What is the “random walk theory” and what it means for investors?


The theory of random walks, the occurrence of the event is defined as a series of random movements – in other words, events that cannot be predicted. For example, you might consider a drunken man walking to be a random walk because the person is impaired and his walk would not follow any predictable path. (For more, read financial concepts: the theory of random walk.)

Application of the theory of random walks to Finance and stocks suggests that stock prices change randomly, making them impossible to predict. The theory of the random walk corresponds to the belief that markets are efficient, and that it is not possible to beat or predict the market because stock prices reflect all available information and new information is seemingly random as well.

The theory of random walks is in direct opposition to technical analysis, which States that future stock price can be predicted based on historical information through observing chart patterns and technical indicators.

Scientists are unable to conclusively prove or agree on whether the stock market really works via random walk or based on predictable trends because there are published studies that support both sides of the question.

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