Happy new year

Banner, Speculation

Few people today call themselves speculators. The word is too loaded. Instead, they are traders, hedge fund managers, and the like. But, whatever they call themselves, they are speculators. They’re the ones people blame for everything from business cycles to political corruption to income inequality to financial crises. And the ones amateurs try to emulate when the economy and markets are booming—day trade, flip this house, risk money to make money fast.

Stuart Banner, in Speculation: A History of the Fine Line between Gambling and Investing (Oxford University Press, 2017), traces how American ambivalence toward speculation, especially as reflected in regulatory and legal decisions, tips one way and then the other. Is the speculator engaged in unsavory conduct or is he performing a service? Is he anti-American or the quintessential American?

Speculation has had its harsh critics since early in the history of this country. And much of the criticism gets repeated generation after generation. For instance, in 1835 a New Hampshire newspaper warned: “In our rising manufacturing villages this speculating mania rages to a great extent, and is laying a foundation for that poverty, dependence and wretchedness which characterizes the population of similar places in Europe. The few are becoming immensely rich, the middling interest poor, and the poor abject.” That has a familiar ring to it, doesn’t it?

Support for speculation is usually more muted. Alexander Hamilton argued that (in Banner’s rephrasing) “the buying and selling of paper did not remove capital from the productive economy … but added capital to the economy.” Elbridge Gerry defended speculators at the Constitutional Convention, saying that “They keep up the value of the paper. Without them there would be no market.” Another justification for speculators, common in the first half of the nineteenth century, is that they stabilize prices, buying when prices are low and selling when prices are high.

Legal attitudes to insider trading, to which Banner devotes a chapter, have followed a different trajectory. In a 1933 ruling, the Massachusetts Supreme Court found that Rodolphe Agassiz, president of Cliff Mining, had not broken the law when he made well over a million dollars in today’s money by trading on favorable inside information. The law, the opinion read, “cannot undertake to put all parties to every contract on an equality as to knowledge, experience, skill and shrewdness.” Seventy years later Sam Waksal sought to take advantage of his advance knowledge of bad news—that the FDA would not permit ImClone’s cancer treatment Erbitux to be sold. But the court no longer thought that exploiting one’s superior access to knowledge was at worst inevitable, at best good: Waksal was sentenced to seven years in prison.

Banner’s history is carefully researched and well documented. It shows just how difficult, and probably impossible, it is to find “the” proper place for speculation in the financial markets. Just when regulators think they have reined in speculators and made the financial world “safe,” allowing good risk and forbidding bad risk (gambling), financial engineers and traders will redefine those boundaries and send regulators scrambling again.

Crosby, The Laws of Wealth

Thinking about your New Year’s resolutions? You know, the ones you never keep? When it comes to investing, The Laws of Wealth: Psychology and the Secret to Investing Success (Harriman House, 2016) by Daniel Crosby might be a good antidote to yet another year of backsliding. His basic message is that one should engage in rule-based behavioral investing to help defeat behavioral risk.

In the first part of the book Crosby sets out ten sometimes counterintuitive rules of behavioral self-management, the behavioral risk side of his equation for success. They are: (1) you control what matters most, (2) you cannot do this alone, (3) trouble is opportunity, (4) if you’re excited, it’s a bad idea, (5) you are not special, (6) your life is the best benchmark, (7) forecasting is for weathermen, (8) excess is never permanent, (9) diversification means always having to say you’re sorry, and (10) risk is not a squiggly line.

He devotes the second part to behavioral asset management. Investing, he argues, is an area in which intuition and common sense fail us because, among other reasons, it is “performed infrequently, provides delayed feedback and includes an overwhelmingly complex array of variables.” In fact, stock picking can be fairly well described using five variables that, according to Daniel Kahneman, lead to suboptimal decision making: a complex problem, incomplete and changing information, changing and competing goals, high stress and high stakes involved, and must interact with others to make decisions.

If we are to be successful investors, Crosby argues, we must automate the process by which we make decisions. We must follow a model and not taint it with on-the-fly judgment calls. We must “set systematic parameters for buying, selling, holding and re-investing funds and follow them slavishly.” We must take advantage of human fallibility and pursue rule-based behavioral investing.

