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The theory is seemingly borne out by a casual comparison of how highly managed
mutual funds or other professionally selected stock portfolios regularly
underperform the market as a whole. Consequently, random walk proponents
recommended wide diversification to mirror the entire market's breadth, such as
by choosing stocks based on indexes like the Standard & Poor's 500 or, more
recently, the Wilshire 5000.
The theory is deeply intertwined with the efficient market theory, which holds
that markets are constantly and immediately correcting prices based on new
information. When markets are efficient, the theory posits, no stock is
undervalued or overvalued at a particular moment, and once information
becomes available that a stock may not be priced accurately in relation to the
company's performance or growth prospects, the markets quickly correct that
condition. Both theories were greeted with skepticism early on, but quickly grew
to exert influence on both academics and professionals.
Opponents to random walk point out the inefficiencies of the market that make it
possible, as they see it, to anticipate with better than random accuracy what a
stock might do under certain circumstances. These inefficiencies include
incomplete or even conflicting information about companies as well as the
market's propensity to under- and overreact to different types of new
information.
FURTHER READING:
Brock, William, Josef Lakonishok, and Blake LeBaron. "Simple Technical Trading
Rules and the Stochastic Properties of Stock Returns." Journal of Finance,
December 1992.
Hulbert, Mark. "A Random Walk Down Wall Street." Forbes, 21 October 1996.
Musgrave, Gerald L. "A Random Walk Down Wall Street." Business Economics,
April 1997.