Financial Concepts: Random Walk Theory
AAA
  1. Financial Concepts: Introduction
  2. Financial Concepts: The Risk/Return Tradeoff
  3. Financial Concepts: Diversification
  4. Financial Concepts: Dollar Cost Averaging
  5. Financial Concepts: Asset Allocation
  6. Financial Concepts: Random Walk Theory
  7. Financial Concepts: Efficient Market Hypothesis
  8. Financial Concepts: The Optimal Portfolio
  9. Financial Concepts: Capital Asset Pricing Model (CAPM)
  10. Financial Concepts: Conclusion
Financial Concepts: Random Walk Theory

Financial Concepts: Random Walk Theory


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. Random walk is a stock market theory that states that the past movement or direction of the price of a stock or overall market cannot be used to predict its future movement. 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.

In short, random walk says that stocks take a random and unpredictable path. The chance of a stock's future price going up is the same as it going down. A follower of random walk believes it is impossible to outperform the market without assuming additional risk. In his book, Malkiel preaches that both technical analysis and fundamental analysis are largely a waste of time and are still unproven in outperforming the markets.

Malkiel constantly states that a long-term buy-and-hold strategy is the best and that individuals should not attempt to time the markets. Attempts based on technical, fundamental, or any other analysis are futile. He backs this up with statistics showing that most mutual funds fail to beat benchmark averages like the S&P 500.

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.

It's hard to say how much truth there is to this theory; there is evidence that supports both sides of the debate. Our suggestion is to pick up a copy of Malkiel's book and draw your own conclusions.

Financial Concepts: Efficient Market Hypothesis

  1. Financial Concepts: Introduction
  2. Financial Concepts: The Risk/Return Tradeoff
  3. Financial Concepts: Diversification
  4. Financial Concepts: Dollar Cost Averaging
  5. Financial Concepts: Asset Allocation
  6. Financial Concepts: Random Walk Theory
  7. Financial Concepts: Efficient Market Hypothesis
  8. Financial Concepts: The Optimal Portfolio
  9. Financial Concepts: Capital Asset Pricing Model (CAPM)
  10. Financial Concepts: Conclusion
Financial Concepts: Random Walk Theory
RELATED TERMS
  1. Capital Loss Coverage Ratio

    The difference between an asset’s book value and the amount received ...
  2. Policyholder Surplus

    The assets of a mutual insurance company minus its liabilities. ...
  3. David Einhorn

    Known for his short selling strategy, activist investor David ...
  4. Net Premium

    The expected present value of a policy’s benefits less the expected ...
  5. Quick Liquidity Ratio

    The total amount of a company’s quick assets divided by the sum ...
  6. Compound Annual Growth Rate - CAGR

    The year-over-year growth rate of an investment over a specified ...
  1. Is the Dow Jones a public company?

    Find out how the Dow Jones Industrial Average tracks the health of the U.S. economy. This fluctuating number indicates the ...
  2. Is the Dow Jones a stock exchange?

    Learn about the Dow Jones Industrial Average and its impact. This historically significant index provides a daily snapshot ...
  3. What's the difference between a long and short position in the market?

    Understand long and short positions for stocks and option contracts; combine long and short positions for added leverage ...
  4. What's the difference between a cash account and a margin account?

    Compare and contrast margin and cash accounts. Margin accounts offer short-term loans, leverage on existing portfolios, and ...
comments powered by Disqus
Related Tutorials
  1. Ethical Investing Tutorial
    Fundamental Analysis

    Ethical Investing Tutorial

  2. Investing For Safety and Income Tutorial
    Bonds & Fixed Income

    Investing For Safety and Income Tutorial

  3. American Depositary Receipt Basics
    Economics

    American Depositary Receipt Basics

  4. Macroeconomics
    Economics

    Macroeconomics

  5. Capital Budgeting
    Investing Basics

    Capital Budgeting

Trading Center