Wall Street’s Bulls & Bears get Plucked

When the stock market goes through convulsive shocks, some scientists see earthquakes in the charts of erratic price swings. Others, like Hebrew University's Lev Muchnik and Sorin Solomon, hear the sound of a muffled guitar.

The March 2003 issue of Business 2.0 reports that Muchnik and Solomon's research (also covered in last October's issue of Nature) has demonstrated how panicky traders keep overshooting the "right" price, first too high and then too low, but gradually dampening their exaggeration and error over time. The oscillating picture strongly resembles the oscilloscope picture of a plucked guitar string.

copyright Sorin Solomon

Short term thinking -- and some technological limitations -- are the root cause of this predictable pattern of market behavior, they tell us. The researchers have used computers to simulate entire markets containing many different types of trading behaviors, taking into consideration how they interact with each other. However, the recipe for "damped oscillation" includes only three ingredients: random traders, market-making traders (large enough to cause market prices to swing), and "inertial" traders (who are slow to change their behavior). Solomon describes all the traders as "opportunists... They are interested in short-term profits and anxious not to miss a trend… If everyone else is buying, they'll tend to buy too, leading to herding behaviour that amplifies small price fluctuations into big ones." Limits on how fast trades can be made add the dampening to the system... a kind of technological friction.

Read the entire Nature article

Read the Business 2.0 brief