Practical Speculation

INTRODUCTION

The Hope Snatchers

Look! You fools! You’re in danger! Can’t you see? They’re

after you! They’re after all of us! Our wives . . . our children

. . . they’re here already! You’re next!

—Dr. Miles Bennell, Invasion of the Body Snatchers (1956 film version)

The nightmare is always the same. I am lying in bed, staring at headlines flashing across a huge monitor installed on my ceiling:

Stocks Fall on Earnings Pessimism

Stocks May Fall for Fifth Consecutive Week on Fears Economy Is Sputtering

Money Market Yields Fall to 1 Percent as Stock Market Woes Deepen

Stocks Fail to Top Y2K High for 450th Consecutive Day

Study Shows More Than 60 percent of All Issues Below 52-Week High

Markets Plummet as January Barometer Signals Decline for Rest of Year

Oracle of Omaha Says Investor Expectations Are Too High

Market Plunges on Fears Before Fed Meeting

Break of Revered Gann Pivot Triggers Massive Selling

Dividend Yields Now 25 Percent Below 1996 Irrational Exuberance Speech

In my dream, I am long IBM, or priceline.com, or, worst of all, Krung Thai Bank, the state-owned bank in Thailand that fell from $200 to pennies while I held it in 1997. The rest of the dream is always the same. My stock plunges. Massive margin calls are being issued. Related stocks jump off cliffs in sympathy. Delta hedgers are selling more stocks short to rebalance their positions. The naked options I am short are going through the roof. Millions of investors are blindly following the headlines. Listless as zombies, they are liquidating their stocks at any price and piling into money-market funds with an after-tax yield of −1 percent.

Stop, you fools! I scream. There’s no danger! Can’t you see? The headlines are inducing you to lean the wrong way! Unless you get your balance, you’ll lose everything—your wealth, your home!

The perfect allegory for this state of affairs is found in Invasion of the Body Snatchers, a 1954 sci-fi classic book by Jack Finney.¹ Aliens secretly invade the fictional small town of Santa Mira, California, one by one taking over the bodies of unsuspecting residents as they sleep. In the morning, the victims look just the same as they did before, but they no longer have the human emotions of joy, fear, ambition, sorrow, excitement, and hope.

The hero, Dr. Miles Bennell, arriving home after an absence in the midst of the alien takeover, at first dismisses the victims’ strange demeanor. However, he soon realizes that something terrible is happening. Using forensic medicine and nitty-gritty detective work, he and his plucky love interest, Becky Driscoll, figure out that the aliens are parasitic seedpods that replicate themselves in greenhouses so they can take over yet more human victims. Their only aim is to survive by parasitism; they cannot make love or have children, and their gray existence ends after five years.

After a harrowing escape from the town, Miles and Becky set fire to the vanguard of an army of advancing pod people. The rest of the pods conclude that Earth is an inhospitable place, and drift back into space to find new victims.

Often interpreted as a warning against blind obedience to authority, Invasion’s depiction of the victims serves as an extraordinarily apt description of average investors’ vacant, resigned demeanor after the fallacies and propaganda embedded in headlines like the ones in my recurring nightmare have once more led them in the wrong direction.

The overriding problem is that these headlines induce hysteria and then paralysis. They can blind investors to the 1,500,000 percent-a-century return that an investment in the stocks of the United States and most European nations yielded in the twentieth century. On average, the backdrop then seemed every bit as bleak as it does now. As science and enterprise help us live increasingly healthier, more prosperous lives, a century is a highly relevant time frame to contemplate for the children of this book’s readers.

Let’s take another look at the first three headlines:

Stocks Fall on Earnings Pessimism

Stocks May Fall for Fifth Consecutive Week on Fears Economy Is Sputtering

Money Market Yields Fall to 1 Percent as Stock Market Woes Deepen

These headlines share a common defect: They label conditions that are bullish as bearish. We explain in detail later in this book:

Stocks Fail to Top Y2K High for 450th Consecutive Day

Study Shows More Than 60 percent of All Issues Below 52-Week High

Markets Plummet as January Barometer Signals Decline for Rest of Year

The phenomena reported in these three headlines are true of any time series with a large random component—such as stock returns. These observations are meaningless to the investor.

Oracle of Omaha Says Investor Expectations Are Too High

Market Plunges on Fears Before Fed Meeting

Break of Revered Gann Pivot Triggers Massive Selling

Dividend Yields Now 25 Percent Below 1996 Irrational Exuberance Speech

These headlines tell stories about misremembered facts that sustain fallacious beliefs harmful to those who trust such pronouncements.

