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This is a misinterpretation of what is meant by the efficient market hypothesis. "a hypothesis that states that share prices reflect all information and consist

This is a misinterpretation of what is meant by the efficient market hypothesis. "a hypothesis that states that share prices reflect all information and consistent alpha generation is impossible". What they're saying is that the market correctly sets share prices based on available information. To say that the market is considering available information is tautological and not interesting. The EMH as its popularly understood is not just "the market considers information" (again, not an interesting claim) but "the market considers all information and synthesizes it correctly" which is deflating to hopeful investors and trivially false. My examples are contradictions to this hypothesis.

YZF 6y ago
The point is that you can not beat the market with your interpretation of the available information. This is not a question of the correctness of any given interpretation. Correctness can never be determined, there is no "correct" or "incorrect" interpretation of the available information. EDIT: So one thing to consider is that markets are predictive. A "correct" interpretation is only correct if it can predict what will happen in the future. And because the future is not predictable (proof needed but whatever) there is no way to know which interpretation is "correct".
- philosopher1234 6y ago
  But this is also obviously false. Markets are subject to human phenomena, like mob mentality, which is the theme of the examples I listed. The same way fantastic tennis players can consistently outperform the rest of the competition, fantastic traders can certainly outperform others. Of course, in an ultra competitive environment, with a massive number of constant competitors, its very hard to retain a number one spot. Its also hard to predict markets because of the very fact that they're inefficient and irrational. There are so many active participants its hard to predict how they will react to available information. Take 2008 for instance. There was public information demonstrating fatal weakness in the housing market, but it was neglected en masse. This makes it very hard to beat the market. Even if you're correct, the market could decide to ignore the facts, and you wouldn't be able to reap any alpha from your observation.
  - imtringued 6y ago
    You don't seem to understand the problem. If there is a way to consistently "beat" the market then everyone will adopt the strategy and you're no longer ahead. The only way you can beat the market is by having exclusive access to information or opportunities (dumb luck) and by definition the vast majority of people do not have these, otherwise they wouldn't be exclusive.
    - ashtonkem 6y ago
      But that’s obviously not true, at least not all of the time. In 2008 there was plenty of information indicating that the market was not healthy, and a number of market actors spotted this early on and won big betting against what the market was doing. They neither had insider information nor was it luck; the market in 2008 was catastrophically wrong about what the price of mortgage backed CDOs should be.
    - thebean11 6y ago
      > If there is a way to consistently "beat" the market then everyone will adopt the strategy and you're no longer ahead. Sure, assuming every market participant has knowledge of the winning strategy, and the skills to employ it..which is a pretty big caveat. By this logic why do some chess players beat others? Wouldn't they all simply adopt the same strategy?
danielbarla 6y ago
I'm stuck between these definitions, which seem to represent polar opposites. On the one hand, I can follow the argument and agree that by that definition, it is "trivially false". However, how do you square this with the generally correct observation that investors in the long term cannot / don't seem to be able to outperform the markets? Or do you feel this is wrong?
- philosopher1234 6y ago
  I think it is true that it is very hard to beat the market. That can be true without the market being perfectly efficient. The way I see it is that the market is ultra competitive and full of very competent & very rational (not perfectly rational) individuals with a very high incentive to interpret facts correctly. So its not easy to beat the market. You have to be very knowledgeable, and invest very deeply in order to generate insights your competitors dont have. As another commenter mentioned, its not clear to me how economically sensible it is to make this kind of investment. If you play chess against someone, and you discover a winning strategy, and you play it repeatedly, they'll eventually discover your strategy and be able to counter you. Your opponents in the market are adaptive in this same way, so trying to always stay ahead is very hard. Some funds find some way (which I am not privy to) to succeed at this, and people still make boat loads of money as professional traders or quants, so there is reason to believe it is possible. The fact that it is possible to have a very successful career in finance as a quant or trader also seems to me like evidence the efficient market hypothesis (taken in its strongest form, that markets are perfectly efficient) is false.
  - imtringued 6y ago
    >The fact that it is possible to have a very successful career in finance as a quant or trader also seems to me like evidence the efficient market hypothesis (taken in its strongest form, that markets are perfectly efficient) is false. It's the opposite. Traders increase market efficiency up to a certain point. If traders didn't exist then markets couldn't be efficient in the first place. Liquidity problems would persist and cause large spreads between buy and sell prices.
- 6y ago
AmericanChopper 6y ago
> "the market considers all information and synthesizes it correctly" This is a further misrepresentation of the efficient market hypothesis. The efficient market hypothesis states that the price agreed upon by the market is accurate to a risk-adjusted level, to the extent that it is not possible to consistently beat the returns of the market. This is generally proven true by the fact that most funds fail to beat their benchmarks in any given year, and the more long term you start to look, the closer the number of funds that outperform their benchmarks gets to 0. Page 9 of this document shows this quite conclusively: https://www.spglobal.com/spdji/en/documents/spiva/spiva-us-year-end-2019.pdf https://www.spglobal.com/spdji/en/documents/spiva/spiva-us-y... Anybody who "beats the market" on any given day could only achieve that by discovering an inefficiency in the markets decision making. The efficient market hypothesis doesn't say that this is impossible. It says that it's impossible to do this consistently, which is reflected quite accurately in the historical performance of mutual funds. I guess the theory is flawed in the sense that it doesn't define how long you have to beat the market for before you can be considered 'consistent' at it, but I'd consider the small number of funds that achieve this over any significant period as being within the error bars of luck.
- deleted 6y ago
  [deleted]

