Stock Pickers Fail

Stock prices are quickly moved by news that is available to virtually all market participants at the same time. Because news is unpredictable and random by nature, we come to the unavoidable conclusion that movements of stock prices are also unpredictable and random. Therefore, the current stock price is the best estimate of the stock’s fair price. This means those celebrity stock pickers appearing on television and the silver screen are no different than a team captain calling a coin toss before a big game. It’s a blind guess as to whether the stock will go up or down in the short term because these events will occur based on news that is unknowable in advance. This means your portfolio, if based on a few hand-picked stocks, will rise or fall on the whims of the daily news.

Ever since the first stock market trade, which took place in 1602 at the Amsterdam Stock Exchange (“Vereniging voor de Effectenhandel”), traders have been looking for ways to predict future stock market movements. They have studied reams of data in search of patterns in securities prices. In 2000, a Nova television special, “The Trillion Dollar Bet,”1 reported that a group of academics in the 1930s decided to find out if traders really could predict how prices moved. Since they could not find any scientific basis for the belief, they decided to run a series of experiments. In one of them, they created a random portfolio of stocks by throwing darts at The Wall Street Journal while blindfolded. After one year, they were stunned to discover the dartboard portfolio had outperformed the portfolios of Wall Street gurus. The academics arrived at a devastating conclusion: The success of top traders was simply due to luck, and patterns in prices appeared by chance alone.

In 1992, 63 years after the stock market crash, John Stossel of ABC’s 20/202 program conducted some follow-up research on the dart throwing. He determined the economists’ findings from more than six decades prior remained true. Stossel interviewed Princeton Professor Burton Malkiel, author of A Random Walk Down Wall Street. Professor Malkiel reminded viewers that stock markets have historically delivered a performance of 9.5% to 10% per year. “To beat the average, should an investor listen to the Wall Street professionals?” Stossel asked. “No,” replied Malkiel. “All the information an analyst can learn about a company, from balance sheets to marketing material, is already built into the stock price because all of the other thousands of analysts have the same information. What they don’t have is the knowledge that will move the stock such as news events, which are unpredictable and impossible to forecast.”

    -1 Nova, The Trillion Dollar Bet, Documentary, Lauren Aguirre (2000; Arlington: Public Broadcasting Service.), Television.
    -2 20/20, Who needs the Experts?, Documentary, John Stossel (1992; New York: ABC News.), Television.
Step 3stock pickersBurton G. MalkielA Random Walk Down Wall Street