V.4:8 (309-314): Assessing risk on Wall Street part 2: Applying the Random Walk by Thomas A. Rorro

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.