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Daily Speculations The Web Site of Victor Niederhoffer and Laurel Kenner

30-April-2006
Predator-Prey Models, by Henry Carstens

We all know about ever-changing-cycles, what wasn't clear to me until yesterday, was the implied notion of 'continuous improvement' in the cycles.

A model:

Assume a predator - prey model. Assume the market is made up solely of mechanical trading systems. Assume that every day new trading systems are injected into the market and old, failing ones removed. Assume that the majority of the new trading systems are incrementally better than prior population (some are better, some worse but as a whole they are just a bit better)

What happens? At each cycle, some prey are removed from the game At each cycle, some predators become prey. At each cycle, old predators continue, but as a whole w/ reduced edge vs the young predators

Who doesn't survive? The fixed predator as he eventually succumbs to the continuous improvement of the new predator systems

Who does survive? No one. But it's the wrong question.

Who thrives? to be continued...

What does volatility look like under Kurzweil's law of accelerating change? to be continued...

What is so striking about this is the extent to which the model mirrors the circle of life...

John Kuhn responds:

I like this post; very interesting and crisply put. What is in the "cycle of life", though less emphasized in this post, is that in, say, the African plains the prey survive by sheer numbers. In systems' use, perhaps the most beneficial system to the overall market "system" is one in which the predator feeds very slowly and the overall population of prey, of protein availability, continues to expand. That predator seems to be the broker interjected into all trades in the form of the commish/spread vigorish.

The use of individual "trading systems" must be fairly limited (in a vast market they'd employ different feeding styles; one a falcon, another a basking shark, still another a shrimp-the fingertrader or crumb seeker) Setting aside for now the highly sophisticated systems of some of my genius friends, just in the daily financial papers there are so many systems for sale - with many sub menus or systems ala omnitrader or of the betty crocker variety ala Tradestation where you add an even higher percentage of your own ingredients albeit all from off the "supermarket shelf" of technicals, enhancing pleasure and pride of ownership. The more adept or fortunate can escape predation longer perhaps, even prey on others for a time; all the while tugging along the remora of vig which aims to feed but not to kill.

One extremely effective predator avoidance adaptation seems to be to just remain absolutely motionless for a very long period of time. Another dominant technique is the use of other peoples' flesh as bait. If one snares a big one, one takes a % of the win. If not, well.. one hopes one's not used up the last sacrificial goat.

One point you make is particularly intriguing; continuous improvement: The last several years' huge inflows into hedge funds suggests folks who may normally be considered as "prey" are looking at success of the predators and throwing their "protein" at them willingly to vastly expand their class. One thing the system perhaps can't tolerate quite so well would be an unnatural bloom of predators versus the prey population. In a natural cycle, this could entrain a gradual starvation based die-off of the predator classes.