I first heard about the efficient market theory in Law School. I remember thinking at the time what obvious bullshit it was. But it was academia, and...moreI first heard about the efficient market theory in Law School. I remember thinking at the time what obvious bullshit it was. But it was academia, and it was pretty harmless bullshit, so let the economists play whatever games they want. What difference did it make?
The theory goes that the markets already consolidate all the information available to them, so that price already incorporates all the information available to the market. From there, we get the random walk theory -- that prices will move in a random fashion, so that each price move is basically the flip of a coin. And from these premises, we then get modern financial theory, including the idea that risk is the same as statistical variance, which leads to the Sharpe ratio for evaluating an assets value, and also leads to the Black Scholes method for pricing options, and to modern portfolio theory (by which a portfolio is designed around the appropriate level of risk for an individual investor). The math for doing this seems very sophisticated, and variations on these approaches have served as the backbone for the financial industry.
But there's a slight problem. The basic assumptions underlying all this theory is wrong. Prices don't vary like the flips of a coin. They are much wilder that tossing a coin. According to conventional theory, Black Monday in 1987 should have occurred perhaps once in an eon. In 1997, there were three days in a short period of time that had moves which the theory would predict should occur only once every 10,000 years or so. And the same thing again for the recent financial collapse.
Wall Street adopted these economic theories. They were relatively easy to use. They have an air of scientific knowledge to them. There are nobel prizes awarded to the developers of them. But, they don't fit the data at all. They grossly underestimate risk, largely because they insist that data should fit a bell curve, when it simply doesn't fit. And they then took risks, this time with their own money, based on these false economic engineering ideas. The result was the near collapse (and the jury may still be out on this) of the entire world financial system.
Mandelbrot, the author of this book, is a mathematician. He invented the field of fractal geometry, and is probably most notable for the Mandelbrot set, which yields incredibly intricate and beautiful fractal designs. As far back as the early 1960s, Mandelbrot did extensive study on Cotton markets. For some reason, there is good data on daily cotton prices going back to the mid 1800s. As a result of his studies, Mandelbrot concluded that markets are more fractal than continuous, and that the assumptions that economists used were simply wrong. He started complaining about this 40 years ago, and as recent history shows, people still are not listening. He claims to have written this book to bring his case directly to the public. (The same process worked pretty well for him in popularizing the idea of fractals in the first place, and ultimately getting them accepted in academia, where math departments were skeptical of geometry with practical application.)
The book is very well written, and easy to understand, especially since it deals with a field where people tend to be abstruse and to obfuscate whenever possible. (Have you ever read any statement by Alan Greenspan, for example?) The criticisms of standard financial theory seem perfectly sound.
However, when it comes to giving practical advice, the book seems on much shakier grounds. He calls for more open minded study of markets, which would not be a bad thing, especially since we now know that the market making companies are all too big to fail. On the last page, he calls for a "coordinated search for patterns in the financial markets." And this is fine. But at several places he makes fun of "chartists, " precisely because chartists think that they have found discernible patterns in the markets. He doesn't offer any evidence to show that they cannot have done so, and his call at the end shows that he thinks there may be such patterns.
Overall, I think this book is worth reading for anyone who is interested in the behavior of markets. And its fun for people, like me, who are deeply skeptical of the usefulness of anything that comes out of an economist's mouth.(less)
I picked this up because I'm interested in studying markets and technical analysis. The Black Swan talks a bit about fractals and the Mandelbrot set....moreI picked this up because I'm interested in studying markets and technical analysis. The Black Swan talks a bit about fractals and the Mandelbrot set. One of the interesting thing about some fractals is that the part resembles the whole. In technical analysis, there are several techniques that apply to charts, and the period of the chart doesn't matter. The same sorts of things work on weekly, daily and hourly charts, etc.... Another part of technical analysis is Elliot Wave theory. Without getting into the details, the proponents of this theory also claim that there are smaller Elliot Waves within a larger Elliot Wave. Both of these observations seem to show that, in market patterns, the smaller part resembles the larger.
So I went looking for a good book on Fractals. Barnes and Noble didn't have anything by Mandelbrot (he's next for me), so I decided to learn something about Chaos, which is related. I'm glad I did.
This book provides a good, and readable, overview of the field. There may be a bit too much about sleds going down mogul fields. But, then again, its a pretty great example for proving the point. For a long time, I've believed that if someone invents the Math, someone else will find a real world application for it. I think Chaos theory might be another example of this phenomenon at work. Unfortunately, it's been a long long time since I've worked with differential equations, and I think I may have to settle for the lay understanding of this sort of field. With the math background that I do have, and the time I've spent away from doing real math, I thought this book was pretty perfectly pitched for me.(less)
I just wrote a long review of this book, and Goodreads or the internet ate it. Grrrr... Here are the high points of that review.
