The Random Walk Hypothesis posits that stock prices evolve according to a random walk and thus, the future price movements are unpredictable and independent of past movements. This theory suggests that the price changes of a stock are random and follow a path that is equally likely to move up or down, making it impossible to consistently outperform the market through technical analysis or stock picking. Mathematically, if we denote the price of a stock at time as , the hypothesis can be expressed as:
where is a random variable representing the price change at time . The implications of this hypothesis are significant for investors and portfolio managers, as it supports the idea that passive investment strategies may be more effective than active trading approaches. Overall, the Random Walk Hypothesis challenges the notion of market efficiency and suggests that the stock market is largely unpredictable in the short term.
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