Thursday, September 02, 2010

Market Power

Here is a Question which every would-be analyst of markets must ask. Can a math model be compiled which will match market performance with sufficient statistical accuracy to provide fully adaptive investment policy? We have a random order market with individual elements acting in independent manner, only united in the goal to show a Profit. The success of Quants will reduce the success rate of other Traders, and thereby alter the direction of the market, unless herd movement adjusts to reduce the seminal advantage to success. No one doubts that Traders and Investors are getting more adept with sophisticated trading technology, but what does this do when it becomes uniform? This is the skew which Felix Salmon discusses.

My take on all this would state that Quants will blend into human trading behavior as the technology becomes more uniform. This means the place for human choice rises as the machine reaction of models lose their advantage over regular Traders; remember, in markets, Profits above the market average must be balanced by an equal constitution of Operations below the market average of Profits gain. The whole thing leaves the arena of a proposition to abandon model direction, to a proposition of When to abandon the models. We are back to a human Guess.

Now We come to the proposition of hazard Trading, where the models are ignored; to be replaced with a Gamblers’ Risk. Many will claim that Quants will have an advantage over hazard Trading, but no one has come up with a clear picture of such fact. One has to spend much less time on data input with hazard Trading, so more Trades can be achieved in the same Time frame. Statistical Odds will tell one that hazard trading will probably be Profitable some 50% of the Time, but incur Profit losses elsewhere. Hazard Trading, therefore, will meet the market average half the Time, fall below it half the Time. Spread of Risk sideways across greater numbers of different Stocks improve the lot, though hazard Traders are loath to sell Stock below what they paid for it; this reduces the amount of capital available for Spread of Risk. The humor of all this remains the fact that consistent performance with markets will cause the majority of Traders and Investors to leave the markets poorer than they entered; this due simply to the fact that markets grind up Profits in derivative payments to the market employees. Markets would be abandoned by Investors and Traders, except for the huge wealth which accumulates to that minority of Traders and Investors who prevail. lgl

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