A Random Walk Down Wall Street
The Time-Tested Strategy for Successful Investing
By Burton G. Malkiel
Category: Money & Investments | Reading Duration: 5 min | Rating: 3.8/5 (163 ratings)
About the Book
A Random Walk Down Wall Street (1973) looks at the unpredictability of stock market prices, linking their movements to a “random walk.” It dispels the generally accepted belief in discernible market patterns, suggesting that consistent gains are not a product of easily-chartered trends.
Who Should Read This?
- Aspiring investors
- Stock market analysts
- Economists interested in financial market patterns
One Big Idea: Understand the random walk of Wall Street
Welcome to this Big Idea Blink. For this type of Blink, our editors choose one thought-provoking insight from a book, allowing you to gain something new in just a few minutes. The idea we’d like to explore this time unearths the surprising notion of the stock market behaving like a “random walk” – with prices moving unpredictably, defying all assumed underlying patterns. This idea comes from Burton G Malkiel’s A Random Walk Down Wall Street, which, although written back in 1973, continues to shake the very fabric of conventional market analysis in the 21st century.
Chapter 1: Stock market prices are unpredictable and follow no discernible pattern.
How would you feel if you were told that trying to predict the stock market is about as fruitful as guessing the outcome of a tossed coin? Unsettling as it might seem, this idea – that stock prices are really a result of randomness – challenges the long-held belief of many investors and market analysts. This concept, known as the “random walk hypothesis,” asserts that past price patterns can’t predict future stock movement. Here’s how it goes.Imagine flipping a coin each day. If it’s heads, the stock you’re tracking goes up, if it’s tails, it goes down. The funny thing is, if you plotted a graph of the various coin flips, it would resemble an actual stock price chart. Sounds a bit strange, right? Surely, the stock market can’t be that random? There has to be a discernible pattern in stock prices.The honest answer is there isn’t, but we want there to be. Humans are incredibly prone to seeing patterns everywhere. It’s even been given a term – apophenia. We’re not fond of randomness or uncertainty – they make us uneasy. So, we’re naturally inclined towards finding patterns in the chaos – it gives us a sense of security, albeit illusory.This is why many investors believe that they can see patterns in a stock chart, refusing to accept the random chaos of the stock market. However, the reality is that these “patterns” are more akin to a gambler’s winning or losing streaks in a casino, rather than being indicators of a predictable trend.There are various methods devised by market technicians that purport to predict the behavior of stocks based on these patterns. They are all faulty. The Filter System, for instance, advises buying stocks when they rise 5% from a low point, and selling when they fall the same amount from a high point. It operates with the conviction that this indicates a stable market trend. Similarly, the Dow Theory advises buying when stocks exceed a previous peak, and selling when they go below a recorded low. It’s based on the belief in a concept of “support and resistance” levels. Then there’s the Price-Volume system which holds that rising stock prices accompanied by increased trading volume signal a continued upward momentum, while falling prices with high volume indicate a downward plunge.Each of these strategies, no matter how complex or ingenious, has been shown to offer no significant advantage over a basic strategy of just buying and holding onto a diverse portfolio of investments for a long duration. The bottom line is, despite what many perceive or want to believe, historical price movement can’t consistently help an investor outperform a simple buy-and-hold strategy.Appreciating that price changes in the stock market resemble a random walk rather than a predictable pattern is a hard pill to swallow for many. However, understanding this truth, and consequently minimizing frequent buying and selling based on unreliable market predictions, can save us from costly investing mistakes, and guide us towards a robust, diversified portfolio and a long-term investment strategy. Just as the randomness of a coin flip doesn’t sway a seasoned gambler, the randomness of the stock market shouldn’t deter a wise investor.
Final summary
To quickly recap – despite numerous theories, systems, trends, and expert advice, the stock market remains a “random walk,” with no consistent pattern. The stock approaches by so-called “market experts” are no more efficient than the simple buy-and-hold strategy. To stand the best chance of returns on the stock market, it’s better to focus on buying and holding a diversified portfolio of assets.
About the Author
Economist Burton G. Malkiel is especially known for his engagement with the volatility of stock markets.