Could this be the end of stock market crashes?

Oct 19, 2012
Could this be the end of stock market crashes?

(Phys.org)—A 72-year study of the Dow Jones could help avoid the kind of stock market crash that struck the world economy in 2008.

Professor Tobias Preis has led a study of the second oldest US market index and discovered that a portfolio of shares, far from being diverse and spreading risk during a time of stock market slump, start behaving the same.

This new study has been carried out in collaboration with Dr. Dror Y. Kenett (Boston University, USA), Prof. H. Eugene Stanley (Boston University, USA), Prof. Dirk Helbing (ETH Zurich, Switzerland), and Prof. Eshel Ben-Jacob (Tel-Aviv University, Israel).

In their paper entitled "Quantifying the Behaviour of Stock Correlations Under Market Stress," Professor Preis reveals that the 'diversification effect' that protects a portfolio of shares through the vagaries of the stock market disappears when there is a general slump in the market.

Professor Preis believes this pattern can be used to anticipate 'diversification breakdown' in share portfolios and allow investors to steer away from a major crash by spreading their investments elsewhere or 'hedge' their money.

It could help traders avoid the major crashes that hit stock markets in 2008. Between September and December four of the five biggest daily falls in the hit the US stock exchange. It was part of one of the biggest stock market crashes and led to the most of the world is still suffering.

Professor Preis, who is associate professor of behavioural science and finance at Warwick Business School, which is part of The University of Warwick, said: "We analysed the daily closing prices of the 30 stocks forming the from March 15, 1939, to December 31, 2010. Our results also shed light on why correlation risks in mortgage bundles were underestimated at the beginning of the recent financial crisis."

The results of this study, published in Scientific Reports, provide crucial information on the behaviour of markets in times of stress.

"We found a striking result," said Dr Kenett. "The average correlation between these stocks increases at the same rate as market stress. Consequently the diversification effect, which should protect a portfolio, melts away in times of market losses, just when it would be needed most."

Their research has important applicative implications.

"We could use this to anticipate diversification breakdowns, which could guide the design of portfolios and contribute to the increased stability of the financial markets." says Professor Preis.

The German physicist, who founded Artemis Capital Asset Management, believes the data he has collected from 72 years of Dow Jones closing prices can be used to help portfolios steer clear of crashes.

Professor Preis said: "When financial markets are suffering significant losses our findings could be used to anticipate the increasing lack of diversification in portfolios. This would enable a more accurate assessment of the risk of making losses."

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More information: www.nature.com/srep/2012/121018/srep00752/full/srep00752.html

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JoeBlue
2.7 / 5 (14) Oct 19, 2012
Holy pile of BS.

Ideal systems can not predict non-ideal systems. Then again today's stock market is essentially a fraud and rigged....
EBENEZR
1 / 5 (3) Oct 19, 2012
... (A) study of the second oldest US market index . . . discovered that a portfolio of shares, far from being diverse and spreading risk during a time of stock market slump, start behaving the same.


Professor Preis believes this pattern can be used to . . . allow investors to steer away from a major crash by spreading their investments elsewhere or 'hedge' their money.


I'm sure I've got the wrong end of the stick here, but the first paragraph suggests that portfolios are actually the problem, then the fourth appears to say this pattern can avoid a crash BY spreading their investments (a portfolio, right)? I'm no economist so can someone please clarify what I'm misunderstanding here?
Arcbird
2.4 / 5 (14) Oct 19, 2012
This is absolute bullshit. The system is not going to be better, it's been going downward since it's birth.
Infiniteloop
4.5 / 5 (8) Oct 19, 2012
Q: Could this be the end of stock market crashes?
A: No.
axemaster
5 / 5 (4) Oct 19, 2012
EBENEZR - I think what they meant is that during the run-up to a crash, many stocks become synchronized, making many "diversified" portfolios ineffective. The solution then would be to identify unsynchronized stocks, and switch over to using those.
boater805
1 / 5 (3) Oct 19, 2012
Strongly correlated stock movements across segments have long been known to signal an impending crash (although the magnitude of such crashes I have not seen focused on before). I don't think the study suggests the market will be changed to prevent future crashes, merely that investors can detect coming crashes by charting correlation and thus get to the sidelines before such a crash occurs. If enough investors do this, it becomes self-avoiding prophecy and the crash won't even happen.
EBENEZR
1 / 5 (3) Oct 19, 2012
EBENEZR - I think what they meant is that during the run-up to a crash, many stocks become synchronized, making many "diversified" portfolios ineffective. The solution then would be to identify unsynchronized stocks, and switch over to using those.


