Random Walk Theory

Random Walk Theory

An investment philosophy holding that security prices are completely unpredictable, especially in the short term. Random walk theory states that both fundamental analysis and technical analysis are wastes of time, as securities behave randomly. Thus, the theory holds that it is impossible to outperform the market by choosing the "correct" securities; it is only possible to outperform the market by taking on additional risk. Critics of random walk theory contend that empirical evidence shows that security prices do indeed follow particular trends that can be predicted with a fair degree of accuracy. The theory originated in 1973 with the book, A Random Walk Down Wall Street. See also: Efficient markets theory.

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Random walk theory. The random walk theory holds that it is futile to try to predict changes in stock prices.

Advocates of the theory base their assertion on the belief that stock prices react to information as it becomes known, and that, because of the randomness of this information, prices themselves change as randomly as the path of a wandering person's walk.

This theory stands in opposition to technical analysis, whose practitioners believe you can predict future stock behavior based on statistical patterns of prior performance.