8 ms·

Fisics and Phynance

38 points by agarttha 14y ago

crntaylor 14y ago
The general thrust is spot on. Models are approximations. Don't confuse your models with reality. Know what your assumptions are, and have a plan for what to do when those assumptions no longer hold. Know why your models work, so that you know when they are likely to stop working. Get deep domain knowledge. Know that the market can stay irrational longer than you can stay solvent. Experiment ruthlessly. Apply the scientific method. Start simple and iterate. This probably applies to more than just finance.
- scotty79 14y ago
  Basic error is that you think you can predict fully random process. You develop a model that seems to work excellent until it doesn't. It doesn't matter whether it's sophisticated algorithm running on big iron or hunch running on wetware. You will fail because nobody knows the future. Trying to reliably squeeze money out of the market by better predicting its behavior is like trying to build perpetum mobile by trying more and more convoluted designs. All the smarts of traders ... they do nothing: http://finance.fortune.cnn.com/2013/01/24/buffett-hedge-fund-bet/ http://finance.fortune.cnn.com/2013/01/24/buffett-hedge-fund... There is money that can be reliably extracted from investing though. If you can trade faster than others, you can drain some money from them. That's why algorithmic trading yields returns. Your strength comes not from predicting future better, but from acting and reacting faster.
  - niggler 14y ago
    "If you can trade faster than others, you can drain some resources from them" What's embarrassing is how many intellectual resources are focused on this problem. For those not in finance, compare it to focusing talent on finding better advertising techniques.
  - crntaylor 14y ago
    Certainly you need to protect against over fitting your models, and you need to consider tail events. But to say that the entire market is fully random is to claim that the efficient market hypothesis holds, which it clearly doesn't - not even in weak form. Anyone who wants to claim that the EMH is true needs to explain the equity premium puzzle, the success of value investing and the persistent outperformance of momentum investing - among many other price anomalies that I could name.
    - lutusp 14y ago
      > But to say that the entire market is fully random is to claim that the efficient market hypothesis holds, which it clearly doesn't - not even in weak form. Of course it does. All evidence supports the Efficient Market Hypothesis (EMH), and note my use of the word "evidence". A contradiction would have to be a series of funds that applied a given, predefined (internally) strategy and (very important) didn't reveal its picks to the public (to avoid the announcement effect). Such an experiment hasn't been done, and those cases in which a specific strategy was applied have been universal failures. Let's say for the sake of argument that there is a surefire winning strategy as is so often claimed in worthless investment books. If it were to be recognized and then applied, it would become the new market norm, everyone would apply it, and its differential value would evaporate overnight. That hypothetical experiment merely supports the EMH. > Anyone who wants to claim that the EMH is true needs to explain the equity premium puzzle, the success of value investing and the persistent outperformance of momentum investing - among many other price anomalies that I could name. Those result from a combination of the announcement effect and insider trading. Berkshire-Hathaway is successful because people expect it to be successful, and who invest in the same stocks when they're announced. It's a self-fulfilling prophecy. The only fair, scientific test would be a strategy that is applied in secret, not in public like Berkshire-Hathaway, and in a way that doesn't tweak the market itself by way of large purchases that create their own following of fanboys. In other words, a pure computer model that is defined in advance, not tweaked enroute, that doesn't actually invest but only models hypothetical investments, and that shows its value over other systems in perpetuity. There is no such thing, and the EMH is true. Remember the Null Hypothesis, the basis of modern scientific thinking. The Null Hypothesis assumes something without evidence is false. All evidence supports the EMH.
scotty79 14y ago
Blaming people who develop algorithms for purposes of gambling (also called investing) for decade of market crashes is just silly. All markets have crashes. Faster markets have crashes more often. Markets are getting faster due to computer technology not trading algorithms. Even if algorithms were really simple it would still lead to more frequent market crashes just because dumbest algorithm can trade faster than humans previously could. And blaming physicists for 2007-08 worldwide financial collapse is just silly. It's not them that hid the risk in convoluted instruments and then sold them as if they were as solid as cash in the bank.
- lutusp 14y ago
