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The Almighty Buck Science

Mandelbrot Suggests A Hunt For Financial Patterns 323

Posted by timothy from the ineffables-abound dept.
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.
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Mandelbrot Suggests A Hunt For Financial Patterns More

Mandelbrot Suggests A Hunt For Financial Patterns

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  • I'd like to see it too. (Score:5, Funny)

    by Anonymous Coward on Saturday August 07, 2004 @09:12AM (#9908044)
    Considering that Hayek has been dead for over 10 years, I think that debate would definitely be worth seeing.

  • Alternative headline... (Score:5, Funny)

    by Anonymous Coward on Saturday August 07, 2004 @09:12AM (#9908045)
    Mandelbrot watches Pi [imdb.com], has idea...
  • How would you map this, though? He isn't real specific on WHAT he wants to map/track to predict the market.
    • 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.

      • Re:And what if we DID map it? (Score:4, Funny)

        by Anonymous Coward on Saturday August 07, 2004 @09:20AM (#9908077)
        "And what if we DID map it?"

        Well, it'd probably make a really good screensaver...
        • You'd get the name of God.

          I've just read through the comments and it's hard to believe that no-one has mentioned Pi [imdb.com]. The film is about a mathematician who is working on exactly this - spotting trends in the stock market by describing patterns in Chaos. It's a strange intense film and in addition to being pursued by shady stock market brokers, he's hounded by a jewish Kabbalah sect who believe he might be working out the true name of God.

          Top of the list of 'Films to be Watched On Acid."
      • 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
        • 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.
        • Exactly. The very nature of stock trading is that no money is created, it's only moved.

          Can someone explain precisely how this got modded up? This statement is true only if there is no actual money in the market when you measure "wealth": i.e., if to measure its accuracy, you need everyone to sell all their stock and then measure the aggregate amount of money in all former stockholders' bank accounts.

          The stock market in fact has a wealth multiplying effect, as all financial markets do: the "money" you ha

          • Re:And what if we DID map it? (Score:5, Insightful)

            by wfberg ( 24378 ) on Saturday August 07, 2004 @10:59AM (#9908449)
            The stock market in fact has a wealth multiplying effect, as all financial markets do: the "money" you have in $100 Yahoo shares isn't sitting in a bank account somewhere, but is instead being used by Yahoo to invest in other companies (through stock swaps), is being loaned to companies to make capital investments, is being used as collateral by individuals, etc.

            You're wrong in two ways;
            1) Money does not sit dormant in a bank account. It gets loaned out or invested by the bank. Banks can lend out (usually in the form of mortgages, overdraughts and credit) or otherwise invest money held in their accounts for up to 90%.

            2) Money is only injected into companies like yahoo to actually invest when they issue new stock.
            Stock-swaps are basically using monopoly money to buy monopoly money, and aren't captical investments anyway. Post-IPO gains in a stock's price doesn't put money into the corporation's hands.

            And you're kind of wrong in a third way too; if I buy $100 of Yahoo stock post-IPO, I'm buying them from some other guy who might be using that money to invest elsewhere.

            On the whole, the money that is tied up in the markets (in the form of shares held by investors) isn't doing much "work"; over the long term it's comparable to a savings account.

            If your aim is to stimulate the economy, you'd be better off spending money on high risk ventures that don't have as much of a zero-sum nature; e.g. venture capital, small (starter) business loans, junk bonds, etc.

            The markets reflect how well the overall economy is doing mostly on account of the fact that people don't throw money into the market if they need their cash to feed hungry mouths. Other than that they only reflect how well a company or a bunch of companies is doing relative to others.


            Bottom line: stop talking out of your ass about something you clearly know nothing about.
            You said it.
      • It would survive. The problem, here, is that the market will encompass any accessible model, then start using it to predict its own behavior -- after a short term gain, the market then deviates away from the old model, and a new one has to be formed.

