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Stock Markets and Clouds: The Patterns are Just as Meaningless
If someone looked at the U.S. stock market on Jan. 19th and 20th, they might conclude that prices were in a downward spiral. Over two days the Dow Jones Industrial Average plummeted by 336 points.
But if they looked from March 9, 2009 through Jan. 20, 2010, they might conclude the opposite: the market was in an upturn as the Dow soared by 3,843 points. Again, the same observer looking at the Dow between October 2007 and January 2010 would see a pattern that indicated a downturn, with the Dow falling 3,774 points.
What's going on here?
All of these observations are true as far as they go. So which pattern is right-up or down?
Neither: in fact, there is no pattern. This is a typical case of our human tendency to see patterns where they do not exist. In fact, the movements essentially are random. As one set of researchers noted in 1974: "People have a very poor conception of randomness; they do not recognize it when they see it and they cannot produce it when they try." The stock market's movements between those dates did not indicate a pattern tied to causes but rather was random movement, just like fair tosses of a quarter. Even though, on average, coin tosses should split about evenly between heads and tails, given enough tosses there will be all types of seemingly meaningless patterns that appear to be determined. In a series of one million tosses, for instance, several strings of 50 straight tails would not violate the rules of randomness.
A random market
Burton Malkiel, a Princeton professor and author of "A Random Walk Down Wall Street," argues that enough research has shown that the performance of stocks is so random that unless you have insider information you can-not hope to profit by trying to exploit changing prices.
Numerous studies show that investment experts-whether highly paid Wall Street analysts or famous newsletter writers- fail to beat the market on average. Then why do some of them individually beat the market, and, more impressively, beat it year after year?
It is a phenomenon similar to the coin tosses: given enough people involved, one or more are likely to beat the market merely by chance.