  > Blaming people who develop algorithms for purposes of gambling (also called investing) for decade of market crashes is just silly. Unfairly blaming analysts isn't the problem. The problem is assuming that anyone can predict the future of equities markets. There's no evidence to support this idea -- all successes are chance successes, and all failures are chance failures. This is why market index funds perform on average better than funds in which a manager tries to choose future winners and charge you for the privilege of being a member, an "insider".
cjbenedikt 14y ago
Interesting but flawed....Scotty79: to argue that models cannot be blamed for market crashes is the same type of argument that says guns don't kill people. Both statements outside context are correct, yet...btw: another academic created the option formula already: Vincent Brontin who taught in Triest in 1910...and not the physicists who knew howcto treat formulae appropriately survived the crashes but street smart traders like Taleb did...experienced option traders never used Black-Scholes anyway because they knew it was flawed...an accident waiting to happen...
- barry-cotter 14y ago
  Taleb's fund failed.
  - yarou 14y ago
    And? That makes his point about ridiculous risk models no less valid.
  - cjbenedikt 14y ago
    actually it didn't ...its successor Spitznagel's Universa made enormous profits in 2008 to the tune that he now manages $6 billion....also: Taleb made his money in the '87 crash...and Empirica made a lot in 2000/2001. Taleb closed it because he suffered from trader fatigue....something quite common btw
lutusp 14y ago
A quote: "And at least some physicists have been phenomenally successful as fund managers. Indeed, the fund that is widely viewed as the most successful hedge fund of all time, the Medallion Fund, was run for twenty years by mathematical physicist James Simons–the same James Simons who lent his name to Chern-Simons theory, which has been studied extensively by string theorists." When are financial sector writers going to stop assuming that a chance success in finance is in any way the result of specific training or background on the part of a fund manager? One of two things is true -- either the Efficient Market Hypothesis (EMH) is true, in which case who you are doesn't matter, or the EMH is false, in which case anyone can make bazillions in the markets by simply applying the kinds of "sure-fire winning strategies" that are touted in any number of worthless investment best-sellers. All the evidence suggests that the EMH is true, that markets are unpredictable, and all successes are chance successes. The Wall Street Journal "Dartboard Contest" supports this idea, to the chagrin of any number of stockbrokers and analysts, who would prefer it if there were any credible evidence that their services have value. http://whyfiles.org/037wall_st/predict.html http://whyfiles.org/037wall_st/predict.html
- yarou 14y ago
  >A quote: "And at least some physicists have been phenomenally successful as fund managers. Indeed, the fund that is widely viewed as the most successful hedge fund of all time, the Medallion Fund, was run for twenty years by mathematical physicist James Simons–the same James Simons who lent his name to Chern-Simons theory, which has been studied extensively by string theorists." P Quant math is relatively easy to grasp, so much so that an undergraduate with some statistics and calculus background can understand it quite easily. >All the evidence suggests that the EMH is true, that markets are unpredictable, and all successes are chance successes. Markets are unpredictable, but people (read: rational, utility-maximizing investors) aren't. Generally there is a level of herd behavior that can be modeled.
  - lutusp 14y ago
    > Markets are unpredictable, but people (read: rational, utility-maximizing investors) aren't. Generally there is a level of herd behavior that can be modeled. You're overlooking the fact that some of those modeled people are analysts who are also trying to model, and act on, the behavior of the mob. In fact, analysts constitute their own mob. :) That restores the EMH to its rightful place.
tunesmith 14y ago
Articles like that frustrate me. So much smartness and explanation, and yet it all is still only devoted to figuring out how to be smarter than the other masses of investors out there, in order to make a buck off of them.
- Tycho 14y ago
  On the other hand, the stuff they work on could easily be useful in other fields - modelling, ultra low latency systems, maybe even AI.
- gammarator 14y ago
  The author (a former classmate of mine) is a professor of physics and philosophy, not a trader.
hogu 14y ago
I think hiring has shifted away from physics to signal processing, and machine learning people. But I am a signal processing guy so that maybe my bias. Also because we've moved away from complex derivatives.
elliptic 14y ago
First I've heard anyone referring to James Simons as a physicist.
- balsam 14y ago
  Speaking as a member of APS... what do you expect from an APS magazine :)? What on earth is a "mathematician"? We have to call Edward Thorp an "American" because we don't know about his "theories" (c.f. the article)! (And how are "theories" different from "theorems"?) EDIT: You beat me to the comment.
- deleted 14y ago
  [deleted]
- emini_guy 14y ago
  Yes, that's a bit of a stretch and I say so as a physicist. But he is referred to as a "mathematical physicist" which is as close as possible to being a physicist if you are really a mathematician and your work has been used in physics.

