Sep

5

I wonder if the resemblance between how molecules are structured and how stocks are traded can be used to explain some "irrational" price moves that occur sometimes. By irrational I mean large jumps or declines in the price despite no new information.

When heat (energy) is added to a substance two things can happen: A higher temperature is observed, caused by higher kinetic energy. Or, if the substance changes phase, the heat will change the bonding of the molecules, increasing the potential energy. The idea is that stocks have phases (or equilibria) that change in much the same way.

Note the two fundamentally different reasons for trading: #1 Buy one, sell another to take advantage of differences in relative prices, #2 Buy or sell based on whether consumption or investing makes one better off.

These equivalents are being used: Temperature (kinetic energy) <=> The expectancy and return at the price where #2 buying and selling balances. Bonding (potential energy) <=> The value the #1-participants add to the market. Heat (kinetic + potential energy) <=> The price from the impact of both #1 and #2

Normally stocks can be thought of as being in the liquid state. Trades trying to benefit from the differences in valuation (#1) are the forces which keep the stocks connected. This will normally imply very little impact on the price from selling or buying (#2) in a particular stock when no new information is released.

When the net price impact from those who go in and out of the market (#2) is higher than the #1-traders can deal with, stocks will change phase.

If the change is a negative one, price will fall until we again find that Price = Money in / Shares out (#2), This new frozen price will be where the expectancy and risk is the same as for liquid stocks; i.e. a stock could fall from P=10 to P=5 despite no new information and be neither more nor less attractive than before. The reason is that the individual participants no longer have the benefits the #1 traders give them. Few will have incentives to trade because relatively small volumes will move the price in an unfavorable direction. A low price also harms the fundamentals, and private placements are less favorable for the existing shareowners; which can be considered costs of buying a frozen stock.

Similarly, when a stock boils it has more buyers than there are available sellers. A bubble will occur, and the participants who are fond of the stock have the power over its price. During the Internet bubble no one could stop it, and those who tried going short were most likely squeezed out anyway.

Whereas the individual stock must be in any of the three states, the entire market exists of a fraction of the stocks in each state. This is comparable to a pool of water which has an ice cube floating in it at zero degrees Celsius.


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