Efficient market theory - not

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BradMajors
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Efficient market theory - not

Post by BradMajors » Wed Jan 15, 2014 12:47 pm

Efficient market theory definition: http://www.investorwords.com/1672/Effic ... heory.html "The bottom line is that an investor should not be able to beat the market since there is no way for him/her to know something about a stock that isn't already reflected in the stock's price."

Google buys the company Nest. The stock price of Nestor, a totally unrelated company, is up 4900% on massive volume:

http://www.zerohedge.com/news/2014-01-1 ... chart-back

Wagnerjb
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Re: Efficient market theory - not

Post by Wagnerjb » Wed Jan 15, 2014 1:04 pm

BradMajors wrote:Efficient market theory definition: http://www.investorwords.com/1672/Effic ... heory.html "The bottom line is that an investor should not be able to beat the market since there is no way for him/her to know something about a stock that isn't already reflected in the stock's price."

Google buys the company Nest. The stock price of Nestor, a totally unrelated company, is up 4900% on massive volume:

http://www.zerohedge.com/news/2014-01-1 ... chart-back
You forgot the word "consistently" when referring to beating the market. In this case, some naive investors provided a $20 bill for smart investors to pick up off the street....and they did so. But you cannot make a good living waiting to find other $20 bills on the ground.

One has to wonder if the same volume surge on this thinly-traded stock would have made a different at all in the stock price of Walmart of Coca Cola or Microsoft.

In this case, the information so efficiently impounded in the NEST stock price (that it might be a takeover target) was wrong, and I assume the NEST stock price quickly adjusted once the correct news was more widespread. Because the stock was thinly-traded, a tiny bit of "incorrect" money can influence the stock price. Let's be thankful that isn't the case with larger stocks.

Best wishes.
Andy

bberris
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Re: Efficient market theory - not

Post by bberris » Wed Jan 15, 2014 1:17 pm

The EMT does not state that the market is always and everywhere rational. It says you can't get a significant edge legally. In this specific instance, how could you predict that people would be so stupid as to confuse the two companies? So EMT does allow for the madness of crowds. Madness is a difficult thing to predict.

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Steadfast
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Re: Efficient market theory - not

Post by Steadfast » Wed Jan 15, 2014 1:27 pm

You forgot the word "consistently" when referring to beating the market.
Indeed, particularly after deducting the fees and expenses involved in trying.
We don't see things as they are, we see things as we are.

pkcrafter
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Re: Efficient market theory - not

Post by pkcrafter » Wed Jan 15, 2014 2:23 pm

Brad, the EMH was developed under beliefs in Expected Utility Theory, but now Prospect Theory is replacing it, and that's something Fama is having a hard time accepting. These are some of the differences.
Investors in standard finance are rational. Investors in behavioral finance are normal, sometimes normal-smart and at other times normal-stupid, swayed by cognitive errors and misleading emotions. Investors in standard finance build portfolios by the rules of mean-variance portfolio theory. Investors in behavioral finance build portfolios by the rules of behavioral portfolio theory. Markets in standard finance are efficient. Markets in behavioral finance are not efficient but difficult to beat. Expected returns in standard finance are determined by utilitarian factors alone, such as risk and liquidity. Expected returns in behavioral finance are determined by utilitarian, expressive and emotional factors.
https://blog.wealthfront.com/meir-statm ... ally-want/


Paul
When times are good, investors tend to forget about risk and focus on opportunity. When times are bad, investors tend to forget about opportunity and focus on risk.

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G-Money
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Re: Efficient market theory - not

Post by G-Money » Wed Jan 15, 2014 2:33 pm

BradMajors wrote:Efficient market theory definition: http://www.investorwords.com/1672/Effic ... heory.html "The bottom line is that an investor should not be able to beat the market since there is no way for him/her to know something about a stock that isn't already reflected in the stock's price."

Google buys the company Nest. The stock price of Nestor, a totally unrelated company, is up 4900% on massive volume:

http://www.zerohedge.com/news/2014-01-1 ... chart-back
So how much money did you or the author make on Nestor?
Don't assume I know what I'm talking about.

FafnerMorell
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Re: Efficient market theory - not

Post by FafnerMorell » Wed Jan 15, 2014 2:37 pm

Ironically, the OP's original point is more of a "proof" of Efficient market theory:
- The price of NEST did not reflect that Google might acquire a similarly named company.
- As soon as the acquisition became knowledge, THEN the price went up by 4900% (new information (even if wrong) causes a change to the price)
- Once it becomes knowledge that that people bought the wrong stock, THEN the price will plummet back down. (new information causes a change to the price)

I suppose one could try to game the system by buying penny stocks with names similar to companies which might be acquired by big name tech firms (if there's a slight rise in stock prices of such penny stocks, then this would also serve to confirm EMT).

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Clearly_Irrational
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Re: Efficient market theory - not

Post by Clearly_Irrational » Wed Jan 15, 2014 2:43 pm

pkcrafter wrote:Brad, the EMH was developed under beliefs in Expected Utility Theory, but now Prospect Theory is replacing it
Thanks, I didn't realize there was a name for that. I was just calling it the "Super Weak Form" of EMH.

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baw703916
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Re: Efficient market theory - not

Post by baw703916 » Wed Jan 15, 2014 2:58 pm

The market quickly incorporates all new misinformation!! :D
Most of my posts assume no behavioral errors.

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galeno
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Re: Efficient market theory - not

Post by galeno » Wed Jan 15, 2014 3:01 pm

EMT does not have to be 100%. Even if it's only 80% rational Bogleheads will bet on the 80 and not on the 20.
AA = 40/55/5. Expected CAGR = 3.8%. GSD (5y) = 6.2%. USD inflation (10 y) = 1.8%. AWR = 4.0%. TER = 0.4%. Port Yield = 2.82%. Term = 33 yr. FI Duration = 6.0 yr. Portfolio survival probability = 95%.

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G-Money
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Re: Efficient market theory - not

Post by G-Money » Wed Jan 15, 2014 3:25 pm

galeno wrote:EMT does not have to be 100%. Even if it's only 80% rational Bogleheads will bet on the 80 and not on the 20.
It doesn't even need to be 80%. So long as the market collectively knows more than I do (which, believe me, isn't much at all), I'd be better off piggy-backing on an index.
Don't assume I know what I'm talking about.

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