I recently performed an experiment on Excel to determine whether or not stocks follow a random walk.
That is to say, the probability of a stock moving up or down every day, is 50/50 in the short term. And with a positive upward drift in the long term.
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 (source: https://en.wikipedia.org/wiki/Random_walk_hypothesis)
If this were true, it would mean that strategies such as Technical Analysis is an illusion. And that technical traders are Captain Hindsights.
The Coin Flip Experiment
To perform this experiment, I used the =RANDBETWEEN() function in Excel, to have it choose a number between 0 and 1. This simulated a coin flip for the experiment.
0 = Tails
1 = Heads
I started with at 0 and then started flipping coins.
If a coin flip turned out heads, I would add +1 to the total and move up the chart 1 space. If tails, I would subtract -1 from the total and move down the chart 1 space.
Then I plotted each point on a chart.
You can easily perform this same experiment on your own using the same method in Excel with your own numbers and runs.
Coin Flip Test Run #1
In my first test run, I flipped a coin 88 times (88 because I randomly copied and pasted the formula down that many rows) and produced the following results:
Immediately, we can see that a technical trader will look at this graph and call a support level at the -4 area shown above, which is during coin flips #13 to #38.
They might also say that this coin is “trading within a range” between the -1 to -4 areas 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.)