Technical market analysis applies mathematical analysis of patterns in
2-D data sets to stock market (actually, any financial market) buy,
sell, and hold decisions. The two dimensions are, of course, market
price and time. This entry looks at one reason such data sets should be
viewed as chaotic systems.
You've all heard that the so-called Butterfly Effect is a characteristic of chaotic systems. It is the fact that small, seeming unrelated happenings can have major effects on results in a chaotic system. The classic version says that a butterfly flapping its wings in China (or some other remote location) can cause a hurricane to hit South Florida.
Since few of us have a real feel for how global weather patterns develop, we all tend to say: "Yeah, yeah. Blah, blah, blah. I've heard it before, and sure it might be real to weather patterns, but it's not real to me."
This story, however, illustrates in a way we all can relate to how the Butterfly Effect works in another chaotic system -- financial markets of all kinds. I offer it up to help unbelievers understand that these markets are truly chaotic. How chaos rules stock market price movements, and how to understand its effects, is mathematically complex, but the starting point is to accept that accurate financial market analysis is impossible without using chaos theory.
That's not to say technical market analysis based on chaos theory tells the whole story. The full development shows that fundamental stock analysis is necessary to understand the forces driving stock-price movements, which technical analysis only describes.
This story depicts characters and events that are fictitious. Any similarities.... You know the rest. That the story depicts how real people and events interrelate you can judge for yourself.
In 1992, Xin Hua was a wildlife photographer in China on assignment as part of a Peoples Republic grant to Professor Yau Khan of Beijing University to study insect flight dynamics for the purpose of improving the performance of high-speed aircraft. Prof. Yau wanted to obtain high-speed video of butterflies in free flight, rather than tethered in a wind tunnel.
Such free-flight photography is difficult because, unlike the situation in a wind tunnel where the insect is constrained to be stationary in the vision system's field of view, the insect is free to move in three dimensions, while the camera must follow it. For this reason, Prof. Yao hired Xin, reputed to be the best photographer in China for this type of assignment, rather than try to do it himself or assign it to a graduate student.
Xin spent weeks trying to obtain a few minutes of film that would meet Prof. Yau's specifications. The weeks turned into months as Xin filled dozens of CDs with hours of clips showing hundreds of different butterflies flitting across fields in rural China. Finally, he had an hour or so of video that could be used in Prof. Yau's study, along with days worth of video that was beautiful, but not quite what Yau needed.
Being one of China's hungry young entrepreneurs, Xin negotiated a contract with Beijing University and the People's Republic Central Committee that would allow him to market his excess butterfly video worldwide through stock photography service Corbis. Xin shared the royalties with Beijing University. The Central Committee was pleased to have economic stimulus.
Akira Matsumori was an advertising executive at a firm in Tokyo, Japan. One of his firm's client's was the Japanese Tourism Bureau, and, in early 1994, he was assigned to create a wonderful new ad campaign to promote the Cherry Blossom festival to potential tourists throughout the world. Matsumori developed a campaign composed of a number of ads that all climaxed with a butterfly landing on a cherry blossom.
There was no way he was ever going to obtain actual footage of a butterfly flying in from the left to land on a cherry blossom located on the right side of the screen, with all of the action limited to the bottom third of the frame, so he hired the American film graphics company Industrial Light and Magic to create a lifelike sequence using CGI technology.
To ensure that the butterfly flight was realistic, ILM artists purchased stock video from Corbis showing slow-motion butterfly free flight. The video they studied was, of course, Xin Hua's, because it was practically the only slow-motion close-up video of butterflies in free flight existent.
From Xin's video, the ILM artists developed models of how a butterfly's wings would move if it were flying horizontally from the left and landing on a cherry blossom on the right. They then used thier models to render a butterfly animation to match Matsumori's art director's specifications. They gave the butterfly a dramatic wing coloration pattern based on stock photos of North American Monarch butterflies, with black borders and an arresting gold-color fill.
By the Fall of 1994, the Matsumori's ad campaign was ready to roll out worldwide to generate interest for the 1995 Cherry Blossom Festival in late Spring. By January of 1995, the ads were blanketing television channels all over North America, from Mexico to Canada.
