Number crunchers

by Rebecca Priestley / 24 April, 2013
How physics can help predict the movement of sharemarkets.
Photo/Thinkstock


What does physics have to do with finance? The science behind understanding complex, seemingly random systems such as atmospheric circulation can also be used to predict the movement of financial markets, says James Owen Weatherall in The Physics of Wall Street: A Brief History of Predicting the Unpredictable.

This is how physicists became some of the most successful money managers on Wall Street. Despite their apparent “wild randomness” and “underlying chaos”, financial markets sometimes behave in a “somewhat orderly” fashion, in much the same way that a bunch of seemingly mindless particles bumping around in the sky sometimes organise themselves into a hurricane.

In this entertaining and wide-ranging book, Weatherall traces physicists’ attempts at modelling financial markets from late 19th-century Paris to mid-20th century Las Vegas and on to late 20th-century Wall Street. Despite some physicists’ early recognition of patterns in the market, they could take the models they developed only so far. Early computers were little more than “souped-up adding machines”, and there was little realisation of the extent to which they could be used to study complicated systems. Even weather forecasting – now a process involving supercomputers crunching millions of pieces of data through complex models – was done on the basis of “gut feelings, rules of thumb and brute luck”.

Physicists Norman Packard and Doyne Farmer began working on “predicting the unpredictable” in the mid-1970s. They started out using computers to solve the differential equations necessary to predict the outcome of the spin of a roulette wheel.

After 15 years working on chaos theory, they “had an unprecedented understanding of how complex systems work and the ability to use computers and mathematics in ways that someone trained in economics … would never have imagined possible”.

Then, believing that “a firm grasp of statistics and a little creative reappropriation of tools from physics were enough to beat the Man”, they set up The Prediction Company and began using their complex models to predict financial markets that everyone agreed were random and unpredictable.

Within a few years, Wall Street bankers were busily recruiting people with physics PhDs to develop, interpret and adapt complex models aimed at understanding and predicting financial markets. The arrival of these “legions of quants”, says Weatherall, changed Wall Street forever.

Weatherall became interested in this topic during the 2008 financial meltdown. The danger, he says, “comes when we use ideas from physics, but we stop thinking like physicists”.

Despite recent market crashes, including what’s become known as the “quant crisis”, there is still a place for sophisticated investors to profit. “You just need to be the most sophisticated investor, the one most carefully attuned to market patterns and the one best-equipped to find ways to turn patterns into profit. And for this task, a few decades of experience in extracting information from chaotic systems plus a room full of supercomputers could be a big help.”

THE PHYSICS OF WALL STREET: A BRIEF HISTORY OF PREDICTING THE UNPREDICTABLE, by James Owen Weatherall (Scribe, $37)

Send questions to science@listener.co.nz
MostReadArticlesCollectionWidget - Most Read - Used in articles
AdvertModule - Advert - M-Rec / Halfpage

Latest

Artist Judy Millar creates a show-stopper at Auckland Art Gallery
77134 2017-07-28 08:53:07Z Arts

Artist Judy Millar creates a show-stopper at Auckl…

by India Hendrikse

A brand-new, puzzle-like artwork by Judy Millar at Auckland Art Gallery exuberantly fills a tough space.

Read more
Cat control and 'barking consultants': Is the council coming after your pet?
76916 2017-07-28 00:00:00Z Politics

Cat control and 'barking consultants': Is the coun…

by Bill Ralston

Councils must be barking mad to be considering spending millions more controlling cats and silencing dogs.

Read more
Filmmaker Raoul Peck: Karl Marx, James Baldwin and me
76930 2017-07-28 00:00:00Z Movies

Filmmaker Raoul Peck: Karl Marx, James Baldwin and…

by Helen Barlow

A film-maker focuses on two thinkers who questioned the social order of their day.

Read more
PayWave's great, but we're light years behind China's payment methods
76945 2017-07-28 00:00:00Z Technology

PayWave's great, but we're light years behind Chin…

by Sophie Boot

New Zealand is in the dark ages compared with China’s electronic payment methods and we need to upgrade if we want more of that country’s business.

Read more
Ain’t No Taco: Symonds Street gets a new taqueria with a twist
77130 2017-07-27 14:58:01Z Auckland Eats

Ain’t No Taco: Symonds Street gets a new taqueria …

by Kate Richards

Peter Barton, co-owner of Burger Geek, opens a taqueria a few doors down the road

Read more
Synthetic cannabis: The killer high
77113 2017-07-27 11:56:15Z Social issues

Synthetic cannabis: The killer high

by Susan Strongman

There have been eight deaths related to synthetic cannabis in just over a month. People know it's killing them. So why are they smoking it?

Read more
Winston Peters criticises use of te reo in Parliament
77102 2017-07-27 10:34:33Z Politics

Winston Peters criticises use of te reo in Parliam…

by RNZ

New Zealand First leader Winston Peters has criticised Te Ururoa Flavell for using te reo Māori in Parliament during question time.

Read more
NZ has done 'horrific job' protecting most vulnerable - commissioner
77095 2017-07-27 10:06:22Z Social issues

NZ has done 'horrific job' protecting most vulnera…

by Emile Donovan

Abuse of intellectually disabled people in state care over five decades has been brought to light in a new report by the Human Rights Commission.

Read more