Three years to read th...moreI just wrote a long review of this book, and Goodreads or the internet ate it. Grrrr... Here are the high points of that review.
Three years to read this. Of that, almost the full time was stuck on the first two parts of the second book, which seemed both dull and pointless. It ended up that it was just dull, but necessary to understand his ideas on morality.
First book - Understanding. It blows up the idea that there's a foundation in reason for induction, causation, the persistence of objects, and even for the idea of the self. This is radical skepticism at its finest. It's even more amazing that Hume presents these arguments in a way that is cogent, and engaging. There are few writers of philosophy who write better than Hume, and none of them are also systematizers. The systematizers tend to be insufferably dull (Locke) or unreadable and incomprehensible (take your pick, but Heidegger is a good example).
Second book - the bog. It's about the passions, and it couldn't be less passionately presented. Pride, humility, love, hate. If the first book awoke Kant out of his dogmatic slumbers, I would have thought that the first parts of this book would put him safely back to sleep. The curious thing here was that, after destroying the idea of causation, Hume spends most of this book focusing on causes for the passions.
The book takes off again when Hume gets to the will. He tries to reconcile free will and determinism. I wondered why he bothered. Since causation has no foundation in reason, but rests on human custom and habit, it doesn't seem necessary to me to then try to reconcile it with free will. It can also rest on other customs and habits. If the two seem to contradict each other, I don't understand the big problem. Neither of them has a foundation in reason anyways, so why get troubled over a seeming contradiction. It would have been enough to say they rest on different customs, and people are irrational.
Third book - Morality. He does a great job of showing that justice is not natural, but an invention of men. He's less good about showing the basis for morality, and this stems from his being less rigorous here than in the first book. For Hume, all perceptions are either ideas or impressions. With causes, he showed that causes are not based on ideas, and also showed that there is no impression that corresponds to a cause. Thus, no causes. He doesn't do the same with moral perceptions. He does show that moral perceptions have no basis in ideas or reasons, and then abruptly concludes that they must be impressions. I think he could pretty easily have argued that there are no moral impressions either. And I'm not sure why he didn't. Perhaps the religious climate at the time precluded him from being as radical a moral skeptic as he was a skeptic when it came to the understanding.
I also found it odd that he bases all moral judgments on an appreciation of character. He has argued elsewhere quite convincingly that its impossible to know a cause from its effects. But in morality, all of our judgments come from just that process. We only see the effects of a person's character, and never the character itself. That, we only infer from those effects, and that is just what Hume has argued against elsewhere (famously, in his argument that we can know nothing about God from our observation of the world, if indeed God created the world.)
Finally, even though Hume tries to explain morals to us, it looks like he could not bring himself to show any true moral distinction. At bottom, for him, morality is just another species of pain and pleasure, and he doesn't try to show in what manner it differs from other types of pain and pleasure. Indeed, towards the end of the book, he admits that he can't draw a sharp distinction between morality and other natural attributes, such as intelligence.
There are many other quibbles I have with this book, but I am dumbfounded that he wrote it when he was in his twenties. It's as well written as I think a book of this type and scope can be. The ideas are truly challenging, even 250 years later. Anyone interested in philosophy or the scientific method should read at least the first book. I'm actually a bit embarrassed that I haven't read the whole thing before. And now I wonder where I should turn next. What would make a suitable encore? (And not Kant, I've already read the Critique.)(less)
Given a finite sequence of numbers, how does one prove either that they follow a pattern (and will continue to do so), or that they are random? As a p...moreGiven a finite sequence of numbers, how does one prove either that they follow a pattern (and will continue to do so), or that they are random? As a pretty thorough skeptic, I've been fairly sure for a long time that there is no proof, one way or the other. So why do I come back again and again to the possibility of trading, and technical trading at that?
I got this book to get reacquainted with the trader's way of thinking and talking. On that level, it certainly did why I wanted it to do. I would also have liked it to persuade me away from my skepticism. On that score, I would say that it was a bit less successful.
A few years ago, I got more deeply involved in the possibility of trading. I had developed a few test systems. One of them showed a potential profit of approx. 1100% per year, using a moderately aggressive money management system. A more experienced friend thought that system left something to be desired, mostly from a risk/reward standpoint on individual trades. He thought I should shoot higher on individual trades.
