Thursday, September 20, 2012

Randomness

nice article from the world question center by Mr. Charles Seife...

Randomness

Our very brains revolt at the idea of randomness. We have evolved as a species to become exquisite pattern-finders — long before the advent of science, we figured out that a salmon-colored sky heralds a dangerous storm, or that a baby's flushed face likely means a difficult night ahead. Our minds automatically try to place data in a framework that allows us to make sense of our observations and use them to understand events and predict them.

Randomness is so difficult to grasp because it works against our pattern-finding instincts. It tells us that sometimes there is no pattern to be found. As a result, randomness is fundamental limit to our intuition; it says that there are processes that we can't predict fully. It's a concept that we have a hard time accepting even though it is an essential part of the way the cosmos works. Without an understanding of randomness, we are stuck in a perfectly predictable universe that simply doesn't exist outside of our own heads.

I would argue that only once we understand three dicta — three laws of randomness — can we break out of our primitive insistence on predictability and appreciate the universe for what it is rather than what we want it to be.

The First Law of Randomness: There is such a thing as randomness.

We use all kinds of mechanisms to avoid confronting randomness. We talk about karma, in a cosmic equalization that ties seemingly unconnected events together. We believe in runs of luck, both good and ill, and that bad things happen in threes. We argue that we are influenced by the stars, by the phases of the moon, and by the motion of the planets in the heavens. When we get cancer, we automatically assume that something — or someone — is to blame.

But many events are not fully predictable or explicable. Disasters happen randomly, to good people as well as to bad ones, to star-crossed individuals as well as those who have a favorable planetary alignment. Sometimes you can make a good guess about the future, but randomness can confound even the most solid predictions — don't be surprised when you're outlived by the overweight, cigar-smoking, speed-fiend motorcyclist down the block.

What's more, random events can mimic non-random ones. Even the most sophisticated scientists can have difficulty telling the difference between a real effect and a random fluke. Randomness can make placebos seem like miracle cures, harmless compounds appear to be deadly poisons, and can even create subatomic particles out of nothing.

The Second Law of Randomness: Some events are impossible to predict.

If you walk into a Las Vegas casino and observe the crowd gathered around the craps table, you'll probably see someone who thinks he's on a lucky streak. Because he's won several rolls in a row, his brain tells him that he's going to keep winning, so he keeps gambling. You'll probably also see someone who's been losing. The loser's brain, like the winner's, tells him to keep gambling. Since he's been losing for so long, he thinks he's due for a stroke of luck; he won't walk away from the table for fear of missing out.

Contrary to what our brains are telling us, there's no mystical force that imbues a winner with a streak of luck, nor is there a cosmic sense of justice that ensures that a loser's luck will turn around. The universe doesn't care one whit whether you've been winning or losing; each roll of the dice is just like every other.

No matter how much effort you put into observing how the dice have been behaving or how meticulously you have been watching for people who seem to have luck on their side, you get absolutely no information about what the next roll of a fair die will be. The outcome of a die roll is entirely independent of its history. And, as a result, any scheme to gain some sort of advantage by observing the table will be doomed to fail. Events like these — independent, purely random events — defy any attempts to find a pattern because there is none to be found.

Randomness provides an absolute block against human ingenuity; it means that our logic, our science, our capacity for reason can only penetrate so far in predicting the behavior of cosmos. Whatever methods you try, whatever theory you create, whatever logic you use to predict the next roll of a fair die, there's always a 5/6 chance you are wrong. Always.

The Third Law of Randomness: Random events behave predictably in aggregate even if they're not predictable individually

Randomness is daunting; it sets limits where even the most sophisticated theories can not go, shielding elements of nature from even our most determined inquiries. Nevertheless, to say that something is random is not equivalent to saying that we can't understand it. Far from it.

Randomness follows its own set of rules — rules that make the behavior of a random process understandable and predictable.

These rules state that even though a single random event might be completely unpredictable, a collection of independent random events is extremely predictable — and the larger the number of events, the more predictable they become. The law of large numbers is a mathematical theorem that dictates that repeated, independent random events converge with pinpoint accuracy upon a predictable average behavior. Another powerful mathematical tool, the central limit theorem, tells you exactly how far off that average a given collection of events is likely to be. With these tools, no matter how chaotic, how strange a random behavior might be in the short run, we can turn that behavior into stable, accurate predictions in the long run.

The rules of randomness are so powerful that they have given physics some of its most sacrosanct and immutable laws. Though the atoms in a box full of gas are moving at random, their collective behavior is described by a simple set of deterministic equations. Even the laws of thermodynamics derive their power from the predictability of large numbers of random events; they are indisputable only because the rules of randomness are so absolute.

Paradoxically, the unpredictable behavior of random events has given us the predictions that we are most confident in.

Wednesday, September 19, 2012

Taleb's Anti-fragility

from the world question center...

Antifragility

Just as a package sent by mail can bear a stamp "fragile", "breakable" or "handle with care", consider the exact opposite: a package that has stamped on it "please mishandle" or "please handle carelessly". The contents of such package are not just unbreakable, impervious to shocks, but have something more than that , as they tend to benefit from shocks. This is beyond robustness.

