Do you believe EMH? I heard many times from people that you can't beat the whole market by buying a small basket of stocks let's say 30 stocks from the market. I find it amazing that people believe in whatever the "expert" says. I don't buy everything the academic says. I always use logic and reason to question everything I heard. After my experiences, I called this BS.
For the past couple years, I've contructed my own portfolio and compared it with the index. I observed the daily % change for couple months and found my portfolio is less volatile than the index. For example, the index goes down 1% and mine goes down 0.5%. or the index goes up 1% an mine goes up 0.7~1%. In the long term, my portfolio beats the index by 5%~10% per year while the standard deviation of my portfolio is equal or less than the whole market. No, I am not an day trader. I trade only a few times every couple months.
It's possible to select a subset of stocks from the WHOLE market and beat the market consistantly in the long term. The reason is simply not every business is equal. It's true that the stock price reflect majority of information in the short term but it can't predict the future not to mention all stocks go on fire sale once every couple years. Also, majority of investors are sheeps. Only minority of peole are inteligent investors,those are the people who correct market mistakes(over or undervaluation). If every market participant is smart, we won't have stock bubble. It's because people believe in EMH that they'll buy stocks at any price. They give the money to the bank and say here you go buy me some stocks.
See the criticism from wiki:
http://en.wikipedia.org/wiki/Efficient- ... hypothesis
EMH
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secretwealth
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Obviously the market isn't 100% efficient, or we'd have equilibrium; instead we have violent swings and maybe something vaguely resembling cycles, but not really.
Market efficiency assumes that the market knows itself, but the fact is that both technical analysis and fundamental analysis assume that you can understand a market with numbers. But markets are full of people, and people are at least sometimes (I'd say almost always) arbitrary. Psychology adds a non-numerical dimension to markets that mean they are never fully knowable or predictable, hence market efficiency is impossible.
But the market knows itself somewhat, so the question is whether an individual can know the market more than the market knows itself without insider information. I think this is sometimes possible if an individual specializes in one sector and learns enough about it, and I can give plenty of examples to prove my point. Someone who saw the bursting of the housing bubble in 2007, for example, could have made a lot of money off of shorting PHM, C, and BAC.
Michael Lewis tells the story of some of these people in The Big Short, and you could say they knew the mortgage derivative market better than the mortgage derivative market did, so they were able to profit off of insurance policies on the market. This is a great example of expertise outsmarting the market.
Market efficiency assumes that the market knows itself, but the fact is that both technical analysis and fundamental analysis assume that you can understand a market with numbers. But markets are full of people, and people are at least sometimes (I'd say almost always) arbitrary. Psychology adds a non-numerical dimension to markets that mean they are never fully knowable or predictable, hence market efficiency is impossible.
But the market knows itself somewhat, so the question is whether an individual can know the market more than the market knows itself without insider information. I think this is sometimes possible if an individual specializes in one sector and learns enough about it, and I can give plenty of examples to prove my point. Someone who saw the bursting of the housing bubble in 2007, for example, could have made a lot of money off of shorting PHM, C, and BAC.
Michael Lewis tells the story of some of these people in The Big Short, and you could say they knew the mortgage derivative market better than the mortgage derivative market did, so they were able to profit off of insurance policies on the market. This is a great example of expertise outsmarting the market.
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jacob
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I think it's a useful approximation. The EMH is intended to make academic papers [in the 1970s] tractable---now professors have computers and are thus able to build bigger (better?) models. Suppose you want to calculate something about the market; what do you do? Maybe all you have are the closing prices for the last 10 years. So you make a hypothesis that says that all information is reflected in those prices(*). Then you don't need more data. This is how the EMH came about.
(*) It's a little bit like saying that all political opinions are reflected in congress. Or at all possible consumer needs and wants are reflected in the inventory at Walmart. It's a good approximation but it's also clearly not completely correct.
Similarly, suppose, again, that all you have are daily closing prices. Then again you can pretty much only define risk as standard deviations and correlations. And so you have modern portfolio theory.
I think the controversy originates in the work "efficient" which has a lot of subjective connotations. If the EMH was called "Model A: All information is reflected in market prices", it wouldn't be such a big issue. It would simply be yet another model and not be treated with the religious reverence that some do. In particular, a truer definition would be "all decisions are reflected in market prices" would be better, because that's true by definition. Indeed, it would not be impossible for a fund manager to have information that he can not reflect in market prices because his fund prospectus does not allow him too (e.g. "The ABCDX fund must be 95% invested in large cap"---even if market conditions don't warrant any lage cap ownership at all).
As it is, the EMH just provides ammunition to professional non-investors (I shan't mention any names here) who refuse to think that any amateur can beat any professional; and to the latter, the market savvy, for implying that their efforts are worthless.
