Just Blame Fred

While responding to a microblog on Facebook today, I came up with an revision to the opening of the Deceleration of Independence, more suited for our day and age.

We hold these truths to be self-evident, that all Individuals have within themselves a Yearning for Freedom, Liberty, and the Pursuit of Happiness, which shall not be abridged by any other Individuals; nor any Governments, Corporations, Municipalities, nor other Associations of Collective Power.

Indeed, the Individual reserves the sole power in making decisions to forward his own Progress towards Freedom, Liberty, and the Pursuit of Happiness, and those choices must be respected by all.

We live in a day and age where many systems of bureaucracy exist whose sole purpose is to deprive Individuals of their Yearnings, to turn into Functional Slaves at the pleasure of Others.

Yet, we also live in a day and age where we have hyper-connectivity between and among Individuals to allow for many multi-scale levels of Spontaneous Association, the likes of which no old-guard Government, Corporation, or other bureaucratic system can stand against.

To that end, a call for ALL Individuals across the World at Large to recognize the lofty yet obtainable  Goals of Freedom, Liberty, and Happiness, and to put those Goals to the forefront in all doings.

Many years ago, a large prominent figure wrote an essay by the name, “The World as I see It.” In no way do I presume to even approach the stature of the man who wrote that — Albert Einstein.

However, we do live in a different world than Einstein’s in many respects. For starters, the geopolitical landscape is far different today than it was then. Today’s world affairs are borne on the back of what took place since Einstein’s time.

And yet, in many respects, not much have changed. We still have silly “tribal” conflicts and squabblings, and big “tribes” love to beat up on the smaller “tribes”, and the smaller “tribes” will fight back by any means possible against the bigger “tribes”.

But what about the major differences? In today’s world, we have a level of hyper-connectivity that has never existed before in the history of mankind — the Internet. We also have diversification of wealth at levels that have never existed before. We have mass travel, where anyone can travel great distances to any part of the world in just a few hours and some bucks. We also have far more people alive today than then. We also have diversified levels of education and knowledge that would’ve been the stuff of Science Fiction back in Einstein’s era. And many other wonders.

We also have the specter of ultra-powerful hyper-stable governments that are firmly entrenched and very controlling. We have military machines, weapons, and other technology that would’ve been beyond the imagination of many back then.

And for the first time in human history, humans have the power to wipe itself clean off the map at just the “push of a button”. Those, that “button” currently resides in the hands of the most powerful governments, but the danger increases as that power becomes more distributed among the lesser nations.

Alas, nuclear weapons are not the only threat to our existence. Biological threats exists as well, and as biotechnology progresses, the more possible it will become for anyone to engineer a biological threat that can wipe out large numbers of people.

On the other hand, big powerful governments and corporations are controlled by the hands of a few whose agendas and goals may not be in the best interests of the individual. Pharmaceutical companies may push governments to institute mandates for vaccines that may not be necessary or safe. Military contractors may influence governments to choose military options over diplomatic ones to keep themselves on the gravy train. Big Finance may convince governments to allow them to cowboy the economy. And so on.

Meanwhile, the “little guys” — you and I — are caught in the middle of all of this. Activities of the “Big Boys” may wipe us out individually without the Boys even knowing it, like kids horsing around in a playground trampling ants. Military conflicts sacrifice the lives of innocent men, women, and children to serve some geopolitical — or geo-corproate interest. Entire villages of the “little people” may be bombed out of existence in the efforts to “war against terrorism.”

If you are one of those villiagers, who is the true terrorist in your eyes as you watch your hut go up in flames or one of your kids fragged by an exploding bomb?

Or here in the US, you may be someone who have worked hard all of your life to have a “nest-egg” to rely on in your retirement — except the IRAs and the 401K investments were wiped out in value by downturns in the equities markets.

And it gets even better. Developing nations are creating greater and greater demands for resources that are finite both in absolute size and in the ability to exploit them for use. China and India are probably the two fastest growing in this regard, but there are others as well. Utilization of those resources also creates concomitant impacts on the environment, which is also limited in scope and its ability to adapt to human activities.

Where is all of this headed? What will be the end result?

