I tend to look at stock markets in much the same way that a quantum physicist looks at photons or electrons. Every stock has an individualistic aspect to it (call it particlelike behavior) and a market aspect to it (call it wavelike behavior). A stock's market price at any given moment of any given day is determined by a very large number of influences-- some that influence just this particular business (like a profit warning or a big project award) and some that influence the overall market to varying degrees (like a natural disaster or a hike in interest rates).
When a stock is not being carefully observed day-to-day (or minute by minute) it can be considered to have a very wide range of possible movements. These price swings between new highs and new lows over any given period of time is inconsequential to us-- just a function of the stock. However, once any particular stock is added to our personal portfolio (it is "observed and measured"), it takes on a definite valuation-- our purchase price-- and all future price movements will be precisely monitored from this (irrelevant to the universe, but very relevant to us) new base value.
The range of all possible stock values has suddenly collapsed into one very important personal portfolio value because of our decision to purchase it. Future returns on this stock with every market movement are no longer viewed in terms of possibilities, but in terms of definite positive or negative percentages away from our clearly defined cost basis. The stock's return potential has suddenly moved from the realm of uncertainty to certainty.
There is, to put it mildly, says physicist Jeffrey Schwartz, something deeply puzzling about the collapse of wave function. The Schrodinger equation itself contains no explanation of how observation causes it; as far as that equation is concerned, the wave function goes on evolving forever with no colapse at all. And yet that does not seem to be what happens. All that we know from experiment and hard-nosed mathematical calculations is that the Schrodinger wave equation, describing a microworld of superposed wave functions, somehow becomes a macroworld of definite states. The most philosophical question about quantum mechanics is: "What happens to turn Schrodinger's wave equation into a single observed state, and what does that process tell us about the nature of reality?"
There have been at least three views expressed by physicists on this question. Einstein believed that the world was governed by what he called hidden variables. Although so-far undiscovered and perhaps undiscoverable, they are supposed to be the certainties of which the wave function of quantum physics describes the probabilities. As Schwartz explains, Einstein would compare us to goldfish rising to the surfact of their tank or pond with every passing giant blurry observer, somehow understanding there was some probability of flakes of food being sprinkled into the water with such occurrences. If only our little friends knew more about the world outside their confines of the pond or tank, they would understand that the arrival of the food is completely causal (a certain human walks over and sprinkles flakes on the water's surface at given feeding times).
Einstein's hidden variables view, in other words, says that things look probabilistic only because we are too stupid to identify the forces that produce determinism. If we were more clever, we would see that determinism rules. Einstein's beliefs tended in this direction, leading him to his famous pronouncement (often misrepresented as a religious statement from a scientist) "God does not play dice with the universe." It is easy to have the same opinion about stocks and markets, that we could possibly know where the price of any stock would trend tomorrow if only we were smart enough to anticipate and interpret all the causes and effects.
A second interpretation of quantum physics came from physicist Hugh Everett III in 1957. Instead of attempting to answer how the act of observation induces the wave function to collapse into a single possibility, the many-worlds view holds that no single possibility is ever selected. Rather, the wave function continues evolving, never collapsing at all. Every one of the experiential possibilities inherent in the wave function is realized in some superrealm, Everett proposed. If the wave function gives a fifty-fifty probability that a radioactive atom will decay after thirty minutes, then in one world the atom has decayed and in another it has not. Correspondingly, the mind of the observer has two different branches, or states: one perceiving an intact atom and the other perceiving a decayed one. The result is two coexisting parallel mental realities, the many-minds view. Every time you make an oservation or a choice your conscious mind splits so that, over time, countless different copies of your mind are created.
In terms of stock market reality, Everett's many-worlds view offers an interesting proposal. Every stock really does have an infinite number of possible returns, as it can be purchased by an infinite number of portfolio managers at an infinite number of specific times. Each individual portfolio will have its own reality over time as the stock price continues its vacillation among all its probabilities of movements. In some worlds, some portfolios will achieve gains from their fortunate purchase at what, in hindsight, turned out to be a low price, while others will suffer losses after urchasing at what turned out, in hindsight, to be a high price. For some portfolio managers, it is a good stock, and for others, simultaneously, it will be a bad stock.
A third view of the change from superpositions to a single definite state is the one proposed by Neils Bohr. For Bohr, the abrupt change from superpositions to single state arose from the act of observation itself. This view developed during the intensely creative 1920s when the greatest minds in physics-- Paul Dirac, Neils Bohr, Albert Einstein, Wolfgang Pauli, and Werner Heisenberg-- struggled to explain the results of early quantum experiments. Bohr insisted that quantum theory is about our knowledge of a system and about predictions based on that knowledge; it is not about reality "out there." That is, it does not address what had, since before Aristotle, been the primary subject of physicists' curiosity-- namely, the real world.
Before the act of observation, reasoned Bohr, it is impossible to know which of the many probabilities inherent in the Schrodinger wave function will be actualized. This is not to say we can't calculate the probability of any single outcome, but we simply can't know with certainty which outcome will become our reality. We don't know exactly which stocks will be winners and which will be losers next year. But that is not to say we can't enhance significantly our judgment of the probability of a given stock falling into either category by employing a set of rational business screens. Uncertainty is not to be feared; it is the spring from which opportunity flows.
As Schwartz notes, physical theory at this time underwent a tectonic shift, from a theory about physical reality to a theory about our knowledge. Science is what we know, and what we know is only what our observations tell us. It is unscientific to ask what is "reality" out there, what lies beyond observations. Physical laws as embodied in the equations of quantum physics, then, ceased describing the physical world itself. They described, instead, our knowledge of that world. Physics shifted from an ontological goal-- learning what is-- to an epistemological one: determining what is knowable. This is not entirely unlike the shift from informed market speculation in the robber baron days to the Graham/Buffett methods of business analysis.
This article is extracted from The Philosophical Investor, published by WallStraits, 2005.
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