From the NY Times, an interesting read (PDF). An excerpt:

Models have other advantages beyond their accuracy and consistency. They allow an organization to codify and centralize its hard-won knowledge in a concrete and easily transferable form, so it stays put when the experts move on. Models also can teach newcomers, in part by explaining the individual steps that lead to a given choice. They are also faster than people, are immune to fatigue and give the human experts more time to work on other tasks beyond the current scope of machines.

Last night on Nightline, T. Boone Pickens (made 1.4 billion in 2005) reminded the fawning reporter:

“I have been broke 3 or 4 times. But fortunately for me I’m not an MBA, so I didn’t know I was broke.”

Now that’s good stuff. Love it.

Janice Dorn sent in nice feedback:

Without realizing it, people tend to perceive things according to how they want to see them, suggests a new study, soon to be published in the Journal of Personality and Social Psychology. In five separate tests conducted by a graduate student from Cornell, participants regularly labeled an indistinct figure in a way that would lead to their obtaining a taste reward.(in this case fresh-squeezed orange juice as opposed to a lumpy gelatinous veggie smoothie). In other words, when faced with ambiguity, the subjects made the choice which would result in something pleasurable for them. This gives credence to the age-old hypothesis that wishes, hopes and desires actually influence what a person sees. The analogies to trading are clear. We see whatever is happening in light of our expectations of reward, and will use all manner of neural trickery to rationalize “why” something is happening rather than to deal with the reality that it is actually happening. We want the orange juice, and will lie to ourselves about what we are actually seeing, in order to attempt to obtain that reward. Just as we feel uncomfortable in our personal lives when faced with “uncertainty” or not knowing, so do the markets. We want to get the orange juice, and this tends to distort our perceptions and lead to an insidious kind of self-deception. Sigmund Freud said that neurosis was the inability to tolerate ambiguity. Do we bias the outcome of ambiguous situations in favor of hope and away from fear? What do you think?
Janice Dorn, M.D., Ph.D.

From tonight:

By Christopher Wang,
AP Business Writer Wall Street,
Reeling From a Whirlwind of Bad News, May Find Solace in Earnings, Economic Data

NEW YORK (AP) — Although a whirlwind of bad news and deepening uncertainty sent stocks tumbling last week, Wall Street could see a return to reason in the week ahead with a fresh round of economic and earnings data that could help investors regain their footing.

I don’t understand. A return to reason is for all markets to go up? If we make it back to reason, will there ever be a time when need to leave reason again?

David Harding recently responded to a letter to the editor. I have had the opportunity to spend some time with David for an interview; he is a very sharp guy. Here is the published letter and his response (PDF).

Feedback emailed in tonight:

I just recently got a job working for an investment bank here in New York. During my interview I asked the senior vice-president of the firm what methods they use to determent what securities to recommend for their clients. He said to me, “we will show you how to interpret what CNBC is talking about and how to find out what other major firms are doing.” How can anyone rely on this kind of advisement?

From Peter Coy at BusinessWeek Online comes ‘questions’:

“We’re halfway through 2006, and the year still seems as opaque and unpredictable as it did last New Year’s Eve. Investors are puzzled: Will the economy march forward, with business investment picking up the slack from a retrenching consumer? Or is the Federal Reserve on the verge of overtightening monetary policy, undermining the housing market and sending the U.S. into its second recession of the new millennium? Was the stock market’s big gain on June 29 a harbinger of a second-half bull market, or just a feint?”

Just once, I mean only once, it would be nice to see a reporter for a national magazine or newswire say, “We have no clue about anything so we advise first waiting for the market to move in a direction then to get on board.”

Feedback from a reader in Malaysia:

