The Tide of My Life

 

     In my early life, I was a curious child, very interested into sciences, but the destiny had something else prepared for me. When I was 11 years old, I had a near to death experience due to an almost fatal accident. Afterward, I became aware of the importance of respect for life and the right to live. It’s not like I didn’t respect life before, but this time it became the core of my life. The importance of life was not exclusive for humans, it was extended to animals as well and that led me to become a vegetarian.

     As an avid reader, I was a boy with multiple interests during high school: I was in love with physics and mathematics, then architecture grabbed my attention for a while, music was another of my passions, spirituality and psychology appealed to my humanitarian side, and I also liked high-tech devices. One day, when I was 14 I came across a psychology book called Eric Berne: Games People Play. After that reading, it was clear for me that I must become a psychologist.

Since then, I felt my mission in life was to help others, provide empathy and warmness, and make them feel wide awake about their right to live. I didn’t think I was going to be able to reconcile the scientific interest and the humanitarian sense until I became a psychosomatic psychologist.

 

The Waves in My First Career

 

For 25 years I was a psychologist, and as I was helping others with therapy and consultation, I developed as well in a parallel path that my soul was calling for. I wanted numbers, measurements, and I found it as a psychosomatic psychologist. In my profession, I got the opportunity to work with athletes, even with Olympic Teams and everything was about helping the athletes to achieve better performances through reconditioning the automatic stress response of the nerve system.

The natural human instinct in front of danger is to survive; this type of stress response is called fight/flight/freeze. The body cannot interpret complex situations as our brain does, the hormones released during extenuating physical training are interpreted as danger and they trigger the stress response, which can diminish the performance of professional athletes. The constant body stress can generate feelings of anger and fear, and also the excess of cortisol can affect physical fitness by making the body accumulate fat – it is an evolutionary trait we still have left because a stressful situation for the pre-historical human was not being able to find food -. In psychosomatic psychology, we monitor biomarkers of stress, in order to have a panorama of how the athletes are adjusting their response to constant muscle stimuli – stress for the body -, and responding to the recondition. Using the words of the markets, we create a “correction bottom” different from total collapse, so that the athletes can continue their “impulse”. As an additional comment, it made me smile when I came across trading psychology and discovered traders try to control their emotions as well.

You might be wondering at this point, what does this have to do with Elliott Waves and the markets? The thing is that this is the succession of events that led me to stumble into the trading world. In my profession, we utilize high-tech medical devices in order to obtain the metrics we needed to objectively review the physical status of an athlete. We use BIA, or bio impedance analysis, which helps to measure body composition, the proportions of fat, bone, muscle, and liquids in the human body.

In order to measure the response of the nerve system, we use different medical devices like electrocardiogram, electroencephalogram and lie detector. The result of those analyses is provided with a chart displayed in a computer.

One day I came across a trader and I was shocked by the similarities of the charts used in my profession and those market charts.

Image of stress factor analysis 

Image of the CAD/USD Forex major currency pair

Getting to the Market Waves

 

The day I met that man couldn’t possibly be the best. After more than two decades of service, living for others and fully committed to my self-imposed mission of helping others, my soul was asking for a change. For 25 years I managed to professionally help others, but at the same time, as a human being, I couldn’t prevent that personal problems of others affected me somehow. Many psychologists would agree that they may have seen many tragic outcomes of different stories, and despite the distance professionalism demands, you feel every bad ending as you failed for someone important. I was working a lot with final stage cancer patients, and it was a heavy burden for me knowing that sooner or later they were going to pass away, and no one could do something about it.

      There are other sad stories of people conditioned by their parents or the society to sabotage themselves; it is like they had a truncated or deviated sense of self-preservation. It’s like they felt they don’t deserve to live or being happy. After 25 years, I felt I accomplished my mission and touched many lives. I needed some fresh air.

The life changing moment in my life was brought by this man, a passionate trader who showed me some basic thing on market charts, and started to tell me some stories about traders. I was never thinking of money of being rich, I lived a simple life being satisfied withs smiles, with grateful gestures coming from my patients who get better on the way. When I learned abot the market, stock excanges and foreign exhanges, it was not the money. I was thundered by the similarity of charts. I wanted to know more, to understand, because I felt this cannot be a coincidence.

I am very grateful for this person, whom I call today my friend, my mentor because with the spark in his eyes he gave me a new paradigm, a new perspective, a new hope. As some days passed, I started to call him more often, then we started to speek daily. We was talking for endless hours, sharing time, ideas, notes, discoveries. Every day a felt this is my new interest, I started to think about the market in a scientific way, as I did in my old profession.

When I saw the market chart, I wanted to unveil what it meant, what was it talking about, the operation of it. My curiosity was alive again; I wanted the scientific explanation of those graphics. I felt so passionate about everything I learned every day during researches on my own, that I decided to begin a new career as an economist. This friendship helped me a lot, I cannot be grateful enough, I will never forget that moment and those days.

 

The Economic Laws and the Laws of Nature

 

I couldn’t be more surprised when I learned that a social science was so mathematical and the market phenomena are so complex. It became a new fascination. In my learning process, I came across the mathematics of the markets as well as the models, and how the models somehow mimic physics in their attempt to explain the forces that drive the market. But this was not the only way in which nature was hidden in the market.

As in physics, the markets never are in absolute conditions of order or chaos, this is why chaos theory appears in the game. Chaos theory doesn’t imply everything as a total chaos, as the name suggests, instead, it comprises every dynamic in the systems with constant motion since order and total chaos are conditions rarely found in nature, or in the markets. We will never get to see a model exactly reflected in a real-life situation because models are static and markets are in motion. In real life, there are hidden relations that control the motion of systems. Chaos theory implies that any disturbance in a system will be attenuated by the hidden order within that system, and an underlying concept that allows understanding those behaviors is the feedback loops.

