Around 1665, the Dutch physicist Christiaan Huygens observed a strange and unexpected phenomenon between two pendulum clocks hanging next to each other. As if someone had joined them through an invisible force, the pendulums driving each clock swung in perfect (anti-phase) synchronization. By experiment, he disturbed one and watched in amazement as they slowly and naturally synchronized back up again...all by themselves. He later reported this "odd kind of sympathy," as he called it, to the Royal Society of London, explaining how very tiny, almost imperceptible, vibrations caused the phenomenon.
Having invented the pendulum clock and serendipitously hanging two in close proximity, Christiaan stumbled across one of the most basic examples of synchronization among what are now referred to as "coupled oscillators." With science not yet ready to understand the implications of his discovery, his findings went mostly ignored; however, synchronization is now considered a universal phenomenon arising in nearly all complex systems, regardless of whether they're composed of fish, neurons, Wildebeests, atoms, people, or mechanical devices.
One of the most profound implications of synchronization is that simple rules or local interactions can lead to large-scale cooperative, self-organizing, and collective behavior. This has been, and continues to be, the most controversial and mysterious aspect of complex systems. Not only is it hard for people to believe that complex systems can naturally organize, but that this could even occur among non-intelligent or low-intelligent things was once thought impossible.
As early as 1917, two and half centuries after Christiaan's discovery, we see in the journal Science how radical this notion was at the time. Here, Phillip Laurent reveals, "Some twenty years ago I saw, or thought I saw, a synchronal or simultaneous flashing of fireflies. I could hardly believe my eyes, for such a thing to occur among insects is certainly contrary to all natural laws." Unable to then accept what he observed with his very own two eyes, Laurent then explained how this amazing phenomenon was actually an illusion fostered by the "twitching or sudden lowering and raising of my eyelids. The insects had nothing whatsoever to do with it."
Although this was later solved by observing that each firefly obeyed a simple rule of adjusting its own rhythm to match that of its neighbors, that it could result in widespread cooperative behavior between mindless insects was incomprehensible, even up until the 20th Century.
Many people are familiar with the mysterious behavior of large flocks of birds (e.g. murmurations), schools of fish, or massive herds of animals acting as one mind (see video below), but this is really just the tip of the iceberg. Less known but ubiquitous examples are seen at every scale in the known universe between atoms, cells, neurons, organs, people, and celestial objects. Just to describe a few: synchronization of large groups of cardiac pacemaker cells give rise to a consistent beating heart, the spreading synchronization of contracting muscle tissue leads to birth, the synchronous wave-like propagation of cells cause food to pass through our miles of intestines, and the complex synchronous behavior of neurons between different regions of the brain allow for the processing of information, awareness, intelligence, and, of course, consciousness. However, these are just a few examples. More recently, synchronization has been shown to operate at the quantum level, giving rise to entanglement.
That we regularly see synchronous behavior in the market should also be no mystery. Everyone is familiar with the herd-like collective behavior of investors rushing to buy or sell all at once as they respond to the irresistible impulses, or "animal spirits" as Keynes called them, of fear and greed. Although bubbles and crashes are the most visible examples of this phenomenon, there is a far more subtle and pervasive level of synchronization that occurs between investors at an unconscious level.
A couple years ago, PNAS (Proceedings of the National Academy of Sciences) published the results of a fascinating multi-year study showing how day traders communicating within a firm about continuous changes in the market unconsciously synchronized the timing of their trades at an extremely high level. They also found that higher levels of synchronization resulted in greater average performance of each individual trader, resulting in a form of collective intelligence. Ars Technica reports:
[T]raders who unconsciously time their trading activity to synchronize precisely with that of their peers are less likely to close out in the red at the end of the day. The researchers, it seems, were motivated by an analogy from nature—cicadas that chirp in perfect sync with the rest of the swarm are best able to balance the reward of finding a mate and the risk of being located by a predator. The paper also explores the role of instant messaging in synchronizing trading activity, as it exposes traders to information that helps them unconsciously synchronize in an unplanned, decentralized manner.
