Saturday, March 20, 2010


I have been studying the Second Law of Thermodynamics. One example of the Second Law is how particles in a gas, when heated, tend towards increasing randomness and disorganization as they move towards a state of equilibrium. A generalization of the Second Law is that entropy increases.

Scientists define systems as closed or open and moving towards equilibrium or not. Measuring the movement and position of particles in a gas was viewed from the perspective of a closed system. In contrast, measuring the movement and position of financial prices in a market can be thought of from the perspective of an open system that does not move towards equilibrium. What is equilibrium in the market anyway? Sideways price movement? Narrow range price bars or range trading over a particular time period? A price where seller and buyer agree?

One can make the argument that entropy is similar to information content. If we have less information, then we have more uncertainty, and vice versa, the more information we have, the more we know, the less uncertain we are. Thus the amount of entropy in a system is similar to the amount of uncertainty that exists. What I find very interesting is that if maximum entropy occurs in a closed system when equilibrium is reached, then maximum uncertainty would also occur at equilibrium. Somehow, this seems counter-intuitive. One would think that as equilibrium is reached, that things “settle down,” stabilize, and should theoretically be more known or certain. I need to think more about this.

On a different note, there were no trades this week. These three trading models can be quite boring sometimes.

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