Random walk theory is a financial model which assumes that the stock market moves in a completely unpredictable way. The hypothesis suggests that the future price of each stock is independent of its own historical movement and the price of other securities.
Random walk theory assumes that forms of stock analysis - both technical and fundamental - are unreliable.
Learn how to start buying and selling shares online with our step-by-step guide.
Random walk theory was first coined by French mathematician Louise Bachelier, who believed that share price movements were like the steps taken by a drunk; unpredictable.
However, the theory became famous through the work of economist Burton Malkiel, who agreed that stock prices take a completely random path. So, the probability of a share price increasing at any given time, is exactly the same as the probability that it will decrease. In fact, he argues that a blindfolded monkey could randomly select a portfolio of stocks that would do just as well as a portfolio carefully selected by professionals.
Random walk theory has been likened to the efficient market hypothesis (EMH), as both theories agree it is impossible to outperform the market. However, EMH argues that this is because all of the available information will already be priced into the stock’s price, rather than that markets are disorganised in any way.
Traders that adhere to the random walk theory will believe that it is impossible to outperform the stock market and attempting to do so would incur large amounts of risk. Believers in the hypothesis tend to take a buy and hold strategy, as the theory suggests that longer-term positions will have the most chance of success.
Traders will look to hold a diverse selection of shares that best represent the entire stock market – exchange traded funds (ETFs) and indices are popular instruments, as they track a range of companies’ share prices.
Critics of random walk theory argue that it is possible to outperform the market through careful consideration of entry and exit points – this just takes a significant amount of time, effort and understanding.
Through careful analysis – whether its fundamental or technical – and research into each position you want to open, it is possible to identify trends and patterns amongst the chaotic market movements. There will always be an element of random market behaviour, but traders can mitigate the risk of unpredictable movements with a risk management strategy.
Discover how to trade with IG Academy, using our series of interactive courses, webinars and seminars.
New client: +65 6390 5133 or accountopening@ig.com.sg
Clients: Help and support
WhatsApp: Click here
IG | Sitemap | Terms and agreements | Privacy | Security | IG Community | Refer a friend | Cookies | About IG
Disclaimer:
All forms of investments carry risks and trading CFDs may not be suitable for everyone. CFDs are leveraged instruments and can result in losses that exceed deposits, so please ensure that you fully understand, and are aware of, the risks and costs involved. Refer to the Risk Disclosure Statement and Risk Fact Sheet.
IG Asia Pte Ltd (Co.Reg.No. 200510021K) is regulated by the Monetary Authority of Singapore and holds a capital markets services licence for dealing in capital markets products that are over-the-counter derivatives contracts and is an exempt financial adviser.
IG provides an execution-only service. The information in this advertisement does not contain (and should not be construed as containing) investment advice or an investment recommendation, or an offer of or solicitation for a transaction in any financial instrument. IG accepts no responsibility for any use that may be made of these comments and for any consequences that result. You should consider your specific investment objectives, financial situation or particular needs before making a commitment to trade, including seeking advice from an independent financial adviser regarding the suitability of the investment, under a separate engagement, as you deem fit.
The information on this site is not directed at residents of the United States or Belgium and is not intended for distribution to, or use by, any person in any country or jurisdiction where such distribution or use would be contrary to local law or regulation.
This advertisement has not been reviewed by the Monetary Authority of Singapore.
CFDs are leveraged products. CFD trading may not be suitable for everyone and can result in losses that exceed your deposits, so please ensure that you fully understand the risks involved.