Practical Speculation by Victor Niederhoffer and Laurel Kenner

Victor Niederhoffer: 1943-2026

Best suited for the intermediate-level investor or higher. Victor Niederhoffer is an eclectic, associative thinker: many of his ideas and insights emerge indirectly from what at first seem like off-topic tangents on literature, horse racing, sports or old films. Sometimes his writing requires a little extra patience, but it's always helpful to climb into his brain and poke around. You'll usually climb back out with a few new (and often highly unorthodox) ways to think about investing.

I've always deeply respected Niederhoffer's candor about investing's various emotional and psychological challenges. Remember, he blew up twice: once in 1997 during the Asia crisis, and then a second time in 2007, four years after this book came out. Niederhoffer is entirely open about these blowups[1], and he is equally open about the regret, embarrassment and self-loathing that came with them. And yet each time, he returned to the game to try to learn and get better at it. Many investment writers tend to gloss over (or perhaps repress) these often-vicious emotions of investing, which can also include anything from shame and humiliation to rage, fear, even terror. We all experience these things whether we want to admit it or not: better to own it. In a lot of ways emotional self-management is the only problem in investing.

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I'll briefly single out three other highly useful topics from the book. First, be sure to note Niederhoffer's discussion of propaganda techniques as used in corporate earnings reports, as well as propaganda as used in the financial media. As always, financial media should be either ignored or used cynically as a cue to lean the other way. Second, his commentary on permabears is likewise insightful, and it includes an extensive discussion of the stopped-clock permabear Alan Abelson, who warned readers away from the stock market for decades in his widely-read Barron's column. Permabears are part of the furniture of Wall Street[2], and they always seem more rigorous than they actually are. Watch out for them. Finally, his chapter on Ben Graham is fascinating, as Niederhoffer basically slays one of the central gods of value investing.

Now onto some problems. Some chapters in Practical Speculation simply lose their way. While Niederhoffer's eclectic tangents are part of the "furniture" of his writing, a meaner editor would have helped the book retain more focus, particularly through the last few chapters. Further, the book could have used a continuity reader to go through and strip out several repeated ideas and notions--although note that this is often an occupational hazard when a collection of essays is adapted into a single work.

Despite these minor problems, this book--and, more generally, Niederhoffer's mind--is worth exploring. He teaches.

Footnotes:

[1] Note that Niederhoffer discussed in great detail his blowups in author Kathryn Schulz's book Being Wrong, as the two of them had extensive and wide-ranging discussions on every imaginable facet of risk, error and rationalization. I read Schulz's book years ago: it is good enough to be worth a reread.

[2] There's a bit of a burst of permabear activity right now, for whatever that might mean. The other day in fact I was shocked to see the mid-1990s-era permabear Paul Kedrosky re-emerge, this time making observably false statements about Anthropic as part of yet another permabear narrative. Thirty years ago he kept investors out of the 1990s bull market by crying wolf several years too early. Maybe this time he'll be right?

[Readers, what follows are my notes and quotes from the text: I write these out in order to order my thinking and better remember what I read. If you're into investing you might want to skim the bolded parts, but otherwise please feel free to skip.]

Notes:

Acknowledgments:

vff Note the mention of Brett Steenbarger, "whose contributions appear throughout this book" and who "was among the early readers who became dear friends." [Steenbarger wrote Enhancing Trader Performance, an insightful book exploring investing's psychological challenges.]

Introduction: The Hope Snatchers

1ff The author shares some of his repeated nightmares; holding some of his worst stocks and options during a market plunge, watching investor sell into alarmist market headlines like zombies. "The naked options I am short are going through the roof." He screams at all the zombie investors, "Stop, you fools! The headlines are inducing you to lean the wrong way!" Reference here to the 1954 sci-fi/horror movie Invasion of the Body Snatchers: "Often interpreted as a warning against blind obedience to authority, Invasion's depiction of the victims serves as an extraordinarily apt description of average investors' vacant, resigned demeanor after the fallacies and propaganda embedded in headlines like the ones in my recurring nightmare... The overriding problem is that these headlines induce hysteria and then paralysis."

3ff The author does a textual analysis on these headlines; headlines like "Stocks Fall on Earnings Pessimism" he argues label conditions as bearish that are actually bullish; other headlines are meaningless as they assigning a "cause" to what are really random stock movements. He describes these as propaganda techniques, propagating headlines based on myths, which then extract contributions from credulous investors, just like pre-scientific societies would extract offerings from the masses using their own myths to maintain social order. "This phenomenon explains why the public contributes so much to the commissions, spreads, research expenditures, communications costs, skyscraper rents, sales outlays, marketing expenses, and phantasmagoric bonuses for traders and executives that make up the massive infrastructure of Wall Street."

4 Interesting factoid here that until 2000-2002, the last time the US stock market went down three years in a row was 1939-1941.

5 On the search for anecdotal evidence to justify something in retrospect that yet offers nothing of predictive value; how investors lose the ability to differentiate the helpful from the unhelpful; because all the news, propaganda and excess information they are being primed to overtrade and "contribute to the market infrastructure." On how all this makes people investors into pod people "bereft of optimism and hope." [He's right: most market information should be ignored; most of it conditions you to lean the wrong way.] The author contrasts this to becoming a "speculator in life": he calls it a heroic quest and that heroism "is a potent antidote to the cynicism and alienation so many of us accept." [I think of this mindset as looking for opportunity no matter what the conditions. The mindset itself is a self-fulfilling mental state. It's harder to become discouraged and enervated by the world if you always look for ways to practice opportunity-seeking.]

6 The author talks about his blowup in 1997, going from having one of the best performance records, a large staff of traders and analysts, etc., and then basically losing everything. [Note how the author tells us he was the top hedge fund manager in a Barclays report in 1996, its own reverse indicator right there.] On his previous book The Education of a Speculator [I've read it, it's useful, but it doesn't quite belong in the firmament of great investing books.] The author then quotes a New York Times article which he says captures his decline with that newspaper's "inimitable schadenfreude." [Note also that Niederhoffer had extensive conversations with the author Kathryn Schulz in his book Being Wrong, which is a good read. I give Niederhoffer all the credit in the world to own up to his blowup, to talk about it openly, and yet to continue to play the game, continue to learn.]

7 In a few sentences of jargon he explains what happened: he was leveraged long the largest bank in Thailand, which fell 99%, at the same time the US stock market closed early (after a 550-point decline in the DJIA triggered circuitbreakers); and so he margin-called when there was no way to sell anything and meet the liability. This blew up his entire fund; he had to take out a large mortgage on his house at a 15% interest; he had various physical and psychological symptoms of depression, and then the "final indignity": he had to sell his antique silver, joining a long list of Wall Street speculators who "placed their silver up for sale in time of malaise." How he received 55 copies of Tuesdays with Morrie and 10 copies of the Rudyard Kipling poem "If" from friends, family and acquaintances.

9ff Niederhoffer starts a collaboration with a former Bloomberg editor, Laurel Kenner; he mocks himself by writing "people wrote in to say that this was the most ridiculous thing in the world: a guy who had lost everything writing columns to tell other people what to do." He shares some of the other harsh comments, ranging from recommending "to take the opposite side of your trades"; "It's very clear why you blew out your account" etc. Note Niederhoffer's thought here: "a soft answer turns away wrath" as he gives an example of a very humble response he wrote in response to someone mocking him for blowing up his fund, writing back "I am not an authority. I am trying to learn." And that person's next response was extremely conciliatory. [A useful lesson for all of us when we receive mockery...]

12 "Since Laurel and I began writing together in 2000, We have heard countless heartbreaking tales from readers in shock from seeing their wealth and retirement accounts cut in half or worse. People wrote to us for advice on how to rebuild, on how to live with themselves. They specifically wanted to know how I handled my own bout with disaster. The answer we give these distressed readers is not to avoid risk. Risk is part of all heroic endeavors... Not only is risk necessary for me; it is the inescapable lot of human beings." Note also the author's comments on how avoiding risk leads to cynicism and personal anomie. [Or worse, it makes you into a curmudgeonly permabear!]

13 "Just like the victims in invasion of the body snatchers, the victims of investment fallacies seem perfectly normal and rational. Yet their collective behavior can lead to evil and terrifying consequences. Professional market parasites who make their living off investors can only thrive when people give in and become unthinking pods."

13 Here the author mentions his [famous] habit of clipping articles out of the National Enquirer, his "favorite newspaper."

14ff A summary of the book: the first part, "Mumbo Jumbo and Moonshine dissects the errors, myths, fallacies and propaganda from financial media. Notable among the following chapter summaries here is a beautiful nugget asking about Alan Abelson, the permabear who wrote for Barron's for decades and the subject of Chapter 4: "How can a writer be wrong for practically his entire working life and still be the most influential figure in financial journalism?" Also discussions on hubris in Chapter 5; questioning the worship of Benjamin Graham in Chapter 6; and a potentially interesting Chapter 7 discussion of how "most contemporary financial news reports can be done by computers working from a limited database of erroneous ideas and quotes from mediocre money managers."

16ff Part Two: Practical Speculation includes a discussion of survival which "comes first"; Chapter 8 on avoiding spurious correlations, and recommendations to use scatter plot graphs; other notable-sounding chapters include here Chapter 15 on techniques to bargain for an edge in the market; also Chapter 17 on how to counteract "earnings management" techniques. 

20 Note the closing quote here from Robert Bacon, author of Secrets of Professional Turf Betting: "The principle of ever-changing trends works to force quick and drastic changes of results sequences when the public happens to get wise to a winning idea." [Basically this is an analogy to investment markets: when everybody thinks the same thing, run! Stuff is really going to change in a hurry.]

Part One: Mumbo Jumbo and Moonshine

Chapter 1: The Meme

23ff The author quotes various media stories, including a permabear on CNBC launching into an evidence-free monologue valuations; Niederhoffer then writes about Alan Greenspan's "irrational exuberance" comment which he made off-hand in an after-dinner speech; Niederhoffer describes how we feel strong emotions for unknown reasons after absorbing market media like this. "I suddenly, inexplicably, feel anxious and wretched... Why am I worried?"