That makes sense, thanks.
jscroft
2.3 / 5 (9) Oct 19, 2012
So... when the market drops, the MARKET drops! Nobel prizes all around!!!
BloodSpill
4 / 5 (4) Oct 19, 2012
So... when the market drops, the MARKET drops! Nobel prizes all around!!!

It sounds like this article is announcing a new 'red flag' for the current state of the market.
Isn't the problem that putting up these warnings just causes the market to fail faster through herd mentality?
ian_j_allen
5 / 5 (3) Oct 19, 2012
This is sadly amusing. If the market is crashing, of course stocks will tend to correlate. Downwards. If investors "get to the sidelines" whenever a downwards correlation begins to appear, they will simply aggravate the problem for everybody else. Thus, by "predicting" a crash, the algorithm would actually cause more of them to happen. As usual, the people with better connections who can get their money in and out first, are the winners. Everybody else is in the dogpile.
antialias_physorg
5 / 5 (3) Oct 19, 2012
If enough investors do this, it becomes self-avoiding prophecy and the crash won't even happen.

Actually if enough investors do this then it will precipitate a crash (since everybody will flee these synchronized portfolios simultaneously)

That's the real problem with such a 'hard and fast' rule in investment: As long as only a few use it they can make money (or avoid losses - which is basically the same thing). As soon as a majority use it you always cause a crash.

But in the end what the article is saying is:
If you are a private person don't even think about investing in stocks or portfolios - because you will always be the last to know when a crash is coming. Once traders detect an impending crash this way they will off-load their stocks on people who are as of yet unaware - viz.: the small-time investor.
sstritt
1 / 5 (4) Oct 19, 2012
EBENEZR - I think what they meant is that during the run-up to a crash, many stocks become synchronized, making many "diversified" portfolios ineffective. The solution then would be to identify unsynchronized stocks, and switch over to using those.

I think the point is that there would not be any unsynchronized stocks, so a hedging strategy would be required such as selling covered calls on your portfolio.
cantdrive85
1.9 / 5 (9) Oct 19, 2012
When people think intelligently instead of reacting emotionally, there will be an end to stock market crashes. Hence, crashes will continue unabated (well, not until after the election).
Deathclock
1.9 / 5 (9) Oct 19, 2012
The fallacy here is the assumption that stock market crashes are mistakes and are not intentionally engineered by those that would benefit from them...
cantdrive85
1.9 / 5 (14) Oct 19, 2012
The fallacy here is the assumption that stock market crashes are mistakes and are not intentionally engineered by those that would benefit from them...

Tin foil hat on a little tight? Conspiracy is possible in the financial markets, but not academia, right?
Deathclock
3.4 / 5 (10) Oct 19, 2012
The fallacy here is the assumption that stock market crashes are mistakes and are not intentionally engineered by those that would benefit from them...

Tin foil hat on a little tight? Conspiracy is possible in the financial markets, but not academia, right?


Conspiracy is not only possible in the financial markets it has been proven and is a matter of well documented and established history.
Doug_Huffman
2.3 / 5 (6) Oct 19, 2012
Read Nassim Nicholas Taleb on fragility and The Black Swan events.
cantdrive85
1.3 / 5 (8) Oct 19, 2012
The fallacy here is the assumption that stock market crashes are mistakes and are not intentionally engineered by those that would benefit from them...

Tin foil hat on a little tight? Conspiracy is possible in the financial markets, but not academia, right?


Conspiracy is not only possible in the financial markets it has been proven and is a matter of well documented and established history.

So, why did you bring it up, is that supposed to be a joke?
A2G
2.5 / 5 (8) Oct 19, 2012
Deathclock, You are spot on. Hedgefunds are one of the big culprits in the "game". They use large $ to make moves that affect the price of stock to their advantage. It is stealing to put it bluntly. The smarter hedgers are better thieves of assets from those who have less and cannot make moves that change stock prices.

