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Daily Speculations
May 2003

 

Old Speculators’ Association Forum:
Markets and the Theory of Least Effort

 

Victor Niederhoffer:
My first exposure to the theory that man tends to satisfy his desires with the least amount of effort came when at the age of 10, when I asked my grandfather which way the stock market was likely to go. He replied that the market’s path of least resistance was down.

The year was 1953.

The next came in a study of a study of Zipf’s law, which states that people use the least amount of effort in framing their words. So they use the shortest words most often.

Then Albert Jay Nock described Esptean’s law:

I was at lunch in the Uptown Club of New York with an old friend, Edward Epstean, a retired man of affairs. I do not remember what subject was under discussion at the moment; but whatever it was, it led to Mr. Epstean’s shaking a forefinger at me, and saying with great emphasis, “I tell you, if self-preservation is the first law of human conduct, exploitation is the second.”

This remark instantly touched off a tremendous flashlight in my mind…Spencer and Henry George had familiarized me with the formula that man tends always to satisfy his needs and desires with the least possible exertion; but they had given me no idea of its immense scope, its almost illimitable range of action. If this formula were sound, as unquestionably it is, then certainly exploitation would be an inescapable corollary, because the easiest way to satisfy one’s needs and desires is by exploitation.

In their observations on the phenomena of gravitation, Huyghens and Kepler anticipated Newton closely. It was left for Newton to show the universal scope of an extremely simple formula, already well understood in limine, and hence this formula is known as Newton’s law. As a phenomenon of finance, it had long been observed that “bad money drives out good,” but Sir Thomas Gresham reduced these observations to order under a formula as simple as Newton’s, and this formula is known as Gresham’s law. So for an analogous service, more important than Gresham’s and, as far as this planet is concerned, as comprehensive as Newton’s, I thought that the formula, “Man always tends to satisfy his needs and desires with the least possible exertion,” should bear the name of Epstean’s law.

I was indescribably fortunate in getting, as early as I did, a clear sense of the bearing which three great laws of the type known as “natural” have on human conduct…. By luck I stumbled on the discovery that Epstean’s law, Gresham’s law, and the law of diminishing returns operate as inexorably in the realm of culture; of policis; of social organization, religious and secular; as they do in the realm of economics. This understanding enabled me at once to get the hang of many matters which far better men than I have found hopelessly puzzling… for example … [w]hy was it impossible to improve society or the individual through political action? Simply because all such well-meant enterprises ran hard aground on Epstean’s law.

Birds will stop hunting if they are provided suet by a friendly bird fancier. This explains the tendency to embrace socialism and slavery.

Next, I came across a Chines paper describing the action of water in following the path of least resistance, and stating this was a general law of physics.

Next, I saw it applied to military strategy by Liddell Hart. For example, in describing how Germany overran France in World War II, he said: “The advantage which the Germans had gained by their deep strategic penetration along the line of least expectation and the line of least resistance was not reinforced by the advantage of tactical defense.”

A Google search saw the law of least effort applied to the concept of geographical areas chosen by serial killers, who commit their crimes in places involving the least amount of travel. Apparently wedge-shaped paths are chosen, rather than circular. (But in hiding the victim’s remains, they don’t follow it.)

Also on Google are attempts to explain the theory of least effort as the basis of major sociological laws of human behavior.

I believe the theory of least effort can be applied with great fruitfulness to predicting market movements. What paths seem most likely, other than the obvious such as volume of limit orders to sell above and the volume of limit orders to buy above the current price, round numbers, et al.?

