The book “A Random Walk Down Wall Street” is about the application of random theory in the area of Wall Street activity. The purpose of the book is to focus on index funds as the most beneficial investing strategy of investors and to highlight the cause-and-effect relation of the processes and phenomena taking a place in the stock market of the U.S.
The author is Burton G. Malkiel, the professor at Princeton University with great economic experience in the U.S. structures, prestige educational establishments, and financial businesses. The prevailed hypothetical premise of his opinion is the efficient market with the wide available market information provided and reflected in price of traded stock. Therefore, his work is dedicated to thoughtful consideration of the inputs and outputs of the stock market.
The publisher of the book is New York publisher W. W. Norton & Company Incorporated dealing with a wide range of the works, including art books, textbooks, and professional books. Completely revised and updated edition of “A Random Walk Down Wall Street” was published in 2003 and provided more clarified inclusion of a life-Cycle guideline for personal investing in 463 pages. The genre of the book is professional literature that can serve as a practical textbook in financial practice and academic preparation.
The issues and concerns of the book raised the question of purchasing and holding of stocks addressed to numerous investors participated in the Wall Street stock exchange. The book by Burton G. Malkiel stated that stocks constitute index funds excelling in trading sufficiency and investment returns. The book is divided into fourteen chapters provided sustaining arguments for the logic and exhaustive study of the stock market mechanism and the emerged circumstances accompanied its functioning. Prevailed opinion of the author is based on the detailed conceptual and historical context of stocks’ management.
Theoretical basis of the book contains the provisions of the theories of stock prices, random-walk, and modern portfolio. Malkiel used the techniques of fundamental and technical analysis to verify the influence of random in the stock market and modeling to explain the pricing of capital assets. Practical and theoretical evidences were provided during comparison of various investment practices. Malkiel’s work was acknowledged as one of the best investment advices and guidelines for ensuring the sustainable and valid financial decisions. Numerous investing strategies, disproved superstitions, truisms, and axioms constitute the content and premise of the revised and updated edition of the book.
Emphasizing the role and value of the stock in market conditions, Malkiel exploited methodical toolset towards the main processes occurring in stock competition and environment to obtain properly accomplished theoretical background. The main points of this chapter define the basic ideologies of investment referring to the theoretical provisions of firm formation and so-called castles in air (Malkiel 95). The theory of firm foundation determinates the decision of an investor relied on the real value of investment medium. If the investors decide to purchase the stocks of certain company, they should identify the real value of this business and invest in it. The assumptions of the theory of castles in air refer to the strategic behavior of an investor deciding to invest in the same potential objects of investment occupied by the crowds. This behavior assumes that the crowds follow the financial trends or their decisions are based on foundation of a firm. In spite that there is a difference in these strategic approaches to the investment behavior that differ the failure or benefit of the performed investment, these theories are recommended to use under different circumstances.
A random-walk approach takes a central position in the book (Malkiel 118). This notion explains that whatever the efforts could be made by the investors and experts to select the right portfolio, it will have the same winning chances as the choice of a portfolio by blind-folded monkey playing in darts with financial data. This comparison suggest and idea of unfounded confidence of financial expectations and inability to predict short-term shifts of stock prices. Herein, the author demythologized the fact of proper beneficial assumptions. Professionals in the stock market are used to cover the gap between their practical experience and the onslaught of academic individuals with technical analysis and fundamental analysis uncovered in the second part of the book.
Throughout the history of active marketing operations on stock, the crowds were shown as the numerous investors striving to get benefits from the speculating as the hidden motive lied in the basis of investing. Malkiel demonstrate the speculating outcomes by the provision of the book with the examples of tulip-mania, bubble in the South Sea, and the crash of Wall Street in 1929. The market showed gangbusters, high growth, and overvalued portfolios. Nevertheless, the values returned back to their more normal and fair level in rapid path. These changes marked medium-term craze in the stock prices and consequential return to their prior value that was before the run-up.
Crazy sentiments and intentions of the market participants were considered by Malkiel as the example of unpredictable phenomena, like the influence of the crowds on the demand and dynamics of the stock market. The author gave the historical examples of cross-sections occurred in the stock market in the past. Historical period from the sixties to the nineties was chosen significantly for demonstration that overvaluation repeated time after time. Investors were speculating primarily in marketing blue chips due to their high prices. In the turn of century, their value returned to normal level.
History of stock market brings the new wave of investment. Application of the theory of castles in the air continued at the beginning of 2000s. Malkiel focused on the bubbles’ concentration due to IPO mania, the tricky South Sea businesses, and pursuit of future benefits happened with the stocks of railroad at the turn of 1850s (Malkiel 93). All these facts confirmed the position of the author about the existence of various investment strategies and distinguishing outcomes of investment. Comparing the historical situations and related circumstances, the author paralleled the effects of craze demand, the consequences of its influence on the stock market, and gradual decline of the stock price.