So let us coin the appellation "antifragile" for anything that, on average, (i.e., in expectation) benefits from variability. Alas, I found no simple, noncompound word in any of the main language families that expresses the point of such fragility in reverse. To see how alien the concept to our minds, ask around what's the antonym of fragile. The likely answer will be: robust, unbreakable, solid, well-built, resilient, strong, something-proof (say waterproof, windproof, rustproof), etc. Wrong — and it is not just individuals, but branches of knowledge that are confused by it; this is a mistake made in every dictionary. Ask the same person the opposite of destruction, they will answer construction or creation. And ask for the opposite of concavity, they will answer convexity.

A verbal definition of convexity is: benefits more than it loses from variations; concavity is its opposite. This is key: when I tried to give a mathematical expression of fragility (using sums of path-dependent payoffs), I found that "fragile" could be described in terms of concavity to a source of variation (random or nonrandom), over a certain range of variations. So the opposite of that is convexity — tout simplement.

A grandmother's health is fragile, hence concave, with respect to variations in temperature, if you find it preferable to make her spend two hours in 70? F instead of an hour at 0? F and another at 140? F for the exact 70? F on average. (A concave function of a combination f(½ x1+½ x2) is higher than the combination ½ f(x1)+ ½ f(x2).

Further, one could be fragile to certain events but not others: A portfolio can be slightly concave to a small fall in the market but not to extremely large deviations (Black Swans).

Evolution is convex (up to a point) with respect to variations since the DNA benefits from disparity among the offspring. Organisms benefit, up to a point, from a spate of stressors. Trial and error is convex since errors cost little, gains can be large.

Now consider the Triad in the Table. Its elements are those for which I was able to find general concavities and convexities and catalogue accordingly.

The Triad



FRAGILE
ROBUST
ANTI-
FRAGILE
Mythology — Greek
Sword of
Damocles, Rock of Tantalus
Phoenix
Hydra
Biological & Economic Systems
Efficiency
Redundancy
Degeneracy (functional redundancy, in the Edelman-Galy sense)
Science/Technology
Directed Research
Opportunistic research
Stochastic Tinkering (convex bricolage)
Human Body
Mollification, atrophy, "aging", sarcopenia
Recovery
Hypertrophy,
Hormesis, Mithridatism
Political Systems
Nation-State;
Centralized
Statelings, vassals under a large empire
City-State; Decentralized
Income
Companies
Income of Executives (bonuses)
Civilization
Post-agricultural
Modern urban
Ancient settlements
Nomadic and hunter-gatherer tribes
Decision Making
Model-based probabilistic
decision making
Heuristic-based decision making
Convex heuristics
Knowledge
Explicit
Tacit
Tacit with convexity
Epistemology
True-False
Sucker-Nonsucker
Ways of Thinking
Modernity
Medieval Europe
Ancient Mediterranean
Errors
Hates mistakes
Mistakes are just information
Loves mistakes
Learning
Classroom
Real life, pathemata mathemata
Real life and library
Medicine
Additive treatment (give medication)
Subtractive treatment (remove items from consumption, say carbs, etc.)
Finance
Short Optionality
Long Optionality
Decision Making
Acts of commission
Acts of omission ("missed opportunity")
Literature
E-Reader
Book
Oral Tradition
Business
Industry
Small Business
Artisan
Finance
Debt
Equity
Venture Capital
Finance
Public Debt
Private debt with no bailout
General
Large
Small but specialized
Small but not specialized
General
Monomodal payoff
Barbell polarized payoff
Finance
Banks, Hedge funds managed by economists
Hedge Funds (some)
Hedge Funds
(some)
Business
Agency Problem
Principal Operated
Reputation (profession)
Academic, Corporate executive, Pope, Bishop, Politician
Postal employee, Truck driver, train conductor
Artist, Writer
Reputation (class)
Middle Class
Minimum wage persons
Bohemian,
aristocracy, old money

The larger the corporation, the more concave to some squeezes (although on the surface companies they claim to benefit from economies of scale, the record shows mortality from disproportionate fragility to Black Swan events). Same with government projects: big government induces fragilities. So does overspecialization (think of the Irish potato famine). In general most top-down systems become fragile (as can be shown with a simple test of concavity to variations).

Worst of all, an optimized system becomes quickly concave to variations, by construction: think of the effect of absence of redundancies and spare parts. So about everything behind the mathematical economics revolution can be shown to fragilize.

Further we can look at the unknown, just like model error, in terms of antifragility (that is, payoff): is what you are missing from a model, or what you don't know in real life, going to help you more than hurt you? In other words are you antifragile to such uncertainty (physical or epistemic)? Is the utility of your payoff convex or concave? Pascal was first to express decisions in terms of these convex payoffs. And economics theories produce models that fragilize (except rare exceptions), which explains why using their models is vastly worse than doing nothing. For instance, financial models based on "risk measurements" of rare events are a joke. The smaller the probability, the more convex it becomes to computational error (and the more concave the payoff): an 25% error in the estimation of the standard deviation for a Gaussian can increase the expected shortfall from remote events by a billion (sic) times! (Missing this simple point has destroyed the banking system).

