Whodrivesthemarket.com has developed a proprietary technology to provide unique insights into the driving market forces by making publicly available current and forecasted estimates of the fraction of  fundamentalist traders (information based traders, value investors) versus the fraction of technical traders (noise trading chartists, trend followers) currently active in the markets on a daily basis. Currently, we survey selected American, Asian, European, German, Australian, Emerging Markets, and an increasing number of other national stock markets, as well as some commodities markets. Click on the following figure for getting to our trading strategy estimation chart section:

Why should I care?
Coming back to Soros, he provides the following example on how to exploit on the estimated market driving forces of whodrivesthemarket.com: In the end of 1960s, poorly informed investors became excited in reported annual earnings of conglomerates. The truly informed investment strategy in this case, says Soros, was not to sell short in anticipation of the eventual collapse of conglomerate shares but instead to buy in anticipation of further buying by uninformed investors (simple trend followers, noise trading chartists). The initial price rise stimulated their appetite and induced further price increases in a self-fulfilling prophecy style – until eventually, prices were driven back to fundamentals by short selling informed fundamentalist traders. As market participants are often driven by greed, this pattern repeats itself in numerous other occurrences, of which one is the more recent rise in technology shares, such as Yahoo, Ebay, or Amazon, during the new economy stock market bubble in 1999/2000.

What can I expect in the close future?
Within the next couple of weeks, whodrivesthemarket.com will be providing the following additional services:

1. Comprehensive market analyses: your daily one stop comparative markets state report and forecast: e.g., direction, strength, and persistence of price trends, volatility, market driving forces, and estimated fractions of informed fundamentalists vs. noise trading chartists.
2. Concrete trading recommendations derived from the market analyses . Which market (represented by an appropriate instrument) to buy or sell at which extend? When to keep your hands off, when to close positions, are questions to be answered precisely. Focusing on longer term end-of-day and end-of-week strategies, easily to be followed in your spare time, we will also provide promising back-tested results.

Whodrivesthemarket.com is an initiative by Klein’s investment research which is backed by knowledgeable finance and computing experts that have several years of experience in the industry. Access to our services is free of charge. However, if you’ve become as excited as we are about our current and upcoming investment services, please provide us with your contact details. Your comments are very welcome!

Berlin, 2009-06-13

References:
Soros, G. (1987): The Alchemy of Finance, New York: Simon and Schuster.

In contrast to the above basic approach, the estimations presented on this website are based on a methodology, which allows estimating highly complex real multi-agent-based financial market models at high frequency. The methodology is the result of several years of intense research conducted at Humboldt University, Berlin, Germany and Hohenheim University, Stuttgart, Germany. The approach has been presented by the main author at the 14th International Conference on Computing in Economics and Finance 2008 at the Sorbonne University in Paris, France.
The following figure compares estimation results of our approach (red line) vs. a very recent basic approach of [Boswijk et al. 2007]. We use a more complex model and yield more detailed, daily estimation results, while Boswijk et al. only yield yearly results.

References:

The whodrivesthemarket.com approach:

• Klein, A., Urbig, D.: “Who drives the Market? Estimating a heterogeneous Agent-based Financial Market Model using a Neural Network Approach”, presented at Conference on Computing in Economics and Finance (CEF), Sorbonne University, Paris, France, 2008.

Estimations following the basic methodology lined out:

• Alfarano, S., F. Wagner and T. Lux (2005): “Estimation of Agent-Based Models: The Case of an Asymmetric Herding Model,” Computational Economics, 26, 19-49.
• Boswijk, H. P., C. H. Hommes and S. Manzan (2007): “Behavioral Heterogeneity in Stock Prices,” Journal of Economic Dynamics and Control, 31(6), June, 1938-1970.
• Vigfusson, R. (1997): “Switching Between Chartists and Fundamentalists: A Markov Regime-Switching Approach,” International Journal of Finance & Economics, 2(4), October, 291-305.
• Westerhoff, F. and S. Reitz (2003): “Nonlinearities and Cyclical Behavior: The Role of Chartists and Fundamentalists,” Studies in Nonlinear Dynamics & Econometrics, 7(4).

Agent-based financial market models, some rather simple examples:

• Brock, W. A. and C. H. Hommes (1998): “Heterogeneous Beliefs and Routes to Chaos in a Simple Asset Pricing Model,” Journal of Economic Dynamics and Control, 22(8), 1235-1274.
• Kirman, A. (1993): “Ants, Rationality, and Recruitment,” Quarterly Journal of Economics, 108, 137-156

Crowd behavior: LOW fraction of chartists (<20%)

Example figure

Low fraction of chartists

Market assessment
Business as usual. Rational investing reigns based on fundamentals. No exaggerations. Safe waters.

