In this Article we are going to talk about random walk and non-random walk hypothesis. This theory can applied to cryptocurrency market as well as other financial markets.
Burton Gordon Malkiel, a Princeton economist, published a book named “A Random Walk Down Wall Street” in 1973. In this book, he explained the random walk hypothesis. Malkiel explained in his book that the price movements in financial markets are unpredictable. Actually, he believes that using technical and fundamental analysis are wasting of time due to random walk and unpredictable movements. Therefore, he recommends investors to buy and hold stocks. In return, he provided two theories against technical and fundamental analysis.
Firm base theory
At first, he talks about “Firm Base” theory as a fundamental fact. This theory addresses that each stock has an intrinsic value, which is determined by the decline in liquidity or cash flow (income). As a result, investors would be able to use valuation techniques in order to recognize the real value of a stock or market. It means, that this valuation determines the best time to buy or sell.
Castle in the air
On the other hand, he talks about “Castle In The Air” theory as technical fact. In this theory, he explains an assumption that a successful investment depends on the financial behaviors. For this reason, one should recognize the market condition first. It means one should recognize that the market is bullish or bearish. According to this theory, valuation is unimportant because a stock value depends on how much is one willing to pay for it. The “Castle in the Air” theory do not criticize the reflection of information on the price. Basically, it explains that this information is random and unpredictable.
In contrast to random walk theory, Archie Craig MacKinlay and Andrew Lo published a book named “A Non-Random Walk Down Wall Street”. This book consists of several articles, which provide empirical evidence in order to extract data and information form price. The Authors used powerful computers to develop econometric analysis. The purpose was to determine how random the stock price is.
Although this book is difficult to understand, it provides evidences, which shows price prediction is possible. Earlier than that, Lo published an article in Finance magazine in the year 2000. In this article, he studied the stock price charts of the United States’ stock market from 1962 to 1996. As a result, he could provide a solution in order to identify the technical pattern. It means that one could collect valuable data and information by using technical analysis indicators.
To be fair, we can say there are both random walk and non-random walk in the market. In truth, the price movements are usually exactly based on patterns and indicators. However, they do not follow patterns and are random in some cases. A technical analyzer is responsible in order to recognize the right from wrong. In fact, traders should become adapted to any unpredictable situation.