I'd like to apologize for not being present when my post was first made. After registration, my account needed to be "approved" by some sort of administrator after having confirmed my account via email.
What about situations where price and market movement is based mainly upon a predatory basis? When market players catch wind of an LTCM on the ropes that needs to liquidate, they will push the price further against them despite "rational" value. How does EMH deal with this situation?
Well this topic is always interesting.. I personally have no idea what the definition of EMH is. What is rational? Is that logical? No. How was the theory proven? Does it say anywhere it's impossible to make money in the markets? I don't know or don't care. Stick your theories in a book I'm dealing with reality.
Well, Olmifon, apparently you don't understand traders and they don't understand you. You might as well be on two different planets. Renegen's comment sums the situation up very nicely: "Well this topic is always interesting.. I personally have no idea what the definition of EMH is. What is rational? Is that logical? No. How was the theory proven? Does it say anywhere it's impossible to make money in the markets? I don't know or don't care. Stick your theories in a book I'm dealing with reality." Trading is concerned with one time frame and academic investment theory with another. The EMH may hold, on average, over long periods of time. This, however, has little to do with trading. If markets were instantaneously efficient, arbitragers would be out of business.
I just realized I may not have made my position clear on how I see EMT. I find most of my peers tend to agree to some degree or another what I'm about to say. The markets are not perfectly efficient. There is though an enormous amount of evidence complied by researchers (some as far back as the 1920's) that all seem to heavily elude that "technical analysis", "stock picking", and other well documented strategies do not produce superior results on a risk adjusted basis when compared to a market index. I notice a few people are talking about the differences between theory and reality. I find it almost a little funny that this is said by those favoring a stance against EMT. Academics is about theories, that includes not just formulating them, but also testing them, and testing them vigorously. The overwhelming majority of academic research is not theory production, but rather testing those already in existence against empirical evidence. The empirical evidence just doesn't point to chaotic markets where profit can be made frequently like some proclaim. I would love for that to be the case, but there is just too much evidence rejecting that possibility.
Just a couple of comments. I agree that, as you say, "technical analysis" and "stock picking" don't necessarily produce profitable results. That is why we rarely "pick stocks" or rely on "technical analysis" for making money in the markets. Do we look at technicals, sure, as one aspect of determining which 2 or 3 stocks to become intimately familiar with so we can become "surrogate specialists" in those stocks and trade them day in and day out. This allows us to trade "with" vs. "against" the Specialist without having the obligations and restrictions they have. They've been making money for 200 years, why fight them when you can join them. Our "stock picking" is done primarily with fundamentals and the relative "value" vs. "growth" stock for our correlated pairs trading. We tend to be long the value stock, of course. When the academics hit the options floors in 1979-1980 period, with Black-Sholes models in hand they didn't last very long. We quickly determined which options they would be interested in, actually changing prices to "lure them into our den" (LOL) with hopes of selling us calls at inflated prices. Yeah, sure...we would buy one, then offer it at the same price, lower the bid by half a dollar, and go on. When we would see these guys coming to our pit, we simply raised prices, sold them what they thought were "cheap" options, and when they left, we would simply lower the prices back and make more money. We had the computers too, along with floor experience, and a fair amount poker experience. Worked pretty well for us. I'm not saying that academic types cannot become good traders, it's just harder now since the trading floors are going away, leaving a vast wasteland for actual, live on the job training. You need to be risking real money, IMO, to become a market player. Sure, market mechanics can be learned, but they must also be experienced. Those looking for perfect markets, will not find them and those concerned about "chaotic" markets need to learn how to respond to them. (off soapbox now, LOL). All the best, Don
As others have noted, timeframe becomes a serious question in regards to this testing. I've been given the impression that academic testing in the area of high frequency data (which is frankly the realm in which most folks here probably operate) draws a somewhat different conclusion. You're going to need to clarify your use of the term "chaotic" here. Are you going the direction of chaos theory or just using the more common conotation of randomness?