Tapping Into the Future

By Kerim Derhalli, CEO and Founder, invstr

All over the world, investment managers, financial professionals, day traders and individual investors habitually pore over charts trying to get a glimpse into the future. It is a practice that has been going on for literally hundreds of years, since candlestick charts were first developed by an eighteenth century rice trader in Japan called Munehisa Homma. Chartists now use a plethora of different techniques to discern repeating patterns of human behaviour,and calculate differing measures of momentum to project the markets forward. For over thirty years, I have also studied financial charts of all kinds, trying to get clues about the future price direction of currencies, bonds, equities and commodities. How wealthy we would be, if only we could peer into the future. Well, now we can.

Efficient market theorists will tell you that looking at charts is a pointless exercise: everything that is known about the future is already discounted in the current price. On that basis, markets would only move when there is ‘news’, in other words something that had not previously been known or anticipated. Anyone who has traded the markets for any period of time, however, will know that markets are just as likely to move when there is no news and that they are not nearly as efficient as some would have us believe.

By Kerim Derhalli, CEO and Founder, invstr

Why is that? For a start, market participants do not all have the same objectives. Some are profit maximisers, some are hedgers. Professional money managers are constrained by differing investment mandates. Capital and liquidity vary enormously as events like the flash crash in May 2010 demonstrate. Humans react at different speeds and with different personal risk preferences. Transaction costs also need to be taken into account. All of these factors mean that, in the real world, market movements are discontinuous, even in the absence of news.

I also believe that people hold latent expectations about markets which are not expressed in current prices because investors are not active in the markets at all times. If we can extract those expectations through a fair exchange – you tell me what you are thinking and we will tell you what everyone else is thinking – then we can create collective insight into market direction that doesn’t exist anywhere else, including the current market price.

The means of bringing people together efficiently to participate in such crowd-sourced exercises readily exist. We are all now trained in using our smartphones to share views on social networks. Two other factors make crowd-sourced market predictions even more powerful. Our increased propensity for playing games, witness the enormous success of King’s Candy Crush Saga, combined with the natural emotional roller-coaster ride of the financial markets can serve to draw in large numbers of people to play financial games. And the larger and more diverse the crowd, the better the prediction. Participants don’t necessarily need to be experts. In fact, it has been shown that a combination of experts and non-experts produces better predictions than experts acting alone, because this eliminates the propensity for group think among the so-called experts.

Games can also be set up to provide for quantitative polling rather the somewhat useless and subjective interpretation of natural language. By making games easy for anyone to play – the user is just required to tap a button indicating whether he or she thinks the price is going to go up or down a little or a lot, or sideways – large numbers of predictions across numerous instruments and timeframes can easily be harvested. The more people that tap those buttons, the more likely they will be to tap into the future.

Aha, say critics. If everyone knows where the market will go then it will not move at all. And what good would that be? Well, not much for those people, who, like me, have made a living out of the movement of markets. But when markets don’t move so much and the price of things becomes more predictable and uncertainty declines, then investment tends to go up. And with investment comes jobs and hopefully positive returns in the future. It might just be a better world to bequeath our children than the debt-laden one they face today.