Feb

14

Two summers ago, at the Spec Party in Central Park, Victor said something to me which was at once profound yet seemingly too simple. "There is only so much money." To someone who did not understand,it would seem rather sophomoric, or even downright cryptic. But it was all he needed to say because I had read his books.

The statement referred to a simple conservation law much like the conservation laws of physics. In physics, energy and mass are the most significant variables in most mechanical systems. So we have laws such as Conservation of Energy, Conservation of Mass and Conservation of Momentum. In financial markets a similar law applies. Money is conserved. At any given time there is only so much money.

Let us imagine an island economy where there are only two stocks, X and Y. There is only so much money on the island. When the traders on the island decide they want to invest in X they need to figure out how to pay for the purchase. The only liquid source of money is stock Y. So they sell Y. The price of X goes up and Y goes down.

Let us draw this on an X-Y coordinate plot and assign some real numbers to it. The relationship between X and Y would show up as a line from high up on the Y axis sloping downward to some point of a large X value. Suppose the amount of money was $100. If everyone wanted to own Y and no one wanted X then we would have Y=100, X=0.

Conversely if everyone wanted X and not Y then Y=0 and X=100. We can think of the distance of the current market valuations as the distance from the origin which is equal to the buying power of the money. It is a simple conservation law on our island. The $100 defines a radius from the origin. It therefore defines a circle. It is easy to draw on a 2D chart or even in 3D. Drawing a 5000 dimensional sphere for the 5000 actively traded stocks is a project still in progress.


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