26ff Comments on Thailand's 1996 economic problems and the Mars Rover landing; these events at the time filled him alternately with fear and soaring spirits. Other examples follow: the resolution of the 1997 financial market chaos was followed by more financial chaos in 1998; the Monica Lewinsky scandal; the Russian government devalued the ruble and then and defaluted, triggering the September collapse of Long Term Capital Management; comments on wide range of accounting frauds that came to light in 1999 including Cendant and Sunbeam; also GE's rampant earnings smoothing.

29ff Niederhofer puzzles over Warren Buffett's famous "shooting down Orville Wright" anecdote where Buffett discusses the bad economics of the airline industry, and how most of the early aircraft makers went bankrupt; he questions why Buffett would make such a negative statement about innovation or technology when so many innovations like pharmaceuticals, tabulating machines, packaged foods, etc., were a big reason stocks produced such tremendous returns during the 20th century. [This metaconversation is interesting, but I wonder if Niederhoffer may be overinterpreting what Buffett was saying here: Buffett is just talking about avoiding capital-intensive industries without very big moats; and also he wants to avoid investing industries that can lose their market from technological change or technological substitution.]

30ff Note the extended quote from Ivan Turgenev's novel Clara Militch, where a man surrounded by prosperity has this sinking feeling that evil is coming; then comments on Richard Dawkins idea of memes: self-replicating informational entities; this idea perturbs Niederhoffer still more. [Reading through this section for the book, you really can really imagine the author flipping through old books and novels, trying to pull up scenes and quotes that either reflect his fears... or assuage them.] 

34ff The author starts running a sort of timeline from beginning of the tech selloff in March 2000, as it accelerates into the summer and fall. The "meme" of general loathing and bearishness seems to take over the minds of everybody; Niederhoffer cites how the bearishness got so bad that people reached back "to find 'experts' whose chronic pessimism had discredited them in the 1990s" like David Tice, Robert Shiller and the Barron's permabear Allen Abelson; the author sees it as a viral pandemic where people are infected by bearishness.

37ff "When a plague overwhelms a city, people trying to escape only carry the disease to new places." The market continues to decline, and then 9/11 happens. [One gets the impression that Niederhoffer here is sort a "reverse Allen Abelson" here as he's decrying everyone's bearishness--but only halfway through the bear market! The market didn't bottom until mid-2002.] Then onto a rather ill-timed quote from Buffett as on March 9, 2002, he writes in his annual shareholder letter that he and Charlie Munger have "decidedly lukewarm feelings about the prospects for stocks in general over the next decade or so."

39ff Finally on high-profile convictions and prosecutions that happened in the late 2002 period, which [ironically] marked the market bottom: Tyco's Dennis Kozlowski: Worldcom's CEO and CFO; also the famous perpwalk of Enron's CFO Jeff Skilling, with a two-page timeline of many of these events.

42 The chapter ends with a quote from Viktor Frankl: "Unlike an animal, man is not told by drives and instincts what he must do. And in contrast to man in former times, he is no longer told by traditions and values what he should do. Now, knowing neither what he must do nor what he should do, he sometimes does not even know what he basically wishes to do. Instead, he wishes to do what other people do--which is conformism--or he does what other people wish him to do--which is totalitarianism."

Chapter 2: Earnings Propaganda

43ff This chapter starts off with four axioms [all false, as we'll see] that show up in investment textbooks, Investment 101 classes, that every news reporter in the financial industry, every finance professor, and even uninformed laypeople all "know" to be true:

* Earnings and the market move up and down together.

* The greater the earnings increases, the higher the market's return.

* When earnings are up it is time to buy, when earnings are down it is time to sell.

* When the market's P/E ratio is high it is time to sell.

Niederhoffer describes these as fallacies with "superficial plausibility."

44-5 Holy cow on this quote about Ben Graham, citing how financial academics perpetuate the "earnings-returns" fallacy citing studies showing at certain high P/E's the market is ready to fall: "These studies, in turn, energize the value boys, who still revere Benjamin Graham even though his methods enabled him to go broke at least twice and kept most of his followers out of the bull market of the 1980s and 1990s, when the Dow rose 14-fold."

45-6 And holy cow once again on this quote, talking about the movie Forrest Gump where the author, Winston Groom, had a contract to receive 3% of net profits, but the film--despite grossing $650 million--actually had a net loss of $60 million. "Tom Hanks, more experienced in the ways of Hollywood and perhaps benefiting from better legal advice, negotiated a share of the gross. As for Groom, he settled his lawsuit against Paramount for a promise of a share of the gross in a Gump sequel that never materialized." [Oh, man, wow.]

46ff The next few pages involve the author testing whether stocks go up when earnings go up (or down when earnings go down); he actually finds a slight opposite relation, offering scatterplot graphs to show it.

50ff Next he tests whether a high (or low) P/E predicts higher (or lower) stock returns, again using scatterplot diagrams; he finds a statistically trivial inverse relationship. Note also on page 50 this interesting anecdote about Robert Schiller, who asked Fed chairman Alan Greenspan "When was the last time a Fed chairman actually commented that he thought the level of stock prices might be too high?" {Quite a sophisticated metaquestion!] Comments here on how difficult it is even to arrive at the proper P/E data, because earnings are later revised, some people use reported earnings, or calendar year earnings, it's also hard to know to what extent people adjust for negative earnings when running these analyses. The author cites the typical example here of the high P/E ratio of the stock market in 1929 which was followed by low returns over the years that followed; but Niederhoffer notes that the low P/E of 1970 was followed by -6% average returns per year for the next five years. Also in 1994 the P/E was a relatively high 21x and the 5-year market return turned out to average 21% per year. [Also it's worth pointing out the massive change in profitability and in the types of companies that are publicly traded now versus then. The idea that we should somehow return to 1930s-era or 1950's era P/Es is hilarious.] Note the interesting criticism here Niederhoffer levels at Robert Schiller: that Schiller excluded 5-year returns because that would have showed the opposite relation from his claims of 10-year returns! [Shiller's CAPE measure for market valuation has terrible problems on a bunch of levels.]

53 [Very, very interesting data artifact here,  I had not thought about this before.] "Because of the way P/Es are calculated, there is a strong bias for the data to show a positive relation. The bias hinges on the little noted fact that the earnings of calendar year reporting companies are not released as of year-end. They're released from a month to three months later. If there is a nice positive surprise in these earnings, then the return that year will get a head start. That introduces a bias in favor of the negative correlation that Schiller wanted to show. [This actually sounds a little bit confusing, but Niederhoffer then explains it further in an example here]: take a stock that's $100 and the earnings are $10 a share (thus the P/E is 10x). In March the company prints $12 as a surprise upside earnings result; thus retrospectively, the P/E was not 10x at the beginning of the year, it's 8.5x using "actual" earnings. But the stock then goes to 120 (thus staying at a 10x P/E), and so we already have a 20% return for that year's market. Thus once the "E" comes out as a positive surprise then the stock "looks" like it had a lower P/E, and--further skewing the data--it's already up because of a surprise upside. [Great example!] Only recently have there been some attempts to adjust for this skew in recent data sets.

55ff Various comments here on how accounting earnings themselves are suspect; subject to various assumptions and latitude; accounting practices are constantly evolving; then a list here of various techniques used to obscure the picture of a company's financial health: using leverage; "front-end income loading" [basically this is a type of aggressive revenue recognition, see Boeing for example]; capitalizing costs; timing costs to move discretionary costs around to smooth earnings; timing sales, writing-offs after acquisitions; restructuring charges; timing of an accounting method switch, etc. [All of this stuff is totally true, which is why no income statement can really stand alone: you have look at operating cash flows to make sure that the accounting earnings have some sort of rhyme or reason with the actual cash flows the business generates. Also: whenever you see a company that smooths their earnings, run.] 

58 Nice list here of three books on detecting accounting manipulations:

Thornton O'glove: Quality of Earnings

Howard Schilit: Financial Shenanigans

Aswath Damodaran: The Dark Side of Valuation

58ff Other types of biases, like the "illusion of validity" you get from some officially published "studies show science" paper; see also a sort of "illusion of control" you get where people feel like P/E ratios somehow make stocks tractable, giving you some traction somehow on what's going to happen. Interesting also to see that Niederhoffer actually has a lunch with Robert Schiller ("we expected the sparks to fly") but finds him surprisingly tentative about the robustness of his results, to the point where Shiller actually said "Perhaps the relation has changed or is no longer valid." [!!!!!] Note another type of error discovered by one of Shiller's students who called out the use of market data from overlapping periods [e.g., the ten year period from 1930-1940, then the ten year period from 1931-1941, etc.], which causes spurious regression problems when looking at long-term returns.

60ff How earnings propaganda works, including an excellent, concise working definition of propaganda: "Propaganda induces individuals to take actions that benefit the messenger more than the listener." Mention of the "1939 classic" The Fine Art of Propaganda by Alfred McClung Lee and Elizabeth Briant, talking about the seven basic techniques for disseminatng false information, including name-calling, generality, transfer, testimonials, plain folks, card-stacking and the bandwagon:

63 Thoughts on why these beliefs [about market returns mentioned at the beginning of this chapter] persist: the author talks about how investors can grasp more easily how "bad" earnings for an individual stock they own results in them earning losses, but "[t]he problem comes when they try to generalize this to the broad market. Such generalizations suffer from logical errors: the fallacy of composition, the fallacy of aggregation, and the ecological fallacy." Also on other various confusions between what people know about an individual stock versus what they know about the stock market; also "the fallacy of aggregation" is that assumption that what holds true on a small scale is also true on a large scale; "the ecological fallacy" is the opposite: the assumption that what is true in a large scale is true on the small scale.

64ff Comments on the vagueness of what "earnings" actually are: are we talking about year-over-year comparison of earnings? Earnings relative to expectations? Which expectations--whisper numbers? Published analyst estimates? And what kind of earnings: operating, pro forma, GAAP? Also comments on a type of card-stacking that occurs here, as managements guide research analysts' numbers down so that they can be "beaten" later; this triggers quantitative models to think that earning surprises have predictive significance.