Crosby suggests one such investing model , which combines value and momentum along with risk assessment (using such metrics as Montier C-scores and Altman Z-scores to vet all purchases).

The Laws of Wealth does not offer a path to consistent outperformance (which, Crosby argues, is one reason his model will have lasting power). Over time, however, systematic behavioral investing should produce an impressive track record. Which, of course, should translate into wealth.

Happy holidays

Bytheway & Metzler, Central Banks and Gold

Central Banks and Gold: How Tokyo, London, and New York Shaped the Modern World (Cornell University Press, 2016) by Simon James Bytheway and Mark Metzler is an academic study that covers the period between the late 1890s and the 1930s. Although it’s no page turner, by relying on extensive archival research and bringing Japan into the picture it highlights some hitherto unknown aspects of the international central banking system.

Here are a few bullet points.

In the 1890s Great Britain was the world’s largest creditor country, replaced by the United States in 1914. In the 1980s Japan replaced the U.S. as the world’s largest creditor country and remains so today.

The Bank of England and the Bank of Japan “secretly developed a close form of cooperation in the early years of the [nineteenth] century. … [F]or much of the period from 1896 to 1914, the BoJ was the Bank of England’s largest single depositor. The Bank of England’s ability to maintain its global financial position during the decade and a half before 1914 was supported by its ability to manage these Japanese funds and quietly to draw on them in moments of need.”

In early 1915, well before the United States entered World War I, American private banks, backed by the Federal Reserve Bank of New York, “began to finance the enormous military purchasing programs run by the British and French governments in the United States.”

“Every truly major international financial crisis of the era—1907, 1920, 1929—appeared first in Tokyo, having an onset some three to six months earlier than in New York and London.” Tokyo markets were “a sensitive leading indicator.”

Eckett, The Harriman Stock Market Almanac 2017

This is the first year I’ve seen The Harriman Stock Market Almanac by Stephen Eckett, although its first edition was published in Great Britain in 2004. This is the tenth edition. (Yes, I do know how to subtract. It seems that the almanac wasn’t put out every year.)

Although clearly inspired by the American Stock Trader’s Almanac, now in its fiftieth year, the British almanac has some unique features that make it particularly valuable.

First, the calendar section includes daily historical data for the FTSE 100 (from 1984), FTSE 250 (from 1985), S&P 500 (from 1950), and NIKKEI (from 1984). For each of these indexes the almanac provides three numbers (Sinclair Numbers) for every trading day, week, and month of the year: (1) the proportion of returns that were positive, (2) the average change, and (3) the standard deviation of the returns.

Second, the almanac looks at quite a few trading strategies, some nonsensical (like the Super Bowl indicator), some most likely coincidental (like the market rising sharply between lunar eclipses occurring in consecutive months), some producing inconsistent results (odd and even week returns). Others might have some merit, or at least trigger further ideas for testing: the FTSE 100/S&P 500 monthly switching strategy, the quarterly sector strategy, and the bounceback portfolio.

Oh, and if you didn’t know the conclusion of the adage “Sell in May and go away,” it’s “don’t come back till St Leger Day.” The St Leger is “the last big event of the UK horse-racing calendar and usually takes place in mid-September.”

The Harriman Stock Market Almanac is hardbound, which means that, unlike its American counterpart, it doesn’t open up flat. Even so, it’s going to be my desk “calendar” for 2017. Time for a change, for a more global outlook.

Millstein, The Activist Director

Ira M. Millstein practiced law for over 50 years, counseling some of the top U.S. companies on governance matters. Among his clients and policy projects in which he was involved were General Motors, American Express, Westinghouse, Macy’s, Drexel Burnham Lambert, Mayor Abraham Beame and New York City during the fiscal crisis, Con Edison, Planned Parenthood, the Organization for Economic Cooperation and Development, the New York State Task Force on Pension Fund Investment, and the New York State Commission on Public Authority Reform. In The Activist Director: Lessons from the Boardroom and the Future of the Corporation (Columbia Business School Publishing, 2016) he recounts stories of corporate governance failures (and, in the case of Planned Parenthood, success) and offers guidelines for making boards more active and effective.

