DEFINITION of 'Chaos Theory'

A mathematical concept that explains that it is possible to get random results from normal equations. The main precept behind this theory is the underlying notion of small occurrences significantly affecting the outcomes of seemingly unrelated events.

Also referred to as "non-linear dynamics".

BREAKING DOWN 'Chaos Theory'

Chaos theory has been applied to many different things, from predicting weather patterns to the stock market. Simply put, chaos theory is an attempt to see and understand the underlying order of complex systems that may appear to be without order at first glance.

Related to financial markets, proponents of chaos theory believe that price is the very last thing to change for a stock, bond, or some other security. Price changes can be determined through stringent mathematical equations predicting the following factors:

1) A trader's own personal motives, needs, desires, hopes, fears and beliefs are complex and nonlinear.
2) Volume changes
3) Acceleration of the changes
4) Momentum behind the changes

Chaos theory is highly controversial and extremely complicated.

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