Use random walk to make $$$

Discussion in 'Strategy Building' started by Thumama, Aug 5, 2008.

  1. Thumama



    Assume that the market is efficient and that prices move randomly.

    1. For any stock, test the randomness of its price moves. There are many tests for randomness: for example, use the variance ratio test.

    2. If the value of the variance ratio test indicates a nonrandom behavior of the time series, extend the time series by adding values ( future prices) that will force the variance ratio test to indicate a random walk. (revert to its expected value)

    3. Try this for different timeframes and on average you get some abnormal returns.

    I am just thinking..
    Any thought?

  2. What if your initial assumption is incorrect? ie. the market is <i>not</i> random?

    Try challenging your own preconceptions and formulate WHAT IF scenarios and back-up plans. You might not need them, but then again, you might do.
  3. What test for randomness will you apply? How will you determine the distribution of the population? How will you account for skedasticity?
  4. Random walk doesn't exist.

    The fact that there is a correlation between stocks within the same industry group or the broad market as a whole on decisive up/down days puts random walk to rest. If it was truly random walk, would you ever see two graphs in the same industry that look the same? Think about it.
  5. MGJ


    That son of a bitch Claude Shannon has beaten you to the punch. Google "Shannon's Demon" to find his 1966 method for making money from a random walk.

    Professional money managers use variations of Shannon's Demon today. But they call it "optimal rebalancing" and/or "volatility pumping" to impress their investors.
  6. Daal


    isnt this method based on the gamblers falacy?
  7. Brandonf

    Brandonf ET Sponsor

    I lost money over and over and over again until I accepted the fact that the markets are mostly random. In the end what it comes down to is this, the markets are a lot more random than most traders hope they are or want to believe they are, but at the same time the markets are also not as random as an academic would have you think. The trick is to understand the most of the action is random, and get yourself involved in the siutation where the randomness is not involved.
  8. What a rare and wise response! Less than 1% of all the traders can grasp the concept of randomness! And, yet, that is the only way to make money on the markets whether you like it or not! The understanding of true randomness of the markets has been a life-long research for me. Thanks God I never gave up! I found the true meaning of this word and found the way to profit from it.
    I never looked back since. It is my 5th consecutive year with no loosing months, so, as you can see, it is possible! :cool:
  9. eagle


    I can agree with you if we define random as in the sense of the market is slightly predictable, but not the sense of mathematical definition that it is absolutely unpredictable.

    To avoid confusion, we shouldn't use the word random. We should use something like the market is almost impossible to predict.

  10. hmm ... thank you. :)
    #10     Aug 5, 2008