66ff Comments here on General Electric and their infamous earnings management techniques [for much more on this topic I can't recommend enough the book Power Failure: The Rise and Fall of an American Icon, William Cohan's wonderful book about the multi-decade decline of GE]; also on Jeff Skilling who famously called an analyst an "asshole" on a live conference call in April, 2001; on the general bullish bias of Wall Street sell-side analysts because of underwriting fees. [Note a subtlety here as Niederhoffer shows the so-called bias of analysts to have more buy rather than sell/hold reports: it is true that this bias probably exists, but also there's a good case that this could be an example of a "bias bias" (having a bias to see a bias). Analysts' are going to seek out and cover companies they think will do well, they are less likely to cover at all companies they think are crappy.]

70ff Niederhoffer closes the chapter with a squash metaphor here: he tries to get his opponent to lean the wrong way; in the same way news propaganda mechanisms get investors to overtrade, buy high and sell low, etc., it gets them leaning the wrong way too.

Chapter 3: The Hydra Heads of Technical Analysis

71ff Niederhoffer claims here that he and his staff have tested every technical indicator over 45 years and have not found one that passed the test; commenting that the domain of technical analysis itself is unscientific, it is subjective, not refutable or testable, "more of a religion than a method."

73ff On the commonly used assertion "The trend is your friend," including the phrase "The trend is your friend unless it is about to end" which the authors call "our favorite"; there's no way to measure this sentence's idea in the form of a testable hypothesis because it's slippery and subjective; a discussion of various up/down combinations, including the observation that there are only six occasions in the past 102 years where the market declined two years in a row; also testing market correlations of different time periods: for example future market returns are negatively correlated with previous periods. Even on shorter time frames, like a 20 days, there's a slight negative correlation and the correlation gets larger the longer the time period. But there's really no real useful investable pattern.

79ff masturbatory passage here talking about trend following in sports in the form of the "hot hand" debate, the section should have been cut.

82 Questioning whether stocks themselves have "memories": cards don't have a memory, although players do; the authors want to argue that the trend is not your friend but "no fixed rule can be expected to last forever" as cycles are always changing. Note also the comments here about market anomalies having a sort of Murphy's Law aspect to them: by the time the academic research comes identifying the anomaly, it usually is about to mean revert; see for example small cap stock outperformance discussed in a 1981 study, after which small cap stocks lagged for the next 18 years. See yet another double irony here where a paper came out on "Murphy's law and Market anomalies" after which small cap stocks finally started outperforming again! 

85ff On Japanese candlestick charting, another method that the authors determine to be untestable and not predictive; note the candlestick body refers to the opening and closing price while the whiskers/wicks that extend from the top and bottom mark the intraday high and low.

87ff On the idea that "technical analysis is art as well as science" claim which the author claims is a validity bias [something seems valid when it's actually not]; also another thing about technical analysis is how if you change the scale or time period of a chart the technical indicators completely change.

90ff On the TRIN index or the Arms index, both of which are basically ratios of up volume divided by down volume; again Niederhoffer finds it mostly random and not predictive.

92ff On volume as an important component of technical analysis, but nobody agrees on what kind of volume you want and when.

93ff On the so-called "head and shoulders" technical indicator which again doesn't offer any statistical advantage; also interesting to see some possible explanations for the survival and popularity of these technical/charting trading strategies: for example, humans are prone to see non-existent connections between things; we remember pleasant or successful experiences more than unpleasant ones; a belief or a behavior--even if it's mostly unrewarding--can survive a long time when it is randomly reinforced.

98ff "Do you really expect a straight line to point the way?" Discussion here on deception in various forms, ranging from war to chess and checkers. Comments here on the unexpected: "Unless you were prepared to expect the unexpected, be prepared to expect unexpected defeat."

102ff Once again going over the various propaganda techniques used to support the use of technical analysis. [This part of the chapter has lost its way a little bit.]

104 On earmarks of pseudoscience from Robert L. Park's book Voodoo Science, including:

* A discovery is pitched directly to the media.

* A powerful establishment is claimed to be suppressing the discovery.

* An effect is always at the limit of detection.

* New laws of nature are proposed to explain an incredible observation. 

[Most things that you see in the media are fake and gay anyway, so the fact that you see them in the media is its own contrary indicator...]

105ff The other asks himself rhetorically if all he ever does is knock things down; is there any indicator or approach that he actually uses? He talks here qualitatively [and insightfully] about doing the opposite of what seems obvious, and also doing the opposite of what is recently profitable. "The market likes to throw you tricky moves when you are off guard... the market loves to throw in a nice ten percent rally when the gloom is greatest." Also discussion of the VIX indicator which is the author's favorite, it indicates extremes in market sentiment; a normal level is 25 and when it's below that it signals complacency; when it's well above that level it signals that investors are frightened and thus it is good time to buy.

108ff The author give some examples of how the VIX was tested; note the unusual mention of an investment academic who did some of this testing, David Simon at Bentley College, who actually went from a hedge fund into academics... and actually does his own investing and trading. [You hardly ever hear of examples like this!] Also comments on the intuitive link between risk and expected return.

110ff Comments here on how while certain technical indicators may work for certain selected periods, they will often fail the moment the greatest amount of money is thrown at them; and thus the author says a good indicator of the ever-changing cycles in technical analysis is the marketing of technical trading systems. The author describes how systems start off being offered to a handful of specially-chosen wealthy investors at very high prices; but then eventually by the later stage of their life cycle they're offered at low end prices to retail investors. [As always: don't be retail.] This takes the author to another heuristic: see what trend followers are doing and do the opposite. Finally comments referring to Brett Steenbarger again and his increasing skepticism about technical analysis over the course of his career. [Steenbarger's book Enhancing Trader Performance came out in 2006 and I don't recall him discussing this nuance in it.] The chapter ends with sort of masturbatory story from Brett Steenbarger about killing the Hydra of the TRIN indicator using Victor Niederhoffer's wisdom.

Chapter 4: The Cult of the Bear

115ff This chapter opens with a quote from the permabear columnist Alan Abelson from Barron's: "This will all end badly." [Variation of the phrase "this will not end well" are very typical in permabear writing. You see it all the time: the frequent use of it by itself shows that these guys don't realize what a tell it is!] Niederhoffer addresses Abelson's permabearishness. "It is amazing to see an adult who has not only maintained a false belief for his entire working life, but has also consistently ridiculed others who do not share his beliefs." On Ableson's long-term weekly column in Barron's; his wit and "sardonic pen." "Though he is a clever and talented writer, by any objective standard Abelson has the distinction of being one of the worst Market forecasters in history." [Yup!] The author cites Abelson's bearishness across his entire tenure--a period during which the Dow went up 37x.

117ff Comments on people unwilling to adjust their beliefs to reality; reference to Leon Festinger's book When Prophecy Fails and the doomsday cult the book discusses. "The remarkable thing about Abelson's columns is that they provide a real-world case study of cognitive dissonance involving trillions of dollars of lost wealth..." On how attempting to maintain consistency in one's beliefs gives rise to maladaptive behavior.

118 "Investors who followed the columnist's advice during the many years he was wrong would have long ago lost all their chips."

119ff Co-author Laurel Kenner actually interviewed Abelson in 2001, in which he talked about how he felt he made a contribution as a skeptic; backgrounder on him here: his career in journalism and then at Barron's beginning in 1956; at the time he didn't know anything about investing; Abelson claims here, interestingly, that until the 1960s, nobody ever wrote anything critical of the stock market.

120 On other writers who have been also bearish for decades: the author cites "hard money" newsletters here, making a specific callout to Howard Ruff with his 1970s-era forecast for $1,000 an ounce gold. The parenthetically writes: "As we write [2003] gold is at $350 down from $850 in January 1980." [And in another reminder of how important it is to stay humble, I parenthetically write that today gold is around $4,000 an ounce!]

121ff Comments on the need for certainty, control and simplicity in a complicated world; the author draws parallels between cults and Abelson's financial writing; also on how you can always use P/E ratios or nearly any of various measures of the stock market to come up with a reason for bearishness, and this provides illusory comfort; on Abelson's appeal to fear; his frequent comments about 1929. On the fact that people pay a lot more for a negative forecast, they'll pay more attention to it, because such forecasts are unusual and noteworthy. [I usually recommend when people cite some metric suggesting the stock market is "too high" is to flip the thought around and ask more a meta-question: what might it be about the stock market that would drive a XYZ metric? This is a more thought-provoking question that sometimes takes you to insights.]

122 "What pursuit could have been more pointless than to write a bearish column weekend, week out, during the entire run of the greatest bull market in history?" The author criticizes Abelson not only for hundreds of thousands of readers who might have traded on his advice, but also for those who had been so accustomed to seeing him wrong that when a crash did come "they held tight to their stocks" thinking that Abelson was just crying wolf once again. [Hence the epithet used for Abelson and permabears like him is to call him "a stopped clock."]

123ff On how in the world of writing there isn't the same kind of feedback that there is in investing and trading; real-world traders who are wrong about reality are quickly blown out of the game and replaced by traders who are less wrong. [The same holds true for academics.] The author argues also in writing that the lone wolf--the iconoclast--tends to be more newsworthy in part because of his rarity. "Abelson was not subject to the normal self-correcting process that exists in other fields."

125-129 The author studied 525 of Abelson's columns throughout the 1990s [Oh man, why??] and did a breakdown of the various examples of illogic, followed by a selection of quotes and what actually happened in reality afterwards. Note the one example where the authors write "Too bizarre to rebut."

130 Interesting passage here from William Worthington Fowler's 1870 book Ten Years in Wall Street where a permabear mocks other investors during a market correction, shouting "I told you so! I told you so! Ha, ha, ha!" [This gets to the underlying psychology we might infer from quite a number of permabears: that they appear to be either deeply jealous of others' gains or they love the experience of schadenfreude... or both.]

132 Final point here where the authors talk about how Ableson never closes out his trade: his bearish predictions remains open and so whatever crash he is constantly calling for actually might occur, thus providing vindication. [This is a totally correct insight: the payoff for a permabear is they are in a position to claim they "predicted" a crash if ever one occurs--and every once in a while one does!]

