Chaos Theory

Explaining Chaos Theory is not easy. I am merely going to focus to get closer to it and try explaining in my paper the basics of so called ’Chaos Theory’. To do that in financial sence,of course, it might be the best way to try analysing from macro stand point looking at world as a hole, looking at the big picture. Science is trying to explain chaos as long as it exists and try to extrapolate the formula for it, trying to get the predictions as accurate as possible.

Since its inception, science relied on predictability and order. The true beauty of science was its uncanny ability to find patterns and regularity in seemingly random systems. For centuries the human mind as easily grasped and mastered the concepts of linearity. Physics illustrated the magnificent order to which the natural world obeyed. If there is a God he is indeed mathematical. Until the 19th century Physics explained the processes of the natural world successfully, for the most part. There were still many facets of the universe that were an enigma to physicists. Mathematicians could indeed illustrate patterns in nature but there were many aspects of Mother Nature that remained a mystery to Physicists and Mathematicians alike. Mathematics is an integral part of physics. It provides an order and a guide to thinking; it shows the relationship between many physical phenomenons. The error in mathematics until that point was linearity. Quote:

“Clouds are not spheres, mountains are not cones, bark is not smooth, nor does lightning travel in a straight line.”

The secular definition of chaos can be misleading when the word is used in scientific context. The word caos in dictionary is defined as total disorder. The scientists, mathematicians and intellectuals present were hesitant to define a concept in my opignion they did not truly understand yet. They left the scientific community with a rather cryptic and oxymoronic definition of chaos.

The principles of Chaos Theory are complex and abstract. Perhaps the simplest and most essential ideas behind chaos theory are embodied in the aphorism known as the Butterfly Effect. The butterfly effect states that the flapping of a butterfly’s wings in Hong Kong can change the weather in New York. It means that a miniscule change in the initial conditions of a system, in this case the weather, is magnified greatly in the end conditions of that same system. The ultra sensitivity to the initial conditions of a system was not a new and striking discovery. In fact it was shown in ancient folklore:

“For want of a nail, the shoe was lost;

For want of a shoe, the horse was lost;

For want of a horse, the rider was lost;

For want of a rider, the battle was lost;

For the want of a battle, the kingdom was lost!”

The smallest variation in the initial conditions of a system can result in huge differences in concluding events. There was no nail, and because of this seemingly insignificant detail in the initial condition, the kingdom was lost. Another example of the butterfly affect is two pieces of wood floating on a river. Place those two logs at nearly the same point on the river and let them go. It is absolutely impossible to predict where those logs will be later downstream. When those logs are set on the water a slight breeze, a fish that swims underneath one of them, or even a single droplet of additional water in the initial stage can totally change the end result until no resemblance between the two is seen. There is a definite correlation between that small butterfly and a storm in New York, as well as the two logs. Chaos Theory states that within the unpredictability that makes those changes there is indeed a specific order. Chaos works in order and within all order there is chaos.

The stock market is indeed chaotic and also self similar. It is truly random, but shows an orderly trend. It is highly dependant upon initial conditions, but because it is nearly impossible to describe those initial conditions it is impossible to predict the action of the market. Short term trading is random and futile. Long term trading however is not random at all. A deterministic order comes from chaos over time. Chaos Theory has made quite an impact on the modern world. Even in its infancy it has been a powerful tool in shaping popular thought of the natural world. Once dismissed as a theoretical science with no practical application, chaos theory has blossomed into an intricate and beautiful pattern, much like the fractals it deals with. Chaos theory is a complex combination of math and physics, but with its mastery