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6/21/05
Ten Variations On The Theory of Least Effort, by Victor Niederhoffer

Article: Human Brain Applies Law Of Least Effort When Solving Problems
Old Speculatorsí Association Forum: Markets and the Theory of Least Effort

  1. I first heard of the theory of least effort when reading Nock's Memoirs of a Superfluous Man as he used it to explain the tendency of birds and humans to prefer welfare to work, nay I heard of it when my grandfather would always tell me at the age of 13 that "the path of least resistance now would be down in the market" since it was so far above the 1929 levels. Recently I note that two scientists at the Carnegie, Eric Reichie and Patricia Carpenter have shown that the brain uses least effort to solve problems that can be solved alternatively by visual or verbal methods. Whichever way the student is better at, they use to solve the problem and the better they are at a problem the less they have to work to solve that problem. They use MRI's to show that " brain functions associated with a verbal strategy produced relatively more activation in a network of brain areas specialized for language processing, including Broca's area, which governs the ability to talk. The use of visual strategy shifted the activation towards a network of brain areas particularly the parietal cortex ". Perhaps this provides an alternate explanation over and above the mumbo one as to why some use charts and some use counting.
  2. I find the distribution of prices classified by the leading number like 97 equals 9 much too regular for chance. Do prices cluster by levels much more than they should? Here's a rough estimate of the distribution of prices by leading number as of year end 2004:

       Number of 10's        Number of 1's
         in lead digit           in final digit
                10                            4
                9                              8
                8                              2 2 8
                7                              none
                6                              1 2 3 4 6 6 777 9
                5                              00 11 22222 3 5 6666 899
                4                              0 1 222 3 4 5 7777 8 999
                3                              0 0 11 2222 3333 44 5 666666 7 8 999
                2                              0 11 3 0 3 4 5 6 77 88 9
                1                              0 0 3 4 55 6 7 8 999
                0                              4 7

    Why no 7's and why none above 104? And so many thirties.

  3. The explanation for this to me is not splits but the forces that cause the canopies of trees to be so uniform in height. The tree has the choice of growing to get more food versus the difficulty of getting the water up there. When there's more sunlight unbroken above, it's always easier to grow the extra foot, and they choose that option.
  4. Itís so easy to push the opponent over when he's leaning the wrong way. The market mistress always looks to see which way everyone is leaning and then takes the easiest path. Most people lean in the same direction as they recently and most vividly made some money--- and this provides so much grist for the mill.
  5. The same way people develop templates to solve problems via least effort, thus reducing the dichotomy between mind and brain, a la the Carnegie paper, the market develops easy solutions to keeping its infra structure going. And why not keep it simple by using the smallest number of methods of making the public contribute to the upkeep. That's why patterns work. But the problem is that the patterns are always changing.

To be continued. Your suggestions and augmentations appreciated.

Sushil Kedia responds:

The theory of least effort, in all its possible manifestations revolves around the concept of the path of least resistance.

Even revolutions, wherein individuals may endure much more hardship than in the prevailing order, are incited and sustained by mapping individual minds to a collective emotion that appears to be the path of least effort in obtaining a much larger comfort which otherwise is seeming improbable.

Resistance to collective thoughts or collective action which when minimized have produced more lasting and richer outputs. Mark Twain in America or Shakespeare in Britain or Kabir in Indian all have a common characteristic in producing long-lasting literature because their choice of expressions (words and ideas) related to the masses, producing least resistance.

Thoughts, principles and philosophies originating even from the sciences have found resistance of the highest order when the communication was such that was offering a high resistance for the masses to understand. Scientists who could convert their findings into a readily usable 'invention' were embraced and those who let complex-theories hang in there met with proportionate resistance. Needless it might be to illustrate here the example of Copernicus's landing in jail. His thought being right he was still wrong in the theory of least effort.

I assume that the human mind which has evolved through inheritances of wisdom (ability to apply gathered intelligence), has been getting increasingly codified with the evolving perception of the physical reality. So if mankind has seen water finding its level and has considered it to be a law of nature, the mind too is conditioned with these observed laws of nature. The path of least resistance and thus the theory of least effort is at the centre of all perceiving we humans may have been through generations. The brain thus operated by the mind, seeks methods of least effort.

The unending rise in the popularity of P/E ratio is because of its simplification of a much more elaborate discounted cashflow value since the mind on average operates on the theory of least effort.

Let for a moment it be granted here that price is discovered at any given moment of time when the vector sum of all existing and expected bets in the market turns zero; where each of such individual bets is a vector represented by individual willingness & individual ability (classical demand & supply ideas).

If one were to choose what most others have chosen to do or are willing to do, one could hope to be rewarded at best the same as these most others after taking care of the vig. The collective vector sum of willingness (that keeps fluctuating as explained by the idea of reflexivity) and ability (that too keeps moving as per reflexivity) produces a mammoth resistance for the vig to be collected. Hence, the market in turning this vector sum to zero, moves away from the consensus.

Therefore, to get extraordinary rewards one might have to find that point of least resistance where either collective willingness is overstretched and/or collective ability is overstretched.

Trendfollowers as also the contrarians are then both the birds of the same flock since both seek the path of least resistance. The first seeking to profit when majority action is high on ability and low on willingness (read as disbelief or confusion) thus making the trend prevail. The latter seeking to profit when the majority action is high on willingness as compared to the prevailing ability thus starting diffusing yet another consensus while letting the market mistress turn the vector sum of all existing and expected bets into zero.

Tom Ryan responds:

My variation on least effort as it relates to markets is that the path of least effort for the marketmaking ecostructure to extract the maximum level of vig from its participants is to encourage as much turnover in positions and volume as possible. For example I would not be surprised to see by the end of my lifetime an additional set of option expirations at start of month as well as third week. Anyway, the path of least effort to encourage high turnover is to create maximum uncertainty in participants just prior to a calendar effect such as the close of the day, the last hour of the week, the last day of the month, last week of the quarter. And lately with the market so flat in the last week right before earnings announcements and end of quarter this looks like another attempt to sow uncertainty and a set up for a bout of early July volatility.

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