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Efficiency requires that new information is rapidly assimilated into share prices. In the sophisticated financial markets of today the speedy dissemination of data and information by cheap electronic communication means that there are large numbers of informed investors and advisers.
These individuals are often highly intelligent and capable of fast analysis and quick action, and therefore there is reason to believe many stock markets are efficient at pricing securities.
However, this belief is far from universal. Thousands of highly paid analysts and advisers maintain that they can analyse better and act more quickly than the rest of the pack and so make abnormally high returns for their clients.
Don’t stoop down
There is a well-known story which is used to mock the efficient market theoreticians: A lecturer was walking along a busy corridor with a student on his way to lecture on the efficient market hypothesis. The student noticed a £50 note lying on the floor and stooped to pick it up. The lecturer stopped him, saying, ‘If it was really there, someone would have picked it up by now’.
With such reasoning the arch-advocates of the EMH dismiss any trading system which an investor may believe he has discovered to pick winning shares. If this system truly worked, they say, someone would have exploited it before and the price would have already moved to its efficient level.
This position is opposed by professional analysts: giving investment advice and managing collective funds is a multi-billion pound industry and those employed in it do not like being told that most of them do not beat the market (but it is true!).
However, a few stock pickers do seem to perform extraordinarily well on a consistent basis over a long period of time. There is strong anecdotal evidence that some people are able to exploit inefficiencies – we will examine some performance records in later Newsletters.
What efficiency does not mean
To provide more clarity on what efficiency is, we need to deal with a few misunderstandings held by people with a little knowledge (a dangerous thing):
- Efficiency means that prices do not depart from true economic value. This is false. At any one time we would expect most shares to deviate from true value, largely because value depends on the future, which is very uncertain. However, under the EMH we would expect the deviations to be random (i.e. not systematic, not biased).
- You will not come across an investor beating the market in any single time period. This is false because you would expect, in an efficient market, approximately one-half of shares bought subsequently outperform. So, many investors, unless they buy such a broad range of shares that their portfolio tracks the market, would outperform. Note that, under the EMH, this is not due to skill, but simply caused by the randomness of price deviations from true economic value.
- No investor following a particular investment strategy will beat the market in the long term. This is false simply because there are millions of investors…………………………….To read the rest of this article, and more like it, subscribe to my premium newsletter Deep Value Shares – click here http://newsletters.advfn.com/deepvalueshares/subscribe-1
