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Doyne Farmer Looks Back

By Nina Mehta

Starting a financial trading firm was anything but easy for physicists Doyne Farmer and Norman Packard. Even agreeing on a suitable name was difficult. But after dismissing Infinite Regress, Nostradamus, The Vision Thing and Dukes of Destiny, they settled on Prediction Company—a name that calmly summed up the firm's intention to foretell the future of the markets.

The story of the company's tumultuous evolution roars through Thomas Bass' The Predictors: How a Band of Maverick Physicists Used Chaos Theory to Trade Their Way to A Fortune on Wall Street.

Did the firm make money? Yes, indeed, and lots of it. Did it take money from the capital markets like candy from a child? Not exactly.

Farmer, Packard and a motley crew of five other physicists, plus one non-physicist, launched Prediction Company in 1991, determined to use chaos theory to split the markets open and extract valuable patterns of information from the murky soup of bond and stock prices. Farmer and Packard, the company's globetrotting stars, were two of the five physicists who, in the late 1970s, had formed the Chaos Cabal in the graduate physics department at the University of California at Santa Cruz—a ragtag group that helped launch the field that launched a thousand dissertations and now feeds academic departments around the world.

"We started out assuming that simply using sophisticated time-series techniques would give us a clear advantage that would allow us to make profits,” Farmer says now. "But we found there were no magic bullets. We had to think harder about how the markets worked and structure our models to make the data speak to us. The data didn't speak to us automatically.”

There were discouraging times. The firm didn't get off the ground immediately, and it was three years after the firm settled into its offices, within sight of the Sangre de Cristos (Blood of Christ) mountains, that it was trading in earnest—and several years after that "before we were really trading in a way that was profitable,” says Farmer. Along the way, there were several false starts, and the company went for months without making a profit. The Predictors swings through the highs and lows of the company, from paying for office furniture to hauling the company dog-and-pony show to the kingpins of Wall Street in search of a funding partner. (The Chicago-based O'Connor & Associates wound up spouse.)

There were also surprises. "It was easier to get Wall Street interested than we had thought,” recalls Farmer. "Perhaps the timing was right, or they just liked our sales pitch. Also, I think Norman and I underestimated the value of our credentials—they were taken seriously.” One thing that wasn't so easy, however, was the day-to-day logistics of production—"actually running the models in live trading proved to be harder than we imagined,” he says.

Management also proved to be something of a briar patch for Packard and Farmer, who had previously run a small company that tried to beat the roulette wheel in Las Vegas with a toe-operated computer. (Bass recounted that hardscrabble effort in an earlier book,The Eudaemonic Pie.) "It was difficult learning to listen to other people, and learning to understand other people's psychology well enough to keep them happy and get them to work hard,” says Farmer. "Frankly, I had assumed that since I was outgoing and liked people that would have been easier.”

So what are the Dukes of Destiny doing now?

Packard remains at Prediction, modeling the future as CEO of the 24-person firm, which now advises UBS on how to use Prediction Company models to control a proprietary fund (O'Connor wound up in the kitty of the Swiss bank). Farmer is at the Santa Fe Institute, developing a nonequilibrium theory for price formation based on likening the financial strategies developed by "agents” in the markets to the evolution of biological species. "If patterns in the market are equivalent to food sources, for instance, speculators can formulate strategies to exploit those patterns for profit, just as animals fight for sources of food,” he explains.

In the offing: If not another book, then at least a mathematical food-fight theory to make sense of the ever-dyspeptic financial markets.

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