A Random Walk

The efficient-market view provides an important way of analyzing price ~m.ts in organized markets. Under this approach, the price movements of stocks should look highly erratic, like a random walk, when charted over a period of time. A price follows a wall when its movements over time are completely unpredictable.” For example, toss a coin for, heads or tails. Call a head “plus 1” and a tail “minus 1.” Then keep track of the running score of 100 coin tosses. Draw it on graph paper. This curve is a random walk. Now, for comparison, also graph 100 days’ movement of Microsoft stock or of Standard and Poor’s 500 index. Note how similar all three figures appear.

The efficient-market theory explains why moments ill stock prices look so erratic. Prices respond news. to surprises. But surprises are unpredictable like the flip of a coin or next month’s rainstorm that may move in any direction. Because move in response to erratic events, stock themselves erratically, like a random.