One of the main reasons the rich get richer and the poor are getting poorer. If our government was truly "of the people", hedgefunds would be as illegal as they should be.
A2G
1.8 / 5 (5) Oct 19, 2012
TO get you started on hedge fund managers and the real truth start here.

http://hereisthec...ll-evil/

A quote from that article:

"when groups of hedge funds sold short,and then spread exaggerated rumours that their target companies were facing near-term bankruptcy. Long-only funds couldn't benefit from this scam because they couldn't go short but, he claimed, some hedge funds were undertaking bear raids all the time – using derivatives and credit default swaps to make massive profits, while destroying companies and the livelihoods of the less-well-off."
cantdrive85
1.7 / 5 (10) Oct 19, 2012
There must be an evil scapegoat to impute this upon, should it be the joos, Nazis, or, I know, it must be the hedge funds! So, know you're claiming conspiracy too, I thought it has been "been proven and is a matter of well documented and established history." that the evil hand behind the curtain is impossible.
krundoloss
2.3 / 5 (4) Oct 19, 2012
I have to wonder, does this group of elite that controls and manipulates the world get larger? Are there more and more people that are rich and can influence the world to thier advantage, or are they backstabbing each other until there is only one super rich person that controls the world from behind the scenes......the rest of us have to wonder - Why? If you are rich, why do you want to be richer? What is the point in making billions after you already have millions? Greed will destroy us all!
rubberman
1.8 / 5 (5) Oct 19, 2012
The fallacy here is the assumption that stock market crashes are mistakes and are not intentionally engineered by those that would benefit from them...

Tin foil hat on a little tight? Conspiracy is possible in the financial markets, but not academia, right?


Conspiracy is not only possible in the financial markets it has been proven and is a matter of well documented and established history.


I would go so far as to refer to it as policy. As pointed out several times here, the more money you have, the easier it is to protect it, and the more help you will have from your equally money laden piers.
EBENEZR
2.6 / 5 (5) Oct 19, 2012
I get worried when people use the term "real truth", it's almost definitely necessary to neglect said "truth".
R2Bacca
2.5 / 5 (4) Oct 19, 2012
I hate to break it to you folks, but capitalism is predicated on there being winners and losers. There is only a finite amount or money out there. If one person has a bunch of it, somebody has less. That's just the way it works.

The real problem here is that for some reason everyone seems to think that they are *entitled* to the same amount of money as everyone else. That somehow just because you live in America, you should have it all. The fact of the matter is that we Americans are, as a collection, the 1% of the global population with most of the wealth.

Look at what most of us enjoy on a day-to-day basis. Computers? Cars? Running Water? Heck we *pay* to have other animals live with us and we CLEAN UP THEIR EXCREMENT FOR THEM. We have gotten Fat. We have gotten lazy. It's like we're arguing how to distrubute a bag of halloween candy when the kid down the street might not even be getting dinner.

We have all gotten rich at the expense of others. Admit it. It is just human nature.
R2Bacca
1 / 5 (1) Oct 19, 2012
So the next time you feel that pang of jealousy when you see some rich guy driving down the street in a Aston Martin, when you go to bed that night and turn off that miracle of a device you call a computer and you snuggle those blankets up to your nose while your furnace runs in the background heating the room you are in (and every other room in your house) and your refrigerator keeps all of your food fresh, think of a kid living in a cold, dark hut somewhere without a blanket. Think about someone who didn't get to eat a meal that day or even the day before. And when you've done that and you still feel like you've somehow been slighted by society because you don't have an XBox AND A PS3, please do us all a favor and stick your head in an oven.
VendicarD
5 / 5 (2) Oct 19, 2012
The stock market self organizes to a chaotic state. This is the case because if any method becomes available to predict it's state, then that method is used to anticipate the market state, thereby changing the assumptions upon which it relies to operate.

R2Bacca
4.5 / 5 (2) Oct 19, 2012
The stock market self organizes to a chaotic state. This is the case because if any method becomes available to predict it's state, then that method is used to anticipate the market state, thereby changing the assumptions upon which it relies to operate.



