Nonlinear Theory Explains May 6 Market Break

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1 Response

  1. Ken says:

    An observation: I think you may have used “non-linear” to mean “discontinuous.”

    More importantly, though, is that the cause of sudden plummeting prices is not non-linearity, nor is it discontinuity of prices; rather, it is a very simple concept known well in physics and mechanical engineering–unstable equilibrium. When an object is at rest in stable equilibrium, any displacement from its equilibrium point will result in a restorative force tending to push it back towards its equilibrium point. To the extent that market price is driven by “best estimates of underlying business value,” any price movement away from that estimated value point will result in corresponding buy or sell orders tending back towards the “value” point.

    Unfortunately, what you’ve characterized as the “efficient market hypothesis” has little to do with the speculative market most trading takes place in. Warren Buffet buys stock because of its underlying business value. Most speculators/traders buy stock because of their short-term expectations of price movement. And to the extent that their expectations are bayesian, strongly influenced in the time domain by most recent evidence, the market is always teetering on the edge of unstable equilibrium.

    And BTW, the answer to your question about the suggestion of an assymetric market is simple: Unstable equilibrium never causes an object to suddenly fall up. Or in the terms of your terminology, we’ve yet to see a market crash up because of panic buying.