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Wednesday, 11 July, 2001, 08:15 GMT 09:15 UK
Can academics predict the market?
A meteor in the Hong Kong sky
Is the answer to stock market movement in the skies?

By BBC News Online's Orla Ryan

Academics at Oxford University are patenting a formula, which they say can forecast stock market movements.

These same academics must be hoping that stock market traders have short memories.

The world economy stuttered in 1998, when Long Term Capital Management, famous for the Nobel laureates who graced its board, had to be bailed out.

The Oxford academics swear their formula is different, but whatever the truth of it, in times of sliding stocks, market players are likely to look for inspiration in unlikely places.

A question of physics?

Dr Neil Johnson and colleagues at Lincoln College in Oxford are using the laws of physics to predict stock market movements.

They have been working on the project for two years, using robot computers fed by real data.

Could these formulas predict crashes such as the Wall Street crash in 1929?
Could these formulas predict crashes such as the Wall Street crash in 1929?
These 'traders' had different strategies to choose from. When patterns emerged in the strategies they chose and the 'traders' began to behave in the same way, this indicated that a large market movement could be imminent.

"As soon as people behave as a crowd, that means there is going to be a large movement one way or the other," Dr Johnson said.

This same formula could be used to analyse internet and road traffic, to highlight where there might be future congestions.

The LTCM dilemma

It all sounds good, but mathematical analysis has sounded this good before.

Famously, the Long Term Capital Management hedge fund lost $2.3bn in 1999.

Nobel laureates Myron Scholes and Robert Merton lost out when the fund's investments in Russian markets were hit by the rapid devaluation of the rouble in August, which saw the currency lose 70% of its value.

As soon as people start to behave as a crowd, that means there is going to be a large movement one way or the other

Neil Johnson
LTCM had bet millions trying to anticipate future movements in the world's financial markets using options and futures investments.

"The problem is that markets move in that way 99% of the time. It was a wonderful model for 99% of the time. They were unlucky. They hit the 1% time that got them," Neil Johnson said.

"You could say that 1% isn't good enough...The reason it didn't work in that 1% of the time was because of the collective move of all those objects, that is what interested me as a physicist."

Complex issues?

For academics like Johnson, the stock market is an opportunity to test out physics theories.

"The problem... is there are no concrete systems you can look at in the real world with lots of data, where you can test out your ideas," he said.

Enter the stock market, the ideal playground for mathematicians and would-be entrepreneuers alike.

People come to us when the market is dead and gone

Financial astrologer Ali Mustafo
"One of the attractions of stock markets is you have a mass of data, this greatly appeals to some academics. With modern computing methods they can have a gigantic database of every sort of economic statistic, they can then play around with these," London School of Economics' Roger Alford said, voicing his concern that one formula cannot cover all the options that traders have to consider.

Is it in the stars?

Academic formulae are only one option for the more adventurous trader.

In the US, there are astrological funds, such as the one run by Henry Weingarten.

In the UK, Christeen Skinner, the astrologer, uses the movement of the heavens to predict the market, by looking at the 'birthdate' when companies were formed and then drawing up an astrological chart.

However, her reputation was dealt a blow when she was beaten by four-year old Tia Laverne Roberts in a week-long contest to see who could make the most (or lose the least) money on the London Stock Exchange.

Citystats Ali Mustafo uses astrology as a mood indicator for stock markets, claiming to be able to predict short bursts of stock market activity.

In a time of stock market uncertainty, such as now, investors will consider taking advice from all quarters.

"People like me are mocked, ridiculed, stamped on. People come to us when the market is dead and gone," he said. "They don't mind it when it is going up for no reason at all, they do mind it when it is going down for no reason at all."

A random walk?

Trying to see magic and method in stock market numbers is nothing new.

There are several well-respected methods of doing so.

One method of technical analysis is derived from a 13th century Italian mathematician, Fibonacci. Fibonacci levels refer to a pattern of numbers often found in nature. The general rule is that the sum of two numbers is equal to the third number.

But many economists believe that the price of any individual stock on a given day is determined not by some formula, but purely at random.

In a famous book, A Random Walk on Wall Street, Burton Malkiel argues that stock prices cannot be predicted from one transaction to the next.

If you were simply to record pluses and minuses consecutively as transactions take place, you'd find that you can't predict the next movement from the previous one, he says.

London School of Economics' Roger Alford is sceptical of the new theories.

"The random component would remain very large. What you are trying to foresee is what is going to happen to the economy....what is going to happen to the indexes."

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See also:

02 Oct 98 | The Economy
Greenspan defends hedge-fund bail-out
24 Dec 98 | The Economy
LTCM partners set for Christmas bonus
25 Sep 98 | The Company File
Wall Street rescue for hedge fund
23 Mar 01 | Business
Four-year-old beats City expert
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