        It reminds me of the Heisenburg Uncertainty Principle, on a macro scale. The better a model works, the faster it breaks.
      • If they did then it would instantly be replaced by something even more inexplicable.

        (theory copyright HHGTTG)
      • How can markets continue to exist, if their highs and lows can be predicted?

        See "Timescape", Benford. Also, time value of money [wikipedia.org], although the article neglects the inherent disutility of delayed gratification.

        I think that the very act of prediction will change the outcome... basically making this impossible to practically achieve.

        "The Psychohistorians", Asimov, from "Foundation", book one of the Foundation Trilogy. I'd agree with that offhand, but it would be nice to see a proof. (For a nasty view

        • A prediction does not change an outcome. Looping that prediction back into the pool of information on which decisions are based changes the outcome. It would be much easier to predict market activity if you never told anyone what the results were (but, of course, trading based on this secret prediction counts as introducing the prediction into the market and would change the course of events, so you couldn't profit from this prediction even if you were right).

      • Re:And what if we DID map it? (Score:4, Insightful)

        by xelah ( 176252 ) on Saturday August 07, 2004 @12:53PM (#9908937)
        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.


        The outcome would be that financial markets would still exist but that the predictable pattern would disappear.


        Financial markets aren't just about short term speculation. The purpose of, say, a stock or bond market is to match people wishing to lend money and bear risk to those wishing to borrow.


        Contrary to some posters opinions this is not a zero sum game. The borrowers use the money to invest in business and produce a return - a return which wouldn't have been possible if there had been no way for the borrower to find that source of finance.


        If financial markets work perfectly then the prices within them represent the 'best guess' of the value of the underlying asset. The result is that investors' money goes in to the best investments - those which will give the best returns. Imagine if dot-com stocks had been correctly priced. How many fewer doomed companies would have been able to float or raise additional capital? That money could have been diverted to investments which, instead, produced good returns and helped the economy to grow.


        If market returns could be predicted (so that buying stocks became risk free) then investing in stocks would be just like investing in, say, treasury bonds. A market would still exist because the underlying need - matching borrowers to lenders - still exists. Perfect predictability will never happen, though - company values depend on unpredictable factors out there in the real economy. Think of future consumer tastes, harvests, weather, the outcome of sporting events and terrorist attacks. In fact, a perfectly functioning market that takes all available information in to account would probably not contain any (exploitable) patterns. It should be obvious why: if prices correctly take in to account all available information then only new information can cause them to change (given constant interest rates and risk premia). Without having had this information in advance you couldn't have predicted the change - and if you had the information then this contradicts the assumption that it's new.

    • Almost ten years ago I worked as a researcher for two of my accounting professors, David H. Lindsay [csustan.edu] and Annhennrie Campbell [csustan.edu] on a project titled A Fractal Approach to Bankruptcy.

      I gathered data on daily stock market returns on 5000 companies listed in Standard and Poor's listing of U.S. publicly traded companies.

      I normalized then crunched the data through a fractal analysis tool that quantified the level of chaos (randomness) in the changes of each company's stock market value from one day to the next.

  • Laws and feedback (Score:2, Insightful)

    by JohnFluxx ( 413620 )
    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?

    • 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?

      I agree. It'd be funny to think that should such patterns become visible, either they'd be designed with the ability to take into account the effect of their own predictions, or they'd only be able to make predictions on the state had

    • Hello commie.

      No seriously, computer trading is nothing new. Been there done that. Computers are very good at spotting small trends and acting on them very fast. That whole day trading stuff was related to it. Nothing to do with real investment but then the stockmarket ain't got much to do with investment either.

      So no there are no laws against you using a computer or whatever to analyse the market and then use that info to trade. Using a computer to do it automaticcaly is also hardly illegal. Major banks d

    • Also, I remember very vagually that there are laws about getting a computer buying and selling automatically, to try to curb this?

