FRACTAL FINANCE
Welcome To The World Of Chaos
Making Sense Of Fractals
by Erik Long
What is chaos? Here's a tool you can use to trade on the cutting edge of chaos and fractal theory.
Chaos is evident just about everywhere: in lightning, weather patterns, earthquakes, and financial markets, to name only a few. It may seem to appear in a random fashion, but it doesn't. In a nutshell, chaos is a nonlinear, dynamic system that appears to be random but actually is a higher form of order.
When you are studying the markets, complexity is the point at which the transition to chaos takes place. That should be the focus of your interest. Order and randomness exist simultaneously, and this gives us a degree of predictability. Social and natural systems, including private, governmental, and financial institutions, all fall within this category. People design these complex systems only to find those systems take on a life of their own. Each of these networks is sustained by complex feedback loops that reenter the system at unpredictable points in their cycles. This little-understood abstraction causes people to go about their business bewildered by the very systems they helped create.
Chaos is the realm of the nonlinear, and therefore is important to traders. Because financial markets are chaotic, it is necessary to use nonlinear tools to forecast market dynamics - tools that identify the hidden order in the apparently random process of the markets. But what underlies a nonlinear, chaotic system?
FIGURE 1: THE FRACTAL DIMENSION INDEX (FDI). In this daily chart of March 2003 crude oil contracts, notice the FDI beginning to decline as the market starts to trend.
...Continued in the May 2003 issue of Technical Analysis of STOCKS & COMMODITIES
Excerpted from an article originally published in the May 2003 issue of Technical Analysis of STOCKS & COMMODITIES magazine. All rights reserved. © Copyright 2003, Technical Analysis, Inc.
Return to May 2003 Contents