Theory, in the present context, means something different but related to practice, something ‘from which practice is derived’. Interpretation of a work of literature is a complex process. In each attempt to understand a literary text, certain ideas and methods are at work. Theory is a conscious attempt to substantiate those ideas and methods. Literary theory deals with those set of ideas and methods that we apply in studying a work of literature.
To better understand literary theory we must distinguish it from literary criticism. Strictly defined, “literary criticism” refers to the act of interpreting and studying literature. A literary critic is not someone who merely evaluates the worth or quality of a piece of literature but, rather, is someone who argues on behalf of an interpretation or understanding of the particular meaning(s) of literary texts. The task of a literary critic is to explain and attempt to reach a critical understanding of what literary texts mean in terms of their aesthetic, as well as social, political, and cultural statements and suggestions. A literary critic does more than simply discuss or evaluate the importance of a literary text; rather, a literary critic seeks to reach a logical and reasonable understanding of not only what a text’s author intends for it to mean but, also, what different cultures and ideologies render it capable of meaning.
Any literary interpretation is based on certain theoretical presuppositions – ideas, principles, and concepts
"Literary theory" is the body of ideas and methods we use in the practical reading of literature. By literary theory we refer not to the meaning of a work of literature but to the theories that reveal what literature can mean. Literary theory is a description of the underlying principles, one might say the tools, by which we attempt to understand literature. All literary interpretation draws on a basis in theory but can serve as a justification for very different kinds of critical activity. It is literary theory that formulates the relationship between author and work; literary theory develops the significance of race, class, and gender for literary study, both from the standpoint of the biography of the author and an analysis of their thematic presence within texts. Literary theory offers varying approaches for understanding the role of historical context in interpretation as well as the relevance of linguistic and unconscious elements of the text. Literary theorists trace the history and evolution of the different genres—narrative, dramatic, lyric—in addition to the more recent emergence of the novel and the short story, while also investigating the importance of formal elements of literary structure. Lastly, literary theory in recent years has sought to explain the degree to which the text is more the product of a culture than an individual author and in turn how those texts help to create the culture.
 Professor Paul Fry, Introduction to Theory of Literature, http://oyc.yale.edu/transcript/451/engl-300
Formalism, also called Russian Formalism, is a 20th-century Russian school of literary criticism and literary theory, having mainly to do with structural purposes of a particular text. (Read more…)
New Criticism was a formalist movement in literary theory that dominated American literary criticism in the middle decades of the 20th century. It emphasized close reading, particularly of poetry, to discover how a work of literature functioned as a self-contained, self-referential aesthetic object. The movement derived its name from John Crowe Ransom’s 1941 book The New Criticism. Also very influential were the critical essays of T. S. Eliot, such as “Tradition and the Individual Talent” and “Hamlet and His Problems,” in which Eliot developed his notion of the “objective correlative.” Eliot’s evaluative judgments, such as his condemnation of Milton and Shelley, his liking for the so-called metaphysical poets and his insistence that poetry must be impersonal, greatly influenced the formation of the New Critical canon.