Throughout the ages, man has always inquired about how things work through studies and research. This inquiry also involves investments and has led to several investment theories.
There are many theories postulated by different individuals based on studies about what makes the market work. Understanding what controls the market can help you control the market itself.
These many studies and claims have led to the development of mainly two factions, which are:
- Those who believe they can beat the market, and
- Those who are rather more sceptical and hold the notion that stock always trades at their fair value.
Let’s look at the different investment theories
The history and evolution of investment theories
Invest theory brought about a merging of statistics, predictability, finance, and economics. Researchers like Fisher, Regnault, Cowles, Macaulay, and many others, came up with most of the theories we have today. All these happened in the 19th and early 20th centuries. They aimed to understand the investment (stock) market, how it works, and therefore predict its movement.
These theories still apply in today’s market, beyond stocks, and economists and investors around the world still consult them
7 Investment theories you should know
1. Efficient Market Hypothesis:
The Efficient Market Hypothesis (EMH) states that the market price for any share incorporates all the known information about that stock. You either believe in the EMH and adhere to it or take your chances by predicting stock growth based on potential.
2. Greater Fool Theory:Â
This theory proposes that you can always make a profit from your investment, as long as there is a greater fool to purchase the investment at a higher price. Adhering to this theory, you ignore market valuations, earning reports, and other data that provide insight into the market. There is a good chance that it backfires.
3. The Fifty percent rule:Â
This rule predicts that a market trend would undergo a half to two-third reduction in price before it continues to rise. For example, a stock in an upward trend that gains 30%, would fall back to 15% before continuing to rise again. If the trend reduction increases beyond 50%, then it is an indication that it has failed.
4. The Odd Lot theory:
This theory tracks the sale of small odd lots held by individual investors and uses it as an indicator of when to buy a stock. The assumption is that small investors are usually wrong, and it encourages you to buy in when they sell out. If you assume the odd-lot theory, still carry out research to be sure because small investors will not be wrong all the time.
5. Rational Expectations Theory:Â
They base this theory on rational reasoning. It conforms you to act in a way that is in accordance with what we can logically expect. In doing so, you create a situation that helps bring about an expected future event. Little risk, much planning, and observing.
6. Prospect Theory:
This theory postulates that people’s perceptions of gain and loss are skewed. Therefore, they are more afraid of a loss than encouragement to gain. Most individuals would always go with the prospect that presents less chance of a loss than the one with the most gain.
7. Short Interest Theory:
This theory follows common sense in that a stock with high quick interest (investors sell within a short time), is due for a correction. During the correction, the stock value rises.
Conclusion
Every theory tried to develop consistency in the fluctuation patterns of the market investment. However, no single theory has managed to lay claim on the operational blueprint of the investment market. It’s worked for some and terribly cost others.
One thing for sure is that you need to carry out a proper investigation and market analysis to even stand a chance.