Chapter 5: "We Are Number One" Usually Means "Not Much Longer"

133ff Various comments here about Enron, Cisco, Lucent and their huge price declines after the 2000 peak; also a mention here of the February 2002 AARP magazine Modern Maturity which cited unnamed experts recommending Lucent and the already bankrupt Enron as good investments for the post September 11th downturn. [This claim is so unbelievably ridiculous that I had to check for myself, and yes it is true! The author of this article, John F. Wasik, went on to write 19 books.]

134 On studying CEOs who make outrageous boasts as well as studying executives known for humility. Also other Wall Street superstitions like the "flashy new headquarters indicator." the "magazine cover indicator" and the "stadium naming indicator." [These are usually things that happen in the later innings of an upcycle for a company, thus they tend to signal a coming downcycle.]

135ff The tale of Icarus and his hubris as he flew too close to the sun; note the authors' comments about Aeschylus, who "believed that the gods begrudged human greatness and inflicted hubris on men at the height of their success." Citing Robert Sobel's book When Giants Stumble and his 15 deadly sins of various leading companies, including nepotism, cutting corners and hubris; also mention of the 1939 book Diplomacy by Harold Nicholson, warning of the "dangers of vanity in a negotiator."

137ff Returning to comments here on Lucent, Enron and Cisco; comments about Carly Fiorina and her tenure at Lucent [I forgot even that she was there, I remember her later at Hewlett-Packard and her undistinguished time there as she rode that company into the ground, I totally forgot she emerged from Lucent], and then a discussion of John Chambers the famous CEO of Cisco who really could tell a story, the authors are exactly right to describe him as an exemplary storyteller. [While they are correct to malign LU and Enron, one thing I think the authors miss here about Cisco's business model back then was how they used acquisitions in a creative way to essentially outsource R&D and product development: they would acquire companies at a certain stage and maturity and this was a big part of their growth path for quite a while. Their method resembles how the large pharmaceutical companies will buy up biotech startups. Another thing that's very typical of technology cycles is the extreme initial overenthusiasm and overoptimism, but in general we tend to underestimate the magnitude of a new technology trend over a longer 10-20 year time horizon; this is precisely what happened with the internet and various IP-type communications protocols. Ironically you may have had a 90% decline with Cisco stock if you bought it right at the top, but if you dollar cost averaged into the decline (and waited quite a while), you actually did okay: see the long term chart below.]

140 Note here how Niederhoffer cites himself as an example, as he quotes a reader commenting on one of his columns how Niederhoffer was the number one hedge fund manager in 1996 "and promptly fell into oblivion."

142 In a section here called "It ain't boasting if you can do it" the authors try to quantify some of the effects of hubris, searching for various boastful phrases, including a real doozy from Martha Stewart: "I can almost bend steel with my mind. I can bend anything if I try hard enough."

143ff The authors reprint an extended letter from an insightful engineer at Lucent, describing how the company's management, previously highly competent engineers, was replaced by marketing types who didn't really understand the underlying business, and then it evolved into a company fascinated by its own fantasy image.

146ff More on searching for humble companies: unfortunately the authors cite the deeply unrigorous and anti-predictive book Good to Great by James Collins. The author cite the outperformance of the companies cited in this book in the two years after its publication [Good to Great came out in 2001, so this book had two years' worth of time to judge the book]. [A comment here: while it is true that some of the book's cited "great" companies did outperform in a declining market, in the years that followed many showed underperformance--in some cases embarrassing underperformance. Also there were quite a number of "chart crimes" in this book along with several other examples of low rigor. I recall reading it in the early 2000s and being appalled at how popular it was among management/strategist types in its day: everybody seemed to love it--including the then-director of AIG's (soon to be ill-fated) asset management division, who loved to quote the book's phrase "Get on the bus!"]

148 Repeat mention here of Warren Buffett's joke about shooting down the Wright brothers at Kitty Hawk. [This is a standard structural problem of taking a collection of essays and consolidating them into a book: you'll have errors and repeated ideas. The book could have used a "continuity reader" to go through and strip out these things.]

149 On the skyscraper indicator, which Niederhoffer amusingly dates back to Nimrod (who tried to build the Tower of Babel) and more recently manifested in the towers of Kuala Lumpur in 1997; also citing flashy new headquarters like Enron's gigantic headquarters that it had almost completed when it declared bankruptcy. [This is absolutely a famous and widely-used indicator, but I suspect it's subject to some of the same biases the author criticizes elsewhere, starting with the availability heuristic.]

150 Note the odd parenthetical comment here that Niederhoffer named four of his six daughters after Ayn Rand heroes.

153ff The authors test the "flashy new headquarters indicator" and find pretty significant company underperformance of companies in the years following the completion of a major new headquarters.

154ff Other widely-noted jinxes like the "magazine indicator" and the "stadium indicator" [the mother of all stadium indicator examples was the FTX buying naming rights for the NBA's Miami Heat]; the authors cite here stadium examples are all really anecdotal, because there are plenty of examples where the companies did fine after naming stadiums after themselves.

157ff On company performance after a major acquisition, another potential example of hubris; the authors discuss how a large acquisition gives the acquirer the ability to manage earnings like nothing else. The authors do a comparison of serial acquirers versus companies that did one or no acquisitions, but their table here on page 159 is strange: it only gives stock performance from January to July of 2002, a time period too unique, narrow and useless to be meaningful.

161ff Comments here on various things companies can do with their accounting with acquisitions; one is simply mechanical: if you're a high P/E company buying a low P/E company, you usually get a stock priceboost when the high multiple company's PE gets placed on that low multiple company's earnings once it's acquired--basically you buy "cheap earnings"; also you get all sorts of opportunities to write certain items up or down to your advantage. Niederhofer then quotes his partner for 35 years, Dan Grossman, who gives advice based on a career of buying a wide range of businesses, including things like: * Buy a company that regular people can run

* When evaluating an acquisition, it picture what it would be like trying to sell it

* Avoid mixing acquisition analysis with some other need in your life, like if you're looking for a new career or a new place to work: it makes you less objective

* Have a good accountant explain to you how inventory can be used to juggle earnings and why it's almost impossible for a buyer to determine the accuracy of reported earnings

* [This one is an unexpected piece of advice, and an interesting one]: "Time is the friend of a growth company and the enemy of the bargain or value company. The longer you are going to own, the more important to pay up for growth." [I'm not sure what I think of this, but it's worth thinking about.]

162 "Lords on boards": a section here discussing hiring celebrities, another form of hubris exhibited by companies and their managements; see for example Kmart's association with Martha Stewart, Kathy Ireland and Jaclyn Smith; RJR Nabisco putting golf pros on the payroll; also HSBC with all sorts of knighted and titled board members.

Chapter 6: Benjamin Graham: Mythical Market Hero

165ff The author notes how in all the articles eulogizing Ben Graham there were no criticisms or negatives; the author criticizes the illusory bargain of trying to find companies that trade at 50% of net current asset values; you simply can't find these kinds of companies in the modern stock market--and even in the 1930s when they're supposedly were a lot of them the commissions and huge bid-asks spreads made these bargains illusory. Sometimes the companies are burning cash so rapidly that the discount goes away because of the cash burn [Hilarious: the stock price doesn't have to change, the company just burns cash (and its valuation) until it's no longer at a discount]; the author points out Warren Buffett generating tremendous tax losses by purchasing the textile company Berkshire Hathaway [that was a historically awful "value stock" of its own] and then finally Charlie Munger basically told him to stop buying dying dinosaurs, because these companies tied up capital, consistently lost money, and were never able to be sold at higher prices than what Buffett--nobody else wanted them either!

168ff Looking at Graham's performance. "Considering the great gap between Graham's theory of value investing and the chances of putting it into practice, it is not surprising that performance of the funds he managed was not as attractive as legend would have it." He was crushed by the 1929 crash; also it appears he was scarred for life by it, saying that whenever the DJIA was more than 100 that it was "too high," and so he was always too defensively positioned. Note that the Dow never fell below 100 after 1942; he also told his students in the 1950s (when the Dow was at 300) that the market was too high then too, and he advised them against going into investing. [!!!] Also some murky-sounding background on his investment in Geico, which Graham writes was the one investment he made where he didn't follow his own methods; Niederhoffer also argues that a real-world example of the returns from following Graham's methods can be seen by looking at the Rea-Graham Fund, which massively underperformed. "Thus, we can summarize the performance in practice of Graham's method as follows: His performance was disastrous in the 1930s when he liquidated. He started again in the late 1930s and got out of the market in 1956, missing the move from Dow 500 to Dow 1,000 over the next 20 years. A fund that put his methods into practice from 1976 to 1996 underperformed the S&P 500 by a factor of 4 to 1."

169ff Discussion here of the Value Line stock research service; this gives clear evidence that value stocks consistently underperformed growth stock since 1965 based on chance research from Value Line in an unintentional experiment; because the stocks were selected by value-based groups contemporaneously, it's not a back-tested or survivor-biased sample: it's actually a real-world, real-time sample; it turns out here that the growth stock segment massively outperformed all of the different values stock categories.

172 This chapter ends with a extraordinarily weird blurb: Ben Graham tragically lost his son to suicide, and when he went to collect his son's belongings he fell in love with his late son's girlfriend. "As Graham was already married, he suggested to his fourth wife, back home in California, that she share him with his new amour. Much to Graham's wife's distress, she thenceforth saw her husband only six months out of every year. The tail has odd echoes of Zeus's philandering and Persephone's annual six-month descent into the underworld to be with her husband, Hades, lord of the dead, during the winter months. Belief in Zeus and the feats of Hercules eventually dwindled into insignificance. We suspect that the legendary father of value investing will be treated no better by the gods."

Chapter 7: News Flash: Computer Writes Stock Market Story!

173 Quite a striking introductory quote to this chapter from Thomas Henry Huxley: "The foundation of all morality is to have done, once and for all, with lying; to give up pretending to believe that for which there is no evidence, and repeating unintelligible propositions about things beyond the possibilities of knowledge."