Maria Delgado was a travel agent in Tijuana, Mexico. Her husband, Manuel, had a highly successful leather-goods store catering to tourists. Part of Manuel's sales strategy was to mark relatively high prices on his goods, so that he could give deep "discounts" during protracted negotiations with customers. This was lots of fun for the tourists, and gave them a sense of accomplishment by negotiating the deep discounts. Manuel's shop did very well.
Manuel brought in a large stock of handbags, boots, leather jackets, and pants to sell during the annual motorcycle run starting from downtown San Diego, California and ending in a big parade along Tijuana's main thoroughfare. It was to be a huge tourist marketing event, and Manuel's shop was busting at the seams!
The week before the motorcycle run, Maria saw Matsumori's Cherry Blossom Festival advertisement. Being in the travel business, she had arranged vacations for hundreds of tourists, but, being an aggressive Mexican entrepreneur like her husband, she had never taken a vacation herself. Matsumori's ad made the travel bug bite her hard!
She loved the exotic scenes of Japanese landscapes. She wanted to go shopping in the Ginza. She wanted to visit Buddhist temples. Especially, she absolutely fell head over heels in love with ILM's CGI animated butterfly. It was so lifelike and moved so beautifully.
Making an instant decision, she threw caution to the winds and negotiated a practically free flight for her, Manuel, and the children to go for a month-long tour of Japan during Cherry Blossom time. With her travel-business connections, she obtained cut-rate accommodations near all the great Japanese tourist attractions. It was going to be a huge surprise for Manuel when she told him at dinner that night.
Oh, it was a surprise alright. In fact, it was more of a shock. "We can't do that! My shop is full to bursting with stuff for the motorcycle run as well as the stuff for the rest of the Summer. I can't just walk away and leave it for a month."
"We can afford it," countered Maria, "We've been doing very well. We can afford to take a month off for the children to see Japan before they grow up. Besides, I can't cancel all these reservations. I had to put down deposits and everything."
"But, all our cash is tied up with this stock."
"You'll just have to sell it during the motorcycle run. Clear the store out , and we'll have cash to enjoy our trip."
During the mid-1990s, my wife, Bonnie, and I were living in western Arizona, and we attended the Tijuana Run every year with friends from the local motorcycle repair shop across the border in Needles, California. In 1995, I'd just sold a struggling magazine I'd started and been trying to keep afloat. For the first time in a couple of years, we had a little money in our pockets.
After the motorcycle run and the parade, we settled down for some serious shopping. Bonnie was still carrying around the beige handbag I'd bought her several years before. It certainly didn't go with her black leather motorcycling outfit, and was well past its prime, anyway. So, she was in the market for a replacement that would be more appropriate. She found it in Manuel's shop.
Now, I never really enjoyed the kind of aggressive negotiations Manuel specialized in. I don't much like confrontation, and don't much care whether a pocketbook costs $30 or $50 as long as I have the cash and think it's not a ripoff. Bonnie, however, likes negotiating a bargain. So, I always let her do the deals.
"You pick out anything you want, and get the price you want. I'll pay for it," is what I told her.
Because Manuel's travel-agent wife had fallen in love with an animated butterfly based on a real butterfly photographed by a Chinese wildlife photographer, the market price for that handbag in that shop at that time on that morning was $15 -- well below the $45 I'd have expected to pay for it in the States.
Notice that the handbag did have an intrinsic value based on the cost of the materials, labor, energy to make it and transport it to Manuel's shop, along with carrying costs Manuel incurred by keeping it in the store, and having a store to keep it in. That intrinsic value is the value a financial accountant would arrive at by fundamental analysis.
It is not, however, the market value. The market value is simply set by two parties negotiating one sale. It's based on a host of factors including, but not limited to, the two parties' ability to negotiate, their desire to make the sale, and the amount of coffee they'd drunk within one hour of starting the negotiations.The intrinsic value of the the item is only one factor among many.
In this case, the flapping of the Chinese butterfly's wings had a profound affect on the two parties relative willingness to make a deal, which had a major affect on the price arrived at.
