11 June 2013

The Random Dance Theory of Stock Market Movement

Dancers might expend more energy than someone walking to market, but at the end of the dance they’re usually right where they started.

This month I decided to track daily changes in my portfolio, just to see what’s going on day to day.  During the first week, the daily average was a movement of 69 basis points (0.69%). You might think that all that movement would add up to a lot of change. If it all went in the same direction, it would have meant that my portfolio would have gone up or down by nearly 3.5%. But of course the market dances far more than it marches. Net for last week? My portfolio moved by 1 basis point, or 1/100th of a percent. All of that movement resulted in almost no movement.

Now before you think that this is an anomaly of last week or my portfolio, take a look at NASDAQ from 1999 to 2004 – a period of six years rather than six days. From 1999 to 2004, the NASDAQ moved by magnitudes of 85%, 40%, 20%, 30%, 50%, and 9%. During this time, the NASDAQ moved by an average of 3,933 basis points a year – or nearly 40%. Net movement for all that time? NASDAQ had dropped by 80 basis points, or less than one percent. As with my little portfolio in the space of a week, all that movement in one of the world’s most important capital markets over a span of years resulted in almost no movement.

Which makes me wonder why the random walk theory of stock market movement became so popular. It’s obviously not a walk. Instead, it’s a random dance, a dance we do to attract wealth instead of rain. Maybe someday we’ll better determine how to use our trillions in capital to create value rather than chase it. When capital stays in one place long enough to build a bridge or start a business instead of just pricing it, two things could happen: markets could become less volatile and returns could become more sustainable. Meanwhile, this morning, my portfolio is down by 110 basis points. I think they used to call this break dancing.

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