The Physics of Wall Street: a brief History of Predicting the Unpredictable

Swimming Upstream 
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revolutionize financial markets. Still, his work did not make the splash 
on Wall Street that more developed versions of his ideas would, in the 
hands of other researchers just a short time later. osborne was a tran-
sitional figure. He was read widely by academics and some theoreti-
cally minded practitioners, but Wall Street was not yet ready to move 
firmly in the direction that osborne’s work suggested. In part the diffi-
culty was that osborne believed that his model of market randomness 
implied that it was impossible to predict how individual stock prices 
would change with time; unlike Bachelier, osborne didn’t connect 
his work to options, where understanding the statistical properties of 
markets can help you identify when options are correctly priced. In-
deed, reading “Brownian Motion in the Stock Market” and osborne’s 
later work, one gets the sense that there is no way to profit from the 
stock market. Prices are unpredictable. the speculator’s average gain 
is zero. Investing is a losing proposition.
Later, people would look at osborne’s work and see something 
more optimistic. If you know that stock prices are essentially random, 
then, as Bachelier pointed out, you can figure out the value of options 
or other derivatives based on those stocks. osborne didn’t take his 
work in this direction — at least, not until the late 1970s, when others 
had already made similar moves. Instead, he spent much of the rest 
of his career trying to figure out the ways in which stock prices aren’t 
random. In other words, after tying himself to the enormously con-
troversial claim that stock prices represent “unrelieved bedlam” (his 
words, in many of his articles), osborne systematically and exhaus-
tively searched for order and predictability.
He had some limited success. He showed that the volume of trad-
ing — the number of trades that take place in any given stretch of time
— isn’t constant, as one would naively assume in a Brownian motion 
model. Instead, there are peaks in volume at the beginning and end of 
a trading day, over the course of an average trading week, and over the 
course of a month. (All of these variations, incidentally, represent just 
the kind of “slow fluctuations” osborne had explored with his migra-
tory salmon — applied not to prices, but to numbers of trades.) these 
variations arise from what osborne took to be another principle of 
market psychology, that investors have limited attention spans. they 

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get interested in a stock, they make a lot of trades and send the volume 
of trades way up, and then they gradually stop paying attention and 
volume decreases. If you allow for variations in volume, you have to 
change the underlying assumptions of the random walk model, and 
you get a new, more accurate model of how stock prices evolve, which 
osborne called the “extended Brownian motion” model.
In the mid-sixties, osborne and a collaborator showed that at any 
instant, the chances that a stock will go up are not necessarily the same 
as the chances that the stock will go down. this assumption, you’ll re-
call, was an essential part of the Brownian motion model, where a step 
in one direction is assumed to be just as likely as a step in the other. 
osborne showed that if a stock went up a little bit, its next motion 
was much more likely to be a move back down than another move up. 
Likewise, if a stock went down, it was much more likely to go up in 
value in its next change. that is, from moment to moment the market 
is much more likely to reverse itself than to continue on a trend. But 
there was another side to this coin. If a stock moved in the same direc-
tion twice, it was much more likely to continue in that direction than if 
it had moved in a given direction only once. osborne argued that the 
infrastructure of the trading floor was responsible for this kind of non-
randomness, and osborne went on to suggest a model for how prices 
change that took this kind of behavior into account.
this was a hallmark of osborne’s work, and it was one of the rea-
sons he’s such an important figure in the story of physics and finance. 
the idea that prices are equally likely to move up or down was part of 
osborne’s version of the efficient market hypothesis, a central assump-
tion of his original model. When he realized this assumption didn’t 
hold, he began to look for ways to tweak the model to account for a 
more realistic assumption, based on what he had learned about real 
markets. osborne was explicit from the beginning that this was his 
methodology, in keeping with the kinds of theoretical work he was 
familiar with in astronomy and fluid dynamics. In those fields, most 
problems are much too hard to solve all at once. Instead, you begin by 
studying the data and then make simplifying assumptions to derive 
simple models. But this is only the first step. next, you check carefully 
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t h e p h y s i c s o f wa l l s t r e e t

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