II

Jensen's Inequality as the Hidden Engine of History

Now the central point. By a simple mathematical property, one can show why, under a model of uncertainty, items on the right column will be likely to benefit in the long run, and thrive, more than shown on the surface, and items on the left are doomed to perish. Over the past decade managers of companies earned in, the aggregate, trillions while retirees lost trillions (the fact that executives get the upside not the downside gives them a convex payoff "free option"). And aggressive tinkering fares vastly better than directed research. How?

Jensen's inequality says the following: for a convex payoff, the expectation of an average will be higher than the average of expectations. For a concave one, the opposite (grandmother's health is worse if on average the temperature is 70 than in an average temperature of 70).

Squaring is a convex function. Take a die (six sides) and consider a payoff equal to the number it lands on. You expect 3½. The square of the expected payoff will be 12¼ (square 3½). Now assume we get the square of the numbers on the die, 15.1666, so, the average of a square payoff is higher than the square of the average payoff.

The implications can be striking as this second order effect explains so much of hidden things in history. In expectation, anything that loves Black Swans will be present in the future. Anything that fears it will be eventually gone — to the extent of its concavity.

Monday, September 17, 2012

From Mr. Hussman's latest commentary

Last week, we observed a syndrome of evidence that matches only a handful of market extremes in history, including August-December 1972, August 1987, April-July 1998, July 1999, and March 2000, and April-July 2007. Investors with a good sense of market history will recognize all of those instances as points from which subsequent outcomes were steeply negative, even if stocks held up or advanced moderately over the short-run. With regard to the potential for steeply negative outcomes, we find that when we look across history, conditions similar to the present have been “enriched” with steep declines – another way of saying that the negative tail of the distribution is very fat here.

For example, if we break our estimates of prospective market return/risk into five quintiles or “buckets”, present estimates are clearly in the most negative bucket. Historically, 31% of instances in that worst bucket have been followed by a market decline of at least 10% over the following 6 month period, while 41% of all 10% market declines (occurring within a 6-month period) have started from instances in that bucket. In other words, while the lowest quintile captures 20% of the historical data, that bucket captures 10% market corrections more than twice as often as one would expect if those 10% declines were randomly distributed across market conditions. Similarly, the periods in the lowest quintile of prospective return/risk capture 45% of all 15% market declines that have occurred within a 6-month window, 54% of all 20% market declines, 69% of all 30% declines, and 87% of all declines of 35% or more (what would commonly be considered “crashes”).

In short, saying that our estimates of prospective return/risk are negative does not indicate that the market will or must plunge. Rather, it says that the average outcome has been quite negative, and the likelihood of extreme “tail events” is vastly enriched compared with more typical conditions throughout history. In this environment, market exposure has typically been far more costly than it has been beneficial, and investment opportunities have generally emerged after a period of market losses.

Mr. Hussman even more negative

As noted last week, Mr. Hussman has a very unfavorable risk-reward view of the U.S. equity market.  Mr. Hussman has been negative for quite awhile now, but look at what he thinks now...

Friday, September 14, 2012

What worries Mr. John Hussman


So what do I worry about? I worry that investors forget how devastating a deep investment loss can be on a portfolio. I worry that the constant hope for central bank action has given investors a false sense of security that recessions and deep market downturns can be made obsolete. I worry that the depth of the recessions and downturns – when they occur – will be much deeper precisely because of the speculation, moral hazard, and misallocation of resources that monetary authorities have encouraged. I worry that both a global recession and severe market downturn are closer at hand than investors assume, partly despite, and partly because, they have so fully embraced the illusory salvation of monetary intervention.


me too...

Tuesday, September 11, 2012

Mr. Seth Klarman quotes

Some good advice and knowledge to absorb from http://www.hedgefundletters.com


“Most institutional investors… feel compelled… to swing at almost every pitch and forgo batting selectivity for frequency.”

“So if the entire country became security analysts, memorized Benjamin Graham’s ‘Intelligent Investor’ and regularly attended Warren Buffett’s annual shareholder meetings, most people would, nevertheless, find themselves irresistibly drawn to hot initial public offerings, momentum strategies and investment fads. People would still find it tempting to day trade and perform technical analysis on stocks. A country of security analysts would still overreact. In short, even the best trained investors would make the same mistakes investors have been making forever, and for the same immutable reason – that they cannot help it.”

“I will be buying what other people are selling. I will be buying what is loathed and despised.”

“In capital markets, price is set by the most panicked seller at the end of a trading day. Value, which is determined by cash flows and assets, is not. In this environment, the chaos is so extreme, the panic selling so urgent, that there is almost no possibility that sellers are acting on superior information. Indeed, in situation after situation, it seems clear that fundamentals do not factor into their decision making at all.”

“In the aftermath of this financial crisis, I think everyone needs to look deep within themselves and ask how they want to live their lives. Do they want to live close to the edge, or do they want stability? In my view, people should have a year or two of living expenses in cash if possible, and they shouldn’t use leverage anywhere in their lives.

“Baupost build numerous new positions as the markets fell in 2008. While it is always tempting to try to time the market and wait for the bottom to be reached (as if it would be obvious when it arrived), such a strategy has proven over the years to be deeply flawed. Historically, little volume transacts at the bottom or on the way back up, and competition from other buyers will be much greater when the markets settle down and the economy begins to recover. Moreover, the price recovery from a bottom can be very swift. Therefore, an investor should put money to work amidst the throes of a bear market, appreciating that things will likely get worse before they get better.”

