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