YZF 6y ago

The point is that you can not beat the market with your interpretation of the available information. This is not a question of the correctness of any given interpretation. Correctness can never be determined, there is no "correct" or "incorrect" interpretation of the available information. EDIT: So one thing to consider is that markets are predictive. A "correct" interpretation is only correct if it can predict what will happen in the future. And because the future is not predictable (proof needed but whatever) there is no way to know which interpretation is "correct".

philosopher1234 6y ago
But this is also obviously false. Markets are subject to human phenomena, like mob mentality, which is the theme of the examples I listed. The same way fantastic tennis players can consistently outperform the rest of the competition, fantastic traders can certainly outperform others. Of course, in an ultra competitive environment, with a massive number of constant competitors, its very hard to retain a number one spot. Its also hard to predict markets because of the very fact that they're inefficient and irrational. There are so many active participants its hard to predict how they will react to available information. Take 2008 for instance. There was public information demonstrating fatal weakness in the housing market, but it was neglected en masse. This makes it very hard to beat the market. Even if you're correct, the market could decide to ignore the facts, and you wouldn't be able to reap any alpha from your observation.
- imtringued 6y ago
  You don't seem to understand the problem. If there is a way to consistently "beat" the market then everyone will adopt the strategy and you're no longer ahead. The only way you can beat the market is by having exclusive access to information or opportunities (dumb luck) and by definition the vast majority of people do not have these, otherwise they wouldn't be exclusive.
  - ashtonkem 6y ago
    But that’s obviously not true, at least not all of the time. In 2008 there was plenty of information indicating that the market was not healthy, and a number of market actors spotted this early on and won big betting against what the market was doing. They neither had insider information nor was it luck; the market in 2008 was catastrophically wrong about what the price of mortgage backed CDOs should be.
  - thebean11 6y ago
    > If there is a way to consistently "beat" the market then everyone will adopt the strategy and you're no longer ahead. Sure, assuming every market participant has knowledge of the winning strategy, and the skills to employ it..which is a pretty big caveat. By this logic why do some chess players beat others? Wouldn't they all simply adopt the same strategy?

danielbarla 6y ago

I'm stuck between these definitions, which seem to represent polar opposites. On the one hand, I can follow the argument and agree that by that definition, it is "trivially false". However, how do you square this with the generally correct observation that investors in the long term cannot / don't seem to be able to outperform the markets? Or do you feel this is wrong?

philosopher1234 6y ago
I think it is true that it is very hard to beat the market. That can be true without the market being perfectly efficient. The way I see it is that the market is ultra competitive and full of very competent & very rational (not perfectly rational) individuals with a very high incentive to interpret facts correctly. So its not easy to beat the market. You have to be very knowledgeable, and invest very deeply in order to generate insights your competitors dont have. As another commenter mentioned, its not clear to me how economically sensible it is to make this kind of investment. If you play chess against someone, and you discover a winning strategy, and you play it repeatedly, they'll eventually discover your strategy and be able to counter you. Your opponents in the market are adaptive in this same way, so trying to always stay ahead is very hard. Some funds find some way (which I am not privy to) to succeed at this, and people still make boat loads of money as professional traders or quants, so there is reason to believe it is possible. The fact that it is possible to have a very successful career in finance as a quant or trader also seems to me like evidence the efficient market hypothesis (taken in its strongest form, that markets are perfectly efficient) is false.
- imtringued 6y ago
  >The fact that it is possible to have a very successful career in finance as a quant or trader also seems to me like evidence the efficient market hypothesis (taken in its strongest form, that markets are perfectly efficient) is false. It's the opposite. Traders increase market efficiency up to a certain point. If traders didn't exist then markets couldn't be efficient in the first place. Liquidity problems would persist and cause large spreads between buy and sell prices.
6y ago

AmericanChopper 6y ago

> "the market considers all information and synthesizes it correctly" This is a further misrepresentation of the efficient market hypothesis. The efficient market hypothesis states that the price agreed upon by the market is accurate to a risk-adjusted level, to the extent that it is not possible to consistently beat the returns of the market. This is generally proven true by the fact that most funds fail to beat their benchmarks in any given year, and the more long term you start to look, the closer the number of funds that outperform their benchmarks gets to 0. Page 9 of this document shows this quite conclusively: https://www.spglobal.com/spdji/en/documents/spiva/spiva-us-year-end-2019.pdf https://www.spglobal.com/spdji/en/documents/spiva/spiva-us-y... Anybody who "beats the market" on any given day could only achieve that by discovering an inefficiency in the markets decision making. The efficient market hypothesis doesn't say that this is impossible. It says that it's impossible to do this consistently, which is reflected quite accurately in the historical performance of mutual funds. I guess the theory is flawed in the sense that it doesn't define how long you have to beat the market for before you can be considered 'consistent' at it, but I'd consider the small number of funds that achieve this over any significant period as being within the error bars of luck.

deleted 6y ago
[deleted]