Headlines that induce fearfulness are often based on myths, not reason. Propaganda techniques, not the verifiable propositions of science, convey these ideas. Just as the high priests of prescientific societies used myths to maintain the social order and extract offerings from the masses, today’s market professionals use bold, simple myths to extract contributions from credulous investors. This phenomenon explains why the public contributes so much to the commissions, spreads, research expenditures, communications costs, skyscraper rents, sales outlays, marketing expenses, and phantasmagoric bonuses for traders and executives that make up the massive infrastructure of Wall Street.

The headlines listed here are by no means isolated examples that we have culled to make our case. They are typical of the backdrop of myth, misinformation, and propaganda bombarding investors daily through every media channel. Uncritical acceptance of the fallacies embodied in such headlines—whether wildly bullish or terrifyingly bearish—leads investors straight to the slaughter.

Although propaganda is ubiquitous in the market and in other aspects of our lives, a simple antidote can protect us from manipulation: the scientific method. If theories about the market are framed in a testable fashion, they can be verified by counting. Not only will embracing the scientific method preclude debates about the meaning of words such as irrational and exuberant, but also it will relate market theories to the real world. A side benefit will be that those theories that are verified can actually lead to practical profits (which is, after all, why you are reading this book).

Don’t get us wrong. It is not that skepticism toward bullish propaganda is inappropriate. We take a backseat to no one in loathing the bullish flummery invariably fed to investors after the market has displayed a sharp rise. Many companies store earnings in a silo and release them at opportune times to lure investors into buying stocks, enabling executives to cash in their options. We are strident critics of the conflicts of interest that can cause brokerage house analysts never to recommend selling shares in a company that is a client of the investment banking side of the firm. We abhor the hubris that leads executives like Enron’s Jeffrey Skilling to curse analysts who question the bona fides of the corporate balance sheet, and the egomania that encourages other executives to authorize golf courses as a necessary management perquisite.

That said, if you are going to err on one side or the other, it pays to err on the side of optimism. After all, until 2000-2002 the last time the U.S. stock market went down three years in a row was 1939-1941. The situation is much the same in other countries. It is hard to overcome a 1,500,000 percent-a-century upward drift in common stocks worldwide, even with clever market timing.

Erroneous, untested suppositions dominate the market today. Despite the advances that have come about in the four decades since efficient markets theory was developed, finance is still largely in the Dark Ages. The public is barraged with commentary from journalists who offer nothing but superstitions, descriptions, backward-looking observations, and interviews with fund managers struggling to keep up with the market averages.

Most of these reports purport to find a relation between the day’s market performance and reports of a certain company’s earnings feats or woes, attributing an up day to earnings optimism in a few stocks, or a down day to earnings pessimism in some other stocks. But the market landscape is so enormous and varied that on any given day some companies inevitably will report conditions are better (or worse) than an arbitrary standard. If investors place any credence in such reports, they become victims of market vagaries. They search for anecdotal evidence that is always available to justify something in retrospect, but that offers nothing whatsoever of predictive value. Worse, unscientific investors lose the ability to differentiate the helpful from the unhelpful, or to build a foundation for making informed, rational decisions in the future. Since none of the commentators ever presumes, for example, to determine the precise magnitude of the relation—if any—between earnings and market performance, investors are led to accept nebulous untestable assertions about the market without applying the normal skepticism that they have learned is essential in other areas of their lives.

Faced with market moves that seem to bear no relation to what they believe to be true, investors quickly become disenchanted and disgusted when the market declines, and hyperactive and wildly exuberant when the market rises. In either case, they are being primed to overtrade and to make more than their fair share of contributions to the market infrastructure. The end result is an army of disgruntled investors, ironically ever more ready to be batted around by the next pronouncement from a market guru, each ready to leave the market at the drop of a hat for money-market funds with negative real returns at precisely the juncture when conditions for equities are best. Ultimately, the market is the richer, and customers and investors are left without any yachts—or pensions.

Worse yet, the market’s victims become like the pod people of Santa Mira, cynical about all new ideas, bereft of optimism and hope. They are ready to fall into step with those who do not believe in technology, do not believe in growth, and, after many disclosures of corporate fraud, do not believe in the enterprise system itself. Dr. Bennell could very well have been talking about investors when he said:

I’ve seen how people have allowed their humanity to drain away. Only it happens slowly instead of all at once. They didn’t seem to mind ... All of us—a little bit—we harden our hearts, grow callous.