Despite the fact that stock valuation fluctuated during long term from its peak to crash and repeat these cycle, Malkiel did not assume and explain it like coincidence. On the contrary, the economist point it out that there is no any coincidence. Malkiel’s substantiated the researched fluctuations with the arguments of life cycle. Thus, the market mechanism, including the stock market, is able to return to the prior condition. Market is sufficient from time to time. Therefore, when ineffectiveness occurs, market weeds it out in certain period of time.
Similar return is prescribed to investments. Along with life cycle and business cycle of the economics, investment returns with different amount. The methods and principles of value evaluation were not considered in the book as balance wheel. Moreover, their use by the investors with firm-foundation or castle-in-the-air strategies distinguished investment outcomes (Malkiel 31). Although any standards of stock value are difficult to evaluate, different market conditions make the investors to compare the rates of growth that seem implicit in certain price levels.
Actual question that the author raised to the readers engaged in investment is the choice of right strategy that would be applicable on the conditions of market dynamics and its unpredictable character. Malkiel noted that repeatability of the market situation is accompanied with usage of various tools and the objects of investment. The efficiency or failure of the stock market is confirmed by cyclical investment activity and various applied strategies.
Support of Random-Walk Approach
Promoting the central notion of the book and ideas of market sufficiency provided with numerous practical examples, Malkiel moved to consideration and critical review of the forms of analysis that were most used in Wall Street: fundamental and technological. In this part, the economist compared and contrasted these forms, described them in details, gave the rationale for their application, and clarified their techniques.
The most interesting is that the author described fundamental analysis as the methodology and practical experience of the market professionals focused on the sustainability and health of particular interested businesses by careful and thoughtful dissecting of their market place and competitors, competitiveness, financial outcomes throughout financial statements, balance sheets, and cash flows. This type of analysis applied by the participants of the stock markets allows them to verify the future ability of the interested investment medium to provide the growth and success to their shareholders. Therefore, the businesses are researched in their market environment as the areas of development or failure. The author assumes that fundamental analysis is more likely to be applied by the firm-foundation investors interested in study of the business background and the stock potential.
On the other hand, the toolset of preceding investment research in Wall Street relied on technical analysis (Malkiel 118). By Malkiel, it is the research of price dynamics in the stock market. This type of analysis includes historical data of performance to use for speculation on future performance. The outcomes of technical analysis are demonstrated through trend lines and complex charts. This type of analysis is used to drive the managerial and investment decisions that are based on probable extrapolation of prior dynamics on modern tendencies according to existence of a business cycle.
Comparing these types of analysis, Malkiel pretty clear indicated his own position regarding to the proper choice of analysis. As the author insists on the absence of coincidence and market unpredictability, he has more respect for fundamental analysis, as it based on modern peculiarities of a company located in market environment. Thus, the influence of the stock and other markets has already reflected in the outcomes of the business. This part of the books is noted by the critical fitting of these types of analysis to a random-walk theoretical approach.
It is interesting that Malkiel decimated technical analysis and substantiated its real invalidity and non-applicability towards the stock market. Special chapter of the book is dedicated to deficiency of technical analysis in the stock market on the assumptions of its unexpectedness. The strongest evidence was the comparison and correlation of the stock market with the avеrage lеngth of a hеmline in the female fashion (Malkiel 151). Overall, technical analysis was considered by Malkiel as the type of research that looks for correlations and connections between the dynamics of the stock market and accompanied circumstances in the past. It has been considered as one of the market superstitions, or at least the reason of failure of the market professionals in their forecasts for certain companies. However, the majority of these correlations and connections showed themselves as spurious and fallacious. Focusing on the creation of graphical outcomes, like charts and lines, investors waste a time, cut their vision from more common and broader scope of observation, and make the fallacious conclusion and correlation even worse and more invalid.
Describing the erratic application of technical analysis for the research of the stock market through the prism of filter system and the Dow Theory, Malkiel provided more arguments for fundamental analysis due to its foundational logic and more openness to wide variety of rapidly changed information (Malkiel 146). Nevertheless, he founds fundamental imperfection of this type of analysis. There was a range of defects of fundamental analysis’ application to choice right portfolio and benefits: non-occupation and non-anticipation of random events, involvement of doubtful financial information of the business, omission of contributed analysts, human factor, etc.
During his researches related to fundamental analysis, Malkiel made common conclusion that professional analysts ignored the individual needs of investors. He assumed that the reason in open access to already open information and another source. Therefore, the advantage of this type of analysis is minimal. One of the basic ideas constituted the second methodological part is not about the application of technical or fundamental analysis, but that an investor is not able to invest and obtain more profit than he/she has already obtained during the investing in index funds after taking a risks defined by the analysis’ outcomes.
