First Contact
My first contact with the stock market was marked by massive overwhelm. Countless advisors, explainer videos, real-time news services, and other offerings bombarded me. At that time, I didn’t recognize that this opacity was a typical characteristic of complex systems. It was up to me to respond appropriately or fail because I was vainly searching for simple solutions that did not exist.
Definition
The stock market is an open, complex, socio-technical system. What do the individual terms of this definition mean? Below, I simplify everything significantly, capturing only the essentials so that we move towards concrete assistance in dealing with complexity using the stock market as an example. We must remain capable of taking action!
Functioning of Stock Market / Opacity
“Stock market” refers to a regulated market where standardized objects, such as stocks, are traded. It balances supply and demand. Thus, the stock market itself sells nothing but brings buyers and sellers together. At its core, an order book is processed to maximize turnover. This processing, also known as Level-2, is visible to everyone and is where prices are ultimately formed. At this point, neither the future nor the past matters. The order book knows no plans. If a seller wants to sell a large part of company shares and there is no equally willing buyer to take the opposite bet, that it would be better to own the shares, then the sale takes place over many days or even weeks. With this simplified view, and yes, it is a significant simplification, we already appropriately respond to the mentioned opacity by reducing information and gaining an initial useful insight: As a stock market novice, I thought I would be lost without costly real-time stock market news, yet large sell orders and their actual, often gradual, execution are usually significantly time-separated, and relevant company news does not necessarily coincide with the individual orders. In any case, when opacity occurs in the form of missing information, we must actively acquire it, or, as in the case of the stock market, when it presents as an overload of information, we must reduce it. A good option for this is First-Principles Thinking, where we revisit the basics, such as the principles of price formation.
Open System
We first explain an open system using the properties of a closed system, like a PC. There, I expect that pressing “a” within Word will display “a” at the top left of the first line – otherwise, there is an error. I always expect the same output with identical input. Excluding updates or similar changes, programs or the operating system do not change, and I must consciously change hardware myself. I also know the limits of my PC and can predict when it will crash. The stock market, including necessary market participants and economic sectors, learns, adapts, and naturally exchanges with its environment. Thus, the repeated failure of major banks triggers a different reaction than the first time. A crisis is not necessarily bad but a restructuring or exploration of new stable states. The crisis as the failure of many traditional retailers appears dangerous, only to be considered in the next step as a transformation towards online trading.
Socio Technical
“Socio technical” refers to the combination of humans and machines, such as computers, etc. Here, however, the term “complex” is important. In everyday language, it is used synonymously with “complicated.” However, “complicated” refers to something intricate that can also be unraveled. If we understand how the individual parts work, we can also understand the whole and make precise, reliable predictions. Computers consist of thousands of parts, usually built according to the von Neumann architecture, and CPU, GPU, RAM, hard drive, OS, etc., together produce nothing surprising. “Complex,” on the other hand, means something composite, where the whole is more than the sum of its parts, making it fundamentally unpredictable. Starting with “opacity,” we have no better choice but to explore the other four character traits from P-O-C-A-I, namely Polyteleology, Complexity, Autodynamics, and Interconnectivity..
Polyteleology
A computer is designed to perform specific tasks such as data processing and program launching. At the stock market, however, people pursue different plans: some aim to make quick money, while others prefer safe investments. Because of this variety of goals, we must be flexible, carefully evaluate information, and quickly adapt. Most importantly, we need to decide what is most important to us and sometimes make compromises. If my goal is to invest my money safely, I might have to forgo the opportunity to make quick profits because safe investments often yield less profit. Or, if I decide to invest in stocks to earn more, I must also be willing to accept the risk of potential loss.
Complexity (Variety of Variables)
The hardware components of a PC interact according to specific rules. These connections are clearly defined, and data exchange follows fixed protocols. If the PC slows down, we can systematically check which component is defective or overloaded. The cause of the problem can often be identified and fixed because the relationships between the components are stable and known. At the stock market, numerous factors such as company profits, interest rates, political events, and investor psychology complexly influence the market. These factors are highly interconnected and often change unpredictably. Since it is impossible to fully capture all these variables, it makes sense to focus on essential information and develop simple, understandable models. This strategy of information reduction helps to minimize the risk of misinterpretations and makes the models more practical. While detailed models could theoretically be more accurate, they often lead to overfitting in reality and are therefore less reliable.
Autodynamics
A PC does not change its behavior autonomously; its functions and reactions remain the same unless someone makes changes. Changes result exclusively from direct inputs, such as installing software updates or executing new commands. This predictability simplifies the control and prognosis of system performance. In contrast, the stock market possesses inherent autodynamics that cause independent changes without my intervention. This dynamic arises from the decisions and actions of market participants and internal and external events, often leading to unforeseen effects. Given this unpredictability, it is crucial to remain flexible, continuously monitor investments, and quickly respond to market developments. This enables us to seize emerging opportunities and limit potential risks.
Interconnectedness
In a PC, components such as the processor, memory, and hard drive are directly interconnected. These connections are clear and straightforward, so changes in one part have specific, predictable effects on the system. This simple networking makes it easy to identify and fix problems. Conversely, the stock market is a network where many factors, such as corporate news, economic data, and investor sentiments, are intertwined. This interconnectedness means that a change in one area can have far-reaching and often unpredictable effects on the entire market. To be successful in this complex network, investors must structure information and gain a clear understanding of the relationships and influences. This helps them make better decisions and effectively respond to market movements.
Summary & Outlook
To tackle complex problems, we start with Polyteleology: We recognize that multiple goals can exist simultaneously and set clear priorities. Then, we face opacity by actively seeking information and accepting uncertainties. Complexity urges us to reduce information and focus on the essentials. Autodynamics remind us to be vigilant and ready for quick adjustments as conditions can change unexpectedly. Finally, understanding interconnectedness helps us recognize and leverage the interactions between different elements. By strategically addressing these five characteristics, we strengthen our ability to effectively master complex challenges.
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