INVESTMENT

      There are a number of ways to apply the Nomothetic Theorem to make money in the securities markets. It is an excellent tool for a hedge fund that employs multi-directional trading. Although one of the theorem's greatest strengths is its ability to make predictions, it can also help the investor make sense of volatility and avoid trading in situations when the ability to predict is very low.

      Application involves developing mathematical algorithms to identify the trend, the "norm", and the "normal range of volatility" for the system being studied. Once an accurate system model is constructed, the part of the theory that leads to logical predictions is overlaid. Unfortunately (for you the reader) the methodology for making accurate predictions is a proprietary trading tool used by Lennox Financial and is not being made public here. We encourage you to contact Lennox Financial directly for more information. However, so that you do not go away empty handed, a current suggestion is offered below that relates to the Nomothetic Theorem.

      A lot of investment theory talks about how efficient the markets are and why it is so difficult to beat the averages. However, the Theory of Volatility tells us that there will be places and periods of random volatility. Just as "irrational exuberance" drove the markets up in the late 1990's, it is not unreasonable to expect that there will be some excessive volatility to the downside also. While many investors think that volatility is their enemy, the smart investor will learn to use volatility to advantage.

      Let us consider one stock by way of example only. (There are hundreds of such stocks that you could consider.) Instead of a "buy and hold" approach, the Nomothetic Theorem emphasizes an understanding of how volatility works. On December 21, 2000 you could have purchased this particular stock at $7.375 just as I did. If you had looked on the Internet at the financials of the company filed with the Securities and Exchange Commission, you would have seen that the stock was selling way below its book value. You might have had the same multi-year target of a double, just as I did. But on January 30, 2001 the stock hit $11.00. If you were paying attention to the Nomothetic Theorem, you might have realized that a 49% profit in six weeks was a bit much considering general market conditions. In other words, volatility had pushed the price way above the normal trend, and the Theory predicted a return to the trend. Therefore a sale was appropriate.

      During the week of April 4, 2001 this same stock hit a new 52 week low of $4.44 and could easily be purchased below $4.75 (as I did). On May 7, 2001, you could have sold the stock at 7 (as I did again). During the late summer, the stock was beaten down along with all the other technology stocks. It has been possible to repurchase the stock below $4 per share (as I have once again). It certainly may go lower, but it is still a solid viable company selling below book value and with considerable cash on hand. I can only think of three reasons why you wouldn't own it: 1) You are ignorant 2) You think their business model stinks and they cannot grow their earnings 3) Their accounting is fraudulent and you cannot trust the calculation of book value. Failing any of the above reasons, here is an opportunity to take advantage of volatility and purchase a cheap stock.

      Would you like to make 18% per year? Due diligence requires asking what are the chances that this technology company can grow its earnings between 10% and 30% per year over the next four years while everybody hooks up to the Internet and links their computers together with local ethernets? Different analysts might arrive at different conclusions regarding the rate of growth, but it doesn't seem unreasonable that a company well positioned in a fast growing industry could grow by 18% per year. That would imply a doubling of the stock price in four years. Considering that the stock had a high of $24.10 in 2000, projecting a double to $8 in four years does not seem outrageous. Let's be honest, wouldn't you be happy with an 18% per year return?

      Suppose you purchase the stock below $4 and it does in fact double in four years. Do you realize that the daily change in price would be less than $0.0032? That is less than one-third of one cent per day. Watching your investment grow would be more boring than watching paint dry. Worse, it might not go up at all for weeks or months. Then it might go up ten percent in a matter of days. Since you cannot predict the future degree of volatility to the upside, it is important to understand that patience is a primary requirement when you take an investment position with a multi-year target.

      Does it sound like I am promoting a buy-and-hold strategy when I refer to a multi-year target? I am not. Understanding how volatility works allows the investor to multiply results compared to the "buy-and-hold" investor. The prime difference is that opportunistic sales and repurchases are identified by the Nomothetic Theorem. In the example given, by actually trading in and out of the stock profitably, I actually now own shares in the company for free. The only capital I now have invested in this stock is the profit that was made from earlier trades. This is an example of how The Nomothetic Theorem provides a framework for understanding volatility. It is an even more powerful tool for making accurate predictions, when properly applied.

      To learn more about investment applications, follow the link below.