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. ### 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 >>
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. ### How is the Dow Jones Industrial Average used in the Dow theory?

Discover how the Dow Jones Industrial Average is used in the Dow Theory, which is used by traders to figure out the trend ... Read Answer >>
5. ### What is capital structure theory?

Discover capital structure theory as it relates to financial management and the methods in which companies attempt to raise ... Read Answer >>
6. ### How does money supply affect inflation?

Learn about two competing economic theories of the role of the money supply and whether money supply necessarily causes inflation ... 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. Insights

### Elaine Chao

Secretary of Transportation
3. 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 ...
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. Investing

### Interest Rate Predictions With Expectations Theory

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

### 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.

### 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.
8. Investing

### 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. ### Biased Expectations Theory

A theory that the future value of interest rates is equal to ...
3. ### Demand Theory

A theory relating to the relationship between consumer demand ...
4. ### Accelerator Theory

An economic theory that suggests that as demand or income increases ...
5. ### New Growth Theory

An economic growth theory that posits humans' desires and unlimited ...
6. ### Expectations Theory

The hypothesis that long-term interest rates contain a prediction ...
Hot Definitions
1. ### Leveraged Buyout - LBO

The acquisition of another company using a significant amount of borrowed money (bonds or loans) to meet the cost of acquisition. ...
2. ### Current Assets

A balance sheet account that represents the value of all assets that can reasonably expected to be converted into cash within ...
3. ### Tax Liability

The total amount of tax that an entity is legally obligated to pay to an authority as the result of the occurrence of a taxable ...
4. ### Preferred Stock

A class of ownership in a corporation that has a higher claim on its assets and earnings than common stock. Preferred shares ...
5. ### Net Profit Margin

Net Margin is the ratio of net profits to revenues for a company or business segment - typically expressed as a percentage ...
6. ### Gross Margin

A company's total sales revenue minus its cost of goods sold, divided by the total sales revenue, expressed as a percentage. ...