About the Market#

I have begun to think that every complex system has a core that determines its existence. The market, for example, is the result that emerges from the interplay between people’s desires to make money.

What began as a simple trading system gradually developed into today’s market through people’s pursuit of wealth. How will the market evolve? No one knows, but everyone has their own judgment. The actions arising from these judgments collectively form our subjective understanding of the market as a complex system. Those actions then provoke counteractions from other market participants, creating negative feedback. Once everyone in the world has contributed their own understanding to the system, the complex system is complete. Yet at its heart, it remains a system in which everyone pursues their own profit—and where one person’s profit will most likely come from someone else’s loss. This also gives rise to the market’s spontaneous countermeasures, or negative feedback.

In other words, this is how I understand its origins and development. But even if I know where we are now, can I calculate what comes next? I do not think so. For one thing, there is not enough computing power. For another, the market is not completely rational. It is precisely because it is emotional that all kinds of FOMO occur.

This offers some insight into market reflexivity: when the market is gripped by FOMO, the trend is often nearing its end. This is the negative feedback mentioned above, or a reversion to value. That does not mean everything completely abandoned by the market is bound to turn around. But for an asset that I judge to be undervalued, I can begin waiting for the possibility of its value being rediscovered once market sentiment has been fully exhausted.

This also shows that no trader can avoid losses entirely. As noted above, when someone begins to profit, what is essentially occurring is a transfer of wealth through the market: wealth moves from losing traders to profitable traders and exchanges or market makers. In other words, if an unbeatable trader were to exist, their counterparty would effectively become the entire market. Once that consensus formed, no amount of calculation, understanding, or adjustment could overcome it, because the trader’s opponent would be the market itself.

Of course, this does not mean that traditional indicators are completely meaningless. When the time horizon is extended and most emotional effects are filtered out, the underlying patterns remain unchanged. What I mean is that there can be no universal solution that always wins in the market. Even if one worked in the present market, shortly after becoming effective it would be identified, and the entire market would begin setting traps for that trading pattern.

The same applies to using AI to generate strategies. Ultimately, what AI does when analyzing the market’s direction is pattern recognition: it determines what was most likely to happen in similar situations in the past. This is certainly useful over the long term. After all, no person can grasp all the information in the market, whereas AI can collect information on that scale. Over the short term, however, as explained above, the market does not strictly follow historical patterns; it is governed entirely by emotion. Human emotions are irrational, and when the opposition includes trading bots colocated at exchanges with latencies of only a few milliseconds, I see no reason to believe that an individual can devise any strategy with a positive statistical edge. Even if such a strategy existed, as noted above, its pattern would quickly be identified and the market would begin trading against it.

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About Currency#

As a side note, let me also discuss currency—or perhaps expectations. Although currency is issued by a state and backed by its credit, the main determinant of its value is not actually the amount circulating in the market, but the public consensus about what it should currently be worth.

In other words, if the intrinsic value of a commodity remains unchanged, then an increase or decrease in the amount of money the public is willing to pay for it is itself an expression of how the public values the currency.

Or should this be described as expectations? Using a currency in transactions inherently carries expectations about its depreciation. Once those expectations exceed what merchants can absorb, they will be reflected in prices. (From this point onward, I will use expectations of depreciation as the example.)

This transmission from merchants to the public begins with essential goods. An event causes the market to form a view of the currency’s future direction—or a consensus emerges that the currency has already entered a particular trend. These expectations then shape the price forecasts of commodity and essential-goods merchants, who use futures markets to stabilize their returns. As commodity prices rise, products that use those commodities as raw materials also begin raising their prices. This is the commodity bull market that appears at the beginning of a currency’s depreciation.

At the same time, as spending on various goods rises, the expenses of companies throughout society also increase. To maintain their revenue, companies begin raising their quotes and service prices. As prices gradually rise across society, the public develops expectations of further currency depreciation. The resulting stockpiling of goods—which consumes future purchasing power—further fuels the commodity bull market and creates an inflationary spiral.

At this point, the currency’s value has been transmitted step by step from the market’s initial expectations into the actual foreign exchange market.

Of course, central banks can also influence foreign exchange markets by printing money. In reality, however, the funds at a central bank’s disposal are merely a drop in the ocean compared with the market. Such actions are more about managing expectations and guiding the market in the hope that it will develop in the desired direction.

Returning to currency, the discussion above concerned changes in the value of currency relative to the same goods at the macroeconomic and market levels. The following returns to currency itself—that is, how individuals use it directly.

When currency is used, the currency itself is really nothing more than numbers or pieces of paper. Yet it can facilitate the exchange of value in transactions because it is a universal equivalent issued by the government and backed by government credit.

But does that explanation truly hold? It is true that currency is issued by governments, but can its value really be quantified against anything? Government bonds? Gold? By that definition, most governments in modern society should already be bankrupt. So why does society remain so calm?

Under the gold standard, credibility was guaranteed by allowing one unit of currency to be pegged to a standard amount of gold. What about modern society? There is nothing tangible. Today’s currencies are not anchored to physical objects, but to assessments of current society and government, along with expectations for their future development.

These expectations can begin with individuals or with groups and institutions. The expectations themselves determine the currency’s actual value. In individual transactions, pessimism about the future creates expectations of currency depreciation. In other words, goods offered at the same price as before will now feel cheaper.

Of course, this is only an individual expectation. But if that judgment becomes a social consensus, individuals will begin borrowing against their future purchasing power to stockpile goods, while merchants will raise their prices.

However, the climax of this sentiment can easily produce abc, leaving the government ample opportunity to intervene. But if government measures reinforce the public’s expectations—or if the government itself shares those expectations—then this publicly driven effect can easily develop into a self-reinforcing death spiral.

Incidentally, the commodity bull market described above will also cause companies reporting in the local currency to show additional growth in their financial statements, which will drive up the stock market priced in that currency. (This is not the case when measured in US dollars. Moreover, higher nominal profits will instead result in higher taxes, reducing actual returns in dollar terms.)