Replies to post #29180 on A.I.M. Users Bulletin Board (AIMUSERS)

[ls7550]

Hi Tom

It spells out the futility of prediction models

I think it's good to recognise/accept the random model, as then you can better play the game by coming to terms with money management as being the principle key factor of gameplay.

Anti-Martingale styles (adding after a gain/reducing after a loss), which includes buy-and-hold, compares equally with Martingale styles (which includes AIM) over all possible price motion combinations. Both amount to zero-sum games across all possible combinations.

With money management however Martingale's can be mapped to a positive overall game-play by excluding the worse case combination.

A bit like a 2 flip coin-toss game which has possible unique win (1) and lose (0) combinations of 00, 01, 10, 11. If mapped to stocks and investing $x at a $100 initial stock price and another $x invested at a (lower e.g. Martingale style) stock price of $50 then the next downside leg of a $0 stock price will never occur assuming a major index is being played (excepting some extreme condition - and in which case likely money would be valueless anyway other than its potential worth by being burnt for heating purposes).

So the 00 outcome combination never occurs, leaving an overall positive biased gameplay set of 01, 10 and 11 possible cases.

The stock market can be likened to a casino 50/50 like event/payout game, but when correctly money managed can be played in a fashion that has a finite limit as to the maximum losing cases deviance (drawdown).

Having established an overall positive sum gameplay via money management, the next stage is to maximise the gain potential. Which generally involves minimising the risk of a worse case combination event being encountered (loss avoidance).

Taleb, Mandelbrot and others proclaim how real world measures exhibit fat-tailed/power-law like bell curve distributions. The few outer edge events occurring more frequently than might otherwise have been anticipated. Personally however I do not find that to be anything out of the ordinary as the conventional measure assumes a constant central Bell-ring (hanger) point, which in the real world is not a constant.

If you take a bell-curve and move it from side to side (deviate the central point) then the effect is for the edges to become enlarged relative to the overall average central point.

Simple averages aren't sufficient, you have to start considering the average of averages. As in how the prospect of a Dow=4000 price level from a Dow=12000 start point has little bearing when the Dow start price is moved to 8000. From the Dow=8000 price level a Dow=4000 price becomes more probable (Bell curve tails are enlarged).

Best regards.

Clive.

[aaCharley]

The challenge is to come up with something for an investment which gives a reliable positive return and without correlation to the stock market or US economy. Then find several of those which are not correlated with each other.

I would not really think that Taleb would call a stockmarket decline as a Black Swan. The cause of it, imploding major banks, might qqualify.

Further, I don't believe a buy on the decline method will not offer much protection from the Taleb style Black Swan. His recommendation is to buy very cheap mispriced insurance against the Black Swan events in order to directly profit from them. That will be generally unprofitable on a daily basis and probably for many years running.

Consider how you would have responded to a suggestion, made two years ago, that economic conditions would change so that GE would not be able to roll over its debt without a govt. guarantee. Or look at how AIM would have done with GE as the security being used as it declined from $40 plus to $15. I'm not trying to pick on GE, BTW. But, not being wiped out yet does not mean that it won't be in another year. There are any number of possible country defaults that are now possible, on the order of investments in Iceland.

When you have finished the book I expect that your thoughts on possible Black Swans will be changed.

[Neil Scott]

Hello Tom,
I read Nassim's first book which did make me think about things in a different light.
It was written in a way that did not spoon feed you but just had stories in that were based on probabilities.
Just been reading a story on the Bloomberg website that said that apparently 2/3 of millionaires in the U.S. thought that their investment advisors had failed them because they had lost during the crisis.
One would wonder if they would have taken their advisors advice if 18 months ago their advisors had told them to sell all their shares and hedge funds and stick their money in cash.
I bet the reaction would have been "are you some kind of idiot? this is the boom we've been waiting for!'
It is funny how prudence goes out of the window during a boom, there is no conserving of funds for the lean times that must surely follow.
The lean times are what Lichello built AIM for but we still add our own tweaks so that we don't miss the stock market leap up and then bang, it collapses in a heap and we all wish we had followed the strict rules.
Our company started laying more people off today, thought I'd seen the last of it before Christmas but it seems like they are preparing for the worst.

Regards

Neil