But life, like the markets, offers the greatest rewards to those willing to assume risk. Assuming risk brings uncertainty, anxiety, and occasional loss, but it also brings out the best in us. In becoming a speculator in life, each person embarks on a heroic quest, becoming more than he or she already is. Heroism is a potent antidote to the cynicism and alienation so many of us accept.

If you’re familiar with my story and you’ve read this far, you may be asking: Where does Victor Niederhoffer come off writing another book about speculation and investing? Didn’t his hedge fund go defunct in 1997?

Until 1997, my record was the best in the investment world. Barclay’s, the hedge fund industry scorekeeper, named me the top hedge fund manager in 1996. I collected best-performing hedge fund manager awards and toured the world giving lectures in elegant settings about markets and music, accompanied by concert pianist Robert Schrade. I employed a large staff of traders and analysts from top schools, many of whom had been with me for a decade or more. I was a partner with George Soros in numerous investment ventures, and we were inseparable throughout the business and recreational day. My book, The Education of a Speculator, had just been published and was a bestseller.² My funds under management and personal wealth were growing exponentially, yet at a measured pace.

Then the roof caved in. I lost everything. In popular Wall Street parlance, I blew up.

The story has been extensively chronicled. On December 13, 1998, an article in the New York Times, Trappings of Faded Richness: Sold! by Geraldine Fabrikant, captured my decline with the inimitable schadenfreude of the Times:

A five-foot horn of plenty made of silver and podollan ox horn, once the property of King Charles XV of Sweden, is Victor Niederhoffer’s favorite in his collection of silver trophy pieces. But Mr. Niederhoffer can no longer afford his horn of plenty. The money manager lost all his capital in October 1997, when the Global Systems funds he managed for himself, his family, and investors were hurt first by his leveraged and unhedged speculations in the Thai stock market, and then by his bet that the United States market would not decline dramatically. The two catastrophes wiped out the funds. And so Mr. Niederhoffer is struggling to pay his debts, support the four of his six children who are still at home, maintain the family’s lifestyle, and tiptoe back into the only business he knows: trading.

A comeback—both financially and psychologically—from the devastation of his funds’ collapse has been far harder than even Mr. Niederhoffer had imagined. It is hard to be resilient when you’re 55, he said during an interview in the library of his home. When you have bad fortune, your suppliers and customers are afraid. I’m on a very short leash.

After 20 years of success, many investors had become friends. But many of his friendships unraveled. My phone stopped ringing a lot, he said. He feels it’s important that he suffered with his investors. I’m saddened and chastened, he said. My wisdom is quite suspect. He compares his downfall with the bailout of Long-Term Capital Management, the much bigger hedge fund recently rescued by Wall Street. I could have used Long-Term’s breathing time, Mr. Niederhoffer said. Instead, he is selling his silver.³

In an instant, I plunged from the top of my profession to the depths. My employees quit en masse. My customers, many of whom had been my best friends for years, deserted me.

To boost my returns and stay number one, I had invested in the stock market in Thailand, a country I knew too little about. In the United States, it is a good bet that a 90 percent decline in bank stocks precedes a rebound. In Southeast Asia, that is apparently not the case. My biggest holding—the largest bank in Thailand—lost a whopping 99 percent. My losses abroad depleted my reserves. The rest of the tale is still too sad and raw to retell. Suffice it to say that the decline in Asian stocks spilled over into an unprecedented one-day, 550-point decline in the Dow Jones Industrial Average. This was enough to trigger a stock exchange rule that closed the market before 2 P.M. that day. Confronted with a demand to come up with many millions to meet margins the next day, I was forced to close my fund.

In addition to losing my investment business, I had to sell my holdings in my other financial activities. I took out a large mortgage on my house, with rates starting at 15 percent a year. The final indignity was selling my extensive collection of antique silver. A representative quote from my introductory note in an auction house brochure captures the flavor:

From a reading of business history, I had learned that many Wall Street speculators at various times in their tumultuous sagas had placed their silver up for sale in time of malaise. . . . One of my most enjoyable purchases in this regard was a trophy presented to Jay Gould for winning a professional tennis championship. Little did I figure on those occasions of Schadenfreude that I would one day be joining such immortals.

