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I love the belief in the efficient market hypothesis as an active investor, because it means so much less competition. I am saddened by the belief in the effici

I love the belief in the efficient market hypothesis as an active investor, because it means so much less competition. I am saddened by the belief in the efficient market hypothesis as a lover of fellow humans, because it is such a colossal untruth that it harms people immensely and takes away agency. If you understand an industry or market segment deeply, you can indeed do much better than the index within that segment. It’s a fact born out by my own experience - you can separate a MongoDB from an AWS if you know a bit about technology and don’t look simply at press releases and Gartner reports.

xyzelement 4y ago
I think the efficient markers hypothesis kinda accounts for that. Like, if Mongo is mispriced relative to Amazon, and you confidently see it, you will trade accordingly and erase the price difference. In what I recall from my CFA studies, research shows that only genuine insider information can consistent outperform the assumption that all information is already priced in. And for example, let's say you perceive Amazon and Mongo as mispriced, but what if that's because some even bigger expert than you saw something you didn't and traded accordingly? (For what it's worth, I used to work for one of the world's most significant hedge funds. Our win/loss rate on trades was something like 52/48. So even as literally the worlds top investors who spent more effort, brainpower and money to gain insight, we were right just a bit over half the time. It really drew the point home that a random non-insider individual who thinks can do that over decades is likely delusional)
- monero-xmr 4y ago
  It has to do with amount of capital, time horizon on the investment, how early you are, and all manner of things. It’s much easier for the individual investor to deploy capital than a hedge fund that has huge bags and therefore needs to make huge trades. There are benefits to being small as well as negatives to being huge. Writing off any ability to beat the market is defeatist because it happens all the time. Someone has to buy the mis-priced stock and it isn’t high frequency firms who exit positions every night.
  - xyzelement 4y ago
    I agree that someone has to buy the mispriced stock. I disagree (because of evidence to the contrary) that someone can consistently identify the genuine mispricings in a way that pays off on risk adjusted basis.
    - greenyouse 4y ago
      There are some market inefficiencies that have been documented but they seem rare. The post earnings announcement drift (PEAD)[0] is a thing that exists but shouldn't if markets were totally efficient. That gets used for gains pretty consistently but not 100% of the time. Euan Sinclair had a book where he mentioned a return of 9-27% when traded on annually.[1] Some of the big players have moves like that which work well given the right market conditions. My guess is that they have many, many patterns like that to trade on or models which are right more often than not. I don't know anything though since I'm a 101 retail investor... Positional options trading and volatility stuff makes my brain hurt :( Have you seen strategies like that before? It's really interesting to dig into but seems to require a lot of knowledge to know how to trade on. [0] https://en.wikipedia.org/wiki/Post%E2%80%93earnings-announcement_drift https://en.wikipedia.org/wiki/Post%E2%80%93earnings-announce... [1] Positional Options Trading: An Advanced Guide, pg. 90
- jongjong 4y ago
  The main problem with efficient market hypothesis is that it pretends that the only way to get money out of the economy is by providing economic value for others who also provide economic value. It ignores the fact that participants within the system are only efficient with respect to the basic incentive structure created by the monetary system which itself is highly inefficient and wasteful. The government could essentially just print money to incentivize people to push a boulder up and down a mountain for no reason... You can be sure that those who will get paid the most will the the fittest ones who can push the boulders up faster than anyone else; the most efficient boulder pushers if you like... But can it be said that these people are efficient at all in the grand scheme of things? Is it an efficient market if the monetary environment within which those markets exists is itself artificial and inefficient?
