. Some of them are about investing; others are onlyperipherally related and may not suit your tastes or interests. But I have included the reasons why each one helped me in investing so you can decidehow each might be useful to you.Practical Speculation (Wiley, 2003) and Education of a Speculator (Wiley,1998) by Victor NiederhofferI really cannot say enough about these two books. How often can you getadvice about investing from a guy who has been involved in every aspect ofinvesting over the past 40 years? Not to mention that he was world squashchamp for 10 of those years, achieving a level of success in two fields whenI would be happy to achieve it in just one. In addition to being a researcher,a pit trader, a trader for Soros, a hedge fund manager, and an owner of anM&A business for 20 years, he has also been an excellent writer in the markets, writing each week for MSN, still testing new ideas and asking newquestions about the markets whenever he can.The most important idea in these books is the notion that one needs totest everything. This is no small matter. Often the media makes gross claimslike:• “When P/Es are high, the markets go down”• “Stock XYZ just crossed above its 200-day moving average, which isvery bullish.”
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• “The market is forming a head and shoulders pattern, which is verybearish.”And the list goes on. Regardless of whether any of these statements are true(none of them are), they are all testable. Many of the investment books Ihave read since the early 1990s have recommended systems that did notstand up under basic testing. Why is this? I honestly cannot tell you. Evenif one wants to trade on gut and not using a systematic method, basic testing will help build intuition by simply showing you the facts about what hasworked in the past and what has not.Practical Speculation contains chapters on how to identify spuriouscorrelations to more “fun” topics such as: Has Alan Abelson ever been bullish on the markets?Confessions of a Street Addict (Simon & Schuster, 2002) by Jim CramerJim Cramer often gets a bum rap. He is high energy and it shows when heis on CNBC on Kudlow & Cramer. He has single-handedly popularized theconcept that individual investors can invest for themselves and not hand alltheir money to the often incompetent people at brokerage houses or mutualfunds. The Web sites he has started through thestreet.com umbrella havebecome the best brands in online financial journalism. (I am biased, ofcourse, since I write for them.)At the end of the day, it is hard to beat Cramer’s track record. For theyears he was in business, he returned a solid 30 percent a year—very legitand hard for anyone to beat. And yet what stands out in his book are not hissuccesses, but his brushes with failure. His first week in business he wasdown nearly 10 percent and almost had to shut down. And then again inmid-1998 he was down 20 percent year to date. Being a hedge fund managerand learning to survive those periods are critical to success. The 1998 chapter is a classic.One thing that stands out to me about both Jim Cramer and VictorNiederhoffer is that both responded to my initial e-mails despite having noidea who I was or any reason to write back to me. For those gestures I amgrateful and hope to be able to emulate at least some of their successes.Market Wizards (Harper Business, 1994), The New Market Wizards(Harper Business, 1994), Stock Market Wizards (Harper Business, 2003) byJack SchwagerI am a sucker for biographies and interviews with people in whatever field Iam interested in. All three of Schwager’s books have some excellent interviews, and almost every interview has some takeaway that can help an investor. My favorite interviews in the books were:
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• Monroe Trout. His technique is all about testing patterns in the marketfor statistical significance. I strongly believe in this approach and haveprobably reread this interview no fewer than 20 times. I also like his approach to money management and capping his losses per trade andmonth at fixed amounts.• Gil Blake. I am not a big fan of mutual fund timing, but in his interviewBlake mentions the idea that he just needs to create systems with positive expected value and then make as many trades as possible in thosesystems. His quote on diversification: “If the odds are 70 percent inyour favor and you make 50 trades, it’s very difficult to have a downyear.” The key, I guess, is getting the odds 70 percent in your favor.• Mark Cook. Some of Cook’s ideas on the tick inspired me to start looking at it for my own trading, some of the results of which appear in thisbook.These are just a few of the interviews but, again, all of them had sometakeaway that I found useful.SuperMoney (Warner Books, 1973) and The Money Game (Random House,1976) by Adam SmithI love pop finance books from the 1970s. In particular, these investmentbooks by Adam Smith have never gone out of date. For instance, in one ofthe books, I forget which, he mentions a friend calling him and saying amajor bank is about to collapse due to some problem with derivatives. Thiswas written thirty years ago and on a daily basis I still hear this rumor.In SuperMoney he also pals around Omaha with then-unknown investor Warren Buffett. Buffett at the time had about $40M and was trying tofigure out what to do with his life. While they were driving around, Buffettpointed at the Nebraska Furniture Mart and said, “Someday I’m going toown that.” The rest is history.In the very next chapter, Smith provides the details of a Swiss bank heinvested in that went bankrupt, and the founder ended up spending time injail. The founder, Paul Erdmann, went on to become one of the most successful financial thriller writers ever. I highly recommend his first book,The Billion Dollar Sure Thing (Berkeley Publishing, reprint, 1988).Along these lines of 1970s pop finance books is Andrew Tobias’s book,The Funny Money Game (Playboy, 1972), detailing the rise and fall of National Student Marketing, the high P/E growth stock that he was in themanagement of. If ever there was a dot-com before the late 1990s, this wasit. And it also shows that the Internet bubble was not the first of its kind,nor will it be the last. Again, these books from the 1970s are great examplesof how things never change.
