Activists turning chaos into predictions

How we wish that we could understand capital markets. Then it would make sense to do all the things we currently are doing, like make short-term forecasts on equity markets and certain equities.

Level two chaotic system. 
How we wish that we could understand capital markets. Then it would make sense to do all the things we currently are doing, like make short-term forecasts on equity markets and certain equities..
Published 2015-10-21

Level two chaotic system

However, predicting markets does not make any sense at all. Improving companies and their communication however does.
    
Historic development of equity prices cannot be predicted because it is truly chaotic. So many uncontrolled forces are at work and their unpredictable interactions are so complex those extremely small variations in the strength of the forces and the way they interact can produce huge differences in outcomes. Historic equity market development is what is called a “level two” chaotic system. Chaotic systems come in two forms. Level one is chaos that does not react to predictions about it. The weather is a great example of a level one chaotic system as although it is influenced by a myriad of factors, and we can build computer models that take more of them into consideration, the development of the weather does not react to our insights.
    
Level two chaos is when the predictions themselves change the outcome of the chaos. Equity markets, for example, is clearly a level two chaotic system. If an analyst develops a simulation that with 100 per cent accuracy will forecast the price of IBM tomorrow, the price will instantly react to the forecast, which would consequently fail to materialise. An example would be if the current price of IMB shares is $150, and the infallible computer program predicts that in a month it will be $200, the skilled analyst would rush to buy shares so that they can profit from the predicted price rise. As a result, the price will shoot up to $200 over the next few days rather than in a month. What will then happen in a month? Nobody knows.
    
The chaos in equity markets is the classic issue of “what” and “why”. We can clearly se what happens and can produce “what”-related financial theories. No one can however explain “why” things happen. It is too complex.
    
What do make sense however are the actions of activists. They do not take a chance on the “why” but take control of the outcome. They abolish the chaos in equity markets by changing companies regarding strategies, management and corporate reputation, the things that truly matter for the investment community.
    

Ulf Löwenhav


The article is written by Ulf Löwenhav
Send email to ulf.lowenhav(at)reaktionvalue.com
Twitter @ulflowenhav

 

EQapital.com

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