I agreed to look a bit more deeply, and offered to test a promising system that he was developing. My testing showed that this system was not only less than promising, but that in three out of five years, it would lead to financial ruin. In my ignorance, I got scared. (The truth of the matter is that a trader should be ecstatic when he finds a really, really bad system, because all he has to do is trade the opposite, and he has a good winner. At the time, however, I was simply mesmerized by the idea that my "experienced" friend could come up with such a dog.)
At about the same time, I realized that I could probably do well with my own systems. But there was a small catch. It would mean giving up a few things for the indefinite future -- like sleep. So that was the end of that, but not through any conscious decision.
Now, I'm thinking about it again, and again I'm stuck at the start: who has it right, the random walkers, or the technicians? And I don't think there is an answer to that question. At this level, Schwager doesn't impress me.
Here are two quotes from the book about using judgment in trading:
"In conclusion, the skeptics are probably correct in claiming that a Pavlovian response to chart signals will not lead to trading success."
"Act on market dreams. ... Such dreams are often right because they represent your subconscious market knowledge attempting to break through..."
OK, so here he is making a case that skill, experience, intuition and even dreams are vitally important to a sophisticated trader. And there are lots of people who believe this, I guess...
But then, here he is talking about trading plans:
"The more specific the trading strategy, the better. ... Of course, the most specific trading would be one based on a mechanical trading system."
"How did I resolve my conflict? I decided to focus completely on mechanical trading approaches in order to eliminate the emotionality in trading."
Unless Philip Dick got it right, and androids do dream of electric sheep, these two sets of statements contradict each other. Schwager doesn't even attempt to resolve the conflict. He seems to think that they are both true. This problem makes it much harder for me to find many of his other points all that useful.
Another thing I've noticed in these trading books: they all spend the majority of time talking about the set-ups for initiating trades. Then, after doing this, they will pretty uniformly say that the secret to success in trading is money management and knowing where to exit (cutting losses while allowing profits to accumulate). But they pay much, much, much less attention to the areas that they say are more important. On that, this book is no different. There is the customary nod to money and risk management, but it takes a definite backseat to the "sexier" subject of when to pull the trigger.
Finally, Schwager wrote a couple of books consisting of interviews with successful traders. He summarizes some of what he learned from that experience in tips at the end of this book. One of the things he concluded from those interviews is that, looking at the success of those traders, and looking at their consistency, the market can't simply be random. Too bad he, nor anyone else, has ever written a book consisting of interviews with hopeless failures at trading. The sample pool is much bigger, and my guess is that there are probably many, many more lessons to be learned from people's failures. What Schwager fails to consider is that the pool of people who start trading is enormous. Given the number of people who start, even if the market were random, some of those people would end up as very big winners. When all you do is interview the winners, you are bound to start seeing the skill and design in what they did, even if it was just a random occurance. (Given the same number of people who have traded on the stock markets, a model of random success and failure over the same period of time would produce at least one person as successful as Warren Buffett. So, is he a genius or very lucky, or both?)
Anyway, I'm still skeptical. But if there is a skill to trading, I'm confident I can learn it. Or who knows? Maybe I might just get lucky. (less)
We don't know what we don't know. Pretending that we do can cause all kinds of harm.
Taleb takes those basic ideas and spins them out in many, many dir...moreWe don't know what we don't know. Pretending that we do can cause all kinds of harm.
Taleb takes those basic ideas and spins them out in many, many directions. For me, despite his self-satisfaction and tendancy towards being insufferable, I enjoyed the writing. More, I like the ideas. They are ideas that seem simple, but are very easy to forget or willfully ignore.
Here's an extrapolation from the book. I've wondered why Science Fiction as a genre seems to have failed. Taleb argues that history, and especially the history of science and technology, is made up of Black Swan events, events that were highly unlikely, unforseen, and had a huge subsequent impact. Easy examples are things like the invention of the transistor, or the wheel, or moveable type, or the rise of Christianity or Islam. The events with the greatest impact also tend to be the least foreseeable. What does this have to do with science fiction? When we project into the future, we tend to extrapolate from what we know. Science fiction that dealt with computers tended to deal with the consequences of a huge centralized computer, and extrapolation of the IBM mainframe. After a few decades, most science fiction just seems silly, because they got everything wrong. Just think of the scene in 2001 where the guy stops at a phone kiosk to make a video call home. It's likely that kids today won't even know what a phone booth was. So, science fiction, which tends to take a Japanese engineering approach to the future, becomes outdated very quickly, because it simply can't predict the astonishing leaps forward that are bound to happen, even though no-one knows what they are.
