A complex market is not the same as a complicated market - Know the difference

 

There is a difference between complicated and complex systems, and it is important to understand the distinction. Complicated markets are not the same as complex markets. You will have problems as an investor if you don't understand or confuse the difference. Investors should accept the idea that markets are generally complex and not just complicated. 

A complicated market may have many components or parts. It may be technically difficult to manage, but the components can be separated and dealt with in a systematic way. A car engine can be complicated, but it can be taken apart, rebuilt, and still work effectively. The parts work together to achieve an outcome. There is a linear and precise way that a complicated system can work. 

A complicated market can be understood by working through steps. For example, if the Fed lowers rates, it is clear what will happen to bond and stock markets and it will be clear how that rate change will work through lending channels. There may be many steps, but they can all be described and the reaction or outcome is known.   

So, what is a complex system? A complex system may not have a high degree of order or control. There is  not clear predictability. A complex system cannot be known with certainty. There is a level of ambiguity with how a complex system works. There can be competing explanation for how the system works. It is not a clear engineering problem. 

The Fed may lower rates, but we are not able to precisely tell you what will happen to markets. We may have a good idea for what will be the reaction, and we may have history to guide us, but there may be surprise responses on what will be any given reaction. 

Complicated versus complex market system 

When central banks thought of themselves as economic engineers that used optimal control methods. They failed with controlling economic behavior. We have many reasons for this failure but all fall within the problem of complexity. Many financial engineering solutions failed because of unindented consequences or changes in behavior to the system that could not be anticipated. Markets are complex not complicated. 

A complicated market can be understood and effectively managed. It is just a matter of gain the right knowledge. You hedge against ignorance. A complex market cannot be understood, so investors need downside hedges to protect from what is unanticipated because the market system cannot not be knowable.