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One thing to keep in mind before starting any finance project is the efficient market hypothesis. In order for you to make a profit relative to the market, you

One thing to keep in mind before starting any finance project is the efficient market hypothesis. In order for you to make a profit relative to the market, you must by definition be better at modeling than everyone else. (There are certain caveats in terms of liquidity and leverage, but the general theme is correct). I'll only note that beating everyone else is quite challenging, especially when you are competing against very well funded trading firms. EDIT: Slight fix of wording as suggested by comment below.

ditonal 7y ago
The joke is, two economists are walking down the street, and one sees a $100 bill on the ground, and the other says don't bother going to pick it up, if it was really $100, someone would have already picked it up.
- sandoooo 7y ago
  A million pairs of economists walked down a million streets in a million possible worlds, but no jokes were made there because they didn't find squat.
throwlaplace 7y ago
the efficient market hypothesis is an axiom use to simplify models not an empirical fact. that's why it's a hypothesis not a law.
fancyfredbot 7y ago
The models here actually assume efficient markets and no arbitrage. You calibrate them to market, and if you use them to price a market traded derivative you hope they give you the market price you put in (if not then by definition they've gone wrong). They are useful for pricing or replicating other derivatives without available prices, but not really aimed at getting an edge on the market.
- smabie 7y ago
  Sure they are. If the price you calculated and the price in the market is significantly different, the law of no arbitrage is violated and therefore you have can fulfill your sworn duty as a market participant and arbitrage it away until everything is hunkydory again.
  - infinite8s 7y ago
    Thats also the reason why the market can never go to 100% passively managed money.
    - xorfish 7y ago
      yes, but 99% is possible.
      - smabie 7y ago
        Possible, but would negatively affect liquidity and increase volatility. Trading would become more expensive as well.
smabie 7y ago
What you’re saying is not what EMH says at all. EMH posits that there is only one Sharpe ratio: the market Sharpe. In other words, I cannot earn better risk adjusted returns than the market. But anyways, no one actually believes that. EMH is used as a framework to price securities and as a way to reason about the market. Quant finance doesn’t work without the no arbitrage condition and therefore, EMH. EMH has absolutely nothing to do with “making a profit.” If fact, quant finance and EMH are built on a sure fire way to make a profit: the risk-free rate. In short, while alpha is, by definition, a zero sum game, beta is not. So we can make profit pretty easily, and this is what most of the world does: obtain exposure to beta and make money.
- lalaland1125 7y ago
  Correct. I should have been explicit. By "profit", I meant profit relative to the market. I do agree that the EMH doesn't exactly hold. Empirical proof of that is the existence of profitable trading firms. However, the reasoning behind EMH does imply something about the difficulty of earning profit relative to the market. And I do think it is a theory that people should be aware of when they start trying to understand finance.
  - xorfish 7y ago
    Isn't the whole point of these forms arbitrage? There is lots of data that shows that active managers don't do better than the market.
    - throwawaymath 7y ago
      No, there is a lot of evidence showing that most active managers, investors and analysts can't outperform the market. There are counterexamples which demonstrate consistent outperformance, they're just the minority. Likewise most basketball players aren't good enough to join the NBA, and most players in the NBA aren't good enough to secure $10 - 100 million contracts. The EMH doesn't even preclude the possibility of consistently beating the market (consistently mining alpha); it simply states that the cost of providing those investments as a service rationally rises to cannibalize the outsized returns, so it becomes a wash. We see this in practice: the well known hedge funds which demonstrate consistent alpha eventually close their doors to outside investors. Why pool risk with external capital when you're printing money? Investors are a hassle and no strategy can scale infinitely. When you can consistently mine alpha it's strictly better to just become a prop shop and run on your own money.
dvt 7y ago
I think this post is being unfairly downvoted. The idea is that making money via stock market trading is hard and that doing it consistently is even harder. Sure, one of us might be the next George Soros, but it's important to keep expectations curbed.
- ci5er 7y ago
  > Sure, one of us might be the next George Soros, but it's important to keep expectations curbed. He made his first big money by shorting the pound, which (to me, oddly) turned out to be a self-perpetuating burn-it-all-down machine. Which required that he had the resources to place the bet in the first place, but much like LTCM, kind of self-funded after the first dominoe fell. So - great financial system hacker! For sure! Stock picker? I'm not quite so certain. (It's possible you know enough more about this than I, that I could be overlooking some great "picking" behavior. I'd love to learn.)
galaxyLogic 7y ago
I agree. But at the same time stock-market is not zero-sum because economy is growing, productivity is increasing due to innovation. So the question is how to take the maximum possible slice of the growth in the pie. Can quants help? That I am not certain. And many people like re-creational gambling. So why not gamble on a non-zero sum game, the stock-market?
logicchains 7y ago
It's only an efficient market because of arbitrage. If the price of copper futures in Europe suddenly soars, the price of copper futures in America doesn't magically, spontaneously rise to meet it; somebody has to do the work. You don't need to be better at modelling, you just need to be faster, or have a way of getting information earlier.
- bdkoepke 7y ago
  Not necessarily true; if you got a mark on copper futures in Europe then you would expect the best American copper futures bid/ask to change fast. Updating bid/ask doesn't require trading.
  - infinite8s 7y ago
    It requires active participants in the market.
deleted 7y ago
[deleted]

ditonal 7y ago

The joke is, two economists are walking down the street, and one sees a $100 bill on the ground, and the other says don't bother going to pick it up, if it was really $100, someone would have already picked it up.