One snarky comment, if I may. In the essay added for the second edition, Taleb praises building redundancy into systems to make them more robust, and less vulnerable to the bad effects of highly improbably events. It struck me that that might explain some of the structure of his book. But, if you have an interest in skepticism, or in randomness, then this book is definitely worth it. (less)
This is easily Bourdain's best book since Kitchen Confidential. Once again, he is confessional and autobiographical, and there is less repetition, les...moreThis is easily Bourdain's best book since Kitchen Confidential. Once again, he is confessional and autobiographical, and there is less repetition, less verbatim from what I've seen on the TV shows than in Nasty Bits or Cook's Tour. And this time, he seems a bit more at peace with himself, and maybe even happy. I love his writing voice, and found myself laughing out loud in several spots.
I especially liked the counter-intelligence ops that he describes pulling to poison his daughter's mind against McDonalds. There is also a wonderful chapter describing fish cleaning at a fine New York restaurant (and I know that sounds like something odd to have a wonderful chapter about, but Bourdain does a beautiful job with it.) (less)
I really liked this, and especially liked the fairly even handed treatment Weir gave to these people. But there is one notable exception. Compared wit...moreI really liked this, and especially liked the fairly even handed treatment Weir gave to these people. But there is one notable exception. Compared with everyone else, Weir seemed to take delight in Thomas Cromwell's execution and even in the fact of the executioner botching the job and taking two swings of the axe to finally sever his neck. With others, Weir seems to see both sides of a person's character. But, for her, Cromwell was Henry's evil genius, and she seems to think ill of Cromwell even while she is disposed to look favorably on his master. I found that a bit odd. Of course, I may be a bit prejudiced by James Frain's amazing portrayal of him in the Showtime series, The Tudors.
The legal hoops that get jumped through are pretty amazing. Katherine married Henry's brother, but it got annulled with Papal dispensation on the grounds that the marriage was not consummated. Henry then had his marriage to Katherine annulled because it was incestuous, based on the prior marriage to his brother. Lots of people think of Katherine as simply a victim in this. But it's pretty clear that she would have been pleased for her nephew to go to war with England to restore her marital rights. And its also clear that she insisted on her rights, even if upholding them insured that England would fall again into civil war as a result. On top of that, she also seems to have had a soft spot in her heart for the burning of heretics.
Anne Bolyn was probably a horrible woman. It's pretty clear that she was willing to poison her. But, its also abundantly clear that the charges against her were completely fabricated. Henry needed an alliance with Spain at that point, so Anne was a political handicap. She hadn't given him a son, and was a pain in the ass, so she had to die. (And so did several totally innocent men, just to complete the tableau.) This marriage got annulled on the grounds that it was incestuous -- since Henry had already had an affair with Anne's sister Mary before marrying him. You would think after the exact same problems with his first marriage, that Henry might have learned something...
Jane Seymour was the wife Henry liked best. I think this is because, of all his wives, she had the good taste to die before he got bored with her.
Katherine Howard is another great case. She probably cheated on Henry. However, its pretty clear that she was precontracted to marry Dereham, and thus her marriage to Henry was void, and she could not have committed adultery against Henry for the simple reason that they were not truly married. It's also pretty clear that Henry understood this, but he was hurt and wanted her dead for it. And his handlers wanted her dead for fear that Henry would get over being hurt, and take her back. She was too Catholic for them, so she had to die. Thus, they had to make her adultery a capital crime. Dereham also had to die. His crime was having sex with the future queen, before the King had even met her. This marriage never got annulled. And that makes sense, since it was the only one that had a legitimate basis for annulment.
Of his other two wives: Anne of Cleves was fortunate. She repulsed Henry from the outset, and he put her away. Thus, he never got bored or disappointed with her. And she seems to have lived a fairly good life. Katherine Parr escaped burning by very, very little. Basically, the courier who had the warrant for her arrest dropped it, and it was discovered by someone loyal to Katherine. So she learned of her peril in time, and managed brilliantly to make amends. Otherwise, Henry would have succeeded in killing half his wives. Instead, Katherine Parr got to survive Henry and then die horribly from the complications of childbirth.
As vile and fascinating as the characters in Henry's court were, the big impression I got from this book was how incredibly scary childbirth must have been in Tudor times. It was incredibly common for the woman to die of complications afterward. It was even more common for the kids to die. And if the kids did manage to grow up, chances are they would die young from the plague or war or something equally terrible. But, of course, there was always the chance that they would grow up to be incredibly successful, at least until their rivals figured out some way to get them attainted and put their heads on the block.(less)