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New Trade Theory |
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New Trade TheoryModels of trade that, especially in the 1980s, incorporated aspects of imperfect competition, increasing returns, and product differentiation into both general equilibrium and partial equilibrium models of trade and trade policy. Many contributed to this literature, but the most prominent was Krugman, starting with Krugman (1979).Similar MatchesDow theoryDow theoryIn 1887 Charles Dow (as in 'The Dow Jones') developed two stock market 'averages':The Industrial Average, made up of 12 blue chip stocksThe Rail Average, made up of 20 railroad companiesIn 1900 he wrote a series of articles noting that the direction of prices in each average appeared to be based on a set of rules. Collectively, these became known as The Dow Theory and the key precepts are summarised below.Dow TheoryA share price reflects everything that is known about a stockThis means that all the positives and all the negatives about a company are assumed to be known by the market and built into the share price. Implicitly, no stocks are undervalued, because the market has 'perfect' knowledge.At any given time, there are 3 trends unfolding in the stock market:The primary trend lasting for more than one yearThe secondary trend which is a corrective reaction to the primary trend and usually lasts form one to three monthsThe tertiary or minor trend which is a short term movement lasting from one day to three weeks.Primary trends have three phasesAggressive buying by well informed investors ahead of economic recovery while most investors are still bearish about the marketGeneral buying by the majority of investors as company earnings pick up and economic conditions improveHeadlong rush into stocks by everybody, as companies report record earnings. Meanwhile, the well informed investors are starting to sell even though prices may be rising.Volume Confirms the TrendRallies in the market are accompanied by increasing volume, and falls with decreasing volume.A Trend Continues Until a Reversal SignalIf a primary trend is confirmed by the movement of both averages it will continue until there is a definite reversal signal. So once a primary trend has started the chances are it will continue, but once it has been around for a while the chances of continuation are less. Capital market theoryCapital market theoryThe generic term for models which aim to price assets, usually shares or baskets of them, in terms of the trade-off between risk and return that investors seek.The best known and most influential of these is the Capital Asset Pricing Model. Efficient market theoryEfficient market theoryThe theory that claims that the current price of a share reflects everything that is known about the company and its future earnings potential, and that is it impossible to beat the market consistently.Efficient market theory suggests that the army of analysts and fund managers in the City whose job is to actively manage superior-performing portfolios are engaged in a futile exercise because everything they find out is rapidly transmitted around the market, and share prices instantly reflect the common knowledge. In other words, no one can get one up on anyone else. And the logical extension of this is that passive funds - tracker and index funds - are the best place to park your money, because their management costs are much lower and they are mathematically structured to match the performance of their chosen index.Plenty of people disagree with efficient market theory, and their ranks include people like Warren Buffett who has consistently produced returns of over 20% on his portfolio over a 30 year period. Agency theoryAgency theoryThe analysis of principal-agent relationships, in which one person, an agent, acts on behalf of another person, a principal. Short interest theoryShort interest theoryThe theory that a large interest in short positions in stocks will precede a rise in the market prices, because the short positions must eventually be covered by purchases of the stock. Further SuggestionsModern portfolio theoryGreater fool theory Bubble theory Complexity Theory Trade theory Theory of second best Purchasing power parity theory Expectations theory of forward exchange rates Dow Theory Dow dividend theory Local expectations theory Dependency Theory Efficient markets theory(EMT) Preferred habitat theory Cushion theory Conduit theory Bicycle Theory Labor theory of value Normal backwardation theory Product cycle theory Portfolio theory Odd lot theory Presidential election cycle theory Elliott Wave Theory Game Theory |
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