Online Stock Trading | Are markets really that efficient?

Are markets really that efficient?


Filed Under Market Psychology |

Market efficiency advocates would tell you yes they are efficent.  They hypothesis states:  market prices always fully reflect all available, relevant information.  Adherents believe that the adjustment to new information is virtually instantaneous and its is virtually impossible to beat the market (definition by Bloomberg).  It is true that 75% of money managers fail to beat the S&P 500 on a yearly basis but what about the other 25%?  Is this 25% virtually impossible? 

Efficient market theory neglects the “Human Element” to the markets.  It assumes that those who trade in the market are making decisions based upon a mathmatical, logical decision.  Basically, what drives trading is a bunch of black box trading outfits executing trades.  This is plain non-sense from the academic world of finance.  Real world, reality shows us that decisions are mostly irrational and emotionally driven. 

I’ve found a nice article written for Investor Home.  Here is the first two paragraphs:

Much of economic and financial theory is based on the notion that individuals act rationally and consider all available information in the decision-making process. However, researchers have uncovered a surprisingly large amount of evidence that this is frequently not the case. Dozens of examples of irrational behavior and repeated errors in judgement have been documented in academic studies. Peter L. Bernstein in Against The Gods states that the evidence “reveals repeated patterns of irrationality, inconsistency, and incompetence in the ways human beings arrive at decisions and choices when faced with uncertainty.

A field known as “behavioral finance” has evolved that attempts to better understand and explain how emotions and cognitive errors influence investors and the decision-making process. Many researchers believe that the study of psychology and other social sciences can shed considerable light on the efficiency of financial markets as well as explain many stock market anomalies, market bubbles, and crashes. As an example, some believe that the outperformance of value investing results from investor’s irrational overconfidence in exciting growth companies and from the fact that investors generate pleasure and pride from owning growth stocks. Many researchers (not all) believe that these humans flaws are consistent, predictable, and can be exploited for profit.

Read the remainder of the article here.

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Comments

One Response to “Are markets really that efficient?”

  1. DeMerchant on July 18th, 2007 3:07 pm

    I think the only thing you can count on is people acting irrationally… you just need to figure out how the hordes work and take advantage of it

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