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. Which of the following statements is least accurate with respect to the various ...

    The correct answer is: b) The tax preference theory simply argues that capital gain return results in a higher after tax ... Read Answer >>
  6. Does the tradeoff model or the pecking order play a greater role in capital budgeting?

    Understand the difference between the trade-off theory and the pecking order theory, and learn what these theories tell companies ... Read Answer >>
Related Articles
  1. Investing

    7 Controversial Investing Theories

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

    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 ...
  3. Investing

    Globalization and the Butterfly Effect

    Discover how the butterfly effect applies to global capital markets and witness how chaos theory can describe market volatility.
  4. 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.
  5. Trading

    Manipulating Facts to Fit a Theory: A Dangerous Trading Practice

    This practice is common with experienced and new traders, and it can lead to huge losses. Find out how to avoid it.
  6. Investing

    Interest Rate Predictions With Expectations Theory

    The expectations theory uses long-term interest rates to predict future short-term interest rates.
  7. Investing

    Efficient Market Hypothesis

    An investment theory that states it is impossible to "beat the market".
RELATED TERMS
  1. Chaos Theory

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

    A theory that the future value of interest rates is equal to ...
  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. Accelerator Theory

    An economic theory that suggests that as demand or income increases ...
  6. Expectations Theory

    The hypothesis that long-term interest rates contain a prediction ...
Hot Definitions
  1. 403(b) Plan

    A retirement plan for certain employees of public schools, tax-exempt organizations and certain ministers. Generally, retirement ...
  2. Master Of Business Administration - MBA

    A graduate degree achieved at a university or college that provides theoretical and practical training to help graduates ...
  3. Liquidity Event

    An event that allows initial investors in a company to cash out some or all of their ownership shares and is considered an ...
  4. Job Market

    A market in which employers search for employees and employees search for jobs. The job market is not a physical place as ...
  5. Yuppie

    Yuppie is a slang term denoting the market segment of young urban professionals. A yuppie is often characterized by youth, ...
  6. SEC Form 13F

    A filing with the Securities and Exchange Commission (SEC), also known as the Information Required of Institutional Investment ...
Trading Center