Fractals and the market voice
Mandelbrot’s network
Rereading The (Mis)behavior of Markets after more than a decade had passed since the previous read — a decade in which one noted misbehavior was the firm establishment of five network upstarts to market value dominance — I was this time struck by the prevalence of network terminology I had not noticed before. In a text that does not mention networks even as a concept, let alone an indexed word, the recurring appearance of clustering, scaling, interdependency, and power law effects, stands out.
Admittedly, the author avoided speculating on causes of market fractality, but sought merely to observe and as a scientist demonstrate the unpredictable choppiness of the subject. But we who are not scientists can speculate without shame, and my take is that markets — complex and diverse interconnected networks of complex and diverse participation — (mis)behave the way that social networks do, only much more so: a function of their vastly more complex, diverse and multilayered constitution.
Which is to say, there are influences and influencers, agreements and disagreements of assorted strength, topics that draw varied attention by and for assorted interest groups, links among the nodes that may solidify or break, clusters that may grow or shrink or altogether vanish just to reappear… Only, in markets these form a richer and more fragile mosaic, necessarily, resulting in what may show on charts as chaos. But it isn’t that, it’s just complex, and fractal.
One other clue for the imagination to run wild among Mandelbrot’s scientific findings, points us to an even more precise conclusion about the nature of this complex social web. According to the author, market prices have memory — are influenced, in other words, by prices past — the more immediate the past, the more immediately influential.
This speaks of sentiment, I think, which grows with immediacy and fades with distance. As much as investors may try to resist it in their decision making, sentiment in markets is a fixture — intrinsic and extrinsic — if anything, a matter of type and degree. For analytic purposes, it forms a special challenge in that sentiment is difficult to forecast, can be contagious in both rise and fall, and is thus hard (i.e., impossible) to hedge. The multi-layered complexity of the market network, as described, adds considerably to the challenge; and where we see a jagged line rather than the trajectory our models had anticipated, that is because there is no noise, there is only signal.
A prevailing mood
Around this time, many investors step back and with a pillow underneath their head reflect on the year nearing its end and that which is itching to get started. It is an artificial boundary, but generally accepted and accounted for, and it may as well be part of nature. This season I am thinking about a sentiment I’ve noticed more of in the recent past, and speculating on its consequences, some of which perhaps still underway or in a state of reversal. Who knows.
The sentiment to which I refer: Distrust… widespread and deep, it seems to me, and growing.
It is a particular type of distrust that I sense, different from that which may seem normal in a market economy, rightly or wrongly driven by a zero-sum mentality: one trader gains what another loses, and trust is generally a naive stance. We don’t always trust stock research because there is an underlying profit motive. We don’t trust ads because someone wants to sell us something that we probably don’t need. We don’t trust other investors because they’re talking their books, as they should, and so are we. We don’t always trust the data because it depends on the analysis and how it’s done and why. These are distrusts akin to healthy skepticism — like peer review in science, if you will — or, as a trader friend used to kid but not really: because you’re paranoid doesn’t mean you aren’t being followed. It can’t be helped for speculators to calculate this way, and we’re all speculators, even when we think we’re not. Like sentiment, it’s a question of type and degree.
But no, the distrust that is now building is a different breed. It is a disconnect in both directions between individual and institution, and between institution and institution, which, as it expands to varied fields and deepens in its breakage, could be a sentiment of dominating impact that will be difficult to manage on both sides. This thing I think I notice, call it institutional distrust, may be a thing worth noticing.
Despite or because of fractals
Not the markets, however — the subject of this essay — we don’t distrust the markets.
That is not to say that we agree with what the markets tell us, or that we trust participants and the respective institutions, but when a price moves for or against us we accept it as the market voice, which speaks the market truth — a truth that matters. It may be fractal and complex, like truth is prone to be even in straightforward circumstances; it requires interpretation, which we may botch or otherwise ignore; but it’s a voice that can be trusted and is always speaking.
Perhaps the reason that we feel this way is the market’s multitude and diversity. In networks, that’s something like decentralization. There is no editor-in-chief, there is no artifice or censorship, no concentration of ideals that, in effect, can turn a network centralized. Despite the power law effects that form in pockets of the market, which may build bubbles or pop them, which sometimes create centers of so-called thought leadership or financial concentrations, in whole the market leaves us free to speculate, to bet for or against, to participate in bubbles or centralized pockets if we choose, to take risk and hope to gain from it, or simply leave (which is itself a risk position). The market doesn’t judge and doesn’t want from us. It accepts us as we are, and in the last analysis, perhaps, this is what defines trust.
According to Simone Weil, who was not a stock arbitrageur (to my knowledge) but a conscientious observer of human nature nevertheless, among the many human needs there are the need for truth, the need for private property, and the need for risk. We follow and trust markets, I believe, despite (or because of) our perpetually broken understanding.
A thesis, not a forecast
In his study of financial markets, Mandelbrot does wonder why these would display their fractal patterns in ways so similar to those in nature. My interpretation, as may be evident by now, is that nature, like financial markets, is shaped by networks and network characteristics. Conversely, markets mirror nature.
The particular type of network from which financial markets are formed — unlike the roots and branches of the plants, the nervous system, rivers, or the galaxies — is a sentiment network, as already suggested, because people directly or indirectly are its nodes. To say that information leads and capital follows — an idealized representation of market flows — is also to say that sentiment leads and capital follows — a more realistic representation, no doubt, as information is never transacted upon in unfiltered state. Markets are thus, in principle, sentiment exchanges, and no wonder that their ups and downs are marked by a blend of choppiness and calm that only fractal geometry can approximate.
Some analysts seek to quantify market sentiment with volume and volatility measures, in addition to the more obvious price direction that everyone already follows. This is not a flawless quantification, as very little (maybe nothing) that relates to sentiment is without flaw. The best analysis, I believe, would add a probabilistic qualifier.
Based on the discussion that preceded, which is subjective though not without evidence, I believe that markets in the coming year(s) will be marked by:
- increased volume (reflecting a relative degree of popular trust in markets, in contrast with other worldly affairs), and
- increased volatility (reflecting the relative distrust of worldly affairs, in contrast with the markets).
This is a thesis, not a forecast, and while directionally linear it is the underlying zig-zags and rugged fractal edges that would as always dictate where the profits and the losses are realized.
Related essays:
Markets and the years ahead: The Investment Thesis
Linear perception, exponential change, and the new value
