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Mandelbrot Suggests A Hunt For Financial Patterns
Phoe6 writes "Wired is carrying an Open Letter of Benoît Mandelbrot, the father of the fractal, to the wizards of Wall Street, calling on them to recognize a pattern in the finantial and economic trends in the world. Mandelbrot says, If we can map the human genome, why can't we map how a man loses his livelihood? If millions can contribute a few cycles of their PCs to the search for a signal from outer space, why can't they join a coordinated search for patterns in financial markets?" I'd like to see a debate between Mandelbrot and Friedrich Hayek.
We can find a patterns in the genome because it is deterministic. We can find patterns (to the level of fidelity suggested by Mandelbrot) because the financial markets are stochastic. He should read "Against the Gods" by Bernstein for background.
Won't there be problems with predicting what will happen, then acting on the predictions? Almost to the point of being self-fulling prophecy?
Also, I remember very vagually that there are laws about getting a computer buying and selling automatically, to try to curb this?
What would be the outcome? How can markets continue to exist, if their highs and lows can be predicted? I think that the very act of prediction will change the outcome... basically making this impossible to practically achieve.
Visit the Game Programming Wiki!
Technical analysis of markets is a waste of time. When a pattern is found, it is exploited by many, which changes whatever "meaning" the pattern had before.
Send lawyers, guns, and money. Dad, get me out of this.
Better then to focus on economies, and what fundamentals control them. Many of those fundamentals seem to be known, i e you know what things are "good" (low taxes on work, flexible labor market, well educated work force, good infrastructure, good governance and legislation wrt to right of ownership, free trade). Problem is quantifying them and make them interact with all the other less known factors...
I lose nothing by running Seti@HOME, and I have nothing (or at least little) to gain. Let's say that my computer is the one that finds the "alien signal" paving way to a real sustainable contact, visits, technology exchange and what have you with an alien civilization. I'd be lucky to end up in a history book.
Similarly, the research groups working on the signal processing, detection, filtering and what have you, will freely share information - again because they have nothing to gain by refraining therefrom.
But financial markets? If my computer can detect that in a few weeks General Electric's shares will plummet - why would I want to give that information away? Would I get a reward from the research group (at a financial institution somewhere most likely) that could (and of course would) benefit from this information?
Would the algorithms even be developed? Why would one group (at Citibank for example) share their information with another group (at GE Capital or whatever)?
There would not be sharing of knowledge. There would not be sharing of results. Simply because the potential gain you have by keeping the information confined is too great.
If you could forecast financial markets reliably on a large scale, imagine how powerful you could become. You could buy the planet.
And this, ladies and gentlemen, is why shit like this won't happen. Not as long as financial markets deal in things that have material value.
...finding aliens will have great importance for society. Solving AIDS or cancer or other great medical vices of our time will have great importance for society. But financial markets?
Who'd profit from that? Remember that most of the money made in the stock market is made off the losses of other stock holders - one person's loss is another's gain. If you alone can find the pattern, you profit. If everyone finds the pattern, it has very little value.
Something that made everybody run twice as fast, wouldn't in any real way change sports. The fastest would still be the fastest. Have you truly achieved anything then? I don't see this as a useful cause to dedicate my clock cycles to, do you?
Kjella
Live today, because you never know what tomorrow brings
I have never understood the markets. They appear to have nothing to do with the performance of a company and everything to do with the moodyness of investors. It seems like every day I hear on the radio that a particular company beat wall street expectations, yet the stock price fell anyway. Or that gas prices are going up because of the fear that there might be a disruption and not a real disruption. How does one model fear? It seems to me that markets are nothing more than a scam.
-- Thou hast strayed far from the path of the Avatar.
The very nature of stock trading is that no money is created, it's only moved.
Not quite. Transaction fees are the friction in this system. Buying and selling stocks is not a zero sum game. The brokers and exchanges always come out ahead.
Math is a very crude tool for interpreting the world.
It works great for physics but it's so naive and/or grandoise to think you can solve "humans" with it.
I've seen statisticians try to prodict market behavior by analyzing charts. They're always like
"oh yes this stock will SURELY rise in the next trading day, unless of course we are still on the edge of an ablahblah curve in which case it may go down instead!"
In otherwords "The shit might go up it might go down past trends are no indication of future performance and I am a fucking charalatan"
And of course the guy spews his bullshit with a total straight face and this very self important tone like he is not a fruad. Sometimes people with advanced degrees in math can be so damn myopic.