My concerns are as follows:

1. The Forever Resource Wars — in some form or fashion, resource wars will not only continue, but grow in aggression amidst the deceptions, the propagandas, and the outright lies to “justify” the wars back at home. The allocation of intellectual and financial resources to fight the resource wars put a net drain on the global economy as a hole, not to mention destruction of wealth of the victim nations, deaths to millions of innocent lives, and a dimunition of what it means to be human.
2. Financial and Social Instabilities brought on by Dwindling Resources — as resources become increasingly scarce, prices will rise, destabilizing the financial and social picture on a global scale. More propaganda will be promulgated by the Big Governments to divert people away from the true problems to blame each other, only creating more unrest, socially and geo-politically, feeding the push for The Forever Resource Wars, and other nasties.
3. Ecological Impacts that may be Irreversible — Human activities on a global scale that results in the release of even more carbon and various pollutants into the atmosphere and the biosphere in general, which will have nonlinear and unpredictable impacts on the environment, which most likely will feed into Financial and Social Instabilities, among other things.
4. A Negative Synergism — an emergence of a global set of problems emerging from the interplay of the first 3, which in and of itself might take on an irreversible mode leading to a downward spiral of the overall well-being of humans on this planet.

Note that my above 4 concerns cannot be taken in isolation, but must all be considered. We may project  best-case scenarios and worst-case scenarios from the above, across time into the future.  Some may argue that there is no cause for concern, but it is hard to see how we should not be at least a little concerned given the issues at hand.

It is my estimation that the “Big Boys” will not appreciate the full impact of the above until it is too late — that is, until after its beyond the point of no return. And even if they did, what would they do? Would their major concern be what’s best for us individuals? Or what’s best for themselves? Would they seek to maintain status quo? Or do the right thing? What exactly would they do? That is the question of ages.

There are certain fallacies the “Big Boys” operate from. They are:

1. The Fallacy of Infinite Growth — this bedevils both the financial and resource markets. Both assume that they can continue to have “infinite growth” despite the very obvious and plain fact that resources and people are finite.
2. The Fallacy of “Might Makes Right” — just because loads of  “power” does not mean it’s a good thing to use that power against the individual. If it increases suffering somewhere, how is it ever “right”?
3. The Fallacy of the Assumption that the “Little Guy” can always be “controlled” — You can only fool individuals so many times before they catch on.

The immediate question that comes to mind is what can we do about it, as individuals? As individuals, we acquese power and control to the power elite, collectively, and those few that resist are put down by other individuals that have bought into the “power of authority”. Thus, you have police arresting people even if they’ve done no wrong, soliders kicking the doors in of innocent families even that family has done nothing wrong, etc. Ultimately, we are talking about the little guy being pitted against the little guy at the behest of the “Big Boys”.

But the Big Boys would not have any power or dominance unless there’s acquiescence. It’s just that plain and simple.

More on this later.

Back in 2000, I used to be a day trader full-time. Everyday I would watch the markets and attempt to capitalize on short term price movements. In order to “predict” those price movements, I would look at lots of data and news every day, and even wrote some software to analyze some of that time-series data to give me a kind of “forecast” for the trading day.

We all know about “price discovery”, being “overbought”, “oversold”, “retracements” and the like. A difference is assumed between the “investor” and the “trader”, even to the point of absolutionist morality. It is seen as a “good thing” by the general public to be an “investor”, and a “bad thing” to be a “trader”. There’s lots of misconceptions about the equities market, and a lot of those misconceptions are intentional by those who stand to gain from the general ignorance and folklore on the part of the public.

Ah yes. But if we didn’t have the “traders” in the market short-term, there would not be enough liquidity for the long-term “investors”. They need each other, it would seem.

But the real question what is really going on needs to be understood and answered to truly understand the equities market.

Firstly, one must understand the basic fundamentals of the equities market. It is a zero-sum game. Exchanges occurs between one trader and another; between one investor and another. The goal of anyone in the equities market — investor or trader — is to find a “greater fool” than oneself to buy the stock at a higher price than one’s “strike price”.

That is to say, that every dollar you make in the equities market came at the expense of someone else, and every dollar you loose in the equities market  goes in somebody’s pocket.

This is a very tough concept for some to accept, because if you listen to all the spin about the equities market, you are lead to believe that the wealth one could supposedly make happens by “magic”. It does not. It happens at the expense of other players in the market.

That reality is played out — rather painfully — by the market “crashes” such as the one we are having now,  where so many loose their “investment”. They are paying for the profit of others before them. Plain and simple. And the sad reality of this is that prices will not rise again until the greatest fools of all jump out of the market in sheer panic and terror.

Indeed, it is a requirement for this to happen. Prices must fall. The giveback must occur. The Faustian bargain must be paid in full. This is the mathematical reality of a zero-sum game.

After you understand and appreciate the inanity of this, consider it even more insane that many are encouraged to put their retirement investments in the equities market.

Why does this happen? Simple. Because the supply of fools are finite, and to carry the market higher so for the Big Players to make a profit, they must suck in legions of smaller fools who don’t know any better.

