Efficient Markets and the Random Walk

Economists and finance professors have long studied prices in speculative markets, like the stock market, and markets for commodities such as corn. Their findings have at controversy and have even angered many financial analysts. Yet this is an area in.which the facts have largely corroborated the theories.

We’ll see in a minute why this proposition. is plausible First, let’s consider its factual basis. There have been numerous studies over the years about rules or. formulas for.making money. Typical rules are “Buy after 2 days of increases” or “Buy on the bad news and .ell on the good news.” An early study by Alfred Cowley in Instigated the recommendations of stock broken. He examined- how well different brokers performed .., looking at the return (in dollars of total ID come per year per dollar invested) on the stocks they selected. He found that, on average, a stock- ~er’l choices did no better than a random portfolio (or combination)of stocks.

This paradoxical view has been generally confined in hundreds of studies the last four decades. Their lesson is not that you will never become rich by following.a rule or’ formula but that, OW such rules cannot outperform a diversified portfolio of stocks.

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