A Random Walk Down Wall Street
“Never buy anything from someone who is out of breath.”
A Random Walk Down Wall Street
The book introduces concepts of investing and theories of value in a digestible way. It discusses practical tips for where to park your money alongside the economic rationale to do so. I’d like to write through the different theories of values proposed in the book.
Starting with theories of value. Random Walk Down Wall Street introduces two differing theories of asset valuation at the start of the book: “Firm-Foundation” and “Castle-in-the-Sky”. The conceptual distinction depends on whether markets operate on myth or reality. Regardless, the two theories have to answer the question of value assignment.
To illustrate the point for Firm-Foundation, consider the methodology employed by its believers. Taking a look, they are all quantitative methods for determining what the asset should be and take advantage of any existing “arbitrage”. “Pairs trading”, “Discounted cash flow”, and “Trading multiples” are examples of the methods used. Quantitative methods are dedicated to assessing “price”, not “value”, in assets. However, at some point, value has already been assigned, whether it is the stock price or the net assets of a company.
Castle-in-the-Sky believers aim to either value an asset by pricing or predict the value of an asset by using market information. There is a sense where Castle-in-the-Sky can be described as operating in the “short-run” and Firm-Foundation on the “long-run”. When I think of the methods for Castle-in-the-Sky, I primarily think of “Charting” as a way of predicting the market. It can be nontechnical or technical, i.e., relying on line patterns or empirical metrics. What they don’t do is say what the price should be, rather what the movements will be based on changing market beliefs.
Practically speaking, use Castle-in-the-Sky methods if you want to day trade, use Firm-Foundation when you want to invest and forget.