From left to right: Andrea Rapisarda, Alessandro Pluchino, Alessio E.Biondo and Dirk Helbing (at Lipari Summer School 2013)

Are random trading strategies more successful than technical ones?

Can they also reduce the volatility of financial markets, limiting the occurrence of bubbles and crashes?

A.E.Biondo, A.Pluchino, A.Rapisarda, D.Helbing

 

PLOS ONE(2013) 8(7): e68344. doi:10.1371/journal.pone.0068344

 

PHYSICAL REVIEW E 88, 062814 (2013)

 

For a review of the main results see:

 

A.E.Biondo, A.Pluchino, A.Rapisarda
Micro and Macro Benefits of Random Investments in Financial Markets

Contemporary Physics, Volume 55, Issue 4, 2014

 

arXiv version

 

Reducing Financial Avalanches By Random Investments

 

Modelling Financial Markets by Self-Organized Criticality

 

Versione in Italiano

.... . ....

A random investment might beat the advice of your financial advisor: this is the new and counterintuitive result of this study just published in the journal "PLOS ONE". It resulted from an interdisciplinary collaboration between an economist, Alessio Emanuele Biondo, two physicists at the University of Catania, Alessandro Pluchino and Andrea Rapisarda, and the physicist and sociologist Dirk Helbing at ETH Zurich (in the picture above, from left to right: Rapisarda, Pluchino, Biondo and Helbing).

 

The research analyzes the performance of financial markets. Based on the observation that some randomness ("noise") often improves the functioning of physical and biological systems, and thanks to recent findings obtained exploiting the beneficial role of noise in other socio-economic contexts, the article compares some of the most popular trading strategies with a completely random one.

 

As the data base for their simulations, the four researchers used 15-20 year long time series of four market indices chosen among the most representative and popular in the world (the FTSE MIB for the Italian market, the FTSE UK for the London Stock Exchange, the DAX the Frankfurt Stock Exchange and the S&P 500 index for the NYSE U.S.). On this ground the different trading algorithms were compared with a random strategy in an attempt to predict the trend of the market day by day.

 

The results clearly show that the performance of the random strategy in predicting the evolution of the market is, on average and in the long term, quite similar to that of traditional approaches, but its variability on a small time scale is much lower. In other words, the study shows that, if a trader bets at random, he would be exposed to lower risks of serious losses, while the long-term gains will be comparable to those of popular chart-based trading strategies.

 

This research is part of a broader and ongoing literature debate questioning the theory of Efficient Markets. It provides a relevant contribution to the efforts of the international scientific community to understand and mitigate major financial crises and their devastating effects. The fragility that comes from the high complexity and interconnectivity of global markets today can be much more dangerous, as it inevitably exposes all market participants, including National States, not only to large financial speculations, but also to unpredictable crisis which periodically causes serious economic losses and dramatic drops in consumption. In this context, random strategies, used not only on an individual scale but also on a global one and at the level of economic policy, may also be able to avoid herding effects among investors and, consequently, to reduce the probability of dangerous "avalanche effects" that have been among the main causes of the recent collapses of the stock markets.

 

More recently, building on similarities between earthquakes and extreme financial events, we used a self-organized criticality-generating model to study herding and avalanches dynamics in financial markets. We consider a community of interacting investors, distributed on a small world network, who bet on the bullish (increasing) or bearish (decreasing) behavior of the market compared to the day before, following the S&P500 historical time series.

 

Remarkably, we find that the size of herding-related avalanches in the community can be strongly reduced by the presence of a relatively small percentage of traders, randomly distributed inside the network, who adopt a random investment strategy. These results suggest a promising strategy to limit the size of financial bubbles and crashes. We also find that the final wealth distribution of all traders corresponds to the well-known Pareto power law, while that one of random traders only is exponential. In other words, for technical traders, the risk of losses is much greater than the probability of gains compared to those of random traders.

 

Finally, we realized a financial market model, characterized by self-organized criticality, that is able to generate endogenously a realistic price dynamics and to reproduce well-known stylized facts. We consider a community of heterogeneous traders, composed by chartists and fundamentalists, and focus on the role of informative pressure on market participants, showing how the spreading of information, based on a realistic imitative behavior, drives contagion and causes market fragility. In this model imitation is not intended as a change in the agent's group of origin, but is referred only to the price formation process. We introduce in the community also a variable number of random traders in order to confirm their beneficial role in stabilizing the market. Finally we also suggest some counterintuitive policy strategies able to dampen fluctuations by means of a partial reduction of information.

