Sheepdog, shepherd, hunter or all three?

An Evolutionary Perspective to Trading: the Herd & the Herder

This article has been written with the benefit of insights provided by a seasoned trader, on Twitter as @CypherSpook

Darwin’s Dangerous Idea

The premise worth examining is simply that of natural selection. As Dawkins put in his seminal, The Selfish Gene, humans are mere survival machines for the genes they carry, which are, in a sense, immortal. The point he was trying to make was that of correctly identifying the unit at which natural selection operates. It occurs not at the level of the society or group, nor at the level of the individual — though those levels all provide very useful mathematical heuristics for the underlying dynamic — but at the level of the gene.

A herder causes herd behavior

When we see herd behavior being suggested as the phenomenon that is at the seat of market movements, it is surprising that we look past the obvious question: What is the agent that causes the herding?

Market Makers as the Herders

We can apply much of the same logic to financial markets.

Mechanism 1: Discipline and Coordination

The coordinated attacks that are the hallmark of our lions and whales is common among the MMs, as well. It bears noting that, as CypherSpook puts it:

Mechanism 2: The Stop-Loss Cascades

An integral component of the MM trading approach is that of the pride of lions or pod of whales that learns how intensely a group of its prey needs to be triggered before it behaves like a herd.

Mechanism 3: Disinformation

A trigger for herd behavior according to standard economics theory is an information cascade, where correlated behavior is triggered on the basis of a cascade of information that is, in itself, correlated. Such an information pattern obviously thrives wherever there is the possibility for linking across individuals, either serially in a queue, or simultaneously in a real or virtual social network.

Mechanism 4: Mechanical Lions

If these and other mechanisms that MMs use in their strategies appear somewhat too mechanical and scripted, then it should not come as any surprise that they can, indeed, be mimicked.

Survival of the Smartest

When futures were introduced to Bitcoin late last year, understandably the average individual investor took this to mark a sea change in the game. After all, institutional interest had finally arrived!

Social scientist interested in the economics of innovation. Part-time author. Full-time blockchain explorer.

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