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Comment by josephlord | Hacker News Reader

I think a blend of your advice and that of the original post is correct.

I agree that the Efficient Market Hypothesis is a load of rubbish repeatedly disproved by the movements of the markets not to mention the impossibility of the assumptions on which it relies (perfect information etc.). However if you are investing from a position of ignorance or sentiment (rather than on the Intelligent Investor basis) then the EMH may as well be true. It is only worth trading when you believe that you have an advantage from such proper analysis. For most people this is pretty much never - which is where the original poster's advice comes in.

So if you do have valuable industry knowledge and the time to glance at the basic company figures OR time to fully analyse the fundamentals of companies in the Intelligent Investor style go ahead you may well come out ahead but do remember that the market can know something you don't and/or remain irrational so you need fairly long time horizons.

My summary is if you have an advantage use it, if not then use index funds.

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Where do you get the idea that the EMH assumes perfect information?

In any case, since you are now revealing that the movements of the market disprove the EMH, I take it you've already made your billions by trading your EMH-disproving strategy?

Where do you get the idea that the EMH assumes perfect information?

EMH assumes that the market perfectly translates all information about stocks into prices. In a strong form, that requires perfect information, you can dilute that to almost perfect but just claiming the market is anywhere close rational or efficient is a huge leap given our history of stock markets and bubbles. That claim has been shown to be false in just about every boom bust cycle so far, but to take one specific example - mortgage cdos in the last decade - what about that market was efficient?

I take it you've already made your billions by trading your EMH-disproving strategy?

Disagreeing with the efficient market hypothesis implies nothing about trading or investing competence.

but to take one specific example - mortgage cdos in the last decade - what about that market was efficient?

The existence of apparent bubbles does not contradict the EMH. Scott Sumner has a great post explaining this: http://www.themoneyillusion.com/?p=25011

If you believe the boom&bust cycle shows the market to be irrational, what is the EMH-disproving trading strategy? "The market did something I don't like" is not the same thing as "the EMH is false."

The existence of apparent bubbles does not contradict the EMH.

I didn't find that link at all convincing, in particular the vague handwaving about bitcoin - because that is as-yet unproven and very uncertain I don't think it's a good example - why not use one of the many stock market busts? Booms and busts are not 'apparent bubbles' in any sense, they are all around us, and cause real movements in the markets regularly. They are a great illustration of markets behaving completely irrationally and becoming divorced from any efficient relationship between price and underlying or future value due to euphoria, panic, over-abstraction or obfuscation of assets and risk, monetary stimulus, corruption, cornering, rumour etc, etc. Sudden resets (often overreactions), and wild swings are the result, so much so that many of our markets have circuit-breakers which stop trading to attempt to discourage their natural movements.

There are a whole host of reasons why our markets are not currently anywhere close to perfect or efficient, and to simply assume they are and then attempt to cut the facts to fit the procrustean bed of market theory is not at all convincing. What is dangerous about the EMH to me is that it encourages a sort of worship of markets, which are seen as efficient and all-knowing, and which can never be gainsaid. In fact markets get things wrong all the time, they are pretty irrational quite a lot of the time, they are just the least-bad system we know.

If you believe the boom & bust cycle shows the market to be irrational, what is the EMH-disproving trading strategy?

Again, not believing the EMH is not the same as believing you can beat the market with short term trading, the two concepts are completely unrelated. I have no idea what sort of trading strategy you think would disprove EMH, but we're not talking about trading strategies but models for markets. Personally, I wouldn't trade short-term at all in stock markets, but do invest. I happen to mostly agree with the author here, but again, that has nothing to do with efficient markets.

The EMH is a postulation which makes extraordinary claims about markets in general, it does not need to be disproved, it needs to be proven in the first place by comparison with the real markets it claims to describe. Many leading economists (e.g. Greg B Davies) have pointed out flaws in it, and EMH is far from being a consensus.