The party works for a while. The more fools you suck in, the higher the prices are driven. Until, of course, you hit a wall and are unable to suck in anymore fools. Then the prices fall mercilessly, and many see their hard-earned life’s wealth washed away into the pockets of others.

The media calls this a “loss”. It should really be called a “transfer”, because that’s exactly what it is — a transfer of wealth.

They are encouraged to “stay in so they can catch the next uptick”. The sad irony is, of course, that if they would all stay in as they are recommended to by the financial planners, the market would never rise again. It only rises when many jump out of the market, giving up their holdings at prices below their strike, to smarter fools that will simply lie in wait for the whole “Ponzi Scheme” to repeat itself.

Now, with that notion in our minds, we are now in a stronger position to understand the true psychodymanics of the equities market.

I have struggled for some time now to conceive of a good model for the stock market. My latest one goes like this: On a given day, a given stock trades in a limited range of prices, at a certain volume. That volume and price range represents new ownership of that stock at a range of strike prices for that day. Since it is not known who owns what, I turn the issue on its head, and consider each individual stock as its own owner.

Crazy, you say? Maybe. But why not? If one person bought 10,000 shares of XYZ, would not the psychology be more or less the same as though 10 people bought 1000 shares each of XYZ? Or a hundred people purchased 100 shares each?

You are starting to see the picture here. Of course, in actuality, the specific goals of 100 people will probably all be different from each other — some may be doing this in a retirement account; others may be day traders. Some may be a mutual funds management. But that’s the whole idea. If I consider each individual stock as its own owner, then I can assign “flocking behavior” to groups of XYZ that all behave the same way. it allows me to reduce the problem of ownership to its bare elements. If 10,000 shares of XYZ all behave the same way, does it really matter if it had one owner or 10,000 with the same mindset? No, it does not.

When a share is traded, it looses is past owner and has a new owner at a new strike price. So now you have two components to deal with — the strike price and the goal of each share of stock.

When a the market is trading above the strike price of a owned stock, that owner is said to be “happy”. If the market price is trading below the strike, that owner is said to be “sad”.  We can then assign some probability of “ownership flipping” to that stock based on its own goals of greed and fear and the expectation of price evolution.

We can generally state that the probability of ownership flipping increases as the market price moves away from the strike price. But the probability curve is not symmetric for “happy” stocks and “sad” stocks. The probability increases faster for “sad” stocks than it does for “happy” stocks. Also, the details of the dynamics of how the price moves away from the strike is important. Fast moves will increase the probability of a flip faster than slow moves.  Price moves in certain patterns may shift the probability faster than other patterns. External factors such as news will also have an effect on that probability of a flip. Then there are automatic trading systems and the like. The picture becomes rather complex.

Add to that the fact that a flip influences others to flip. One single flip could trigger an avalanche of flips. This is self-organized criticality speaking here.

Now, it is clear that we, for the most part, have no ready access to the ownership space and distribution of the market capitalization of an equity at any given point in time. However, we do have a print of past history of stock price ranges and volumes for fixed intervals (minutes, hours, days, weeks, months, years).

So, for any given time period p, where volume v of stock activity occurred, we know that at most v shares of stock are owned over the price range of p. We also know that at least min(t) shares are owned, t being the number of shares traded of a single tick over p. But this amount is so small in comparison that we can safely assume that w — the number of shares flipped during p — will be much larger than min(t) — that is, v >= w >> min(t).

For simplicity, we will simply ignore, for the moment, the possibility of shares flipping multiple times during p, as would be the case with day traders. We will also ignore shorting, but will treat it later.

So, given p₁, p₂, …, p_n, we have D₁, D_{лаптоп2}, …, D_n, where D_i = D(p_i), price distribution for period p_i. Of course, D shall be confined to the price range of the associated period. We also have ξ, the complete set of stock ownership for a given equity, where D_i is a subset that is dynamic on i.

Wow, what a whirlwind of news we’ve all heard over the past couple of weeks! Merrill Lynch, Lehman Brothers, AIG, and who’s next?

All this squabbling over ecomomic growth problems. All this scrambling to “fix” the problems. All the politics being flung around by Obama and McCain over who’s to blame. All the people on “Main Street” staring like deer in the headlights. All the talking heads making crazy pronouncements of impending doom and gloom. All the other financial institutions scrambling to “protect” themselves from being the next major jaw-dropping headline. All the investors, traders, fund manager, market makers on wall-street shooting worthless tokens — whoops, I mean stocks — back and forth to each other in a never-ending zero-sum Ponzi scheme of Ages.

And yet, a true understanding of what’s really going in is so simple even a 5-year-old can grasp it — if you know where to look and how to understand the results.

