Random Walk
The random walk theory states that stock prices are not reliant on the past. In other words, today’s price has no relation to yesterday’s price. This theory is only partially true, however. Trading action is independent of the past because each trade is a conscious decision made by an individual. Because of the individual basis, many people think that technical information of the past is worthless. This would be akin to playing roulette, for example. Just because there is a 50/50 chance of it landing on red, this doesn’t mean that it must alternate red/black/red/black. Each spin is an individual occurrence and it is not uncommon for four consecutive spins to land all red.
But this is not how the stock market operates. Because people have an influence over the price of stock, technical data is important not because it is a predictor of the future, but because it is a predictor of human psychology. If a specific pattern occurs, many traders would respond the same way to it. This makes it possible to predict a stock’s future based upon its past because that’s what people expect to happen. In roulette, the ball will not land on red just because people anticipate that red will hit. There is no human control over the roulette wheel like there is in the stock market. Psychology has absolutely no bearing in the casino games.
Technical analysis is not effective all the time while using the Daily Momentum Trader. But it’s right often enough to disprove that the random walk theory applies to active trading in the stock market.