Wednesday, March 11, 2009

Reading the Entrails

From How to Read the Dow Jones Industrials Indicator:

When interpreting the chart above, you need to remember that the most important factor is the relationship between Index Price and the Volume Moving Average (VMA). Here we see that the index has taken an advancing trend with not much supporting volume to cause this change. This occurs because investors are taking profit from covering their short orders; this causes the market to increase. When the VMA has peaked, professional investors once again enter into a short position by selling; this action causes the index to trend down again. It is just after this VMA peak that one should make a trading decision.
From Sacrificial Divination: Confirmation by Extispicy:
Observational divination inferred the gods' will through close examination of portents from the world around. The gods could also send messages though dreams and divinely inspired utterances, or oracles, to any citizen of Assyria. But sometimes it was not enough to wait for the gods' messages. The king might need to resolve a pressing political problem, or he might not be certain whether to trust the human intermediary of a divine oracular pronouncement. Under those circumstances he commissioned a sacrificial divination, or extispicy, to obtain a divine yes-no answer to a question he put to the gods. His haruspex (bārû, literally "seer") examined the entrails of a sacrificed ram for ominous marks, counting up good and bad and declaring the most prevalent as the divine response to the king's query.

The liver of the sheep, with the zones considered ominous in Neo-Assyrian royal extispicy.

If a Design is drawn from the centre of the top of the Station to the Gate of the Palace and a "weapon"-mark points parallel to it: a leader will leave his country.

If a Design is drawn from the centre of the top of the Station to the Gate of the Palace and a "weapon"-mark points to it: a leader will enter the country.

If a Design is drawn from the centre of the Gate of the Palace to the Station: the gods have heard the wailing of the land.

If a Design is drawn between the Station and the Path: a god will request an emblem or a censer from a man.

If a Design is drawn twice between the Station and the Path: a man's wife will have her husband killed.

If a Design is drawn three times between the Station and the Path: a man's wife will write again and again about killing her husband, "Kill my husband and marry me!"

One might want to believe that reading modern market indices is a very different matter from the ancient practice of divination, where the entrails of a sheep or goat were methodically examined to predict the future. And until last summer, it did seem as though there must be a considerable difference, since the masters of high finance, aided by bona fide math geniuses, using the most sophisticated computer models, were so consistently doing so spectacularly well. Now we know better.

And if we'd given things a little more thought, we should have figured it out long ago. For example, the method shown above for predicting the zigs and zags of the market, based on the relation between the price average and the VMA, or "Volume Moving Average," is extremely suspect. For one thing, it fails to take account of exceptional cases that might not perform as expected and could trigger huge losses under certain circumstances. For another, it doesn't take into account the liklihood that a great many investors could be using the same model, creating a situation George Soros has described as "reflexivity":
which holds that our thinking is inherently biased. Thinking participants cannot act on the basis of knowledge. Knowledge presupposes facts which occur independently of the statements which refer to them; but being a participant implies that one’s decisions influence the outcome. Therefore, the situation participants have to deal with does not consist of facts independently given but facts which will be shaped by the decision of the participants.

Consequently many traders using more or less the same methods will influence the outcome of their methods in ways that are inherently impossible to predict. Not to minimize the contribution of George Soros, a man of extraordinary intelligence, this is not rocket science and should have been obvious to the geniuses programming the computers that made such trades, sometimes as many as a million a day per firm, as I understand it.

The Dow Jones Industrial Index for today, March 11 (from The Financial Times):

Taking a close look at today's Dow Jones Industrial "entrail," we see that it wound up at pretty much the same place as it started. But look at all those squiggles in between. This is what is called a "volatile market." Certain types of traders, particularly day traders, are very fond of such markets because they provide many opportunities to make bets as to which direction the entrail will take at any given time. And the more such bets are made, the more "opportunities" there will be, thanks to the effects of Soros's reflexivity. I think it safe to say that the majority of what is happening today in all these market indices is due to the placing of such bets, rather than any legitimate reflection of what is actually happening in the business world as far as profits and losses are concerned. What we are dealing with is indeed a type of necromancy, inherited from age-old traditions based on sheer superstition.

So what does it mean when we see that the Dow ended the day up or down by so much? As far as the average investor is concerned it might seem to matter a great deal. But to the trader it hardly matters at all. His money is made or lost each time the little squiggle moves up or down, as it can do thousands of times in a single day.

Is there any longer any reason for continuing with this nonsense? Sorry, but I can't see any. When you place a bet in a casino, at least you know the odds.

No comments:

Post a Comment

Add to Technorati Favorites