Understanding Various Stock Trading Theories

People who do a lot of stock trading will tend to have a particular theory or philosophy that they follow

. If those theories and methods are taken away, then investing in the stock market will essentially be nothing more than gambling, no different from betting in a casino. By using a financial theory that has evidence of success, a trader will be able to manage their risk more effectively when investing. The theory does not necessarily have to have evidence of always working; instead, it is enough that a high number of other people use that theory.

Fibonacci patterns in stock trading are often used. This theory has its roots in a number sequence that was discovered by Leonardo Fibonacci several hundred years ago. The terms in this sequence can be manipulated to create percentages and ratios that are found everywhere in nature, but also in the financial market. There is not much in the way of proof that explains how these numbers exist in the financial markets, but the theory does work on a regular basis. It is likely that this theory is one that is created by the investors, rather than already existing; however, it is a viable method of investing.

The Elliot Wave Principle is another theory used in the trading of stocks that has similarities to Fibonacci trading patterns. What this theory suggests is that the group mentality of investors is strong enough to force the market to move certain ways. The founder of this theory, Ralph Nelson Elliot, believed that there were five main waves to how the market moved, with three corrective waves. Each wave has its own type and is determined by the historical mood of investors. As a result, trading decisions are often made with these waves in mind.

A third trading theory is called the Random Walk Hypothesis. This theory essentially states that nothing can be predicted in the stock market and so whatever decision you make has a fifty-fifty chance of being the correct one. There is a lot of research that supports this theory though few investors feel comfortable making decisions with their money that are the equivalent of playing roulette. However, belief in this theory allows an investor to invest confidently in knowing that everything comes down to chance.

The ultimate goal in stock trading is to increase profits. This is possible largely when traders take the time to learn and follow a particular trading plan or system. Each trader will have their own preference, but usually it does not matter which theory is chosen. What is important is that the theory is one practiced by many other people. This will help increase the percentage of the theory's patterns to appear in the market.

by: Ken Anderson.

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