Section 2.4

Theories and Strategies

The fundamental question of how one can make money in the market is always answered the same way by finance professors:  It depends.  Financial systems are so complex that no single belief system of how things work has dominated all thinking on the matter.  There are many different schools of psychology for similar reasons; human behavior is so complex that competing ideas cannot be easily eliminated.  Criminologists have developed myriad theories as to why individuals commit crimes, and no one theory dominates the field.  For our purposes, a theory is merely a systematic explanation of how financial markets (or some aspect of them) work.  These theories are important because if we can hit on the right one, then we can predict changes in the market and profit from that foreknowledge.

Some investors have no use for theories; they believe that they can use changes in stock prices and other technical indicators to predict changes in asset prices.  If they are correct, it does not matter why the change happens, so long as it is predictable using a pattern or indicator.  Prediction without explanation is antithetical to science, but technical traders don’t care much about science either.  Below, we will consider a cross-section of theories and strategies that you will encounter as you further study financial markets and investing.  Some of these will be important to us in later sections as we develop a portfolio allocation strategy, and those are given a longer treatment.

[ Back | Contents | Next ]