What do the biosphere, Twitter, Facebook, a colony of ants, your brain and the financial markets? They all are complex systems. understand the true nature of financial markets is a crucial step for become better savers: you will look at the evolution of investments with a more disenchanted and aware eye. Without slices of mortadella on the eyes, in short.
What is a complex system?
To understand what a complex system is, it is good to start from a simple system: one in which the behavior of the whole can be understood starting from its smallest components. A bucket of sand, for example: from the physical and mechanical properties of a single grain, those of the bucket full of sand can be deduced with great precision.
Not so for one complex system, which behaves very differently than the individual parts. Take the biosphere: the four most abundant elements are hydrogen, oxygen, carbon and nitrogen, whose chemical/physical properties are well known. But, based on them, it is impossible to deduce the evolution of weather and climate. The same happens with the financial system. The most important micro elements (men), have well-known properties (psychology). But the behavior of the aggregate, ie the market, is very different. More complex, to be exact. Let's delve a little deeper.
What characteristics does a complex system like the financial one have?
– High interconnection
The agents of the financial system, i.e. banks, mutual funds, traders, hedge funds, pension funds, central banks, individual savers and so on are linked to each other. There are many possible links: credit/debit relationships, or buyer/seller relationships, or belonging to the same company or group. The graphical representation of interrelationships looks like this.
– Feedback
What happens in one part of the financial system affects another sector: for example, aSell-off of government bonds in Greece influences the decisions of other traders, triggering a sale of bondItalian, Spanish and Portuguese. THE feedback they can self-reinforce, in a positive way, amplifying the phenomenon: sale triggers sale…
– Memory
And the feedback between two different moments: a past event can influence the present and the future. For example, the closure of the Tokyo stock exchange can affect the opening of the European stock exchanges. Or, the trend of the markets influences i medium, which in turn influence the markets.
– Adaptation
Agents adjust to conditions, learn and adaptFor example, as the FED changes interest rates, managers change portfolios. Or, introducing the Tobin Tax on a financial centre, operations migrate to other exchanges where the tax is not applied.
- Opening
The financial system is open, influenced by external events such as wars, political events, macroeconomic data, news events, etc. In 2001, the attack on the Twin Towers in New York caused panic selling and the US stock index S & P500 lost the11,60% in two weeks.
- Alive
The financial system evolves in an apparently autonomous and unpredictable way: it looks like a living organism. Think about it: how often do we talk about “market mood”? Or "exchange nervousness"?
– Non-linear phase transitions
They arise spontaneously extreme and violent phenomena that take individual operators by surprise; for example, crash and “ran to the counter”. If a massive number of traders perform similar actions, it goes from normal to extreme conditions in a short time.
The graph in the photo shows the daily returns of the stock index Dow Jones in the last century: the alternation of these moments is evident, true phase transitions, such as when a substance passes from the liquid to the solid state. The disproportionate reaction can be caused by a few subjects: just as in a packed theater a thunderous applause can arise from the applause of a single spectator, so in the Stock Exchange aSell-off it can start from single sales operations.
The implications for savers
A complex system is almost impossible to predict and control in the short term. There is no control panel to maneuver the markets, like that of your car. This rules out the demented theories of the “great conspiracy” of the financial markets, the subject of regular rantings on medium.
Furthermore, episodes of great volatility, crash, moments of panic, are typical of the markets. Like summer storms. Then they pass. And in the long run, the financial system remains, at least for now, the best place to invest your savings.