sandoooo 7y ago
A million pairs of economists walked down a million streets in a million possible worlds, but no jokes were made there because they didn't find squat.

throwlaplace 7y ago

the efficient market hypothesis is an axiom use to simplify models not an empirical fact. that's why it's a hypothesis not a law.

fancyfredbot 7y ago

The models here actually assume efficient markets and no arbitrage. You calibrate them to market, and if you use them to price a market traded derivative you hope they give you the market price you put in (if not then by definition they've gone wrong). They are useful for pricing or replicating other derivatives without available prices, but not really aimed at getting an edge on the market.

smabie 7y ago
Sure they are. If the price you calculated and the price in the market is significantly different, the law of no arbitrage is violated and therefore you have can fulfill your sworn duty as a market participant and arbitrage it away until everything is hunkydory again.
- infinite8s 7y ago
  Thats also the reason why the market can never go to 100% passively managed money.
  - xorfish 7y ago
    yes, but 99% is possible.
    - smabie 7y ago
      Possible, but would negatively affect liquidity and increase volatility. Trading would become more expensive as well.

smabie 7y ago

What you’re saying is not what EMH says at all. EMH posits that there is only one Sharpe ratio: the market Sharpe. In other words, I cannot earn better risk adjusted returns than the market. But anyways, no one actually believes that. EMH is used as a framework to price securities and as a way to reason about the market. Quant finance doesn’t work without the no arbitrage condition and therefore, EMH. EMH has absolutely nothing to do with “making a profit.” If fact, quant finance and EMH are built on a sure fire way to make a profit: the risk-free rate. In short, while alpha is, by definition, a zero sum game, beta is not. So we can make profit pretty easily, and this is what most of the world does: obtain exposure to beta and make money.

lalaland1125 7y ago
Correct. I should have been explicit. By "profit", I meant profit relative to the market. I do agree that the EMH doesn't exactly hold. Empirical proof of that is the existence of profitable trading firms. However, the reasoning behind EMH does imply something about the difficulty of earning profit relative to the market. And I do think it is a theory that people should be aware of when they start trying to understand finance.
- xorfish 7y ago
  Isn't the whole point of these forms arbitrage? There is lots of data that shows that active managers don't do better than the market.
  - throwawaymath 7y ago
    No, there is a lot of evidence showing that most active managers, investors and analysts can't outperform the market. There are counterexamples which demonstrate consistent outperformance, they're just the minority. Likewise most basketball players aren't good enough to join the NBA, and most players in the NBA aren't good enough to secure $10 - 100 million contracts. The EMH doesn't even preclude the possibility of consistently beating the market (consistently mining alpha); it simply states that the cost of providing those investments as a service rationally rises to cannibalize the outsized returns, so it becomes a wash. We see this in practice: the well known hedge funds which demonstrate consistent alpha eventually close their doors to outside investors. Why pool risk with external capital when you're printing money? Investors are a hassle and no strategy can scale infinitely. When you can consistently mine alpha it's strictly better to just become a prop shop and run on your own money.

dvt 7y ago

I think this post is being unfairly downvoted. The idea is that making money via stock market trading is hard and that doing it consistently is even harder. Sure, one of us might be the next George Soros, but it's important to keep expectations curbed.

ci5er 7y ago
> Sure, one of us might be the next George Soros, but it's important to keep expectations curbed. He made his first big money by shorting the pound, which (to me, oddly) turned out to be a self-perpetuating burn-it-all-down machine. Which required that he had the resources to place the bet in the first place, but much like LTCM, kind of self-funded after the first dominoe fell. So - great financial system hacker! For sure! Stock picker? I'm not quite so certain. (It's possible you know enough more about this than I, that I could be overlooking some great "picking" behavior. I'd love to learn.)

galaxyLogic 7y ago

I agree. But at the same time stock-market is not zero-sum because economy is growing, productivity is increasing due to innovation. So the question is how to take the maximum possible slice of the growth in the pie. Can quants help? That I am not certain. And many people like re-creational gambling. So why not gamble on a non-zero sum game, the stock-market?

logicchains 7y ago

It's only an efficient market because of arbitrage. If the price of copper futures in Europe suddenly soars, the price of copper futures in America doesn't magically, spontaneously rise to meet it; somebody has to do the work. You don't need to be better at modelling, you just need to be faster, or have a way of getting information earlier.

bdkoepke 7y ago
Not necessarily true; if you got a mark on copper futures in Europe then you would expect the best American copper futures bid/ask to change fast. Updating bid/ask doesn't require trading.
- infinite8s 7y ago
  It requires active participants in the market.

deleted 7y ago

[deleted]