(*) It's a little bit like saying that all political opinions are reflected in congress. Or at all possible consumer needs and wants are reflected in the inventory at Walmart. It's a good approximation but it's also clearly not completely correct.
Similarly, suppose, again, that all you have are daily closing prices. Then again you can pretty much only define risk as standard deviations and correlations. And so you have modern portfolio theory.
I think the controversy originates in the work "efficient" which has a lot of subjective connotations. If the EMH was called "Model A: All information is reflected in market prices", it wouldn't be such a big issue. It would simply be yet another model and not be treated with the religious reverence that some do. In particular, a truer definition would be "all decisions are reflected in market prices" would be better, because that's true by definition. Indeed, it would not be impossible for a fund manager to have information that he can not reflect in market prices because his fund prospectus does not allow him too (e.g. "The ABCDX fund must be 95% invested in large cap"---even if market conditions don't warrant any lage cap ownership at all).
As it is, the EMH just provides ammunition to professional non-investors (I shan't mention any names here) who refuse to think that any amateur can beat any professional; and to the latter, the market savvy, for implying that their efforts are worthless.
" they knew the mortgage derivative market better than the mortgage derivative market did, so they were able to profit off of insurance policies on the market. This is a great example of expertise outsmarting the market."
As I recall from the big short, the insurance derivatives that people made money off of were not priced by market mechanisms so I don't think this is a counter example to emh. I.e. Burry and others bought the contracts directly from the sellers who came up with a price on their own (and obviously they mispriced them greatly).
"Do you believe EMH? I heard many times from people that you can't beat the whole market by buying a small basket of stocks let's say 30 stocks from the market. "
EMH doesn't imply that an individual can't beat the market rate of return.
As I recall from the big short, the insurance derivatives that people made money off of were not priced by market mechanisms so I don't think this is a counter example to emh. I.e. Burry and others bought the contracts directly from the sellers who came up with a price on their own (and obviously they mispriced them greatly).
"Do you believe EMH? I heard many times from people that you can't beat the whole market by buying a small basket of stocks let's say 30 stocks from the market. "
EMH doesn't imply that an individual can't beat the market rate of return.
@Photoguy
"Definition of 'Efficient Market Hypothesis - EMH'
An investment theory that states it is impossible to "beat the market" because stock market efficiency causes existing share prices to always incorporate and reflect all relevant information. According to the EMH, stocks always trade at their fair value on stock exchanges, making it impossible for investors to either purchase undervalued stocks or sell stocks for inflated prices. As such, it should be impossible to outperform the overall market through expert stock selection or market timing, and that the only way an investor can possibly obtain higher returns is by purchasing riskier investments. "
Read more: http://www.investopedia.com/terms/e/eff ... z224Z9ptqA
Value investors tend to able to beat the market. EMH believers say the time frame is too short. Given longer time, the market will catch up these value investors. . The fact is the longer the time frame, the more value investor's return diverges from the market.
Comparing the long term performance of 30 stocks to the whole market is like comparing apple to orange. But EMH believers say the superiority of a business is priced in so no better performance can be obtained from buying higher quality business at fair or cheap price. The EMH suggests the reason stock pickers can out perform the market is because they invest in riskier asset. The truth is high risk asset have chance of high return(Gambling) but high return asset is not necessarily risky(Non gambling)!
Now if we compare a portfolio contains same numbers of stocks from the market but employing value investing techniques to change weighting. It'll be harder to beat the market but not impossible.
"Definition of 'Efficient Market Hypothesis - EMH'
An investment theory that states it is impossible to "beat the market" because stock market efficiency causes existing share prices to always incorporate and reflect all relevant information. According to the EMH, stocks always trade at their fair value on stock exchanges, making it impossible for investors to either purchase undervalued stocks or sell stocks for inflated prices. As such, it should be impossible to outperform the overall market through expert stock selection or market timing, and that the only way an investor can possibly obtain higher returns is by purchasing riskier investments. "
Read more: http://www.investopedia.com/terms/e/eff ... z224Z9ptqA
Value investors tend to able to beat the market. EMH believers say the time frame is too short. Given longer time, the market will catch up these value investors. . The fact is the longer the time frame, the more value investor's return diverges from the market.
Comparing the long term performance of 30 stocks to the whole market is like comparing apple to orange. But EMH believers say the superiority of a business is priced in so no better performance can be obtained from buying higher quality business at fair or cheap price. The EMH suggests the reason stock pickers can out perform the market is because they invest in riskier asset. The truth is high risk asset have chance of high return(Gambling) but high return asset is not necessarily risky(Non gambling)!
Now if we compare a portfolio contains same numbers of stocks from the market but employing value investing techniques to change weighting. It'll be harder to beat the market but not impossible.
