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September/October 2013
BOOK RE V I E W
Dow Jones Industrial Average turned
in its sixth-largest single-day point loss
with a drop of 554 points. Sornette
made a prot of 400 percent.
Te Physics of Wall Street is lled
with anecdotes and explanations of basic
ideas in physics that allow readers who
arent physicists or mathematicians to at
least sense how the mind of one works.
Te pattern is observation, model,
testing, failure, revised model, testing,
failure, followed by another revised
model and so on. Weatherall says this
is a better way to think about markets,
regulations, banking, and consumer
protection. Organizations like the
Federal Reserve and the Securities and
Exchange Commission, even the World
Bank, should be the most sophisticated
players in the game, he writes, and if
these groups are not up to the task, we
need some new research organization
devoted to interdisciplinary economic
research to help guide them.

Brooks C. Sacket t , CI MA , CFP ,
AI FA , i s presi dent of Chi ef Capi t al
Management , Inc . wi th of f i ces i n San
Jose , CA, and Spokane , WA. Cont act
hi m at brooks@chi ef capi t al . com.
and investment banks are
highly secretive, and they
dont give a whit about peer
review.
Yet lucky for us,
Weatherall pursued the par-
allels of physics and nance.
In Te Physics of Wall Street,
he shares some great sto-
ries that sure make it look
reasonable to draw parallels
between the laws of nature and the laws
of markets. One of my favorites is about
physicist Didier Sornette, whose early
research focused on the failure of mate-
rials under stressspecically Kevlar
fuel tanks used on the European Space
Agencys Ariane 4 rockets. He detected
self-organization and coordination
within the particles of the tank material
itself and observed a pattern in vibra-
tions known as acoustic emissions just
before the tanks ruptured. Tis acceler-
ating signal became the basis for mod-
ern testing of pressurized fuel tanks.
Sornettes work expanded to
research on earthquake prediction. He
also studied world nancial markets,
evaluating his models with real-time
data. In the late summer of 1997, he
detected a familiar pattern that indi-
cated a major event was in the ong.
Te pattern of the nancial data mir-
rored that of acoustic emissions from
stressed fuel tanks. He and a colleague
sent a notice to the French patent oce
on September 17, 1997, predicting a
market crash in October. He then put
his money where his mouth was and
began buying out-of-the-money put
optionslow-cost long-shot bets that
only pay o with a catastrophic drop in
share value. On October 27, 1997, the
Trust in Allah and tie your
camel.
Imam at-Tirmidhi
J
ames Weatherall was
teaching physics and
math at the University
of California, Irvine, when
the nancial collapse of
2008 got him thinking about
physics and Wall Street. He
started reading up on Louis Bachelier,
Maury Osborne, Benoit Mandelbrot,
Edward Torp, Fischer Black, Myron
Scholes, James Doyne Farmer, Norman
Packard, and othersa legion of quants
who had come to Wall Street and
changed it forever. Te implication
was clear, he writes. Physicists on Wall
Street were responsible for the collapse.
Nonsense, you say. Weatheralls dis-
sertation advisor said so, too. When
Weatherall told his advisor hed found
examples from physics that helped him
understand nance, the advisor told
him that physicists may have inuenced
nance, but its impossible to do science
on Wall Street.
Weatherall gets that. He explains
how physics is a way of learning about
the world through discovery, testing,
and continuous revision. A physicist
with a new insight typically submits
a paper to a professional journal. Te
paper undergoes peer review and it
might never be published. If it does
make it into print, it may generate new
tests, models, and theoriesor it may
just collect dust; be shared but never
exploited. New insights are handled
dierently on Wall Street, however.
Teyre exploited but never shared;
enjoyed but not debated. Hedge funds
The Physics of Wall Street: A Brief
History of Predicting the Unpredictable
Revi ewed by Brooks C. Sacket t , CI MA

, CFP

, AI FA

Te Physics of Wall Street:

A Brief History of Predicting
the Unpredictable
By James Owen Weatherall
304 pages, hardcover
ISBN-10: 0547317271
ISBN-13: 978-0547317274
U.S. $27, Houghton Miin
Harcourt, 2013