There are a select few who regularly profit from their involvement
in organized markets, and there is the great ma jor ity of people
who do not. Among the points which distinguish successf ul
traders and investors on one hand from the vast ma jority of market
participants and most of the academic community on the other, are the
acceptance by the latter group of the notion of organized markets as a
random walk, and the ability to distinguish organized from unorgan
ized markets because of the so-called "efficient market" theory.
The most important - yet simplistic - implication of market logic
is that anyone can now locate value in an organized (or in fa ct any)
market. Thus, one can determine when price is below value, at value
or above it. Armed with this inf ormation, so long as one has the other
requi site characteristics, one can join the ranks of the few who make
money consistently in the organized markets. A secondary implication
of market logic must ther efore be that it ref utes both the random walk
and efficient market theories currently in vogue among the ma jority of
the academic community. Consider each of these long-accepted theo
ries regar ding market activity.
The theory of price fluctuation as a random walk (and the term itself)
has been used for centuries. There are numerous definitions of ra ndom
walk, and each definition varies in shades depending on who is doing
the defining. According to Robert Hagin 's Dow Jones-Irwin Guide to
Modern Portfolio Theory, random walk is a term used in mathematics
and statistics to describe a process in which successive changes are
statistically independent. A random walk implies (that the market's
price displays) no discernible pattern of tra vel. The size and dir ection
of the next step cannot be predicted from the size and direction of the
last or even fr om all previous steps. The serial correlation is (f unc
tionally) zero. In other words, the random walk theory holds that it is
impossible to predict tomorr ow's price changes based on what has
occurred today.
One of the central points developed throughout this book is that all
markets operate similarly and are motivated by the same principles,
and that anyone who can understand these principles - plus observe
and record the individual characteristics of the specific market - and
can employ a sound trading strategy and discipline himself, can profit
handsomely from any market. Thus, a central thesis of market logic is
that there is little distinction between organized or exchange-traded
markets such as stocks, futures, options, etc. , and all other so-called
"unorganized" markets where no federally regulated exchange floor
exists. (Certainly the exchange-traded markets often of fer a narrower
bid-ask spread, thus creating a higher degr ee of liq uidity and hence
lowering transaction costs as compared to those of unorganized mar
kets .)
Every market is an auction market, either passive or active. In a
passive auction, the individual does not take part in an active negoti
ating process but selects from products offered at dif ferent prices which
make up the range. In an active auction, participants negotiate the
range . Whether the auction is passive or active, all markets •• auction"
or trend up and down in order to fulf ill their purpose, to facilitate trade.
In an auction, prices do not develop ra ndomly, but rather to fulfill the
purpose of the auction.
The purpose of any market is to facilitate trade. Lack of trade
fa cilitation inevitably causes price to move. This price movement
behavior is as true in the organized markets as it is in a grocery store
or any other everyday market. Thus, price changes to sati sfy the
condition of the market and every price is a result of the condition of
the market. The fact that price moves for a specific reason further
precludes price from developing in a random manner.
Furthermore, prices are not stati stically independent of each other.
Price, in moving to satisfy the condition of the market, provides an
inf ormational flow. In other words, markets must generate trade, and
in doing so, prices fluctuate, generating inf orm ation about where trade
is being conducted and where it is not. This inf ormation is valuable to
the market participant, as we shall soon demonstrate. But true
randomness does not generate valuable information. In other words, in
statistically random situations, knowledge of the present is not impor
tant, for it conveys no advantage. If knowledge of the present structure
of a market is important and does convey an advantage - as we shall
see in later chapters - a market cannot be a random walk.
--Steidlmayer