The take home lesson is that hundreds of such seemingly unrelated events affect each and every sale of a financial instrument, whether the deal is struck between amateurs, professionals or 10 year olds swapping baseball cards. That fact makes stock markets -- indeed all markets -- chaotic systems.
You've all heard that the so-called Butterfly Effect is a characteristic of chaotic systems. It is the fact that small, seeming unrelated happenings can have major effects on results in a chaotic system. The classic version says that a butterfly flapping its wings in China (or some other remote location) can cause a hurricane to hit South Florida.
Since few of us have a real feel for how global weather patterns develop, we all tend to say: "Yeah, yeah. Blah, blah, blah. I've heard it before, and sure it might be real to weather patterns, but it's not real to me."
This story, however, illustrates in a way we all can relate to how the Butterfly Effect works in another chaotic system -- financial markets of all kinds. I offer it up to help unbelievers understand that these markets are truly chaotic. How chaos rules stock market price movements, and how to understand its effects, is mathematically complex, but the starting point is to accept that accurate financial market analysis is impossible without using chaos theory.
That's not to say technical market analysis based on chaos theory tells the whole story. The full development shows that fundamental stock analysis is necessary to understand the forces driving stock-price movements, which technical analysis only describes.
This story depicts characters and events that are fictitious. Any similarities.... You know the rest. That the story depicts how real people and events interrelate you can judge for yourself.
In 1992, Xin Hua was a wildlife photographer in China on assignment as part of a Peoples Republic grant to Professor Yau Khan of Beijing University to study insect flight dynamics for the purpose of improving the performance of high-speed aircraft. Prof. Yau wanted to obtain high-speed video of butterflies in free flight, rather than tethered in a wind tunnel.
Such free-flight photography is difficult because, unlike the situation in a wind tunnel where the insect is constrained to be stationary in the vision system's field of view, the insect is free to move in three dimensions, while the camera must follow it. For this reason, Prof. Yao hired Xin, reputed to be the best photographer in China for this type of assignment, rather than try to do it himself or assign it to a graduate student.
Xin spent weeks trying to obtain a few minutes of film that would meet Prof. Yau's specifications. The weeks turned into months as Xin filled dozens of CDs with hours of clips showing hundreds of different butterflies flitting across fields in rural China. Finally, he had an hour or so of video that could be used in Prof. Yau's study, along with days worth of video that was beautiful, but not quite what Yau needed.
Being one of China's hungry young entrepreneurs, Xin negotiated a contract with Beijing University and the People's Republic Central Committee that would allow him to market his excess butterfly video worldwide through stock photography service Corbis. Xin shared the royalties with Beijing University. The Central Committee was pleased to have economic stimulus.
Akira Matsumori was an advertising executive at a firm in Tokyo, Japan. One of his firm's client's was the Japanese Tourism Bureau, and, in early 1994, he was assigned to create a wonderful new ad campaign to promote the Cherry Blossom festival to potential tourists throughout the world. Matsumori developed a campaign composed of a number of ads that all climaxed with a butterfly landing on a cherry blossom.
There was no way he was ever going to obtain actual footage of a butterfly flying in from the left to land on a cherry blossom located on the right side of the screen, with all of the action limited to the bottom third of the frame, so he hired the American film graphics company Industrial Light and Magic to create a lifelike sequence using CGI technology.
To ensure that the butterfly flight was realistic, ILM artists purchased stock video from Corbis showing slow-motion butterfly free flight. The video they studied was, of course, Xin Hua's, because it was practically the only slow-motion close-up video of butterflies in free flight existent.
From Xin's video, the ILM artists developed models of how a butterfly's wings would move if it were flying horizontally from the left and landing on a cherry blossom on the right. They then used thier models to render a butterfly animation to match Matsumori's art director's specifications. They gave the butterfly a dramatic wing coloration pattern based on stock photos of North American Monarch butterflies, with black borders and an arresting gold-color fill.
By the Fall of 1994, the Matsumori's ad campaign was ready to roll out worldwide to generate interest for the 1995 Cherry Blossom Festival in late Spring. By January of 1995, the ads were blanketing television channels all over North America, from Mexico to Canada.