173ff The author talks about typical news stories about daily market moves in the financial media, and he gives a simple formula that can be used [just like Bitcoin FUD dice!] to churn out "explanations" of why the market is up or down, and explains how they could just as easily be written by a computer. The reporter can flesh out the story with an interview with a money manager followed by another relevant quote from some government economist, followed by a card-stacking list of companies that happen to be up (or down) that day. "Such stories are completely worthless to anybody who trades." [Although they are useful to the money manager who gets publicity for his fund.]

176ff Note this quote which capably articulates a nuanced type of mendacity that we see in the financial media: "By focusing everyone's attention on a bogus explanation, the investor is led away from finding out the truth from some other source." [In other words, you feel like you've been given the answer, thus the story gets you to stop looking for what's really going on. You settle, unknowingly, for a half-assed explanation of reality. I think this is quite an understated insight--it's less obvious that it seems. In fact, you can take this even further: stories like this throughout all media feed our general sense of epistemic arrogance, causing us to be overconfident about not just what we know but about what we know can be known. I think it would be extremely useful to consider this idea from a few angles.]

176 "...these assertions amount to nothing more than an invitation to trade the wrong way."

177ff The author offers his Market News-O-Matic program in a flowchart diagram on page 177, it's pretty amusing actually. "From time to time, investors should make up stock stories themselves for their educational amusement." [He's right! Man, after you hear enough of these stories they really do begin to sound like formulaic word sausage] The author then shares an example of the News-O-Matic's output: "US stocks [rose/fell] as unexpectedly [strong/weak] earnings from company fueled [optimism/pessimism] for a rebound in earnings by year end."

Part Two: Practical Speculation

181ff "Part One described what is wrong with common approaches to investing... In Part Two, we provide a series of approaches that together can serve as a foundation for investors. We begin with the one thing that comes before everything else in the quest for investment success: survival." [This author ought to know, in fact he's going to "know" it all over again within a few years of writing this book as he would blow up again in 2007.] 

182 "We are as bullish as ever on stocks... However, the vicious declines of 2000-2002, as well as Vic's own disaster in 1997, have prompted us to rethink how we prepare for risk." The authors cite chess master David Bronstein from his book The Modern Chess Self-Tutor, writing that you should not be thinking about mate or gaining an advantage, but to think about proceeding to your aim in stages, always reckoning with your opponent's ideas and counter-actions; you want to ensure the safety of your own king and first build a shelter for your king. [Interesting thoughts here]. Niederhoffer takes this to mean: don't get in over your head; understand how the market will swing violently against you; keep in mind that a long-term illness or college education or other types of emergencies can impact your situation; he again quotes Bronstein recommending that players build "a virtual palace with double pawn walls and a personal guard." Then once your king is secure you can mount an offense, starting with a steady reasonable advantage, rather than risking a wipeout for a startling win; and then, once you've added to your speculative capital you can start taking longer range buy and hold positions without having to risk your survival if some major market crash happens. [Again this is an interesting way to think about it.]

184 Translating Bronstein's comments on chess into an analogy for putting together a portfolio: the central idea here is defend first and don't give your enemy any targets; also an interesting metaphor here of offering a draw in a chess tournament against certain players or to give yourself a rest; this is an analogy for stepping away from the market for a time.

185 "In the following chapters, we describe how to use quantitative methods to look for cases where the market overestimates risk."

Chapter 8: How to Avoid Spurious Correlations

187ff Comments on how most of the things thought to influence stock movements are actually will-of-the-wisps "persisting just long enough for the public to lose money." The author puts a number of these notions to the test, once again discussing the value of scatterplots diagrams as well as how to build them and interpret them.

193ff Extended discussion here of statistical methods for calculating correlation coefficients, using covariances to find variances, then on calculating the square root of those which is the standard deviation, etc.

196 Eventually the authors arrive at the conclusion that none of the assumed correlations between interest rates and S&P 500 returns is significant enough to trade on. "In practice, we have found any number [meaning: correlation measure] above 0.10 or below -0.10 based on 100 or more observations to be useful." For smaller sample sizes, Niederhoffer argues you want the correlation coefficient x the number of observations to be greater than 10: thus for 50 observations you need a correlation of 0.20 and for 20 observations the correlation must be at least 0.50 to find something useful.

197 Other uses of scatterplots: it helps you see outliers, either an error in data collection or a sign of a changed relation; also one way to enhance a scatter diagram is to show the path of a time series by drawing arrows between the dots in the sequence they occur. [Interesting.]

200 On not placing too much reliance on scatter diagrams, correlations or regressions: "They are associations, not a proof of causation." On ascribing relationships that are actually random or spurious due to either randomness, a third variable, changes in the underlying population that you're testing, or a fallacy of aggregation. "Sadly, most studies of market relations suffer from all of these fallacies simultaneously."

199ff Examples here of randomness, including investors or managers who made a market call that happened to be correct, or the newsletter investment scam where you mail opposite stock market predictions to two groups--after four or five iterations you'll look like you were a genius to a very small percentage of them; likewise, there's always some "technical indicator" that looks like it's responsible for something. Examples here of omitted third variables as well: for example sentiment has an indirect relation to future market movements but only because of its relation with recent market movements--which were either up or down, making that sentiment positive or negative. Also on studies relating longevity to occupation: music conductors may have a longer lifespan than poets, but that doesn't mean that prospective poets could improve their longevity by choosing conducting over poetry, especially given the amount of time required to become a conductor; thus when you look at this more broadly, the "longevity" of conductors actually disappears once you look at males of age 35 and older! [We could analogize this to modern interventionist healthcare: once you remove infant mortality--in other words compare people in the past who made it to adulthood to people today who made it to adulthood--any lifespan extension resulting from most medicine becomes trivial.] Other examples: small companies that are growing quickly don't remain in the "small company group" long enough, or "value company group" companies include so many companies experiencing financial problems that they disappear out of the sample, leading to survivor bias in the results. "Much of the superior retrospective performance attributed to value stocks is attributable to this survivorship bias." [He's right, but as a point of intellectual rigor I'd be really interested to know if Niederhoffer actually ever worked with Joel Greenblatt's "magic formula" and whether he found this strange anomalous double measure of value stocks to be as useful as many others do.]

Chapter 9: The Future of Returns

205ff On the first comprehensive database of daily prices of US stocks from 1929 to 1960 created in the 1960s at the University of Chicago; leading to the science of securities analysis. On an international version of this project described in the book Triumph of the Optimists, tracking global investment returns over 101 years.

207-8 "Is there an actual company that survived over this period and had this kind of performance, or are the returns based on indexes where new winning firms regularly replace the losers until they, too, fall by the wayside? Wouldn't this kind of substitution bias all security indexes upward?" This was a question posed to the authors of Triumph of the Optimists, and they responded by saying that any company that did survive over a specific interval will have different machines, different employees, the business will have changed, etc., and the same will be true with a mutual fund: it has a changing collection of securities. "The indexes represent the cumulative performance of a portfolio... There is no need for any constituent company to survive." [This is quite an interesting point: companies, mutual funds, they are all kind of like the Ship of Theseus.]

208ff Niederhoffer makes his own attempts to improve returns from a simple buy-and-hold index strategy: one variation would be to buy in the second year after any down year: this improves the century returns "magnificently" and appears to be statistically significant. [In other words, just put more money to work after a market decline.]

213ff Another approach involved using leverage of up to 150% stock exposure which magnified returns quite significantly, although you would have been down 90% from 1928 to 1932 for example; it "would have been a wild ride." There's also a kind of embarrassing variation Niederhoffer shares here of buying in years ending in five, a likely artifact.

215 Note the mention of Richard Sears, who created a site to track stocks recommended by George Gilder at gtindex.com [this site still exists, although Sears stopped updating it in 2011, as most of the companies Gilder tracked were defunct by that time]. The author quotes Sears arguing that it's impossible to know why markets did what they did and certainly impossible to predict it, calling it a "fatal conceit," borrowing the words the phrase from Hayek's book of the same name.

216 Finally, the author talks about various assumed ranges of returns going forward, like somewhere between 4-6% real returns, and the author uses a metaphor of two travelers who start from London heading for California, where one ends up in San Jose [presumably the 4% guy] and the other arrives to San Francisco. "Whichever of us is right, the returns are superb." [While the choice of San Francisco looks a bit unfortunate today, I get the metaphor: you don't know precisely where or at what pace you're going, but you will eventually arrive to much better weather by investing in stocks.]

Chapter 10: The Periodic Table of Investing

217ff The author goes over a metaphor for the history of knowledge where one accumulates disconnected facts and properties, then uncovers effects that explain these properties, and then a given field awaits a "Copernicus" or a "Linnaeus" who will come up with a classification scene that fits and forms the relations into a coherent whole; an example is how Mendeleyev and Meyer independently came up with the periodic table of elements based on the extensive work of people who came before. The author asks if there is something similar for properties of individual stocks.

218ff Comments on the stochastic properties of stocks; their ever-changing cycles [the author uses "cycles" here not in the economic cycles sense but in the sense of cycles of discontinuities and inefficiencies going through cycles of being exploited and then competed away]. On how much of stock market research is "pre-scientific"--the authors term for how properties are stated in a non-testable fashion; also on investing as a branch of the social sciences, not physical sciences, thus the rules are not "fixed" in the same way. The authors call for "Statistics on the table!" by first presenting certain facts and relations about the stock market (e.g.; risk can be reduced by diversification, insiders tend to buy and sell at propitious times; small companies tend to outperform in most periods, etc.), but he contrasts the predictiveness of Mendeleyev's periodic table where he could actually leave spaces for as-yet-undiscovered elements but yet know their properties in advance, whereas stock market and financial predictions are far more suspect.

220 Note some of these sarcastic quotes about economists: 

"Ask five economists and you'll get five different answers (six if one went to Harvard)."

    --John Kenneth Galbraith

"An economist is an expert who will know tomorrow why things he predicted yesterday didn't happen today."

