Stock Markets: The Castle in the Air vs The Firm Foundation Theory

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Market Theories Investments Seminar Table of Contents Introduction 3 Castle in the Air Theory 3 Firm Foundation Theory 3 Effects of the Market 3 Market Theories 5 The Tulip-Bulb Craze 5 Today’s “Tulip-Bulb” Craze, the Dot-Com Crash 5 Conclusion 6 Introduction Castle in the Air Theory The Castle in the Air theory was introduced by John Maynard Keynes, an well known economist and successful investor of the 1930s. It was Keynes’ theory that the keys to investing came from supernatural or psychic means. He applied psychological rather than financial principles to the study of the stock market. He believed that it was not only too difficult but also quite time consuming to determine the intrinsic value that would yield a promising return on investments. He thought that it should not take all of that. He proposed that the best way to do so was estimating which investment situations that the public would focus on and then buying “before the crowd.” In other words, instead of picking out six out of a hundred stock based on how attractive they may have looked on the outside, it was better to select those stocks that the public were more likely to like the best. Or more so to predict what an average opinion of the best stocks are likely to be. The Castle in the Air theory speculates that an investment is worth a certain price to a buyer because the buyer would expect to sell it to someone else at a higher price. And the new buyer anticipated the same thing. Keynes’ approach did pay off for him during the Great Depression. He became famous by playing the stock market from his bed for half and hour each morning and became quite successful. While other investors were struggling to find out the financial magic number of the best investment, he simply anticipated their next move and bought before anyone else. In the text, this theory was also named the greater fool theory because it proposed that there was a sucker born every minute. These “suckers” existed to buy an investment at a higher price than what was paid. The behaviors of the masses as well as the behavior of the economy could be observed and speculated in such a way that... ... middle of paper ... out too soon too fast. Companies were not ready to go into this thing for the long term and they should have been thinking like so. The industry fell and fell hard after such a short time. Yet, overall taking a risk was perhaps one of the best things to have come out of this craze as well as all others. Conclusion In conclusion, I think that it is important for investors to understand both theories. The Castle in the Air theory sets an stage that is easier in my opinion to deal with. It has a way of encouraging an investor to look at and observe the behaviors of the market. The firm foundation theory, in my opinion is a worthwhile theory to research and develop. Knowing how to calculate different values and study the trends of such I believe are a good way to at least be able to make a more reasonable investment decision. Overall, I think that both methods are good because it can generate a better understanding of the market as a whole. Risk taking is a must and an investor is going to have to take risks in order to generate a return. That’s a given. However, it is by far a better thing to use these two theories in order to better equip investors for survival in the market.

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