The most promising approach to study financial markets is through observation and modelling micro-changes in the market.
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Storms rarely happen without signs. The question is whether one can pick up those signs. In weather forecasting, data about micro changes are collected by sensors, which are used to form bigger pictures and make predictions. Forecasts are never perfect, as our models on changes are not. Nevertheless, a micro-changes approach represents our best shot at weather forecasting today. It is rather surprising to see that this approach is relatively untouched in economics.
Price movements of financial markets are the result of their structure, the behaviour of market participants, the balance of supply and demand and pending limit order. We do not know a priori, when traders make buy or sell orders and cannot anticipate the size of the next price move. There is, however, a lot of information that is available that has not been researched. All trading activities from opening to closing of positions are recorded, tick-by-tick. In fact, all orders, including those that are not executed, are recorded. With this information, it is possible to build models of trader behaviour and gain an insight, how in aggregate positions in the market built up and closed out again. The process has an impact on the price evolution and is a valuable tool to make inferences about the future price evolution. Detailed studies of trading behaviour and price movements give us a better understanding of market behaviour. For example, what is the impact of big orders, how much over-shooting do they cause? Large movements force leveraged traders to close out their positions, which brings about a cascade of further margin calls accelerating the price movements There is a wealth of data sitting there that needs to be studied. Very little has been done so far.
Maintained by: Edward Tsang; Created: 2009.09.16 Last Updated: 2016.04.04