Efficient Market Theory
EFFICIENT MARKET THEORY
Theory Described
Efficient Markets Theory (EMT) has for many years been a virtual religion in the investment community. But now, among the great minds of investing, there is some evidence that allegiance to EMT is beginning to crack. Simply put, the belief that our securities markets are extremely efficient in digesting information is one of the cornerstones of EMT. The idea is that new information spreads very quickly and is immediately incorporated into the prices of securities. Most economists believe that neither technical analysis of price patterns nor fundamental analysis of a companies' earnings, personnel, leadership, market niche and so on, will help an investor to achieve returns better than the markets as a whole.
The theory holds that it is not that the experts are incompetent, but that they are so efficient in factoring in all these things, that the market always reflects their diligence and judgment regarding the implications of all market information that is known. In other words, they believe that in an era of declining costs for communications and computing power, information (fundamental analysis) and modeling (technical analysis) advantages are increasingly difficult to achieve at all, let alone sustain. This belief leads to the conclusion that over the long term, no one can achieve returns greater than would be attained by buying and holding one of the broad stock market indices.
But Alice is still in Wonderland. Efficient Markets Theory is unable to explain a large number of stock market anomalies that persist for relatively long periods of time such as Dogs of the Dow, the January Effect and the long term speculation that has resulted in excess market returns since 1982.
Enter a small number of academics whose area of study is known as behavioral finance and who focus their attention on what they call "exploitation of irrational investors."...
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