“Here’s how to know if you have the makeup to be an investor. How would you handle the following situation? Let’s say you own a Procter & Gamble in your portfolio and the stock price goes down by half. Do you like it better? If it falls in half, do you reinvest dividends? Do you take cash out of savings to buy more? If you have the confidence to do that, then you’re an investor. If you don’t, you’re not an investor, you’re a speculator, and you shouldn’t be in the stock market in the first place.”

Friday, April 27, 2012

Bamboo and Trading

I found this on Don Miller's site and I liked it...

Keep Watering Your Bamboo Tree - Eric Aronson

In the Far East, there is a tree called the Chinese bamboo tree. This remarkable tree is different from most trees in that it doesn't grow in the usual fashion. While most trees grow steadily over a period of years, the Chinese bamboo tree doesn't break through the ground for the first four years. Then, in the fifth year, an amazing thing happens - the tree begins to grow at an astonishing rate. In fact, in a period of just five weeks, a Chinese bamboo tree can grow to a height of 90 feet. It's almost as if you can actually see the tree growing before your very eyes. Well, I'm convinced that life often works in a similar way. You can work for weeks, months and even years on your dream with no visible signs of progress and then, all of the sudden, things take off. Your business becomes profitable beyond your wildest dreams. Your marriage becomes more vibrant and passionate than you ever thought it could be. Your contribution to your church, social organization and community becomes more significant than you have ever imagined. Yet, all of this requires one thing - faith. The growers of the Chinese bamboo tree have faith that if they keep watering and fertilizing the ground, the tree will break through. Well, you must have the same kind of faith in your bamboo tree, whether it is to run a successful business, win a Pulitzer Prize, raise well-adjusted children, or what have you. You must have faith that if you keep making the calls, honing your craft, reading to your children, reaching out to your spouse or asking for donations, that you too will see rapid growth in the future. This is the hard part for most of us. We get so excited about the idea that's been planted inside of us that we simply can't wait for it to blossom. Therefore, within days or weeks of the initial planting, we become discouraged and begin to second guess ourselves. Sometimes, in our doubt, we dig up our seed and plant it elsewhere, in hopes that it will quickly rise in more fertile ground. We see this very often in people who change jobs every year or so. We also see it in people who change churches, organizations and even spouses in the pursuit of greener pastures. More often than not, these people are greatly disappointed when their tree doesn't grow any faster in the new location. Other times, people will water the ground for a time but then, quickly become discouraged. They start to wonder if it's worth all of the effort. This is particularly true when they see their neighbors having success with other trees. They start to think, "What am I doing trying to grow a bamboo tree? If I had planted a lemon tree, I'd have a few lemons by now." These are the people who return to their old jobs and their old ways. They walk away from their dream in exchange for a "sure thing." Sadly, what they fail to realize is that pursuing your dream is a sure thing if you just don't give up. So long as you keep watering and fertilizing your dream, it will come to fruition. It may take weeks. It may take months. It may even take years, but eventually, the roots will take hold and your tree will grow. And when it does, it will grow in remarkable ways. We've seen this happen so many times. Henry Ford had to water his bamboo tree through five business failures before he finally succeeded with the Ford Motor Company. Richard Hooker had to water his bamboo tree for seven years and through 21 rejections by publishers until his humorous war novel, M*A*S*H became a runaway bestseller, spawning a movie and one of the longest-running television series of all-time. Another great bamboo grower was the legendary jockey Eddie Arcaro. Arcaro lost his first 250 races as a jockey before going on to win 17 Triple Crown races and 554 stakes races for total purse earnings of more than $30 million. Well, you have a bamboo tree inside of you just waiting to break through. So keep watering and believing and you too will be flying high before you know it.

Thursday, April 12, 2012

Understanding Probability

The market is changing, uncertain, and dynamic, and it is this which changes the underlying probabilities of a situation. As a system trader, I find it helpful to use time frames in order to better understand the probabilities.

I believe the changing cycles of the market affect the underlying probabilities of my trading models in both the short run and the long run. For example, I know that my trading models have a long run 70-80% win rate, but I also know that in any shorter term time frame the probabilities can change. It is not uncommon for me to experience 30-50% win rates within shorter time frames.

The short run probability may be quite different than the long run probability. We see this most clearly when we witness streaks. What is a streak in probabilistic terms? In Tom Stoppard’s play, Rosencrantz and Guildenstern are Dead, Rosencrantz and Guildenstern flip a coin which at one point has landed heads 92 straight times. Guildenstern states, “A weaker man might be moved to re-examine his faith, if in nothing else at least in the law of probability.”

Losing streaks can make us feel like Guildenstern, however, sound money management, risk controls, the passing of time, and most of all faith, can help while we await the reassertion of the long run probabilities.

Wednesday, April 11, 2012

Comparative Performance Statistics First Quarter 2012

Comparative performance statistics are in for the first quarter of 2012. Our results were better than both the Systematic Traders and Discretionary Traders Indices, however, no one could match the stellar 12% return on the SP 500 Cash Index.