I was devastated in every way. My sister, Diane, is a psychiatrist. She noted that patients with severe (a euphemism for suicidal) depression normally have 10 symptoms of clinical depression, ranging from weight loss to loss of sexual abilities. I had all 10 of them. At a meeting with outside lawyers, I mentioned this as a joke and perhaps an appeal for pity. My own lawyer took me aside afterward and admonished me never to do that again: The only reaction the other side will have is anger that you didn’t pull the trigger.

Friends and family did their best to see me through. I received 55 copies of Tuesdays with Morrie.⁴ The senders all emphasized to me that Morrie was able to deal with his impending death with dignity, and they advised me to take a similar stance.

I also received 10 copies of the Rudyard Kipling poem If, which remains an inspiration. Some of the senders underlined the following words:

If you can make one heap of all your winnings

And risk it all on one turn of pitch-and-toss,

And lose, and start again at your beginnings

And never breathe a word about your loss;

If you can fill the unforgiving minute

With sixty seconds’ worth of distance run,

Yours is the Earth and everything that’s in it,

And—which is more—you’ll be a Man, my son!

Suffused with Tuesdays with Morrie, thoughts of my own deathlike experience, and other melancholy contemplations and nightmares, I paid frequent visits to the grave of my father, Arthur. He was a scholar and a cop of infinite strength and support whose good spirit has uplifted his family at times of trouble and all other times since his untimely death in 1981 at the age of 62. I later asked my uncle, Howie Eisenberg, who served as a model for my loss by snatching defeat from victory in the finals of 43 separate national handball championships (he also won 18 of them) what he thought Artie might have said about my fall. Together, we came up with the following:

So what of it? It’s not the end of the world. You and your family are in good health; you’re still able to live the life that you wish. That’s what’s important. All of your strategy, practice, and experience led to taking that shot at that point. You went for the overhead to get further ahead in the match and missed. It was still the right shot for you then. It was the same strategy that got you the substantial lead that you had.

Suppose, which I don’t believe for a moment, you don’t come back. It’s not so terrible. You can still teach, and I’ll help you with the bills. Here. I’ve taken a mortgage from the co-op.

The consequences of missing the shot were a revelation for you. You now realize that while you had every reason to believe your advantage would be increased, you exposed yourself and those who were playing with you to possibly losing the whole match. You now have a different perspective. You can see that although the potential to maximize your advantage may seem to be the correct course of action, it should be tempered by a strategy that limits, if not precludes, the possibility of not only losing the match but all of your racquets. You don’t want to be in the position of not having the wherewithal to continue playing the way you want, or causing those who bet on you to lose their pants. The crucial thing is that you are still in the game, once again racking up points.

Whatever you do, be more careful in the future. Be good to your family and friends. You have a beautiful life and everything in the world to look forward to. Take it easy.

I did not have the luxury of wallowing in my misery for too long. I had six kids, six private-school tuitions, a former and current wife, extensive recurring household expenses from the previous good days, and the usual legal expenses for events of this nature. We pick a basket of berries, the basket falls, and we fill the basket again. I had to fill the basket once more. But I did not have any capital of consequence to meet these expenses. More important, none of the usual suspects for my kind of trading had any interest in establishing a normal working relationship with me.

I was well experienced in losing from my career in sports. But this comeback was much more difficult. Not only had I lost my standing in the tournaments, I had lost my equipment, my coaches, my entourage, and my fans. I could not even get into the qualifying tournaments, because the officials there were afraid of adverse consequences.

Under the circumstances, an alternate pursuit seemed appropriate. That alternative was to combine with Laurel Kenner in writing a column that would communicate the remedial lessons I had learned from my fall and perhaps prevent others from succumbing. I figured that by trying to teach others, I might learn something myself.

When I met Laurel in 1999, she was the chief editor for North American stock markets at Bloomberg, one of the two biggest financial news wire services. Ironically, she was one of the very people responsible for perpetuating the misinformation and disinformation about the market described in this book. Life being short and time constantly ticking away, she decided to write a column herself. Readership soon topped that of other columnists. The kind of pieces she wrote, filled with lessons for investors from baseball, Moby Dick, and Beethoven symphonies, did not endear her to her traditionally minded bosses; and she was being eased out the door. Finally, she quit without any source of income in sight. It might have been a tragedy except for the fact that she now had the freedom to collaborate with me in writing columns she considered worthwhile.

