The Fluctuating Movement Of Mutual Fund Prices
First of all, what is a random walk? The classic description of a random walk is the scenario of a drunk man who starts off at a lamp post. Over time, as the drunk starts walking, his veering in random directions make him drift away from the lamp post. This scenario is also known as the drunkard's walk. The idea illustrated here is that each time the drunk takes a step, he moves in a completely random direction from before.
The price of a security such as a high yield mutual fund or even a money market deposit account moves up and down over time as evidenced by a time-series graph. Even tracking it minute-by-minute (should one be able to access such data) the up and down motion is evident although at smaller scales than over days or weeks. Based on this observation, it has been proposed by financial economists and statisticians that this fluctuating movement that goes up and down is akin to a random walk. Whereas the drunkard walked in two dimensions, the price of a stock executes a one dimensional random walk.
The usefulness of the random walk view point is largely mathematical. Should the price of a low risk investment obey a random walk, then it follows that the price should always move up and down around an average value. It should also follow that the deviations from the average value can never be too large, in fact, following a normal or Gaussian distribution. These observations surprisingly are true for many securities, at least on an intra-day basis.
In fact, the Black-Scholes theory of options pricing based on ideas drawn from random-walk mathematics was the reason for a Nobel Prize in economics. Readers will find the details of the theory daunting, but should keep in mind that it is no more than a formalization of the random walk idea.
However, there are limits to the validity of the random walk view point. For example, metrics like the Dow Industrial Average reflect the value of companies in totality. Over time, the value should increase because companies are productive and add to the country's GDP. As a result, the stock price of securities should generally rise over long times, rather than continue to fluctuate around an average value. Second, there have been times in financial history in which stock prices have plunged dramatically, revealing large deviations from random walk behavior.
The normal person who is more worried about a 401K or IRA account that contains high yield mutual funds, GNMA investments and bonds may find the discussion very theoretical. Indeed, it is likely that these mathematical concepts are only useful for a day-trader who must contend with making profits from swings in stock prices on the short term.
Article Source: FxTradingStock.com
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The writings provided for facts about high return mutual funds and investments will be useful to many. If you are interested in the purchase of deposit account money market, come check out our site.
by: Warren Cheng
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Word Count: 470
Date: Sat, 5 Jun 2010
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