    --Lawrence J. Peter

220 "How helpful it would be if there existed a classification scheme for stocks as perfect as the periodic table of elements..."  The author goes on to say that there actually is a parallel in the stock market to a periodic table of elements, it is the Value Line stock ranking system. A quick history of Value Line as a company; its founding after the 1929 crash; the ranking system created by Sam Eisenstadt, who started at the firm in 1946 as a proofreader. Comments on the original founder, Arnold Bernhard, who actually did a sort of early version of "visual regression" plotting out annual earnings and stock prices on a logarithmic scale; his fitting process would produce a multiplier on earnings that could be applied to an earnings forecast, and it would give you a "normal value": this "normal value line became known as the Value Line, and stocks that fluctuated above (or below it) indicated overvaluation (or undervaluation). This was seen as a major achievement at the time. [The problem here of course is that the elements are stable whereas stocks (and the underlying companies, as well as any prediction or ranking system of them) are recursive and self-referential and are participating in an investment environment that is likewise recursive and self-referential as people try to rank and re-rank stocks in order to outperform everybody else. As a result the Value Line has also degraded as a source of outperformance.]

222ff On Eisenstadt taking it one level further, by comparing companies with statistical regressions (this required tremendous computing power at the time) leading eventually to Value Line's grouping system, ranking stocks by what Value Line calls "timeliness" and "technical ranking" [It is of course always dangerous to use gaussian-style/normal curve statistical analysis to measure a violently stochastic and autocorrelated ecosystem like the stock market.] Niederhoffer posits a long/short strategy, buying Group 1 stocks and selling Group 5 stocks; the author calls the Value Line timeliness rankings "the greatest practical demonstration of forecasting accuracy in the history of prediction." The methodology has not changed much over time. [It's sobering--but it should not be surprising--that Value Line's outperformance has essentially disappeared. It just goes to show that any "system" in picking stocks stops working.]

225ff On the Value Line's other ranking system "technical analysis"; the outperformance of Group 1 versus Group 5 is even more significant, this is followed by the author hypothesizing "What if the two ranking systems were combined?" before further datamining the system here by saying that the Value Line rankings function much better in the first and fourth quarters of the year than in the second and third. [Given the author's demand throughout the book for testable "scientific" rigor, seeing him engage in datamining here is highly disappointing.]

229ff Criticisms of Value Line's system: that it does not work in many quarters; there are periods of atrocious results; some critics have said this is just outperformance due to beta or volatility; also the Value Line mutual fund underperformed the strategy itself [just like the Rea-Graham fund applying Ben Graham's methods]; that Group 1 returns is solely a theoretical number ignoring transaction costs and dividends; that most of the Group 1 stocks tend to only trade a few thousand shares a day, thus there are huge liquidity costs, etc.

230 The author cites an outlier investor, Henry Hill, who religiously rebalanced his portfolio based on Group 1 rankings and allegedly turned $80,000 into $48 million over 23 years.

231ff The authors interview Eisenstadt, asking him whether he was "discouraged by recent results" [this is an odd and euphemistic way to discuss how the Value Line "edge" completely disappeared!], and he responds that it's due to a recent "value bent" to the market overall and that the outperformance will return. [It hasn't.]

Chapter 11: When They Swing for the Fences, We Run for the Exits

236ff This chapter is a extended baseball metaphor, starting with babe Ruth; the authors start with a thing they call "the home run indicator" it's hard to tell if they're being facetious here or not, but two years after Babe Ruth hit 60 home runs there was a market crash; likewise, after Mark McGwire broke Roger Maris's record there was a market crash.

238ff On the so-called "dead ball era" of the first two decades of the 20th century, when the ball didn't go far, spitballs and doctored balls were permitted, ERAs of 3.0 were the norm and home runs were rare; after World War I baseballs were made with cork cores, trick pitches, spitballs and doctored balls were outlawed, home runs started going up, and Babe Ruth started doing what he did. The authors make sort of a sociological parallel here between home runs and economic environments: likening the 1935-43 era (with lower home run totals) to the Depression-era psychology of the time; but also the post World War II home run expansion paralleled the economic and stock market expansion of that time. The authors hypothesize that Major League Baseball anticipates the mood of the fans by adjusting the balance between offense and defense, and they can do so by changing rules in a wide range of ways, ranging from pitching rules, strike zone changes, the surface of the fields, the makeup of balls, bats and gloves, etc. [This is a readable, but odd, chapter so far. It strikes the reader as a bit masturbatory.]

240ff The authors attempt to test their proposition, finding that "overly numerous home runs presage poor stock performance." [Sounds a little bit like the skyscraper indicator, that it's a zeitgeist that you want to "fade" because people in general are a little too enthusiastic and optimistic when things have been a bit too good for too long: it indicates a coming downcycle.]

243ff Multi-page timelines here of stock market history and baseball history. [Again, masturbatory.]

245 "At a 2001 Yankee playoff game... it was mentioned as a matter of routine that a certain batter had the third highest percentage of foul balls per pitch with two outs during playoffs of all American League players. If only market practitioners were to keep at their fingertips one-thousandth of that kind of knowledge about the picks of their favorite analysts--returns to be anticipated, winning streaks, balls, strikes, and so on--the market would be a far more sensible and profitable place." [Actually it probably would be even less sensible--and certainly less profitable--because we'd all be playing against far more informed counterparts...!]

Chapter 12: Boom or Bust?

247ff On real estate as an (allegedly) ideal alternative to a roller-coaster stock market, except for the fact that REITs have underperformed stocks; the author thinks investors can benefit from studying the patterns linking real estate cycles and business cycles; on real estate as the largest of any asset class, with commercial properties worth some $5 trillion dollars and residential property worth some $12 trillion compared to $11 trillion in stock and $5 trillion in corporate bonds. [Note that these figures are from 2003; the global numbers today are quite striking to look at, see photo below.] The author also notes that real estate also represents about 20% of the assets on every corporate balance sheet, so anyone who holds stocks technically has real estate exposure as well. "Americans have a large part of their wealth in real estate, probably more than they realize." Comments on how it absorbs much of people's spending, something like a third of a family's income will go towards real estate spending in one form or another. [Ironically this is one of the reasons why real estate is a crappy investment: it's capital intensive and operating cost intensive.] 

248ff Comments on various real estate speculative booms: the South Sea Company, the Mississippi Company, 1980s Japan, etc., arriving at the 1997 Thailand collapse that "forced Vic to close his hedge fund and mortgage his home" which likewise was largely a speculative real estate bubble. Also the reader learns here the co-author Laurel Kenner's father was a mortgage banker who refused to sign off on what he considered to be inflated appraisals of commercial properties: he lost his job and the REIT he worked for collapsed.

249ff Discussion of the REIT vehicle itself, with its tax advantages, how it gives small investors opportunities to invest in office buildings, shopping centers, apartment houses, etc.; one can think of a REIT as a mutual fund for property with more liquidity than direct real estate investment and (often) with dividend yields as well.

250ff On how REIT indexes have significant survivor bias problems, in fact, the survivor bias probably drives 2-3 percentage points of phantom returns per year according to one study. On how Wall Street analysis of REITs is pretty much useless, the author highlights the when analysts compare the dividend yield of a REIT compared to the yield on bonds, you have to make sure you differentiate a high positive spread implying undervaluation from a spread that just represents higher risk.

252 Comments on the relatively high correlation of REITs to stocks; on the fact that this relation broke down in the late 1990s as REITs fell when stocks boomed and the early 2000s when stocks fell and REITs held up fairly well; the REIT industry then loudly proclaimed how their correlation with stocks decreased, thus you should buy REITs to diversify. The authors claim that there aren't any "incremental returns from such diversification." [After owning my own little collection of REITs over the past 30 years or so I have in general been disappointed with their performance, with some minor exceptions.] Other comments on REITs here: they tend to have above-inflation returns and higher returns than plain bonds, although not as high as stocks, but they're also less volatile than stocks too.

253ff Even though investing in REITs won't significantly improve your returns, "the speculator will find real estate a highly profitable field of study for understanding stock market cycles." Discussion here of Henry George and David Ricardo and their theory that business cycles are mainly caused by movements in real estate values, because rents and land prices rise when business conditions are good; but then the cycle eventually reverts as businesses fall behind on rents and mortgage payments, leading to a default cycle/credit cycle period, followed by land prices declining. "This simplified model is so obvious and so elementary that it almost seems naive to present it, except that throughout history and across countries the cycle George and Ricardo described seems to repeat over and over again."

255ff The authors try to identify any kind of relationship between REIT prices and stock prices, citing once again the 2000-2002 period when there was a massive divergence of performance in REITs versus the stock market; then a chart of REIT returns after a year of decline; the author's talk about a bearish call on REITs in 2002 after two massive years of outperformance, citing other warning signs like fuzzy accounting, a burst of popular books on the topic and the addition of major REITs to the S&P500 [it is usually a pretty reliable bet to reduce your exposure to any sector that catches wide favor among investors or the financial media]; they also saw an increase in vacancy rates at the time; the authors also cite the incredible amount of vilification they got in their columns for CNBC Money when they made a prediction that REIT prices would decline. [That's another tell: when people have strong emotional reactions to something.]

260ff The authors interpreted the "torrent of vituperation" to mean their call was correct; also comments on idiosyncrasies of REIT capacity: when developers, banks and investors think business conditions warrant expansion--and because it takes so long for new supply to reach the market--that new supply tends to reach the market when conditions have changed dramatically. [This is exactly like how commodity cycles work with long lead-time commodities like metals, also typically all the new supply comes to the market all at once too.]

262 "The near-unanimous negative sentiment that our article on REITs elicited is all too typical of what happens at market peaks. Such virulent reactions explain why the public consistently loses, over and over again, much more money than it has any right to lose." [Once again: don't be retail.]

Chapter 13: Market Thermodynamics

264ff On applying concepts from physics to the stock market: repeat discussions here about the wonders of the scientific method; the authors write "Odd though it may seem, given the scientific method's successes, the investment field has not universally embraced it." [The investment field, unfortunately, is subject to the same "studies show science" that soft sciences, economics, medicine are subject to, most of which produces research outputs that are useless or outright wrong]. Mention here of Thomas Kuhn and his 1962 book The Structure of Scientific Revolutions, and a discussion that new theories result from funerals, not truth-seeking; [!] also comments on cross-pollination among disparate fields and the arbitrary way science breaks down academic science, dividing up the universe into domains of physics, chemistry, biology, etc., when the reality recognizes no such boundaries.

