What is meant by Randomness of Share Prices?

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Random Walk Theory

In a "random walk", a variable does not follow a trend and it moves at random. When we apply this theory to stock prices, it suggests that the stock prices move at random and it is impossible to predict their movement, either through fundamental or technical analysis.

According to the Random Walk Theory, the stock prices of any listed company follows a random walk. The theory also assumes that movement of stock prices of two different companies are independent of each other.

Randomness of Share Prices

The randomness of share prices is related to the concept of fair pricing and efficient capital markets. In an efficient market, the security prices are determined depending on supply and demand. When the demand is high, the prices of shares go up. And, if the supply is more than the demand, the prices of shares come down.

So, how do the investors make a decision to buy or sell shares in the market? This is done depending on the cognizance of various factors associated with the company and its shares.

  • In a fair market, the information about a share is known to all investors and they can decide upon the fate of a share depending on the information.

  • In an efficient market, the price and the outstanding number of shares are known to all. When a share has favorable conditions, its price goes up. It happens because the market acts as a mediator between the sellers and buyers. The seller cannot increase the price of a share without sufficient support from the market. That is, the condition must be fair for the company to increase the price of the share.

  • In an efficient market, there is no actual third-party body that wants conditions to turn in its favor. In other words, the trade of a share happens only between the buyer and the seller in an efficient market. Therefore, the prices of shares may move up and down for several instances. This is known as the "randomness of share prices."

Randomness is Natural in an Efficient Market

In an efficient market, the randomness of share prices is a natural phenomenon. As the prices are only dependent on supply and demand, the price of shares vary randomly in a market. That is why, when the company has strong fundamentals and when the news and events of the company are found profitable, its share prices go up randomly. In the reverse case, when situations are not good, the price of a share may go down too.

Conclusion

The share prices are not constant. Rather, it is a random variable that goes up and down depending on market conditions. When the demand for a share is high, the share price goes up while when the conditions are not in favor, the share prices may go down.

The randomness of share prices is a known and accepted phenomenon among shareholders and they know and act accordingly. Therefore, in an efficient market, all the necessary information is supplied to the investors and shareholders so that they can make an informed decision depending upon the facts.

raja
Updated on 25-Mar-2022 05:45:35

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