 

Art Cooper:
This is simply the sociological aspect of nature's general principle of least action, which manifests itself in all areas of life & nature. Numerous books have been written on this subject. --Art Cooper

 

Ross Miller:
Actually, this is how the physical universe works (well known to all who have taken the Feynman approach to learning physics), though it goes by the name of the principle of least action, and from it Newtonian mechanics and much of modern physics can be derived. See http://www.eftaylor.com/leastaction.html (on the website of MIT professor Edwin F. Taylor) for vast resources on the topic, including the following quote:

"The least-action principle is an assertion about the nature of motion that provides an alternative approach to mechanics completely independent of Newton's laws. Not only does the least-action principle offer a means of formulating classical mechanics that is more flexible and powerful than Newtonian mechanics, variations on the least-action principle have proved useful in general relativity theory, quantum field theory, and particle physics. As a result, this principle lies at the core of much of contemporary physics."
--Thomas A. Moore "Least-Action Principle" in Macmillan Encyclopedia of Physics,    Simon & Schuster Macmillan, 1996, Volume 2, pages 840

While the universe may not actually try to follow the "path of least resistance," it acts as if does. This is not a trivial result, but profoundly deep and essential to an understanding of our universe.

 

Easan:
I can see how the theory of least effort applies to physical objects, but in the realm of the psyche, emotion and intellect, from which spring greed and fear, which inspire trading, there is also a manic, hyperactive energy.

Whirling dervishes come to mind. Great amounts of activity result, much marginally productive in the final analysis. The Least Action Principle seems to be looking at the passive, the rocks that roll down hill, the still pool of water which seeks its own level. Put some humans in the picture and they'll soon be throwing the rocks at each other and splashing in the pond. For the market, we need to factor in these forces too.

Though I am going to quote Prof. Taylor's paragraph below the next time my wife asks me to clean up the garage.

 

Alix Martin:
Light travels in a path that minimizes the optical path covered (real distance x optical index of traversed material).

Markets can't travel in straight lines without offering stat arbitrage opportunities to trend followers, that add wiggles in the process of exploiting straight lines.

 

Russell D Sears:
What I find most fascinating is that the path of least effort often produces the most force.

In physics it is Mass X Velocity. It is more intuitive to me why the path of least resistance, less friction, produces the greatest velocity. But why the most mass also chooses this path is not as intuitively clear.

I am reminded of the "burning match" that is mentioned in Vic's book and how my driveway was washed way by the mass of water washing over it in the recent Midwest storms.

Also, I am reminded of a few of my calculus prof's favorite phrases:

This I believe is the strength behind KISS (keep it simple stupid). But also an indicator to true brilliance behind a trading system, such as the VIC. Simple thoughts are often the most powerful.

 

Derek Gard:
This discussion of least effort and the other discussion of technical analysis perhaps compliment each other. As stated in earlier posts, I am primarily a day-trader. Not terribly sophisticated compared to others on the List, but I make a comfortable living and do all right. I trade using a cross-over of two moving averages and a variant of the slow D% stochastic. I typically make two or three round trips per day. I recently was discussing TA ideas with a colleague and he showed me his charting of price patterns. He used 2 moving averages, drew support and resistance lines, trend lines, had on it Bollinger bands, stochastics, Chaikin's money flow, MACD with a signal line, and relative strength. On top of all that he also had candlestick interpretations. Of course he had a reason for needing every one of these indicators and argued that I could not possibly make money as my system does not take into account enough variables.

I asked him how many trades he had done that day, and he said none because he did notreceive enough signals. "Paralysis from analysis." Perhaps the antithesis of "KISS" should be kept in mind when evaluating an edge. No matter how effective the system may be, if it is too complicated to be used it becomes worthless as an edge.

In our quest to learn more, and then to demonstrate that increased knowledge (perhaps influenced by hubris), humans make their endeavors more difficult than they need to be. Often the most intelligent people in a room have the most difficulty with the simplest concepts of a discussion.

 

Mark Serafini:
Lao Tsu.....Taoism. Whe we are in tune with the "chi" all is well (and profitable). When we are in conflict with the "chi" we are on the wrong path (and losing). "Be the ball Danny"-- Chevy Chase, Caddyshack

 

David Higgs:
I know you disdain individual stock, but perhaps this will spark a greater thought than I can produce.........looking at companies that can produce a good at a lesser cost than others seems like a path to least resistance, gold companies or damond companies that find these minerals on the top surface, as to having to tunnel to thecenter of the earth.