To fix a broken market.

The exercise

Some teachers of quality control present their students with a series of pictures like Figure 1.

Figure 1: Center the process on (0, 0). The students are tasked with centering the process at zero in both dimensions.

The students put the center near where they’ve seen points.  It is, after all, their job to fix processes.

The trick

The trick is that the process was centered at zero in the first place.  The students’ efforts to reduce noise actually increases the noise.  We all have a tendency to downplay the role of randomness in whatever we’ve seen.  We can’t see the bloodstains on the door.

Not broke

This is reminiscent of the old saying, “If it ain’t broke, don’t fix it.”

Markets are “broken” — they are not going to reflect their true value.  It is the job of market participants to “fix” the market, to move it towards the true value.

Questions

Certainly a lot of trading just adds to the noise instead of reducing it.  Can we tell which is which?

Epilogue

things is always better than they seem

from “Handcuffed to a Fence in Mississippi” by Jim White

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