Random Walk – Views from a Technical Perspective

Random Walk – Views from a Technical Perspective (by a student of the market)

The random walk hypothesis is a financial theory stating that stock market prices evolve according to a random walk and thus cannot be predicted. It is consistent with the efficient-market hypothesis (EMH is an investment theory that states it is impossible to "beat the market" because stock market efficiency causes existing share prices to always incorporate and reflect all relevant information!)

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.

Now, if we assume that it is so, it would be very difficult to make profits and losses. Moreover, a market that was created by humans would be more powerful, encompassing than the subjects that invented it aka Frankenstein!

But what if the markets could be predictable to some extent. As Technicians, our bread and butter depend on charts – The Trend is your Friend. Assuming this track, we could undertake studying TA.

It might not be easy to apply TA but it is worth the effort instead of relying on Random Walk. Moreover, TA could be used in diverse markets and products – like commodities, currency, etc. It opens new doors of opportunity.

Even Fundamental Analysts also undertake studious analysis to find undervalued stocks – that they could sell at a higher price when market finally “values” it properly or even overvalues it! Why give so much effort if markets are random?

Furthermore, if it is random, then it has equal chance of going up or down. Thus, around half of the participants would be winners while the rest would be losers. However, history records the count of losers (there are more losers than winners – with the exception of brokers, who are the real winners). 

However, great investors, although few in number, have beaten the markets like Warren Buffett, George Soros, Peter Lynch, etc (You can find more about them in the Market Wizards books by Jack D Schwager).

If we look at the Dhaka Stock Exchange Index (DSEX) over the last year, barring the month of December ’16, it is almost an eerie reflection if we draw an imaginary mirror line on 1 May 2016. For a Technical Analyst, it is an almost perfect picture of supply and demand. 

Could this be randomness?

From 1 Nov 2016, the reflection does not take hold. It is becoming more of an uptrend.

Instead of thinking about randomness, as a trader, we could build scenarios – if this happens, then I will do this. This is how we can be prepared – when the situation arises, we do not have to give it much thought (and be embroiled with emotions) rather we can take actions. Taking decisions is harder than undertaking complex analysis.

On a side note, (scenario) analysis of Bengalwtl could be used as examples:

http://imti77az.blogspot.com/2016/11/technical-analysis-of-bengalwtl-on-29.html

http://imti77az.blogspot.com/2016/12/technical-analysis-of-bengalwtl-part.html

Discipline is another important criterion for building success. With time, one could learn and fine tune’s one strategy – initially to survive in the market and later, to increase profitability. Hard work, learning, discipline are skills that could be used to counter any randomness, if it occurs.

It is a game of unpredictability, uncertainty. It is challenging. But is not totally random.

Just as we need to be prepared for “random” fluctuations, we also need to capitalize on strong trends, when they occur.

It is challenging but it is fun too . . .