We can't just "find the pattern" in the stock market, since its created by people in the first place. To attempt to find said pattern it to say that human beings act in a particular way by nature, not volition, and that even in the presence of external force, people will act the same way. The problem becomes harder the more people you have working on it. One person may make a model which is accurate in the broad sense, precisely because he is unaware of the other stock market players, and vice versa. If everyone in the market got together to try and figure out the pattern, then the pattern would be whatever everyone wanted.
I want to delete my account but Slashdot doesn't allow it.
Ever heard of Long Term Capital Management? They tried some sophisticated modeling in the late 90's, and at first it went great, but the Asian crisis wiped them out when their models fell apart. All modeling based on historical trends falls apart eventually. I tend to fall in to the camp that believes the mere act of predicting markets makes them less predictable.
When "chaos theory" (better to call it "field", or "approach to complex systems", maybe?) broke upon the world in 1970s, it's not like finance people yawned and ignored it! Au contraire, there was tremendous interest for the subsequent decade, as everyone searched for power laws, fractal dimensions and attractors. But now 30 years have passed, and the conclusion that was reached after research, and not in ignorance, as Mandelbrot suggests, is that financial markets are not predominantly chaotic. In other words, the "randomness" that we see in financial series is unlikely to be generated by underlying repeated actions of some simple nonlinear system; instead, it's really stochastic, really comes from un-anticipatable non-deterministic shocks. And if you really think about how the world works, with companies cheating and countries defaulting on debt, you'll find that intuitive, as well.
Here's one overview of the current state of the matter: Barnett and Serletis, 1998 (disclaimer: found after a 5 minute search of RePEC, there are likely even better papers).
"I am just a customs officer; but I, too, wish to understand what is going on" -- Bertold Brecht
Of course a mass investigation into this implies a mass awareness of the result. That awareness though would immediately change the pattern as they try to act on it. Better try to figure it out on your lonesome then aye?
...of the stock market are fear and greed. Once Mandelbrot can find a pattern in these two uniquely human traits, his problem will have solved itself.
(Note: I have degrees in mathematics and finance.) Mandelbrot is not talking about making price predictions in the stock market, e.g. "if the price goes up on Monday, it will go up on Tuesday". As many ./ers have already noticed, any such scheme would be self-defeating: if people began to anticipate a Tuesday price rise, they would buy on Monday, driving the price up a day early -- and erasing the pattern.
For this reason, most financial models assume that stocks follow a kind of stochastic (i.e. random) process called a "martingale", meaning that returns are uncorrelated over time, so you can never beat the market with a strategy like the one above. However, this leaves open the question of which probability distribution the returns follow.
The earliest models, such as the Black-Scholes model for option pricing, assume that stocks follow geometric Brownian motion -- this means that returns follow a normal probability distribution, i.e. the usual bell curve. However, real world markets do not follow a normal distribution: the tails of the distribution are much "fatter", meaning that the Black-Scholes model underestimates the risk of extreme market moves. Therefore, this is a bad risk model, and a company full of Nobel prize winning PhDs, called Long Term Capital Management, followed it off a cliff in the late 90's, nearly bringing down the US financial markets. (For a captivating account of LTCM's rise and fall, check out the book "When Genius Failed".)
This is what Mandelbrot means when he "encourage[s] the study and adoption of more-realistic risk models". We need a better model for the statistical dynamics of markets in order to properly understand (and price) risk -- i.e. to be able to compute accurately the probability that such-and-such price move will happen -- not to make simple-minded stock predictions.
If you're interested in Mandelbrot's own mathematical work on the subject, I'd recommend his book "Fractals and Scaling in Finance". For a great read about the inherent unpredictability of the markets, try the books "A Random Walk Down Wall Street" or "Fooled By Randomness".
Cheers,
IT
Power corrupts. PowerPoint corrupts absolutely.
There is only one premise on what has to happen. Add ethics to basic economic fundamentals for christs sake. I think ethics should be one basic cornerstone of economics otherwise we run into the hellish mess we now have where shareholder value has replaced basic fundamental thinking on what is good for the people in the end is also good for the company. All the disasters of the recent past can be traced back to one thing, no ethics and greed running rampand on the altar of the fast buck.
