ACCA Financial Management (F9) Certification Practice Exam

What does the Random Walk Theory assert about share prices?

1. Prices follow a predictable pattern

2. Price movements are random

3. Prices are solely based on historical performance

4. Prices are influenced by economic factors

The correct answer is: Price movements are random

The Random Walk Theory asserts that price movements in financial markets, particularly share prices, are random and cannot be predicted. This theory posits that stock prices reflect all available information and that this information is incorporated into prices in an erratic manner. As a result, movements in share prices are not influenced by past trends, making it impossible for investors to reliably forecast future price movements based on historical data. This perspective aligns with the efficient market hypothesis, which suggests that stock prices quickly adjust to new information, thereby making it difficult to outperform the market consistently through technical analysis or prediction models. The implication of the Random Walk Theory is that investment strategies based on historical price patterns may be ineffective for gaining an edge in stock trading. In contrast, options that suggest prices follow a predictable pattern, are solely based on historical performance, or are merely influenced by economic factors do not align with this theory. The emphasis on randomness highlights the unpredictability of the market, challenging the notion that investors can take advantage of identifiable trends or conditions based on past data.