Samuelson has received the <u>Nobel Prize</u> for his <b>martingale theory</b> to justify <b>EMH</b> (Efficient Market Hypothesis). The implication of his theory is that at every moment the market's price is equal to the <b>fundamental price</b>. For many years it was believed that the <b>fundamental price</b> was equal to the <b>discounted cash flow of dividends</b> which is the <u>pilar of finance</u>. Then many academic researchers tested this hypothesis and found that market's price was far from following the fundamental price's law, only after a very long time market would revert to the <b>fundamental price</b> refered above. That's how they pretend that market is still efficient. But as Mandelbrott has pointed out (I translate from french) "according to the datas of Prince Omar Toussoun, the transitional phase of the Nile has been lasting for at least one thousand years. A transition phase that lasts so long and which nobody knows towards what value it tends should not be qualified as temporary !". So most academics now agree on the facts but they don't agree on the definition. But definition is pure convention, a "cat" in english is "chat" in french but "chat" in english has not the same meaning than the one in french. So saying that market is efficient or inefficient, if the definition is not the same in the two cases, is ridiculous debate since it's a debate about convention and not about the phenomena. [To be continued...]

quite interesting... so how would you define both phenomena? efficient = pdf does not allow to extract other than random profits?? I still wonder how one can try to justify the market' suspected efficiency (as per def above) if it remains in its obvious cyclic structure. The market does allow to extract profits in a consistant manner, but it this also true for one's own psychology? best & good trades, cosmic

harrytrader wrote: But as we have seen, as many academics and practitioners are pursuing hidden markov models (HMMs) in quantitative finance, they are essentially subsuming Technical Analysis anyway, albeit more mathematically.

I think the relevant question here is how much of "inefficiency" markets exhibit on the regular basis. In other word, what is the "guaranteed" level of inefficiency that markets inherently possess? Another relevant question is: what is the minimum reliable magnitude of the market fluctuations around their equilibrium level? If the answer is found it would present a fundamental discovery that could lead to a strategy development based on extraction of profits during maximum inefficiency.

"History only happened once; with a sample size that small, how can it be relied on or even useful?"-Fisher Black

It's not because they are persuing something that they have achieved the thing - like persuing the transforming of lead to Gold for example . At current state they are very far from proving TA. Although indicators (you can use markov models for that if you want it doesn't change the conclusion) seem to be "scientific" they can be as unscientific as any indicators if they are not statistically significant. Above all the most esoteric TAs like Dow Theory, Elliott and Gann are judged as pure psychological and IRRATIONAL FADS by most academics, all the more so that Gann often justified his stuff with astrology and Elliotists often refer to the moon ... to explain irrationality of crowd . I suspect - and I will say why later - that mysticism has been introduced to hide the rationality behind some "magic" so that people could not suspect what's really behind for what serious academics would consider these ridiculous theories about the planets ? My answer would be that the planets are just pretext because I have the rational equations - I don't need to include planets for that - and they can unify Dow, Elliott and Gann (the three seem to be rather unrelated for most practioners of each school).

See "The use of Mysticism to fool the people " http://www.elitetrader.com/vb/showthread.php?s=&threadid=27129

I will answer this remark first and others tomorrow One classical definition given by Jensen in 1978 and which is accepted widely among academics is this one: "A market is efficient with respect to information set Omega[t] if it is impossible to make economic profits by trading on the basis of information set Omega[t]" This correspond to your sense of efficiency : "efficient = pdf does not allow to extract other than random profits??" But in Jensen's you can remark that Efficiency is indeed a relative concept because it is conditional to information set Omega[t]. The question one can ask is : does information set composed only of datas or does it include also the MODEL used to decipher the datas ? In conventional sense of "information" it generally refers to datas but when one wants to test efficiency with statistical tests it is obligatory to take also the model used to fit the datas, so that researchers have problem because of that: they have used more or less sophisticated models - like GARCH, ARIMA and so like - and even if they had found some apparent ineffiencies they can't conclude definitely in favor of inefficiency of market because other pro EMH academics have said that they don't have the "true" model that's why the market appears to be inefficient. To others they seem to rely more and more on tautology since they don't believe in the existence of such equations for the market could have just no real law at all. Statistically it is not obligatory that a system above all where human intelligence can interfer that it follows any law because the humans can just change the law any time they want. [to be continued...]

Now let's suppose that my model is the true model that is to say the FUNDAMENTAL one (in rational economic sense not in irrational psychological sense) - or at least something that approach it - then the market is EFFICIENT RELATIVE TO THAT MODEL (I remind that according to Samuelson the market price is equal to the fundamental value if the market is efficient). But this model is a DETERMINISTIC not a STOCHASTIC model this implies that TRUE PREDICTION (notably of top and bottom) would then be possible and this is CONTRARY to EFFICIENCY because Samuelson pretend that his theory implies non-predictability. So in the case of existence of a deterministic model EFFICIENCY OF MARKET is NON-SENSE THEORY :since it contains CONTRADICTION . Happily for EMH propagandists I'm not an academics and at the moment all academics work on stochastics models, the rare ones that work on determistic model are using analogy with quantum/fractal theory which are just as esoteric as Gann or Elliott since they only formalise the form they don't really know the cause. The big consequence is that Efficiency can hold by propaganda and ignorance that's why it's not astonishing that technical traders are often refered by academics/quants as "noisy traders" whereas the quants are more than less more noisy traders . Quants trade noise since they do arbitrage whereas technical traders - excluding the novices - do trade the real signal. (see comment for today's example http://www.elitetrader.com/vb/showthread.php?threadid=27118&perpage=6&pagenumber=2) <IMG SRC=http://www.elitetrader.com/vb/attachment.php?s=&postid=410039>

Efficient market just means that the sum of all the participant's opinions are vectored. I would say that the maket could be modeled as a transfer function with some feedback. How one would do that exactly, I cannot say at this point, but the feedback is certainly evident. Regenerative feedback certainly causes bubbles, and degenerative feedback could account for quiet times. If somebody could model the transfer function then the feedback required to reach the latest level of "efficiency" would tell us a lot about the market. Sentiment indicators are like that, and as feedback signals rather than market output signals, they behave appropriately as contrarian indications: When the feedback signal's excursion is at it's greatest positive or negative level the ineffeciency of the market is at an extreme. This is going to require some thought as to how many market vectors can be quantified and how they all add together to form a transfer function...... Ok I thought about it, I'm getting a headache, it's impossible!! Just kidding, but the idea of feedback has a little merit. Max