      There are curbs [invest-faq.com] put on automated trading programs to prevent single-day surges or plummets in prices. That is to prevent the self-fulfilling problem you mentioned...
  • 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.

    • "Technical analysis of markets is a waste of time."

      When you made this comment, were you aware that people apply technical analysis to problems other than forecasting market direction?

      What Mandelbrot is suggesting is not the development of a predictive model for entry and exit of positions. Rather, he's suggesting a better model for evaluating the risk in a portfolio once the positions have already been established by whatever means the investor is using. Since risk in this context refers to the risk of un
  • rejected this notion...

    I suspect these wizards are more concerned with buying and selling than looking at the bigger picture, which, while being nice, and explaining boom and bust, together with mini-boom and mini-bust (ad infinitum), doesn't actually help the predictions...

    I thought that while fractals look in some ways to be predictable, they are in fact, when examined in detail, highly unpredictable.

  • Most financial institutions already do (Score:5, Informative)

    by EpsCylonB ( 307640 ) <eps&epscylonb,com> on Saturday August 07, 2004 @09:15AM (#9908063) Homepage
    using either linear algorithmic models or a parrallel neural network approach.

    However while most people agree that past performance is indicative of the future nothing can predict what is going to happen. Things such as politics and current events have a huge impact but are not easily factored in to a computer program.

    There are many sophisticated solutions to recognising and predicting complex patterns but with the stock market there is an element of trying to predict the lottery.

    If the lottery is run properly then every draw should be completely random, any pattern detected in past draws should be about a useful as picking your numbers out of a hat.
    • However while most people agree that past performance is indicative of the future nothing can predict what is going to happen.

      If most people agree to that, then how come almost every prospectus contains the boilerplate "Past performance is not indicative of future results"?
      • If most people agree to that, then how come almost every prospectus contains the boilerplate "Past performance is not indicative of future results"?

        Indicative is probably the wrong word. Partially deterministic is a better way of saying it. Past data can be used to partially determine future trends. Of course when it comes to the stock markets how much you can determine is not very clear.

    • Re:Most financial institutions already do (Score:5, Informative)

      by Thomas Miconi ( 85282 ) on Saturday August 07, 2004 @11:15AM (#9908510)
      using either linear algorithmic models or a parrallel neural network approach.

      Mandelbrot is one of the people who demolished the idea of applying linear filters (or just about any predictive method) to stock markets.

      In particular he showed two things:

      - Market parices are strongly non-gaussian. They do follow a bell curve (approximately as many ups than downs, with a concentratino near the middle) but if you try to calculate the mean and variance of market data and draw a gaussian curve based on it, you'll notice that the real data will have a much lower density around the mean, and much longer, higher tails at each side. This is because market price data have a distribution that favours extremes in comparison to gaussians: there are many more extreme variations (up or down) that would be expected in a gaussian process.

      - Market prices have the same behaviour, regardless of the scale. If you look at a given graph of variation, it is impossible to determine wether they cover a week, a month, a year or even a decade.

      Thomas Miconi

  • I've heard this before. (Score:5, Interesting)

    by London Bus ( 803556 ) on Saturday August 07, 2004 @09:16AM (#9908064)
    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.

    • LTCM (Score:3, Insightful)

      by mplex ( 19482 )
      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.

    • Re:I've heard this before. (Score:5, Interesting)

      by IntelliTubbie ( 29947 ) on Saturday August 07, 2004 @11:24AM (#9908547)
      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
      • >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!"

        Thats the main problem with technical analysis, eventually all methods fall back on "This trend will continue until it doesn't".

        What it does provide is a nice, clean and easy to understand set of rules. The future accuracy will always be in question regardless how well it worked in the past.
    • Past attempts at solving the problem have failed. Therefore all present and future attempts must fail too.

      A classic fallacy.

      • "Past attempts at solving the problem have failed. Therefore all present and future attempts must fail too."