Millstein starts with “the previously untold story of how GM directors finally woke up twenty-five years ago to deal with the company’s financial meltdown. … For the first time, independent directors, meeting separately, challenged an angry, typically imperial CEO [Roger Smith]—and later fired his chosen successor publicly.” During the ten years, beginning in 1985, in which Millstein was involved with GM, the company became competitive again. What happened after that time, how it ended up needing a government bailout, Millstein leaves for others to tell.

Then there was Drexel, “the terror of Wall Street.” Millstein’s client was Fred Joseph, Drexel’s CEO, so he had “an excellent perch from which to watch a good thing going wrong.” And wrong it definitely went. By the end Drexel was bankrupt and Michael Milken was in jail.

Millstein was deeply involved in all of these crises and provides a fresh perspective on them. That alone would make this book worth reading. But he also makes recommendations on how boards can “partner” with management, valuable advice for corporations that want to remain competitive.

Best books of 2016

Readers are forever prodding me to do a list of the best books of the year. My inclination is to resist, in part because my list is inevitably idiosyncratic, in part because I don’t relish being a prize committee of one. But, with apologies to the authors of books that on any other given day might well have bumped chosen titles off this list, here’s my stab at the best books of 2016, with links to my reviews.

Howard B. Bandy, Foundations of Trading

Anders Ericsson and Robert Pool, Peak

William N. Goetzmann, Money Changes Everything



Aron Gottesman, Derivatives Essentials

Wesley R. Gray and Jack R. Vogel, Quantitative Momentum

Michael Lewis, The Undoing Project



Mark Andrew Lim, The Handbook of Technical Analysis

Richard L. Peterson, Trading on Sentiment

Gray and Vogel, Quantitative Momentum

It’s always noteworthy when the folks at Alpha Architect produce a new book. Their offerings thus far are Quantitative Value, DIY Financial Advisor, and now (well, actually not so “now” but my review copy was slow in arriving) Quantitative Momentum: A Practitioner’s Guide to Building a Momentum-Based Stock Selection System (Wiley, 2016). The most recent volume was written by Wesley R. Gray and Jack R. Vogel.

Momentum can, as countless studies have shown, be the basis of a sound trading strategy. Of course, implementing a successful momentum strategy is not as simple as buying strength. Between 1927 and 2014 buying short-term winners returned less than the risk-free rate while buying short-term losers outperformed the S&P 500. Long-term momentum is also a sub-optimal strategy. The sweet spot is, as has again been well documented, intermediate-term.

Less extensively researched is the path dependency of momentum. Using a simple algorithm based on the percentages of negative days, flat days, and positive days, the authors distinguish between high-quality momentum, which has a relatively smooth path, and low-quality momentum, which has a jumpy path. Over the same 1927-2014 timeframe, high-quality momentum outperformed low-quality momentum by about four percentage points annually and outperformed the S&P 500 by more than seven percentage points annually.

Since momentum is a highly seasonal anomaly, the authors recommend exploiting seasonality in timing portfolio rebalancing. The difference between the annual results of a rebalanced portfolio using seasonality and an agnostically rebalanced portfolio is about half a percentage point.

Gray and Vogel spell out their reasoning and their methods in detail. No black box here. No complicated math. And they make the case for the persistence of momentum outperformance into the foreseeable future. As they write, “strategies like value and momentum presumably will continue to work because they sometimes fail spectacularly relative to passive benchmarks.” So investors, both the DIY variety and professional fund managers, will be loath to commit to quantitative momentum strategies. The momentum anomaly will persist.

Bhargava, Non-Obvious 2017

For the past seven years Rohit Bhargava has been making annual predictions about business and marketing trends in his non-obvious trend series. I missed the 2011-2016 editions but am now on board with Non-Obvious 2017: How to Think Different, Curate Ideas & Predict the Future (Ideapress Publishing, 2017). Although most readers of these books are undoubtedly trying to capitalize on the author’s predictions, I am going to focus instead on the art of curating trends.