It is remarkable that the economist recovered the provisions of his opinion, basing on his own experience in practical and academic areas. This condition allows the readers to assume that the author will provide the alternative way for the individuals to invest in proper and qualified objects of investment. He contrasted the attitude of academics and practical people to castle-in-the-air and firm-foundation theories and introduction of fundamental and technical analysis in research stock valuation and price prediction.
In order to substantiate his random-walk approach to promotion of index funds, Malkiel used portfolio theory. Application of this theory is critical and logic, as its provisions are closely matched his views and preferences. The author gave the portfolio theory as the idea that it is better for investors to have wide choices of investment portfolio for selection in order to ease the maximization of rewards and minimization of risks. Although the author did not concentrate significant importance on diversity of assets and stocks, he pointed out on the investors who would be exposed to certain degree of emerged risk. Malkiel tended to use modern theory of portfolio along with critics of risk minimization strategy (Malkiel 199).
One of the interesting and challenging statements of the book concerns reaping of benefits from a risk increasing. The provisions of this part of the book were complicated for comprehension of unprepared and unsophisticated reader, but they continue the previous researches and introduce the notion of beta. The economist presents it as the number determined the measure of how close the individual investor respond to common behavior on the stock market in previous time period. The books practically demonstrated that the investor or stocks with higher beta should go up on the conditions of market growth and dive later according to a life cycling of market mechanism. Nevertheless, it should be admitted that is the common situation, while some specific cases would be hardly distinguished by accurate occurrence of this situation.
Among specific peculiarities of Malkiel’s approach to the research, there was consideration of human factor reflected on the financial decisions. The book provides emotional and cognitive biases to the choices of investment portfolio and the effect of these biases on common market dynamics. By Malkiel, the notion of behavioral finance include the behavioral principles that will prompt to a investor correct and rational investment decisions, like avoid long-tern investment in modern peak assets or do not overtrade stocks (Malkiel 241). These positions may constitute certain conceptual framework of random-based advices.
Going through critical overview, Malkiel discarded poor superstitions and facilitate his own position with arguments. For example, the author deconstructed some ideas of B. Graham about the long-term investment in value assets and stocks. But he could miss the basis of Graham’s assumption that value stocks will be always valued. Malkiel noted that value stocks and growth stocks will be correlated to the common stock market. However, in contrast to value stocks, growth stocks have terrible flops. This omission would not significantly damage the concepts of Malkiel, but it makes some of his assumptions inaccurate.
Among ordinary advices on investment, the book advices to avoid taking into account past performance while investing in future rewards. Therefore, the author returned to invalidity of the technical analysis’ findings in forecasts and plans. He assumed that long-term stocks overwhelm inflation and bonds, but short term will show another results owing to random and risk. Therefore, the economist emphasized that investment period and choice between bonds and stocks will predict an advance or handicap of investment activity.
Based on previous findings and axioms of economic activity, Malkiel provided particular guideline on investment behavior. These provisions are considered among the most valuable provisions of “A Random Walk Down Wall Street”. Its author noted that long-term objective should not be supported by the stocks with long-term haul, while short-term objective should be provided with diverse cash and bonds with the lowest risk. Moreover, Malkiel named investment in target fund on retirement as profitable according to his life-cycle guideline on investing.
The book provides the life-cycle guideline with advices on advantageous division of a portfolio between bonds, REITs, stocks, and other assets (Malkiel 351). Usage of index funds enables an investor to diverse the portfolio. It should be marked that there was no any concept and term defining index fund till the first edition of “A Random Walk Down Wall Street”. Modern comprehension of index funds became ordinary in the area of stock management and marketing.
More specific advices refer to certain investment tips addressed to various investment periods and ability to manage investment. If an investor lacks a time for micromanagement, he/she should perform investment activity on index fund as the most fitting objects. In the case of the management of individual stocks, an individual investor should deal with reasonable amount of stocks. Other managed options should be properly considered and hedged from risks. These prescriptions were named by the author as the steps down Wall Street signifying the financial decisions in the stock market.
To sum up, Malkiel’s book is a complete literary scientific work that leaves a positive impression and well-grounded advices on investment decisions. It should be noted that the book has excellent theoretical and practical background that allows putting the provisions of the author in real practice. It takes a little more time on verification of Malkiel's vision, but such solid study is explained by the attention to details. The value of the book lies in the fact that it is applicable in the practice of investors with the interests and investment appetites of any scope and in the academic activities of students. Special place is taken by index funds as new notion in the area of beneficial investment. Provided advices are the valuable contribution to the development of the stock market and finance sector of the national economy. As the book is full of innovative ideas to investment and regards the stock market in common, its particular provisions are of special attention while studying macroeconomic phenomena and peculiarities of successful investment.