        Sure, why not?
        After all, if fractals can be used to forecast future trends from past events,
        then isn't the fact that "Past attempts at solving the problem have failed"
        itself a past event which can be used to demonstrate that
        "all present and future attempts must fail too"? ;-)
  • Why are we supposed to take SlashDot articles about highly academic topics seriously if the editors can't even spell "Mandelbrot" or "financial" (see: "finantial" (sic))?

  • as already mentioned, this was covered in Pi (Score:5, Funny)

    by Ark ( 7744 ) <kgarner@kgarne r . c om> on Saturday August 07, 2004 @09:17AM (#9908067) Homepage
    8:14 read slashdot
    8:15 restate my assumptions:
    1. /. is the language of nerds.
    2. Everything around us can be represented and understood through discussion threads and trolls.
    3. If you graph these numbers, karma emerges.

    Therefore: There are karma whores everywhere in nature.

    8:17 Press Submit
  • Doesn't knowing the pattern change the pattern? So this chaotic funtion is to have a fixed point? [wikipedia.org]
    • [Disclaimer, IANAE (economist), but studying physics and I'm currently reading through statistical physics textbooks with fairly interesting econophysics chapters.]

      I thought about the same.
      If everyone applies the found patterns and algorithms, the amount time you will be able to forecast the market will just drop to zero. One is essentially extracting money from the patterns and if everyone is doing that, no one can be left, so the predictability will be gone. For me, this looks like collectively hunting a
  • why can't they join a coordinated search for patterns in financial markets?

    They could, but lets say they find a pattern and say "sell SCOX, its price will drop". Everyone will sell SCOX, and its price will drop, but will it be because of preexisting conditions? Or because of the reaction to the "pattern"?
    • Well, this may not be such a good example.

      In order for any market predictions (or market advice, for that matter) to be useful data, it must be tied to a specific time period in which is can be used to make a profit. "Buy Enron" doesn't make a lot of sense if you get in for $50K right before it tanks, but it does make sense if you get in at the IPO and sell a month before the big drop.

      So you could differentiate between self-fulfilling behaviors and independent behaviors: if the predictions says "SCOX wi
  • Problem is with markets is that many decisions are taken based on indicators. If the research Mandelbrot suggest is undertaken, it will just be another indicator, and hence fed back into the loop.

    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). P

  • In a relatively low-dimensional nonlinear system, characterization of the possible trajectories of the system might be possible (determining the bounds of the trajectory, the likelihood of following one manifold versus another). But we already know that the market is a horribly high-dimensional system which is perturbed almost all the time by forces external to the system. Probably the most you can hope for is an analysis leading to the same sorts of conclusions we already know, but which unfortunately ar
  • This concept was explored in an Aussie movie of a couple of years back, called The Bank [imdb.com]. A person previously wronged by a bank was employed to investigate stock market trends, using 'chaos theory' and 'fractal geometry'. Quite an interesting movie to watch.
  • Mandlebrot suggests donating 5% of the proceeds from all the online dating services to find out how to really get a date on a Saturday night.

    But seriously, though there are patterns in most human endevors, it is an extraordinary complicated thing. The reason it hasn't succeeded in the past is that the chaotic factors that determine the outcome of the system are unknown and probably unknowable.

    Who ever expected that a bunch of guys wearing hiking gear in Seattle would sweep through the music business

  • Simple: Because of greed (Score:5, Insightful)

    by Oestergaard ( 3005 ) on Saturday August 07, 2004 @09:26AM (#9908103) Homepage
    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.
    • Even if you could predict the patterns, and were so benevolent as to release this information publicly (after a suitable period of 'testing' it for yourself), it sure seems like it would have to be a real masterpiece of work to still predict the markets after everybody started using it to predict the markets.

      I think this is why there are laws restricting the ways computers can be used to trade stocks. If many people start using similar algorithms to analyze the market to make optimal trades, the system st
  • To stop the problems with the financial markets, the whole system should be slowed down from the current "by the second" approach to dealing in shares.

