Application of Heisenberg uncertainity principle in Finance.

In quantum physics, the Werner Heisenberg principle states that there is a fundamental limit to the precision up to which a particle’s physical properties of position and momentum can be known. It means that the more precisely a particle’s momentum is determined the less precisely its position can be determined and vice versa. Financial markets have their own uncertainty principle, the implication of this principle is that either you can determine the direction of the move precisely or you can determine the timing of the move. For example, we all know (direction) that markets will touch new highs sometimes in future but we exactly don’t know (time) when. In this example we know the long term direction of the market is up but we are unable to determine the exact time of touching new highs. On the other side, before important news events like the recent Federal Reserve or ECB meetings, we knew (time) fairly well that a big move would come on the day of announcement but then we didn’t know precisely (direction) if that move would be up or down, which depending upon the news could be either ways. After the announcement the more the direction became clear, the lesser we knew how long will it continue? This uncertainty principle particularly applies to options market because the knowledge of a move’s direction and exact timing is most important there.

Nobody can know, at the same time, both the direction and the time of a move.

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The connection with the Heisenberg uncertainty principle is silly and makes it sounds like you don’t know finance or physics. The Heisenberg uncertainty principle is (currently thought to be) a fundamental law built into the fabric of the universe. In particular, it suggests that no amount of information can add to your precision of predictions beyond a certain point. Thus far, in finance, there is no indication that the kinds of uncertainties you are talking about cannot be improved by better analysis or information, even if that information (like the psychological states of all investors) is difficult - in practice - to acquire.

Market analysts have long known that it’s a bad idea to give a prediction target and a date simultaneously, as it’s too hard to establish that one is wrong if you do. You give a target price or direction, but never a date.

@bchad:I studied this while preparing for FRML1 .FRM core materials and even schweser writes a few lines to describe the link between Heinsberg principle and stocastic process used to derive stock movement.

It’s still silly. Quantum effects are perhaps the only truly random events in the universe. Virtually all other events use randomness as a substitution for incomplete information about the world (and often the underlying process).

The mathematics may be similar in the sense that this is how you model things that involve random variables, but that is not the same as saying there is a fundamental law saying that if you know the price or the direction, you cannot know the time. In fact, in fixed income, the closer the bond gets to maturity, the better you can predict its value. There is default risk, of course, but certain bonds have so little default risk that a diversified portfolio of them will have no meaningful uncertainties about their nominal value.

@bchad:I don’t think in the FRM curriculum Heinsberg principle was used to model bond prices.It was used to model stock and option values mostly.

Oh well, as long as a fundamental principle of the universe only applies to stocks and not to bonds, I supose everything is ok.

The main thing is that lots of finance people suffer from “physics envy,” because physics has managed to make so many successful predictions about the world using mathematics. Saying “this is just like the Heisenberg Uncertainty Principle” sounds to me like someone who doesn’t really know the HUP very well noting a casual similarity in order to say “See, we’re just like physicists, just with money.”

This tends to lead to the idea that - as long as we use enough math - finance will be predictable like physics. This is a really good way to sell people on products, since it makes the marketing promises sound like guarantees, rather than just a bunch of math papering over bad knowledge.


@bchad:thanks for all the feedback. yes

Right on, bro! Also, the return realized by a stock until it reaches a 30-day moving average level or some other benchmark target is smaller in its own frame of reference compared to the corresponding return measured in the moving frame of refence of my portfolio, which is zooming by in upward direction at high relative speeds. This phenomenon is called “alpha dilation” and is a direct consequence of special relativity applied to finance.

Keep your relativity out of my quantum mechanics, unless you want to go down a black hole…

God does not play dice with the financial markets!!

I wonder how Schrödinger’s Cat is doing?

Not sure, haven’t seen him.

Shrödinger’s Cat half-died a long time ago.

I think I saw it at the H-bar.

You get a point for that, I just have no idea how fast it’s moving!

Can the point given be a singularity?

Furthermore, it applies only at the subatomic level.

People have tried to extrapolate Heisenberg to a number of macro-level observations; it never works. As here.

Does any one of you really use heinsberg principle in Finance or it is just a bookish concept?

It’s a bookish fantasy.