Assessing risk on Wall Street part 2: Applying the Random Walk by Thomas A. Rorro
The Random Walk theory lets the investor evaluate the risk of an investment before the investment is
made. In the first article in this three-part series, the potential profitability of this approach was
demonstrated. Investments were reduced to a graphic representation of profit vs. the underlying common
stock price. In this article, we will examine a technical analysis approach to the Random Walk.
Profit characteristics of basic investments
The profit characteristics of market instruments are determined by their nature. Investors avoid many of
them because of lack of understanding or an inherent fear of the risk involved. In fact, all market
instruments should be viewed as tools for building profit and controlling risk. Figure 1 displays the profit
characteristics of simple market instruments, showing both long and short positions. In these
representations, market instruments are described as a function of annualized percent profit and the
underlying common stock price.