Tuesday, September 25, 2012

The Uncertainty Principle of Financial Markets



In quantum physics, the Werner Heisenberg principle states that there is a fundamental limit to the precision up to which a particle’s physical properties of position and momentum can be known. It means that the more precisely a particle’s momentum is determined the less precisely its position can be determined and vice versa.

Financial markets have their own uncertainty principle, the implication of this principle is that either you can determine the direction of the move precisely or you can determine the timing of the move. For example, we all know (direction) that markets will touch new highs sometimes in future but we exactly don’t know (time) when. In this example we know the long term direction of the market is up but we are unable to determine the exact time of touching new highs. On the other side, before important news events like the recent Federal Reserve or ECB meetings, we knew (time) fairly well that a big move would come on the day of announcement but then we didn’t know precisely (direction) if that move would be up or down, which depending upon the news could be either ways. After the announcement the more the direction became clear, the lesser we knew how long will it continue?

This uncertainty principle particularly applies to options market because the knowledge of a move’s direction and exact timing is most important there.

Nobody can know, at the same time, both the direction and the time of a move. As traders we should always keep in mind our limits and trade accordingly. We traders are managers of risk and player of probabilities.

(Contributed by Jitender Yadav)

7 comments:

Ssaameer Sunil Limaye said...

Fantastic comments and fantastic expamples quoted. Simply outstanding.

Dinesh Rishi said...

Thanks Sir

Singh Gajendra said...

Waw ! It's great
It's is the most scientific way of technical analysis of financial market ,,,,in practicality it's naturly true .i pay great thanks to me Jitendra yadav for this post for all treders.

SantoshG said...

Good one! Keep it coming!

Dinesh said...

Dear Sir,
This is an excellent depiction of the current situation where everyone seems convinced of the upmove (look at FII data) but not able to predict when that upmove is possible.
Regards,
Dinesh

Yousuf said...

nice explanation...,Heisenberg uncertainty principle and Financial market co-related.
i remembering my college physics classes when read this..

gourv said...

Dear Sir,

Please keep posting in your blog.
I have few questions.
1)What % of monthly return is aimed by professional trader like you?
2)Is it possible for professioanl trader to get their required return by trading only stock, I mean not using futures.

Regards
Gourav