Issac Newton once fell for the falacy that Astrology can predict the course of history because he exagerated the importance of the very gravity he helped identify and name. Berating former student and long time friend Sir Edmund Halley who questioned Newtons adherence to the `science', Newton quipped, "I have studied it, Sir. You have not!"
It seems that Dr. Mandelbrot has confused the real world with the similarities in patterns which can be found in the equations of the very fractals he invented. The real world doesn't work that way. Just because it looks like there is a correlation, doesn't mean there is one.
As it turns out, all of the empirical sciences themselves are pretty poor in explaining a great many things. The closer one looks at nature, the more theories get thrown out the window. Just as Ptolomey gave way to Copernicus and then to Kepler and Einstein, and even now with visible and measurable matter thought to occupy less than one quarter of the universe, the success of science has at best been illusary. The more we think we know, the more we are confronted by things we do not.
Science is an asymtotic persuit in which the ultimate truths can never be known. Predicting the financial markets may just be one of those things.
Really? In all the near catastophes cited by Madelbrot (http://www.wired.com/wired/archive/12.08/view.htm l?pg=2?tw=wn_tophead_7), a common theme resonates: irresposible and/or corrupt government regulation of banking systems. But...we've known that for years haven't we - that irresponsible government banking regulation precedes financial catstrophe?
Here, let me make a prediction - AND YOU REMEMBER IT: Argentina will recover from it's current financial crises only to again borrow massive sums of money and yet again crash it's economy. But...along the way, Argentina's economy will be hailed as a "Tiger". Then, after the crash, the Argentines will blame thier irresponsibility on an "International Jewish Banking Conspiracy". It happens EVERY TIME.
See...corrupt government regulation at work. I don't need a model to predict THAT future.
After all, if you're going to replace war with flows of money, what makes you think you are going to have honest scientific discourse in the field of economics?
Its eat or be eaten.
The real solution to war isn't to replace it with economics but rather to direct it against acquisitors who steal from creators. If you do that, then there is a positive sum environment and war becomes far less necessary.
Seastead this.
Some forms of basic research should be publicly funded because they have no inherent reward. For example, Research on Black Holes.
Research on stock markets, is a whole different kettle of fish. He who achieves a superior understanding of the operation of markets may choose the nature and amount of his reward. This type of research will be amply funded by the private sector, and it is. Every major bank employs a large staff of PhD's in Finance, Economics, Physics, and Math, to research these issues. They are handsomly paid and very well supported. (one of these banks is the biggest APL shop around).
Dr. Mandelbrodt's request that the SEC should use public money to fund research on markets shows that he does not understand the distinction between these types of research. The SEC should not use money as he proposed. The SEC should use money to help it discharge its fundamental duty, which is the protection of investors.
A couple of prominent recent examples are high pressure sales of investments to soldiers and selling non-tradeable real estate trust shares to retirees [the Wall Street journal Story was much better, but is on their subscription only site that I cannot hack]. When the SEC figures out how to spot these types of scams before the newspapers, which are reactive organisms too, then they can start worrying about esoterica like the underlying mathmatcal basis of markets. Of course, by then chickens will have lips.
In the land of the blind, the one-eyed man is king.
> What [technical analysis] does provide is a nice, clean and easy to understand set of rules.
"For every problem, there is a solution that is simple, elegant, and wrong." -- HL Mencken
Chris Mattern
Sorry, Benoit, but this is just crap. The whole point of the markets is that those who have knowledge end up with the money of those who are ignorant. No matter how good your study is, the markets will change and adapt in response to its conclusions. You won't stop any people losing their livelihoods with such a study unless you give the results to them and nobody else (and then, others will lose their livelihoods instead).
Economics is not hard mathematics. It is not hard science. There are absolutely no axiomatic truths to be had; you cannot even build a wooden shithouse of logic on the foundations that are available, because the foundations shift with every new insight -- and the advantage goes to those who can predict how long that insight will be valuable for; when the uninformed will still believe in it but the cognoscenti will have abandoned it.
You can't map the market, because the market depends on people and world events. You would have to predict or compensate for natural disasters, russia defaulting on loans, rogue traders, etc.
The analogy of the market to the human genome isn't a good one, IMHO, simply because the human genome is essentially in a vacuum, and the market isn't. The market today is very different than it was 20 years ago, but the human genome is still the same as it was 200 years ago.