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A market, in the abstract, looks like a [[nomological machine]]. There is a bounded environment, a finite trading day, a limited number of market participants and financial instruments regarding which one can engage in a limited range of transactions, the outcome of which will be to set a price for that instrument, which will be either higher or lower than (or the same as) the most recently traded price for the instrument. From this information we can extract a mathematical relationship: price went up, price stayed the same, price went down. | |||
Notice how arbitrary that “relationship” between two discrete transactions is. If they are independent of each other — and in a first order sense, they are — the participants in the later trade do not know who or where the participants in the earlier even are, let alone what their motivations for trading were — then a “trend” we draw between them is more or less meaningless. | |||
But we draw it because we make some assumptions about the homogeneity of all market participants: we assume all have more or less perfect price information, and that all are propelled by an essential economic rationalism: you don’t sell things you expect to perform better than comparable investments, and you don’t buy things you expect to perform worse. Each investor’s private motivation is nuanced and personal — how is the rest of it's portfolio placed, what are the local macro risks to which it is especially sensitive, but largely these proclivities cancel themselves out in a large sample and we can treat professional market participants as largely homogenous. | |||
This is good: it gets our model out of the gate. If investors were not broadly homogeneous, our statistics would not work. “What is the average height of all things” is not a meaningful calculation. | |||
But there is a second order sense in which the earlier and later trades are related: the later participants know about the earlier trade and its price — and its position in a trend from the trade before that —and they will use l this abstract information to form their bid and ask. | |||
buy or sell. In the modern days of computerised trading everything is very clean, tidy observable, unitary and discrete. | |||
====Derivatives trading==== | ====Derivatives trading==== | ||