We both were sick of seeing investors leaning on the wrong foot so often. The mumbo jumbo constantly fed to investors was painful to us, and we both had a reason and the knowledge to do something about it.

To Overwhelming Applause

Get out of here! was a typical reaction when we started writing. Reader after reader wrote in to say that this was the most ridiculous thing in the world: a guy who had lost everything writing columns to tell other people what to do. One of the first letters we received suggested that instead of writing a column, I should be working as a dishwasher to pay my investors back.

Here are representative responses that came in early 2002, after we warned investors against blindly following those who believe the trend is your friend:

Let me conclude by encouraging you to continue writing your column on MSN Money and sharing your thoughts with us. A good way to trade profitably seems to be to take the opposite side of your trades.

This is probably one of the worst articles I have ever read. Keep sending the same message to the sheep, leading them to the slaughterhouse. Vic used to be one of the best money managers in the world . . . guess that’s why he is peddling stock advice on MSNBC. Give me a break.

It’s very clear why you blew out your account.

I find it interesting that a man who lost $125 million in one day and skipped out on the bill has a job giving out advice to investors.

My thinking is that you guys are some comedy act. Show me your actual trade figures over the past five years. I hear you went belly up. I don’t think many trend traders did.

All I can say is, how many times has Niederhoffer gone belly up and had to beg his friends to pony up some cash for him to start trading again? (from the TurtleTrader Web site).

Last time I checked, Niederhoffer was not the lead investor in the Boston Red Sox ownership group. John Henry is.

Your articles are uncivilized, but I will forgive you if you change your life.

Some readers simply send us viruses:

Subject: Fwd: Possible Virus Found in E-Mail

A message from: [email protected] may contain a virus. This message will be quarantined under the name vm.02285185015.10682 in the quarantine area on host mh2dmz4.bloomberg.net.

We usually reply to the nonviral letters, and find that a soft answer turns away wrath. One reader, James Taylor, asked in an October 4, 2002, e-mail:

Why/how are you an authority on investing? After all, you blew up your fund.

I replied:

I am not an authority. I am trying to learn. I guess they figure that people trying to learn might have an audience. Perhaps it was my education and my need of a job?

The reader quickly wrote back:

Sorry about my prior e-mail. It was rude and not fair. I was just venting because I see so many analysts and so-called experts on CNBC daily, who don’t have sense to come in out of the rain.

Your insight and experience can only be a great addition to the column. I do have your book, The Education of a Speculator, and thought it was a good read. Trading is a difficult business and can test us, especially if we are aggressive.

One of the reprehensible traits of market commentators is to pretend that they are lonely voices in the wilderness, bereft of support and praise. The truth is, we are hardly bereft in that respect. Hundreds of thousands of people read our columns on CNBC Money each month. For every barb, we receive many hundreds of letters of thanks. No matter what we say, some critics will inevitably say, Forget about anything these two advise, because Vic couldn’t make a dollar if his life depended on it. We encourage such beliefs; they let us go about our affairs in peace. We sometimes reply to such correspondence by saying:

Yes, you’re right. Vic has been reduced to writing a column to cover the expenses of his large extended family, starting with the tuitions of his six daughters. He couldn’t get a job as an assistant squash coach because the hardball game he used to play is extinct, so he took a job as a night watchman. The column is a good second job because he can write during the day. With any luck and continued hard work, he will be able to climb up the first stair of the investment ladder once again so that eventually he will not need to supplement his income by writing.

We do not always feel patient. A Texas economics student, responding to a column on dividends, wrote us that the 100 years of data on dividends we used wasn’t enough, and that he intended to do some real econometric work that wasn’t so simplistic. Vic, as usual, had a mild reply: Hopefully, you will find a data series of relevance for more than 100 years and be able to teach us. When the reader responded by calling Victor a name too obscene to put in print and wished us both great financial misery, Laurel became indignant and wanted to go beat him over the head with her three-inch heels.

Although we may be hurt by such correspondence, we understand that people have lost a great deal of money and are angry with everyone—from CNBC to analysts to pundits and columnists.

In fact, neither of us has to write for a living. The income derived from writing columns and books does not go far to defray our living expenses, or to pay for the databases we need to debunk the fallacies that enthrall the investing public. But for the sake of the open-minded who are interested in participating with us in mutual education, we are offering a serious response to the critics.

Since Laurel and I began writing together in 2000, we have heard countless heartbreaking tales from readers in shock from seeing their wealth and retirement accounts cut in half or worse. People wrote to us for advice on how to rebuild, on how to live with themselves. They specifically wanted to know how I handled my own bout with disaster.

