How random?

There might have been a time a long time ago, where some one could predict stock prices the way Bob thinks he can. But those days are long gone. If there was something quite predictable about stock prices, it'd soon be noticed. There are many Harvard Physics Ph.D.'s and postdocs that have gone into Wall St. Hundreds of theoretical physicists have been hired into quantitative positions to try to eek out as much prediction as possible. Day traders might think they're quite something having invested in some handy dandy off-the-shelf neural net software stock analysis tools. software. But that is positively stone-age compared to what the pros have at their disposal.

Let's say there was an effect, like that stock prices are lower on Mondays than other days of the week. In fact it is claimed that this "Monday effect" actually used to be the case, but now this effect seems to have completely disappeared Why? Because the market is self correcting. Once this has been noticed, people thinking that stock prices are going to be lower on Mondays will buy stocks then, raising their price. All people have to do is look for this effect and if they find it, they'll exploit it for all its worth, causing it to quickly disappear.

How likely is it for an army of Ph.D. nerds being paid well into the six digits, to find the Monday effect? Extremely. They'll analyze every conceivable correlation and measure that you could think of, and zillions that you can't, in order to milk every last cent of profit. By doing so, they get rid of such correlations, making the market even more unpredictable.

Of course there will always be people out there that think they can outsmart the market like most day traders did during the late 90's. They mostly got crushed by the sharks swimming in the tank, and still new ones continue to provide free food for them. Their trades are cruelly and mercilessly snapped up quickly by the large predators that they're trading with. For this reason these only have a very short term effect on the market. If you trade through GreatDealDiscountTrades.com, you're not getting direct access to the market. Any delay on your order can be exploited to make money, say by waiting till prices have changed in a direction disfavorable to you.

Hypothetically, some incredibly rich idiot could announce that he's buying huge amounts of CSCO stock, day after day, no matter what the price is. Then there'd be a huge feeding frenzy and the price would sky rocket in no time. If he keeps on buying whatever the price, then at some point he'll run out of money at which point the price will collapse. There's rarely anyone out there that has that much money to lose, and is that brain-dead. Anyway, a person like that wouldn't stay rich very long. Those that were lucky enough to be able to actually make a buy, will be happy.

Barring this extremely bizarre behavior, the short term price of a stock is very unpredictable, a fact that is kept in check by armies of nerds and traders, all doing their thing.

The short term unpredictability is clear from analyzing the data. However the Warren Buffet strategy of cleverly predicting stocks based on their underlying worth, may be a sensible approach. However that involves a lot more than just reading the charts and watching CNN.

josh 2010-10-20