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The price of a security is, formally speaking, a (weighted) sum of many disparate data points related to the security. The more data is available about the secu
by dsacco 9y ago
The price of a security is, formally speaking, a (weighted) sum of many disparate data points related to the security. The more data is available about the security, the more efficiently it's priced. Individuals do not need to explicitly share information about any given security to each other for it to spread through the market, because there exists a feedback cycle between any security and the publicly available data related to it. The price is literally a function of that information.
In other words, every time a security is traded, its price is updated with a very small amount of new information. It's not important that any single individual has all the information, it's important that the market has all the information. That is the essential function of the market - price discovery. No single investor (or even a team) could hope to accurately encapsulate everything there is to know about a given security. The market "prices" new information into a security, which is precisely what it means for data to be diffused.
Stated another way, novel information about a security represents a potential price inefficiency. But that price inefficiency is essentially lost once the data has become public.
- vanderZwan 9y ago> it's important that the market has all the information. I'll be honest with you: when I read this my first response was "what does this even mean? What is "the market" and how does it "have information"?" I guess the sentences preceding it are supposed to explain the structure that the market has built up to automagically capture this information, but I don't quite follow. I'm not criticising your comments, I'm very grateful that you are trying to explain how this works and the logic behind it, but so far it's black-box abstractions all the way down.
- Retric 9y agoSuppose you have: A current price aka price at last trade of 10$ and nobody willing to sell for less than 10$ and nobody willing to buy for more than 9.99$. A new seller shows up, if they are willing to wait they might get more than 9.99$ or they can accept 9.99$. Or a new buyer shows up they can buy for 10$ or wait for a lower price. Now, without effort people can just look at the history of trades and see the price rise or fall. This is independent of whatever reason that causes more people to suddenly want to buy or sell, just the fact that people are buying or selling in it's self moves the price.
- vanderZwan 9y agoOk, so half-guessing at what you meant, wouldn't this be the crux of the problem then: > In other words, every time a security is traded, its price is updated with a very small amount of new information. The update happens after trading, so before that the price is by definition outdated, meaning it has that bit of "inefficiency" you spoke about. Hence "doing your homework" as a hedge-fund manager would in theory allow you to spot this inefficiency and make better trades.
- dsacco 9y agoYes, that's mostly correct. But I'm not sure what your question is. It's not enough to have the data, you also have to have reasonable confidence in how the price will change once the information does impact the market. There's practically an eternity of information available, but you can't use all of it. You have to pick and choose. Moreover, you have to choose how much to weight any particular set of data with respect to another. This is not to say that most hedge funds are right to ignore any given set of meaningful data. It just means that they have to make decisions about which data to use and how much they'll prioritize it. Then they have to see if they have the requisite infrastructure to trade on that information before anyone else.