  - lupire 4y ago
    You are describing an unfree market. By definition, the EMH applies to a free market where people choose where to put their money. The EMH says nothing about efficiency of producing value, only about price discovery.
    - dragonwriter 4y ago
      > By definition, the EMH applies to a free market where people choose where to put their money. “The EMH only applies to an idealized analytical fiction and is not applicable to the real world” would also be a problem with the EMH.
      - jongjong 4y ago
        Totally. It is a valid critique. Suggesting that it's valuable in a hypothetical environment is similar to the "not true communism" defense used by communists to explain past failures.
  - scottLobster 4y ago
    Uh, yes. Have you not been paying attention to the weekly "what potential fed action is the market pricing in this week?" articles? Efficient markets take into account everything from politics to corruption to the odds of natural disasters. I'm not sure where you read otherwise. You think investors don't price in the political risk of dealing with, say the Chinese government? You think bond investors aren't paying attention to the fed?
- skippyboxedhero 4y ago
  > In what I recall from my CFA studies, research shows that only genuine insider information can consistent outperform the assumption that all information is already priced in. Even if you assume there are no information inequalities outside of inside information (there are), markets are myopic. Expectations focus around one scenario which is why you see slow adjustments to trends. Btw, it is actually worse than people think: I have countless anecdotes from execs who run companies, who were "experts", who had substantial inside information and were still unable to predict industry trends better than me. There is a social, cultural, institutional context...you see vastly different investor behaviour even between countries that are very similar (i.e. US/UK). This focus on information above all is a conceit to assist the construction of economic theories, not a distinction that is useful in practice. Also, you may or may not have worked for a very impressive hedge fund but win rate tells you nothing about profitability. I know a fund that made one decision in 1992, made poor decisions constantly after, almost everyone who works there is worth $100m+, and they manage $100bn. You can go 10 years with only one good idea and outperform everyone else. Win rate means nothing.
- rofo1 4y ago
  > It really drew the point home that a random non-insider individual who thinks can do that over decades is likely delusional) You are, of course, correct, and it has been proven time and time again. People think that just because we had a few years of 0% rates that they are somehow geniuses who can do 15% CAGR for 50 years without a problem. In reality, almost nobody can beat the S&P500 low-cost index fund, after all expenses. People still dream, though.
paulpauper 4y ago
The EMH is not perfect but it seems to be the most accurate. When a stock tanks, usually this precedes negative developments about the company that are later made public. Price action precedes news. Markets are not efficient all the time, but efficient enough of the time to make it useful, at least from a theoretical perspective, anyway.
wmf 4y ago
MongoDB sucks but the stock 10Xed. I probably could make money by betting against quality every time but passive investing is far less depressing.
- skippyboxedhero 4y ago
  I remember seeing a retailer that was literally dead in the water the second they IPO'ed then 5x and collapse twice over ten years...they still aren't dead but have collapsed permanently. Large companies are often able to generate low-quality growth that keeps things going for a few more years. The trick is distinguishing between high and low quality growth. Tech companies can add more sales people, that is easy, it can keep things going whilst equity markets are open. Quality growth can't be bought like a salesperson. MDB was always seemed anomalous to me, I am not surprised they are down 65% because competition is only increasing. But, either way, the real money is on the long side (predicting which companies are going to fail is a lot easier than predicting success, the problem is funding that position and what happens in the middle because companies have so many ways to fake success until the next bear market).