“A great trend,” Bhargava writes, “is a unique curated observation about the accelerating present.” That’s not an accurate statement: a trend is not the same as the observation of a trend. But I quoted it nonetheless because it has the ingredients of a powerful concept. Start with the notion of an accelerating present, combine it with the author’s definition of curation (“the ultimate method of transforming noise into meaning”), and add an element of creativity. I would recast Bhargava’s point as follows: To identify a non-obvious trend is to observe and process a signal about an accelerating present in a creative way.

Bhargava elaborates on the notion of curation, listing five habits of trend curators. They are curious, observant, fickle (in the sense of “moving from one idea to the next without becoming fixated, or overanalyzing each idea in the moment”), thoughtful, and elegant (that is, they seek “beautiful ways to describe ideas that bring together disparate concepts in a simple and understandable way”). Put a little differently, trend curators always ask why, see what others miss, learn to move on, take time to think, and craft beautiful ideas.

For his own work Bhargava uses the haystack method. This is “a process where you first focus on gathering stories and ideas (the hay) and then use them to define a trend (the needle) that gives meaning to them all collectively.” I guess you could call this method a low-level form of data mining. The haystack method has five steps: gathering (saving interesting ideas), aggregating (curating into clusters), naming (creating elegant descriptions), elevating (identifying broader themes), and proving (validating without bias).

Investors and traders who are in search of non-obvious trends might well find some insights in Bhargava’s book.

Lewis, The Undoing Project

Assume you’ve never heard of Michael Lewis but you’ve read a slew of books and papers about behavioral finance. You might decide to skip this one, figuring it’s more of the same. Put that cognitive bias aside. The Undoing Project (W. W. Norton) is a moving account of the incredibly productive but eventually fraught friendship of Daniel Kahneman and Amos Tversky.

Michael Lewis, the author of such best sellers as Flash Boys, The Big Short, Moneyball, The Blind Side, and Liar’s Poker, is a consummate storyteller. In many fields algorithms may trump experts, but so far writing is not one of them. We still rely on skilled writers to tell us stories we need and want to hear. The Undoing Project is one of those stories.

Other than their brilliance and their commitment to the defense of Israel, Kahneman and Tversky had little in common. Kahneman was insecure, moody, “like Woody Allen, without the humor.” Yet he was a brilliant teacher and bounced from one enthusiasm to another, trying anything, readily accepting failure, moving on. Tversky was the life of the party, an intellectual magnet who “had a preternatural gift for doing only precisely what he wanted to do. … He didn’t pretend to be interested in whatever others expected him to be interested in—God help anyone who tried to drag him to a museum or a board meeting.”

The intense collaboration between these two men produced work that changed the way we think about decision making, risk taking, predicting, our own inherently flawed rationality. It gave rise, at least in some circles, to a collective self-doubt—doubt that we could make wise investing decisions, for instance. And to more of a reliance on models that may exploit cognitive biases but don’t themselves succumb to them.

Although Lewis describes some of the most important discoveries of Kahneman and Tversky, his book is at heart a poignant drama. Dare I admit I cried at the end?

For those who expect something other than emotion from me, here are some notes that Tversky took on conversations he had with Kahneman in 1972, “early fodder” for their paper on how people make predictions, usually quite badly.

People predict by making up stories
People predict very little and explain everything
People live under uncertainty whether they like it or not
People believe they can tell the future if they work hard enough
People accept any explanation as long as it fits the facts
The handwriting was on the wall, it was just the ink that was
  invisible

People often work hard to obtain information they already have
  And avoid new knowledge
Man is a deterministic device thrown into a probabilistic Universe
In this match, surprises are expected
Everything that has already happened must have been inevitable

Since I had no commitments on Thanksgiving, I spent the day reading The Undoing Project. It was a true feast. We should give thanks for people like Daniel Kahneman, Amos Tversky, and Michael Lewis.

Price, Investing Through the Looking Glass

Tim Price takes on the financial establishment in Investing Through the Looking Glass: A Rational Guide to Irrational Financial Markets (Harriman House, 2016).

He skewers banks, central banks, economists and financial theorists, fund managers, and the financial media. He also exposes what he considers to be core delusions of the bond and stock markets: that “bonds are safe assets that rightly form the cornerstone of long-term savings schemes” and that “the stock market always rises over the long term and is therefore the best place for your savings over the long run.”

