Random Walk Theory

AAA

DEFINITION of 'Random Walk Theory'

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.

BREAKING DOWN 'Random Walk Theory'

In short, this is the idea that stocks take a random and unpredictable path. A follower of the random walk theory believes it's impossible to outperform the market without assuming additional risk. Critics of the theory, however, contend that stocks do maintain price trends over time - in other words, that it is possible to outperform the market by carefully selecting entry and exit points for equity investments.

This theory raised a lot of eyebrows in 1973 when author Burton Malkiel wrote "A Random Walk Down Wall Street", which remains on the top-seller list for finance books.

RELATED TERMS
  1. Underperform

    An analyst recommendation that means a stock is expected to do ...
  2. Black Swan

    An event or occurrence that deviates beyond what is normally ...
  3. Outperform

    An analyst recommendation meaning a stock is expected to do slightly ...
  4. Market

    1. A medium that allows buyers and sellers of a specific good ...
  5. Efficient Market Hypothesis - EMH

    An investment theory that states it is impossible to "beat the ...
  6. Risk

    The chance that an investment's actual return will be different ...
Related Articles
  1. Investing Basics

    The Five Biggest Stock Market Myths

    Stocks that go down must come up, right? Wrong. We bust this myth and four other common market misconceptions.
  2. Active Trading

    What Is Market Efficiency?

    The efficient market hypothesis (EMH) suggests that stock prices fully reflect all available information in the market. Is this possible?
  3. Active Trading

    Viewing The Market As Organized Chaos

    Find out how a cat and a ladybug prove markets are both random and efficient.
  4. Fundamental Analysis

    A Disaster-Protection Plan For Your Portfolio

    If you can't predict the future, you'll need to plan ahead to protect your assets from the impact of major world events.
  5. Active Trading

    10 Books Every Investor Should Read

    Want advice from some of the most successful investors of all time? Check out our reading list.
  6. Active Trading

    Introduction To Stationary And Non-Stationary Processes

    What to know about stationary and non-stationary processes before you try to model or forecast.
  7. Fundamental Analysis

    Monte Carlo Simulation With GBM

    Learn to predict future events through a series of random trials.
  8. Term

    What are Mutually Exclusive Events?

    In statistics, mutually exclusive situations involve the occurrence of one event that does not influence or cause another event.
  9. Mutual Funds & ETFs

    ETF Analysis: PowerShares DB Commodity Tracking

    Find out about the PowerShares DB Commodity Tracking ETF, and explore a detailed analysis of the fund that tracks 14 distinct commodities using futures contracts.
  10. Mutual Funds & ETFs

    ETF Analysis: PowerShares FTSE RAFI US 1000

    Find out about the PowerShares FTSE RAFI U.S. 1000 ETF, and explore detailed analysis of the fund that invests in undervalued stocks.
RELATED FAQS
  1. What are the primary assumptions of Efficient Market Hypothesis?

    The primary assumptions of the efficient market hypothesis (EMH) are that information is universally shared and that stock ... Read Full Answer >>
  2. What is the "random walk theory" and what does it mean for investors?

    The random walk theory is the occurrence of an event determined by a series of random movements - in other words, events ... Read Full Answer >>
  3. What assumptions are made when conducting a t-test?

    The common assumptions made when doing a t-test include those regarding the scale of measurement, random sampling, normality ... Read Full Answer >>
  4. What is the utility function and how is it calculated?

    In economics, utility function is an important concept that measures preferences over a set of goods and services. Utility ... Read Full Answer >>
  5. What are some of the more common types of regressions investors can use?

    The most common types of regression an investor can use are linear regressions and multiple linear regressions. Regressions ... Read Full Answer >>
  6. What types of assets lower portfolio variance?

    Assets that have a negative correlation with each other reduce portfolio variance. Variance is one measure of the volatility ... Read Full Answer >>

You May Also Like

Hot Definitions
  1. Stock Market Crash

    A rapid and often unanticipated drop in stock prices. A stock market crash can be the result of major catastrophic events, ...
  2. Financial Crisis

    A situation in which the value of financial institutions or assets drops rapidly. A financial crisis is often associated ...
  3. Election Period

    The period of time during which an investor who owns an extendable or retractable bond must indicate to the issuer whether ...
  4. Shanghai Stock Exchange

    The largest stock exchange in mainland China, the Shanghai Stock Exchange is a nonprofit organization run by the China Securities ...
  5. Dead Cat Bounce

    A temporary recovery from a prolonged decline or bear market, followed by the continuation of the downtrend. A dead cat bounce ...
  6. Bear Market

    A market condition in which the prices of securities are falling, and widespread pessimism causes the negative sentiment ...
Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!