Booms and busts are not 'apparent bubbles' in any sense, they are all around us, and cause real movements in the markets regularly.

I'm confused. Sumner showed the EMH predicts exactly this, for a certain distribution of information and returns. How is the real world agreeing with Sumner's model evidence against Sumner's model being correct?

What is dangerous about the EMH to me is that it encourages a sort of worship of markets

The EMH is simply a rule which allows you to turn a statistical distribution of new information into a statistical distribution of price movements. This is what Fama did to get the Nobel prize. A corollary is a "speculators can't make money except by chance" theorem, or in it's weak form, "technical traders can't make money except by chance".

It's not a "markets are benevolent wizards that solve all the problems" theorem. It's not a "no recessions ever occur" theorem. It's not a "prices will never change suddenly" theorem - in fact, it proves the opposite of the latter for certain information distributions. If you argue against these latter claims, you are not arguing against the EMH.

it needs to be proven in the first place

That's not how science works. You prove theorems, the best you can do to theories is fail to disprove them.

Thanks for the response, I think we'll continue to disagree, however perhaps we just have a different evaluation of the efficiency of markets - this is probably a difference of degree, as I doubt you subscribe to the market always being 100% efficient? Specific examples about stock market crashes or extreme movements modelled by EMH would be more persuasive than discussion of Bitcoin, I've attempted to give one below.

Sumner showed the EMH predicts exactly this, for a certain distribution of information and returns.

Assuming you are only talking about the blog post you linked, I can't see any sort of proof there, there are some hypothetical numbers about Bitcoin plucked out of the air, and he then goes on to assert that EMH is true whatever happens. If a theory is true whatever happens, it is not a useful model for thinking about the world.

If you take the EMH to mean that prices perfectly (or near perfectly) reflect information (public and private) about an asset, I'd say that mortgage CDOs (to pick a historical example) provide a perfect example of prices NOT reflecting all information - Goldman Sachs insured them with AIG knowing that the prices were incorrect days before the bust, but the price didn't reflect this. Given the incredibly broad claims made by EMH (market prices efficiently reflect all information), one counter-example of corruption, euphoria etc etc driving prices rather than underlying value is enough to disprove it, if it is a meaningful model of markets which can make useful predictions. That is why people cite booms and busts as evidence against EMH, because sudden changes in value are often completely unrelated to the consensus price as measured several days later or before, they are caused by panic, irrational behaviour (in aggregate, not just individually), or insider knowledge; information is so unevenly spread in markets, and manipulation pays so well (e.g. LIBOR), that they are nowhere near efficient.

Perfect information may not have been the right term.

Steve Keen devotes a the second half of chapter 11 in Debunking Economics to the EMH. The core issues are that the empirical data does not support it and that the maths behind it is all based on the assumptions that everyone can borrow freely at the same risk free rate and secondly that everyone has the same expectations ("homogenity of investor expectations: investors are assumed to agree on the prospects of various instruments - the expected values, standard deviations and correlation coefficients..." - Sharpe 1964 quoted in Debunking Economics 2011.)

That the EMH may be false does not mean that I believe I will necessarily win any more than the fact that Poker is significantly a game of skill means that I would necessarily win. I can be outplayed and/or have luck against me. But I wouldn't play for significant money unless I strongly believed that I had the advantage, the same is true for the market.

What empirical data disagrees with the EMH? I also have no idea why you believe the EMH requires investors to agree on the prospects of various instruments. It doesn't. If it did, the EMH would be a "no one ever trades" theorem.

If the EMH were false, a trading strategy generating above-market (risk-adjusted) returns over the long haul would exist. Claiming such a strategy exists is far more plausible if you've already traded it and won.

Would wide swings in the price of an individual stock on no material news not suggest that perhaps the market pricing is not perfectly efficient? (And if it doesn't, then I don't think anything could. I mean, that is one of the primary means you would prove it is not efficient, so if you reject that, then there's not much else I could offer you.)