    To do this, all trades should be done on a weekly basis. During the week you can put in all your share orders, buy or sell, and on Sunday they get computed. Monday moring you can see what you got.

    • It wouldn't work. Let's say Frobozz Inc. sells for $100 a share. During the week, the market receives orders to sell 10,000 shares and orders to buy 2,000 shares. On Sunday, it clears all of the buy orders and only 20% of the sell orders. The people with unfulfilled orders are going to be upset, especially if they want to liquidate their position now, before they suffer additional losses. Investors are suspicious of schemes that reduce liquidity. Loss of liquidity is often a warning sign that something very
      • But that's the whole idea - to slow the whole system down to the point where if you want to invest in the stock market you have to invest for the long term and not try to gamble and turn day profits.

  • One of the corollaries to Mandelbrot-type thinking is that one could, look at a particular "graph" generated via the Mandelbrot set and generate an equation to explain how it got there.

    Granted this would include a huge number of variables, even on a mathematical level, but theoretically, so they say, it is possible.

    When thinking of it in terms of Economics, there would be even more variables to consider (ever play Sim City?) but again, it's possible, theoretically, if only on a small scale.

  • Well (Score:5, Insightful)

    by Kjella ( 173770 ) on Saturday August 07, 2004 @09:28AM (#9908114) Homepage
    ...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
  • 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.

  • This would amount to predicting the future (Score:3, Interesting)

    by humblecoder ( 472099 ) on Saturday August 07, 2004 @09:42AM (#9908151) Homepage
    I don't think he understands that financial and economic markets are linked to world events. Therefore, in order to accurately predict the movement of financial markets, you will need to be able to predict the future! Do you think that a computer could have predicted 9/11 or the Iraq war or elections of world leaders or the Microsoft settlement or a myriad of other news events which effect the direction of the markets? If anyone actually believes that we will be able to design a computer to do this, feel free to reply to me because I have a bridge to sell you!

    (Before all you chart-heads jump on me, I do not think technical analysis or charting has any validity, so please do not waste any time trying to convince me otherwise, because it won't work!)
    • Do you think that a computer could have predicted 9/11 or the Iraq war or elections of world leaders or the Microsoft settlement or a myriad of other news events which effect the direction of the markets? If anyone actually believes that we will be able to design a computer to do this, feel free to reply to me because I have a bridge to sell you!

      I'd like to buy your bridge...

      Only joking, I do think we may be able to build such a computer but it won't be anytime soon. As for the rest of your post, I comp
  • You can't just map all the data in the stock market and look for a pattern. The amount of socio-financial data to pattern would be... incomprehensible. This is truly a "butterfly effect" situation. Millions of rumors swirl throughout the trading floor - some make it to us as news - and mapping all that data... it's not that it is impossible, but conceiving of that today is unlikely.

    You'd almost need some kind of impartial Bayseian analysis to traffic through millions of petabytes of data. There are pattern

  • Schroedinger's Stock Market (Score:3, Insightful)

    by Gothmolly ( 148874 ) on Saturday August 07, 2004 @09:51AM (#9908180)
    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.
    • Comparisons to the human genome is another terrible analogy. Studying people and their actions/opinions is way too difficult. What do you want to do , hook everyone to a biofeedback machine ?

      If everyone followed a certain economic model then they might choose another action that is just as perplexing if they know that some out there knows what they are going to do.

      My analogy is a thief robbin a 7-11 but knows there's a camera in the store so therefore he uses a mask.

  • Finding market structures is destroying them (Score:3, Informative)

    by file-exists-p ( 681756 ) on Saturday August 07, 2004 @09:51AM (#9908181)
    As soon as a structure usable to make money has been found, so many people exploit it that it instantaneously disappear. This is especially true when such structures are explained to the public and not kept ultra-secret in some bank basement.