The answer we give these distressed readers is not to avoid risk. Risk is part of all heroic endeavors, whether in trading, business, philanthropy, construction, exploration, art, music, sports, sailing, or romance. Not only is risk necessary for gain; it is the inescapable lot of human beings. As Paul Heyne wrote in The Economic Way of Thinking, Everyone who makes a decision in the absence of complete information about the future consequences of all available opportunities is a speculator. So everyone is a speculator.⁵

When my fund closed in 1997, the returns to that point had been such that most of the investors who had been with me for any length of time ended up with net profits. Since 1997, I have climbed back up the stairs. Along the way, I have made and lost millions, with the former providentially much greater than the latter.

Avoiding risk can lead to the cynicism often produced by failure. One philosopher clearly saw the dangers:

Cynicism may be a by-product of anomie in the social structure; at the same time it may also prepare the way for personal anomie. . . . Anxious over a personal failure, the individual . . . often disguises his feelings with a cynical attitude, and thus negates the prize he did not attain. Frequently he includes in his cynicism all persons who still seek that prize or have succeeded in winning it, and, occasionally, deprecates the entire social system within which the failure occurred. As the cynic becomes increasingly pessimistic and misanthropic, he finds it easier to reduce his commitment to the social system and its values.⁶

The author was my father. He was a cop, and he was writing about law enforcement officers. But his words apply equally well to the forlorn state that investors often fall into, especially after years of market losses.

Anyone who ventures out into the thick propaganda of Wall Street risks ruin. A rudder is necessary. To discover what people should understand if they want to improve their financial situations by trading in the market, we read hundreds of books on trading, investment, statistics, risk, and behavioral finance. Alas, almost everything disseminated about buying stocks is promotional, and most of the advice is completely untested. Indeed, these authors are careful not to frame their assertions in terms that can be tested.

Irrational faith in untested propositions is a throwback to feudal times, when people lived in utter squalor and poverty and had no possibility of improving themselves, no opportunity to retire early and do creative things, no chance to find cures for disease and extend their lives. Academic studies might seem to promise a better approach, but they often suffer from Monday-morning-quarterbacking biases and are almost always outdated by the time they are published.

Just like the victims in Invasion of the Body Snatchers, the victims of investment fallacies seem perfectly normal and rational. Yet their collective behavior can lead to evil and terrifying consequences. Professional market parasites who make their living off investors can only thrive when people give in and become unthinking pods. Only in an environment that is without skepticism and the scientific method can investors’ losses mount wildly.

It all makes want us want to say, along with Dr. Bennell, Help! Halt! Stop. Stop and listen to me! Don’t you see? They want us to be like the pod people so that we’ll pay our dues to the market system!

In this book, Laurel and I play the roles of Becky Driscoll and Dr. Bennell, to help readers escape becoming pod creatures and succumbing to the market fallacies replicated daily, if not hourly, by those who would take away their wallets. Laurel draws on a vast knowledge of deceptive alien techniques gained from her work as U.S. stock market editor at Bloomberg News, a financial news wire service. Unlike Dr. Bennell, who cured patients and prevented alien invasions, I am merely a doctor of statistics. The main help such a doctor can provide is assistance in understanding the regularities and uncertainties of numbers. Like Dr. Bennell, however, I am in the habit of clipping odd articles from newspapers for items that might add up into grand insights somewhere down the line. For the past quarter-century, I have searched my favorite newspaper, the National Enquirer, for tales about the heroics of common people, their survival skills, and their unquenchable common sense and good nature, to fit myself for an optimistic approach to investments that roots out the pods before they can grow in the bearish greenhouses. We hope that readers will find this approach profitable.

Practical Speculation extends the themes that Laurel and I have been developing in our columns over the past three years. Together, we have fought off mysticism, hubris, and market propaganda in some 500 hard-hitting columns for four different Web sites. (It is true we were fired from most of these jobs, starting with a seven-week run of Laurel’s column at Bloomberg and a two-month stand at thestreet.com, where we debuted our first joint column, The Speculators’ Corner. We put in a year and a month—quite a long spell for us—writing a daily column at worldlyinvestor.com, where we were eased out by new editors who wanted us to educate financial planners instead of concentrating on our clarion calls to the public to beware of ballyhoo. The odds are better than even money that by the time this book is published, we will have been fired by our current employer, CNBC Money.

