A Random Walk in the Markets

May. 23, 2022 | RedChip Companies


One of the many ideas that the book "Against the Gods, the Remarkable Story of Risk," contemplates is whether stock prices "follow a random walk--that they resemble the aimless and unplanned lurches of a drunk trying to grab hold of a lamppost," or have a memory and thus follow a predictable pattern. The authors make a few simple observations regarding the debate.

1. The capital markets are fluid and competitive.
2. Investors are engaged in a war of wits, trying to outsmart each other.
3. New information is rapidly reflected in the price of stocks.
4. New information arrives in random fashion.
5. Investors sometimes interpret data differently.
6. Investors have different reasons for buying, holding, or selling.

Conclusion: stock prices move in "unpredictable" ways.

Here is what we do know according to the authors of the book: the stock market on average has gone up. "From January 1926 to December 1995 the Standard and Poor's Index of 500 stocks saw an average annual increase of 7.7% (excluding dividends)." In 47 of the 70 years in the period studied, stocks went up. But what the study reveals is that "the stock market record" is more like a "random walk" than a predictable pre-planned 25 mile run, as after correcting "for the upward drift," changes in the S&P 500 were as likely to be upward as downward over the 70 year period.




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