A feedback loop is a process where we can see an effect causing a chain reaction type of behavior and being back to be the cause of the same effect.  Meaning the effect becomes the cause itself of the result. There is time when price action in the stock markets cannot be explained by purely economic reasons, but instead by feedback loops that the bounded rationality of human decision-making triggers. Classical economic models viewed the market through idealistic views of perfect information and optimal decision-making, and they believed that any price distortion was going to be nullified by rational economic agents. The problem is that there are a lot of variables that make humans take decisions that are sub-optimal, like the emotions, misinterpretations, imperfect information, and other inner or external factors. The general economic view about human behavior is, that humans are rational, the are able to prioritize their whish lists, the can rationally choose between the baskets of goods, they know what they want, they are aware what they need and so on. Psychology say the opposite, psychology see the cruel reality. 

One of the biggest examples on how the human factor is important could be the impact of the sub-prime crisis in 2008, probably the biggest in our recent history. The subsequent economic disaster was lasting, no matter the efforts of the governments on trying to solve the liquidity shortfalls. There was money, the problem is that there was no trust in the economic agents, no stimulation was able to return the market to motion because everyone saw the “financial magic” of the institutions, and nobody liked it. After the disturbance, the crisis became its own cause, and it only got exponentially bigger with the side effects. What happened there is comparable with the situation of an avalanche. This phenomena is called the “black swan” event as Nassim Nicholas  Thaleb points out in this book. Black swan is the methaphor of an unpredictable event that undermines everything you’ve known before. These kind of events cause markets to collapse in a moment, where sophisticated mathematical models and theories don’t work and stability and prediction of the future seems useless. Despite his great insight, I cannot agree with Taleb's main message. He say that people are fools, and the world is too complex to understand. We must live in the complex world, where we are fooled by our instincts. The world is predictable only in hindsight but we fool ourselves into thinking we can somehow predict the future. The world is highly unpredictable, black swan events are constantly changing the course of history and the truly significant ones can never be predicted.

What I agree thet feedback loops can cause collapses or other unpredictable events and feedbacks can be cause of the next event, causing a self generating and amplifying system which can have tragic outcomes of all kind.

In an avalanche - a feedback loop of nature - prior to the event there is a big mass of snow on the side of a mountain. As it continues snowing, the snow mass increases and it seems calm and quiet on the surface, but there are underlying forces acting hidden at plain sight: the pressure is accumulating, and the snow is more unstable, the avalanche is just waiting for a triggering condition to happen. Then one day, one small snowing, one last snowflake is enough to break a snow bank and start a movement that loosens more snow below it and more snow ahead of it. After the snow cascade reaches the base of the mountain, the place where the chaos started is stable again.

One thing to understand is that the avalanche can only happen only under instability conditions, just like it happens in the market when the indicators are not clear, or the participants of the market are frightened. The trigger is just the beginning of the reaction, but not the cause, the cause is instability and the feedback loop creates a repetitive pattern within the system that extends the cause and effect cycle. In the case of the crisis, the underlying instability was the institutional mismanagement of risk, the trigger was the revelation of the lack of liquidity of the banks, and the feedback loop was the human sentiment of fear and the lack of trust.

 

The feedback loops are a constant in nature, for example, in my previous work you could say stress is a cause of stress. When a person is stressed, whatever the trigger is, either physical or emotional, causes feelings that lead to more stress. With enough time of exposure to the hormones causing the stress reaction, the negative feelings increase and it leads the person to collapse, due to the side effects of stress, like anxiety and depression. As we can see, the systems’ structures allow the effect to magnify as it becomes the cause. This is often the natural course of it. What I used to do in my work was providing the rationality, the optimal conditions to erase the possibility of collapse and taking the person back to stability like it would happen in a perfect market.

As our understanding of the world is cyclic, the feedback loops are true for the technology and the things humans have created. For example, when you assist to a conference, it must have happened at least once that the audio system has a terrible and undesirable screeching sound. It is caused by an audio feedback. When the speaker starts the conference, the sound comes out at a higher volume through the sound system. If the volume is high enough or the distance of the microphone in relation to the amplifiers is too small, the sound that came from the amplifiers reenters the microphone a lot louder than the triggering audio input. The cycle repeats, even when the speaker has stopped, because the sound builds itself. Of course, not all audio feedbacks have to be annoying; guitars use the same audio feedback to create exciting and innovative sounds.

 

Discovering Fractals

 

      While discovering the sameness, repetitions, and scales in the market, it was natural for me that I found the mathematical base of it. I started to see the world with new eyes when mathematics showed me that there was a pattern in everything, even in equations. When I discovered the Taylor series - a method of function approximation through a polynomial built based on a series of derivatives of that function - I realized that when calculating the derivatives for the terms of the Taylor polynomial, there usually was a pattern that revealed how the following terms were going to be expressed without the need for calculation, this is why Taylor series are used to get an approximate of how the prices are going to behave in the future. There is a harmony in the terms Taylor series.

I felt at this point that science was making visible the invisible for me, and then my wondering eyes discovered fractal geometry in the hands of one of its pioneers, Benoit Mandelbrot. Fractal geometry is a new way to view everything in the world, because, like in chaos theory, you will be able to see order in the apparent chaos or irregularity. Benoit Mandelbrot realized that classic mathematics is limited and they are not capable of explaining the world around us, they are about smoothness and regular perfection. He opened the door of fractal geometry, the way mathematics can rid of limits so they can explain everything around.

 

 

The first Mandelbrot set built on a PC; this is the most representative of the fractals.