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August 16, 2011

The Market as a Fitness Landscape

The best description (or the one I liked best) of a Complex System is one proposed by Stuart Kauffman: a group of independent agents competing on a fitness landscape.

Think of a fitness landscape as a plateau with various hills and mountains. The object of the game is to go as high as possible. A strategy of always seeking higher ground is not a winning strategy because if you are at the top of a very low hill, you can't go higher. A winning strategy needs to get you off the top of low hills.

Fitness landscapes come in various shapes: very flat, hilly, mountainous or even stark like a Moonscape. And that is not all. The landscapes are flexible, as the players trample around, they deform the landscape meaning that the winning strategy today could stop working tomorrow.

In real life fitness landscapes are additionally deformed by technological advances such as optic fiber and algorithms as well as by legislation.

If the above is true, then Louis Navellier's approach: "What is working NOW on Wall Street" seems to be the right one. In addition, one needs to survey the oddities of the landscape such as the power law distribution of wealth (Pareto), the fractal nature of prices (Mandelbrot), the asymmetry of price moves around the mean (Faber), reversion to the mean and who knows what else to form a picture of the basic landscape that is subsequently deformed by the players.

Denny Schlesinger


Why Does the Average Mutual Fund Underperform? (Pareto distribution) by Denny Schlesinger
At Home in the Universe: The Search for the Laws of Self-Organization and Complexity (Fitness landscapes) by Stuart Kauffman
The Misbehavior of Markets: A Fractal View of Financial Turbulence (Fractal nature of prices) by Benoit Mandelbrot
Where the Black Swans Hide & The 10 Best Days Myth (Asymmetry of price moves) by Mebane T. Faber

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