efficient market theory in trading

Discussion in 'Trading' started by cashmoney69, Jul 24, 2006.

  1. buy 5 random stocks, hold for a week, make money. Simple huh?.

    I asked my Economics teacher why people lend their $$ to money managers, if their chances of success are just as great. His answer was "I dont know". It seems that Efficient market theory states that random markets are efficient markets.

    It would be interesting to see if this would work on a smaller time frame fit for a trader.

    - Nathan
  2. Chagi


    I think you are mixing up two concepts here - efficient market hypothesis, and random walk theory.

    The variants of efficient market hypothesis essentially state that all information about a stock is already priced in (i.e. all market participants have equal access to information). Random walk theory essentially states that you cannot ever use the past to predict the future (so much for trending eh?).

    Try asking your econ prof about Jensen's Measure, that will start leading you in the right direction regarding why people pay fund managers to (hopefully) outperform the market. :)
  3. Simple, because: 1. they don't believe in EMT, 2. they believe money managers can do better than they can, 3. they believe the return on their loan is "guaranteed", and is worth the risk.

    Besides, I read an article in WSJ that some academics are beginning to debunk EMT, academically. I'll post the link when I find it.
  4. andread


    Chagi, if it's not too long to explain, would you mind going a bit more into detail?
    The fact that all information is already priced doesn't mean that the price will then follow a random walk?
    I thought the two things were basically the same.
  5. I look at the EMT as a 'blanket theory' for people who are too lazy/lack the skill to derive more specific theories of the market. It is easy to jsut assume the markets are efficient to avoid having to do any of the crunch work involved with finding patterns, trends etc which I thnk do exist.
  6. Arnie


    I think EMT was laid to rest long ago. To believe in EMT you need to believe that everyone that will act on the information gets it at the same time, acts on it at the same time, and most importantly, will act on it the same way. Regarding RW, I think the market does that a lot, but there are times where the future will be just like the past, only a little bit different.
  7. Unfortunately, EMT is still the underlying theme in most finance textbooks.

    I do agree that financial markets are somewhat efficient. However, I disagree with its underlying assumptions that markets are perfectly efficient, that all investors think alike and "efficiently", and that information is priced instantaneously. Anyway, I'm sure EMT has been argued to death in this forum.
  8. Market cant never be efficient. Just to give u two examples:
    1) A trader press the wrong button, buy instead of sell or he added an extra 0 for the quantity. Instead of reversing, he decided to hold on waiting to breakeven. EMT doesnt account for this and it does happen everyday.

    2) A trader takes profit because he is afraid of losing his paper profit. Does EMT model anything about people being affected by emotion ?
  9. It's called alpha....look it up
  10. Asazel


    Don't arbitrageurs keep the markets efficent?
    #10     Jul 26, 2006