267 Note the cute example here of a guy who came up with a notion of "particle finance," talking about the different risks embodied in a single financial instrument; see also various examples of "idea transfers" in science, like the discovery of blood circulation which borrowed ideas from hydraulics.

267ff Another metaphor here: conceptualizing money as energy [this is an idea that will make enormous sense to any bitcoiner who has tuned into the thinking of Michael Saylor but to hear Victor Niederhoffer talk about it in 2003 it's quite striking]: how it can be transferred from person to person, how it can exist in different forms (currency, land, goods), how commerce transfers this energy around in a circular flow, how we could think about it as "potential energy" (say in the form of an oil well yet undiscovered, seeds stored in a farmer's shed, or technological innovations in some entrepreneur's mind); the author then moves to the First Law of Thermodynamics, the conservation of energy, an idea originated by Julius Robert Mayer in 1842 but also applied to social sciences by thinkers like Herbert Spencer.

268ff The author translates this conservation of energy idea into ideas like a move upward in bonds is counterbalanced by an equal move downward in stocks [We also see this in sector rotations within the stock market as well, you might see consumer products up at a time when industrials or economically sensitive sectors of the market are down]; also on the ideas of "storing energy": sometimes the movement of money or asset prices happens with a lag, kind of like a wound-up watch that gradually unwinds.

269ff A variation of this idea talking about a drawdown in economic potential energy during a period like the 2000 tech crash: on the way up, people converted their money into equities, the equity market begins to decelerate, then people convert their equities back into cash, stock prices go down, and the cycle repeats; on the fallacy that the money "disappeared" or "trillions of dollars evaporated in a stock market decline": money doesn't disappear, it just goes somewhere else: for every investor buying there's a seller on the other side of the trade and vice versa.

272ff Another variation of the conservation of energy: where does money for IPOs come from? Comments that a dearth of IPOs is highly bullish, meaning that that money comes from existing stocks.

274ff On money available to buy stocks as a form of "potential energy": money piles up on the sidelines, so to speak, and it seems like it has disappeared from the market but in reality has just been converted into potential energy form.

275ff On entropy, the Second Law of Thermodynamics: looking at the stock market as a mechanism to transfer wealth just like heat dissipates into a room from a glass of hot water; the author uses a metaphor here of how a sharp downward move in prices requires a lot of energy, thus the additional energy to take the price still lower is even greater, thus the price may take the path of least resistance and rebound. Additional comments here on friction and heat dissipation; the author talks here about financial friction in the form of bid-ask spreads, broker commissions, fees, etc. "An easy way to improve your returns in the market is to reduce trading expenses."

277ff On sector rotation and entropy production, where certain sectors may hold on to heat or energy by showing relatively strong performance, which causes people to further chase the trend; the authors find that changing sectors doesn't seem to produce outperformance. Also on entropy when the market has a correction and that economic energy is then distributed among diversified asset classes, not just in stocks. 

 279 Final comments here on thermodynamics, differentiating closed systems from markets, which have other, exogenous energy forms like emotional and psychic energy, or productive energy like new technology; it is an open system and so there are unpredictable ways in which energy can be converted to kinetic energy or waste heat; this makes measuring or quantifying these sources of energy nearly impossible [fortunately we can just think of it as a metaphor and use it as such]. The author quotes a friend saying, "In the realms of biology and physics, it might be possible, but in a realm with Alan Greenspans and printing presses, you can't."

Chapter 14: Practical Market Lessons from the Tennis Court

281ff Here the author translates certain metaphors from tennis into investing, like picking your spots, choosing your surface, etc.; the metaphor here is the stock market has an upward drift, so buy and hold; also other metaphorical applications like you have to know when and when to not enter a tournament.

284ff On having a game plan; don't try to work out your shots right before the match; likewise prepare for the market long before the open or long before a major event happens. [As obvious as this admive may sound, it really is valuable--and most people rarely do it--to have a "bid list" of stocks you want to buy on any correction or market disclocation, or to have already-prepared scenarios worked out and written down for what you would do with a stock at different prices.] Other metaphors: have sufficient stamina: the one part of sports where you have control is over your own fitness; likewise in the market the larger your asset base relative to fluctuations in your holdings, the more "stamina" you'll have in the marketplace as well.

285ff On controlling the center of the court: a metaphor for maintaining a financial position that lets you maneuver into good opportunities easily.

290 Comments here on the end game: the author talks about how whenever he was ahead he would imagine the score was against him by the margin of victory that he was ahead; this keeps you from playing defensively and it keeps you focused on every point; the metaphor here is to avoid undue risks when you are ahead, take gains when you're up in a good run, and never underestimate your "opponent" [the stock market].

Chapter 15: The Fine Art of Bargaining for an Edge

291ff General advice here, like practicing negotiation in everyday life, always be willing to ask respectfully for a better price; and then [more subtle advice here] learn also about hidden patterns in the negotiating process so you can get past certain barriers or caricatures associated with negotiators.

293 Never say yes right away: people expect to bargain and if you say yes right away the other person is will be regretful, when bargaining is done well people can be very satisfied with even a lousy deal. Note also in the stock market the movements of a stock are designed to show attractiveness and scarcity to potential buyers. [Interesting, I had never really thought about it that way.]

294ff On managing your costs: also on always letting your counterparties know about your bad trades... they might give you a better fill next time! If they know you're doing well they'll do the opposite. Niederhoffer talks here about always buying a few ticks below the current bid with a limit, and selling a few ticks above the offer, again with a limit. Also on picking your time and place when buyers (or sellers) are desperate; the analogy here is like buying a car at the end of the month or on Christmas Eve, or where you wait and let a good deal come to you.

297ff Comments here on having proper information before you enter into a negotiation.

299 Final comments here on flexibility of price; not being too eager; exercising care around numbers; also on always being friendly: "No one wants to reduce the price for someone they dislike." [The Millennials were right!!] Finally: "...it is not shameful for people to say at what price under the quoted one they would buy."

Chapter 16: An Amiable Idiot in the Biotechnology Revolution

301ff Discussion here paralleling a biotech company trying to get a new molecule approved by the FDA with Jason attempting to capture the Golden Fleece; this is followed by a discussion of the author's view that the FDA should be abolished.

305ff A list here of predictable arguments for eliminating the FDA: that it stifles competition, that it makes it too difficult to bring new drugs to market; the consumer protection and safety that the FDA allegedly provides is offset by all of the drawbacks; on the trade-offs of Type I and Type II errors [in other words, the balance between the FDA approving a harmful drug versus not letting a good drug go to market] and how no one sees the faceless lives lost because of a drug that could have been let through the FDA gauntlet; on how aspirin and penicillin would never make it through FDA approval today, etc. [Note that there isn't any discussion here (how could there be? This was stuff that didn't become obvious until the COVID era...) of the regulatory capture problem at the FDA, or its proclivity lately to approve high-SAE treatments like the COVID vaccine or remdesivir.]

306 Various examples given here [some very unfortunate in retrospect, particularly with statins] of the FDA blocking or delaying approval and causing harm according to Niederhoffer; see for example beta-blockers, held up for eight years because the FDA thought they were carcinogenic--Niederhoffer claims an estimated 119,000 people died who might have been helped [he gives no math behind this claim]; on the antibiotic drug Septra, which was delayed by five years, the author cites someone claiming that five year delay cost 80,000 lives; other examples: Mevacor, a cholesterol-lowering drug: delayed three years; the author argues that 1,000 people died from heart disease because of the FDA's delay [once you know that statin meds do not offer any mortality benefit, you can't help but laugh out loud at such a claim: there's no way to argue that "lives were lost" by delaying it. This section is deeply ironic, as the author demands thoughout his book that claims be tested, that there be rigor, but here he has really taken a day off from rigor.]

308ff Next the author pivots to information asymmetry in the context of insider purchases of shares; starting with a metaphor of the sale of a used car where the seller knows more about the vehicle; also insurance buyers know more about how sick they are than an insurance company selling policies. Thus on a practical level, looking at biotech executives who buy their own shares, would they do so thinking their product is likely to be rejected? Other trade-offs on insider buying: sometimes companies have scheduled sales; also an executive could buy minimal shares as a setup for a later, larger sale. Niederhoffer and one of his interns tests insider buying for biotech companies to see if it's predictive for investment outperformance. Their first attempt produced a 25% return in one year but then when they repeated the trial for the following year they found a negative result. [This chapter is disappointing and largely a waste of time.]

Chapter 17: Earnings Imposters

315ff General rules here for avoiding accounting problems--"imposters"--in investing: first on the importance of paying attention to cash and cash equivalents on the balance sheet; as well as paying attention to cash flow from operations, especially if profits don't show up in cash flows; also has a company announced a buyback, does it pay dividends, what is going on with receivables and inventory? Also, a good one: does the company pay taxes? [This implies the company's earnings are actual real earnings.] "You don't need a green eyeshade to understand this stuff."

316ff On cash flows, the author goes through a few paragraphs here discussing how an educated lay reader can reconcile a company's net income with their cash flows. The author shows an example from General Electric where most of the net income came from changes in inventory and receivables. [This example is strangely incomplete, it doesn't really make sense to me as a reader. I wonder if there might have been an editing or continuity error here.]

317ff On buybacks and dividends: buybacks signal that the board thinks the stock is undervalued, also it reduces the share count so this improves certain financial metrics like earnings per share and return on equity; also buybacks can be one-offs, there's no implied commitment like when a company begins paying dividends; also how companies that do consistent buybacks tend to outperform. [This is a good example where there's "a third variable": Buffett/Munger-style "wonderful businesses" that are highly profitable and highly cash generative tend to be able to do consistent buybacks... but their stocks outperform because they're wonderful businesses, not because of the buyback per se. Also: Be careful of company buybacks in cyclical industries! See for example what Boeing did: in the 2013-2019 period Boeing bought back a ton of share, some $60B at prices ranging from $300-440 a share, but then because of a cyclical downturn (and other problems at the company) they had to do an equity share offering of some $20B in 2024. In other words, BA "bought high" for years, but then had to "sell low" in order to raise desperately needed money later.]

