The average stock price over the past month on wall street is an example of:

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Dec. 23, 2022 at 8:44 p.m. ET on TipRanks.com

Stock prices change everyday by market forces. By this we mean that share prices change because of supply and demand. If more people want to buy a stock (demand) than sell it (supply), then the price moves up. Conversely, if more people wanted to sell a stock than buy it, there would be greater supply than demand, and the price would fall.

Understanding supply and demand is easy. What is difficult to comprehend is what makes people like a particular stock and dislike another stock. This comes down to figuring out what news is positive for a company and what news is negative. There are many answers to this problem and just about any investor you ask has their own ideas and strategies.

That being said, the principal theory is that the price movement of a stock indicates what investors feel a company is worth. Don't equate a company's value with the stock price. The value of a company is its market capitalization, which is the stock price multiplied by the number of shares outstanding. For example, a company that trades at $100 per share and has 1,000,000 shares outstanding has a lesser value than a company that trades at $50 but has 5,000,000 shares outstanding ($100 x 1,000,000 = $100,000,000 while $50 x 5,000,000 = $250,000,000). To further complicate things, the price of a stock doesn't only reflect a company's current value–it also reflects the growth that investors expect in the future.

The most important factor that affects the value of a company is its earnings. Earnings are the profit a company makes, and in the long run no company can survive without them. It makes sense when you think about it. If a company never makes money, they aren't going to stay in business. Public companies are required to report their earnings four times a year (once each quarter). Wall Street watches with rabid attention at these times, which are referred to as earnings seasons. The reason behind this is that analysts base their future value of a company on their earnings projection. If a company's results surprise (are better than expected), the price jumps up. If a company's results disappoint (are worse than expected), then the price will fall.

Of course, it's not just earnings that can change the sentiment towards a stock (which, in turn, changes its price). It would be a rather simple world if this were the case! During the dot-com bubble, for example, dozens of Internet companies rose to have market capitalizations in the billions of dollars without ever making even the smallest profit. As we all know, these valuations did not hold, and most all Internet companies saw their values shrink to a fraction of their highs. Still, the fact that prices did move that much demonstrates that there are factors other than current earnings that influence stocks. Investors have developed literally hundreds of these variables, ratios and indicators. Some you may have already heard of, such as the P/E ratio , while others are extremely complicated and obscure with names like Chaikin Oscillator or Moving Average Convergence Divergence (MACD) .

So, why do stock prices change? The best answer is that nobody really knows for sure. Some believe that it isn't possible to predict how stocks will change in price while others think that by drawing charts and looking at past price movements, you can determine when to buy and sell. The only thing we do know as a certainty is that stocks are volatile and can change in price extremely rapidly.

Random walk theory suggests that changes in stock prices have the same distribution and are independent of each other. Therefore, it assumes the past movement or trend of a stock price or market cannot be used to predict its future movement. In short, random walk theory proclaims that stocks take a random and unpredictable path that makes all methods of predicting stock prices futile in the long run.

Key Takeaways

• Random walk theory suggests that changes in stock prices have the same distribution and are independent of each other.
• Random walk theory infers that the past movement or trend of a stock price or market cannot be used to predict its future movement.
• Random walk theory believes it's impossible to outperform the market without assuming additional risk.
• Random walk theory considers technical analysis undependable because it results in chartists only buying or selling a security after a move has occurred.
• Random walk theory considers fundamental analysis undependable due to the often-poor quality of information collected and its ability to be misinterpreted.
• Random walk theory claims that investment advisors add little or no value to an investor’s portfolio.

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Random Walk Theory

Understanding Random Walk Theory

Random walk theory believes it's impossible to outperform the market without assuming additional risk. It considers technical analysis undependable because chartists only buy or sell a security after an established trend has developed. Likewise, the theory finds fundamental analysis undependable due to the often-poor quality of information collected and its ability to be misinterpreted. Critics of the theory contend that stocks do maintain price trends over time – in other words, that it is possible to outperform the market by carefully selecting entry and exit points for equity investments.

Efficient Markets are Random

The random walk theory raised many eyebrows in 1973 when author Burton Malkiel coined the term in his book "A Random Walk Down Wall Street." The book popularized the efficient market hypothesis (EMH), an earlier theory posed by University of Chicago professor William Sharp. The efficient market hypothesis states that stock prices fully reflect all available information and expectations, so current prices are the best approximation of a company’s intrinsic value. This would preclude anyone from exploiting mispriced stocks consistently because price movements are mostly random and driven by unforeseen events.

Sharp and Malkiel concluded that, due to the short-term randomness of returns, investors would be better off investing in a passively managed, well-diversified fund. A controversial aspect of Malkiel’s book theorized that "a blindfolded monkey throwing darts at a newspaper's financial pages could select a portfolio that would do just as well as one carefully selected by experts."

Random Walk Theory in Action

The most well-known practical example of random walk theory occurred in 1988 when the Wall Street Journal sought to test Malkiel's theory by creating the annual Wall Street Journal Dartboard Contest, pitting professional investors against darts for stock-picking supremacy. Wall Street Journal staff members played the role of the dart-throwing monkeys.

After more than 140 contests, the Wall Street Journal presented the results, which showed the experts won 87 of the contests and the dart throwers won 55. However, the experts were only able to beat the Dow Jones Industrial Average (DJIA) in 76 contests. Malkiel commented that the experts' picks benefited from the publicity jump in the price of a stock that tends to occur when stock experts make a recommendation. Passive management proponents contend that, because the experts could only beat the market half the time, investors would be better off investing in a passive fund that charges far lower management fees.

What is a random walk quizlet?

Which of the following is not an example of probability sample?

Which of the following is a method of sampling that many researchers regard as being essentially equivalent to simple random sampling?

Is a set of all units usually people objects or events we want to describe and understand?