Determinism and market madness

The past few months of misery in the stock market have been so obviously driven by fundamentals that there’s something a little bit lightheaded and silly about saying a rebound is on the way because of technical factors. Consider the following chart (click to enlarge), which doesn’t even take into account the political and military complexities in North Africa:

Yes, I know, technical analysis is supposed to (depending whose explanation you read about why it works) operate independent of events external to the price of the stock, or perhaps to incorporate those factors in such a way that there’s no need to look at anything but the price; but there are philosophical holes in that explanation the size and stickiness of the La Brea Tar Pits. Leaving aside whether those holes can be patched (and, also, my apologies for the layers of mixed metaphor I seem to be building up here like a stale rhetorical napoleon), it’d be nice if we could look at this market death spiral we’re in and see it as something regular and predictable (and finite!). People operate in the everyday world by matching patterns and proceeding as if those patterns will continue, what Sherlock Holmes always called “deductive logic” but is really inductive; I don’t think they do it by following anything remotely like the rules of formal logic (I think modeling the brain as a computer running a program puts the cart pretty far out in front of the horse), but they do do it in a fairly consistent way. By making that distinction, though, I'm at odds with a lot of people in cognitive science, philosophy, and artificial intelligence.

Three hundred years ago, around the same time that Adam Smith was laying the ground work for those researchers by asserting that we were all members of the supremely logical species Homo economicus, his empiricist contemporaries elsewhere in Western Europe were coming out pretty strong in favor of a pure determinism: the world as giant clock. It’s a seductive way to think, and I admit to having the following quote from the Marquis de Laplace on my fridge:

We may regard the present state of the universe as the effect of its past and the cause of its future. An intellect which at any given moment knew all of the forces that animate nature and the mutual positions of the beings that compose it, if this intellect were vast enough to submit the data to analysis, could condense into a single formula the movement of the greatest bodies of the universe and that of the lightest atom; for such an intellect nothing could be uncertain and the future just like the past would be present before its eyes.

The thing about Laplace’s brand of determinism is that it’s compelling on a really fundamental level because it’s how we live our lives day-to-day; if it weren’t so compelling, and weren’t so familiar, then why would the head-scratching, insomnia-inducing philosophical discontinuity between it and the concept of free will even be worth talking about? The steady encroachment, warranted or not, by scientists onto the traditional grounds of metaphysics has muddied the popular conception of what the free-will debate is about, by introducing the idea of quantum particles with unknowable and/or unpredictable states. But, woo-woo stuff like that aside, where determinism impacts our lives isn’t in the question of whether you or I, as conscious beings riding around in our heads and looking out of our eye sockets, act predictably to satisfy our needs, but whether all those other eye-socketed things around us act in a way that we can predict well enough to function. And it seems that they do. (This is a finer-grained version of the truism that we all, like it or not, are in practice practicing Rousseauians: without the Social Contract, how would you ever make it through five minutes on the freeway alive?)

In 1980 I was an avid reader of Creative Computing magazine, which, like other great magazines of the early home-computer culture of the late 1970s and early ’80s, published in each issue complete programs (not just illustrative snippets of code) that you could type into your computer, save, and run. Most were games, but many were serious applications, such as primitive databases; Compute! even published a full-featured word processor. Believe it or not, this was until 1990 or so (I think PC World was the last holdout, or maybe one of the Atari- or Amiga-specific magazines) one of the chief ways that non-commercial software was distributed (the other being BBSs). So, late in 1980 Creative Computing printed a program, with accompanying explanatory article, that was supposed to predict the outcome of that year's Presidential election. As a kid I thought this was magic. Via simulation games that had you playing a bullfighter or king of Sumer, I had gained an intuitive grasp of the way that software could model a small part of the real world; but I couldn't make the leap of generalization from those toy models to one that would, accurately enough to be interesting, simulate the behavior of 100 million adults. (Never mind that like most people under the age of 25 or so, I found the behavior of even a single adult totally incomprehensible, period.)

I'm reconstructing this from memory, of course, and I'd love to see a copy of the magazine again, or have someone email me saying that they wrote that program. I imagine that the algorithms used were predicated on some sort of deterministic optimism about voter behavior in the 1980 race, i.e., an assumption that similar factors were present as in prior elections. (Or were there? Carter’s single term is now remembered mostly for an unusually heated level of strife in the Middle East and an economy so screwed-up that a relatively new term of art from economics became common currency just so people could grasp what was happening.) Probably there was also a dash of statistics added in, since if I remember right the program was supposed to narrow in on its best guess as you entered numbers from the earlier-reporting states, just like the TV networks do. (“As X goes, so goes the nation.”) It’s this latter algorithm, or group of algorithms, that most intrigues me. It’s pattern matching of a sort; and pattern matching, no more and no less, is what technical analysis of capital markets is all about. When we see that A usually precedes B, after a while we begin to expect B when we see A; if we get what we expect, our predictive model is strengthened. It’s a little bit circular, but so is all inductive reasoning.

That circularity becomes a problem only when we mistake an A-prime, or a C, or even a Z, for an A, and have become complacent enough that we mistake the B-prime or D or unrecognizable squiggle that follows for a B—and then act as if a B is guaranteed. On that path lies madness, and something worse than madness: losing money.