319ff On dividends, you have to have the cash in order to pay out the cash; dividends are more tangible than just accounting statements; you can actually look at just the dividends of your portfolio and not concern yourself with the portfolio's value; note the author's comment here about the unfavorable tax treatment of dividends [which has since changed as dividends used to be taxed twice once at the corporate level and then again at the shareholder level, this is not true anymore]. On the risk that dividends can be cut; also on a sort of meta-interpretation of dividends--a negative one--it implies the company doesn't have any better use for the cash.

322 Interesting discussion here on a famous quote from Bill Gross [back in the day when he was still highly regarded and running PIMCO's bond portfolio]: one at one point in 2002 Gross argued that the Dow should have a dividend yield comparable to bond yields, thus the Dow should be at 5,000 rather than its current value at the time of 8500. "Such an argument is so naive that we are almost embarrassed to hear it expressed." [I vividly remember this! The authors here are as appalled as I was when I heard it at the time.] Note there are lots of reasons why, all else equal, stocks yield less than bonds: they may want to retain earnings for growing the business, for reinvestment, to buy back shares, also dividends have a growth rate where bond yields are fixed, etc.

324 The authors look at periods when per-share dividends fell for the S&P500, something that happened in only 6 years between 1938 and 2002. They also found that in those 6 years the average gain was 17% and then in the year following the gain was another 10%; thus the claim that stocks can't go up unless dividends go up is clearly not true. [A few thoughts here: the sample size is 6, so it's hard to generalize anything, but usually dividend cuts are a lagging indicator of a change in fortune of companies; if lots of companies cut their dividends, it means things have already been pretty bad, thus it's not unreasonable to expect mean reversion in the years to follow.]

325 Another interesting way to look at possible fraudulent companies or companies with accounting disasters: look at whether actual cash taxes were a high percent of the company's EBITDA. The logic here is you would think a company would not want to pay taxes on money they never made in the first place. [!!] 

326ff Also on the point that there are different rules for calculating a company's IRS tax liabilities versus generally accepted accounting principles that are used to report accounting income to the public: you can use different depreciation measures, amortize intangibles, you have latitude for revenue recognition, etc. Note the author's finding here that companies that paid less tax on the same amount of income did worse than companies that paid more: this is an interesting and counterintuitive finding; you'd think the companies that were better able to manage their tax liabilities would be better managed and thus would perform better.

229ff Comments on inventory: when inventory is down this is bullish, when it's up it's bearish; the implication is if inventory is higher than normal the company will have to sell it at a discount in the future. Various examples here of Nvidia in 2002, as well as Tellabs and Motorola during the same period: all had large increases in inventory right when the tech boom ended. [Another way to think about this is when a company has an increase in inventory, it may mean they sold much less stuff than they expected, implying things are slowing more than the company expects. Of course there can be various other reasons too, you have to hear what the company says about this inventory increase and see if it makes sense.]

331ff Another "studies show science" finance study here where researchers found that company stock performance suffers after a period when accrued earnings exceed cash earnings; the author then ties this back to a discussion of focusing on the cash flow statement.

332 Note this interesting quote here from one of the authors of the study on p331, as he loses his virginity when it comes to how accounting works: "I entered Columbia's PhD accounting program with a blind trust in accounting numbers. Four years later, when I got out, I had developed a healthy skepticism... Accounting can be dirty." [Good for you dude! Welcome.]

Chapter 18: Finale

341ff The authors address the question "Do they use any technical indicators at all?" Niederhoffer answers in sort of a weird third person essay, talking about how long he's been working in the business, tracking market prices by hand, that he worked for Soros, and had very intelligent people working for him, thus any system would have been already researched and found wanting, etc. [This is a weird "appeal to authority" type argument you would think would be beneath the author.]

343ff On the question "How do you find all your offbeat, down-home philosophers who have wild but useful ideas about the markets? The author talks about his "Spec List" circle of experts, a group of people who would exchange emails on investing. [Note that you can access many of the day-to-day thoughts of Niederhoffer's circle of brains on his site Daily Speculations, which is still running hard despite Niederhoffer's recent death. It is really important to get input, feedback and criticism from unusual and insightful thinkers if you want to do well in investing.]

348ff A discussion of ever-changing cycles, including one called "cheat the prophet," where everybody believes some rapidly growing market (like web page views or energy derivatives trading) will be immensely profitable, but some change,some small movement in the competitive environment sends the domain into decline. This is a sort of "law of opposites." The author also cites Julian Simon discovering this principle as he noted how real commodity prices seemed to constantly decrease over the long term, while frequent predictions of commodity shortages always seem to end up being wrong. This is attributed to innovation, improved methods of production of goods, price signals that cause new supply to become available, etc. [Julian Simon's book The Ultimate Resource is a great read by the way, I recommend it.]

350 Brett Steenbarger quoted here on predictability itself being a variable, one could look at the stock market as completely unpredictable and random (like the efficient markets hypothesis view) or view the market as predictable (say what a quant or technical analyst might think), but perhaps it's more nuanced and more accurate to think about how the markets vary in their degree of predictability; that predictability itself should be viewed as a variable. Thus there might be value in establishing models and trading "metarules" for shifting both your model and your modeling process in response to market conditions. And if you consider this idea, you realize you cannot follow a single trading system because changing cycles force you to change. The point here is most discussions of trading systems focus on the first level of complexity (entries/exits/stops) without consideration of how these are modified in the face of shifting market conditions. "To the extent that this second level of complexity is missing, a trader can be expected to do well under one set of marketing conditions and dismally in others--which is what we're seeing with many traders who made money in the late 1990s and now are having a difficult time." [Interesting mental model right there.]

352ff Extended session section here applying fishing metaphors to stock market investing: be on the lake when fish are feeding (meaning know what sectors the market likes); don't go fishing when the lake is packed with tourists; sometimes the fish just won't bite; sometimes you find yourself in the middle of a school of feeding fish, thus just keep your hook baited in the water, etc.

358ff Comments on Alan Greenspan and the author's view that he's a destructive villain who caused the 2000-2001 market crash. The section has a weird tangent talking about the Islamic fanatics that caused the 9/11 attack, comparing that mentality to an anti-tech mentality that runs parallel to the development of Western culture across the centuries; on the strong irony that Islamic terrorism uses Western technology in order to destroy it. This is one of the strangest passages of the entire book, but I think the author is trying to liken Greenspan to other bureaucrats and leaders who want to exercise rigid control over trade, business and freedom.

361ff Finally a section here on what books the author would recommend: he starts with works [not even books] from a long time ago, including Magazine of Wall Street by Richard Wyckoff from the early 1900s and Hunt's Merchant's Magazine published in the 1870s. But then he says "that was then," now he recommend Triumph of the Optimists. And then a section here explaining why he recommends the 1956 movie Invasion of the Body Snatchers as well as the original 1954 book which Niederhoffer says "is about the danger of losing hope and passively accepting the status quo. If you succumb to conformity and stop thinking for yourself, the pod people will get you." The point here is to be a contrarian, and surround yourself with other contrarians, this will encourage you to think for yourself and not get caught up in the herd.

Afterword

367 The book closes here with the author talking mournfully about failure when he blew up in 1997; how he takes his loss personally, how he's been trying to crawl back up the stairs since then, "not entirely without success." On how he has doubts, how he thinks he's the world's worst. "I am invariably too early and too contratrend in my trades... I am still trying to improve, however..." Finally the book ends with a encouraging message from his uncle basically telling him to let go of his self-doubt.

To Read:

***Paul Heyne: The Economic Way of Thinking

Guy de Maupassant: "The Horla" (short story)

***Elroy Dimson, Paul Marsh and Mike Staunton: Triumph of the Optimists: 101 Years of Global Investment Returns ["the best investment book ever written"]

Steve Stigler: Statistics on the Table ["marvelous"]

***Robert L. Bacon: Secrets of Professional Turf Betting

Mario Puzo: The Last Don

Mario Puzo: Fools Die

Mary Buffett and David Clark: Buffettology

Albert Jay Nock: Memoirs of a Superfluous Man

Ivan Turgenev: Clara Militch

Robert Shiller: Irrational Exuberance

Thornton O'glove: Quality of Earnings

Howard Schilit: Financial Shenanigans

Aswath Damodaran: The Dark Side of Valuation

Alfred McClung Lee and Elizabeth Briant: The Fine Art of Propaganda: A Study of Father Coughlin's Speech (1939 edition) ["a classic"]

David Bronstein: The Modern Chess Self-Tutor

Daniel Defoe: A Journal of the Plague Year

Paul Dickson: Baseball's Greatest Quotations

John E. Cooke: Life of Stonewall Jackson

Robert L. Park: Voodoo Science: From Foolishness to Fraud

*** Zvi Bodie: Essentials of Investments [textbook]

Leon Festinger: When Prophecy Fails
***Flo Conway and Jim Siegelman: Snapping

***William Worthington Fowler: Ten Years in Wall Street

Robert Sobel: When Giants Stumble: Classic Business Blunders and How to Avoid Them
Harold Nicolson: Diplomacy (1939) ["classic"]

***David Bronstein: The Modern Chess Self-Tutor

Read Hastie and Robin M. Dawes: Rational Choice in an Uncertain World

***F.A. Hayek: The Fatal Conceit

Sanford Jacobs, ed.: The Quotable Investor

William A. Sherden: The Fortune Sellers

***Henry George: Progress and Poverty (1879)

Homer Hoyt: One Hundred Years of Land Values in Chicago

Abhinay Muthoo: Bargaining Theory with Applications

Thomas C. Scheling: The Strategy of Conflict

Francis Galton: The Art of Travel

Henry Clews: Twenty-Eight Years in Wall Street

Jack Finney: Invasion of the Body Snatchers