Have Physicists Cracked the Stock Market?

New Scientist is reporting that physicists have largely figured out how to predict the end of bull markets:

A team of physicists and financiers have … successfully predict[ed] a steep fall in the Shanghai Stock Exchange.

Their model, which employs concepts from the physics of complex atomic systems, was developed by Didier Sornette of the Financial Crisis Observatory in Zurich, Switzerland, and Wei-Xing Zhou of the East China University of Science and Technology in Shanghai. The idea is that if a plot of the logarithm of the market’s value over time deviates upwards from a straight line, it’s a clear warning that people are investing simply because the market is rising rather than paying heed to the intrinsic worth of companies. By projecting the trend, the team can predict when growth will become unsustainable and the market will crash.

Sornette, Zhou and colleagues applied their model to the Shanghai Composite Index, which tracks the combined worth of all companies listed on the Shanghai Stock Exchange, the world’s second largest.

Early this year, the index gained 50 per cent in just four months. In July, the
team predicted that the index would start to fall sharply by 10 August (www.arxiv.org/abs/0907.1827). The index duly began to slide
on 4 August, falling almost 20 per cent in the subsequent two weeks.

So we can all predict the stock market and make a ton of cash, right?

Not so fast:

“If enough investors take action based on our predictions, the evolution of prices will probably be affected,” says Zhou.

In other words, everyone will start factoring in the predicative power of the model, and selling out of late-stage bull markets earlier.

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