Kind of like collapsing a wave function when you try to observe it.
Sanescience
2 / 5 (4) Oct 19, 2012
Be on the look out for unintended consequences, like behaviors that might spread the contagion from the stocks in stress. Or if a large number of traders using the same heuristics see an innocent "dip" and all simultaneously jump to different stocks thus seriously harming the stock that otherwise would have been fine...

Wait, that already happens!
VendicarD
5 / 5 (1) Oct 19, 2012
Yes. I have noted the similarity before.

In the case of a wave function, the act of observing necessarily alters the observed, but in the case of the stock market, it is not the observation, but the act of exploitation that causes the self organized chaos.

"Kind of like collapsing a wave function when you try to observe it." - R2Bacca
VendicarD
5 / 5 (1) Oct 19, 2012
It bothers me that market analyists spend so much time studying a self disorganizing system like stock markets, unaware of the fact that whatever rules they wish to find, will immediately vanish when they become generally known.

The stench of idiocy pervades all of these kinds of studies, and all of these researchers.

Pressure2
1.8 / 5 (5) Oct 19, 2012
TO get you started on hedge fund managers and the real truth start here.

http://hereisthec...ll-evil/

A quote from that article:

"when groups of hedge funds sold short,and then spread exaggerated rumours that their target companies were facing near-term bankruptcy. Long-only funds couldn't benefit from this scam because they couldn't go short but, he claimed, some hedge funds were undertaking bear raids all the time – using derivatives and credit default swaps to make massive profits, while destroying companies and the livelihoods of the less-well-off."

Are they referring to Romney here?
Pressure2
1.8 / 5 (5) Oct 19, 2012
Deathclock, You are spot on. Hedgefunds are one of the big culprits in the "game". They use large $ to make moves that affect the price of stock to their advantage. It is stealing to put it bluntly. The smarter hedgers are better thieves of assets from those who have less and cannot make moves that change stock prices.

One of the main reasons the rich get richer and the poor are getting poorer. If our government was truly "of the people", hedgefunds would be as illegal as they should be.

That's only half the story, on the money they queezed out of you they pay less than 1/2 the taxes you paid to earn it in the first place. That leaves them plenty of money to hire lobbyist to keep things the way they are.
Moebius
1 / 5 (4) Oct 20, 2012
Diversification is BS. There's nothing wrong with putting all your money in one good stock if you get it at a good price. Like I'd buy Apple right now except for the fact it's what I already have.
kochevnik
1.8 / 5 (5) Oct 20, 2012
Long-only funds couldn't benefit from this scam because they couldn't go short but, he claimed, some hedge funds were undertaking bear raids all the time – using derivatives and credit default swaps to make massive profits, while destroying companies and the livelihoods of the less-well-off."

Not being able to short a stock is the epitome of stupid. It reflects the positive-definite American bias of kool-aide and eternal sunshine. "Long-only funds" are dinosaurs.

The stock indices are rigged by deleting losers and adding companies with a future in their sector. So OF COURSE the index will go up once the fossils are farmed out. Moreover the FED policy of 0% return forces flight to stocks in an effort to stymy inflation loss. Hence weakness is portrayed as strength.

If America wanted success it would put taxpayer money in science research, which has a 7:1 return. Instead half of the US budget goes to the military, which is larger than all other armies COMBINED.
kochevnik
1.8 / 5 (5) Oct 20, 2012
In the case of a wave function, the act of observing necessarily alters the observed, but in the case of the stock market, it is not the observation, but the act of exploitation that causes the self organized chaos.

"Kind of like collapsing a wave function when you try to observe it." - R2Bacca

Not so sure about that. Market behaviors are strongly correlated to the electric gradient on Earth, which is directly altered by planet alignments (astronomic, not astrological). The field is so strong it could be asserted that it links minds together and produced time-varying behaviors such as market trends. Typical of chaotic dynamic systems the sole parameter of the electric equation is the opening date of the market in question. From there the electric field potential sculpts the shape of market oscillations for all time forward.
VendicarD
5 / 5 (1) Oct 20, 2012
I said that on some U.S. newspaper comment section a few months back.

You should have seen all of the mindless ConservaTards calling me a liar.

They are spectacularly ignorant about their own nation.

