What is Random Walk Theory?

Random walk theory is a financial concept that states that the price changes of stocks in the past is independent from and will not affect the future prices of the stocks. It further states that stocks have the same probability distribution. Despite this, prices generally follow an upward trend over a long period of time. Basically, stock price fluctuations are random and do not follow any kind of pattern.

The random walk theory became widely known when the investment classic book entitled “A Random Walk Down Wall Street” by Burton Malkiel was published in 1973. However, the idea was first analyzed in 1953 by Maurice Kendall.

This theory believes in the equal probability of stock prices of going up or down without regard to previous stock prices or current market conditions or market sentiment. Malkiel became controversial for dismissing the performance of fundamental analysis and technical analysis as an immense waste of time according to his book. Furthermore, Malkiel maintains that such analyses remain unreliable because it hasn’t been proven definitively yet in outperforming the markets.

According to Malkiel, the best way to handle the market is to employ a long-term buy-and-hold strategy. He also advised against timing the market and using fundamental analysis and technical analysis. As evidence, Malkiel presented statistics that indicated the majority of mutual funds that failed to beat various benchmark averages.

A considerable amount traders follow the ideas of random walk theory. These people believe in the impossibility of outperforming the market without assuming additional risk. Until today, there remains loyal followers of Malkiel while other traders counter his theory by considering the time at which the book was published. People questioned the relevance of the book that was already over 40 years old and refrained from using his framework to analyze a market that they believe has already changed dramatically since the time of publishing.

Until now the theory remains a theory. It is up to you to follow what you think would benefit you best.