A random Walk Down Wall Street: The Time-Tested Strategy for Successful Investing

IS THERE MOMENTUM IN THE
STOCK MARKET?
The technician believes that knowledge of a stock’s past
behavior can help predict its probable future behavior. In
other words, the sequence of price changes before any given
day is important in predicting the price change for that day.
This might be called “the wallpaper principle.” The technical
analyst tries to predict future stock prices just as we might
predict that the pattern of wallpaper behind the mirror is the
same as the pattern above the mirror. The basic premise is
that there are repeatable patterns in space and time.
Chartists believe momentum exists in the market.
Supposedly, stocks that have been rising will continue to do
so, and those that begin falling will go on sinking. Investors
should therefore buy stocks that start rising and continue to
hold their strong stocks. Should the stock begin to fall or “act
poorly,” investors are advised to sell.

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These technical rules have been tested exhaustively by
using stock-price data on the major exchanges going back as
far as the beginning of the twentieth century. The results
reveal that past movements in stock prices cannot be used
reliably to foretell future movements. The stock market has
little, if any, memory. While the market does exhibit some
momentum from time to time, it does not occur dependably,
and there is not enough persistence in stock prices to make
trend-following strategies consistently profitable.
One simple set of tests compares the price change for a
stock in a given period with the price change in a subsequent
period. For example, technical lore has it that if the price of a
stock rose yesterday it is more likely to rise today. It turns
out that the correlation of past price movements with present
and future price movements is very close to zero. Last
week’s price change bears little relationship to the price
change this week, and so forth. Whatever slight dependencies
have been found between stock-price movements in different
time periods are extremely small and economically
insignificant. Although there is some short-term momentum
in the stock market, as will be described more fully in chapter
11, any investor who pays transactions costs and taxes

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cannot benefit from it.
Economists have also examined the technician’s thesis that
there are often sequences of price changes in the same
direction over several days (or several weeks or months).
Stocks are likened to fullbacks who, once having gained some
momentum, can be expected to carry on for a long gain. It
turns out that this is simply not the case. Sometimes one gets
positive price changes (rising prices) for several days in a
row; but sometimes when you are flipping a fair coin you
also get a long string of “heads” in a row, and you get
sequences of positive (or negative) price changes no more
frequently than you can expect random sequences of heads or
tails in a row. What are often called “persistent patterns” in
the stock market occur no more frequently than the runs of
luck in the fortunes of any gambler. This is what economists
mean when they say that stock prices behave very much like
a random walk.