For the purposes of the study, the researchers gained access to almost two years' worth of trading data from an anonymous trading firm, where 66 day traders sat in front of computer terminals trading stocks in different sectors during regular market hours. And because all outbound instant messaging traffic is logged by the firm per federal regulations, they were also able to get their hands on millions of IMs sent over that same time period, and to compare the IM traffic to the day trading data and to the market as a whole.
What the researchers found confirms the trading maxim that being early or late with a bet on a stock's direction is often the same as being wrong. Traders who engaged in what the paper calls "synchronized trading," where their trades are timed with those of their peers down to the second, are much more likely than their slightly early or late peers to close out the day with no losses...
Of course, this synchronous trading doesn't happen deliberately—at least, not "deliberately" in the sense of "on my mark, get ready, trade!" Rather, these episodes of natural synchronicity, whether they arise in cicada swarms or in trading pits, are spontaneous and decentralized, with the actors making individual decisions on when to act based on a mix of local information and their own sense of timing.
"There's no way that traders unconsciously synchronize together like this. They must've been consciously working together," a skeptic might say. I asked Professor Brian Uzzi, one of the lead researchers, this question and he pointed out that the synchronization didn't occur for the same stocks, but for different stocks often trading in different directions (i.e., one a buy, the other a sell). So, again, this wasn't a conscious process of coordination or collusion, for example. Really, they had no idea this was taking place. "Yes, but isn't this synchronization merely due to them reacting to news events at the same time?" I asked. In this case, Professor Uzzi explained that when large-scale simultaneous trading took place because of an external signal in the market, they nullified the result. That is, they measured internal, naturally emerging synchronization resulting from unplanned, decentralized decision-making.
Now, in case it's not obvious, the trading patterns of the 66 individuals above weren't told to sit in a lab while the researchers analyzed them for any occurrences of strange insect-like behavior. Rather, Professor Uzzi and his colleagues observed the unconscious synchronization of day traders "in the wild"—that is, in their day-to-day interactions with each other in the market for over a year. This wasn't just a one-time, freak coincidence but, as we see with synchronization in other complex systems, evidence of a pervasive phenomenon that bypasses rational forethought and links us together at an instinctive unconscious level.
In his meticulous observations of crowd psychology and behavior, Gustav Le Bon recognized this property many years ago when he wrote, "Crowds, doubtless, are always unconscious but this very unconsciousness is perhaps one of the secrets of their strength. In the natural world beings exclusively governed by instinct accomplish acts whose marvelous complexity astounds us. Reason is an attribute of humanity of too recent date and still too imperfect to reveal to us the laws of the unconscious, and still more to take its place. The part played by the unconscious in all our acts is immense, and that played by reason very small. The unconscious acts like a force still unknown."
Patrick Schotanus has also been writing about this extensively in his "Inside the Market's Mind" columns. In his most recent, he offers the following quote from Leonard Mlodinow's new book, Subliminal: How Your Unconscious Mind Rules Your Behavior:
If until recently academic psychologists have been reluctant to accept the power of the unconscious, so have others in the social sciences. Economists, for example, built their textbooks theories on the assumption that people make decisions in their own best interests, by consciously weighing the relevant factors. If the...unconscious is as powerful as modern psychologists and neuroscientists believe it to be, economists are going to have to rethink that assumption.
When we consider the unpredictable and complex nature of the financial markets it is clear that there are hidden forces at work that cannot be explained through traditional means. Pockets of researchers, academics, and others (Shiller's reception of the Nobel Prize, for example) are beginning to shed light on the fact that markets reflect the full range of human thought, emotion, and behavior. At the leading edge of this movement is research highlighting the massive role played by the unconscious mind at both the individual and collective level. The physical mechanism for understanding this is found in the science of synchronization.
Cris Sheridan is Senior Editor of Financial Sense. You can follow him on Twitter:@CrisSheridan
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