The Role of Functionalism in the Perception of the Stock Market

How investors feel about a stock is a strong determinant of its price.

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The relation between functionalism, a philosophical theory, and investor perception of the stock market may initially appear far-fetched. However, functionalism provides a comprehensive way of viewing market movements. It explains both behavioral market theory and efficient markets theory as constituents of a larger structure, while rejecting theories that claim to see market movement as the expression of underlying mathematical principles.

The Philosophical Basis of Functionalism

At its purest and most abstract, functionalism proposes that mental states are the product of the causal relations between thoughts in relation to sensory inputs and behavioral responses. Another way of putting this is to say that one's mental state is defined by one's actions -- by how the mind and body function.

A Functional Perception of Market Theory

One interesting application of functionalism is the perception of market theory from a functional point of view. Several market theories, for instance, propose that the market undergoes a price correction when certain conditions apply. The so-called "50-percent principle," to name one such theory, predicts that when a stock gains 30 percent over its last dip, it will fall back by half of that gain, 15 percent, before continuing upward.

The Fallacy of Generalizing Market Theory

This perception, the 50-percent principle, imputes to the market a kind of identity -- that it is somehow the market's nature to behave this way. Functionalism is an antidote to this belief and others like it: A functional perception of the market proposes that at any given time the market is simply the sum of all the market's internal relations that exist in relation to both external inputs -- such as economic movements and historical events -- and investors' behavioral responses. The market has no essence. The particular conditions that apply to the market at a given instance are almost certainly momentary and unique. They are not expressions of some pre-existing internal rule to be discovered by historical or mathematical analyses.

Patterns, Real and Imaginary

The perception of the market from the viewpoint of functionalism does not include a blanket rejection of all market theory. Some recurring patterns may be quite valid. Functionalism, for instance, sees the historical analysis of investor behavior as a valid way of predicting market movement, provided that investor behavior is understood to be only one market determinant among several. Similarly, from the viewpoint of functionalism, efficient market hypothesis -- the understanding that a stock's price at a given moment represents the sum of everything known about the stock by all investors -- is also a valid understanding of the role played by behavioral responses in market pricing. Functionalism confirms in effect that investor behavior and the totality of information about a stock's value are linked.