The Random Walk Myth: Theory vs. Practice

The random walk theory, which started off from academic offshoots, put forth the idea that one should give up trying to predict or beat the markets because it was impossible to do so. In theory, this theory sounds plausible, but in practice, financial history has proven otherwise, with both investors and traders consistently beating the markets.

 

The Random Walk Myth: Theory vs. Practice

The Random Walk Myth: Theory vs. Practice

 

The random walk  theory states that price history is not a reliable indicator of future price direction because price changes are “serially independent”. In other words, there is no definable relationship between the direction of price movement from one day to the next. This does not mean that prices meander aimlessly or irrationally, but it means that prices have no patterns of order within the chaos.

We know that prices are determined by a balance between supply and demand. Random walk theory asserts that prices reach that equilibrium level in an unpredictable manner, moving in an irregular response to the latest information or news release. New information, being unpredictable in content, timing and importance, is therefore random in nature. Consequently, the theory puts forth that price changes themselves are random.

Try this interesting optical illusion:


While price changes might seem random in nature, the trend of prices themselves are not. In reality, price movements contain well-known components of trend, seasonality and cycles which are not random in nature. Although these are mostly clear when prices are considered over the long-term, if one observes prices very closely in the short-run, price trends or patterns are also readily recognisable.

Technical analysis and chart-reading analyses the impact and action of market participants in response to the latest news or information. As a result, it is possible to understand what the different market participants are doing, and which way the market is likely to trend next. Besides, the market is not perfectly efficient, and reading the actions of the smart money will often alert traders to what is happening in the markets.

 

“The illusion of randomness gradually disappears as the skill in chart reading improves.” – John Murphy

Genting – box trading tactics for trending ranges | Technical Analysis | Singapore Stocks


Genting has been trading very nicely within these boxes, and now there is a morning star reversal pattern near the bottom of a box. This is also near the bottom of the downtrend channel. In addition, it could be a false breakout below the 200-EMA which could have trapped some shorts. If you observe carefully, you will notice that a breakout to a new box is accompanied by a test of the opposite side of the box before another breakout. This makes the top of this box an excellent target.

Golden Agri – low risk entry near channel bottom | Technical Analysis | Singapore Stocks


Golden Agri seems to turning up from the bottom of the channel, and has successfully closed the gap (red dotted box), and at the same time forming a W-bottom. Yesterday, the gap was tested via a hammer, and this was also a test of the 20-EMA. This could be a bullish flag which will provide a low risk entry.

Straits Asia – bearishness ahead after violating major trendline | Technical Analysis | Singapore Stocks


Straits Asia has broken the long-term uptrend line and the long-term horizontal support line, which suggests bearishness for the weeks ahead. The short-term target for it would be to test its old low of 1.81. Watch for the markdown phase to commence. It is only a matter of time.

Guest Speaker for STATS Market Outlook & AGM 2010

Today, I was invited as a guest speaker to give a talk at 2009 AGM of STATS (Singapore Technical Analysts & Traders Society) on the “Strategic Outlook for 2010”. Before the talk, there was a poll, and it seemed that the general consensus is for a correction in the medium term. Here also some of the pictures taken from our slides.


Dow Jones Industrial Average

Straits Times Index
Ezra 
 
After finishing my talk, I opened the floor to the public and numerous stock requests were shouted out. Due to time constraints, I only had time to do an on-the-spot analysis for a handful of stocks.