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Tomorrow’s Gold (LSA, 2002) by Marc FaberJust reading this book by Faber is going to raise your IQ. This guy knowshis history, in every market in every country that’s ever existed. The bookis basically about emerging markets and the cycles that make up an emerging market. He details how events such as the Internet boom and even therailroad boom of the 1800s and other periods of technological innovationhad many of the characteristics of an emerging market. The book weavestogether demographics, history, and a global macro understanding oftoday’s markets to put together a consistent investment thesis. At the veryleast, after reading this book you will be able to talk intelligently at cocktailparties about the Asian markets.Famous First Bubbles (MIT, 2000) by Peter GarberThis is a small book that describes in detail the Tulipmania bubble and theMississippi and South Sea bubbles. Like a similar book, Devil Take theHindmost (Plume, reprint, 2000) by [Peter Gruber], Famous First Bubblesdescribes the history but also provides a breakdown of the fundamentals ofeach bubble, which demonstrates that these bubbles were perhaps not bubbles. For instance, in the case of the South Sea Company, as crooked as thecompany was, the fundamentals might have justified higher prices. However, encouraged by the success of South Sea, many other fly-by-night operations were going public and encouraging massive overspeculation untilfinally the whole thing collapsed. Sounds like another recent bubble. (Orwas it a bubble?)I tried two different systems described in this book to see what wouldhappen if you applied the techniques here to the stock of the South SeaCompany in 1721: the 4 percent system and the Turtle system.Recall that the 4 percent system buys a stock intraday when it is 4 percent higher than the close the day before. It closes out the position at theend of the day. The idea is that short sellers who are trying to speculatemidday are going to get squeezed by the end of the day, causing a run intothe close. See Figure A.1, which shows the 4% up system applied to SouthSea Company. The results would have been 35 trades, of which 20 wouldhave been successful and had an average profit per trade of 4.71 percent.Applying the Turtle system described in Technique 7 would also haveworked quite well (Figure A.2, page 217), resulting in one trade with a profitof 443 percent within one year. Not bad.When Genius Failed (Random House, 2000) by Roger LowensteinWhen Genius Failed is like a horror novel. Everyone gets rich, billions ofdollars rich, and then it all comes tumbling down while at the same timeputting the entire world on the brink of financial collapse. As with
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900.00850.00800.00750.00700.00650.00600.00550.00500.00450.00400.00350.00300.00250.00200.00200.00
Volume0.800.600.400.20
FIGURE A.1
South Sea Company, 1720, 4 percent system.
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900.00850.00800.00750.00
Sell 863@630.00443,689.88
700.00650.00600.00550.00500.00450.00400.00350.00300.00250.00200.00160.00150.00
Volume
Buy 863@115.88
0.800.600.400.20
FIGURE A.2
South Sea Company, 1720, slow Turtle system.