38 points by agarttha 14y ago

The general thrust is spot on. Models are approximations. Don't confuse your models with reality. Know what your assumptions are, and have a plan for what to do when those assumptions no longer hold. Know why your models work, so that you know when they are likely to stop working. Get deep domain knowledge. Know that the market can stay irrational longer than you can stay solvent. Experiment ruthlessly. Apply the scientific method. Start simple and iterate. This probably applies to more than just finance.

scotty79 14y ago
Basic error is that you think you can predict fully random process. You develop a model that seems to work excellent until it doesn't. It doesn't matter whether it's sophisticated algorithm running on big iron or hunch running on wetware. You will fail because nobody knows the future. Trying to reliably squeeze money out of the market by better predicting its behavior is like trying to build perpetum mobile by trying more and more convoluted designs. All the smarts of traders ... they do nothing: http://finance.fortune.cnn.com/2013/01/24/buffett-hedge-fund-bet/ http://finance.fortune.cnn.com/2013/01/24/buffett-hedge-fund... There is money that can be reliably extracted from investing though. If you can trade faster than others, you can drain some money from them. That's why algorithmic trading yields returns. Your strength comes not from predicting future better, but from acting and reacting faster.
- niggler 14y ago
  "If you can trade faster than others, you can drain some resources from them" What's embarrassing is how many intellectual resources are focused on this problem. For those not in finance, compare it to focusing talent on finding better advertising techniques.
- crntaylor 14y ago
  Certainly you need to protect against over fitting your models, and you need to consider tail events. But to say that the entire market is fully random is to claim that the efficient market hypothesis holds, which it clearly doesn't - not even in weak form. Anyone who wants to claim that the EMH is true needs to explain the equity premium puzzle, the success of value investing and the persistent outperformance of momentum investing - among many other price anomalies that I could name.
  - lutusp 14y ago
    > But to say that the entire market is fully random is to claim that the efficient market hypothesis holds, which it clearly doesn't - not even in weak form. Of course it does. All evidence supports the Efficient Market Hypothesis (EMH), and note my use of the word "evidence". A contradiction would have to be a series of funds that applied a given, predefined (internally) strategy and (very important) didn't reveal its picks to the public (to avoid the announcement effect). Such an experiment hasn't been done, and those cases in which a specific strategy was applied have been universal failures. Let's say for the sake of argument that there is a surefire winning strategy as is so often claimed in worthless investment books. If it were to be recognized and then applied, it would become the new market norm, everyone would apply it, and its differential value would evaporate overnight. That hypothetical experiment merely supports the EMH. > Anyone who wants to claim that the EMH is true needs to explain the equity premium puzzle, the success of value investing and the persistent outperformance of momentum investing - among many other price anomalies that I could name. Those result from a combination of the announcement effect and insider trading. Berkshire-Hathaway is successful because people expect it to be successful, and who invest in the same stocks when they're announced. It's a self-fulfilling prophecy. The only fair, scientific test would be a strategy that is applied in secret, not in public like Berkshire-Hathaway, and in a way that doesn't tweak the market itself by way of large purchases that create their own following of fanboys. In other words, a pure computer model that is defined in advance, not tweaked enroute, that doesn't actually invest but only models hypothetical investments, and that shows its value over other systems in perpetuity. There is no such thing, and the EMH is true. Remember the Null Hypothesis, the basis of modern scientific thinking. The Null Hypothesis assumes something without evidence is false. All evidence supports the EMH.

scotty79 14y ago

Blaming people who develop algorithms for purposes of gambling (also called investing) for decade of market crashes is just silly. All markets have crashes. Faster markets have crashes more often. Markets are getting faster due to computer technology not trading algorithms. Even if algorithms were really simple it would still lead to more frequent market crashes just because dumbest algorithm can trade faster than humans previously could. And blaming physicists for 2007-08 worldwide financial collapse is just silly. It's not them that hid the risk in convoluted instruments and then sold them as if they were as solid as cash in the bank.

lutusp 14y ago
> Blaming people who develop algorithms for purposes of gambling (also called investing) for decade of market crashes is just silly. Unfairly blaming analysts isn't the problem. The problem is assuming that anyone can predict the future of equities markets. There's no evidence to support this idea -- all successes are chance successes, and all failures are chance failures. This is why market index funds perform on average better than funds in which a manager tries to choose future winners and charge you for the privilege of being a member, an "insider".

