In the stock market, there are a number of these theories at work. From the behavior of the entire market as a whole to the behavior of individuals and other components of the market, different elements come together to guide the market.
Ever heard the line, “there’s a theory for everything?” Theories for why people sleep, theories for why we work, theories for time and so much more. As such, it is only natural that there are also a number of theories that guide the investment game.
A theory represents the rational or generalized thinking about anything. Theories are typically gotten based on observation and research, and they are formed based on available norms.
In the stock market, there are a number of these theories at work. From the behavior of the entire market as a whole to the behavior of individuals and other components of the market, different elements come together to guide the market.
An understanding of these theories will help you predict to a certain degree the workings of the market, giving you the opportunity to make relevant decisions. The following are some of the top theories of the stock market.
Demand and Supply
This is a known theory. It is one that affects all kinds of markets from the usual markets where we purchase foodstuff to the stock market, the law of demand and supply is an economic theory that has been tried and tested and proven times without number.
In the stock market, the law of demand and supply controls everything. When many people want to get the same thing, it means there is a high demand for it. And since there is a finite amount of the thing that can be supplied, the price goes up.
On the flip side, when the price of a thing is too high, the demand for it will reduce and ultimately the price will have to go down to encourage more buyers. The same applies to stocks in the stock market.
What this means is that price-setting in the stock market is controlled by investors themselves. An understanding of this theory will allow you to understand the short term volatility of stocks and inform you of the best time to buy stocks in the market.
Investor Behavior
Since the entire market is controlled by the investors themselves, understanding the psychology of investing is a key theory as well. Investor behavior or psychology is the theory of how you and I behave in the stock market.
If you thought investors were very rational beings who always took well-informed decisions, think again. The overarching theory is that investors are irrational beings!
It is no surprise why the market does not move in a predictable or rational way. The individuals driving the movements of the market are complex beings that take decisions in a diverse range of ways that are unpredictable.
This theory, however, doesn’t mean market behaviour by virtue of the unpredictable human input is also unpredictable; It just means you can have an idea of what could happen but you cannot say it for a fact. Investors could simply follow the crowd.
There are still a number of theories that guide the stock market and they will be discussed in later articles.
Written by Lawretta Egba.
