Psychic octopus passes on.....

This summer, I blogged (here and here) about Paul the Octopus who predicted Spain to win the 2010 World Cup. He passed away in his German tank at age two last night. The aquarium's manager claimed Paul died of natural causes. Mmmmm, I am suspicious of fanatical German soccer fans.

Let this be a lesson, it is dangerous to speak certain truths.

Computers do not have psychology

In previous posts, I discuss equities investing or stocks using technical analysis (TA) to guess the market (see here, here, here and here). One common form of TA is known as Elliot Wave Principle (EWP) which depends on the collective psychology of investors charting price patterns over time into 5 distinctive waves. Over the last couple of years as I have dabbled in stock investing I have attempted to use EWP unsuccessfully with the New York Stock Exchange indexes. EWP came to my attention in the 2007-2009 crash as the price action followed the 5 waves. If it was true then, it must be true just a few months later? I have come to the conclusion that TA including EWP is not very effective at the current time in US stock markets because of how the market's composition has changed even in a brief period. It has to do with investor psychology (or lack of) and other outside influences.

I will give a brief history of how the US stock market changed over the last couple of decades. In 2001, markets began to trade stock in $0.01 increments in a process known as decimalization. Prior to this, all stocks were traded in fractions of (n/16) fractions of dollars. One advantage of fractions was the fact stock brokers with ask and bid prices at the increments. The slight (n/16) difference between the bid and ask price was the amount a stock broker could make buying and selling blocks of stocks for customers. The second innovation was the market switched to partially computerized operations in NYSE operations and is fully computerized in the NASDAQ market. In a nutshell, the pits with traders buying and selling stock are gone. The price action mostly occurs within a giant computer.

This "modernization" of the markets led to new kind of investment strategy, computerized trading at a quick speed. Basically, picture supercomputers directly connected to the exchange computers through a high speed Internet connection. Why would anyone do that? It is capitalizing on the same trade strategy as day traders. Buy and sell millions of stock simultaneously of just a few pennies of profit and the pennies turn into hundreds of thousands of dollars quickly. Add in the ability to trade put in quotes and cancel transactions before they are processed, one has quite a money making strategy. This process is known as high-frequency trading (HFT).

How does this influence TA? As stated before, TA is based upon investor psychology and the desire to hold stock over various lengths of time from hours up to years. Traders make buys and sells in a response to price movement creating the distinctive TA patterns. HFTs buy and sell stock within a matter of seconds. HFTs can even move millions of stocks down to milliseconds time frames! The HFT responds in a near instantaneous, mechanized manner to stock movement. The resulting trade psychology does not appear on the stock price charts. If HFTs were a small minority in the stock community, it would not directly influence TA. This was partially the case during the 2007-2009 crash with HFTs being ~40 % of the market's participants. EWP traced out the 5 distinctive waves. Currently, HFT represents ~60 % of all trades made on the US exchanges and can account for ~70 % on light trading days. Since this represent the majority of trades, the price action is not driven fully by investor psychology making TA less effective. I believe TA is useless over short periods of time.

One other factor distorting the markets are US government authorities. The government's stimulus and various Federal Reserve programs (TARP, TALF, POMO and etc) are putting money into investors hands in indiscriminate, unequal ways. The "free" money ends up being investing in the market in unorthodoxy manners.

The aha moment I had last night was using TA to avoid these unwanted outside influences into the markets. The only market to my knowledge that is too large ($100s billions per day) for authorities to significantly manipulate are foreign exchange markets (FX). These markets are based upon converting money into different currencies worldwide and HFTs would also have no interest in these markets. What FX markets can follow using TA are carry trades and whether investors are seeking risk or are seeking a safe haven for their investing.

Baseball lumberjack

This Yahoo! article reveals a very talented pro baseball player, Mariano Rivera currently of the New York Yankees, and his ability to break wooden bats with pitches. (Links do not work in quotes)

The best pitch ever notched four more kill shots Wednesday night. Mariano Rivera(notes) throws a cut fastball that at its 55th foot takes a hairpin turn into the fists of left-handed batters, and their feeble attempts to hit it end up reinforcing a long-held certitude: The only thing more dangerous to lumber than wood-boring beetles is the New York Yankees’ closer.

The impressiveness of Rivera’s four-out, four-broken-bat save during the Yankees’ thievery of home-field advantage from the Minnesota Twins in a 6-4 victory in Game 1 of the American League Division Series wasn’t because he set some record. He once cracked five bats in an outing. Nor did he earn extra credit for turning baseballs into buzzsaws. An out is an out, shrapnel or not.

This is a significant amount of force to shatter bats. Broken bats are caused by fast balls at either the bat's end or near a player's hand during a jamb. I am guessing Rivera is the master of the jamb against left handed hitters. In this article, the majority of bats that shatter are actually made of maple wood and not the more traditional ash which just cracks. Maple bats have physical properties that encourage shattering in comparison to ash.

What is interesting about Rivera, is his single minded approach to pitching. He has one pitch, a cutter fast ball. To top it off, he has been doing this for 13 years now and is still effective at past 40.

What’s mystifying – what has mystified for more than a decade now and will continue to mystify until Rivera retires, which, even after his 40th birthday, remains a long way off – is that he throws a single pitch, a dirty bomb of a pitch, yes, but just one nonetheless. Not only can hitters damn near never make solid contact, they fare so poorly that the lone weapon at their disposal often turns into a useless recyclable.

This is a demonstration of someone capitalizing a particular talent. Most pro pitchers can throw pitches that hard. It is just a handful who can routinely dominate batters.

As for the future of baseball, you think that getting away from wood might be in the works. There is something about hearing the crack of a wooden bat though to stir excitement into a fan's soul.

Next week is my honeymoon, thus, it will be two weeks before my next post. Cheers!