What is the chaos theory?

By Bob Schneider AAA
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. How are Fractal patterns interpreted by analysts and traders?

    Read about the fascinating and controversial fractal patterns and their uses in technical analysis to spot possible trend ...
  2. How does the "Buffett Premium" increase Berkshire Hathaway's stock price?

    Explore the theory that Berkshire Hathaway stock carries a Warren "Buffet Premium" that would disappear upon his death and ...
  3. How do technical analysts predict bull markets?

    Dive into the methods and assumptions of technical analysis, and see how analysts go about trying to predict a bull market ...
  4. What is a diseconomy of scale and how does this occur?

    Take a deeper look into diseconomies of scale, the economic phenomenon that can make companies less efficient as they become ...
RELATED TERMS
  1. BCG Growth Share Matrix

    A planning tool that uses graphical representations of a company’s ...
  2. Dog

    One of the four categories or quadrants of the BCG Growth-Share ...
  3. Outcome Bias

    A decision based on the outcome of previous events without regard ...
  4. Hindsight Bias

    A psychological phenomenon in which past events seem to be more ...
  5. Centipede Game

    An extensive-form game in game theory in which two players alternately ...
  6. Cournot Competition

    An economic model that describes an industry structure in which ...

You May Also Like

Related Articles
  1. Technical Indicators

    How are Fractal patterns interpreted ...

  2. Chart Advisor

    These 4 Swing Trades Could Place You ...

  3. Trading Strategies

    You'll Lose Profits Without This Trading ...

  4. Investing

    Why These Are 2015's Most-Promising ...

  5. Chart Advisor

    Are These Triangle Patterns Breaking ...

Trading Center