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jennypenny
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>>Value investors tend to able to beat the market.
http://www.multifactorworld.com/Lists/P ... aspx?ID=84
re: EMH
http://www.multifactorworld.com/Lists/P ... aspx?ID=64
http://www.multifactorworld.com/Lists/P ... aspx?ID=84
re: EMH
http://www.multifactorworld.com/Lists/P ... aspx?ID=64
No, I don't believe that statement as defined in Investopedia. I think market equlibria are essentially unstable in a dynamic system, meaning that most tradeable markets are only find equilibrium for short moments that don't last.
"The Misbehavior of Markets" by Benoit Mandelbrot explores these issues: See reviews at http://www.amazon.com/The-Misbehavior-M ... ewpoints=1
The recent book "Tail Risk Killers" that Jacob recommended elsewhere also explores what happens when markets become untradeable. There may be no equilibria at all in such circumstances.
"The Misbehavior of Markets" by Benoit Mandelbrot explores these issues: See reviews at http://www.amazon.com/The-Misbehavior-M ... ewpoints=1
The recent book "Tail Risk Killers" that Jacob recommended elsewhere also explores what happens when markets become untradeable. There may be no equilibria at all in such circumstances.
As it is, the EMH just provides ammunition to professional non-investors (I shan't mention any names here) who refuse to think that any amateur can beat any professional; and to the latter, the market savvy, for implying that their efforts are worthless.
@jacob - I've more frequently seen the EMH used to suggest the opposite: that the average investor can beat any professional simply by investing in an index for long enough.
ToFI -- Under the EMH, it's perfectly possible for an individual to beat the market through chance as opposed to skill or expert stock selection. One individual doing better than the total stock market return is not really evidence for or against the EMH as it could be adequately explained by either cause (skill or chance).
The last sentence in the definition you quoted should probably be changed from "the only way an investor can possibly obtain higher returns "to "the only way an investor can possibly obtain higher expected returns"
"Value investors tend to able to beat the market." -- I consider this to primarily be a risk story and not necessarily contradictory to the EMH. My own portfolio is heavily weighted to value stocks through various index funds.
The last sentence in the definition you quoted should probably be changed from "the only way an investor can possibly obtain higher returns "to "the only way an investor can possibly obtain higher expected returns"
"Value investors tend to able to beat the market." -- I consider this to primarily be a risk story and not necessarily contradictory to the EMH. My own portfolio is heavily weighted to value stocks through various index funds.
@jennypenny
They only look at change in share price without the study of underlying business aka technical analysis.
For example, the market values a business returning 10% ROI in the long term at PE 10 and another business returning 20% ROI in the long term at PE 20. So the market adds a premium to higher quality business. The key is long term. Short term performance is meaningless. Which stock will perform better in the long term. Note: The second business is not necessarily riskier. You can have a money losing business with a low valuation but stay low for long term because it's a money losing business therefore the stock price is not going anywhere. To borrow from Robert Kiyosaki: It's not the investment that's risky. It's the investor that's risky.
@Dragline
Investopedia's definition is the same as Wikipedia unless both are wrong. It's essentially saying investors can't beat the market without taking extra risk than the market.
I agree EMH in a way that the stock price reflects most information available but I disagree that investors can't beat the market without taking extra risk.
Wiki:
"In finance, the efficient-market hypothesis (EMH) asserts that financial markets are "informationally efficient". In consequence of this, one cannot consistently achieve returns in excess of average market returns on a risk-adjusted basis, given the information available at the time the investment is made. "
@m741
What Jacob mentioned are those trying to sell low cost index fund and high cost mutual fund.
What you mentioned are those try to sell low cost index fund only.
They only look at change in share price without the study of underlying business aka technical analysis.
For example, the market values a business returning 10% ROI in the long term at PE 10 and another business returning 20% ROI in the long term at PE 20. So the market adds a premium to higher quality business. The key is long term. Short term performance is meaningless. Which stock will perform better in the long term. Note: The second business is not necessarily riskier. You can have a money losing business with a low valuation but stay low for long term because it's a money losing business therefore the stock price is not going anywhere. To borrow from Robert Kiyosaki: It's not the investment that's risky. It's the investor that's risky.
@Dragline
Investopedia's definition is the same as Wikipedia unless both are wrong. It's essentially saying investors can't beat the market without taking extra risk than the market.
I agree EMH in a way that the stock price reflects most information available but I disagree that investors can't beat the market without taking extra risk.
Wiki:
"In finance, the efficient-market hypothesis (EMH) asserts that financial markets are "informationally efficient". In consequence of this, one cannot consistently achieve returns in excess of average market returns on a risk-adjusted basis, given the information available at the time the investment is made. "
@m741
What Jacob mentioned are those trying to sell low cost index fund and high cost mutual fund.
What you mentioned are those try to sell low cost index fund only.