The random walk hypothesis is a financial theory stating that stock market price

s evolve according to a random walk and thus cannot be predicted. It is consiste

nt with the efficient-market hypothesis.
The concept can be traced to French broker Jules Regnault who published a book i
n 1863, and then to French mathematician Louis Bachelier whose Ph.D. dissertatio
n titled "The Theory of Speculation" (1900) included some remarkable insights an
d commentary. The same ideas were later developed by MIT Sloan School of Managem
ent professor Paul Cootner in his 1964 book The Random Character of Stock Market
Prices.[1] The term was popularized by the 1973 book, A Random Walk Down Wall S
treet, by Burton Malkiel, a Professor of Economics at Princeton University,[2] a
nd was used earlier in Eugene Fama's 1965 article "Random Walks In Stock Market
Prices",[3] which was a less technical version of his Ph.D. thesis. The theory t
hat stock prices move randomly was earlier proposed by Maurice Kendall in his 19
53 paper, The Analysis of Economic Time Series, Part 1: Prices.
Burton G. Malkiel, an economics professor at Princeton University and writer of
A Random Walk Down Wall Street, performed a test where his students were given a
hypothetical stock that was initially worth fifty dollars. The closing stock pr
ice for each day was determined by a coin flip. If the result was heads, the pri
ce would close a half point higher, but if the result was tails, it would close
a half point lower. Thus, each time, the price had a fifty-fifty chance of closi
ng higher or lower than the previous day. Cycles or trends were determined from
the tests. Malkiel then took the results in a chart and graph form to a chartist
, a person who seeks to predict future movements by seeking to interpret past pat
terns on the assumption that history tends to repeat itself .[5] The chartist told M
alkiel that they needed to immediately buy the stock. Since the coin flips were
random, the fictitious stock had no overall trend. Malkiel argued that this indi
cates that the market and stocks could be just as random as flipping a coin.
The random walk hypothesis was also applied to NBA basketball. Psychologists mad
e a detailed study of every shot the Philadelphia 76ers made over one and a half
seasons of basketball. The psychologists found no positive correlation between
the previous shots and the outcomes of the shots afterwards. Economists and beli
evers in the random walk hypothesis apply this to the stock market. The actual l
ack of correlation of past and present can be easily seen. If a stock goes up on
e day, no stock market participant can accurately predict that it will rise agai
n the next. Just as a basketball player with the hot hand can miss the next shot,
the stock that seems to be on the rise can fall at any time, making it completel
y random.
There are other economists, professors, and investors who believe that the marke
t is predictable to some degree. These people believe that prices may move in tr
ends and that the study of past prices can be used to forecast future price dire
ction[clarification needed Confusing Random and Independence (probability theory
)?]. There have been some economic studies that support this view, and a book ha
s been written by two professors of economics that tries to prove the random wal
k hypothesis wrong.[6]
Martin Weber, a leading researcher in behavioral finance, has performed many tes
ts and studies on finding trends in the stock market. In one of his key studies,
he observed the stock market for ten years. Throughout that period, he looked a
t the market prices for noticeable trends and found that stocks with high price
increases in the first five years tended to become under-performers in the follo
wing five years. Weber and other believers in the non-random walk hypothesis cit
e this as a key contributor and contradictor to the random walk hypothesis.[7]
Another test that Weber ran that contradicts the random walk hypothesis, was fin
ding stocks that have had an upward revision for earnings outperform other stock
s in the following six months. With this knowledge, investors can have an edge i

n predicting what stocks to pull out of the market and which stocks
the stocks w
ith the upward revision to leave in. Martin Weber s studies detract from the rando
m walk hypothesis, because according to Weber, there are trends and other tips t
o predicting the stock market.
Professors Andrew W. Lo and Archie Craig MacKinlay, professors of Finance at the
MIT Sloan School of Management and the University of Pennsylvania, respectively
, have also presented evidence that they believe shows the random walk hypothesi
s to be wrong. Their book A Non-Random Walk Down Wall Street, presents a number
of tests and studies that reportedly support the view that there are trends in t
he stock market and that the stock market is somewhat predictable.