The Online Investing AI Blog

Since my posts about BP have been quite popular recently, I thought I would comment on this article on Yahoo Finance. The article talks about how BP may be able to cap the well in the next few weeks. As I mentioned in the first post about BP, usually the market overreacts to bad information.

In this case, it turned out that the situation was really bad, in fact it is the worst oil spill in history. And the blame is landing squarely on BP.  The share price has gone down since the accident,  and it seems that the well will be plugged soon. Although we now know the massive damage caused by the well, it seems that BP’s share price may be turning around.

Does this mean that the price is heading back up?

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As you probably know, there was quite a bit of excitement on Wall Street yesterday. Apparently a panic was caused by images of rioters in Greece. And then it was announced that there was some kind of trading errors that caused or perhaps exacerbated the selloff. Was this really what happened, or is it just a way of trying to calm the markets?

I thought it was an interesting question because it shows the difference between what people expect and what people don’t expect. Events like the Asian Financial Crisis and the Russian default in the 90’s were largely unexpected, and these were termed Black Swans. They had massive effects on the economies and markets of the world, and caused the largest Hedge Fund collapse in history.

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Complexity by nerovivo @ Flickr

We’ve been having an interesting conversation about randomness and how it relates to investing and trading.

George talked about it in his book review of  Nassim Taleb’s Fooled by Randomness and our friend Nick wrote about it in this post at Becoming Capitalist. Like all great conversations, it made me think. The idea all boils down to primarily one question: is the market propelled by either determinacy or randomness?

And it leads to an even more important question: can we predict the market?

As far as whether the market is deterministic or random, I arrived at this conclusion: yes. It’s a “both-and,” not an “either-or” situation. The market is based on both determinism and randomness–at the same time. How can that be? Aren’t they mutually exclusive?

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Today I am finishing Fooled by Randomness by Nassim Taleb, and I must tell you it is a pretty interesting book. Although his wandering and complicated style is over my head, he brings up some very interesting issues that are ignored in just about every other book I have read about trading.

It is particularly interesting for us because it explains many of the technical results that we have achieved during the development of Automated Trading systems. Nassim explains why backtesting is a poor approach at best, and downright fraudulent at worst. But this is really a subset of an idea that has been percolating inside my mind, and he has been able to explain it quite well. It is the idea of the religion of science.

What is the religion of science?

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Black swans really didn’t swim into global consciousness until the late summer of 2008 when the frazzled pieces of the global economy completely frayed, like the rope holding a piano dangling above a busy city street in an old silent film.

But, Nassim Taleb had spotted the creature in 2007, writing about how sudden, outlying events affect the financial markets in Black Swan, the Impact of the Highly Improbable. He mentions September 11 and stock market crashes as Black Swan-type events.

Whether any of the events were truly unpredictable–or just extremely complex, isn’t the point of this piece. What intrigues me now is, if we accept the premise that a Black Swan is unpredictable, can a reverse Black Swan be created?

In other worlds, if a series of seemingly random and unconnected events are behind a stock market crash, it would be foolhardy to believe that a group of government officials could somehow engineer a stock market rally.

This seems to be the goals of a flurry of government initiatives, taxes, bills, and programs–from cap and trade policies to internet affiliate taxes.

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If you’re not sure what the black swan is, check out the book by Nassim Nicholas Taleb.

Essentially (and I’m vastly over-simplifying), Taleb’s point is that your brain is fooled by randomness and that you must be able to recognize the large-scale events that can cause massive and chaotic change in the market.

Taleb refers to these events as “black swans,” based on the notion that everyone believed that only black swans existed, when, lo and behold a species of black swans was discovered it.

To simplify this even more: S**t happens.

The question for me, since I’m interested in how technology can predict asset movements, is: how can we predict a black swan.

I don’t think you need to. The problem isn’t that there is an agnosticism about black swans; the problem is when investors cling to white swans and aren’t nimble enough to jump on the long neck of the black swan.

I believe that technology is suitable adapted–or could be adapted–to not only recognize a black swan moment, but also move assets and change positions into its flight path.

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