Only in academic circles does EMH stay true. Time and time again, reality has shown that EMH is not applicable, or exists in a very weak form. One need only look to the LBO bubble and the dotcom bubble to see counter-examples of EMH.
> One need only look to the LBO bubble and the dotcom bubble to see counter-examples of EMH.
Those are not counterexamples, and they bear no relevance to the present topic. Anyone can misbehave in spectacular ways, but those misbehaviors don't falsify the EMH, any more than an airplane crash falsifies theories of aerodynamics.
But then, what about HFT arbitrage, low P/E ratios, choosing underperforming companies to take advantage of regression to the mean, Piotroski's F-Score, Graham-style value investing, bait and switch dumping, swing trading, the very real problem of pricing goodwill and non-material resources...? If not undermining weak EMH, at least they cast doubts over the strong forms. Or they should. Do also read John Carter's Mastering the Trade for some examples on how market inefficiencies can be exploited reliably.
Supposedly (seen in Wikipedia, so I'm not that confident) market crashes are interpreted to be impossible under strong EMH (and yeah, the bubbles would definitely falsify them), but are allowed in weak EMH to be statistical events of a random process. Now, I've heard an interesting and convincing argument by Steve Keen[1] that the market is not Gaussian noise; it's a fractal process with dimension ~ 1.7 (Gaussian's dimension is 2) whose crashes obey a power law distribution, very different from what a random walk would generate. That falsifies the weak form.
> Prove this wrong -- identify a surefire winning stock picking strategy that is immune to the announcement effect and insider trading, that reliably puts its practitioners ahead of market indices.
Falsifying EMH does not require such a thing, no more than proving relativity requires observing time dilation at all velocities. This is an onerous, diabolical burden of proof.
> Anyone can misbehave in spectacular ways, but those misbehaviors don't falsify the EMH, any more than an airplane crash falsifies theories of aerodynamics.
If you had periodic epidemics of plane crashes that were more frequent than expected, sure, you should definitely suspect something's wrong.
[1] Yeah, some things he says are somewhat crackpotty, but he's definitely not to be completely dismissed beforehand. I refer to his Behavioural Finance Lectures, published in Youtube.
> Falsifying EMH does not require such a thing ...
As a matter of fact, yes, it does. The only acceptable evidence against the EMH is a performance that the EMH cannot accommodate -- a successful strategy for reading and exploiting the market in a way that performs better than market indices. And not just sometimes, but all the time, reliably.
Science requires evidence. Evidence in this case means producing results above the norms set by the market averages, and not just sometimes, but all the time. Anything else is empty philosophizing.
Performances below the norms can be explained in any number of ways, but above the norms is a different story. And by "above the norms" I don't mean 1/2 the time or 1/2 the practitioners -- that's assured by chance factors.
All this talk about the EMH being flawed, not being the whole story, falls down before the fact that no one can invent a strategy to improve on long-term market averages, and that says it all. It is the ultimate evidence in favor of the EMH.
If no one can think of a way to read the market to his advantage, better than average performance, without engaging in insider trading or reliance on the announcement effect, then the default assumption is supported.
> This is an onerous, diabolical burden of proof.
Be that as it may, it is an essential standard of proof. Nothing else matters -- no amount of philosophizing can stand in for actual results.
The expert gets up and says, "The EMH is flawed, meaningless, unscientific, wrong, etc., etc.." Someone from the audience says "All right -- prove it. Produce a strategy that beats the market norms." The expert is naturally taken aback -- "Are you serious? What about the EMH? What about the fact that every single strategy that has ever been tried, has failed in the long term?"
This is like people in a bar talking about sailing. Any number of ideas about sailing are aired over intoxicating beverages, and it's all very interesting, but since no one goes out on the water, it's completely meaningless.
Yes, true, and such an outcome ironically supports the EMH.
> It's actually more useful if the public believes in EMH and in traders' best interest to keep their edges secret.
Actually, it is much, much more advantageous for traders to pretend that there is a surefire winning strategy that only they know about. The problem with that plan is the fact that there is no such strategy.
How do I know this? If there really was a surefire winning strategy, a trader who controlled it could (and would want to) do without any public involvement, and invest his own funds in private until he became absurdly rich.
That's the obvious way to play it -- why share the proceeds, and why risk exposing the method, by dealing with gullible, ungrateful clients? The answer is that those gullible, ungrateful clients are what makes the present system work, not some secret sauce that falsifies the EMH.
