Archive for July, 2007

Market Fractals

Fractal is a form, which appears everywhere in nature both at macroscopic and microscopic levels. Trees, clouds, DNA’s, atomic structures are all fractals. Physics, chemistry, biology, astronomy are full of fractal patterns. Mass psychology is also a fractal. Not very many books and articles are written about this universal truth.

A fractal means a mathematically definable structure which replicates itself across time and size scales. It’s like a building block of creation. A fractal at the heart of every natural creation. Break a Pine tree branch and you see the tree itself. Kenneth G. Libbrecht of Caltech came up with Snowflake physics identifying 35 classification of snowflake fractals. Natural patterns appearing again and again.

The first time a fractal was observed in markets was as early as 1880s, when Charles Dow constructed the DOW 30 and wrote his theory about the first economic fractal. We have to credit the man and his business acumen valued nearly $5 billion today and creating an industry worth trillions of dollars.

He said markets move in a wave like fractal, a tide, a wave and a ripple. There is an accumulation stage, a speculation stage two and greed and public participation finality. After which the form ends and corrects. And then the structure starts again. Dow was the first to see the mass psychology form in financial markets.

DOW 30 survived the centuries but somewhere we lost his fractal. It never got that well deserved attention, unlike modern accountancy, which started somewhere in 1880′s.

Dow identified the fractal and called it an economic theory. Elliott redefined Dow’s work and made an applied forecasting tool called the wave theory. The scale dramatically changed as fractals got seen not only on a multi year business cycle scale, but on every time frame. And on every broad asset and anything traded or non traded statistics with a socio economic aspect and implication. Be it Labor market parameters, macro economic parameters or simply global car sales, just anything.

The reasons which could explain everything about market and economics couldn’t explain why metals, energy, agro commodities, industrial commodities, forex etc. looked alike. And where reasons failed Fractals stood firm, inexplicably.

The wave theory is one tool that works across markets, across subjects on both economic and socioeconomic levels to forecast. This fractal can predict prices of say BRENT CRUDE for a tick, a minute, a day till multi years and decades in future without knowing about the Oil crisis, hurricanes, supply gaps and all that causes that may come in the future. The tool predicts the future without the breaking news, which may come years later.

So why did such a great tool took a back seat and never emerged? 1800′s was too early to understand mass psychology. Stock markets were fancy things. The mass psychology lacked critical mass, the speculator new little about leverage. Leverage reached world scale a century later. And something more was hot, information and its causal implications. There was an information and explanation for what markets were doing. And the great depression was long forgotten as the new generation took over. Econohistory owing to its black aspects was never interesting reading. Who wants to know how many banks failed in an era where a banker is celebrated? 125 years and we are still giving reasons, building businesses and knowledge technology systems unmindfully defining the fractal that defines us. The fractal that is larger than life and continues to move relentlessly with cyclical precision.

We have reached some conclusions, why we forgot the fractal. Human mind is the least understood part of the human body. Recent attempts to map the brains throw interesting light on the subject. Emotion is a key driver for the brain. We are brain dead without emotions. Further work has proved that the lizard brain (Reptilian Complex) rules our impulses, our herding tendencies, how we behave in the society and our stock market games. The lizard also explains why humans remain penny wise and pound foolish. Why we make things complex rather than simplifying them? Why we can’t stop or pause consuming as a society? Why panics happen? Why fear is a bigger motivator than greed? And why complacent society means low volatility? Reptiles also explain why Fractals don’t interest us?

Fractals are not stories we love to hear. The patterns are contrarian by nature looking at exits on greed tops and entry in busts. Fractals by very nature stand alone. They are unconventional. And above this they are a lot visual. People are different and so are their ways to learn.

Drucker classified them as group which learns by reading, or writing. This all leaves us with a small fractal lovers, only a few who can question the status quo standing alone uncomfortably. Fractal needs courage to stand against 200 years of economics and say there is no economics without psychology, and psychology is itself fractaled, patterned.

Everything has its limitations. Even fractals are not fool proof. But they are definitely better than fundamental ratios like Price Earning ratios which fail the back test miserably with no forecasting value whatsoever. Understanding fractals may take a few hours but integrating them in and above economics may take years and then like Eels said, “one day the world will be ready to see and wonder how they didn’t see it”

Simplifying TOPS

“Simplicity or singleness of approach is a greatly underestimated factor of market success.” These famous words of Garfield Drew are very hard to learn. It’s like accepting that being a fool in markets is the first step to profit. As then you are always alert to a market surprise and never get into genius’s bias.

A genius doesn’t make money in the market, the man who accepts his foolishness can turn a better profit against all market intellect. It’s something similar to another street lore, which says “beating the markets is easy, beating yourself is tough”. And to add it all, we have the classic, “Markets don’t work on hope”.

We at Orpheus believe that good research is not about making things complex, but making them easy. This brings us in sync with what Garfield said. If you still find it unpalatable, give us a minute more.

Just like POWER vs. SENSEX (India, Top 30 Index) or GOLD vs. OIL, two assets from the same market or two sectors from the same economy or two trading economies can never be disconnected. It’s all linked, Indian Rupee with Japanese Interest Rates or Brazilian sugarcane with Nat Gas or Shanghai with Soya.

The last two columns we got cues about Indian markets topping any time in the next few weeks owing to the POWER outperformance which means something as simple as an electricity bill getting more attention than all that portfolio “value”. And since ‘POWER’ is also a leading indicator for market tops along with Gold, which is a crisis commodity, we have a lot cooking here in July.

Now with CNXIT (Indian Tech Sector) vs. SENSEX ratio line also reaching an extreme, we have another cue that we are heading for at least a multi month top on India. BSE 30 has never outperformed the CNXIT since 2003. How could it? We are the ‘Tech’ nation, technology being a core competency. No it’s not like that. Technology is an early economic cycle sector, which invariably does worse when markets step in a late economic cycle stage and well in an early economic expansion. It’s a leading sector for the economy and the out performance or parity peformance is CYCLICAL. The last two times SENSEX-CNXIT ratio line reached near parity (1) was in Apr 2004 and May 2006. We all know what happened, massive drawdown, which we had someone to blame on. First time it was the BJP (leading political party) loss and second time the Hedge fund panic.

Now we have reached there again, July 2007. Well timing is a tough job, but it seems there’s not much the indicator can travel north from here. So if we assume we are at another inflexion point, the equity meltdown should start any time soon. INTERMARKET is simple. Let’s see how this simplicity pans out this time.