Predicting big market crashes is a difficult business, but …

Predicting big market crashes is a difficult business, many would say impossible.

A pair of physicists drawing inspiration from the market for bitcoin, no less might be on to something.

They turned to the bitcoin market because it has a unique feature, perhaps related to the fact that it is still fairly young and exotic: Traders place their buyand sell orders early and leave them there for all to see.

Of course, the picture is constantly changing as price movements prompttraders to enter new orders.

Still, the orders visible at any moment already make it possible to predictcrashes.

In a recent paper, Donier and Bouchaud found that the market is prone to crash specifically when buy orders are scarce, and estimated how much a typical-sizesell order should move the price when matched with such buy orders.

Participants don’t place orders well in advance.

Bouchaud and some other physicists initially proposed the formula a couple of years ago, and some preliminary tests by economists on data from five historic market crashes including the crash of 1929 and the Flash Crash of May 6,2010 suggest that it has promise.

What’s not surprising is that the predictive ability comes from carefully teasing out information on emerging trading imbalances, especially the drying up of buyorders.

Now, you might assume that if the formula does turn out to work, markets willadapt and render it obsolete.

Market movements, in this sense, might not be as unpredictable as we’ve been led to think.

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