    The problem with the market is that the knowledge humans have about it modifies it.
    • This is called the efficient markets hypothesis. Not everyone agrees. The idea that every opportunity is fully exploited by an infinite # of eyeballs is empirically cute, but not descriptively accurate.

      Will anyone ask here, what is a pattern? THe field of behavioral finance makes its objective to show how systematic flaws can be exploited due to the particpation of human investors that exhibit irrationality, overconfidence and inconsistency in the use of information sources, and those sources are weight

  • Old theory? (Score:3, Interesting)

    by Quixote ( 154172 ) on Saturday August 07, 2004 @09:53AM (#9908190) Homepage Journal
    Mandelbrot has been talking about using fractals to predict the financial markets for over 40 years now. His first publication was in 1963, titled "New Methods in Statistical Economics."

    IMHO, it is not possible to predict the actions of millions of users (not to speak the 1000s of program trading systems) over a long period of time. However, given a sufficiently small window, it may be possible to predict the motion of a security with a better than random probability; and if you have a direct link to trading systems (i.e. low fees), you might be able eke out a meaningful return on investment.

    As with most other things, you'd need a hefty investment to pull this off.

  • I really can't afford it, on my fixed income, being disabled and fighting a host of diseases, but this sounds like a promising project... I would like to donate half my savings!
  • 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 wo

  • Most posters are missing the point - again. (Score:5, Informative)

    by Schreck ( 137216 ) on Saturday August 07, 2004 @10:03AM (#9908240)
    Let me recap Mandelbrot's point here.

    In the April 2003 settlement of postbubble fraud charges, the biggest Wall Street firms agreed to cough up $432.5 million to fund "independent" research. Mandelbrot then makes the distinction between two kinds of research. One is the kind of research where analysts study a publicly traded company, and then give recommendations to buy, sell or hold. The other kind is fundamental economic research.

    Mandelbrot then suggests that at least five percent of the settlement money be directed toward fundamental research. He does not say that we should look for a way to predict the markets with absolute certainty - that would be impossible, as many here have redundantly pointed out. (He would probably be insulted to know that so many here think that's what he advocated. He's not stupid, you know.)

    He's talking about giving a boost to the kind of fundamental economic research that's already taking place. Stuff like risk management, for example. If you read the article, maybe you noticed that in the beginning he clearly gave examples of what's wrong with our present models in risk management.
    • 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.
  • For crying out loud, some mathematicians book gets extracted in Wired and that's news?

    While Mandelbrot is probably a brilliant mathematician, he could take a lesson or two on social change. If he wants to convince Wall Street to change its ways, merely asking them is not going to work.

    Besides, why waste your time telling rich people how they could make more money? If you figure out a way to better predict stock market fluctuations, use it to your own advantage. Wall Street investment firms will then flock
  • Yeah sure everyone wants the majic formula regarding financial matters, but here is what happened last time - trillion dollar bet gone really bad [pbs.org] --- like where do you think the dot com money came from, where did the enron, worldcom, etc.. money go... easy come easy go??? and teh economic caos it caused and lead to world economic problem and yes... even the war crap we are in now...

    SO NO to trying to find the next magic financial formula.... at least until we really much better unberstand and nutralize GRE
  • 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?

  • Benoit! (Score:2)

    by MrEd ( 60684 )

    Something tells me he just got burned on SCOX....

  • The true driving forces... (Score:3, Insightful)

    by pongo000 ( 97357 ) on Saturday August 07, 2004 @10:40AM (#9908373)
    ...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.
  • Big market moves come in response to external unforeseen events.

    Terrorist attacks threaten oil supplies? Sell.

    Tax laws change to ease growth? Buy.

    Election result makes massive spending impossible? Buy.

    Top accounting firm is found to have aided in massive fraud? Sell.

    No mathematical model of the highs and lows of the market will predict these.

