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Financial markets are random, they evolve, and they may be the most complex dynamic phenomena we humans have yet to solve. Financial markets don’t have precise laws. Financial markets don’t have exact mathematical solutions no matter how much data you have. But two portions of the business sector come the closest to connecting the laws of natural sciences to an unpredictable environment.

If you have ever experienced an economics class, you understand prices fluctuate based on supply and demand. You also understand that supply and demand have a middle spot, known as equilibrium. The laws of supply and demand and how it affects price fluctuations may be the closest thing to the laws of physics.

Before you read further, you must be aware of the three differences between natural sciences and economics.

1. Natural sciences are not based on human feelings or emotions. Contrarily, economics focuses on how humans divide the scarce goods and resources they receive. Given this, economics must account for human emotion and decisions

2. In economics, human attitudes drive where goods and resources go. It isn’t something universal, like the laws of physics, chemistry, or mathematics.

3. You can quantify scientific observations. If you have found a way to quantify social behaviors, let me know.

Despite these complications, econophysics is a growing research field. Econophysics assists to solve economic problems by applying the concepts and methodologies of physics. Think of it as a convergence point between the objective world of physics and the subjective world of economics.

To understand econophysics at a very basic level, three researchers from the Western University of Arad in Romania marked out a couple of allusions. The article is linked at the bottom of the newsletter.

Florin Turcaș, Florin Cornel Dumiter, and Marius Boiță first alluded to the weather. Like the weather, markets are good in the middle. Both are applicable and reasonable at their middle point. Each doesn’t have too high or too low of expectations, but when each reaches their extremes they lose their relevance. You hear lots of chatter at extremes, but everyone is calm in the middle.

The three researchers next alluded to earthquake occurrences. While both are unpredictable, the time between downtrends in financial markets and earthquake eruptions allows for a better estimation of occurrence. Think about the years between the most recent bear markets. From the late 2000s until 2020, we experienced approximately a decade of higher growth. According to the Hartford Fund, a bear market occurs on average every five years. Although the Covid recession was unpredictable, markets were long overdue for a bear market.

The best way to describe the three researchers' following allusion is randomness, also known as the random walk theory. Random is what financial markets are on a daily basis. The random relies on attitudes towards risk and return or market sentiment. Nothing is constant, perfect, or predictable but we can use statistical variables to get a rough idea of where the market goes.

Fourth, investing and forgetting about your investment 90% of the time is like only playing about ten to fifteen percent of your hands in poker. Like playing your hand when it demands you to, you shouldn’t stop investing unless the market demands you to. Luckily for you, it isn’t a common occurrence despite you hearing threats of a market crash every five to ten years.

Turcaș, Dumiter, and Boiță next alluded to an old chemistry principle from 1884. Although not a physics law, the Le Chatelier Principle is fascinating to understand how volume and price action interact with each other. The Le Chatelier Principle is as stated, “If a dynamic equilibrium is disturbed by changing the conditions, the position of equilibrium moves to counteract the change.” Nobel-winning economist Paul Samuelson first equated this principle to the economy in 1947. The price of a company’s stock price relies on its bid/ask spreads, or its supply and demand. When the equilibrium between the bid and ask spread breaks, the asset settles on a new price point. For example, during the late 2000s, as the trend of the market began to decrease, volume spiked attempting to counteract the changing conditions of the market.

Financial markets are dynamic and nonlinear. They experience troughs and peaks and some periods of the market perform better than others. Think of it like ocean waves. When you’re in the water ready to jump a wave, you judge whether you jump over it or duck under based on how big the wave gets. If you made this same analysis when the wave was farther out, you may have made a different decision. Some ETFs and market indices perform better in certain periods of time. Your investment decision and results will depend on your initial conditions.

Financial markets are random, complex, and affected by market participants subconsciously trying to form the market to their best outcome. Any strategy is suitable for any amount of time, but the market changes; it evolves. But don’t expect your results to be the same as everyone else’s. Every investment has a different probability in a different timeframe, even if it is the exact same investment. Even the formulas and laws of statistics and economics can only go so far. Each has thresholds and when conditions exceed the thresholds anything can happen. It is simply unpredictable. The financial markets may be the single most complex phenomenon humans may never be able to solve.

That’s all for this week! I hope you enjoyed this edition! If you have any questions or recommendations feel free to comment down below!

Trey

Link to Article: https://www.researchgate.net/publication/359111287_Econophysics_Techniques_and_Their_Applications_on_the_Stock_Market