The following passage illustrates both how cleverly he writes and where his heart lies.

The downfall of the Western financial system began during an episode of Bonanza. Speaking to the American nation on television on 15 August 1971, interrupting the popular western series in the process, President Nixon announced that the US dollar would "temporarily" no longer be convertible into gold. (The temporary prohibition lasts to this day.)

Price elevates Mises over Keynes, Mandelbrot over Markowitz (who “conjured up a square theory in blissful intellectual isolation and then hammered it into the round hole of the market, with little bits of relevance flying off the theory each time”).

Price is not content to define problems. In the second half of his book he offers solutions. First, he suggests that “value investing is one of the few investment approaches that still makes sense.” He finds Japan particularly attractive, since almost 40% of the Topix stock index trades below one times book value, and over 50% below 1.5 times book value—“Ben Graham’s preferred cut-off demarcating attractively valued businesses from the rest of the market.”

Second, he advocates investing in rules-based, trend-following funds. Trend following “can be like coming in to work for a fortnight and getting your arm broken, every single day. But the rewards can be astonishing.” Of the 11 funds/companies (Berkshire Hathaway was included as a company) that have been in business for an unbroken period of at least 20 years and have generated, on average, over 20% annualized and audited returns, six of them are systematic trend-following funds. Investing in trend-following funds not only holds out the promise of outsize returns but these returns “will likely be delivered with more or less zero correlation to the stock and bond markets.”

Third, gold is “a must-own asset to help ensure the preservation of our purchasing power.” Gold is not, as Keynes suggested, a barbarous relic; “it is the leaders of the world’s central banks that are the barbarous relics here.”

One doesn’t have to agree with Price to appreciate this book. He makes his case in razor-sharp prose.

Psarra, 18 Smart Ways to Improve Your Trading

Maria Psarra, who worked on one of London’s biggest prop trade desks and is now a wealth manager, sketches out 18 Smart Ways to Improve Your Trading (ADVFN Books, 2016). These lessons, each between three and four pages in length, were originally published as articles in Master Investor magazine.

Most of the advice isn’t new, although two of the lessons deal with trading the highly leveraged contracts for difference (CFDs). Among other things, Psarra writes about stop losses, protecting profits, position sizing, overtrading, being afraid to pull the trigger, arrogance, and staying flexible.

Psarra’s book won’t replace standard works in the field, but traders looking for nugget-size advice won’t go wrong with 18 Smart Ways to Improve Your Trading.

Poole, Rethink

Steven Poole is a prolific non-fiction reviewer and the author of such books as Unspeak and Who Touched Base in My Thought Shower?, both dealing with the abuse of language. In Rethink: The Surprising History of New Ideas (Scribner, 2016) he combines writing skill and breadth of knowledge to take an old idea (in its least nuanced form, that there is nothing new under the sun) and rethink it.

Most readers of Rethink will undoubtedly focus on recent discoveries that vindicate long abandoned theories. Mice, it turns out, can inherit a fear of the smell of cherries through epigenetic means. Poor Lamarck. “For the whole of the twentieth century, Lamarck’s name became a kind of ominous joke, a byword for biological theories that were not just mistaken but ridiculous.” And yet, it seems, a kind of Lamarckism is indeed possible. A more stomach-turning example: leeches, those “vampiric slugs,” are frequently used in reattachment operations, skin grafts, and reconstructive plastic surgery; they also relieve symptoms of osteoarthritis when applied to the knees.

Poole gives multiple examples of projects that were set aside or that lost out in the marketplace, such as electric cars or frozen food. Actually, the frozen food case was sadder. In 1626 Francis Bacon, looking at the snow-covered ground from the coach in which he was riding, suddenly had an idea: could meat be preserved with snow? Within minutes he was experimenting, stuffing the carcass of a freshly killed chicken with snow. Apparently, although modern medicine might dispute the account, “he caught such a chill doing this that he died of pneumonia a couple of days later.” The idea of frozen food died with Bacon. It would take 300 years for Clarence Birdseye to unveil his “quick freeze machine.”

