Random Walk Theory and Efficient Market:
Random walk theory suggests that changes in stock prices have the same distribution and are independent of each other.
The efficient market hypothesis states that stock prices fully reflect all available information and expectations, so current prices are the best approximation of a company’s intrinsic value. (Burton Malkiel, 1973)
I believe both of these theories became obsolete in the algorithmic trading era.
Look at the following examples:
As you can see all these stocks have a significant positive correlation..!
Oil and Oil Companies:
After all these examples you should accept that stocks move in Clusters, and their prices could be under influence of others! The market is not efficient anymore..!
Having said this, one way to narrow down your watchlist could be clustering and then choosing between clusters by defining your favorable criteria..!
A lesson from Jim Simons:
"We have three criteria: If it's publicly traded, liquid, and amenable to modeling, we trade it."
“We search through historical data looking for anomalous patterns that we would not expect to occur at random.”
"Efficient market theory is correct in that there are no gross inefficiencies. But we look at anomalies that may be small in size and brief in time. We make our forecast. Then, shortly thereafter, we re-evaluate the situation and revise our forecast and our portfolio. We do this all day long. We're always in and out and out and in. So we're dependent on activity to make money."
I use some statistical modeling and narrow down the 10k to less than 50 to trade options, and I share My options trading watchlist link here:
This list may change accordingly.
There is no point in having many stocks from the same cluster in your watchlist, try to narrow it down as much as possible to increase your trading efficiency..!
Very tricky, I need to diversify my watch list.
Thanks for the tip.