Stock Price Behavior and Trading

Abstract

In recent years, there has been considerable interest in the random walk theory of stock price behavior. This theory, as applied to the stock market, implies that past stock-price movements cannot be used to predict future market prices in such a way as to “profit” from the predictions. By not “profiting,” we mean that a trader using the past history of stock prices cannot apply mechanical decision rules that result in a consistently better performance than a simple buy and hold strategy. If stock price movements were to become systematic so that a “profit” were possible, proponents of the random walk theory argue that a sufficient number of market participants would quickly recognize the recurring pattern and exploit it. In exploiting it, they would drive out the opportunity for “profit,” causing the price series to approximate a random walk.