ATH breakout; gets 40% of $20B business of worker remittances from U.S. to Mexico; owns the No. 1 bank in Mexico.

http://iblnews.com/story_en.php?id=15703

BRS - (oil serv helicopters) CAVEAT: new pref stock sale pending
CPRT - (salvage auto sales, etc.)
CVG - (sw) high headroom to next resis, nice technicals right now
GEO - (oil serv)
HURN - (biz consulting)
MON - (chemicals, genetic mod crops)
SAIA - (trucking) relatively new issue
SJR - (Canada, cable TV) recent pullback from ATH, time to buy
SNH - (REIT) 6.7% div, just added to S&P mid-cap 400
TDY - (defense, etc.) undervalued based on earnings momentum
TRMB - (GPS sys)
UIL - (elec util) shedding crummy businesses, 4.9% div, but low avg daily vol


The "almost" list; watch these for imminent breakout but with pullbacks. These are pre-ATH breakout stocks that tend to have either extended ADX +DI measures or declining ADX -DI measures (which is good) that haven't based yet.

AXS - (Bermuda, insurance)
AYI - (lighting, etc.)
BGC - (cable wire)
EPR - (REIT)
EXR - (REIT)
FPO - (REIT)
JBX - (retail fast food) undervalued, low PEG, restaurant count growth
LDG - (retail drug stores)
LTR - (conglomerate)
NRF - (REIT) 10.0% div (NOT a misprint!)
PBNY - (bank) probable buyout target?
SBS - (Brazil water util)
SNA - (tools)
SPSX - (wire manufacturer)
TROW - (mutual funds)
WRI - (REIT)


Given both lists shown above:
Mon, 8/21 close - 14 up, 15 down, on the day
Tues, 8/22 close - 19 up, 10 down, on the day
Wed, 8/23 close - 4 up, 25 down, on the day
Thurs 8/24 close - 12 up, 17 down, on the day
Fri 8/25 close - 13 up, 1 unchanged, 15 down, on the day

Totally blah week for the entire bunch.
For the entire week ending Aug 25, Fri close vs Mon open (12 up, 17 down):

S&P 500 -0.5%
Russell 2000 -1.7%
Naz composite -0.5%

BBV -2.0%
BRS -0.5%
CPRT -1.8%
CVG +0.2%
GEO -1.7%
HURN -1.5%
MON +0.5%
SAIA -3.7%
SJR +1.2%
SNH +1.0%
TDY -3.7%
TRMB -3.1%
UIL +1.7%

AXS -2.8%
AYI -5.3%
BGC -0.8%
EPR +1.0%
EXR +2.0%
FPO -0.3%
JBX -2.8%
LDG -4.1% ($0.14 div Aug 25)
LTR +1.9%
NRF -0.3%
PBNY +0.1%
SBS -1.5%
SNA +0.3%
SPSX +0.8%
TROW -3.1%
WRI +1.4%

Avg gain of 12 gainers +1.0%
Avg loss of 17 losers -2.3%

My DDD has no volatility left

What's it gonna do next?

[Rob]

Park, that is excellent stuff. Thanks for the write-up. I've recently been paying more attention to the DMIs, and have noted some of the very things you mention.

ADX and its +DI and -DI components vs. RSI

From a couple of e-mails I sent recently:

//
Did you see my post where I go on about paying attention to the absolute reading (such as about <10.0) of the Negative Directional Indicator (-DI) measure? I really do think it is a key to having some success with the candidate stocks that my approach finds. But I certainly don't know how to scan for that particular measure, as it is a component of another measure.

As discussed here:

http://www.stockcharts.com/education/IndicatorAnalysis/indic_ADX.html

[[
ADX is derived from two other indicators, also developed by Wilder, called the Positive Directional Indicator (sometimes written +DI) and the Negative Directional Indicator (-DI).

