Market Inefficiency: The Market is Wrong
“What follows is my personal view on market dynamics and principles that govern my own trading. It is written as simply as I can muster, in plain English, in the hopes of explaining my process to traders of all education and experience levels. Nothing that you are about to read is ground breaking. It is simply my attempt to put down in plain words my approach to the market.
It has been rightly stated that the current market price for a given security or commodity represents the collective agreement of all market participants at a given point in time. It is the “most perfect” price as determined by the collective. What has been grossly misinterpreted is that this price is the “correct price” that markets are efficient and therefore represent what should be.
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Those of you in the world of finance would recognize this principle as EMH or the Efficient Market Hypothesis. For those of you who have not been blessed with an Ivy League education:
The efficient market hypothesis asserts that stock market prices are the best available estimates of the real value of shares since the market has taken account of all available information on an individual stock.
While it is reasonable to suggest that the market has taken into account all available information, (think about it. Every bank, hedge fund, and investment house has a team of numbers crunchers strait out of Harvard Business School working around the clock deciphering every piece of available market data.) What I believe is unreasonable is the idea that the collective takes that information and applies it in a rational way to the market.
A clear indication of this is violent price swings in and around major news events where market participants attempt to reevaluate their previous assumptions with new information. If markets where truly efficient there would be no opportunity to capitalize on such conditions because the market would rationally move from one price point to another as market participants revalued the price relative to the new information. In the real world markets react emotionally, even violently in some cases allowing participants to take advantage of the volatility.”