If one doesn't know of a 'sure fire winning strategy' (== strong form inefficient market hypothesis ?) ( or just statistically useful may be good enough ) one should not participate in the market in most forms ( which market, participate how ). I've heard it compared to a poker game where if you don't know who the sucker is it's probably you.
The general public is misinformed about the markets and gets consistently fleeced yet keeps getting pulled in by dreams of easy money - akin to a lottery.
Markets have defined purposes (theoretical, practical, legal) and serve them accordingly. Enriching 'gullible, ungrateful clients' is not the primary purpose. EMH is a useful explanation to the clients why they got fleeced, and i don't want to disprove it.
It takes a lot of work to figure out how the lottery works and how to consistently game it. It's just a job.
If "statistically useful" means reliably above market averages year after year, then that would constitute a surefire winning strategy. There is no such thing -- if this were not so, we all would know about it by now.
A tiny advantage -- a legal one, not dependent on insider trading or any other questionable premise -- however small, could be exploited to enrich the player who used it.
But there is no such thing.
> The general public is misinformed about the markets and gets consistently fleeced yet keeps getting pulled in by dreams of easy money - akin to a lottery.
Yes, and the key to all these misleading strategies is ignorance of the EMH.
Evidence for the EMH lies in the fact that, in the long term, buy & hold investors do better than players -- in the long term, on average, if all results are tallied objectively.
> It takes a lot of work to figure out how the lottery works and how to consistently game it.
Again, there is no such thing. If there were, businesses would refuse to use equities to raise capital, knowing they would be fleeced by the players. The only reason equities are a reasonable way to capitalize business is because it's a fair approximation of an efficient market.
For the life of me, I can't figure out why people find this so hard to understand.
Just would like to add a distinction that EMH seems to hold from a retail clients perspective, but does not hold from a systematic / structural side.
Markets are structurally exploitable. For example it is (generally) illegal for an institution to front run clients' orders, however it is ok if you are just a trader and know probable (not necessarily sure fire) locations of large orders and front run them.
But "fairness" is what the EMH means. "Fairness" expresses in human terms what the mathematics tells us. An efficient market ruthlessly adjusts for inefficiencies and oversights, sort of like biological evolution, and evolution is the ultimate in ruthlessness and indifference to the fate of individuals. It's also fair -- each species has an equal chance to prevail.
Insider trading is unfair to ordinary investors who aren't criminals. The announcement effect is unfair to ordinary investors who don't have that kind of influence over the markets. If you take away insider trading and the announcement effect, the result is ... more fair. That result is closer to an optimally efficient market.
> Markets are structurally exploitable.
Only by cheating (and as your example demonstrates). The SEC knows this, and they know how corrosive distrust in the fairness of equities can be for society as a whole, so they aggressively pursue cheaters.
Absent cheating, equities markets cannot be gamed. Absent cheating, a long-term buy & hold position is the optimal strategy, By the way, and for what it's worth, Warren Buffett agrees.
I think it doesn't validate EMH if such inefficiencies disappear if exposed, if they depend on skill and systemic knowledge rather than 'cheating' - i suppose it depends on where one draws the line between cheating and skill.
Discovering and exploiting them is a matter of study and work which the public is unwilling to do, and actually actively discouraged by the status quo of this industry.
They're guided into ignorance and defering their finances to the sucky professionals who get paid for amount of assets under management rather than performance.
Warren Buffet doesn't buy and hold indiscriminately. He buys things on sale during market crashes when the panicky public gladly sell to him. For example by selling put options he gets paid just for waiting for the discounts.
And as a potentially controvertial aside, i think his size and connections within the government grant him hypocritical priviledges not available to the public (other than through owning his stock of course).
Yes, but it's well-established that the average investor comes out behind by trying to exploit such inefficiencies, and this outcome supports the idea that the EMH is true, and that a buy & hold position produces the best returns on average, overall.
The problem with Wall Street anecdotes is that successes are given undue weight in the telling, misleading people into the idea that locating and exploiting inefficiencies puts you ahead. On average, this is false -- very, very false.
> Warren Buffet doesn't buy and hold indiscriminately.
Berkshire Hathaway's long-term success is easily explained -- its position is a matter of public knowledge, so others, hoping to see the same growth, buy the same stocks (too late to benefit themselves but just in time to benefit Berkshire Hathaway). It's called the "announcement effect".
Excusing it away feels like a lazy way out, settling for mediocrity. I make a living by throwing sixes time and time again. It's not cheating, it's not easy, it takes skill and work and is doable.
It's just math. There's nothing special about those dice.