julianeon 4y ago
Can you do it for years though? How about decades? The evidence is that even the Harvard-trained finance grads, best of their class, making 1 million a year, heading the very best funds, with 2nd degrees in mathematics etc., cannot do this. I almost feel like the discussion at this point should proceed straight to "no anecdotes please, show your work" (evidence, data, the more the better). The evidence is extremely strong that the index fund strategy vs. human fund managers contest is really just another form of the computer chess strategy vs. human chess player one (or Go, if you prefer that). Just think of it as 'computer game players vs. human game players,' as a category. It really isn't much of a contest in the long term. The computers have been winning, and will continue to win, as history is ever more on their side.
- monero-xmr 4y ago
  As you might guess from my username, one area where I made insane gains is in cryptocurrency, and not because of a Ponzi “greater fool theory” but by carefully analyzing bitcoin and Ethereum (primarily) from economic, technological, and philosophical principles and making investments that I have held for a very long time. My gains are so overwhelmingly absurd and contrary to the supposed “Harvard experts” that making such a calculated, reasoned bet should have been impossible. Yet I have made investments in so many things over the years, so I don’t know how to square it other than, “I personally read the evidence, investigated the tech, thought about it logically, ignored the experts (and HN might I add!)”. According to the efficient market hypothesis such things should be impossible.
  - doubleunplussed 4y ago
    The EMH doesn't say these things are impossible, it says you got lucky and won't be able to reproduce the same gains better than chance in the future.
    - monero-xmr 4y ago
      And I 110% disagree or my many and varied investments wouldn’t continue to far better than an index fund. As another recent example I went hard into oil and gas via ETFs back in May. Why I did this is for various reasons but my conclusion was that demand would surge and supply was constrained. Almost a 2x and that’s in liquid positions. I have taken some profits but still gonna wait a bit. According to EMH I shouldn’t be able to do this, yet here I am sitting on tons of gains.
refurb 4y ago
I disagree strongly because I’ve made investments in the same industry I work in (biotech). Despite having domain knowledge, there are too many factors still out of your control. For example, the science could look great, big addressable market, then some safety issue pops up and the drug is pulled. Or the government changes the rules. Or the FDA does. So while domain knowledge gives you a leg up, you go from 1/100 like an average Joe to like 5/100, in terms of accurately predicting outcomes.
- monero-xmr 4y ago
  I think avoiding industries where the government has arbitrary and capricious power is wise. But even in biotech you can use insight.
nine_k 4y ago
I can't help but remember a classical joke. Two economics professors walk down a campus street, discussing the efficient markets hypothesis. One of them exclaims: — Look, there's something green down there on the pavement; looks very much like a $20 bill! — Nope, — answers the other, — it can't be. If that were indeed a $20 bill, somebody would have picked it up already! The efficient market hypothesis postulates some kind of a static equilibrium. The reality is not static, and the processes that lead to a new equilibrium are neither instant nor independent of subject area knowledge. Due to this, during that last year's bull market, I made a ton of upside on stocks where I understood the business and could make sense of obscure tech news, and nearly nothing on stocks that otherwise seemed like winners and were recommended by likes of fool.com.
- chii 4y ago
  that's why the EMH is just a hypothesis, and not a truth or fact. And even in the theory, they don't claim perfect efficiency - just nearly perfect. Some people obtain mispricings, take advantage of it, but in the process, push that efficiency up just a tid bit more.

