Random Walk Theory
Stock price changes are random and unpredictable — past moves don't predict future moves.
Random Walk Theory states that stock price changes are independent and identically distributed—tomorrow's return is unrelated to today's (or any past) return. This is the weak form of the Efficient Market Hypothesis. Implication: Technical analysis is useless — chart patterns, momentum, and trends have no predictive power. Mathematical model: P_t = P_{t-1} + ε_t, where ε is random noise. Empirical evidence: Mixed. Short-term returns do exhibit slight autocorrelation (momentum effect), violating pure random walk. Long-term returns show mean reversion. Practical: While not perfectly true, random walk is a useful baseline assumption — beating the market consistently is very difficult.
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