Introduction To Financial Interferometry
Interferometry is a technique of superimposing waves upon a system in order to extract information about the complex harmonic motion of the system which is in a dynamic, constantly changing and seemingly random state.
Financial Interferometry is a discipline I made up from scratch to explain my observations and to explain them in terms of known differential equations.
It is in no way any different from any other form of interferometry, it is the use of the principles of wave propagation to gain a deeper understanding of how financial markets operate. Specifically the impulse response of the system or market in question.
It is the constants of this system that you need to know to understand the duration of the trend with any accuracy.
Or to put it in lay terms the study of cycles. We all understand intuitively that markets are cyclic, the word cycle means to return to the same place.
The word rhythm means some thing that reoccurs at regular predictable time intervals. The difference in the two may seem like splitting hairs but it is of great importance when it comes to observing market cycles.
What we are looking for is rhythmic cyclic behaviour which can be predicted in terms of a probability distribution and not just hand wavy platitudes about future economic trends.
Most importantly something a little more sophisticated than Black and Scholes, regardless of the fact that it is the standard in the market does not mean it is the best way to do it.
The assumption that markets are always normally distributed was proven disastrously wrong with the collapse of Long Term Capital Markets. Where Myron Scholes demonstrated that when Clint Eastwood said “A mans got to know his limitations” he knew what he was talking about.
A mathematical definition of the trend and a way to measure the forces that cause it in the first place would be the holy grail of markets.
This is generally considered to be impossible just like every thing else in the history of the world that was worth discovering, having said that all that there may not be a holy grail as such but there may well be a holy integral and if there is I would very much like to know the equation of such a function.
If you have every looked at a market chart in any detail you will be all to aware that markets are made of trends and trends are made of trades or transactions to be more specific. Trades are in themselves just vectors with an opening point and a closing and a closing point.
So all a trend is the sum of all the vectors or trades that formed it, and a market is the sum of all the trends.
The question is how to rationally summarise all this information into a useful set of differential equations that can be applied to determining how dynamics markets behave.
The Laws of Financial Interferometry.
- A price at rest will remain at rest unless traded upon by an outside market force.
- A price in motion will remain in motion unless traded upon by an outside market force.
- For every transaction there is an equal and opposite transaction.
A price at rest will remain at rest unless acted upon by an outside market force.
Unless Somebody buys or sells a security its price cannot change the bid and ask may change but the price is by definition the price of the last time it traded.
Therefore a price will only change when someone applies a force to it either by buying it or selling it.
A price in motion will remain in motion unless acted upon by an outside market force.
For a market that has begun to move all that is required for a trend to form is that there be a bulge in the volume above the long term average to get it moving this is how new money has enters the market.
This extra volume and the new money represents the applied force.
The speculators then keep trading it in circular trades of ever increasing or decreasing prices and leverage.
As the prices change the market leverage changes depending on the direction of the trend. That is to say as the market goes up the leverage of all the speculative positions in the market goes up.
This is the spring force that is the restorative force that brings about the change in the major trend direction in an attempt to reach equilibrium and a steady state solution as profits are taken and the inevitable profit loss distribution curve of a near zero sum game evens itself out. I say near zero as dividends are an inflow.
In a leveraged market this process is highly exponential especially on the down side as the margin calls go out and a cascade collapse take place, this is the real reason markets collapse not because of panic selling but from a lack of new buyers because the system has reached the limit of new money available in the hands of investors.
Also know as a correction.
For every transaction there is an equal and opposite transaction.
If you buy something in a zero sum game then sooner or later you must sell it back to the market. So there are always two sides to a trade, with one for each leg of the transaction and each side of the trade with respect to time these two transactions are of equal and opposite force and cancel out.
As I am sure you are aware these are just rewrites of Newtons laws in the language of markets which is the point, the inputs to market may be non Newtonian but on close inspection a great deal of market behaviour over time suggests that the sum totals of all the input forces form well defined vectors.
Next In this Series The Laplace Transform and Compound Interest