# Chaos Theory Revisited



## wayneL (29 July 2007)

"A butterfly flapping its wings in San Fransisco may cause a tempest in Japan" (paraphraing from memory)

Chaos theory states, in very simple terms, that unexpected results can result from normal equations, because ALL of the inputs are unknown, hence the butterfly quote above.

See: http://en.wikipedia.org/wiki/Chaos_theory
http://en.wikipedia.org/wiki/Butterfly_effect

As applied to the stockmarket, it is applied in two distinct ways

1/ That patterns may emerge where at first glance, there seemingly are none.

2/ That as all inputs into what causes prices to move cannot be known therefore are not predictable past the immediate future.

In the pure scientific sense, the application of chaos theory to finance is controversial, and perhaps erroneous, but in my view, a certain aspect of chaos theory is applicable; that is the Butterfly effect.

This could imply that one small factor in the complex world of finance could take the whole system out. For instance there is incredulous disbelief that a few problems in the subprime sector of the US mortgage market could take out the whole financial system... well it could.

What caused the crash of '87 or indeed 1929, or any of the financial calamities of the last two centuries? We can all look to some explanation after the fact, but at the time, it was butterfly wings.

A few of us here have been pointing to flapping butterfly wings for the last 2 or 3 years and while it doesn't pay to hide in a cave and do nothing, it does pay, if building something, to build to relevant cyclone codes, so that you survive if it does hit.

There are more than a few empires built of sticks out there that will fall over at the first breath of wind. Indeed, some are already falling over, and in rapidly increasing numbers.

So don't exclusively look at the fine skies, the beautiful hostess serving you drinks, your chubby midriff from feasting on the fat of the land, because the barely perceptable breeze from the butterflies wings has started to develop in a swirling wind, the barometer is dropping and there are storms on the horizon.

They might pass by, and cause no damage, but they might not.


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## YOUNG_TRADER (29 July 2007)

As Elton John would say "The bitch" errrrrrrr I mean "The Bear is back" :

This time next year my friend I may join you, until then "En Garde!" :chainsaw:


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## wayneL (29 July 2007)

YOUNG_TRADER said:


> "En Garde!" :chainsaw:



LOL

Don't worry, I have by bullish sectors marked out. 

The thing is, we don't get to choose when we turn into a bear, the market does. This may be it now, I don't know, but I don't think this is the big one.

I am just as pleased as punch that we have a return to volatility, but hope we don't get TOO much vol... it can be a real BYATCH to trade.


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## Bushman (29 July 2007)

wayneL said:


> "A butterfly flapping its wings in San Fransisco may cause a tempest in Japan" (paraphraing from memory)





Quick someone get the fly spray...


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## chops_a_must (29 July 2007)

wayneL said:


> "A butterfly flapping its wings in San Fransisco may cause a tempest in Japan" (paraphraing from memory)
> 
> Chaos theory states, in very simple terms, that unexpected results can result from normal equations, because ALL of the inputs are unknown, hence the butterfly quote above.
> 
> ...



The immeasurability and incalculability of something certainly does not lead it to become indeterminate automatically.

But posing these sorts of questions are good to ponder philosophically when they are applied to the markets. I'm going to start a thread on probability. I find these sorts of questions rather fascinating.


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## YOUNG_TRADER (29 July 2007)

lol Wayne,

I think thats you in the pic about to slay me, one question how on earth did you manage to curve my sword so much? ? ? ? You must be Edmond Dantes!

As for volatility, two of my largest positions have put on between 250%-400%, be interesting to see how far they fall in the past 2-6weeks


Interesting times ahead no doubt,


"If you go down to the woods today your sure of a big surprise ... "


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## Wysiwyg (7 January 2009)

Obviously some order is in place at the moment, maybe due to the end of year holidays but nonetheless order.

One wonders whether there can be any worse news of a contracting economy or if the worst has been revealed.In all probability the worst has been revealed.

Bring back the chaos. via a good reason of course)


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## Stormin_Norman (7 January 2009)

contagion not chaos theory with butterfly wings.


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## rub92me (7 January 2009)

Stormin_Norman said:


> contagion not chaos theory with butterfly wings.



Could you expand a bit on that? I think that I agree with you if you're stating that contagion (or domino effect) is a better description of what we've seen unfold in the past 12- 18 months than butterfly effect. However I also think that what _could_ come next could go beyong contagion.


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## Stormin_Norman (7 January 2009)

it what we have seen the the past 18 months. a flu epidemic starts with a single sneeze.

like a cold in an aids clinic. its bad news.

what's it got to do with the price of eggs in china?


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## wayneL (7 January 2009)

Stormin_Norman said:


> contagion not chaos theory with butterfly wings.



Splitting hairs there mate. Both allegories are.... ummm, allegorical.

Both can be used to characterize what is happening.


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## Stormin_Norman (7 January 2009)

wayneL said:


> Splitting hairs there mate. Both allegories are.... ummm, allegorical.
> 
> Both can be used to characterize what is happening.




yes, that is probably true.