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anything, it is important to be a skeptic. Keep in mind that the portfolio ofLTCM, if left alone, would have had a profitable year. Which is why guyslike Warren Buffett were trying to bid for it. The banks had a panic attackthat the fund was going to fail and trillions of dollars would be lost and shuteverything down. Note that Merriwether’s new fund now is supposedlydoing very well.The book and topic has an interesting psychology to it. Most people Ihave spoken to about LTCM who have read the book seem happy to recount the stories of Nobel Prize winners failing and guys losing billions.Failure and loss is not the point of the book or that story at all. The point is,what happened to LTCM can easily happen to you, me, anyone who engages in this field. Constant self-management and being aware of thelessons of history through backtesting and reading books like When GeniusFailed are the only methods I know of for avoiding this fate.Triumph of the Optimists (Princeton, 2002) by Dimson, Marsh, StauntonWhat was the triumph? The fact that anyone who invested in U.S. equitiesin 1950 would have had a real return of over 9 percent a year. Unbelievable,particularly since at 1950 many members of the Graham and Dodd schoolwere already believing that U.S. stocks were too expensive. In Triumph,the authors analyze the stock, bond, and currency returns of every majorcountry over the past 100 years. To say this is the most important historybook for global market investing would be an understatement. Take fromthis book what you will; my conclusion from the book is to never underestimate the U.S. market.Reminiscences of a Stock Operator (Wiley, 1994) by Edwin LefevreThis fictionalized biography of Jesse Livermore is a classic and the one byLefevre that is commonly quoted, but any book by Lefevre is a must, particularly Wall Street Stories (Greenwood, 1901) and The Making of a Stockbroker (Fraser, 1999). Like the previously mentioned pop finance booksfrom the 1970s, Lefevre’s books underline the fact that even since 100 yearsago, nothing has really changed.The Stock Trader’s Almanac (Wiley, 2003) by Yale Hirsch and Jeffrey HirschThe Almanac is the bible for seasonal investing. It is filled with stats and curiosities about what happens on almost any day, week, month of the year inthe markets. There are lots of fun facts that provide insights into the secretsof the market. Personally, I think the Hirsch family has carved out for themselves the funnest job on the planet—data mining the market day and nightto find the latest info for the next edition. That said, it is somewhat difficult
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to trade on seasonal factors. For instance, once everyone knows that Januarys tend to go up, they start buying in December, and so on. The key to taking advantage of any repeating seasonal factor is to recognize that factorbefore anyone else does—easier said than done.Moneyball (WW Norton, 2003) by Michael LewisMoneyball is the story of Billy Beane and the Oakland As in 2002 when, despite having one of the lowest payrolls in the league, they end up winningmore games than any other team in the American League. How did they doit? By using the same techniques described in this book: uncovering statistical anomalies in their market (the market for good baseball players) andusing those anomalies to reap profits (win more games). A baseball termsuch as the “expected run value” that describes how many runs can be expected from a particular diamond situation is strikingly like the “expectedvalue” term used to describe the average profit per trade in a particularsystem.Gary Kasparov on My Great Predecessors, Part 1 (Everyman, 2003) byGary KasparovKasparov is probably the best world champion ever. Of course, we canargue this and say maybe he never surpassed Bobby Fischer at his peak. Ormaybe the new blood, Vladmir Kramnik might be better. Who knows? In myopinion, Kasparov is the best. And that he does a detailed study of everyworld champion preceding him makes the book worth looking at. As I havesaid before, knowing the history of any field you attempt to master is a critical must.
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Addition of stock to index, 119, 122Allergan, 209AMAT, 172, 174Annual return, 15, 21Average true range (ATR), 194Bankruptcies, buying, 49–54Kmart, 50–52United Airlines (UAL), 49, 50, 51WorldCom (WCOM), 50, 53Berkshire Hathaway, 208, 209Billion Dollar Sure Thing, The(Erdmann), 214Blake, Gil, 214Bogle, John, 119Bollinger, John, 67Bollinger band system, 67–76basic, 67–69and shorting, 74–76short-term, with profit target, 69,71–74Bollinger bands, 97, 99, 106Bonds, 111–117bond allocation trade, 113allocation system, 113junk bond market, 115–116Breakout of recent high, buying on, 95Buffett, Warren, 209Candlestick patterns, 208Chaos theoretician, 179Chen, Honghui, 120