Francis Bacon is, of course, best known for his description of the inductive scientific method, which analyzes nature “by proper rejections and exclusions” and, “after a sufficient number of negatives, come[s] to a conclusion on the affirmative instances.” Jochen Runde has repurposed this method for business management. He asks business executives in his courses to think up a novel idea and then think of something that would be devastating to their plan. And then he asks them to do some research on that devastating something. “That’s when they start learning. These hypothetical things are like probes, into unknown space.” Invariably, Runde says, “the stuff they learn starts leading them to modify what they initially had in their business plans.”

So, not only can ideas be rethought, but so can the very process of thinking. For instance, “the sharp line between experiment and theory has been rethought out of existence."

Poole argues for the indispensability of placebo ideas, a view that follows (more or less) from the precepts of Nietzsche and the pragmatists. The person, Poole writes, “who embraces placebo ideas says that the fact that an idea is useful is a reason not to care whether it is true.” It’s a placebo idea, for example, that your vote matters. No major election “has ever been decided by a margin of only two votes. So your vote is literally pointless, and casting it is a placebo ritual. However, if everyone acted on this true belief and declined to vote, then democracy would fall apart.”

Some ideas that died should definitely stay dead. The earth is not flat, contrary to the belief of flat-earthers. Nor are markets efficient. John Quiggin, in his book Zombie Economics, argues that “not only was the efficient-market hypothesis refuted by the global meltdown of 2007-8, … it actually caused it in the first place. The idea ‘justified, and indeed demanded, financial deregulation, the removal of controls on international capital flows, and a massive expansion of the financial sector. These developments ultimately produced the Global Financial Crisis.’”

Rethink is a book that both informs and makes the reader think and rethink (and occasionally argue with the author). It’s even fun—well, leeches aside. I consider that a winning combination.

Birkenfeld, Lucifer’s Banker

Bradley C. Birkenfeld was, in the words of CNBC, “the most significant financial whistle-blower of all time.” In Lucifer’s Banker: The Untold Story of How I Destroyed Swiss Bank Secrecy (Greenleaf Book Group Press, 2016) Birkenfeld, with the very able assistance of Steven Hartov, tells a harrowing tale, beginning with “All roads that lead to federal prisons are long.”

Birkenfeld got his start in the financial world with summer jobs and eventually a full-time stint at State Street Bank, working for international money managers. Within a year he was handling spot and forward currency trading on 90 institutional accounts with more than $30 billion in assets. He also started keeping track of “squirrelly transactions” and illegal activities at the bank. After he refused to record client calls without their knowledge, a criminal act in Massachusetts, his days at State Street were over. He did not go quietly. Among other things, he took his pile of documentation to FBI headquarters in Boston. The investigation, however, was soon dropped. State Street, he charges, had too many friends in the FBI. And Birkenfeld was blackballed in Boston. Where could “a sharp young banker … make his name and fortune? Why Switzerland, of course.

He started at Credit Suisse for four times what he’d been making at State Street, essentially just to learn the ropes. Once on the “Anglo” desk, he introduced the idea of schmoozing clients and using them to get more clients, a predictably successful endeavor. But he didn’t stay at Credit Suisse for long since his boss moved to Barclays in Geneva and took him along. Once again, he “feted existing clients, proposed more investments, and charmed them into turning over the names of their mega-rich friends.” Barclays, however, started to get nervous. It was 2000, and the Treasury Department and the IRS were targeting tax-evaders. So for a couple of weeks here and there Birkenfeld was sent to London, where tax regulations were lax, to find more rich folks in need of an offshore home for their money.

As Barclays started to divest itself of North American offshore clients, Birkenfeld’s client list was essentially frozen. He got a call one day from a manager at Barclays Bank Bahamas, who wanted to transfer the $200 million account of a real estate tycoon from California, Igor Olenicoff, to Geneva. The problem was that Olenicoff wouldn’t sign the Qualified Intermediary agreement that Barclays demanded. And so Birkenfeld, who had been wooed by UBS, decided to change banks and take Olenicoff’s money with him. With that move and his performance-based bonus (18% of any revenue UBS made from their lofty fees on Olenicoff’s $200 million), Birkenfeld became the highest-paid UBS private banker in Switzerland.