  • Credit to R.N. Elliott (Score:2, Interesting)

    by Code-Ex ( 655722 )
    Mandelbrot wasn't the first to model financial markets using fractals. Elliott [elliottwave.com] was.

  • Why Can't They... (Score:2, Interesting)

    by JohnPerkins ( 243021 )
    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?
    Everyone one could join such a search, but why would they? We contribute cycles to SETI because we want to find aliens. We contribute cycles to cancer projects because we want to find a cure. Where's our incentive to contribute cycles to a financial project?

  • He's talking about dynamics, not prediction! (Score:5, Insightful)

    by IntelliTubbie ( 29947 ) on Saturday August 07, 2004 @11:11AM (#9908494)
    (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
  • While I have great respect for Dr. Mandelbrot, it seems that he has become yet another victim of the "financial markets have patterns" scam. And that's what it is, a scam.

    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

  • What? I need a mathematical analysis to predict certain types of market risk?

    Really? In all the near catastophes cited by Madelbrot (http://www.wired.com/wired/archive/12.08/view.ht m 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 recove

  • Let's see now. . .

    Hm. There's saber rattling going on and Bush is a complete asshole. . . I think I'll buy some gold.

    (Bought at $330 back before Iraq. Now gold is scratching $400. It'll probably go well over $400 when the economy totally melts down. Although, after that happens, where do you sell it and what currency do you ask for? And anyway, who the heck wants gold when food is now the important thing? Can't eat metal no matter how precious.)

    And so. . . Sugar and Spice and everything nice. Inv

  • A bit skeptical (Score:3, Interesting)

    by mysterious_mark ( 577643 ) on Saturday August 07, 2004 @01:04PM (#9908997)
    I remember when I was in grad school for fluid dynamics at the Von Karaman Institute there was a big fad on modelling turbulence using fractals. While it is true that turbulence is more accuratley described with fractal as opposed to Euclidian geometry, this doesn't necessarily mean that useful predictive model can be produced. The many attempts at modelling turbulence with fractals didn't really produce models more effective then the usual stochastic models that were used. There may have been more progress made in the past few years, but I'm not aware of any major breakthroughs. Granted turbulence is a different problem than the financial markets, but the deterministic chaotic behavior is the simular. Also if you could model the dynamics of the stock market, it is unlikely that I'd be willing to donate CPU cycles just so a few day traders can get rich. Mark

  • This reminds me of paranormal "research" (Score:3, Insightful)

    by Baldrson ( 78598 ) on Saturday August 07, 2004 @01:35PM (#9909153) Homepage Journal
    A lot of people have suggested at various times that scientific methodology be applied to paranormal research. However, one of the big problems with paranormal research is the enormous incentive to keep it proprietary with the corollary incentive to inject noise you've generated into the field. What ends up happening is a miasma of bad ethics -- sometimes with entire edifices of human "knowledge" like religions or academic institutions behaving in ways that makes mideval clerics look enlightened.

    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.

  • Great Mathematican, Poor Social Policy Wonk. (Score:4, Insightful)

    by rssrss ( 686344 ) on Saturday August 07, 2004 @02:07PM (#9909309)

    Some forms of basic research should be publicly funded because they have no inherent reward. For example, Research on Black Holes [nytimes.com].

    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 [nytimes.com] and selling non-tradeable real estate trust shares to retirees [nytimes.com] [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.

  • Already being done (Score:3, Interesting)

    by Ohreally_factor ( 593551 ) on Saturday August 07, 2004 @05:35PM (#9910198) Journal
    Wallstreet is already doing this, and throwing some pretty powerful brain power and computer power at the problem. Just don't expect the players to share their information with us.

    I have a friend who got his PhD in mathematics a few years back. His career options were: 1) Teach (there are far fewer teaching positions than there are candidates), 2) Work for the NSA, 3) or go work for a Wallstreet firm.

    He lucked out and got a teaching position at a local city college.

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