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## rub92me (7 January 2009)

wayneL said:


> Splitting hairs there mate. Both allegories are.... ummm, allegorical.
> 
> Both can be used to characterize what is happening.



A **** storm caused by 10,000 butterflies flapping their wings perhaps?


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## Stormin_Norman (7 January 2009)

rub92me said:


> A **** storm caused by 10,000 butterflies flapping their wings perhaps?




overgrown mutant butterflys on steroids.


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## motorway (7 January 2009)

"A butterfly flapping its wings in San Fransisco may cause a tempest in Japan" 

Well , It is more likely to unbalance a nearby butterfly which will flap it's wings
mitigating the chaos causing effects of the first..

These things always rely on

*Cēterīs paribus* all other things being equal..

They never are 

Things have to be far from equilibrium
for chaos to ensue

So the first rally in a bull market
and the first decline in a bear market
have chaotic signatures

But everything otherwise reacts 
and disturbances negated

The second butterfly does not just fall to it's death ,it reacts
and it's flapping wings re-create balance


If such and such then chaos
 but only if -->*Cēterīs paribus*


motorway


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## Glen48 (7 January 2009)

I thought we had Maxwell Smart to fight Chaos and Domino effect was to much Pepperoni on a thin and crispy.... back to online seacrhing.


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## wayneL (7 January 2009)

rub92me said:


> A **** storm caused by 10,000 butterflies flapping their wings perhaps?




Indeed.

But perhaps the first butterfly can be traced right back to '97(?) with Clinton's lending to minorities legislation?


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## Stormin_Norman (8 January 2009)

wayneL said:


> Indeed.
> 
> But perhaps the first butterfly can be traced right back to '97(?) with Clinton's lending to minorities legislation?




yep. markets dont fail. market intervention does.


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## wayneL (8 January 2009)

Stormin_Norman said:


> yep. markets dont fail. market intervention does.



Oh! That's a quotable quote. Post that in the Quotable Quotes thread immediately!


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## eladamrine (8 January 2009)

You can take it one step further and branch into existentialism and say that all that is certain is uncertainty. There is no certainty in anything we experience. We count on something happening because we've done it repeatedly and the same result has occured. So what we then deal with is what another reply has mentioned, probability. 

In the term of markets, i think patterns can appear because they are created by the behaviour of people, which has a tendency to repeat over history as people are predictable. But then that begs the question if people are capable of learning from past mistakes and correct their irrational behaviour in the market caused by emotion, and i think the outcome of the current recession may be a good case study. That is, if people equipped with the lessons of past depressions can significantly reduce the severity of recession through fiscal and monetary policy. But you could argue that there is some minute possibility that everyone acted irrationally  and contrary to what was expected or irrational. But i believe in hindsight what first seems perfectly irrational will later be explainable because not everyone can act totally on the contrary to what they believe to be rational. The probability of this happening would be minute, and have a profound impact on human thought, at which point financial worry would be the least of your concern as it would undermine any security or certainty you have of anything. 

In addition another reply made a good point, "The immeasurability and incalculability of something certainly does not lead it to become indeterminate automatically." That's why its a theory, there is so much that we do not know, and the perception of the human mind only goes so far. Just because we find no suitable means of measure or any neat equation to calculate something does not mean there is no inherent pattern. 

Or you can look at it from a nihilistic point, that there is no over-arching objective to life and that man is forced to create meaning in life. Patterns may be a fabrication of the mind, like literature, values, all of which are created my man as a recluse to rationalise the chaotic and mysterious experience that is life. That is to say that patterns did not ever existed and was a concoction limited to the mind, and thus because it is limited to the realm of thought then naturally it's application would be limited.


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## Wysiwyg (8 January 2009)

Appeciated that yarn eladamine.

The simple triangle is a break in proceedings.Like a steam train slowing down for disembarkation/embarkation.A gradual calmness envelops the train until it is time for movement again.All aboard she said.

At the start of the triangle are profit takers from the recent trend who leave content, followed closely by new buyers wanting a continuation of trend.The numbers of buyers and sellers at this point become relatively even.With a trend continuation not likely (lack of interest, fear, greed, accumulation, distribution, uncertainty) the trading range narrows over an indeterminable time frame.Hence forming a triangular shape.

There is the triangle with (comparative) neutrality,the triangle with bullish bias and the triangle with bearish bias.There is only three ways on my charts ... generally upwards, generally downwards and generally sideways.


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## eladamrine (8 January 2009)

That assumes that people act rationally, that they act in accordance with the information they are given and their personal values of being either risk adverse or risk loving. But i guess what the chaos theory says we never know that people will act rationally, that there might be some extreme coincidence when everyone who sells still sells but those who are counted on to buy does not buy even though it would be sensible to do so. For example say every buyer counted on to buy got struck by some epiphany contrary to market conditions, that the market is unsafe and were deterred off buying. Then what happens? Of course it would require a coincidence of a high magnititude. It is possible but highly unlikely. Hmm...but thinking now it would be impossible because people are incapable of acting irrationally and never to a degree that involves a significant enough portion of the population. Again it is possible, but highly unlikely.


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