THREE MAIN THEORIES

ACADEMIC THEORY

Extensive analysis reveals three main sorts of understanding about how markets work, and thus how money can come to be taken out of the market on anything like a regular basis.

Academic theory. Efficient market theory, a favorite of academics, suggests that all prices reflect all available information. According to this theory, future price direction is unpredictable, since all information is already priced in to price, which will immediately change as information changes. Another academic theory, called “random walk” theory, argues that price change is completely random within certain parameters. Such randomness actually contradicts efficiency, as a truly efficient market would be determined by information, and thus probably not random. In any case, both sorts of academic theories assume that market participants are rational actors. The reality of stock market, real estate, commodity booms and busts belies this assumption. In fact, prices can become extremely extended and extremely oversold as people, trying to make money based not on rational decisions but on fear and greed, follow prices to their point of inflection. Rather than rational, market participants would describe market behavior as manic depressive.