String Theory Applied to the Stock Market

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(Image: Image by Flickr.com, courtesy of kevinzhengli)

String theory has been around a long time in economics and the stock market. Essentially it states that the more severe a pullback in the economy or the equity markets the more intense will be the recovery or rally. String theory in this case refers to a string being pulled taut, not a branch of theoretical physics.

The Push and Pull Thought Process

In a major bear market, stock prices decline in a very forceful manner. The thinking behind the string theory is that when stocks start their price recovery, they eventually do so just as forcefully, recording major jumps in the stock market in the process.

Snap-Back Stock Market Theory

This snap-back market theory is based on the thinking that the underutilized capacity and idle resources that are available can quickly be put back into production, rapidly fueling a company’s return to prosperity. The new blowout earnings that are subsequently announced—thanks to the increase in productivity—will lead to a surge in stock prices.

Popular Among Successful Value Investors

This thinking is why veteran value investors like Warren Buffett love to purchase these stocks on major dips in a bear market as they wait to realize their profits in the snap-back bull market.

Applying the String Theory to the Equity Markets

You as an investor can apply the string theory approach to your own portfolio. View a major stock market decline as an opportune time to go value hunting for fundamentally strong stocks that are poised to break out when the snap-back effect takes hold.

Ways to Implement Your Investing

String theory investing could involve the outright purchase of individual stocks, value-oriented mutual funds or, if you are so inclined and have the expertise, long-term call options. Regardless of the method employed, it is important to understand that based on the stock market string theory, a stock market decline is a good time to take advantage of the bullish snap-back that has historically followed.

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References

  • String Theory Demystified; David McMahon; 2008
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