Introduction: Markets as Energy Systems

In physics, thermodynamics governs the flow of energy within a system. In trading, financial markets behave much the same way.

Markets are not static—they are dynamic, energy-driven systems where price movements resemble heat dissipation and entropy. Trends, much like physical energy, require a source of input to sustain them. Without continuous energy—whether in the form of capital flows, volatility shocks, or regime shifts—they eventually weaken, fragment, and dissipate.

Just as a fire burns only as long as it has fuel, trends persist only as long as energy continues to flow into them. When that energy depletes, the market falls into equilibrium—or chaos.

Understanding financial thermodynamics provides a new way to think about trend following. Rather than seeing markets as predictable, stable systems, we recognize them as entropy-driven environments where order decays over time, and structure is only temporary.

In physics, the Second Law of Thermodynamics states:

“Entropy in a closed system will always increase over time unless external energy is introduced.”

In financial markets:

• Trends begin as energy builds within a system—from liquidity influx, fundamental shifts, or sentiment-driven momentum.
• Over time, without new energy, trends decay—momentum fades, volatility compresses, and price movement stabilizes.
• Volatility shocks act as external forces—revitalizing momentum or disrupting existing trends.

Just as order in the physical world gives way to entropy, structured price trends tend to dissipate unless reinforced by fresh market dynamics.

Markets as Open Systems: The Energy That Drives Trends

Financial markets are not closed systems—they are constantly absorbing and releasing energy in the form of capital flows, investor behavior, and external events.

For a trend to emerge and sustain, it requires an influx of energy:

• Liquidity Injections – Central banks, institutional flows, hedge fund positioning.
• Regime Shifts – Changes in monetary policy, interest rate cycles, or geopolitical upheaval.
• Sentiment Feedback Loops – Herd mentality, speculative mania, and market psychology.

Much like in thermodynamics, markets move from low-energy states (equilibrium) to high-energy states (trending regimes) when external forces disrupt balance.

“Trend followers capitalize on the movement from one state to another, but they must recognize when energy is depleting.”

Entropy and the Decay of Trends

In any system, entropy increases over time—markets are no different.

• Early-stage trends are highly structured – They form as capital enters, participants align, and momentum builds.
• Mid-stage trends begin to face resistance – Profit-taking, counter-trend flows, and slowing momentum create structural decay.
• Late-stage trends exhibit entropy – Trend exhaustion, loss of directional energy, and increased randomness.

Just as a physical system gradually loses usable energy, price trends lose their directional force over time unless new inputs sustain them.

This explains why:

• Long, smooth trends eventually fragment into volatility.
• Markets oscillate between trend and mean reversion.
• Periods of low entropy (strong trend) transition into high entropy (choppy, directionless movement).

“Entropy ensures that no trend lasts forever. Recognizing trend decay is just as important as recognizing trend formation.”

Volatility as a Catalyst: How Energy Re-Enters the System

For entropy to be reversed, new energy must enter the market—this typically happens through volatility shocks and market structure breaks.

• Regime Shifts – Major macroeconomic shifts that create new price dynamics.
• Volatility Expansions – Explosive breakouts that inject energy into a stagnant market.
• Liquidity Shocks – Large-scale liquidations, short squeezes, or panic selling.

These events restart the energy cycle, creating conditions where new trends emerge from high-entropy environments.

“Trend-following strategies thrive in these high-energy moments—capitalizing on the transition from disorder back to structured movement.”

The Heat Death of a Market: When Energy Fully Dissipates

In thermodynamics, heat death describes a state where a system reaches complete equilibrium, and no more usable energy exists.

In financial markets, heat death occurs when:

• Volatility collapses – Markets become range-bound, trend signals weaken.
• Liquidity dries up – No significant buying or selling force remains.
• Price discovery ceases – The market exists in a low-energy, high-entropy state.

During these periods, trend followers step aside—waiting for a new energy source to restart the process.

“Markets cycle between order and chaos, but energy always returns—new volatility, new flows, and new opportunities.”

Trend Following as an Energy Transfer Strategy

If markets behave like energy systems, then trend following can be understood as an energy transfer strategy.

Trends emerge from both endogenous and exogenous forces. Internally, self-reinforcing feedback loops, shifts in trader positioning, and market microstructure changes can generate sustained price movement. Externally, liquidity influxes, macroeconomic shifts, and volatility shocks act as catalysts that amplify or disrupt existing trends.

Momentum is sustained while energy remains high—whether that energy comes from internal structural imbalances or external capital flows.

Entropy increases, leading to trend decay. As market participants adjust, liquidity disperses, and counteracting forces emerge, trends gradually lose their directional impulse.

Volatility shocks inject new energy, restarting the cycle. These shocks may arise from external events or internal shifts in market dynamics, creating the conditions for new trends to emerge.

Rather than attempting to fight the natural decay of trends, trend followers ride energy transfer cycles—capitalizing on movement from one state to another.

“Markets, like physical systems, obey the laws of energy. The key to trend-following success is not prediction—it’s the ability to recognize and react to the energy that drives price movement.”

Conclusion: Trading with the Laws of Thermodynamics

• Trends require energy to persist.
• Entropy ensures that trends decay over time.
• Volatility shocks act as external forces, resetting the system.
• Markets oscillate between order and disorder—providing continuous opportunities.

In physics, energy never disappears—it simply transfers.

“In markets, as in physics, nothing moves without energy. The edge isn’t in prediction—it’s in capturing the transfer before entropy takes over.”