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D. Murali

ONE day it charges, another day it lies low, and yet another day it touches the abyss. We are not talking about moods, but stock market movements. They are as fickle as a politician's promises, say some, while others would compare the swings to weather, spouse's behaviour or marks in CA. If you are among those who don't think that index changes have anything to link as cause and effect, there is company.

Nature has reported about a recent economic paper from the Santa Fe Institute by J. Doyne Farmer and team. The study, titled "The Predictive Power of Zero Intelligence in Financial Markets" suggests that traders "are rather like ants swarming chaotically through the guts of a great clock, barely affecting its ability to tick".

That could look like the perfect anti-thesis of all the shouting and gesticulating usually associated with the outcry method, and the excited calls and general hyperactivity that are visible in the tech-savvy screen-trader. As if to debunk the popular myth that traders are "cold rational beings with perfect knowledge" who follow the economic maxim that dictates `maximise profits' and are aware of what the entire market is doing, Farmer's study paints traders as placing orders "at random rather than on the basis of shrewd calculation and observation of economic trends".

The researchers use data from the London Stock Exchange "to test a simple model in which zero intelligence agents place orders to trade at random." The abstract explains that the model "treats the statistical mechanics of the interaction of order placement, price formation, and the accumulation of stored supply and demand, and makes predictions that can be stated as simple expressions in terms of measurable quantities such as order arrival rates."

Many believe that traders are of two types, bulls and bears. For Farmer too, there are two types, however they are either `impatient' traders or the `patient' variety. Impatient traders "submit market orders, which are requests to buy or sell a desired number of shares immediately at the best available price" and as you would have now guessed the more patient traders "submit limit orders, which include the worst allowable price for the transaction". Thus, market orders are for the overdrive; limit orders stick to speed limits.

If the title of the paper suggests that traders operate with zero intelligence, the conclusion hastens to add: "We do not mean to claim that market participants are unintelligent". The aim rather is to provide "a benchmark to separate properties that are driven by the statistical mechanics of the market institution from those that are driven by conditional strategic behaviour."

And the authors themselves are surprised: "It is surprising that such a simple model can explain so much about a system as complex as a market, and shed light on century-old questions about the rate of price diffusion and the form of supply and demand."

"That is all okay," you might only shrug to ask: "What is the best strategy?" But Nature quips: "It is virtually impossible to find, so everyone reaches different conclusions." Since economic decision-making is varied and complex it would be hard to distinguish it from random choices.

So, better not open the big clock to unravel the mystery, as much as you would not like to take a peek at the restaurant's kitchen to see how they are cooking your dish.

SayCheek@hotmail.com

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