Random Walk Theory posits stock prices move randomly due to efficient markets, challenging predictability. Assumptions drive implications that prices incorporate information promptly. However, behavioral biases and information gaps limit its applicability. Examples highlight its support for the Efficient Market Hypothesis and randomness in stock price movements.
- Weak-Form Random Walk: Prices solely reflect historical price data, implying that past price movements cannot help predict future movements.
- Semi-Strong Form Random Walk: Prices reflect all publicly available information, making it difficult to profit from publicly known information.
- Strong-Form Random Walk: Prices incorporate all information, including insider information, making it impossible to profit from any information.
- Efficient Markets: Markets are efficient, incorporating all available information into prices almost instantly.
- No Predictable Patterns: Price movements are not influenced by historical trends or patterns, making them unpredictable.
- Random Movements: Stock prices follow a random pattern, making it challenging to devise strategies to consistently outperform the market.
- Efficient Markets: Market efficiency implies that all information is quickly priced in, leaving little room for arbitrage opportunities.
- Behavioral Biases: Investor emotions and biases can lead to deviations from random price movements, affecting market efficiency.
- Information Asymmetry: Insiders possessing non-public information may achieve abnormal profits, challenging the theory’s strong-form assumption.
- Efficient Market Hypothesis: Random Walk Theory aligns with the Efficient Market Hypothesis, suggesting that all relevant information is incorporated into prices.
- Stock Price Movements: Observing historical stock price data often reveals movements that appear random, in line with the theory’s assertions.
- Random Walk Theory: Proposes stock price unpredictability due to a lack of consistent patterns.
- Types: Weak, semi-strong, and strong forms classify predictability based on available data.
- Assumptions: Assumes efficient markets and absence of historical patterns.
- Implications: Stocks move randomly, information integrates swiftly, discouraging easy profits.
- Limitations: Human biases, insider trading, anomalies challenge the theory.
- Examples: Theory aligns with Efficient Market Hypothesis, real-world stock price fluctuations resemble random movements.
Connected Financial Concepts
Connected Video Lectures
Main Free Guides: