Financial Markets Are Extremely Complex

August 25th, 2011 | Tags:

1st Financial markets are extremely complex. They are difficult to interpret and predict. And yet, our understanding of it is over-simplified.

2nd Modern investment theory is based on weak assumptions. According to the French mathematician Benoit Mandelbrot, “The market is very, very risky -. A more risky than the standard theory to imagine”

3rd Standard models are not defined or accurately assess risk. Need to evaluate and predict the risk caused by an elegant mathematical equation, which in turn was used to create fancy economic models.

However, current models take a very controlled according to the financial markets. For example, the theory states that the price movement from one moment to another are smooth, when in fact the price developments in the financial markets are volatile. The formula used to measure the risk to ignore the true situation. As a result, pension funds are subject to extreme financial turmoil. “This raises the question: Is your pension fund to take a holistic approach to the risks inherent in financial markets?

4th The standard theory assumes that markets are rational machines, which are the ideal market. This is a world in which the balance of buyers sellers. The basic idea is that financial markets always generate the “right” prices when new information about the property becomes available.

How did this all happen? Well, according to investment theory, people react logically when presented with new information. No emotions attached. This means that buyers and sellers are well-reasoned people who assimilate all available information, transact economically “fair” price. For this work, it is assumed that people have the same goals and it provides some information, they all make the same decisions. It is also assumed that these decisions are made independently of each other, which means that the price reflects the market consensus, and not the opinions of a select few.

5th People who move financial markets. Think of it this way. Market to include thousands of different needs, ideas, investment strategies, tactics, goals, tasks and emotions. As an individual you do not have to change prices or capital growth control.

6th Fundamental and technical analysis of the use of historical data to predict future price movements. Problem: it is impossible to predict what will happen in the future. In addition, the financial markets is fragmented and most pension funds are poorly prepared for surprises.

Except, when scientists find a way to calculate people’s emotions, long-term investors are likely to be followed by a one-size-fits-all “to diversify, invest and hope ‘approach.

7th Gloom and punishment inspires fear. With a hot tip inspires greed friend. Following the advice of others may be detrimental to your bottom line. Basically, you need to change the way you invest and do business.

8th The market will crash again in the future and people will be responsible. When greed gets into the mix, you may have yourself ticking time bomb. 2008 sub-prime crisis shows like this.

9th High-risk strategy is necessary to return again. It is difficult to predict future returns on financial markets and their expected returns may not materialize. Known high-risk strategy is more likely.

10th Retirement planning, as it is today is not effective way to create wealth. The evidence suggests that only 1% of people will no longer be working with the same standard of living they had prior to retirement.

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