When the ADX Indicator is selected, SharpCharts plots the Positive Directional Indicator (+DI), Negative Directional Indicator (-DI) and Average Directional Index (ADX). With the Red, White and Green color scheme on SharpCharts, ADX is the thick black line with less fluctuation, +DI is green and -DI is red. +DI measures the force of the up moves and -DI measures the force of the down moves over a set period. The default setting is 14 periods, but users are encouraged to modify these settings according to their personal preferences.

In its most basic form, buy and sell signals can be generated by +DI/-DI crosses. A buy signal occurs when +DI moves above -DI and a sell signal when -DI moves above the +DI. Be careful, though; when a security is in a trading range, this system may produce many whipsaws. As with most technical indicators, +DI/-DI crosses should be used in conjunction with other aspects of technical analysis.

ADX combines +DI with -DI and then smooths the data with a moving average to provide a measurement of trend strength. Because it uses both +DI and -DI, ADX does not offer any indication of trend direction, just strength. Generally, readings above 40 indicate a strong trend and readings below 20 a weak trend. To catch a trend in its early stages, you might look for stocks with ADX that advances above 20. Conversely, an ADX decline from above 40 might signal that the current trend is weakening and a trading range may develop.
]]

A particular data series in a particular stock chart really turned me on to what to look for with this particular indicator. Go to stockcharts.com and open a daily chart for the stock RIV for only the dates April 1, 2004 to April 1, 2005. Add the ADX(14) plot to the display. Turn your eye to the interval of about July 1, 2004 to about Feb 1, 2005. Notice the pattern that the +DI and -DI plots make relative to each other over that interval. Then also notice how the interplay of those two plots relates to what the pps was doing at the same time.

This was a situation where a casino company in Las Vegas that owns some land was receiving some publicity about what it might do to either sell the company or develop its land holdings found right on the Las Vegas Strip. There had been several publicized land sales to/from casino companies on that part (the "north Strip") of the Strip. So over this timeframe, traders were bidding up the shares in anticipation of some decision by the company to realize its (apparently) latent value.

The key thing to notice, for me, in this section of the chart is how the -DI plot was ALWAYS STAYING BELOW the +DI plot *AND* the -DI plot was LESS VOLATILE than the +DI plot. This was telling me that (1) there was weak selling pressure present during the timeframe, (2) on the other hand, the buying pressure was coming and going in waves of significant amplitude, and (3) the rise in the pps was obviously very sensitive to the presence or absence of BUYERS ONLY because there were such few sellers. When the pps stalled during that timeframe, it was due only to a "buyer's strike" (that is, an absence of buyers) for a few days at a time. And the absence of any strong selling pressure prevented the pps from declining much at all when the buyers happened to be taking a rest.

So from this I have learned to watch for a downtrending and low-valued -DI measure (such as <12 or even <10) as one of the key differentiators among any set of attractive candidate stocks that are making new ATHs. The longer that -DI stays that low, and especially if it is not very volatile while it is staying that low, the better (in this case, more bullish) the pps is going to behave. Because under my methodology this -DI scenario is being combined with a stock making a new ATH and therefore having no technical resistance, you have an opportunity to make that 10% to 15% or more in an unusually short timeframe compared to other uptrending stocks whose pps is found in other positions relative to their own historical support and resistance levels. I have seen so many charts where an uptrending pps achieves an INCREASINGLY POSITIVE SLOPE after the pps passes the previous ATH on a breakout with above-average volume.
//

E-mail #2:

//
Well, I used to be primarily a RSI indicator kind of guy. (I mostly ignore moving averages and stochastics and MACD and would rather identify pps movements between and beyond resistance and support areas on the stock's chart.) Before, I would simply watch for ATH breakouts on good volume and accompanied by an uptrending RSI in the 60 to 70 range. This scenario indicates to me that I am watching an already relatively strong stock (RSI >60 and rising) but also that its RSI has a good bit of room to rise further (>80) if it really heats up in the future due to intensifying momentum for that stock in the market. When this is the case for a stock that just surpassed its ATH and thus no longer has any technical resistance, it can be a thing of beauty to behold. I've seen it many, many times and have profited from it at least "several" times! This approach has generally served me pretty well.