3.5% Risk .58 %

2.0% Risk .32 %

1.5 % Risk .26 %

Systematic Traders Index -.52 %

Discretionary Traders Index .22 %

Hedge Funds Long Short Equity 4.9%

SP 500 Cash Index 12%

Tuesday, April 3, 2012

Some advice from Mr. Ray Dalio of Bridgewater Associates

Time is like a river that will take you forward into encounters with reality that will require you to make decisions. You can’t stop the movement down this river, and you can’t avoid the encounters. You can only approach these encounters in the best way possible.

I want you to work for yourself, to come up with independent opinions, to stress-test them, to be wary about being overconfident, and to reflect on the consequences of your decisions and constantly improve.

Nothing is certain..i believe the best we can hope for is the highly probable

I learned that failure is by and large due to not accepting and successfully dealing with the realities of life, and that achieving success is simply a matter of accepting and successfully dealing with all my realities..

one of the most important things that differentiates people is their approach to handling them (mistakes). I learned that there is an incredible beauty to mistakes, because embedded in each mistake is a puzzle, and a gem that I could get if I solved it, i.e., a principle that I could use to reduce my mistakes in the future. I learned that each mistake was probably a reflection of something that I was (or others were) doing wrong, so if I could figure out what that was, I could learn how to be more effective. I learned that wrestling with my problems, mistakes, and weaknesses was the training that strengthened me. Also, I learned that it was the pain of this wrestling that made me and those around me appreciate our successes. 12

I met a number of great people and learned that none of them were born great—they all made lots of mistakes and had lots weaknesses—and that great people become great by looking at their mistakes and weaknesses and figuring out how to get around them. So I learned that the people who make the most of the process of encountering reality, especially the painful obstacles, learn the most and get what they want faster than people who do not. I learned that they are the great ones—the ones I wanted to have around me. In short, I learned that being totally truthful, especially about mistakes and weaknesses, led to a rapid rate of improvement and movement toward what I wanted.

Understanding reality gives us the power to get what we want out of life, or at least dramatically improve our odds of success.

Success is achieved by people who deeply understand reality and know how to use it to get what they want.

I am just saying that I believe hyperrealism is the best way to choose and achieve one’s dreams.

I believe there are an infinite number of laws of the universe and that all progress or dreams achieved come from operating in a way that’s consistent with them. These laws and the principles of how to operate in harmony with them have always existed. We were given these laws by nature. Man didn’t and can’t make them up. He can only hope to understand them and use them to get what he wants.

I believe that we all get rewarded and punished according to whether we operate in harmony or in conflict with nature’s laws,

my most fundamental principle: Truth —more precisely, an accurate understanding of reality— is the essential foundation for producing good outcomes.

This perspective gives me a non-traditional sense of good and bad: “good,” to me, means operating consistently with the natural laws, while “bad” means operating inconsistently with these laws

In other words, I believe that understanding what is good is obtained by looking at the way the world works and figuring out how to operate in harmony with it to help it (and yourself) evolve.

I believe that evolution, which is the natural movement toward better adaptation, is the greatest single force in the universe, and that it is good.18It affects the changes of everything from all species to the entire solar system. It is good because evolution is the process of adaptation that leads to improvement. So, based on how I observe both nature and humanity working, I believe that what is bad and most punished are those things that don’t work because they are at odds with the laws of the universe and they impede evolution.

I believe that pursuing self-interest in harmony with the laws of the universe and contributing to evolution is universally rewarded, and what I call “good.”

20 The marginal benefits of moving from a shortage to an abundance of anything decline. 21 When pursuing self-interest is in conflict with evolution, it is typically punished.

It is natural that it should be this way—i.e., that our lives are not satisfied by obtaining our goals rather than by striving for them—because of the law of diminishing returns.

Self-interest and society’s interests are generally symbiotic: more than anything else, it is pursuit of self-interest that motivates people to push themselves to do the difficult things that benefit them and that contribute to society. In return, society rewards those who give it what it wants. That is why how much money people have earned is a rough measure of how much they gave society what it wanted—NOT how much they desired to make money.

The faster that one appropriately adapts, the better. As Darwin described, adaptation—i.e., adjusting appropriately to changes in one’s circumstances—is a big part of the evolutionary process, and it is rewarded. 24 That is why some of the most successful people are typically those who see the changing landscape and identify how to best adapt to it.25

Darwin is reported to have said, “It is not the strongest of the species that survives, nor the most intelligent that survives. It is the one that is the most adaptable to change.”

The most important quality that differentiates successful people from unsuccessful people is our capacity to learn and adapt to these things.

So what is success? I believe that it is nothing more than getting what you want

The following five decision trees show these choices. I believe that those who don’t move effectively to their goals do the things on the top branches, and those who do move to them most quickly do the things on the bottom branches.