 

.... . ....

INTERNATIONAL PRESS AND RELATED LINKS:

 

03/12/2014

Presentation of the new Mark Buchanan's book "Forecasts"

 

05/07/2014

"Warto zdac sie na los" on Obserwatorfinansowy.pl

 

18/06/2014

"Stopping Financial Avalanches by Random Trading?" on TheTradingGame.com.au

 

31/05/2014

"Could Random Trading Prevent Stock Market Bubbles & Crashes?" on Thoughtstrategy.co.uk

 

27/01/2014

"Markets, Herding and Avalanche Dynamics" on Pragmatic Capitalism

 

24/01/2014

"A random wolf on Wall Street could calm stock markets" on New Scientist

 

10/01/2014

"Random Walk Portfolio" on Wikifolio.com

 

13/11/2013

Andrey Babitsky: "From time to time" on Esquire.ru

 

04/11/2013

"Let the darts Fly" of Nolan Mannsky

 

14/10/2013

Robert Shiller: ŅLe bolle finanziarie sono come le epidemieÓ on Ass.Paolo Sylos Labini

 

09/09/2013

"Random Is a better pattern" of Sammy Haroon on globalcognition,blogspot

 

22/08/2013

"Why Investing at Random Is as Effective as Hiring a Financial Adviser" on Wired.com

 

21/07/2013

"Why do physicists gravitate towards jobs in finance?" on The Guardian.co.uk

 

16/07/2013

"ĄPuro azar? Dos f’sicos dicen que invertir en bolsa es como apostar en el casino" on Carlos Felice Blog

 

15/07/2013

"Un investimento casuale meglio di un consulente" su LiveSiciliaCatania

 

15/04/2013

"Gb: Studio, scimpanze' meglio di broker. Indici fatti a caso rendono piu' di quelli elaborati da uomo" - ANSA

 

12/04/2013

"Deux petites notes lˇg¸res d'humour ˇconomique" by Amid Faljaoui on Trends-Tendances.be

 

12/04/2013

"ĄPuro azar? Dos f’sicos expertos en procesos aleatorios dicen que invertir en bolsa es como apostar en el casino" - by Martin Burbridge on Cronista.com (Buenos Aires)

 

07/04/2013

"Martingale et journalisme scientifique" - by Arthut Carpentier on Freakonometrics

 

06/04/2013

"Le hasard, martingale boursi¸re?" - by Pierre Barthˇlˇmy on Le Monde, Sciences

 

31/03/2013

"Monkey beats man on stock market picks" by Chris Flood on Financial Time - The original article: "An evaluation of alternative equity indices" by Andrew Clare, Nick Motson and Steve Thomas, Cass Business School, London

 

28/03/2013

"En Iyi Yatirim Stratejisi" on Paradurumu.tv

 

27/03/2013

"The best investment strategy may be random" OBJ_MorningCall (Orlando, USA)

 

24/03/2013

"Random Trading. Se ben usato, un ottimo metodo per guadagnare" di Giuseppe S.Mela su RischioCalcolato.it

 

23/03/2013

"Una scelta a caso" su IncredibleButTrue - Blogspot.it

 

22/03/2013

"Computer Simulation Suggests That The Best Investment Strategy Is A Random One" - by Alex Knapp on Forbes

 

22/03/2013

"La strategia migliore per investire? Affidarsi al caso" su Wallstreetitalia.com

 

20/03/2013

"Banca Centrale intelligente con strategia di investimento random" su TheFielder.net

 

20/03/2013

"Computer Simulations Reveal Benefits of Random Investment Strategies Over Traditional Ones" on MIT Technology Review

 

19/03/2013

"Long-term results: Should You Trade Stocks Randomly?" by Marc Abrahams on Improbable Research

 

May 2013

- A.Biondo, A.Pluchino, A.Rapisarda "The beneficial role of random strategies in social and financial systems", Journal of Statistical Physics (2013) 151:607Š622

 

16/08/2012

"Navigando nella follia dei mercati finanziari" di F.Sylos Labini, Il Fatto Quotidiano

 

27/01/2011

"Physics for financial markets" - Interview to Dirk Helbing

 

November-December 2011

- A.Pluchino, C.Garofalo, A.Raisarda, "Meglio scegliere a caso: come sopravvivere in un mondo complesso adottando strategie casuali", Psicologia Contemporanea