cjbenedikt 14y ago

Interesting but flawed....Scotty79: to argue that models cannot be blamed for market crashes is the same type of argument that says guns don't kill people. Both statements outside context are correct, yet...btw: another academic created the option formula already: Vincent Brontin who taught in Triest in 1910...and not the physicists who knew howcto treat formulae appropriately survived the crashes but street smart traders like Taleb did...experienced option traders never used Black-Scholes anyway because they knew it was flawed...an accident waiting to happen...

barry-cotter 14y ago
Taleb's fund failed.
- yarou 14y ago
  And? That makes his point about ridiculous risk models no less valid.
- cjbenedikt 14y ago
  actually it didn't ...its successor Spitznagel's Universa made enormous profits in 2008 to the tune that he now manages $6 billion....also: Taleb made his money in the '87 crash...and Empirica made a lot in 2000/2001. Taleb closed it because he suffered from trader fatigue....something quite common btw

lutusp 14y ago

A quote: "And at least some physicists have been phenomenally successful as fund managers. Indeed, the fund that is widely viewed as the most successful hedge fund of all time, the Medallion Fund, was run for twenty years by mathematical physicist James Simons–the same James Simons who lent his name to Chern-Simons theory, which has been studied extensively by string theorists." When are financial sector writers going to stop assuming that a chance success in finance is in any way the result of specific training or background on the part of a fund manager? One of two things is true -- either the Efficient Market Hypothesis (EMH) is true, in which case who you are doesn't matter, or the EMH is false, in which case anyone can make bazillions in the markets by simply applying the kinds of "sure-fire winning strategies" that are touted in any number of worthless investment best-sellers. All the evidence suggests that the EMH is true, that markets are unpredictable, and all successes are chance successes. The Wall Street Journal "Dartboard Contest" supports this idea, to the chagrin of any number of stockbrokers and analysts, who would prefer it if there were any credible evidence that their services have value. http://whyfiles.org/037wall_st/predict.html http://whyfiles.org/037wall_st/predict.html

yarou 14y ago
>A quote: "And at least some physicists have been phenomenally successful as fund managers. Indeed, the fund that is widely viewed as the most successful hedge fund of all time, the Medallion Fund, was run for twenty years by mathematical physicist James Simons–the same James Simons who lent his name to Chern-Simons theory, which has been studied extensively by string theorists." P Quant math is relatively easy to grasp, so much so that an undergraduate with some statistics and calculus background can understand it quite easily. >All the evidence suggests that the EMH is true, that markets are unpredictable, and all successes are chance successes. Markets are unpredictable, but people (read: rational, utility-maximizing investors) aren't. Generally there is a level of herd behavior that can be modeled.
- lutusp 14y ago
  > Markets are unpredictable, but people (read: rational, utility-maximizing investors) aren't. Generally there is a level of herd behavior that can be modeled. You're overlooking the fact that some of those modeled people are analysts who are also trying to model, and act on, the behavior of the mob. In fact, analysts constitute their own mob. :) That restores the EMH to its rightful place.

tunesmith 14y ago

Articles like that frustrate me. So much smartness and explanation, and yet it all is still only devoted to figuring out how to be smarter than the other masses of investors out there, in order to make a buck off of them.

Tycho 14y ago
On the other hand, the stuff they work on could easily be useful in other fields - modelling, ultra low latency systems, maybe even AI.
gammarator 14y ago
The author (a former classmate of mine) is a professor of physics and philosophy, not a trader.

hogu 14y ago

I think hiring has shifted away from physics to signal processing, and machine learning people. But I am a signal processing guy so that maybe my bias. Also because we've moved away from complex derivatives.

elliptic 14y ago

First I've heard anyone referring to James Simons as a physicist.

balsam 14y ago
Speaking as a member of APS... what do you expect from an APS magazine :)? What on earth is a "mathematician"? We have to call Edward Thorp an "American" because we don't know about his "theories" (c.f. the article)! (And how are "theories" different from "theorems"?) EDIT: You beat me to the comment.
deleted 14y ago
[deleted]
emini_guy 14y ago
Yes, that's a bit of a stretch and I say so as a physicist. But he is referred to as a "mathematical physicist" which is as close as possible to being a physicist if you are really a mathematician and your work has been used in physics.