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Scientific Trader’s DNA – from dices to chaotic attractors
“Buy, or not to buy..?” Which are the scientific principles and the Stock Physical Analysis Methodologies used to understand our decisional limits and exploit them in the best way, being aware that:
There is no wind that blows right for the sailor who doesn't know where the harbor is.
The future is not what it used to be
Arthur C. Clarke
I've seen things you people wouldn't believe
Blade Runner (1982)…?
Genesis: the original sin
The science was born to predict and control the future. Astrology, tarot card and palm reading were born for the same reason as well…
We are still looking for a method able to satisfy the human need to predict the future and able to give serenity even in front of nature’s unpredictability.
Traders well known this need and the consequent frustration, but today (or rather: for 20 years) they can freed themselves from these sufferance. How? First of all they have to accept the study of the modern sciences and the “cleaning” of what learnt until now (as stated by the fractals’ father, B.Mandelbrot, in his book “The (mis)behavior of markets”).
Which scientific disciplines? Here the “compasses” s for traders:
- Complexity/chaos Theory, to understand that trying to understand is damaging, but it’s possible to “ride” following objective criteria;
- Game Theory, to understand that deciding following rational and consistent criteria is damaging, but it’s possible to obtain much better results adopting “mixed strategies” and the aware mix of conflicting decisions;
- Cognitive Sciences, to understand that Pico della Mirandola was wrong: our free will is a small thing if compared to mass media conditioning (with the diffusions of “cultural viruses”)
The arrogance of knowing the future of complex systems is scientifically a violation of natural laws, a mortal sin.
To resist to this sinful temptation, we have to go back to XVII Century, when Blaise Pascal and Pierre de Fermat helped a dices player with the invention of the probability formula and the first (incorrect) example of a probabilistic, in this case, “attractor”.
The player abandoned its instincts and superstitions and understood that the dices follow a specific behavior: the dices show their six sides an impartial number of times – but only if the dices are not fixed and with a high number of rolls.
The truth is that in nature the dices are always fixed (when are all sides identical?) and, before rolling all the times needed… it’s possible to lose everything. This is true also for roulette, card games, etc., etc.
So, what to do? It’s easy: using the math science to calculate behaviors (called “strategy” in the Game Theory) which optimize the winnings; the calculations have to take into consideration the capital available, the minimum bet, the player life expectancy (!) and, especially, the known “probabilistic attractors” (analyzing the history of dices, roulette, cards, stock’s behaviors).
From Prometheus to the Drunk
From the Gods able to predict the future so, helping us (as the Mythological titan Prometheus) to the understanding of unpredictable behavior, even if probabilistic (like the “random walk” of the drunk), physicians and economists have learned to accept the transition from the phenomena deterministic predictability (“Laplacian” approach from XVIII to XX century) to a probabilistic predictability (XX Century: quantum physics).
But everybody was so disgusted from the chaos, i.e. the sciences’ enemy, that ignored for 60 years the brilliant intuition of J-H. Poincaré, that in 1908 developed what we call Complexity Theory. Finally, during the ’70s we started understanding that chaos and tumultuousness have their laws, an order and a sense so, this time they are “chaotic” or “strange” attractors.
As per the XVII century dices player, we have new scientific disciplines that help us to understand what attracts certain phenomena. Weather phenomena attract attention in the weekend, but the financial phenomena… everyday!
Math and the probability are not enough to deal with Chaos and its unpredictability, computer is necessary. This is why scientists understood what Poincaré discovered during the ‘60s, 60 years before.
Let’s see some of the effects of this scientific revolution for the financial sphere:
- Bull and Bear chained. The predictability paradigm obstinately answers, with “Nobel” formulas, to several questions made on the management of portfolio volatility (Markowitz: what is the risk?), on stocks volatility (Modigliani – Miller: how much does a stock worth?), on the CAPM (Sharpe - Capital Asset Pricing Model: how much does an activity worth?)
- Bull and Bear un-chained. On the other hand, the facts show that there are no formula, model or Nobel Laureate able to handle Bulls and Bears: the markets’ troubles don’t care about the existing math-financial paradigm, but by know they are at the end: from the black Monday on 1987 to the Eastern Tiger Crisis on 1998, from the breakdown of LTCM (1998, hedge fund of Scholes and Merton “Nobel”) to the global financial reactions originate from a whatever Monica Lewinsky…
- The Apocalypse: beginning of the artificial life. The trader cannot imagine the stock market as the result of human interaction, where the human psychology is an important factor. The computers’ psychology became more and more crucial. What does it mean? And what is the Human Trader’s future?
