RANDOM WALK THEORY

• The basic assumption in technical analysis is that stock price

movement is quite orderly and not random

• The new theory came to be known as Random walk theory because

of it’s principal contention that share price movements represent a
random walk rather than an orderly movement.

• A change occurs in the price of a stock only because of certain

changes in the economy, industry or company

• These changes alters stock prices immediately and the stock moves
to a new level, either upwards or downwards, depending on the type
of information
• Further change in the price of the stock will occur only as a result of
some other new piece of information, which was not available earlier.

• According to this theory, changes in stock prices show independent

behavior and are dependent on the new pieces of information that
are received.

• Each price change is independent of other price changes , because

each change is caused by a new piece of information.

• The current stock price fully reflects all information on the stock.

• The price of a security two days ago can in no way help in

speculating the price two days later
• The price of each day is independent . It may be unchanged, higher
or lower from the previous price, but that depends on new pieces of
information being received each day.

• The random walk theory presupposes that the stock markets are so
efficient and competitive that there is immediate price adjustment.
This is the result of good communication system through which
information can be spread almost anywhere in the country
instantaneously.

• The RWT is based on the hypothesis that the stock markets are
efficient . Hence this theory later came to be known as the Efficient
Market Hypothesis or The efficient market model or EMH
 Efficient Market Hypothesis
• EMH is based on the fundamentals that markets are efficient and
prices make an independent movement in these markets.

• Prices get affected by demand & supply situation. Prices reflect

equilibrium position of the demand & supply. These show a wide
fluctuation, only on account of a disequilibrium in the demand and
supply position.

• The EMH is a theory that capital markets operate to a high degree

of perfection. It’s roots lie in the RWT, which postulates the share
price changes are of a random, rather than correlated nature.

• In an efficient market, new information is processed and evaluated

as it arrives and prices instantaneously adjust to new and correct
levels. Consequently an investor cannot consistently earn excess
returns by undertaking FA or TA.
• EMH states that the capital market is efficient in processing
information. An efficient capital market is one in which security prices
equal their intrinsic value at all times, and where most securities are
correctly priced.

• When someone refer to Efficient capital market they mean that

security prices fully reflect all available information. The prices of
securities observed at any time are based on correct evaluation of all
information available at that time.

• The efficient market model is actually concerned with the speed with
which information is incorporated into securities.

• Fundamentalists believe that it may take several days or weeks

before investors can fully assess the impact of new information. The
price may be volatile for a number of days before it adjusts to a new
level. This provides an opportunity to the analyst who has superior
analytical skills to earn excess returns.
 FORMS OF STOCK MARKET EFFICIENCY

• Weak form : each share price is assumed to reflect fully the

information content of all past share prices

• Semi-strong : prices fully reflect all publicly available information E.g

company announcements, broker’s reports, industry forecast, and
company accounts

• Strong form : prices fully reflect all information. The strong form will
thus include what is known as insider information E.g details of a
takeover bid known to senior management of both parties to the bid.
 CHARACTERISTICS OF EFFICIENT MARKET

• Timely & accurate information on the price and volume of past

transactions and on prevailing supply and demand

• Low transaction cost ( cost of reaching the market, actual brokerage

cost & transferring of security )

• Quick adjustment of prices of securities to the new information

• Liquidity means, an asset can be sold or bought quickly at a price

close to the price of the previous transaction, assuming no new

information has been received

 ASSUMPTIONS OF EFFICIENT MARKET HYPOTHESIS

• All available information is costless to all market participants

• There is no transaction costs

• All investors take similar views on the implications of available

information for current prices and distribution of future prices of each

security
 BASIS OF EMH

• Full disclosure and transparency of information

• Free flow of information

• Large number of investors

• Prices reflect information effect

• No one can influence the market unduly

 INDIAN STOCK MARKET MOVING TOWARDS MARKJET
EFFICIENCY

• Automated/ online trading system

• Depository system

• Changes in settlement system

• Ban on badla

• Introduction of derivatives

• Provision of full disclosure and transparency

• Provision to check inside trading

• Corporatisation of stock exchanges