What is Statistical Physics

Overall, statistical physics provides certain formulas and explanations to comprehend probability in a broader sense, without considering all of the work done in the stock market. These equations may then be used in a formula or significantly modified to better fit the situation and to predict future movements in the stock market. 

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Statistical physics is like its own realm of physics and can’t exactly be called “physics” (more of an umbrella topic). The first piece of statistical physics is mechanical physics. Mechanical physics contributes to our understanding of classical mechanics, quantum mechanics, and thermodynamics in statistical physics. This is because it provides a framework for comprehending the minute characteristics of atoms and uses them to relate to the larger objects that we use on a daily basis. The first equation is one of the most fundamental ones in statistical mechanics. It’s the definition of the partition ‘Z’. This just means that it’s a thermodynamic state variable, like temperature or volume.

In this case, the probability is denoted by the letter P, while the state probability is denoted by the letter q. The prior equation remains unchanged, but modified to solve for q's probability.

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Analyzing the stock market can be relatively straightforward compared to other societal areas because we have extensive computer-recorded data. Some physicists used this data to study second-by-second price changes in the market.

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Their study has found that market crashes are not entirely different from the frequent fluctuations seen on a daily basis in the view of statistical physics. Instead, there is a fourth power relationship between the frequency and size of price changes.

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Essentially, if a price changes frequently, the magnitude of these changes tends to be consistent.

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This phenomenon is known as "fat tail" behavior and has been observed in multiple studies, although it is not predicted by the usual random fluctuations typically seen in the market.

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A fat tail in the market is usually compared to the normal distribution of a stock and is observed when there is a variation in the frequency of events, often showing smaller changes than usual.

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Another approach examined the distribution of ten-minute price variations during 1984-1985. By analyzing these variations, researchers (such as Goldman and Leland) aimed to identify potential crashes and market highs through several calculations. At that time, market movements were thought to be somewhat random, influenced by several unknown factors.

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The goal of this study was to understand some of these factors and predict the likelihood of market drops. Although there is still much work to be done, the research shows promising progress.

 

TL;DR:

Understanding the stock market is challenging due to its volatility and unpredictability, influenced by many variables and rapidly changing media. Statistical physics helps scientists analyze market movements by using equations and diagrams, offering insights into market behavior and potential drop predictions.