Market Efficiency

Market Efficiency might be my favorite topic in the whole world to talk about. And if you feed me drinks, I just might get even passionate about it.

It's a "debate". Eugene Fama (Chicago GSB prof) has been credited with this theory. In fact, I think he won a nobel prize for it in 2003. He defined it as pretty simple: Everything that is publicly known about a stock is priced into its current price.

I believe this. The second you pull up a chart, you're up to date. Of course, if you want an "edge" you need to do more research.

One of my favorite books is "The New Market Wizards" (it has caused me to create my blogspot username), by Jack Schwager. The first sentence of the book starts: "The markets are not random. I don't care if the number of academicians who have argued the efficient market hypothesis would stretch to the moon and back if laid end to end; they are simply wrong."

Talk about a great opening, huh?

Well, my opinion on this efficient market hypothesis is that with the definition given above, I believe that it's true. With some wiggle room. First, why I believe it is that if you pull up a chart, you'll notice that EBAY shares took a big nosedive in early 2005. Well, nobody expected them to lower EPS guidance for the entire FY - news that was definitely not known. I believe pretty strongly that if EBAY had reiterated their guidance, shares would have done nothing. I also believe that had they raised guidance as much as they lowered it, shares may have gone up, SOME, but would have been somewhat anticipated. Certainly I do not believe that they would have gone up as much as they fell, therefore, expectations were perhaps a bit lofty. I believe that it's continually increasing expectations that are one major cause of bear markets. People get greedy. And that's where I disagree with the random walk theory.

Human emotions. Behavioral finance. You see it all the time. Biogen and Elan are two of the latest victims. Elan fell from $30's to $3.5 in a month because they pulled their main drug. I would have called a short at the first fall a "high probability trade". Why? Because any hint of bad news causes more sellers. "Well, you can't be sure that more bad news is coming!" you say. You're right, I can't be sure. But, let's look in probabilities... When Clinton was accused of Lewinski - then suddenly Jennifer Flowers and that Paula girl. I watch alot of law and order. Let's say a man is arraigned on sexual assualt charges. Then, blam, another woman comes out and accuses as well. Then a third...now you have a pattern. Bad news tends to stay hidden until the bubble bursts...it begets more bad news. It's human nature.

Now the wiggle room. You see, if Ebay shares, which currently trade in the $37 range, are worth $36, you'll note that there can be profits made, even here. It has traded as low as 36.54 and as high as 37.86 today. Thus, I believe that volatility can be your friend, if you're paying attention. But, to use volatility to your advantage, you need to be nimble. And that's not investing.

All in all, this is a great game that companies have invented, and I look forward to learning more every day of my life...as it will become my new career. To my new classmates (who probably will never read this blog), I look forward to learning from you as well.