LOOKING INTO DIFFERENT INVESTING THEORIES
Efficient Market Hypothesis
This theory has gained a lot of supporters and opponents. Traders and analysts either stick to passive, broad investing strategies or focus on selecting stocks based on growth potential and other factors. EMH states the market price for shares integrates all the identified details about a stock. Since we cannot ascertain the future, those who back the EMH are far better off owning a wide range of stocks and gaining from the overall rise of the market. On the other hand, opponents of this supposition highlight investors can outmatch the market by seeking erratic prices within the general market.
Fifty Percent Principle
A principle postulating an observed trend will go through price correction of one-half to two-thirds of the price change before continuing, meaning a stock, before continuing its surge, will fall back 10% if it has been on an upward trend and accrued 20%. The correction is considered part of the trend, as it is typically caused by fearsome investors who locking in profits early to getting trapped in a real, future reversal of the trend. If the correction goes beyond 50% of the price change, the trend has failed and the reversal has surfaced beforehand.
Greater Fool Theory
It stipulates an investor can profit from investing, given there is a greater fool than oneself to purchase the investment at a greater price. Hence, a trader could earn from an overpriced stock as long as another person is willing to pay more to obtain it from you. In the long run, you will run out of tools as the market for any investment overheats. Those who adhere to this theory ignores earning reports, valuations, and all other data. Ignoring figures is as perilous as paying too much attention to it. At the end of the day, they could be left holding the short end of the stick following a market correction.
Odd Lot Theory
The technical analysis theory utilizes the sale of odd lots, small blocks of stocks owned by investors, to take cue on when to buy into a stock. The primary assumption of this contrarian strategy is small traders are normally wrong. The success indicator depends on whether an investor checks the fundamentals of firms the theory indicates or simply purchases blindly. Individual investors are more mobile than the huge funds; thus, can react to worse news faster. Odd sales can be a precursor to a bigger sell-off in a dwindling stock.
Also called loss-aversion theory, people’s perceptivity of gain and loss are oblique. Most people are afraid of losing than gaining. Ask them to choose between the prospect of ending in a loss and ending in a gain. Chances are they will pick the former. Even though the risk/reward trade off depicts the risk amount a trader must take on to attain desired results, this theory outlines very few individuals understand emotionally what they perceive intellectually.
Rational Expectations Theory
The theory explains the participants in an economy will act in a way conforming to what can be logically be expected in the future. In that manner, the individual establishes a self-fulfilling prophecy, which can lead to the future event. Although important, its usage is improbable. In essence, anything can be altered to explain everything, but it conveys nothing.
Short Interest Theory
It presumes a high short interest is the predecessor to an increase in the stock’s price, which seems to be unfounded at first. This theory implies a stock with a high short interest, a stock which many traders are short selling, is bound for correction. The rationale behind this is that all traders, individuals, and professionals looking into every market figures cannot be wrong for sure. But the stock price may actually climb by being shorted. Now, sellers need to cover their positions by purchasing the stocks they have shorted. And, as a result, the buying pressure from covering positions will glide the stock price upward.
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