| Here's is where we start to have some fun. | | | | a random walk as he observed them. |
| Regardless of how you want to trade the | | | | |
| markets you need an approach. It might be | | | | The best way to demonstrate this is with a |
| spinning a bottle, asking your Aunt Jenny | | | | game. Let say we are going to make a bet on |
| what she thinks or just gut feel. | | | | the toss of a coin. You start with $100. We |
| | | | will toss this coin once per day. If it comes |
| However you do it, even though you may not | | | | up heads you win 3% and if it comes up tails |
| think so, you have an approach. | | | | you lose 2.5%. |
| | | | |
| The majority of traders will eventually use | | | | At the end of the first day you will either |
| some form of technical analysis (also known | | | | have $103 or $97.50. At the end of the second |
| as chart traders, market technicians and | | | | day we repeat the process. |
| chartists). | | | | |
| | | | The probability of the coin landing heads or |
| Just before we go down this road of mystical | | | | tails is exactly 50%. This is because |
| wonder I think it is very important that you | | | | regardless of how many times the coin is |
| hear both side of the argument of why | | | | tossed each event is independent. The coin |
| technical analysis works. | | | | has no memory of what happened the toss |
| | | | before. This means that the results will be |
| For every book that there is on making money | | | | totally random. |
| trading there is probably an opposite book | | | | |
| explaining why it can't be done. Before you | | | | Kendall's paper implies the same effect in |
| dismiss the last statement out of hand. Lets | | | | the stock or commodities market. If each day |
| explore the argument that no matter what you | | | | is an independent event then the markets must |
| do you can't beat the market. | | | | be random. We shall talk about more |
| | | | probability's later. |
| Random Walk | | | | |
| | | | Taking this idea slightly farther if the |
| The random walk theory dictates that a | | | | markets are random then the history of the |
| security prices changes randomly, with no | | | | price of a stock or commodity has no bearing |
| predictable patterns. Now that's quite a | | | | on the future price. It wouldn't help to look |
| statement but there are number of very | | | | at charts or data, as each day there would be |
| respected statisticians who have a very | | | | a 50% chance of the market going up or down. |
| convincing argument to prove it. | | | | |
| | | | You may be thinking by this stage that this |
| It all started in London with a man called | | | | theory is rubbish. I can trade the markets |
| Maurice Kendall who presented a paper to the | | | | and make money! Try this simple test. Have a |
| Royal Statistical Society in 1953. The | | | | look at the two charts below. One is a chart |
| subject of the paper Kendall presented was | | | | of 100 daily closes of the Dow Jones |
| the behavior of stock and commodity prices. | | | | Industrial Average and the other is a 100 |
| | | | random coin tosses. |
| Kendall started out looking for predictable | | | | |
| price cycles in stock and commodities prices. | | | | Makes you think doesn't it! If each day in |
| The problem was he couldn't find any. | | | | the market were in fact an independent event |
| | | | then it would be impossible for you to make |
| Regardless of how he approached it, the price | | | | money from it consistently. |
| of a stock was just as likely to go up or | | | | |
| down on any given day despite what happened | | | | You see any succession of event's |
| on the previous day. Which is where we get | | | | particularly independent events can have an |
| the term Random Walk. Prices seemed to follow | | | | aberrant run. This is what kills the trader. |