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Stock Markets: The Castle In The Air Vs The Firm Foundation Theory

1412 words - 6 pages

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 it would bring on profits for followers of this theory. Psychologically it is to me a crude one, but perhaps it was also a truthful one.

Firm Foundation Theory

The firm-foundation theory speculated that each tool used for investment (stock, real estate, etc.) was directly related to intrinsic value. Intrinsic value could be determined by carefully analyzing present-day conditions and future speculations. It was determined that when market prices fell below or rose above this firm foundation a buying or selling opportunity would come about. Quite simply it became a matter of comparing the...

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