Most helpful critical review
A Random Writing Regarding Wall Street
on January 31, 2001
"I believe the stock market is fundamentally logical." This quote by Burton Malkiel from his book A Random Walk Down Wall Street is the one of the main tenets of the Random Walk Theory. Randomaniacs (my pet name for those who boldly hold to the Random Walk theory) believe the market instantaneously, and efficiently, prices all known news into stock prices at all times, making it futile to search for exploitable stock market situations. Analyzing trends, economic conditions, interest rate levels, etc., is pointless. The market is so efficient one cannot find anomalies or trends that can offer market-beating performance without accepting loads of extra risk.
Malkiel would also have you believe that
1. You cannot consistently outperform the market without increased risk 2. It is better to hold an index fund rather than individual stocks (unless the stocks are a true proxy for the index) Markets get irrational (but not inefficient) and attract unwary investors 3. The disciplines of fundamental and technical analysis are not effective analytical investment tools "...a blindfolded chimpanzee throwing darts at the Wall Street Journal can select a portfolio that performs as well as those managed by the experts." 4. The risk in most investments decreases with the length of time the investment can be held
Being ex Wall Street, I have had a chance to make a living within our "efficient markets." My practical experiences have taught me that there are efficiencies, but the market itself is not efficient to the degree most think. While there seems little doubt that a certain amount of randomness or "noise" does exist in all markets, it is just unrealistic to believe that all price movement in random.
How, for example, would a buy and hold strategy fare in the futures markets where timing is so critical? How would investors know the difference between bull and bear markets if prices are unpredictable and don't trend? In fact, how could a bear market even exist in the first place because that would imply a trend? Give these questions some thought:
1. Has the market been efficiently pricing Internet stocks (are they really worth that much)? 2. Why does the market have "curbs" or "circuit breakers" to temporarily cease trading when it has dropped too far? 3. If you buy a stock at $12 share, and it drops to $6 shortly thereafter, are you going to sell it when it gets back to $12 (come on, be honest!)? 4. If a large number of investors are technicians (use charts to determine entry and exit points from stocks), won't their analysis have a fundamental effect on the market?
Is history a good teacher (I touched the hot frying pan, I burned my finger...I wont do that again!)? Sure it is. Why can't it be a good teacher for the stock market (ergo the use of charts and other technical indicators)?
Malkiel regularly alludes to the element of risk and beta. He believes that beta (a stocks relative volatility or sensitivity to the market) does capture at least some aspect of what we normally think of as risk. His conclusion is that "Investors should scoop up low-beta stocks..." but not use beta as a "...substitute for brains and cannot be relied on as a simple predictor of long-run future returns." Surely, if by definition beta is a backward-looking measurement of a stocks movement relative to the market, couldn't other historical measuring sticks (technical and fundamental analysis) be useful tools also? It is these inherent contradictions that weaken the Randomaniacs theories.
Should this book be bought? Not in my opinion (although, I bought it...).Even though Malkiel tries, he does not statistically prove the Random Walk theory. In reality, it seems doubtful that statistical evidence will ever prove or disprove Random Walk. But, to invest successfully, one must understand how other investors and traders are thinking. Knowing about Random Walk (not intrinsically believing it) should help you make better investment decisions. However, it is not necessary to plow through the hundreds of pages in this book. So, put your darts away and embark on a less-random investment strategy.