Some of them proved that they couldn't even add or subtract when they tried to prove that the fact you now state, and that I stated then, was in their words "a commie lie".

Ignorance, thy party is Republican.

"Instead half of the US budget goes to the military, which is larger than all other armies COMBINED." - Kochevnik

VendicarD
not rated yet Oct 20, 2012
Are you so sure that it isn't market forces that are shaping the electric field?

"From there the electric field potential sculpts the shape of market oscillations for all time forward." - Kochevnik
kochevnik
1.8 / 5 (5) Oct 20, 2012
I said that on some U.S. newspaper comment section a few months back.
Just send them this link. I think it destroys many of their dogmas in three minutes: http://www.youtub...6m3Ua2nw
Are you so sure that it isn't market forces that are shaping the electric field?
LOL well at the rate corporations are destroying the ecology I can see a time where they will start tinkering with the EM field and ionosphere in some weather modification scheme. So far EM radiation is limited to a few brain tumors from mobile phones and leukemia from Homeland security scanners. I have no doubt someone will see a profit in more EM noise.
kochevnik
1.8 / 5 (5) Oct 20, 2012
The 2008 stock crash was precipitated by a change to banking rules allowing insured loans to be put back into capital and loaned out again. (http://www.federa...cbem.pdf page 531) This made capital virtually infinite as long as an insurer could be found! Huge incentive for banks to loan where they can get insurance on loans they make. In USA it was in home loans. Companies like AIG created software models "proving" home loans seldom go bad. That created a perverse incentive: Banksters decided to defraud the insurers, presuming that taxpayers would repay the losses.

Citibank gave home loans to unqualified people. They bought insurance from AIG. They made another loan against that insured money, then sold off the first loan – but kept the insurance. When the homeowner failed to pay, the buyer of that securitized loan was screwed. Meanwhile Citibank collected full value from AIG on the insurance ctd..
kochevnik
1.8 / 5 (5) Oct 20, 2012
Then AIG couldn't pay anymore and the bottom fell out. Suddenly all those insurance-backed loans were based on nothing at all. Citibank's reserves at the meltdown were worse than 1:2,000. (A normal reserve level is 1:20).

Essentially, what Citibank did was like you buying some homes, getting fire insurance, pouring gasoline throughout the house, then selling (and collecting full price) on the homes. When the houses explode and burn to the ground, you collect the insurance money. You have collected twice. A magnificent business model, especially with the taxpayer paying the $trillions in losses.

This new tweak in banking law destroyed the banking multiplier. This would make Central Banks obsolete. Economies can function forever purely on privately created money under the law now, and Americans are debt slaves to fund new insurance scams!
ValeriaT
1 / 5 (4) Oct 20, 2012
IMO the guys who are considering the subprime crisis as a reason of financial crisis are as correct, like the people, who do consider the Hitler as the origin of Nazism in Germany or like the people who do consider the global warming as a consequence of carbon dioxide. They're right, these things were all connected mutually, but the underlying reason are deeper and it can be expressed as an omnipresent lack of energy in the system. It's longitudinal wave effect, not deterministic transverse one. The human civilization expanded without qualitatively new sources of energy and raw materials and the world has became poor. Under such a situation a single Iraq war can deplete the reserves of financial sector stability and this sector will collapse. The subprime sector was just the weakest member of the chain. This is not about justification of avarice of Lehman's bankers, but about realization of deeper connections.
ValeriaT
1 / 5 (4) Oct 20, 2012
That is to say: we excluded/replaced the weakest member of the chain, but we still didn't remove the original reason of the chain tension: so we can just expect, this chain will rupture at another place again (and probably at more places at the same moment this time). The ability to see long-distance interactions and connections requires deeper qualification, than simplistic reductionist approach and a better memory too - but it will enable us to solve the reasons, not just the consequences of the financial crisis.
Argiod
2.1 / 5 (7) Oct 20, 2012
If we put Romney into the White House, there will be no stock market; he'll sell us out to China. Then we can all work for a dollar an hour and no benefits. When you're worn out, you simply find a quiet spot to lay down and get out of the gene pool. Meanwhile, Romney and his fellow wealthy can buy third world countries and live as kings while the rest of us become slaves to keep them in the style to which we'd all like to be accustomed.
ValeriaT
2.5 / 5 (8) Oct 20, 2012
Romney and his fellow wealthy can buy third world countries
It brings the memo of Luis D Elia, undersecretary for the Social Habitat in the Argentine Federal Planning Ministry, in which he spoke of the purchase by Bush of a 98,842-acre farm in northern Paraguay, between Brazil and Bolivia... The Governor of Alto Paraguay, Erasmo Rodríguez Acosta has admitted that George Bush Sr. already owns land in Paso de Patria near to 70 thousand hectares (173,000 acres) as part of an ecological reserve and/or ranch. Bush family who made their millions banking with the Nazi Germany is buying up thousands of acres in Paraguay in similar way, like many former Nazis..
Egleton
1 / 5 (5) Oct 20, 2012
Where are the climate change deniers? We've got to have climate change deniers.
How can we weave climate into the narrative?
OK.So no climate.
OH well.
What is happening is that with communication tending to be instantaneous and ubiquitous all the competitive funds managers are dancing in synchronization.