What to do best?
Chartist strategies such as trend following work best in this scenario. This is as best as it gets, as changes are high that persistent price trends develop. A good scenario for long term investors.

Crowd behavior: Fraction of chartists is RISING from low level – A) due to price bubble

Example figure

Fraction of chartists is rising from low level

Market assessment
As chartists exploit trends, their strategy reinforces the trend, thus attracting more and more chartists. A self-fulfilling prophecy develops, resulting in a price bubble.

What to do best?
The trend is your friend. The trend gains momentum in the already prevailing direction. Profits of trend following strategies rise sharply.

Crowd behavior: Fraction of chartists is RISING from low level – B) due to a crisis

Example figure

Fraction of chartists is rising from low level

Market assessment
A quick and very sharp correction, inversely to the previous market trend is induced. Causes are crises and crashes.

What to do best?
Bad times for long term investors. Short term investors on the right side of the market can make quick profits but also need to get out quickly.

Crowd behavior: HIGH fraction of chartists (>50%)

Example figure

High fraction of chartists

Market assessment
Exciting times, the market is quickly changing its mood and price direction. Chartist patterns in prices have disappeared.

What to do best?
Keep your hands off.

Crowd behavior: Fraction of chartists is falling from high level

Example figure

Fraction of chartists is falling from high level

Market assessment
The bubble has burst / the crisis is about to cease. The price trend has changed its direction, as fundamentalists drive prices back to fundamentals (either up or down).

What to do best?
A fundamentalist strategy seems appropriate. Also, in the settlement of this phase, starting to follow the correcting trend that fundamentalists have induced is viable.

1. Information based fundamentalists (value investors)
2. Noise trading chartists (e.g., trend followers)

The goal of whodrivesthemarket.com is to help you exploit uninformed noise trading market behavior.

References:
Shleifer, A. and L. H. Summers (1990): “The Noise Trader Approach to Finance,” Journal of Economic Perspectives, 4(2), 19-33.

The fractions of trading strategies estimated are based on globally smoothed entry data, as this yields much better estimation results. The following figure compares estimations based on globally smoothed (red line) vs. locally smoothed (blue line) data. On interpreting the strategy estimation results on this website, one has to bear in mind the effects of global smoothing: estimation results are altered in the following way, as more input gets available: (1) insignificant intermittent peaks are smoothed out, (2) ascending curves are elongated into history, and (3) descending curves are elongated into the future. The alterations, which are induced by more data increase the precision of the estimation.

• Present historic and current daily estimates, as well as predictions of fractions of Chartists and Fundamentalists active in financial markets. First, we focus on the U.S. stock market. In the future, we will include estimations also for other markets (forex..) also in other regions (Europe, Asia).

• Present validations of our estimation results.

• Outline our cutting edge estimation techniques, based on our own recent research.

• Aggregate and present trading strategy information.

• Point out concepts how to adapt your own strategy, based on our estimations of strategies used in the markets.

• In the close future, we will present results of an outperforming mechanical trading system which realizes our concept of an adaptive trading strategy by exploiting our estimations of strategies used in the markets.

Coming back to George Soros, he gives a splendid example of such an adaptive trading strategy. Soros basically anticipates steadily increasing trend following behavior in respone to initial buying of informed fundamental investors. These investors first move prices, which is then observed by chartists. They assume the trend induced by fundamentalists to continue and start buying. This triggers further buying of other trend followers, thus creating a self-reinforcing price process. This might lead to the creation of a price bubble. One instance for such bubbles is the boom of internet stocks at the end of the 1990s. More historically, other occurances have been computers in the 1980s, Real Estate Investment Trust (REIT) in the 1970s, and electronics in the 1960s. Soros exploits such self-reinforcing price trend following behavior by buying more in the early stages of this process and later selling to late trend followers.

By providing you with our quantifications and in the future also with forecasts of the fractions of chartists / trend followers and fundamentalists in the markets, we put you in the position to act like George Soros and to realize respective adaptive strategies . Such an adaptation for example could be triggered by a strongly increasing fraction of trend followers from a low level. This clearly indicates the advent of a self-reinforcing process, which Soros exploits.