Roger Babson used the laws of physics more than 100 years ago to forecast future price movement in securities and indexes. The arrow of time is a term, often used in the study of astronomy and physics, that refers to the linear, forward progression of time. Putting the two concepts together, we demonstrate the theoretical basis for Babson’s techniques in the markets.
Physicists — much like Elliott Wave theorists — differ in their opinions about the same thing. In the interest of simplicity and keeping this discussion focused, we will examine two questions with regard to markets and the arrow of time:
- Can the future be predicted accurately by the past?
- Can the past be predicted accurately by the future?
These questions are familiar to physicists and others who have been introduced to the arrow of time concept. Time, on a theoretical level, can be thought of as either symmetrical or asymmetrical. Of course, most have an asymmetrical, forward-progressing understanding of time. The arrow of time describes this way of thinking: A theoretical “arrow” pointing toward the future, toward which the present marches. This depiction describes the perception that we move from the known events of the past to the unknown events of the future.
While this may appear on its surface to have little relevance to those of us who attempt to profit in a world that, without question, moves from the known (past market prices) to the unknown (future market prices), it’s significant. As we analyze the markets, we can glean insight and validation to better position ourselves to take advantage of price moves that have yet to occur.
Babson’s action-reaction lines were one such attempt, designed to forecast the location of future key points in price movement. Their theoretical foundation is Newton’s third law of motion: Every action has an equal and opposite reaction.
It begins with a centerline, drawn from a price peak to a price low. Then, a second line, parallel to the centerline, is drawn from a prior low. This is the action line. Next, a parallel line is drawn into the future. This line is an equal distance from the centerline as is the action line. It is the reaction line and is intended to identify future reaction points. Further action lines could be drawn, with accompanying reaction lines, that extend even further from the centerline (see “Daily view,” below).
“Weekly view” (below) is the same gold chart with the data converted to a weekly format. In this example, the reaction lines come in where prices make various high pivots. This demonstrates the concept that price actions and reactions are equal and opposite. Of course, if the reactions are indeed equal and opposite, then the reaction points also may be used to forecast the action lines.
Indeed, we could imagine that the action points could be found by drawing the centerline and the reaction lines first, appearing to validate a symmetrical understanding of time.