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.

Comments

I've heard this before.

[London Bus]

Are you familiar with Elliot cycles? Probably not. He came up with an idea like this around a decade ago. (Reading back issues of NewScientist can do wonders for you knowledge like this.) These ideas keep getting thrown around but never come to fruition because at their core they are inaccurate. As simple as that. Whether it's based on power laws, or assumptions about the nature of price spikes (up-up-down-up-up-down), trying to reduce markets to mathematical patterns invariably fails.

Re:I've heard this before.

[IntelliTubbie]

Are you familiar with Elliot cycles?

I've heard from mathematical finance experts (such as Nassim Taleb) that Eliot cycles are quite unscientific. Adherents seem to believe that market moves are composed of these cycles -- but that the cycles can also lengthen, shorten, invert themselves etc. As you can probably imagine, anything can be described as cyclic if the "cycles" are allowed to go through these kinds of gymnastics! Searching for cycles using real mathematical tools (e.g. Fourier analysis) reportedly reveals that true cycles don't exist.

Unfortunately, this is pretty typical of "technical analysis", which is the voodoo of charting past patterns to predict future prices. I once spoke with a trader at a major Wall Street firm who believed that prices have "supports" and "restraints" -- i.e. natural floors and ceilings that they don't want to break through. When I asked her what happens if a price breaks through the floor, she responded with the hilariously tautological, "well, it just goes lower until it establishes a new floor!"

Cheers,
IT

Re:And what if we DID map it?

[Ishin]

Exactly. The very nature of stock trading is that no money is created, it's only moved.

People that bought yahoo cheap and watched it become 100x as valuable and sold $100 of stock for $10000 didn't create money or value, all they did was tricked other people out of their money. That's why the stockmarket is a poor representation of economy today, the valuation of the stock isn't very closely tied to the long term dividends companies pay out.

In short, I agree with you. If everyone knew everything about the stock market then everyone would end up leaving the market because there'd be a distinct lack of rubes begging to give away their money for practically worthless pieces of stock paper which were about to take dives. (which is what happened to all the people that bought yahoo at the climax of its value)

Re:Random versus deterministic

[Anonymous Coward]

That financial markets are stochastic is an assumption - with extreme levels of 'deterministic noise' it can appear stochastic - a small difference when specifying an equation to predict a future level can make a massive difference: this is chaotic. Stochastic modelling works OK because of the large levels of noise, most modern finance is built on the assumption errors are Gaussian, a framework formalised in the 60s but assumed even earlier. Sadly today anyone can trot out a Black Scholes thesis, support the group think in academia, and get a PhD from a decent institution (a disease in many disciplines other than economics/finance).

Think of financial markets like the weather - tomorrow is more likely to be the same as today, some minor variance, but saying it is going to be largely similar will mean you're right most of the time: this doesn't help pedict a storm. Likewise tomorrow the stockmarkets will likely be the same as today, but this doesn't help predict a crash. As weather the stock market model can be refined, but in the end it is chaotic and hugely deterministic (many agents looking at each other and others actions).

Many agents looking at each other's actions is important - the market does not exist without agents (buyers/sellers) - it is an endogenous process. A co-operative solution will not work - someone always has to do worse for anyone to do better than the market - the market and the economy is just the sum of the actions of participants, participants cannot move against the market as they, in sum, are the market. Calling on the market to recognise a pattern is folly - a small participant can take advantage of any pattern if discovered, but the market as a whole cannot because if they stop their present action to follow/takeadvantage of/neutralise the pattern they have stopped taking action that creates the pattern.

Patterns in financial markets have long been looked into, a good starting point on current thought, if interested, is technical analysis and elliott-wave theory