Random walk of stock market

1. By Monzur Morshed Patwary

2.  The theory that stock price changes have the
same distribution and are independent of each
other, so the past movement or trend of a stock
price or market cannot be used to predict its
future movement.
 In short, random walk says that stocks take a
random and unpredictable path.
 Under the random walk theory, there is an
equal chance that a stock's price will either rise
or fall from current levels.

3.  While EMT suggests that stock is always
efficiently priced this theory suggests that price
behavior is never based on anything
predictable, but is completely random.
 The random walk theory is the belief that price
behavior cannot be predicted because it does
not act on any predictive fundamental or
technical indicators.

4.  Random walk theory gained popularity in 1973
when Burton Malkiel wrote "A Random Walk
Down Wall Street", a book that is now
regarded as an investment classic.
 Originally examined by Maurice Kendall in
1953, the theory states that stock price
fluctuations are independent of each other and
have the same probability distribution, but that
over a period of time, prices maintain an
upward trend.

5.  random walk hypothesis, 1st espoused by
French mathematician Louis Bachelier in 1900,
which states that stock prices are random, like
the steps taken by a drunk, and therefore are
unpredictable.
 A few studies appeared in the 1930’s, but the
random walk hypothesis was studied and
debated intensively in the 1960’s

6.  Chartists and technical theorists believe
historical patterns can be used to project future
prices. While the random walk hypothesis
claims that such movements cannot be
accurately predicted.
 I'll start by comparing random walk to other
popular theories such as the efficient market
hypothesis, fundamental analysis, and
technical analysis.

7. Generally, there are two competing approaches to
predicting the movements of stocks: fundamental
and technical analysis.
 Fundamental Theorists
o believe the price of a stock is a function of its
intrinsic value, which depends heavily on the
future earnings potential for a company.
o factors such as industry trends, economic news,
Global news and the company's earnings per share
outlook, fundamental analyst can determine if the
stock's price is above or below its intrinsic value.
o Comparing a stock's price to its intrinsic value
allows the fundamental analyst to predict the
potential future direction of the stock's price.

8. o believe that historical movements of a stock's
price can be used to predict future price
direction.
o Using methods such as charting, the technical
analyst will examine the sequence of upward
and downward movements for a stock.
o These patterns of movements allow the
technical theorist to chart what they believe
will be future movements for the stocks they
are examining.

9.  EMH states that financial markets are efficient
and that prices already reflect all known
information concerning a stock or other
security and that prices rapidly adjust to any
new information.
 Information includes not only what is currently
known about a stock, but also any future
expectations, such as earnings or dividend
payments.

10.  It seeks to explain the random walk hypothesis
by positing that only new information will
move stock prices significantly, and since new
information is presently unknown and occurs
at random, future movements in stock prices
are also unknown and, thus, move randomly.
 Hence, it is not possible to outperform the
market by picking undervalued stocks, since
the efficient market hypothesis posits that there
are no undervalued or even overvalued stocks.

11.  While many still follow the preaching of
Malkiel, others believe that the investing
landscape is very different than it was when
Malkiel wrote his book nearly 30 years ago.
 Today, everyone has easy and fast access to
relevant news and stock quotes. Investing is no
longer a game for the privileged.
 Random walk has never been a popular
concept with those on Wall Street, probably
because it condemns the concepts on which it is
based such as analysis and stock picking.

12.  The problem with the random walk theory is that it
ignores the easily observed trends and momentum
factors that do directly affect price movement.
 Professors Andrew W. Lo and Archie Craig MacKinley
(1999, A Non-Random Walk Down Wall Street), a
series of tests demonstrated that at least some degree of
predictability is present in stocks based on a
comparison between price behavior and other
influences (earnings, for example).
 The same authors wrote a paper (2005, 'The Adaptive
Market Hypothesis') in which financial activity (price
behavior) is influenced not randomly, but by the same
factors affecting evolution (competition, adaptation,
and natural selection).

13. The random walk hypothesis has some practical
implications to investors.
 For example, since the short term movement of
a stock is random, there is no sense in worrying
about timing the market. A buy and hold
strategy will be just as effective as any attempt
to time the purchase and sale of securities.

14.  When investors buy stocks, they usually do so
because they believe the stock is worth more
than they are paying.
 In the same way, investors sell stocks when
they believe the stock is worth less than the
selling price.
 If the efficient market theory and random walk
hypothesis are true, then an investor's ability to
outperform the stock market is more luck than
analytical skill.