Null Truths: Chaos Theory and the Market
The cause and effect of daily market moves.
"Economic history is a never-ending series of episodes based on falsehood and lies, not truths. It represents the path to big money. The object is to recognize the trend whose premise is false, ride that trend, and step off before it is discredited"
As a trader, I recognize the experience behind this statement. As a quasi-mathematician, I recognize the underlying thesis as chaos theory.
Because traders operate within short time horizons, they cannot afford to position only for a final truth. There is an eventual truth, but this truth may actually change depending on the path taken, which may itself have many curves and detours along the way. Instead of using the term "lies," I would use the term "null truths," for they are perceptions that prove false because of events. The ultimate truth turns out to be path-dependent.
What does this mean about markets? Chaos is the closest mathematical model to describes this behavior, which is fleeting and much like predicting the weather. Chaos uses non-linear math to describe a world where the ultimate future is path-dependent: What happens next depends on each previous step along the way.
Algebraic relationships do not hold up because the relationships between one variable (like interest rates) to another (like oil stock prices) change over time and price: Rates going down may help oil stock prices at a certain point in the economic cycle and it may hurt them in another. It's very much like the multiple universe theory in physics: Every time a decision is made a new universe is created. This says there are an infinite number of stock markets out there with an infinite number of John Succos trading each one (and an infinite number of Succos that decided instead to be musicians and janitors).
I use this obtuse exercise to make a point: Each day in the stock market affects the next differently. For example, if a portfolio manager in a big fund decides to buy S&P 500 futures on a given day and drives the market higher, this may cause a secondary offering in a particular stock to get done as that stock rises with the general market. It turns out that the deal was crucial to the company for much needed cash to deploy in a venture that turns out to be extremely successful. Without that portfolio manager buying the futures that had nothing to do with that one company, investors would not have been inclined to buy the stock offering and the company would have faltered without the financing.
There are many trends in the market that turn out to not be ultimately correct, but theoretically must be considered correct for some period. Momentum traders exploit null truths for a living: they follow the money. These are all mini-ponzi schemes that collapse under their own weight as marginal money begins to pull out once the null truths are proven to be false.
This process can occur almost instantaneously, so it is always better to be early than late; this is accomplished by using stops to limit losses and target points to take profits. Those lacking discipline have no business trading short term as such. In the game Soros is proposing, discipline is the only useful tool where anything can happen.
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