It is a fundamental law of nature that to evolve one has to push one’s limits, which is painful, in order to gain strength—whether it’s in the form of lifting weights, facing problems head-on, or in any other way. Nature gave us pain as a messaging device to tell us that we are approaching, or that we have exceeded, our limits in some way. At the same time, nature made the process of getting stronger require us to push our limits. Gaining strength is the adaptation process of the body and the mind to encountering one’s limits, which is painful. In other words, both pain and strength typically result from encountering one’s barriers. When we encounter pain, we are at an important juncture in our decision-making process.
Most people react to pain badly. They have “fight or flight” reactions to it: they either strike out at whatever brought them the pain or they try to run away from it. As a result, they don’t learn to find ways around their barriers, so they encounter them over and over again and make little or no progress toward what they want.29
Those who react well to pain that stands in the way of getting to their goals—those who understand what is causing it and how to deal with it so that it can be disposed of as a barrier—gain strength and satisfaction. This is because most learning comes from making mistakes, reflecting on the causes of the mistakes, and learning what to do differently in the future. Believe it or not, you are lucky to feel the pain if you approach it correctly, because it will signal that you need to find solutions and to progress. Since the only way you are going to find solutions to painful problems is by thinking deeply about them—i.e., reflecting 30—if you can develop a knee-jerk reaction to pain that is to reflect rather than to fight or flee, it will lead to your rapid learning/evolving.31

There are literally two different parts of each person’s brain that influence these reactions: the pre-frontal cortex and the amygdala. They work as though they were two different brains that fight for control of decision-making. The pre-frontal cortex is the logical part of the brain that evaluates choices logically and the amygdala is the “animal instinct” part of the brain that triggers emotional reactions like the instinct to fight or flee. When faced with an obstacle or threat, an emotional reaction (e.g. pain) can be triggered that can lead to a fight or flight reaction that “hijacks” decision making away from the pre-frontal cortex, where the rational choices are being made. This can result in our making decisions that produce consequences that we do not want. This typically causes really big problems

Pain + Reflection = Progress
How big of an impediment is psychological pain to your progress?

Ask yourself, “Is it true?” …because knowing what is true is good. How much do you let what you wish to be true stand in the way of seeing what is really true?

People who overweigh the first-order consequences of their decisions and ignore the effects that the second- and subsequent-order consequences will have on their goals rarely reach their goals.36 This is because first-order consequences often have opposite desirabilities from second-order consequences, resulting in big mistakes in decision-making. For example, the first-order consequences of exercise (pain and time-sink) are commonly considered undesirable, while the second-order consequences (better health and more attractive appearance) are desirable. Similarly, food that tastes good is often bad for you and vice versa, etc. If your goal is to get physically fit and you don’t ignore the first-order consequences of exercise and good-tasting but unhealthy food and connect your decisions with their second- and third-order consequences, you will not reach your goal.

And it is subversive because it diverts one’s attention away from mustering up the personal strength and other qualities that are required to produce the best possible outcomes.

Successful people understand that bad things come at everyone and that it is their responsibility to make their lives what they want them to be by successfully dealing with whatever challenges they face. 38 Successful people know that nature is testing them, and that it is not sympathetic.39

How much do you let yourself off the hook rather than hold yourself accountable for your success?

In summary, I believe that you can probably get what you want out of life if you can suspend your ego and take a no-excuses approach to achieving your goals with open-mindedness, determination, and courage, especially if you rely on the help of people who are strong in areas that you are weak.

When you think that it’s too hard, remember that in the long run, doing the things that will make you successful is a lot easier than being unsuccessful. The first-order consequences of escaping life’s challenges may seem pleasurable in the moment, but the second- and third-order consequences of this approach are your life and, over time, will be painful.

Most problems are potential improvements screaming at you.

Identifying the real root causes of your problems is essential because you can eliminate your problems only by removing their root causes. In other words, you must understand, accept, and successfully deal with reality in order to move toward your goals.

More than anything else, what differentiates people who live up to their potential from those who don’t is a willingness to look at themselves and others objectively.

Monday, April 2, 2012

Steve Jobs

This is worth reading...

This is a prepared text of the Commencement address delivered by Steve Jobs, CEO of Apple Computer and of Pixar Animation Studios, on June 12, 2005.

I am honored to be with you today at your commencement from one of the finest universities in the world. I never graduated from college. Truth be told, this is the closest I've ever gotten to a college graduation. Today I want to tell you three stories from my life. That's it. No big deal. Just three stories.

The first story is about connecting the dots.

I dropped out of Reed College after the first 6 months, but then stayed around as a drop-in for another 18 months or so before I really quit. So why did I drop out?
It started before I was born. My biological mother was a young, unwed college graduate student, and she decided to put me up for adoption. She felt very strongly that I should be adopted by college graduates, so everything was all set for me to be adopted at birth by a lawyer and his wife. Except that when I popped out they decided at the last minute that they really wanted a girl. So my parents, who were on a waiting list, got a call in the middle of the night asking: "We have an unexpected baby boy; do you want him?" They said: "Of course." My biological mother later found out that my mother had never graduated from college and that my father had never graduated from high school. She refused to sign the final adoption papers. She only relented a few months later when my parents promised that I would someday go to college.

And 17 years later I did go to college. But I naively chose a college that was almost as expensive as Stanford, and all of my working-class parents' savings were being spent on my college tuition. After six months, I couldn't see the value in it. I had no idea what I wanted to do with my life and no idea how college was going to help me figure it out. And here I was spending all of the money my parents had saved their entire life. So I decided to drop out and trust that it would all work out OK. It was pretty scary at the time, but looking back it was one of the best decisions I ever made. The minute I dropped out I could stop taking the required classes that didn't interest me, and begin dropping in on the ones that looked interesting.

