Butterfly effect stock market

Butterfly effect stock market

By: KeffDf Date of post: 02.06.2017

The butterfly effect concept has become important in the finance world as globalization continues to increase and capital markets connect. Volatility in one small area of the international markets can grow rapidly and bleed into other markets, and a hiccup in one corner of the international markets can have global consequences.

Improvements in technology and wider access to the Internet has increased the degree to which international markets influence each other. This has led to more episodes of extreme market volatility. The butterfly effect has become well-known in popular culture, and the concept has clear applications to finance.

It and chaos theory may provide a partial explanation for the unpredictability of capital markets. The phrase "the butterfly effect" was first coined during a scientific meeting in Scientist Edward Lorenz gave a talk on his work regarding weather prediction models. The phrase suggests that the flap of a butterfly's wings in Japan could create a small change in the atmosphere that might eventually lead to a tornado in Texas.

Lorenz studied how small differences in initial values led to large differences in weather models at the Massachusetts Institute of Technology.

BBC World Service - Business - The butterfly effect and world economics

In , he had entered an initial condition in a weather model as 0. In , he wrote a paper on this concept, titled "Deterministic Nonperiodic Flow.

Study of the butterfly effect has led to advances in chaos theory. Capital markets go through alternating periods of calm and storminess. However, they are not always chaotic, and the shift between calm and chaos is often sudden and unpredictable. Some believe that these concepts of chaos theory can be used to understand how financial markets operate. Markets tend to grow bubbles that eventually pop with drastic consequences.

Financial bubbles often grow because of positive feedback. When investors make money during a rise in the financial markets, other observers think the investors must have made a smart decision, which leads the observers to invest their own money in the markets. The result is more buying and stock prices going higher. The positive feedback loop leads to prices beyond any logical or justifiable level.

The loop eventually ends, and the last investors in are left hanging with the worst positions. The same concept can explain volatile bear markets. The markets can suddenly shift due to outside factors, which causes investors to pay attention only to negative news. Initial selling leads to more selling as market participants liquidate their positions.

The negative feedback loop tends to accelerate quickly, often resulting in a market full of undervalued stocks. Prominent scientist Benoit Mandelbrot applied his work in fractals in nature to financial markets. He found that examples of chaos in nature, such as the shape of shorelines or clouds, often have a high degree of order.

These fractal shapes can also explain chaotic systems, including financial markets. Mandelbrot noted that asset prices can jump suddenly with no apparent cause. Mandelbrot argued that these outliers are important and play a significant role in financial market movements. Traditional portfolio theory tends to underestimate how often these high-volatility events occur.

The Butterfly Effect -Trailer

While his fractals cannot predict price movements, he argued that they could create a more realistic picture of market risks. Although technology has increased the impact of the butterfly effect in global markets, there is a long history of financial bubbles going back to the tulip market bubble in Holland during the 17th century. Tulips were a status symbol among the elite. They were traded on exchanges in Dutch towns and cities.

Subscribe to read

People sold their belongings to begin speculating on tulips. However, prices began to drop and panic selling ensued. There are more recent examples of bubbles. There was no apparent cause for the drop, though the DJIA had some large down days the week before, and there were international issues in the Persian Gulf.

Chaos theory - Wikipedia

In retrospect, issues with panic selling and perhaps program trading might be partly to blame. Similar to Black Monday, there was no single event or cause for the drop. Also like Black Monday, there had been weakness in the Chinese markets in prior months.

Chinese officials had begun devaluing the renminbi. However, the main cause was likely the high degree of margin used by Chinese retail investors.

When prices began to drop, investors received margin calls from their brokers. Retail investors were forced to liquidate their positions quickly to meet the margin calls, leading to a negative feedback loop of selling. In years prior, the Chinese government encouraged people to put their money in the market. Markets will only become more interconnected as technology continues to improve, and the butterfly effect will continue to be a factor in global markets. Dictionary Term Of The Day.

A hybrid of debt and equity financing that is typically used to finance the expansion Latest Videos PeerStreet Offers New Way to Bet on Housing New to Buying Bitcoin?

Globalization and the Butterfly Effect | Investopedia

This Mistake Could Cost You Guides Stock Basics Economics Basics Options Basics Exam Prep Series 7 Exam CFA Level 1 Series 65 Exam. Sophisticated content for financial advisors around investment strategies, industry trends, and advisor education. Globalization and the Butterfly Effect By John Edwards February 17, — 2: Origin and Meaning of Butterfly Effect The phrase "the butterfly effect" was first coined during a scientific meeting in Application of Chaos Theory to Markets Capital markets go through alternating periods of calm and storminess.

Fractals and the Markets Prominent scientist Benoit Mandelbrot applied his work in fractals in nature to financial markets.

Examples of the Butterfly Effect in Markets Although technology has increased the impact of the butterfly effect in global markets, there is a long history of financial bubbles going back to the tulip market bubble in Holland during the 17th century. The OTM butterfly spread offers traders three unique advantages, and can lead to consistent profits.

This relatively simple strategy is designed to provide a profit for investors who believe that there will be minimal price movement in the underlying security until expiration. A butterfly spread is a neutral options strategy with both limited risk and limited profit potential. The strategy involves four options contracts with the same expiration month but with three There are many key advantages offered to options traders who deal only in the underlying securities.

This reversal pattern can make sense of the seeming randomness of market movements and improve your trading. A credit spread has two different meanings, one referring to bonds, the other to options. Bubbles are deceptive and unpredictable, but by studying their history we can prepare to our best ability.

Check out some repair strategies to help boost the profit potential of a losing position. The chaos theory is a complicated and disputed mathematical theory that seeks to explain the effect of seemingly insignificant Read about some common and simple trading strategies to employ after spotting a fractal pattern, and learn which systems A financial "bubble" refers to a situation where there is a relatively high level of trading activity on a particular asset To understand the term "echo bubble", you have to understand what a bubble is.

A financial or economic bubble occurs when Learn about the nuanced relationship between the efficient market hypothesis and economic bubbles and the requirements and Learn how investors contributed to the dot-com bust and how Internet services and investing has changed since the market A hybrid of debt and equity financing that is typically used to finance the expansion of existing companies. A period of time in which all factors of production and costs are variable.

In the long run, firms are able to adjust all A legal agreement created by the courts between two parties who did not have a previous obligation to each other. A macroeconomic theory to explain the cause-and-effect relationship between rising wages and rising prices, or inflation.

A statistical technique used to measure and quantify the level of financial risk within a firm or investment portfolio over Net Margin is the ratio of net profits to revenues for a company or business segment - typically expressed as a percentage No thanks, I prefer not making money. Content Library Articles Terms Videos Guides Slideshows FAQs Calculators Chart Advisor Stock Analysis Stock Simulator FXtrader Exam Prep Quizzer Net Worth Calculator.

Work With Investopedia About Us Advertise With Us Write For Us Contact Us Careers.

butterfly effect stock market

Get Free Newsletters Newsletters. All Rights Reserved Terms Of Use Privacy Policy.

inserted by FC2 system