One of the tenets of orthodox financial theory is that stock prices in liquid markets move according to a random walk, and therefore the market’s future cannot be profitably predicted.
The notion of a random walk itself is sometimes better known as the “drunkard’s walk”, which is the idea that a drunk who starts at a lamppost and staggers, one step at a time, each step in a random direction, will pass the lamppost an infinite number of times, albeit each time longer apart.
An interesting (and more market-relevant) variant, popularized by paleontologist Stephen Jay Gould in an evolutionary context, is that of a drunk who starts at a bar that is 30 feet from a gutter. Each time he moves he staggers five feet, sometimes toward the bar, sometimes away. But every time he hits the bar he has to stop, of course, because he can’t go through it.
In the long run, what happens to this drunkard? Eventually, and with 100% certainty, he ends up in the gutter. Despite the motion being random, the mere existence of a boundary on one side causes him to move haltingly gutter-ward, eventually falling in.
Many things that exhibit superficial random walk characteristics are actually more like the drunkard ricocheting off the bar. That is, they are bounded, which is crucial to understanding some system dynamics.
I got to thinking about all of this about 4am last night while sharing a bed with my five-year old. I was on the left side, he was on the right, and there was a wall beside him. About four times during the night he ended up on top of me, which irritated me to no end, especially at 4am. And then, of course, it struck me: This was a classic right-bounded random walk. While he was going back-and-forth randomly, he could still no more avoid rolling over me than Gould’s drunkard can avoid falling in the gutter.
Scant reassurance, for sure, in the wee hours, but you have to find some solace when being smeared by a rolling five-year-old.