When it comes to investing, there is no shortage of theories on what makes the markets tick or what a particular market move means. The two largest factions on Wall Street are split along theoretical lines between supporters of the&n🧔bsp;efficient market theory and those who believe the market can be beaten. Although this is a fundamental split, many other theories attempt to explain and influence the market, as well as the actions of investors in the markets.

1. Efficient Markets Hypothesis

The 澳洲幸运5官方开奖结果体彩网:efficient markets hypothesis (EMH) remains a topic for debate. The EMH states that the market price for shares incorporates all the known information about that stock. This means that the stock is accurately valued until a future event changes that valuation. Because the future is uncertain, an adherent to EMH is far better off owning a wide swath of stocks and profiting from the general rise of the market. You either believe in it and adhere to passive, broad market investing strategies, or you detest it and focus on picking stocks based on growth potential, 澳洲幸运5官方开奖结果体彩网:undervalued assets, and so on.

Opponents of EMH point to 澳洲幸运5官方开奖结果体彩网:Warren Buffett and other investors who have consistently beaten the market by finding irrational prices within the overall market.

2. Fifty-Percent Principle

The 澳洲幸运5官方开奖结果体彩网:fifty-percent principle predicts that (before continuing) an observed trend will undergo a price correction of one-half to two-thirds of the change in price. This means that if a stock has been on an upward trend and gained 20%, it will fall back 10% before continuing its rise. This is an extreme example, as most times this rule is applied to the short-term trends that 澳洲幸运5官方开奖结果体彩网:technical analysts and traders buy and sell on.

This correction is thought to be a natural part of the trend, as it's usually caused by skittish investors taking profits early to avoid getting caught in a true reversal of the trend later on. If the correction e🐲xceeds 50% of the change in price, it is considered a sign that the trend has failed and the reversal has come prematurely.

3. Greater Fool Theory

The 澳洲幸运5官方开奖结果体彩网:greater fool theory proposes that you can profit from investing as long a🐠s there is a greater fool than yourself to buy the investment at a higher price. This means that you could make money from an overpriced stock as long as someone else is willing t𝔍o pay more to buy it from you.

Eventually, you run out of fools as the market for any investment overheats. Investing according to the greater fool theory means ignoring valuations, e🐎arnings reports, and all the other data. Ignoring data is as risky as paying too m𝔉uch attention to it, and so people ascribing to the greater fool theory could be left holding the short end of the stick after a market correction.

4. Odd Lot Theory

The 澳洲幸运5官方开奖结果体彩网:odd lot theory uses the sale of odd lots—small blocks of stocks held by individual investors—as an indicator of when to buy into 🧜a stock. Investors following the odd lot theory buy in when small investors sell out. The main assumption is those small investors are usually wrong.

The odd lot theory is a 澳洲幸运5官方开奖结果体彩网:contrarian strategy based on a very simple form of 澳洲幸运5官方开奖结果体彩网:technical analysis—measuring odd lot sales. The success of traders following th𓄧e theory depends heavily on whether they check the fundamentals of companiesꦗ or simply buy blindly.

Small investors aren't going to be wrong all the time, and so it's important to distinguish odd lot sales that are occurring from a low-risk tolerance from odd lot sales that are due to bigger problems. Individual investors are more mobile than the big funds and thus can react to severe news more quickly, so odd lot sales can actually be a precursor to a wider sell-off in a failing stock instead of just a mistake on the part of small-time investors.

5. Prospect Theory

The prospect theory can also be known as the loss-aversion theory. 澳洲幸运5官方开奖结果体彩网:Prospect theory states that people's perceptions of gain and loss are skewed. That is, people are more afraid of a loss than they are encouraged by a gain. If people are given a choice of two different prospects, they will pick the one that they think has less chance of ending in a loss, rather than the one that offers the most gains.

For example, if you offer a person two investments, one that has returned 5% each year for three years and one that has returned 12%, lost 3%, and returned 6% in the same years, the person will pick the 5% investment because they put an irrational amount of importance on the single loss, while ignoring the gains that are of a greater magnitude. In the above example, both alternatives produce the same net 澳洲幸运5官方开奖结果体彩网:total return after three years.

澳洲幸运5官方开奖结果体彩网:Prospect theory is important for financial professionals and investors. Although the risk/reward trade-off gives ꦉa clear picture of the risk amount an investor must take on to achieve the desired returns, prospect theory tells us that very few people understand emotionally what they realize intellectually.

For financial professionals, the challenge is in suiting a portfolio to the client's 澳洲幸运5官方开奖结果体彩网:risk profile, rather than reward desires🧔. For the investor, the cha𓃲llenge is to overcome the disappointing predictions of prospect theory and become brave enough to get the returns you want.

6. Rational Expectations Theory

The 澳洲幸运5官方开奖结果体彩网:rational expectations theory states that the players in an economy will act in a way that conforms to what can logically be expected in the future. That is, a person will invest, spend, etc. a🦩ccording to what they rationally believe will happen in the future. By doing so, that person creates a self-fulfilling prophecy that helps bring about the future event.

Although this theory has become quite important to economics, its utility is doubtful. For example, an investor thinks a stock is going to go up, and by buying it, this act actually causes the stock to go up. This same transaction can be framed outside of rational expectations theory. An investor notices that a stock is undervalued, buys it, and watches as other investors notice the same thing, thus pushing the price up to its proper 澳洲幸运5官方开奖结果体彩网:market value. This highlights the main problem with rational expectatio🔜ns theory: It can be changed to explain everything, but it tells us nꦺothing.

7. Short Interest Theory

澳洲幸运5官方开奖结果体彩网:Short interest theory assumes that high, short interest is the precursor to a rise in the stock's price and, at first glance, appears to be unfounded. Common sense suggests that a stock with a high short interest—that is, a stock that many investors are 澳洲幸运5官方开奖结果体彩网:short selling—is due for a correction.

The reasoning goes that all those traders, thousands of professionals, and individuals scrutinizing every scrap of market data, surely can't be wrong. They may be right to an extent, but the stock price may actually rise by virtue of being heavily shorted. Short sellers have to eventually cover their positions by buying the stock they've shorted. Consequently, the buying pressure created by the short sellers covering their positions will push the share price upward.

The Bottom Line

We have covered a wide range of theories, from 澳洲幸运5官方开奖结果体彩网:technical trading theories like short interest and odd lot theory to economic theories like rational expectations and🔯 prospect theory. Every theory is an attempt to impose some type of consistency or frame to the millions of buy and sell decisions that make the market rise ဣand fall daily.

While it is useful to know these theories, it is also important to remember that no unified theory can explain the financial world. During certain time periods, one theory seems to hold sway only to be toppled sooꦫn after. In the financial wo🌜rld, change is the only true constant.