We are not unmindful that we have burned many sacred cows in this book. None of them, or others in the barnyard and factories where they come from, are likely to react over kindly to the conflagration or what they are more likely to call a mere smokescreen.

One thing we should make clear, however, is that there is a wealth of original material appearing in this book that has never seen the light of day. It required much percolation, for example, for us to disclose here for the first time the results of a content analysis of 10 years of weekly financial writing. Same for our analysis and reformulation of the use of scatter charts, the discussions of conservation of energy, and the Value Line periodic table of elements. Furthermore, all the thoughts are fresh thoughts representing our best thinking several years into the new millennium. They have evolved from our experiences on the battlefield of actual trades as well as scholarly and practical criticism from a network of dispersed experts with knowledge and insights that could only have been assembled in modern Internet times.

Through it all, our readers’ comments have augmented our work in immeasurable ways, leading to new areas of inquiry and new friendships. Above all, we have enjoyed the profit and pleasure of finding and testing ideas drawn from patterns observed in the real world, rather than passing along the received wisdom of gurus. Laurel and I hope that the lessons we have learned over the past three years from counting, deflating propaganda, avoiding unwarranted negative thinking, and developing a proper investing foundation will help readers of Practical Speculation prosper.

The Framework for This Book

The first part of this book—Mumbo Jumbo and Moonshine—dissects the common errors, myths, fallacies, and propaganda that induce investors to lean the wrong way and make a maximum contribution to the market’s infrastructure.

Chapter 1: The Meme

Everyone knew that the mere mention from a Federal Reserve chairman of fears about stock prices would lead to an explosive and completely unpredictable reaction in the market. Alan Greenspan’s December 5, 1996, irrational exuberance speech set off such a dire chain of events that we have devoted our Chapter 1 (with apologies to Guy de Maupassant’s classic horror tale, The Horla) to detailing all its consequences, including the reaction against technology, optimism, and growth.

Chapter 2: Earnings Propaganda

As Kuhn noted in The Structure of Scientific Revolution,⁷ science often finds itself in a state in which a growing number of facts conflict with prevailing theory. Such was the state of Newtonian mechanics in the late nineteenth century as experimental evidence concerning the spontaneous decay of particles from the nucleus of atoms began to accumulate. Such is the state of today’s prevailing wisdom that stock market prices are determined by earnings or price/earnings ratios. We subject the most widely accepted beliefs about the earnings-market relation to counting, and offer ways to spot earnings propaganda in media coverage, analyst reports, and company pronouncements to help readers reject the market’s numerous invitations to trade the wrong way.

Chapter 3: The Hydra Heads of Technical Analysis

Violent declines in the market promote fear and dread. Being able to predict up moves in the market would guarantee immeasurable wealth and power. It is not surprising, then, that there is a mythology of momentum, replete with stories of great heroes and heroines who have conquered the mighty forces, to ease investors’ anxieties, to fuel their hopes—and to keep them making wrong moves with no chance for improvement. We apply some science to the cult of technical analysis and its central mystery: The trend is your friend. As we demonstrate, the trend is regrettably not your friend.

Chapter 4: The Cult of the Bear

How can a writer be wrong for practically his entire working life and still be the most influential figure in financial journalism? We interviewed Alan Abelson to find out why, after searching in vain for a hint of optimism in the hundreds of weekly columns he wrote for Barron’s during the great 1990s bull market.

Chapter 5: We Are Number One Usually Means Not Much Longer

To the ancient Greeks, the most grievous sin was hubris, the arrogance of power. Vic’s father, Artie Niederhoffer, who inspired and is memorialized in Vic’s first book, The Education of a Speculator, wrote with great insight on how this flaw impaired the judicial system. We attempt to carry forward his analysis by studying the effects of hubris in the marketplace.

Chapter 6: Benjamin Graham: Mythical Market Hero

The ancients had their gods and demigods, and we moderns have ours. In the Golden Age of Greece, as scientific thinking took hold for the first time, some thinkers began to question the reverence and sacrifices demanded by the gods. It is always a good idea to ask questions. A figure high in today’s pantheon—Benjamin Graham—is the subject of this chapter.

Chapter 7: News Flash: Computer Writes Stock Market Story!

The brilliant mathematician Alan Turing once proposed that a computer might be said to be intelligent if it could fool a human into mistaking it for another human. The converse must also be true: If we