In 1960, meteorologist Edward Lorenz carried out a study of weather patterns and found out that insignificant factors can have huge effects on the overall outcome. It is the same reason why someone rushing to get to work can make a bad decision at a junction and make you late for work half an hour later. You have no direct relationship with the person that slept in, but their actions have a detrimental effect on you and you cannot have prepared for it.
In finance and economics the same can happen and has been studied to great lengths by some of the greatest minds such as Benoit Mandelbrot and Edgar Peters to name but two. You can go into great depth with these, even going into fractal behaviour models and some serious physics-based mathematics. It all ends up to the same basic fact. The last thing to change in the price of a stock will be the price. The price is determined by mathematical predictions of such things as, the traders personal feelings such as national bias and wanting a stock to do well or do badly, the amount of a stock that is available and the speed or momentum that can build up in the wider community of traders who are buying and selling the stock.
Chaos theory does remain controversial though and does have its detracters. Mainly because it does bring into account human behaviours therefore some see it as it cannot be placed into a purely mathematical equation or algorithm. On one side of the fence you have people that study the purely mathematical side and write algorithms based on that or behavioural economists who bring in the strengths and weaknesses of the human being and attempt to understand and prepare for human choices.
If you are looking for a model or method to follow with your investing, whether it be any theories discussed above or Elliot wave, regression data mining, or even closing your eyes and putting a pin in the financial times, the main thing is that you are comfortable and happy with it. Like any experiment, always let it run its course and then evaluate at the end, not part way through unless you know you have made a grave error in your calculations.
Be safe driving to work and the next time you are late, don’t blame the person in front of you attempting a stupid six lane manoeuvre. Blame yourself for not giving yourself enough time to adjust for the bloke who forgot his child’s swimming kit and had to turn around and go back to collect it. Even if it was half an hour before you had your cornflakes.
Paul McLardie is a partner at Total Wealth Management. Contact him at Paul.firstname.lastname@example.org