Efficient Markets Hypothesis and Information

Over the last few weeks, I’ve learned a lot in my Computational Investing class, then I saw this article from Fidelity on ignoring the news and a lot of information on the role of information in stock markets.

Efficient Markets Hypothesis

In Computational Investing, we were looking at market statistics (“events”), and back-testing to see how a particular strategy would have worked.  One thing I really learned was that information is *extremely* important in markets.  There are three versions of the Efficient Markets Hypothesis: strong, semi-strong, and weak.  Under the strong version, the markets are 100% efficient and there is no opportunity to “seek alpha” – or make anything above and beyond what the market makes using information that’s not publicly available.  The semi-strong version says that the market is not perfectly efficient, and there is an opportunity to make more than the market through technical analysis or fundamental analysis.  The weak version, is that the market reflects all publicly available information, still prohibits technical analysis, but allows for fundamental analysis.  All of which are based on information.

I’m not going to get into the “politics” surrounding these theories, but I lean towards the semi-strong version, with some caveats.  After the computational investing class, I understand where there are opportunities for arbitrage; however, I don’t think that a “normal” investor can take advantage of them.  The arbitrage opportunities exist for such a short time (on the order of milliseconds), that unless you have a computer sitting on the stock exchange itself making the decisions, by the time you even noticed the “blip” in the order book, the opportunity would have already evaporated.  The information needed for these opportunities requires computers to notice and act on, I’m certainly not going to be able to do it. So, for all intents and purposes, to a “normal” investor, the Efficient Markets Hypothesis is “strong”.

Information

Information is needed to make investing decisions – but if you “ride” the market by buying index funds, you’re getting the collective knowledge of the people who are watching the markets with computer systems and making those small tweaks to bring the market into “accurate” pricing.  If you don’t need the information feed for making quick investing decisions, then you don’t really need much information at all other than the risk you are taking by investing in that particular index.  So you can proceed to ignore the markets 🙂

I think it’s interesting to see how the markets change according to current news events, but for me it’s purely an academic exercise.  I’m invested in index funds, and have no intentions of selling them until it’s time to re-balance to meet my asset allocation.

How does current news affect your investing?

 

One thought on “Efficient Markets Hypothesis and Information

  1. donebyforty

    I find this stuff interesting, mostly because I have only a rudimentary understanding. But I agree with the concept of a strong efficient market – I don’t believe there’s a way for me personally to beat the markets, so why try?

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