The randomness of Financial Markets and How can be treated


There is a book called “the random walk down wall street” written by Burton Malkiel. The author tries to discuss in this book if the Stocks market is really moving randomly or if there is a pattern in its movement. He explained the four phases of the market which are known as accumulation, trending up, distribution, and finally trending down as the only fact that can be predicted in the stocks market, but all other factors are random. This is, in my opinion, is not true and I am going to put some thoughts regarding all financial markets stocks, Forex, Futures contracts, and commodities regarding if they are really moving randomly or if there is something that is under the investors or traders control can be done.

Stock Market:

The stocks market is the most known financial market that many authors wrote about and try to explain its movement and how can be approached. And it is the most simple market that works in a predictable fashion. The reason behind that is because it consists of stocks of companies that are only a reflection of the financial statements of those companies. what I meant here is that if the fair value of a stock that is generated from the financial statement of its company is high and the price of this stock in the market is low that means definitely you need to buy this stock and wait until it reached its fair value to sell it and make a profit or keep it if the last financial statement for that company released and showed that there is an increase in the fair value of that stock. The only thing that is random here is that when the stock will reach its fair value, is it in a short time period of less than 3 months, or is it in a long time period after 1 or 2 or a maximum of 3 years. This is the approach used by the Oracle of Omaha, Warren Buffett, Who said that I never looked at the screen to see the prices of stocks in the market because it’s just a little fluctuation for the stock prices and in the end, the fair value will be reached. Options which are derivatives instruments generated from stocks of the company also have a fair value which can be used as a guide for those who want to trade it or invest in it. That means somehow they are not moving in a random way and can be treated as socks.

InstrumentsShort Term Movement 3 monthsLong Term Movement (more than 3 years)Percent of randomnessStocksRandom Movement of PricesMoving toward the Fair Value30% to 40%OptionsRandom Movement of PricesMoving toward the fair value30% to 40%Stocks and options Randomness

Forex Market:

The forex market is the most traded market, especially after the advanced technology that was adopted by many individuals around the globe. Unfortunately, those who traded in Forex believe it’s the most profitable market which is right but if traders avoid using leverage or depend on it at least as little as possible. This market is the most random market of all financial markets not because the traders think it is controlled by big banks such as Citi Bank and HSBC and others. The reason is that many companies that work in multi countries and have different nationalities hedge their profits using this market especially when the cost of their products is in one currency and their profit in another currency. This is known to many traders as institutional trades which is only one of so many ways that institutions trade this market and that is the main reason behind the randomness. Since this market is a decentralized market and since it has so many participants that affect its movement, there is no reliable edge that can be used in this market except trading this market using probabilities trading as the one that i discussed before in this blog as trading probabilities.

InstrumentsShort Term MovementLong Term MovementRandomnessForex PairsMoving in random moving in randomAbove 90%Forex Market Randomness

Future Market:

The future market is also the type of market that is only affected by the supply and demand theory. But there is a financial truth which is the main trend for the future market is the downtrend because farmers who own the physical products such as rice, wheat, and other products are selling contracts in this market as hedging for their real deal on the physical market. One good strategy that can work with people who traded these markets is only to sell this market whenever they see a high in contract prices. Technical analysis especially the price and volume is the only source of information for the traders who want to have an edge in this market.

InstrumentsShort term movement long Term MovementRandomnessFuture ContractsRandom movement down Trend, SellingAbout 60%Future Market Randomness

Bottom Line:

To answer the question that if financial markets are random? the answer is for the short term they are working in a random way, but in the long run, the only market that is not moving at random is the stocks market, and those markets that rely on it, which will always appreciate the fair values of those stocks either if they are undervalued or overvalued