Embracing Chaos When Trading And Investing

The "Butterfly Effect" refers to the idea that a butterfly's wings might create tiny changes in the atmosphere that ultimately cause a tornado to appear (or prevent a tornado from appearing). The flapping wing represents a seemingly irrelevant action that can cause tremendous long-term effects. In other words, had the butterfly not flapped its wings, the outcome might have been vastly different.

"Chaos Theory" is a financially related term for the Butterfly Effect. Proponents of Chaos Theory believe that price is the very last thing to change for a stock, bond, or some other security, and that price changes are created through a trader's own personal motives, needs, desires, hopes, fears and beliefs. In addition, those who believe in Chaos Theory believe that it is about explaining apparent disorder in a very ordered way, and that things are not random, just complex.

Financial markets, from the outside, appear to be random and unpredictable, but – as all traders know – every single financial decision is made consciously and is, in fact, the opposite of random. Yet, with the complexity of the trillions of financial decisions made every day, the results can appear to be far from rational.

So, the markets can create an atmosphere of "regulated chaos." Is that something traders should consider as they make their trades? Absolutely. Should they worry about the Chaos Theory and the Butterfly Effect? Probably not. Through risk management, knowing your tolerance, and following your plan, you can thwart the potential effect that these situations might have on your financial picture. Take precautions and accept that chaos and uncertainty is just the inherent nature of the market.

In the meantime, Good Luck on your journey to success…

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