UBS knowingly played fast and loose with U.S. tax laws and Birkenfeld played right along with the bank, living the high life. Then a friend of his found a three-page memo outlining all the activities the bank was warning its employees not to do, “though they were everything we were being paid to do!” Birkenfeld knew who was responsible for this memo, the “bastard Bovay,” who was “like Satan. And what did that make me? A trusting, naïve dupe. Nothing more than Lucifer’s fucking banker.”

Birkenfeld could simply have left UBS quietly. But that wasn’t in his genes. He wrote a memo to the head of legal and head of compliance at UBS. No response. Eventually he resigned. And sued UBS to cough up his bonus, a suit he won. But he wasn’t satisfied. He decided to whistle-blow to the U.S. authorities.

To say that the Department of Justice didn’t welcome Birkenfeld with open arms would be a gross understatement. Birkenfeld spends the second half of his book describing his dealings with the American government and railing against some of its leading players. The upshot: Birkenfeld pleaded guilty to conspiring with a U.S. citizen, Olenicoff, to defraud the IRS of $7.2 million in taxes owed on assets hidden in secret accounts and was sentenced to 40 months in prison. While he was in prison, his lawyers worked on his behalf to get a whistle-blower’s award from the IRS. UBS had paid out $780 million, about $200 million to the SEC and $580 to the IRS. Once released, Birkenfeld, still on probation and forbidden from leaving New Hampshire (where he opted to go because it has no state income tax), received a check, with taxes already taken out, for $75,816,958.40!

Birkenfeld was no angel, but one couldn’t help cheering him on as he confronted slimy bankers and vindictive, sometimes corrupt bureaucrats. All in all, a riveting book.

Updegrove, The Doodlebug War

This weekend, as the American election looms and the market “fear index” has spiked, I’m going to write about two thrillers, one fiction, the other (Lucifer’s Banker) less apocalyptic but unfortunately real.

Andrew Updegrove is back with his third Frank Adversego book, The Doodlebug War: A Tale of Fanatics and Romantics. His second book, The Lafayette Campaign, about hackers shaping a presidential election, was eerily prescient. Let’s hope this one isn’t.

I should note in passing that my review of The Lafayette Campaign wouldn’t qualify me for the political prognosticators hall of fame. I envisaged Donald Trump running as a third party candidate and siphoning votes from the Republican Party. Oh well….

Frank Adversego is a cyber-security expert, this time working madly to protect our massive data storage centers (apparently the largest buildings have over 25 acres of floor space) from annihilation by terrorists. The problem? “The more servers, software, and data you put in a single building, and the more buildings you put near each other, the bigger the target you create. The more everything moves to cloud computing, the more vulnerable we get, especially since the servers that support the Internet and the electrical grid are all hosted in data centers, too.”

The Doodlebug War is a page-turner and, at $0.99, a cheap way to be scared of something other than the outcome of Tuesday’s election.

Siegel, Predictive Analytics, 2d ed.

When I wrote about the first edition of Eric Siegel’s Predictive Analytic: The Power to Predict Who Will Click, Buy, Lie, or Die, I highlighted the work of John Elder, founder and CEO of Elder Research. He ran a small hedge fund for nearly a decade, but eventually found that “the key measure of system integrity began to decline.” At that time I asked readers to offer ideas on measuring system integrity but was met with deafening silence.

Now, three years later, the revised edition of Siegel’s book has been published (Wiley, 2016). Re-reading it (and it is an engaging, if sometimes repetitive read), I was led to Elder’s 2014 white paper “Evaluate the Validity of Your Discovery with Target Shuffling,” an excerpt from “3 Ways to Test the Accuracy of Your Predictive Models.” Systems traders may find some useful ideas here.

Baggini, The Edge of Reason

Julian Baggini is a British philosopher who knows how to write for a general audience. Yale University Press has just released his latest book, The Edge of Reason: A Rational Skeptic in an Irrational World. Although about half of the book deals with morality and political philosophy, I’m going to focus here on a couple of salient epistemological points. I trust readers will see their relevance to the effort to develop rational views of largely irrational financial markets.

