From: floydb@rpi.edu
Subject: re: self-fulfilling vs. self-destroying prophecies
Date: Fri, 13 Nov 1992 16:42:48 GMT

In article <STEVE.92Nov12181915@cucbs.chem.columbia.edu> steve@cucbs.chem.columbia.edu (Steve Stuart) writes:
>
>Here's a question that's been percolating in my brain for a while:
>
>Someone (in the Random Walk thread) mentioned that technical analysis
>has become a self-fulfilling prophecy - since so many people *believe*
>in head-and-shoulders-tops, they all sell when they see one, and
>presto, the price goes down.  Or everyone buys at an "obvious" bottom,
>and presto, the price goes up.
>
>Another argument that I've heard regarding various technical analysis
>or correlation-type techniques is that anyone with a working system
>would have to be crazy to publicize it.  Say you had noticed that the
>market usually goes up on the 19th of every month.  So you start
>buying on the 18th and selling on the 20th.  If you tell everyone your
>idea, they'll *all* buy on the 19th, except for those who want to beat
>the rush and buy on the 18th, etc. 

stuff deleted


>-Steve
>


This is very similar to a thread I tried to start here regarding
Schumpeter innovation cycles and long wave theories.

Essentially the traditional Western education predisposes
individuals to think in short-term (less than one life span)
straight-line causal chains. Hence the often found phrases,
"If something ALWAYS happens on the 19th...".

Not unlike the Moon orbiting the earth or the Earth orbitting
the Sun, many theorists seem to believe that human behavior
orbits some "center". 

Most recently these theories have adopted the language of
"fractals", and "chaos theory", where the "center" is now
referred to as a "strange attractor". This attractor in fact
isn't necessarily envisioned as a single point. It could be
two or more points, a line, a plane, a volume, etc. depending
on the "dimension" of the phenomenon.

The apparent paradox of these systems to beat the market (they
work either because everyone believes it or no one knows it)
is only paradoxical if you think in a straight infinitely
long line.

The paradox disappears if you think in endogenous/recursive
ways and frame your theories in periods of event-relative time
(vs absolute calendar time). Thus, a "new" market theory
emerges after a period of secret success (i.e. few were in 
on it). The theory proves true with increasingly accurate
predictive power as more and more people "know it". A
critical mass of believers base decisions on the theory and
try to enhance the theory (e.g. buy earlier, and earlier, etc.)
diluting the theories original premises (i.e. creative destruction).
The original premises become sufficiently out of synch with the
revised context (eventually requiring new premises) that the
theory begins to fail. A critical mass of believers notice the
new trend and abandon their investment decisions based on the
theory. The theory falls out of favor and dies a quiet death.

This seems to have happened (meta-theory) with long-wave cycles
during the New Deal. The long-wave theory was declared bankrupt
when subsequent (predicted) cycles weren't as pronounced (deep
or high) and took longer or shorter than expected. The cycles
never the less were evident and still are. In fact, since the 
theories rise and fall not one full cycle has occured (approx.
55 years thru 2005), only studies of several centuries of historical
data. The theory's premises must be updated to include the theory
itself and thus update the theory accordingly.

The simple fact that theory and reaction become part of the process
is often overlooked. Very much like the uncertainty principle in
modern physics, where systems have become sensitive to observers,
where in Newtonian mechanics it is much less so (unnoticed but not
absent, merely "negligible").

2 cents worth

barry