Stochastic Processes: The Architecture of Randomness
In classical physics (like throwing a ball), if you know the exact speed and angle, you can predict exactly where the ball will land. This is a deterministic system. Financial markets are the opposite. They are Stochastic Processes.
A stochastic process is simply a sequence of events where the next step is governed by probability rather than absolute certainty. Imagine a blindfolded man walking through a city grid. At every intersection, he flips a coin to decide whether to turn left or right. You cannot predict his exact path, but using a stochastic model, you can perfectly calculate the probability of where he might end up after 100 steps.
The Market Connection
In finance, every tick on a stock chart is a "step" determined by the collective, random decisions of millions of global algorithms and traders. Modeling this mathematically allows quants to price options and manage risk without needing to know the exact future.