A Random Walk Through the Stock Market
Have you ever taken a random walk in the park? If you say yes, then chances are, you are incorrect. Nearly everything we do has purpose and direction to it...if only because our minds have trouble doing anything without it.
The Stock Market exhibits a mathematical phenomena we call a Random Walk. A truly random walk in the park would mean that one starts off in the middle (or somewhere else), spins a four sided dice and decides to take a step forward or backward, left or right, based on the dice roll. Now aside from the question about whether a dice roll is truly random we will say that the path taken by our dice rolling park-walker is random. It may even look like this...
So how does this relate to the Stock Market? If we look at the stock market as a random walk in a 1 dimensional park, or a tight rope, than the price is randomly walking from low to high....or at least it is very nearly randomly walking. Google has been marching upwards for a while, while Microsoft has been backpedaling for a while now. But for the most part we can look at a stock as a very indecisive tight rope walker, he flips a coin and takes a step forward, flips the coin again and takes another step forward, flips the coin a third time and goes back, etc. etc.
So how can we take advantage of a random walk? Let's say that you and a buddy go to see the random tight rope walker. Let's say that your friend likes to gamble. He says to you....I'll bet you $1 that every time the tight rope walker flips that coin, you can't predict whether he will go backwards and forwards. Unfortunately, your friend is unaware that you are an expert in coin flip pattern recognition, and you are able to predict heads or tails with 55% accuracy. As the hours wear on you begin to slowly increase your profit. In fact, if you plotted your profit, it may look something like this...
Thus, a random walk not only describes the movement of the price of a stock, but for a day trader, it describes the value of his bank account. Therefore, one can nearly always make money in the stock market, provided one can predict the next general movement of the market with only a slightly better than 50% accuracy level.
So the real question is....why spend time trying to predict whether my favorite stock will shoot up 20 points in the next month when all I need to focus on is predicting the up and down movements and letting the laws of probability and Random Walk work in my favor?
