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Just like any other field, the investing world has a lot of theories on what moves the market or what a certain move means.
The two most prominent theoretical divides in the investing world are investors who believe the market can be beaten and investors who do not.
However, there are many other theories that divide investors.
Efficient Market Hypothesis
It’s difficult to find an investor who is not either a believer or skeptic of the efficient market hypothesis.
An investor is always one of the two. He might be a believer of this hypothesis so he adheres to passive broad market investing strategies.
Or he might be someone who focuses on picking stocks based on their growth potential, undervalued assets, and so on.
The EMH purports the market price for shares incorporates all of the known information about the stock.
What that means is the stock valued accurately until an event changes that valuation in the future. And because the future is uncertain, a believer of the EMH ought to own a wide variety of stocks to profit from the general rise of the market.
Those who doubt the hypothesis cite Warren Buffett and other investors that have consistently beaten the market by finding irrational prices within the overall market.
50% Principle
The 50% principle predicts an observed trend will undergo a price correction of one-half to two-thirds of the change in price.
So, for example, if the stock has risen 20% on an upward trend, it will fall back 10% before it continues going up.
Obviously, this example is extreme. Most of the time, this rule is applied to short-term trends technical analysts and traders buy and sell on.
Proponents believe the correction is natural part of the trend. It’s caused by jittery investors who take profit early to avoid getting caught in a true reversal of the trend later on.
Greater Fool Theory
This theory suggests you can profit from investing as long as there is a greater fool than you to buy the investment at a higher price.
In other words, you can make money from an overpriced stock as long as someone else is willing to pay more to buy it from you.
Eventually, you will run out of fools as the market overheats.
And using the greater fool theory means you ignore data such as valuations, earnings reports, and the like. This is a risky method.
Odd Lot Theory
The odd lot theory uses the sale of odd lots, or small blocks of stocks held by individual investors, as a signal of when to buy a stock.
Investors who follow the odd lot theory buy in when small investors sell out. The idea is those small investors are usually wrong.
Prospect Theory
The prospect theory is also known as the loss aversion theory. This theory states people’s perception of gains and losses are skewed.
That means people are more afraid of a loss than they are motivated by gains.
The prospect theory is important for financial professionals and investors. Even though the risk/reward tradeoff gives a clear picture of the risk amount an investor must take to achieve the desired returns, the prospect theory tells us very few people understand emotionally what they realize intellectually.
The key to success is awareness. That’s why you need to go and check Finance Brokerage educational websites available. And you can choose the one that suits you the best in the Online Trading Courses offered.
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