I recently performed an experiment on Excel to determine whether or not stocks follow a random walk That is, the probability of a stock moving up or down each day, is 50/50. And its price is independent of where it was the previous day. Note: This experiment was actually already done by Princeton and in the book A Random Walk Down Wall Street
If this were true, it would mean that strategies such as Technical Analysis is an illusion. And that technical traders are Captain Hindsights.
To perform this experiment, I used the =RANDBETWEEN() function in Excel, to have it choose a number between 0 and 1.
0 = Tails
1 = Heads
Then I plotted each point on a chart. If a coin flip turned out heads, I would move up the chart 1 space. If tails, I would move down the chart 1 space.
You can easily perform this same experiment on your own using the same method.
Coin Flip Test Run #1
In my first test run, I flipped a coin 88 times and produced the following results:
Immediately, we can see that a technical trader might consider a support level at the -4 area shown above from coin flip #13 to #38.
They might also say that this coin is “trading within a range” from -1 to -4 during that time.
At coin flip #41, it would have reached the resistance level at -1, and then break through to the top, until it hits resistance again at the +2 and +3 areas, before dropping back down.
Coin Flip Test Run #2
I performed the same experiment again this time, using a million or so coin flips, to get a better sample size (actually, all I did was copy the columns and hit ctrl+D to see how far down the Excel worksheet it would go. This almost crashed my computer.)