Baggini sets forth a notion of reason “which is thin enough for there to be mutually comprehensible reasoning between individuals and cultures in a shared discursive space, without it being so thin as to enable anything to count as reasoning, from nuanced step-by-step argument to thumping the table and insisting on the correctness of your position.” His ‘thin’ view “sees rational argument not as a formal, mechanistic, rigid method but simply as the process of giving and assessing objective reasons for belief. These reasons are those which are assessable and comprehensible by any competent thinker, which stand or fall irrespective of our personal values, and are compelling yet open to revision if the evidence changes.”

Reason, Baggini argues, requires judgment. It is “not a pure algorithm that can be set up and left to run by itself to produce true conclusions.” It cannot be completely schematized and formalized. The inescapability of judgment in reasoning is “philosophy’s dirty secret.”

Moreover, frequently philosophy doesn’t rely on arguments at all; instead, it calls on us to attend to and then interpret an observation. “Attending is often more useful than argument. As Wittgenstein put it, the best way to respond to a skeptic who says ‘I don’t know if there is a hand here’ is to say ‘look closer.’ Attending is a crucial element in good reasoning and provides the clearest example of the ways in which philosophising inevitably requires the use of judgement and cannot rely solely on what logic and evidence dictate.”

But back to arguments. A rational argument is “always in principle defeasible—open to revision or rejection—by public criteria of argument and evidence.” This is not the same as to say that it is always falsifiable in Popper’s sense of the word. Popper’s mistake “was to over-specify something which, if stated in more general terms, should be uncontroversial.” First of all, Popper intended falsifiability to be a criterion for demarcating between science and non-science. “So even if the principle works, it does not allow us to distinguish between the rational and the non-rational, unless we make the further claim that the only form of rational discourse is the scientific one. This is impossible, since such a claim would not be a scientific claim but a philosophical one, and so would be self-refuting.” Second, it’s not clear that all scientific claims are actually falsifiable. For Popper, “falsifiability is possible because theories imply predictions, and we can see if these predictions are borne out or not.” But, as Hilary Putnam argued, “’theories do not imply predictions’ in the straightforward way Popper believed. ‘It is only the conjunction of theory with certain ‘auxiliary statements’ … that, in general, implies a prediction…. This means ‘we cannot regard a false prediction as definitively falsifying a theory’ since there is always some uncertainty of the status of the auxiliary statements and their link with the theory being tested.”

Rationality is being sorely tested in the world today. Baggini’s book won’t, of course, prompt people to shut down vituperative Twitter streams or put an end to radical terrorism. Still, as Baggini writes in his introduction, “The rehabilitation of reason is urgent because it is only through the proper use of reason that we can find our way out of the quagmires in which many big issues of our time have become stuck.”

Kinahan, Essential Option Strategies

J. J. Kinahan, chief strategist and managing director of TD Ameritrade, formerly of thinkorwim, has written a primer for would-be options traders—Essential Option Strategies: Understanding the Market and Avoiding Common Pitfalls (Wiley, 2016). The book is clearly written and well developed, and it more or less covers all the bases. But since it is but one of many introductions to trading options, what distinguishes it from its competitors?

For starters, it avoids the sometimes difficult math that litters beginning books on options. The only concession to numerical concepts is Kinahan’s heavy reliance on standard deviation. But even here, he says simply that “SD refers to the range of stock prices around the average price or mean. The theory says that a stock will close within one standard deviation roughly 68.2 percent of the time, within two SDs 95.4 percent of the time, and within three SDs 99.7 percent of the time.” That, and elementary school math, is all you need to understand Kinahan’s primer.

Second, Kinahan gives a lot of space in this book to probability cones—the probability of profit and the probability of touching. With each strategy he discusses he provides not only a risk graph but also two probability cones. He uses these cones to determine whether the price of a position is worth paying. For instance, in the case of long vertical spreads, as a rule of thumb he is looking for “a better than 50 percent probability of the position at least breaking even and an 80 percent or better probability of it touching the higher strike through the expiration.”

Third, Kinahan walks the reader through case studies, with time parameters, risk factors, and of course probabilities.

For the beginning trader, Kinahan’s book is valuable. The intermediate trader may find a few tips that he can incorporate into his playbook. The advanced trader, or anyone with a quant bias, can move on.