To the modern Sciences the verdict.
Well, but which sciences, and how?
A butterfly’s wing beat.
First of all, it’s essential the modern scientific paradigm of Complexity and Chaos Theory that introduce:
- New concept with which learning to live: unpredictability, weak signals, sensitivity to initial conditions, appearance of a phenomenon’s properties, butterfly effect. In a nutshell: it’s the revenge of the little and modest soldier that through an emotional gesture (the Game theory would define it an “almost-rational” action) is able to change the end of a battle. The aim of the Complexity Theory is to provide the knowledge and the tools to try, find, and act on small and hidden events that generate big changes, or at least, in order to avoid to be surprised.
- New “glasses” able to show the real complex reality in a simplified manner: status diagrams, iterative processes, axial tomography. Put simply: it’s the revenge of the body on the brain. It’s necessary to see, touch and feel the reality in its weak signals, instead believing to model everything in the abstract. Complexity Theory’s goal is to provide, together with new technologies, new ways to see the order and the logics of turbulences, i.e. the chaos attractors.
Pulling the Daisy petals: to buy , or not to buy
The complexity theory on its own can’t teach us to decide despite all the new concepts and glasses described above. So, the game theory helps us; its goal is to guarantee the best behavior to take optimal decision, and it provides for this purpose the strangest “calculator”: the dices.
1994 Nobel Laureate, John Nash, taught us to use them in the optimal “Mixed Strategies”: they are necessary to set decisional processes and criteria, also probabilistic, which are sustainable and winning.
The Boiling Frog
The knowledge of the chaotic phenomena ‘s attractors, which are able to show us the logic at the base of the volatile volatility of stocks, and the wise behavior set by math mixed strategies, which is able to ensure optimal decision, impact with a further limit: ourselves, i.e. our unique cognitive performances.
The cognitive Sciences (‘80s) and the memetic (‘70s, from the genius of Richard Dawkins) showed our decisional limits (Why does the frog –and it is not the only one… - wait until she is boiled while deciding what to do?).
Our free will, which is necessary to implement the knowledge and the decisions supported by the previous disciplines is like a mirage, something that exists but doesn’t exist at least with the same performances. Everybody is a little bit God and little bit Robot.
And well, we use our divine talent when we are in the “God” phase, and we use robot more efficient and rapid than us when we are in the “Robot” phase, i.e. computers. So, we can’t reject our alliance with the Artificial Intelligence if we want to ride chaotic phenomena in the limited “predictability ranges” between two attractors, in accordance to our known cognitive limits.
The future is not what it used to be
How can we orient in a more and more uncertain, unstable, dynamic and chaotic future without an adequate compass? Which are the “North”, “South”, “Eastern” and “Western” for the Scientific Trader?
Below you can find some scientific concepts described above applied to the stock exchange operations
Ride the Bull (or the Bear)
As anticipated the stock exchange phenomenon (chaotic, so unpredictable) allows only one strategy: riding, surfing, or yachting, all the metaphors are good but it’s necessary to avoid predicting the result of the countless “bifurcations” of a chaotic and complex scenario. The bifurcations represent different “Scenarios” (rises and reductions of different size and nature, or several stasis), that in correspondence of the attractors, can be displayed in an unpredictable way, and they are determined from slight variations of the “initial conditions”.
Ideal method: don’t think when deciding.
So… How can we find support for deciding?
Pride ruined more people than petroleum!
The Cognitive Sciences and the memetic help us to set sustainable operative strategies, considering the primary trader’s enemies: memes (“mental viruses), mass-media, the contrary-opinion and especially… the know-it-all-friend. Pride&Vanity reinforce these enemies because they persuade us that we are freer and more independent than we actually are, instead of helping us to accept the limits of our free will. The obsession on this ideal is actually a dangerous “idol”, it’s the real cause of mistakes and sufferance.
Dilemma and Catatonia – trader’s schizophrenia
We understood that the attractors show the crucial situations of a financial stock, where the stock choose for one of the scenario predicted by the bifurcations; when the phenomenon evolves from complex to chaotic, the bifurcations become more and more deep and close. Often we don’t decide correctly according to what we learnt due to memes and cultural and psychological conditioning. Analyzing the bifurcations and their decisions is the most advanced challenge for the Game Theory, which is used to face and solve dilemmas.