It wasn't all romantic. I didn't have a dorm room, so I slept on the floor in friends' rooms, I returned coke bottles for the 5¢ deposits to buy food with, and I would walk the 7 miles across town every Sunday night to get one good meal a week at the Hare Krishna temple. I loved it. And much of what I stumbled into by following my curiosity and intuition turned out to be priceless later on. Let me give you one example: Reed College at that time offered perhaps the best calligraphy instruction in the country. Throughout the campus every poster, every label on every drawer, was beautifully hand calligraphed. Because I had dropped out and didn't have to take the normal classes, I decided to take a calligraphy class to learn how to do this. I learned about serif and san serif typefaces, about varying the amount of space between different letter combinations, about what makes great typography great. It was beautiful, historical, artistically subtle in a way that science can't capture, and I found it fascinating.

None of this had even a hope of any practical application in my life. But ten years later, when we were designing the first Macintosh computer, it all came back to me. And we designed it all into the Mac. It was the first computer with beautiful typography. If I had never dropped in on that single course in college, the Mac would have never had multiple typefaces or proportionally spaced fonts. And since Windows just copied the Mac, it's likely that no personal computer would have them. If I had never dropped out, I would have never dropped in on this calligraphy class, and personal computers might not have the wonderful typography that they do. Of course it was impossible to connect the dots looking forward when I was in college. But it was very, very clear looking backwards ten years later.

Again, you can't connect the dots looking forward; you can only connect them looking backwards. So you have to trust that the dots will somehow connect in your future. You have to trust in something — your gut, destiny, life, karma, whatever. This approach has never let me down, and it has made all the difference in my life.

My second story is about love and loss.

I was lucky — I found what I loved to do early in life. Woz and I started Apple in my parents garage when I was 20. We worked hard, and in 10 years Apple had grown from just the two of us in a garage into a $2 billion company with over 4000 employees. We had just released our finest creation — the Macintosh — a year earlier, and I had just turned 30. And then I got fired. How can you get fired from a company you started? Well, as Apple grew we hired someone who I thought was very talented to run the company with me, and for the first year or so things went well. But then our visions of the future began to diverge and eventually we had a falling out. When we did, our Board of Directors sided with him. So at 30 I was out. And very publicly out. What had been the focus of my entire adult life was gone, and it was devastating.

I really didn't know what to do for a few months. I felt that I had let the previous generation of entrepreneurs down - that I had dropped the baton as it was being passed to me. I met with David Packard and Bob Noyce and tried to apologize for screwing up so badly. I was a very public failure, and I even thought about running away from the valley. But something slowly began to dawn on me — I still loved what I did. The turn of events at Apple had not changed that one bit. I had been rejected, but I was still in love. And so I decided to start over.

I didn't see it then, but it turned out that getting fired from Apple was the best thing that could have ever happened to me. The heaviness of being successful was replaced by the lightness of being a beginner again, less sure about everything. It freed me to enter one of the most creative periods of my life.

During the next five years, I started a company named NeXT, another company named Pixar, and fell in love with an amazing woman who would become my wife. Pixar went on to create the worlds first computer animated feature film, Toy Story, and is now the most successful animation studio in the world. In a remarkable turn of events, Apple bought NeXT, I returned to Apple, and the technology we developed at NeXT is at the heart of Apple's current renaissance. And Laurene and I have a wonderful family together.

I'm pretty sure none of this would have happened if I hadn't been fired from Apple. It was awful tasting medicine, but I guess the patient needed it. Sometimes life hits you in the head with a brick. Don't lose faith. I'm convinced that the only thing that kept me going was that I loved what I did. You've got to find what you love. And that is as true for your work as it is for your lovers. Your work is going to fill a large part of your life, and the only way to be truly satisfied is to do what you believe is great work. And the only way to do great work is to love what you do. If you haven't found it yet, keep looking. Don't settle. As with all matters of the heart, you'll know when you find it. And, like any great relationship, it just gets better and better as the years roll on. So keep looking until you find it. Don't settle.

My third story is about death.

When I was 17, I read a quote that went something like: "If you live each day as if it was your last, someday you'll most certainly be right." It made an impression on me, and since then, for the past 33 years, I have looked in the mirror every morning and asked myself: "If today were the last day of my life, would I want to do what I am about to do today?" And whenever the answer has been "No" for too many days in a row, I know I need to change something.

Remembering that I'll be dead soon is the most important tool I've ever encountered to help me make the big choices in life. Because almost everything — all external expectations, all pride, all fear of embarrassment or failure - these things just fall away in the face of death, leaving only what is truly important. Remembering that you are going to die is the best way I know to avoid the trap of thinking you have something to lose. You are already naked. There is no reason not to follow your heart.

About a year ago I was diagnosed with cancer. I had a scan at 7:30 in the morning, and it clearly showed a tumor on my pancreas. I didn't even know what a pancreas was. The doctors told me this was almost certainly a type of cancer that is incurable, and that I should expect to live no longer than three to six months. My doctor advised me to go home and get my affairs in order, which is doctor's code for prepare to die. It means to try to tell your kids everything you thought you'd have the next 10 years to tell them in just a few months. It means to make sure everything is buttoned up so that it will be as easy as possible for your family. It means to say your goodbyes.

