A:

The chaos theory is a complicated and disputed mathematical theory that seeks to explain the effect of seemingly insignificant factors. The chaos theory name originates from the idea that the theory can give an explanation for chaotic or random occurrences. The first real experiment in the chaos theory was done in 1960 by a meteorologist, Edward Lorenz. He was working with a system of equations to predict what the weather would likely be.

In 1961, he wanted to recreate a past weather sequence, but he began the sequence mid-way and printed out only the first three decimal places instead of the full six. This radically changed the sequence, which could reasonably be assumed to closely mirror the original sequence with only the slight change of three decimal places. However, Lorenz proved that seemingly insignificant factors can have a huge effect on the overall outcome. The chaos theory explores the effects of small occurrences dramatically affecting the outcomes of seemingly unrelated events.

The chaos theory has been applied to many scientific areas, including finance. In finance, the Chaos theory has been used to argue that price is the last thing to change for a security. Using the chaos theory, a change in price can be determined through mathematical predictions of the following factors: a trader's personal motivations (such as doubt, desire or hope that are nonlinear and complex), changes in volume, acceleration of changes and momentum behind the changes. The application of the chaos theory to finance remains controversial.

For more information on stock theories see The Basics Of Game Theory and Modern Portfolio Theory: An Overview.

This question was answered by Bob Schneider.

RELATED FAQS
  1. What's the difference between agency theory and stakeholder theory?

    Learn how agency theory and stakeholder theory are used in business to understand common business communication problems ... Read Answer >>
  2. Why is Game Theory useful in business?

    Game theory was once hailed as a revolutionary interdisciplinary phenomenon bringing together psychology, mathematics, philosophy ... Read Answer >>
  3. What are the differences between weak, strong and semi-strong versions of the Efficient ...

    Discover how the efficient market theory is broken down into three versions, the hallmarks of each and the anomalies that ... Read Answer >>
  4. Is a good's production cost related to its value?

    Learn about the history and debate regarding the metrics used to determine the value of a good and which theories place emphasis ... Read Answer >>
  5. What is the "random walk theory" and what does it mean for investors?

    The random walk theory is the occurrence of an event determined by a series of random movements - in other words, events ... Read Answer >>
  6. How has the Internet contributed to the long tail theory of marketing?

    Learn how the Internet has contributed to the long-tail theory of marketing and how this strategy is being applied by modern ... Read Answer >>
Related Articles
  1. Trading

    7 Controversial Investing Theories

    We take a closer look at the theories that attempt to explain and influence the market.
  2. Trading

    Dow Theory: Current Relevance

    By Chad Langager and Casey Murphy, senior analyst of ChartAdvisor.comThere is little doubt that Dow theory is of major importance in the history of technical analysis. Many of its tenets and ...
  3. Trading

    Modern Portfolio Theory vs. Behavioral Finance

    Modern portfolio theory and behavioral finance represent differing schools of thought that attempt to explain investor behavior. Perhaps the easiest way to think about their arguments and positions ...
  4. Managing Wealth

    Globalization and the Butterfly Effect

    Discover how the butterfly effect applies to global capital markets and witness how chaos theory can describe market volatility.
  5. Investing

    Understanding the Random Walk Theory

    The random walk theory states stock prices are independent of other factors, so their past movements cannot predict their future.
  6. Trading

    Dow Theory: Conclusion

    By Chad Langager and Casey Murphy, senior analyst of ChartAdvisor.comDow theory represents the beginning of technical analysis. Understanding this theory should lead you to a better understanding ...
  7. Trading

    Dow Theory: Introduction

    By Chad Langager and Casey Murphy, senior analyst of ChartAdvisor.comAny attempt to trace the origins of technical analysis would inevitably lead to Dow theory. While more than 100 years old, ...
  8. Trading

    Elliott Wave Theory Basics

    Elliott believed that the movement of the stock market could be accurately predicted by charting patterns. Learn the basics of this theory.
  9. Trading

    Dow Theory: Dow Theory Specifics

    By Chad Langager and Casey Murphy, senior analyst of ChartAdvisor.comSo far, we have discussed a lot of the ideas behind Dow theory along with its main tenets. In this section, we'll take a ...
  10. Managing Wealth

    Redefining Investor Risk

    Changing the way you think about time and risk can change the way you invest.
RELATED TERMS
  1. Chaos Theory

    A mathematical concept that explains that it is possible to get ...
  2. Accelerator Theory

    An economic theory that suggests that as demand or income increases ...
  3. Dow Theory

    A theory which says the market is in an upward trend if one of ...
  4. Demand Theory

    A theory relating to the relationship between consumer demand ...
  5. Market Segmentation Theory

    A modern theory pertaining to interest rates stipulating that ...
  6. Labor Theory Of Value

    An economic theory that stipulates that the value of a good or ...
Hot Definitions
  1. AAA

    The highest possible rating assigned to the bonds of an issuer by credit rating agencies. An issuer that is rated AAA has ...
  2. GBP

    The abbreviation for the British pound sterling, the official currency of the United Kingdom, the British Overseas Territories ...
  3. Diversification

    A risk management technique that mixes a wide variety of investments within a portfolio. The rationale behind this technique ...
  4. European Union - EU

    A group of European countries that participates in the world economy as one economic unit and operates under one official ...
  5. Sell-Off

    The rapid selling of securities, such as stocks, bonds and commodities. The increase in supply leads to a decline in the ...
  6. Brazil, Russia, India And China - BRIC

    An acronym for the economies of Brazil, Russia, India and China combined. It has been speculated that by 2050 these four ...
Trading Center