Hi Michael, First of all I would like to say THANK YOU for writing what must (or should) be the most important finance theory book of recent times. It was an absolute revelation, an eye-opening, out-of-this-world experience…well for me, at least. I work as a fund manager in the largest financial institution, here in Malaysia and it is not easy to put forward this Trend Following concept which seems so alien to the traditional fund managers in Malaysia. As you have rightly mentioned…some people do it to become smart or to show-off their intelligence and capability to analyze hundreds of accounts, economic data and financial data, whereas the enlightened ones..simply do it for money. I have never believed in fundamentals from the very beginning of my training and have been labeled as a loose-cannon cowboy fund manager amongst my peers for my refusal to accept any of the fundamental/traditional economic theories. Your book has given me the enlightenment that I so need and to know that there is such a simple concept/theory as following something as simple and real such as price is absolutely godsend! You wont believe how thrilled and ecstatic I was after reading the book that my wife bought for my birthday. She must have gotten ear bleed from listening to my babblings about Trend Following! I started my training in technical analysis, which after awhile I found to be useless as well because there is no way anybody can predict anything and I have become a complete convert after reading your book. But I would greatly appreciate if you could provide some insights and advice on how to use the system in a long equity (only!) market? I have developed an Excel based system to backtest my parameters and the result is astounding. Using crossings of simple moving averages, the return from the sample data of Top 60 stock (in terms of market cap) in the Kuala Lumpur Composite Index was an unbelievable 1800% for the past 10 years from 1996-2005. Can this be right? Am I doing something wrong or is the system THAT good? Perhaps I need to get the Wealth Lab software for a more reliable backtesting system and get more detailed results and analysis of the system? I would also appreciate if you could advice on how I can argue the concept of following price against fundamentals, as I am continuously being shot down by my superiors and the Chief Investment Officer who seems adamant that there is no other way except the fundamental way! Our daily morning meetings are flooded with discussions on what Bernanke meant, where the US interest rate is going, the Malaysian GDP, the US dollar vs. ringgit, inflation level and the topic of the year, OIL PRICE! And my supremely intelligent research team constantly tries to find non-existent correlations between everything and anything and how it will affect our local stock market! I’m beginning to feel very frustrated that nobody seems to be able to accept that none of that works and the only thing we can use is PRICE! XXX Portfolio Manager – Equities

Wealth-Lab is definitely a step in right direction.

In terms of arguments about trend following v. fundamental analysis, my book, blog and podcasts should give plenty of ammunition!

An article forwarded to me from BW titled Hedge Fund Toddlers (PDF).

A good read about Richard Donchian from 1978 (PDF) – wholly relevant to today’s traders.

I get criticized by some people. They don’t like my message perhaps. Or maybe they detect an attitude that doesn’t work for them. It all comes with the territory. Along those lines I saw Mark Cuban offer a good bit on criticism today at his blog:

“The easiest thing in the world to avoid is criticism. All you have to do is nothing. Do nothing of your own free will. Do only what is asked of you and nothing more, and chances are you will never be criticized. For those of us who set goals and want to have an impact in the business world in particular, criticism is part of the job description. You have to be able to be able to take it and sometimes you can’t be afraid to dish it out. Although criticism is typically perceived as a negative, it can be one of the most positive and motivating forces any of us can experience. The key to turning criticism into a positive is understanding the nature of the criticism. In a nutshell it comes down to content. Is the criticism based on content or not. I’ve received a ton of criticism in the media over the last few weeks. People criticized where, when and how I did things. Not a single person criticized or challenged why. I get criticized a lot. So what. If someone says something of value. I will learn from it. If they criticize to fill up a column or to hear them[selves] talk, I can get a good laugh out of it. What it all comes down to is content and effort. If someone puts in the effort and challenges the content and makes me rethink my position, I come out ahead. So criticize away.”

This ‘attitude’ is useful for anyone and everyone no matter what they do or pursue.

From Morningstar comes this ditty:

“There are several tools that Morningstar uses to interpret the fundamentals of a firm in order to bridge the gap between art and science, hopefully paving the way to a nice profit in the process. Two of our favorite bridges that help us arrive at prediction of a company’s intrinsic value and a “consider-buy” price are moat and risk. Briefly, an economic moat is a firm’s ability to utilize its sustainable competitive advantages to outperform rivals and earn returns greater than its cost of capital. The risk of a company, on the other hand, is the strength of the underlying business and the predictability and certainty of its future cash flows. Risk is determined by analyzing factors such as cyclicality, leverage, legal issues, and other outside events. In turn, risk ratings affect the size of the margin of safety that we build into our investment recommendations. But not everyone’s opinion, interpretation, or prediction of these metrics is the same. This is where we believe value can be found: by correctly selecting firms with economic moats that are trading at attractive discounts to our fair value estimate, given the margin of safety implied by our risk rating.”

How is the average trader (or frankly the professional) supposed to do all of this and do it right? Why do many of the great traders never think like this?