xyzelement 4y ago

I think the efficient markers hypothesis kinda accounts for that. Like, if Mongo is mispriced relative to Amazon, and you confidently see it, you will trade accordingly and erase the price difference. In what I recall from my CFA studies, research shows that only genuine insider information can consistent outperform the assumption that all information is already priced in. And for example, let's say you perceive Amazon and Mongo as mispriced, but what if that's because some even bigger expert than you saw something you didn't and traded accordingly? (For what it's worth, I used to work for one of the world's most significant hedge funds. Our win/loss rate on trades was something like 52/48. So even as literally the worlds top investors who spent more effort, brainpower and money to gain insight, we were right just a bit over half the time. It really drew the point home that a random non-insider individual who thinks can do that over decades is likely delusional)

monero-xmr 4y ago
It has to do with amount of capital, time horizon on the investment, how early you are, and all manner of things. It’s much easier for the individual investor to deploy capital than a hedge fund that has huge bags and therefore needs to make huge trades. There are benefits to being small as well as negatives to being huge. Writing off any ability to beat the market is defeatist because it happens all the time. Someone has to buy the mis-priced stock and it isn’t high frequency firms who exit positions every night.
- xyzelement 4y ago
  I agree that someone has to buy the mispriced stock. I disagree (because of evidence to the contrary) that someone can consistently identify the genuine mispricings in a way that pays off on risk adjusted basis.
  - greenyouse 4y ago
    There are some market inefficiencies that have been documented but they seem rare. The post earnings announcement drift (PEAD)[0] is a thing that exists but shouldn't if markets were totally efficient. That gets used for gains pretty consistently but not 100% of the time. Euan Sinclair had a book where he mentioned a return of 9-27% when traded on annually.[1] Some of the big players have moves like that which work well given the right market conditions. My guess is that they have many, many patterns like that to trade on or models which are right more often than not. I don't know anything though since I'm a 101 retail investor... Positional options trading and volatility stuff makes my brain hurt :( Have you seen strategies like that before? It's really interesting to dig into but seems to require a lot of knowledge to know how to trade on. [0] https://en.wikipedia.org/wiki/Post%E2%80%93earnings-announcement_drift https://en.wikipedia.org/wiki/Post%E2%80%93earnings-announce... [1] Positional Options Trading: An Advanced Guide, pg. 90
jongjong 4y ago
The main problem with efficient market hypothesis is that it pretends that the only way to get money out of the economy is by providing economic value for others who also provide economic value. It ignores the fact that participants within the system are only efficient with respect to the basic incentive structure created by the monetary system which itself is highly inefficient and wasteful. The government could essentially just print money to incentivize people to push a boulder up and down a mountain for no reason... You can be sure that those who will get paid the most will the the fittest ones who can push the boulders up faster than anyone else; the most efficient boulder pushers if you like... But can it be said that these people are efficient at all in the grand scheme of things? Is it an efficient market if the monetary environment within which those markets exists is itself artificial and inefficient?
- lupire 4y ago
  You are describing an unfree market. By definition, the EMH applies to a free market where people choose where to put their money. The EMH says nothing about efficiency of producing value, only about price discovery.
  - dragonwriter 4y ago
    > By definition, the EMH applies to a free market where people choose where to put their money. “The EMH only applies to an idealized analytical fiction and is not applicable to the real world” would also be a problem with the EMH.
    - jongjong 4y ago
      Totally. It is a valid critique. Suggesting that it's valuable in a hypothetical environment is similar to the "not true communism" defense used by communists to explain past failures.
- scottLobster 4y ago
  Uh, yes. Have you not been paying attention to the weekly "what potential fed action is the market pricing in this week?" articles? Efficient markets take into account everything from politics to corruption to the odds of natural disasters. I'm not sure where you read otherwise. You think investors don't price in the political risk of dealing with, say the Chinese government? You think bond investors aren't paying attention to the fed?
skippyboxedhero 4y ago
> In what I recall from my CFA studies, research shows that only genuine insider information can consistent outperform the assumption that all information is already priced in. Even if you assume there are no information inequalities outside of inside information (there are), markets are myopic. Expectations focus around one scenario which is why you see slow adjustments to trends. Btw, it is actually worse than people think: I have countless anecdotes from execs who run companies, who were "experts", who had substantial inside information and were still unable to predict industry trends better than me. There is a social, cultural, institutional context...you see vastly different investor behaviour even between countries that are very similar (i.e. US/UK). This focus on information above all is a conceit to assist the construction of economic theories, not a distinction that is useful in practice. Also, you may or may not have worked for a very impressive hedge fund but win rate tells you nothing about profitability. I know a fund that made one decision in 1992, made poor decisions constantly after, almost everyone who works there is worth $100m+, and they manage $100bn. You can go 10 years with only one good idea and outperform everyone else. Win rate means nothing.
rofo1 4y ago
> It really drew the point home that a random non-insider individual who thinks can do that over decades is likely delusional) You are, of course, correct, and it has been proven time and time again. People think that just because we had a few years of 0% rates that they are somehow geniuses who can do 15% CAGR for 50 years without a problem. In reality, almost nobody can beat the S&P500 low-cost index fund, after all expenses. People still dream, though.

paulpauper 4y ago

The EMH is not perfect but it seems to be the most accurate. When a stock tanks, usually this precedes negative developments about the company that are later made public. Price action precedes news. Markets are not efficient all the time, but efficient enough of the time to make it useful, at least from a theoretical perspective, anyway.

wmf 4y ago

MongoDB sucks but the stock 10Xed. I probably could make money by betting against quality every time but passive investing is far less depressing.

