Final answer:
Behavioral effects can explain momentum in stock prices, which is influenced by investor behavior and market sentiment. The concept of a 'random walk with a trend' implies stock prices are unpredictable in the short term, yet tend to rise over time. Success in stock investing relies heavily on anticipating shifts in market expectations.
Step-by-step explanation:
Behavioral effects can help explain momentum in stock prices. The concept of momentum in the stock market is often seen when prices continue to move in the same direction for some time. This momentum is frequently driven by investor behavior and market sentiment, rather than just fundamental company performance. When investors see that a stock has been performing well, they may expect this trend to continue, leading to increased demand and a continuation of the upward price trend. Conversely, if a stock is in a downtrend, selling pressure can persist as investors expect further losses.
The idea that stock prices follow a "random walk with a trend" suggests that price movements are unpredictable in the short term (random walk) but tend to trend upwards over longer periods due to cumulative positive returns (with a trend). This indicates that, while it's difficult to predict exactly which stocks will rise on any given day, there is a general upward trajectory over time based on positive expectations of future profits.
However, the actual challenge in stock investing is in identifying shifts in expectations. To predict stock price movements successfully, one must anticipate changes in the general market sentiment about a company's future prospects—identifying undervalued companies that will eventually outperform analysts' current expectations.