The biggest challenge for the trader is to avoid to not deciding (catatonia), because, even if unconsciously it’s impossible to not to decide – everything is decision.
Ideal tool: the dices for the probabilistic evaluations of the optimal decisions.
God, Robot or… Matrix?
Taking decisions in correspondence of possible scenarios caused by the attractors but obstructed by our free will, can cause variation from “decision-making with no excitation” (“God Phase”, or “agitated catatonia”) and “hesitation with no decision) (“Robot phase” or “exciting catatonia”). During the “Robot phase” we need efficient IT supports in order to beat our cognitive, autonomy and free will gaps.
Does a chance for the advanced Artificial Life exist?
Well, it already exists and it’s strongly developed…
Ideal tool: the software – any working software.
All software are mostly efficient if compared with our free will, but which are “more similar to the others”?
It’s time for the Scientific Traders, with the support of the Stock Physical Analysis, to understand better and before others the beginning of the Artificial Life, and to be aware that it’s necessary to ally with it, in order to beat our limits and to understand emerging aspects of complex and chaotic phenomena, without which the stock exchange is similar to a roulette or, in the other hand, a small ship shook by powerful manipulators.
The rest… is Chaos.
For information and consultancy: Nicola.firstname.lastname@example.org
Attractors: geometric item which graphically highlight the recurring of a phenomenon, like the level stabilization of coin toss, or rolls dices or roulette’s ball, or the area around which a complex system moves in an apparently casual way (typical of stocks). The attractors can assume “chaotic” and “strange” features according to some aspects that are secondary to the aim of this article.
Bifurcation: moment or situation of which possible scenarios can originate, with no possibility to predict which option will be determined from the slight variations of the initial conditions. The bifurcations begin in correspondence of the attractors, following the simultaneous increase of volatility (and the reduction of inactivity).
Catatonia: kind of schizophrenia characterized by the stop of mental activities with two opposite modality: exciting catatonia (total absence of communication and activities), agitated catatonia (surplus of activities in order to don’t think and don’t decide – typical of some managers).
Initial conditions: set of the more significant values and variables of a phenomenon which are present at the beginning of an evolution. The determinist (predictable) systems are insensitive to the initial conditions (or rather: they are affected in a proportional way). On the other hand, the chaotic systems are very sensitive to the initial conditions, i.e. they experience big reactions to little variations (“Butterfly Effect”).
Contrary Opinion: a typical example of meme diffusion that align investors’ thought and behavior. The Contrary Opinion principle is based on the historical finding that “the mass is always wrong”, so it’s necessary to act on the contrary of the popular opinion (even if it may be difficult to establish what the Mass is and how much an opinion is popular).
Deterministic: math model, or study approach, of a phenomenon of which, given some well know initial conditions, the predictability is supposed.
It’s also called Laplacian, as the physician Laplace, and it supposes that slight variations of the initial conditions influence in a predictable way the results (so, the contrary of the complex “Butterfly Effect” paradigm).
Fractals: the “Fractal Geometry Nature”, created by B. Mandelbrot on 1975, is based on fractal space dimensions and not only entire dimensions. The fractals dimension (for example 2,34) allows to the nature to optimize the relationships among different dimensions, i.e. to obtain huge surfaces in reduced small area (for example, the pulmonary alviolae, or fern leaves).
Memes: word created by Richard Dawkins on 1976. A meme represent a “unit of cultural replication”, i.e. the equivalent of biological viruses. The memes “carry” and inoculate ideas and thoughts that configure the minds where are installed, to better expand to other minds. The Memetic is the discipline that studies memes, applying the same criteria and methodology used by epidemiology.
Strategies: this term is used in the Game Theory to describe the “combination of behaviors”. The strategies can be “pure”, i.e. preconditioned according any well-structured standard, or “mixed”, i.e. not determinate but allocated with known probabilities (for example, rolling special dices with several sides, or taking advantage of our emotions, irrationality, instinctive reactions…).
Volatility: it’s the trader’s bête noire and the real comprehension and visualization objective of the Physical Stock Analysis, unlike the traditional Technical Analysis.
The volatility is very volatile, and cannot make it inflexible in a given coefficient for each stock, but it’s necessary to learn and physically follow the evolution on its maximum values (on correspondence of the stock’s chaotic attractors) and its minimum values (in the attractors’ interregnum).