Having completed our studies of fundamental and technical investment analysis, we turn our attention to the Random Walk investment theory. We have read the comments of its most famous proponent, Professor Burton G Malkiel, in past blogs. However, I want to start this discussion with a passage from Professor Stephen Jay Gould, a paleontologist and essayist, who wrote extensively about paleontology, evolution and the history of science.
Professor Gould, who passed away in 2002, wrote monthly essays in the Natural History magazine which were then put together and reprinted as books. In one of those books, Full House, The Spread of Excellence from Plato to Darwin, he discussed, among many other things, how humans cope with trends and randomness in life, which he then extended to the stock market as follows:
The more important the subject and the closer it cuts to the bone of our hopes and needs, the more we are likely to err in establishing a framework for analysis. We are story-telling creatures, products of history ourselves. We are fascinated by trends, in part because they tell stories by the basic device of imparting directionality to time, in part because they so often support a moral dimension to a sequence of events; a cause to bewail as something goes to pot, or to highlight as a rare beacon of hope.
As one final example, probably more intellectual energy has been invested in discovering (and exploiting) trends in the stock market than in any other subject - for the obvious reason that the stakes are so high, as measured in the currency of our culture. The fact that no one has ever come close to finding a consistent way to beat the system - despite intense efforts by some of the smartest people in the world - probably indicates that such causal trends do not exist, and that the sequences are effectively random.
His characterization of people and their love of stories is basically the same as that of Professor Robert J. Shiller, which I shared in an earlier blog.
I want to paraphrase the most persuasive argument for market randomness I have ever read. Assume you have assembled 5,000 people for a reality TV show, which you will call "The Flip". With Hollywood hype and build up, you flip a coin and each contestant presses a button for either heads or tails. Like the NCAA basketball championship ("March Madness"), this is a "win or go home" competition. Each week, after the flip (which is obviously random), the people who call wrong leave the program. The process continues; and, sooner or later, a handful of survivors will have made a surprising, seemingly skillful, string of correct calls. They may gain some sort of notoriety and celebrity status in the popular media, which you would hope for as the producer of the program. As these things go, sooner or later, there is only one person left - the winner. Does that individual indeed possess some innate talent for calling coin flips? Conversely, is it just luck and the fact that someone will win, given the rules? Much is made of winning streaks of every sort in popular culture. What if it is all due to chance and luck?
We will continue our look at the Random Walk theory in the next blog.
Excerpt from Full House, The Spread of Excellence from Plato to Darwin by Stephen Jay Gould, copyright 1996, Three Rivers Press, pages 30-32.
Comments are always welcome.
I want to paraphrase the most persuasive argument for market randomness I have ever read. Assume you have assembled 5,000 people for a reality TV show, which you will call "The Flip". With Hollywood hype and build up, you flip a coin and each contestant presses a button for either heads or tails. Like the NCAA basketball championship ("March Madness"), this is a "win or go home" competition. Each week, after the flip (which is obviously random), the people who call wrong leave the program. The process continues; and, sooner or later, a handful of survivors will have made a surprising, seemingly skillful, string of correct calls. They may gain some sort of notoriety and celebrity status in the popular media, which you would hope for as the producer of the program. As these things go, sooner or later, there is only one person left - the winner. Does that individual indeed possess some innate talent for calling coin flips? Conversely, is it just luck and the fact that someone will win, given the rules? Much is made of winning streaks of every sort in popular culture. What if it is all due to chance and luck?
We will continue our look at the Random Walk theory in the next blog.
Excerpt from Full House, The Spread of Excellence from Plato to Darwin by Stephen Jay Gould, copyright 1996, Three Rivers Press, pages 30-32.
Comments are always welcome.
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