Our investment strategies are fundamentally based on the theoretical framework of the Fractal Market Hypothesis, as described by Benoit Mandelbrot, in order to describe the way financial markets behave. The Fractal Market Hypothesis is an alternative investment theory to the widely utilized Efficient Market Hypothesis, which fails however to explain why markets experience bubbles and crashes.
The Fractal Theory, developed by the Polish-born French and American mathematician Benoit Mandelbrot, is a powerful and revolutionary mathematical apparatus describing both social and natural processes. It has been applied successfully in various disciplines with great success: from medicine to describe the lungs formation to complex computer-assisted image processing. Based on this theoretical framework, the Fractal Market Hypothesis has been formed, which dictates that financial markets follow cyclical and repeatable patterns depending on the presence or absence of available liquidity.
The Fractal Market Hypothesis regards each market fragmented in different investor groups, with each group having a different investment horizon. According to this, investors share similar risk and reward levels – once an adjustment is made for the scale of the investment horizon – and these similar ratios explain why the frequency distributions of returns look the same across different investment horizons. In this context, markets exist to provide a stable, liquid environment for trading and they remain stable when many investors participate and have many different investment horizons.
However, the Fractal Market Hypothesis seeks to explain investors’ behavior in all, even volatile, market conditions, something the popular Efficient Market Hypothesis fails to do. According to it, during stable economic times information does not affect investment horizons and market prices. There are various numbers of long-term investors who balance the numbers of short-term investors, ensuring securities can easily be traded without dramatically impacting valuations.
Albeit, this assumption changes dramatically during volatile market conditions, caused by any kind of external shock, when liquidity becomes less available and non-uniform. Suddenly, all investors trend towards short-term horizons, reacting rapidly to price movements and incoming information. This shift causes markets to become even less liquid and more inefficient, triggering crashes and crises but still following cyclical and repeatable patterns that can be identified.