skippyboxedhero 4y ago
I remember seeing a retailer that was literally dead in the water the second they IPO'ed then 5x and collapse twice over ten years...they still aren't dead but have collapsed permanently. Large companies are often able to generate low-quality growth that keeps things going for a few more years. The trick is distinguishing between high and low quality growth. Tech companies can add more sales people, that is easy, it can keep things going whilst equity markets are open. Quality growth can't be bought like a salesperson. MDB was always seemed anomalous to me, I am not surprised they are down 65% because competition is only increasing. But, either way, the real money is on the long side (predicting which companies are going to fail is a lot easier than predicting success, the problem is funding that position and what happens in the middle because companies have so many ways to fake success until the next bear market).

julianeon 4y ago

Can you do it for years though? How about decades? The evidence is that even the Harvard-trained finance grads, best of their class, making 1 million a year, heading the very best funds, with 2nd degrees in mathematics etc., cannot do this. I almost feel like the discussion at this point should proceed straight to "no anecdotes please, show your work" (evidence, data, the more the better). The evidence is extremely strong that the index fund strategy vs. human fund managers contest is really just another form of the computer chess strategy vs. human chess player one (or Go, if you prefer that). Just think of it as 'computer game players vs. human game players,' as a category. It really isn't much of a contest in the long term. The computers have been winning, and will continue to win, as history is ever more on their side.

monero-xmr 4y ago
As you might guess from my username, one area where I made insane gains is in cryptocurrency, and not because of a Ponzi “greater fool theory” but by carefully analyzing bitcoin and Ethereum (primarily) from economic, technological, and philosophical principles and making investments that I have held for a very long time. My gains are so overwhelmingly absurd and contrary to the supposed “Harvard experts” that making such a calculated, reasoned bet should have been impossible. Yet I have made investments in so many things over the years, so I don’t know how to square it other than, “I personally read the evidence, investigated the tech, thought about it logically, ignored the experts (and HN might I add!)”. According to the efficient market hypothesis such things should be impossible.
- doubleunplussed 4y ago
  The EMH doesn't say these things are impossible, it says you got lucky and won't be able to reproduce the same gains better than chance in the future.
  - monero-xmr 4y ago
    And I 110% disagree or my many and varied investments wouldn’t continue to far better than an index fund. As another recent example I went hard into oil and gas via ETFs back in May. Why I did this is for various reasons but my conclusion was that demand would surge and supply was constrained. Almost a 2x and that’s in liquid positions. I have taken some profits but still gonna wait a bit. According to EMH I shouldn’t be able to do this, yet here I am sitting on tons of gains.

refurb 4y ago

I disagree strongly because I’ve made investments in the same industry I work in (biotech). Despite having domain knowledge, there are too many factors still out of your control. For example, the science could look great, big addressable market, then some safety issue pops up and the drug is pulled. Or the government changes the rules. Or the FDA does. So while domain knowledge gives you a leg up, you go from 1/100 like an average Joe to like 5/100, in terms of accurately predicting outcomes.

monero-xmr 4y ago
I think avoiding industries where the government has arbitrary and capricious power is wise. But even in biotech you can use insight.

nine_k 4y ago

I can't help but remember a classical joke. Two economics professors walk down a campus street, discussing the efficient markets hypothesis. One of them exclaims: — Look, there's something green down there on the pavement; looks very much like a $20 bill! — Nope, — answers the other, — it can't be. If that were indeed a $20 bill, somebody would have picked it up already! The efficient market hypothesis postulates some kind of a static equilibrium. The reality is not static, and the processes that lead to a new equilibrium are neither instant nor independent of subject area knowledge. Due to this, during that last year's bull market, I made a ton of upside on stocks where I understood the business and could make sense of obscure tech news, and nearly nothing on stocks that otherwise seemed like winners and were recommended by likes of fool.com.

chii 4y ago
that's why the EMH is just a hypothesis, and not a truth or fact. And even in the theory, they don't claim perfect efficiency - just nearly perfect. Some people obtain mispricings, take advantage of it, but in the process, push that efficiency up just a tid bit more.