I lived with that diagnosis all day. Later that evening I had a biopsy, where they stuck an endoscope down my throat, through my stomach and into my intestines, put a needle into my pancreas and got a few cells from the tumor. I was sedated, but my wife, who was there, told me that when they viewed the cells under a microscope the doctors started crying because it turned out to be a very rare form of pancreatic cancer that is curable with surgery. I had the surgery and I'm fine now.

This was the closest I've been to facing death, and I hope it's the closest I get for a few more decades. Having lived through it, I can now say this to you with a bit more certainty than when death was a useful but purely intellectual concept:
No one wants to die. Even people who want to go to heaven don't want to die to get there. And yet death is the destination we all share. No one has ever escaped it. And that is as it should be, because Death is very likely the single best invention of Life. It is Life's change agent. It clears out the old to make way for the new. Right now the new is you, but someday not too long from now, you will gradually become the old and be cleared away. Sorry to be so dramatic, but it is quite true.

Your time is limited, so don't waste it living someone else's life. Don't be trapped by dogma — which is living with the results of other people's thinking. Don't let the noise of others' opinions drown out your own inner voice. And most important, have the courage to follow your heart and intuition. They somehow already know what you truly want to become. Everything else is secondary.

When I was young, there was an amazing publication called The Whole Earth Catalog, which was one of the bibles of my generation. It was created by a fellow named Stewart Brand not far from here in Menlo Park, and he brought it to life with his poetic touch. This was in the late 1960's, before personal computers and desktop publishing, so it was all made with typewriters, scissors, and polaroid cameras. It was sort of like Google in paperback form, 35 years before Google came along: it was idealistic, and overflowing with neat tools and great notions.

Stewart and his team put out several issues of The Whole Earth Catalog, and then when it had run its course, they put out a final issue. It was the mid-1970s, and I was your age. On the back cover of their final issue was a photograph of an early morning country road, the kind you might find yourself hitchhiking on if you were so adventurous. Beneath it were the words: "Stay Hungry. Stay Foolish." It was their farewell message as they signed off. Stay Hungry. Stay Foolish. And I have always wished that for myself. And now, as you graduate to begin anew, I wish that for you.

Stay Hungry. Stay Foolish.

Thank you all very much.

Friday, March 30, 2012

Using Perturbation Theory to Build Trading Models and Systems

I have recently finished reading Mr. Brian Greene’s book, The Elegant Universe. It is a fascinating book about string theory. One of the concepts Mr. Greene discusses is how physicists use perturbation theory to advance their knowledge and theoretical ideas.

Mr. Greene says that the mathematical framework of string theory is so complicated that physicists have to use approximate solutions and calculations, while initially ignoring some details. Later, these solutions and calculations are further refined as more details and knowledge are systematically included. The perturbative process can also be used to build trading models.

I had no idea of perturbation theory before reading this book, but I now feel it describes the process of how I created trading models. The stock market is also complicated and difficult to understand (probably more so then string theory). Initially, I began to systematically organize some variables, ideas, and concepts, while leaving others out. I began to create some general ideas, theories, and approximate solutions to trading. Later, with further testing, experimentation, and pain (the great teacher), I was able to increase my knowledge of how the market works, and I began to systematically include more details and concepts. This led to further refined ideas and theories which eventually became my trading models.

But here is some advice and a word of warning to traders out there—the key is to use a perturbative approach up to a point. The irony is that the more variables added to “refine” and “improve” a model, the more likely it is that the model will breakdown.

Thursday, March 29, 2012

Mr. Larry Williams and Mr. Niederhoffer's, Daily Speculations

I like to read different blogs in order to educate myself about a number of issues and topics. One blog that I like is Mr. Niederhoffer’s, “Daily Speculations.” This blog contains some interesting topics submitted by a variety of individuals. The other day I read a comment by Mr. Larry Williams. He said,

“The other day I heard somebody say:
"Assuming the future behaves the same as the past, I reason that this way makes my funds efficiently used".
I wanted to say, my experience is that the past is never like the future so we waste valuable time and skills on a false postulate.
As I see it, it is better to have a core strategy to deal with equity drawdowns, etc –based on logic–as opposed to a strategy based on the past real results or back tested as that is for the most part a make believe world since it never happens quite that way again.”


Most system traders backtest their ideas and models in order to have some confidence to trade into the future. As a system trader I always think about the future and if it will resemble the past or not. I wonder if the ideas behind my models will ever fail going forward. Mr. Niederhoffer likes to speak about ever-changing cycles in markets. These ever-changing cycles may eventually cause the breakdown of trading models. Perhaps, this is true.

Mr. Williams has spent much of the past teaching traders to backtest ideas, etc. He has made money teaching and writing books that include backtesting, etc. Has something changed? In addition, I believe Daily Spec removed Mr. Williams initial comments (or perhaps I cannot find them), but I can tell you that Mr. Williams had a much different tone in that post regarding the use of backtested info and using it to trade with.

I agree with Mr. Williams about having a logical strategy to deal with drawdowns, but backtesting is not a waste of time.

Friday, March 23, 2012

Our redesigned website- Tradingxyz.com

We have spent the last few months redesigning our website, TRADINGXYZ.COM. Please review it when you get a chance.