- Catastrophe, as related to Thom's work, does not exactly equate to total disaster. The New York Times describes Thom's catastrophe as when "continuous actions suddenly give way to discontinuous change." The theory relies on geometric shapes and abstract mathematical patterns referred to as cusps and butterflies to predict change. Thom's catastrophe theory has been combined with technical analysis to monitor the stock market.
- Technical analysis depends strictly on price data, volume and charts to interpret stock market action. Chartists believe the stock market is influenced by predictable human behavior, which effectively establishes trends and reversals. Trend refers to the tendency of a security to stabilize, or continue increasing and decreasing in value. Investors use volume in conjunction with chart patterns to foreshadow reversals in trends and act accordingly. Catastrophe stock market theory is concerned with the catalysts that manifest these changes.
- Catastrophe theory is an extension of bifurcation theory, which seeks to address the idea of relatively small and unrelated happenings manifesting themselves into sweeping changes of behavior. In terms of stocks, program trading strategies orchestrated by computer formulas, proposed merger deals that fail to close and municipal debt defaults have promulgated changes in trends that range between short-term daily fluctuations and complete business cycles of growth and recession. Catastrophe theory is overlaid against technical analysis and stochastics to predict reversals.
Stochastics use momentum to plot whether an individual security is "overbought" or "oversold" and due to revert toward "normalcy." The stochastic oscillator carries values between zero and 100, in which any calculation outlying the 20 to 80 range signals that the investment has reached a "top" or "bottom." Reversals may be triggered easily by relatively unremarkable events at these points. - Catastrophe theory and its relationship to the stock market peaked during the 1970s. As of 2009, overall sentiment regarding pure technical analysis varies according to the economic time frame. Large investment banks have both hired and eliminated technical analysis desks in response to performance.
Investors often choose to combine aspects of fundamental and technical analysis. For example, traders may research the profitability and financial landscape pertaining to a particular investment before setting a price target to "buy at $50" because the stock rarely falls beneath this price point. Technical analysts would describe $50 as the support level. - Catastrophe theory is characterized by convoluted and abstract mathematical equations. Dr. René Thom's ideas are difficult for the layperson to understand and apply to the stock market. Although the theory emerged as a noteworthy movement during the 1970s, it has fallen out of favor because of its inability to actually predict catastrophe. Catastrophe theory was largely unable to foreshadow, confirm and avoid the 1987 stock market crash, 2000-2002 dot-com bust or the 2007-2009 credit crisis.
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