Maria Delgado was a travel agent in Tijuana, Mexico. Her husband, Manuel, had a highly successful leather-goods store catering to tourists. Part of Manuel's sales strategy was to mark relatively high prices on his goods, so that he could give deep "discounts" during protracted negotiations with customers. This was lots of fun for the tourists, and gave them a sense of accomplishment by negotiating the deep discounts. Manuel's shop did very well.
Manuel brought in a large stock of handbags, boots, leather jackets, and pants to sell during the annual motorcycle run starting from downtown San Diego, California and ending in a big parade along Tijuana's main thoroughfare. It was to be a huge tourist marketing event, and Manuel's shop was busting at the seams!
The week before the motorcycle run, Maria saw Matsumori's Cherry Blossom Festival advertisement. Being in the travel business, she had arranged vacations for hundreds of tourists, but, being an aggressive Mexican entrepreneur like her husband, she had never taken a vacation herself. Matsumori's ad made the travel bug bite her hard!
She loved the exotic scenes of Japanese landscapes. She wanted to go shopping in the Ginza. She wanted to visit Buddhist temples. Especially, she absolutely fell head over heels in love with ILM's CGI animated butterfly. It was so lifelike and moved so beautifully.
Making an instant decision, she threw caution to the winds and negotiated a practically free flight for her, Manuel, and the children to go for a month-long tour of Japan during Cherry Blossom time. With her travel-business connections, she obtained cut-rate accommodations near all the great Japanese tourist attractions. It was going to be a huge surprise for Manuel when she told him at dinner that night.
Oh, it was a surprise alright. In fact, it was more of a shock. "We can't do that! My shop is full to bursting with stuff for the motorcycle run as well as the stuff for the rest of the Summer. I can't just walk away and leave it for a month."
"We can afford it," countered Maria, "We've been doing very well. We can afford to take a month off for the children to see Japan before they grow up. Besides, I can't cancel all these reservations. I had to put down deposits and everything."
"But, all our cash is tied up with this stock."
"You'll just have to sell it during the motorcycle run. Clear the store out , and we'll have cash to enjoy our trip."
During the mid-1990s, my wife, Bonnie, and I were living in western Arizona, and we attended the Tijuana Run every year with friends from the local motorcycle repair shop across the border in Needles, California. In 1995, I'd just sold a struggling magazine I'd started and been trying to keep afloat. For the first time in a couple of years, we had a little money in our pockets.
After the motorcycle run and the parade, we settled down for some serious shopping. Bonnie was still carrying around the beige handbag I'd bought her several years before. It certainly didn't go with her black leather motorcycling outfit, and was well past its prime, anyway. So, she was in the market for a replacement that would be more appropriate. She found it in Manuel's shop.
Now, I never really enjoyed the kind of aggressive negotiations Manuel specialized in. I don't much like confrontation, and don't much care whether a pocketbook costs $30 or $50 as long as I have the cash and think it's not a ripoff. Bonnie, however, likes negotiating a bargain. So, I always let her do the deals.
"You pick out anything you want, and get the price you want. I'll pay for it," is what I told her.
Because Manuel's travel-agent wife had fallen in love with an animated butterfly based on a real butterfly photographed by a Chinese wildlife photographer, the market price for that handbag in that shop at that time on that morning was $15 -- well below the $45 I'd have expected to pay for it in the States.
Notice that the handbag did have an intrinsic value based on the cost of the materials, labor, energy to make it and transport it to Manuel's shop, along with carrying costs Manuel incurred by keeping it in the store, and having a store to keep it in. That intrinsic value is the value a financial accountant would arrive at by fundamental analysis.
It is not, however, the market value. The market value is simply set by two parties negotiating one sale. It's based on a host of factors including, but not limited to, the two parties' ability to negotiate, their desire to make the sale, and the amount of coffee they'd drunk within one hour of starting the negotiations.The intrinsic value of the the item is only one factor among many.
In this case, the flapping of the Chinese butterfly's wings had a profound affect on the two parties relative willingness to make a deal, which had a major affect on the price arrived at.
The take home lesson is that hundreds of such seemingly unrelated events affect each and every sale of a financial instrument, whether the deal is struck between amateurs, professionals or 10 year olds swapping baseball cards. That fact makes stock markets -- indeed all markets -- chaotic systems.