Now I realize that I need to watch the relationship between the +DI and -DI plots to give me some CONTEXT in interpreting the RSI behavior, even for a relatively strong stock (i.e., pps is generally uptrending).

In the RIV chart that I described to you, you might have seen that the RSI can dip (which of course is a byproduct of some amount of dip in the pps) only due to a WANING OF BUYING INTENSITY but with NO INCREASE WHATSOEVER IN SELLING INTENSITY. That is, a decline in the +DI BY ITSELF can be associated with a pps dip and thus with a dip in the RSI, but the context of that RSI dip is a lot less dangerous to my long position than if the -DI were also to show an increase.

This is a great situation to recognize because it would tell me to stay with that long position through the dip in pps (even if that dip violated some other profit-taking trigger). Also, if I see that this situation has happened in the stock's more or less recent past, but at a time before the ATH breakout happened, it would give me some evidence of how that stock's pps behaved under that combination of circumstances, and thereby offering me either greater or lesser confidence in how that stock might behave going forward through the probable breakout and beyond.

I think that the discussion at stockcharts.com and elsewhere in the TA literature about using an ADX +DI/-DI crossover as a buy or sell trigger is marginal advice, maybe only relevant for the nimblest of momentum and reversal traders. Rather, I would say you need to be aware of the absolute magnitude and trending of the -DI plot to be able to interpret the latent strength in a stock's trend, even through a near-term pps dip.
//

Regards,

//PT

P.S. Take a look at the OCN daily chart (use the same plots described above for the RIV chart example) since about April 1, 2006 though the present. You can see a very similar +DI and -DI interplay taking place, AND you are also seeing a stock in a very strong uptrend!

Very good! You are really sharp with da graphics.

After eyeballing all charts at The KirkReport page, it seems that in each case the PPS has moved up to meet a downtrending 50DMA. That's a pretty coarse criterion, but it's obviously catching a lot of stocks.

As Mr. Kirk posted this morning:

//
The bulls can't blame the headlines which have been falling right into place for them all this week. First, we have Middle East peace and then inflation headlines that have taken the fear out of the market. Combine that we a group of traders who've been religiously shorting and selling into strength, and it is difficult to imagine a better script to play out for the bulls as the sheer majority remain wrongly positioned (including yours truly). While we should begin to see more option expiration related activity today (i.e. more volatility), the bulls certainly have the ball. It's been awhile since that we've seen that.
//

[Rob]

Nice-looking charts on those, Park.

List of reversals at Kirk Report

http://www.thekirkreport.com/

ALVR, ATHR
BRKS, BRCM, BWNG
CA
DKS
EZEM
F
ISE
JDSU
KONG
MNRO, MW
NRMX, NTLI
ODP
QCOM
RSH
SPWR, STP
TLB, TOMO
USMO
VRNT

[IIC]

Some people call it "station" because Green Valley Ranch is also the name of a development nearby.

Is this what it's like to have a conversation with you, for pete's sake?

As a matter of fact it is Park...Why is everybody around here so defensive or on edge lately anyway???...Mr. Nitpickey

PS...Actually nobody needs to answer that ???...I know why it is...It is because people are not doing well in the market...Heck, I'm not doing well overall this year either...And yes...I get a little moody sometimes over it too...But overall, I'm still the same guy...Bad times are temporary...I've been thru bad times many times...all part of the game...Get over it...No problem...It always gets better for those that never quit.

Park...Are you sure you weren't at the bar???...It is the Green Valley Ranch.

Yes...I know Station owns it...Just giving you a hard time...Doug(IIC)

Some people call it "station" because Green Valley Ranch is also the name of a development nearby.

Is this what it's like to have a conversation with you, for pete's sake?