As per Investopedia, the random walk theory suggests that stock price changes have the same distribution and are independent of each other, so the past movement or trend of a stock price or market cannot be used to predict its future movement. In short, this is the idea that stocks take a random and unpredictable path.
As for a random walk with drift, the best forecast of tomorrow’s price is today’s price plus a drift term. One could think of the drift as measuring a trend in the price (perhaps reflecting long-term inflation). Given the drift is usually assumed to be constant. Reference
Visual differences between the trend / cycles / types of random walks is nicely shown below:
Assuming FBMKLCI has the property of a random walk (with drift), what would be its predictable forecast range?
The following are the key parameters assumed for the random walk with drift forecasting method:
- Training Set Data Jan 17 – Jul 17
- Testing Data Aug 17
It is observed that the actual data points are within the confidence bands as per the random walk with drift forecasting method:
Nevertheless, the random walk with drift method is a very simplistic method of forecasting future prices. I believe that having the confidence bands will assist in ascertaining whether a security is in ‘over-extended’ position. One should also ask oneself whether he or she believes in the random walk theory.
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