UK Accounting Glossary
Random Walk Theory is the theory that stock price changes have the same distribution and are independent of each other, so the past movement or trend of a stock price or market cannot be used to predict its future movement.
The random walk theory states that in an efficient market, market prices follow a random path and are therefore unpredictable. Random walk theory says that these market prices are not influenced by their past movements, so it is impossible to predict (with accuracy) which direction the market will move. Random walk theory was espoused by Louis Bachelier, a French mathematician, in 1900 and likens the unpredictable movements of market prices to the unpredictable walk of a drunk. If random walk theory is correct, technical analysis won’t work. According to “A Random Walk Down Wall Street,” by Burton Malkiel, random walk theory renders analysis inaccurate. It also states that large transaction costs will outweigh any profits. Random walk theory typically applies to short-term movements. Even proponents of random walk theory acknowledge that long-term movements have generally followed an upward trend.
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This glossary post was last updated: 6th February 2020.