Game Theory in the stock market
Link: http://www.businessinsider.com/ben-hunt-on-the-sentiment-game-2013-11
Of all places, the workings of the stock market is the most intriguing demonstration of the game theory. Price movements defy technicals, numbers and data. Before the collapse of the Lehman brothers, the market stayed strong for so long despite conspicuous evidence of a looming crisis. Another classic example is the adoption of the Elliot Wave principle. In the 1940s, Ralph Nelson Elliot proposed a wave principle which was used to predict market movements on the basis of analysis of price charts. Even though it was a good strategy back then, analysis has shown that modern markets follow those trends more closely than before because the common investor has knowledge about it. Thus, everyone expects the market to behave that way. Therefore, it does. Sentiment is the most deterministic factor and it is fascinating how game theory works here.
As the article discusses, most traders, in order to make the best move, try to think the way the majority thinks. In turn, everyone tries to think the way others think. This creates a recursive process. This thought process is much more complex than what we have discussed in class. Unlike the simple 2×2 matrix games we have discussed thus far, the stock market has millions of players which makes it almost unpredictable. Common knowledge is important because it gives insight into general sentiment and opinion. The article also discusses how governments and people in important positions take advantage of this phenomenon and shape public opinion.
Personally, I believe that the game theory pattern observed in the stock market is also applicable in real life. For instance, members of a party back a politician who they think will get the most number of supporters within the party. Choosing the best strategy is part of our intuition.