Confessions of a Street Addict(Cramer), 213Confirmation, 207Convertible arbitrage, 163Cook, Mark, 214Countertrend indicator, 133Cramer, Jim, 213Deletion of stock from index, 119, 122Dennis, Richard, 83Devil Take the Hindmost, 215Directional trading, 23Draw-down analysis, 15, 19Dunn Capital, 212Eckhardt, William, 83Education of a Speculator(Niederhoffer), 144, 212Ehlers, John, 95End of month, 142–145End of quarter, 141–142Equity high analysis, 15, 20Erdmann, Paul, 214Extreme advances-declines, 151–152Extreme convertible arbitrage, 163Faber, Marc, 215Famous First Bubbles (Garber), 215Federal funds rate, 96Fed Model, 111–112Fischer, Bobby, 205Fisher, Ken, 209
221
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222Ford, Gerald, 175Four down days, 179–182Four-month closing highs, 156Four percent breakout move, 185–1894 percent breakout system,185–187variation of 4 percent breakoutsystem, 187Four up days and short, 182–183Four up days and short for 1 percent,183–184FTUS, 124, 125Funny Money Game, The (Tobias),214Gap, 1Gap trade, 1–21filling gap after down day, 45 percent gap, 4–55 percent gap with market gap,5–13simulation of 5% gap, 8–9, 12–13gap-fill approach, 3shorting the gap up, 14swing trading the gap, 14–21Garber, Peter, 215Gary Kasparov on My GreatPredecessors (Kasparov), 219GoTo.com, 77Greenspan, Alan, 180Gut, trading on, 206Hirsch, Jeffrey, 208, 218Hirsch, Yale, 208, 218Holding period, 101Index funds, 119–124Inforte (INFT), 78, 80Institutional Advisory Services Group(IASG), 212Intraday Bollinger Bands, 169–177five-minute Bollinger band system,170–172
Index
results, 175–177profiting from panic, 172, 175Intraday TICK system, 55–65variation: low-grade panic attack,59, 62–63“Investor Awareness and MarketSegmentation: Evidence fromS&P 500 Changes,” 120JDSU, 120–121Jordan, Michael, 211Junk bond market, 115–116Karpov, Anatoly, 211Kasparov, Gary, 219Kennedy, John F., 172Kmart, 50, 52Korean War, 172Kornblith, Charles, 124Lefevre, Edwin, 206, 218Lewis, Michael, 219Livermore, Jesse, 206Long Term Capital Management, 180Lowenstein, Roger, 215Low-priced stocks, 77–82buy less than $5, 82Inforte (INFT), 78, 80OVER, 77–78, 79WorldCom (WCOM), 78, 81Making of a Stock Broker, The(Lefevre), 206, 218Market gap, 5–13Market Wizards (Schwager), 213Merger arbitrage strategy, 24Microsoft, 208Moneyball (Lewis), 219Money Game, The (Smith), 214Morphy, Paul, 211Moving average, 95, 99200-day, 133–139MSFT, 172, 173
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Nasdaq 100 index, 97, 119New Concepts in Technical TradingSystems (Wilder), 194New Market Wizards, The(Schwager), 213New York Stock Exchange (NYSE), 55TICK indicators, 55Niederhoffer, Victor, 144, 212Nison, Steve, 208Nixon, Richard, 175Noronha, Gregory, 120Option expiration day (OED),155–162Options, 210Orbital Sciences (ORB), 122–123ORCL, 170–171Outside month, 145–146OVER 77–78, 79Pairs trading, 23–24Panic, buying, 147–153P/E, 208–210Pearl Harbor, 175“P/E Myth, The,” 209PIXR, 195, 196Practical Speculation(Niederhoffer), 212Preferred arbitrage system, 165risks, 165–166Preferred stock arbitrage, 164Pyramiding bets, 95QQQ crash system, 97applied to stocks, 106–109simulation of system, 101–105vary holding period, 101vary standard deviation, 101vary moving average, 99RealMoney.com, 207Relative Fed Model, 111
223Reminiscences of a Stock Operator(Lefevre), 218Rocket Science for Traders (Ehlers),95Russell indexes, 119S&P 500, 84–93, 119Schwager, Jack, 213Sealed Air (SEE), 166–168Seasonality, 208Sentiment indicators, 147Shorting the gap up, 14Smith, Adam, 214Standard deviation, 101Steinitz, Wilhelm, 205Stock Market Wizards (Schwager),213Stock Trader’s Almanac, The (Hirschand Hirsch), 208, 218SuperMoney (Smith), 214Swing trading the gap, 14–21Ten percent pullback, 147–151TICK indicator. See Intraday TICKsystemTobias, Andrew, 214Tomorrow’s Gold (Faber), 215Trend-following system, 83Triumph of the Optimists (Dimson,Marsh, and Staunton), 218Trout, Monroe, 214Turtle trading system, 83–96author’s version, 84basket of uncorrelated stocks,93–94S&P 500, 84–93variations, 95Twin Towers, New York City, 175200-day moving average, 133–139approach based on concept ofmean reversion, 137one-day system, 135, 137trading systems, 135, 136
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224Uncorrelated stocks, 93–94Unilateral pairs trading, 23–47code, 44–47system for QQQ-SPY, 24–43United Airlines (UAL), 49, 50, 51USAI, 195, 197Vanguard Group, 119Wall Street Stories (Lefevre), 218Wealth Lab, xii, 170Wednesday wide-range midweekreversal, 189–193shorting with, 198, 200–203
Index
When Genius Failed (Lowenstein),215WHX, 124, 126Wide-range system, 193–194applied to stocks, 194–198Wilder, Welles, 194Wilshire 5000, 119WorldCom (WCOM), 50, 53, 78, 81,209Yields, 111–113
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