Stock Price Movements Are Unpredictable
Burton G. Malkiel is a professor of economics at Princeton University. The 10th edition of his widely read book, “A Random Walk Down Wall Street: The Time-Tested Strategy for Successful Investing” (W. W. Norton & Company, 2011), was published in January. I spoke to him about the case for using index funds.
—Charles Rotblut, CFA
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Charles Rotblut (CR): Could you explain the term “random walk”?
Burton Malkiel (BM): Basically, the concept is not that the market is random or capricious, really, just the opposite: that the market is quite efficient in reflecting new information and when news arises that’s true news, the market adjusts without delay. The true news is unpredictable—in other words, if we have a headline today that says “New York digs out of yesterday’s storm,” that’s not news. What was news is that the storm was much bigger than anybody had predicted. So the true news is random or unpredictable. It’s something that you didn’t know before, such as “Egypt is in crisis.” The markets will then react without delay. But since you can’t predict true news, the market is generally unpredictable. It’s not that it’s capricious; quite the contrary: It’s that it reacts to unexpected events. And if you could predict the unexpected events, you could predict the market. But since you can’t, markets are unpredictable.
The term “random walk” was first used in the science magazine Nature. The problem presented was to try to find a drunk who was left in the middle of a field at midnight. Since you have no idea where the drunk is going to go, the question was, how would you begin the search the next morning? The answer was to begin at exactly where you left the drunk, because you can’t predict in what direction the drunk is going to go. The drunk will stagger randomly around. When you look at it, the stock market looks very much like that kind of random walk where tomorrow’s price change is pretty much unrelated to today’s price change, and it’s basically unpredictable. So the idea is that neither individuals nor professionals can predict the short-run direction of the stock market.
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Burton Malkiel, Ph.D. , Ph.D., is the Chemical Bank Chairman’s Professor of Economics at Princeton University. The 10th edition of his widely read investment book, “A Random Walk Down Wall Street” (W. W. Norton & Company, 2011), was recently published.