How Market Complexity Could Trigger The Next Crash

Complex systems are all around us.

By one definition, a complex system is any system that features a large number of interacting components (agents, processes, etc.) whose aggregate activity is nonlinear (not derivable from the summations of the activity of individual components) and typically exhibits hierarchical self-organization under selective pressures.

In today’s infographic from Meraglim we use accumulating snow and an impending avalanche as an example of a complex system – but really, such systems can be found everywhere. Weather is another complex system, and ebb and flow of populations is another example.

MARKETS ARE COMPLEX SYSTEMS

Just like in the avalanche example, where various factors at the top of a mountain (accumulating volumes of snow, weather, temperature, geology, gravity, etc.) make up a complex system that is difficult to predict, markets are similarly complex.

In fact, markets meet all the properties of complex systems, as outlined by scientists:

1. Diverse
System actors have different points of view. (i.e. bullish, bearish, long, short, leveraged, non-leveraged, etc.)

2. Connected
Capital markets are over-connected, and information spreads fast. (i.e. chat rooms, phone calls, emails, Thomson Reuters, Dow Jones, Bloomberg, trading systems, order entry systems, etc.)

3. Interaction
Trillions of dollars of securities are exchanged in transactions every day (i.e. stocks, bonds, currencies, derivatives, etc.)

4. Adaptive Behavior
Actors change their behavior based on the signals they are getting (i.e. making or losing money, etc.)

And like the avalanche example, where a single snowflake can trigger a much bigger event, there are increasing signs that the complexity behind the stock market has also reached a critical state.

MARKETS IN A CRITICAL STATE

Here are just some examples that show how the market has entered into an increasingly critical state:

Record-Low Volatility
The VIX, an index that aims to measure the volatility of the market, hit all-time lows this summer.

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Disclosure: None.

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