"Dance then, wherever you might be,
For I am the Lord of the Dance said he.
And I'll lead you all, wherever you might be.
And I'll lead you all in the Dance said He."
Jimee
5 / 5 (2) Oct 21, 2012
Do you think "people" like Romney and Ryan would allow this method of enrichment for the upper class to be taken away? The 47% can go die, but the 1% will always prosper as long as we allow them to make the legislation. Save America and the Americans. Make it fair for EVERYBODY.
VendicarD
5 / 5 (1) Oct 21, 2012
What Romney will do is enact a series of austarity measures in order to lower government expenditues - principally for the poor and the unemployed.

He will also dramatically reduce funding for various government agencies in order to reduce the federal budget, and to make it easier for his Corporate buddies to break the law and cheat the American people.

The results will be a re-trenchermen of consumers into low consumption mode. The lower standard of living that will result from this lowered spending will push the U.S. economy that is just now getting back in step, back into recession, and then into a deep, decades long Grand Depression.

"If we put Romney into the White House, there will be no stock market; he'll sell us out to China" - Argoid
VendicarD
5 / 5 (1) Oct 21, 2012
"Save America and the Americans. Make it fair for EVERYBODY." - Jaimee

Don't fool yourself. America is run by corporations, not those 1 percenters.

This business about 1 percenters - while significant and true, is not being promoted because it is particularly significant.

It is being promoted to keep you worrying about "the rich" and not the Corporations who really rule your naton
EBENEZR
1 / 5 (3) Oct 22, 2012
R2Bacca

The real problem here is that for some reason everyone seems to think that they are *entitled* to the same amount of money as everyone else. That somehow just because you live in America, you should have it all. The fact of the matter is that we Americans are, as a collection, the 1% of the global population with most of the wealth.


If you think all Americans are born equal then you need a reality check. The majority of Americans have to weigh their balance sheets and it'd be interesting to see how much they are actually worth. Mortgages, cars on finance and credit cards, how much of what the average American calls their "possessions" do they actually own outright and how much is on borrowed money? If America decided as of 2012, there would be no concept of ownership unless you own it outright, the true rates of "wealth" would show through.
Czcibor
1.8 / 5 (5) Oct 26, 2012
The stock market self organizes to a chaotic state. This is the case because if any method becomes available to predict it's state, then that method is used to anticipate the market state, thereby changing the assumptions upon which it relies to operate.


VD made a reasonable statement concerning economics!!! The only way in which I can explain it (except a random guess) - it's a sign of mass madness that would precede impending doom... ;)
Czcibor
1 / 5 (4) Oct 26, 2012
EBENEZR - I think what they meant is that during the run-up to a crash, many stocks become synchronized, making many "diversified" portfolios ineffective. The solution then would be to identify unsynchronized stocks, and switch over to using those.

Maybe the point here is that during crash you don't have unsynchronized stocks. So either look some alternative investments (short positions; stock exchanges, bonds or real estate in a far away country; some commodities) or simply accept the fact that the portfolio is in fact terribly well correlated.

I understand that simple, long term tactic "buy and hold" is not good enough nowadays to overcome market fluctuations?

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