And so, let me impart this wisdom to you.

The first requirement is that you understand that, dollar for dollar, the stock markets are a zero-sum game. This is a rather tough concept for some to grasp, and I can appreciate that because all the hype you hear about stocks and the related financial instruments tend to hide this plainly obvious fact from you: that every dollar you make on the stock market comes out of someone else’s pocket, and every dollar you loose goes into the pocket of another trader/investor/what have you. That is the definition of “zero-sum”. When you add up all the gains and losses of the entire system, you come up with zero. Get that? Good. Now for my next pearl of wisdom.

If you look at the stock market over time, it indeed looks complicated. A price rises, a price falls. One company rides to success; another goes down in flame. Traders shoot tokens back and forth to each other representing these companies. And when I say “trader”, I mean anyone who dabbles in the exchange of stock tokens on the stock market, directly or indirectly. Long term, day trader, guy in the pit. The distinctions really don’t matter in the long run as you will soon understand.

Now, I will show you something, a simple something. It’s a chart. It’s derivation is not complicated at all, and anyone in the world can pull this same information and understand it, including a 5-year-old. Brace yourselves. Here it comes.

Now, notice that this is the NYSE chart — a calculated average of all stocks traded on the New York Stock Exchange. Notice that this is yearly data going from 1970 to the present (2008). The “candlesticks”, as they are called, show at a glance how the prices shifted for that period. Since this is a yearly chart, a candle represent price movement for the entire year. If the candle is hollow, it means the price ended higher at the end of the year than it began. Red candles mean the price ended lower for that year. The “stick” part of the candlestick represnts the highs and lows of price movements for that year.

Now you are probably thinking, “so what?” Even this chart shows what looks like a general rise in the NYSE, even though that last candlestick looks meanincing (it represents the year to date movenent of this year– 2008). But there’s more to this chart if it hasen’t caught your eye already.

Yes, the bottom part of this chart is where the real story lies. It represents trading volume. The vertical bars are color-coded for the years they represent — a black bar means the candle above ended at a higher price; a red bar means the year ended at a lower price than it began. But that’s not important. The important thing is the trend in volume itself, and it’s relationship to the price movements.

You will note that from 1970 to 2002 the volume has been increasing almost exponentially. Afterwards, you see a leveling off in volume. In fact, this is the first time the volume has been level since 1987. And you will note that the volume now is much higher than it was back in 1987.

And if you haven’t figured it out by now, let me tell you what that 5-year-old can understand once you tell her.

You will recall my quip about zero-sum games earlier. Now, what does the zero-sum game really mean to you as a trader? Come on, think about it! Even a 5-year-old should be able to figure this out!

Ok, if you still didn’t catch on, it means simply this: You, the trader/investor/whatever you are, are a fool for buying a token with no intrinsic value. The only thing you can do with this token, once bought, is to sell it again. And what do you look for when you sell it again, being the fool that you are? Exactly. You need to find a greater fool than yourself to take it off your hands at a higher price than you bought it! That’s right! You only make out if you find a greater fool than yourself.

And so fear sets in if you cannot find a greater fool than yourself and trading is going on below your strike price. Your only options is to go into a “hope and pray” mode and hope greater fools flock back into the market, or to sell it off and take a hit, hopefully advoiding an even nastier hit if you would be so foolish to hold on to this worthless token longer.

Now with that pearl of wisdom, let’s take a look at another chart — NASDAQ.

You see — not suprisingly — the same characteristic volume trend — a near exponential rise until 2001, then a levelling off. You can directly relate the volume to the number of “fools” in the market, and the volume no longer increases exponentially anymore for one simple reason: You have run out of grater fools!!!!!!!!

Is that surprising? I mean, the population on this planet is a finite number, and the stock market has grown far faster than the population can. What that ultimately means is that you MUST run out of greater fools. What happens after that? The prices will shift about chaotically. Confused investors will all scratch their heads wondering why the old tried and true approaches of the past don’t work anymore. Any such foolishness as “being in it for the long term” is to be laughed at, and you can plainly see why if you look at these charts.

During the 20th century, as prosperity spread to more and more of the population, more and more people were drawn into the stock market, either directly as “investors”, or indirectly through 401Ks, mutual funds, IRA accounts, and the like. All their foolish stategies were really predicated on the notion that there will always be greater fools to take the market higher and higher. That there will always be an exponential increase in volume. That the supply of money is infinite. That, in point of fact, the zero-sum game that is the stock market is not really a zero-sum game. That the money is not really coming at the behest of the loss from someone else, that this Ponzi — or pyramid — scheme can continue forever.

The 5-year-old is now laughing at you.