Are Markets Efficient? - The Daily Reckoning
The Daily Reckoning by Bill Bonner
On This Day - 8 March 2014
Are Markets Efficient? A  A  A

- By Asad Dossani, Author, The Lucrative Derivative Report

Asad Dossani
One of the biggest debates among investors and other finance practitioners is whether markets are efficient. Market efficiency means that current prices reflect all information, i.e. market prices correctly reflect the intrinsic value. Market efficiency also implies that it is not possible for an investor to consistently outperform the stock market over long periods of time. If an investor believes that markets are efficient, they should invest in an index fund and avoid trying to outperform the market.

On the other hand, if markets are inefficient, it means that prices regularly deviate from their intrinsic values. This means that an investor who can identify these inefficiencies can make profits by trading on them. One example of inefficiency is the value effect that we discussed last week. The value effect is the tendency for stocks with low P/E ratios and low P/B ratios to outperform the market over time.

It turns out that there is evidence to support both views. In support of the view that markets are efficient, in practice most investors have a difficult time beating the market. This implies that there are very few inefficiencies one can take advantage of, and so the markets must be efficient. On the other hand, evidence such as the value effect show us that it is possible to consistently beat the market if we can find good value stocks.

The answer to the question of whether market is efficient will elicit a variety of responses. In my experience, there are inefficiencies in the market we can exploit, but they are typically difficult to find. In order to make high returns, it a takes a lot of effort and one has to take more risk to earn these returns.

Rather than think of markets as containing easy inefficiencies to take advantage of, the more realistic view is that we can earn high returns if we put in more effort to find profitable opportunities. Thus, earning higher returns is like a compensation for putting in more effort and taking on more risk. This view is consistent with the idea that it is difficult to beat the market but inefficiencies do exist in markets that we can take advantage of.

In the Equitymaster club forum, we are asking the question "Do you think markets are efficient?" We encourage you to please log in and post your views.

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is a financial analyst and columnist. He actively trades his own and others' funds, investing primarily in currency, commodity, and stock index derivative products. Prior to this, he worked at Deutsche Bank as an analyst in the FX derivatives team. He is a graduate of the London School of Economics. Asad is a keen observer of macroeconomic trends and their effects on global financial markets. He is deeply passionate about educating investors, and encouraging individuals to take part in and profit from financial markets. To put it colloquially, he wishes to take Wall Street products and turn them into Main Street profits!

The views mentioned above are of the author only. Data and charts, if used, in the article have been sourced from available information and have not been authenticated by any statutory authority. The author and Equitymaster do not claim it to be accurate nor accept any responsibility for the same. The views constitute only the opinions and do not constitute any guidelines or recommendation on any course of action to be followed by the reader. Please read the detailed Terms of Use of the web site.

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1 Responses to "Are Markets Efficient?"

Prof H.S. Kalra

Mar 9, 2014

Efficient markets do not mean mean you cannot beat the market. But you cannot beat the market consistently.

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