I found myself in the middle of an interesting debate between Barry Ritholtz and Justin Wolfers this afternoon. Barry was advocating the idea of trend-following, when it comes to stocks, while Justin is more of a believer in the random walk. Justin being one of life’s natural gamblers, it wasn’t long until they agreed on a wager.
I picked a stock at random: I used the first letters of the tabs open in my web browser to generate a ticker symbol. I then picked a person walking past (it turned out to be Gregory Galant of Newsgroper) and asked him to name a date in the past few years: he picked October 10, 2004. I then generated a chart of the stock price for the year to that date. Barry examined the chart, and by looking at the trend, decided on where he thought the stock would close on the first trading day of 2005. Justin simply picked the closing price on October 10, and used that as his prediction for the opening price of 2005.
Who won, the trend-follower or the random-walk guy? Well, maybe it wasn’t fair: the stock I picked turned out to be Petrobras, which has been in a strong upwards trend for many years now. The stock price rose significantly in the months up to October 10, 2004, where it closed at $37.53. Barry’s prediction for January 3, 2005, was $44, although when he realized that Justin was simply going to predict $37.53, he softened his prediction to $42.
As it happens, the strong trend in Petrobras shares notwithstanding, Petrobras shares closed at $38.70 on January 3, 2005: Justin won the bet, and is now $20 richer. But as I take another look at the data now, I realize it was very close: Petrobras opened on January 3 at $40.10, and if we’d used that figure, Barry would have been the winner.
Barry, of course, wants a hundred or so rematches: he reckons he’ll win in the long run. But for the time being, it’s Wolfers 1-0 Ritholtz.