Interesting investment theories you should know

Investing is an interesting game. Just like sports, it involves practice, precision, planning, careful execution, and the ability to learn from one’s mistakes.

The reason there are investment strategies and methods of valuation or fundamental analysis available for investors to make better decisions is that over time, trends have been analysed and theories, birthed.

While we are probably all familiar with simple strategies and theories like "Buy low and Sell high,” or the theory of Efficient Market Hypothesis, there are other interesting concepts that might sound off, but could come in handy.

1: Greater Fool Theory

Even though the general idea is to buy low and sell high, there are situations where you can buy high and still make gains from it – you just have to find a “greater fool.”

The greater fool theory, as the name implies, means that investors can make gains from any form of investment as long as there is a greater fool who will be willing to buy the investment at a higher price than what it was purchased for.

Even if the stock is overpriced, you can earn from it as long as there is somebody who is willing to pay more for it. Of course, if this greater fool has carried out enough analysis to purchase the shares and it then grows, the joke’s on you.

2: Rational Expectations Theory

Another pretty interesting theory is the rational expectations theory. This theory is of the opinion that the players in an economy will act in such a way that supports what can be logically explained in future periods.

What this means is that people will invest based on what they expect to be the most rational event that will take place in the future. So if you’re investing in a Covid-19 era, knowing that at some point in time the pandemic will be managed is a rational expectation.

Of course, this also has its limitations because imagining that a stock will go up is not enough to make it go up. It really doesn’t offer so much help.

3: Prospect Theory

The prospect theory which is also known as the loss-aversion theory, explains that investors’ perceptions of gains and losses are not exactly accurate. Since most people are generally more afraid of a loss than they are motivated by gains, it is natural that the market will move in line with investments that have less chances of being lost.

This shows that humans could be more emotional than logical when it comes to making designs. It can, however, be used as an effective tool to determine the level of risk aversion of investors because known there’s a clear tradeoff between risk and expected return.

Any investor who wants to really earn from it, he or she has to circumvent inaccurate predictions made by the market and weather the storm to achieve the desired returns.

Written by Lawretta Egba