The EMH says that the absence of news when news is expected should cause price swings, as well as the presence of news when that news is unexpected. And that the presence of expected news shouldn't cause any price swing.

EMH says more than you can't beat the market. Booms and busts do show inefficiencies.

A trading strategy generating above-market (risk-adjusted) returns may be a proof of the problems in the EMH but it isn't the only one. Also once declared it may no longer be an effective strategy. It also isn't proof because it is impossible to prove that success over n years proves success over n+1 years.

However how about asking Warren Buffet if the EMH is true, would you accept his track record as proof against the EMH? If not what sort of trading strategy/record would you suggest might constitute the evidence that you are asking for.

Going back to my poker example, do you expect me to win the World Series of Poker to prove that Poker isn't just random luck and chance? Is once enough or do I have to repeat it?

The track record of Warren Buffet and a few others is evidence that the EMH is imperfect. The rarity of Warren Buffet-level investors is evidence that it's still pretty accurate.

How does a boom and bust prove the EMH false? Could you explain the mechanics in detail?

Going back to your poker example, if top players in poker were rare and gains/losses seemed random, that would be evidence that Poker is mostly just luck.

I honestly don't understand the proposition that you are making and whether are are actually disagreeing with my previous post or we just have a language issue. My original point was that the EMH is false but that an individual can use it as a reasonable model and therefore are unwise to trade for profit without a particular reason to believe that they have and advantage.

If you accept that Warren Buffet and a few others are evidence that the EMH is imperfect (rather than the positive examples of long lucky runs - in a large population you would expect some very long lucky runs) then you are acknowledging the EMH is false. The existence of those who can beat the market is proof, the number of them doesn't matter.

Booms and busts are evidence (not proof) against the EMH because efficient accurate prices won't jump suddenly without specific new information about the underlying value of stocks/commodities/derivatives. Given the size of the shifts and that common absence of major news that triggered them I think it is hard to argue that a number of busts are evidence against the EMH. Likewise speculative bubbles that have inflated the value of things to many times their previous value based largely on the expectation of further growth are again evidence (rather than proof) of the flaws in the EMH.

If you are claiming that the EMH is a good approximation to reality but imperfect, we have no disagreement.

That is close to my view.

From the perspective of someone considering playing the market the EMH is a pretty good model. However as an overall macro model of the market it is fairly poor and certainly not something that should be treated as true to then develop further theories on top of. For example I do not believe that markets will always produce the best results and price goods correctly but I am generally sceptical of people claiming to be able to beat the market (such people probably exist but it is hard to distinguish them from the lucky).

Could you explain that second sentence a bit? I don't see how EMH being wrong implies that there's a strategy that beats the market.

Let's say I think the EMH is false, because, I dunno, I think people are irrational and emotional a lot of the time. It doesn't necessarily follow from that that I can beat the market by betting on people being irrational -- irrationality is really hard to predict, people could be irrational in many different directions.

The EMH does not assert that people are rational. The EMH can be true even if every single person is irrational.

http://en.wikipedia.org/wiki/Efficient-market_hypothesis

How it implies there is a strategy to beat the market? Simple. Suppose you have knowledge (e.g., the next iPhone causes cancer) that the market has not incorporated. You can use that knowledge to trade since the people not using that information will give you favorable prices (in this case by shorting AAPL).

Ultimately the problem with the EMH is the name. It's a fairly technical result that most people don't understand. People hear "Efficient Markets Hypothesis", they think it means "markets are magic fluffy bunnies that protect puppies from twisted stomachs and cure inequality", and argue against that.

I'm still confused as to what your ultimate point is. Are you saying that nobody has ever made a bet like that before? I made 4x on TSLA earlier this year. I don't claim to have refuted the Efficient Market Hypothesis, I just saw a situation where most institutional investors had a wrong idea and I thought I could beat them.

You seem to think that "market is sometimes wrong" somehow implies "you can always beat the market". That's not what we're saying. We are saying the market is clearly wrong often, so there exists some space for speculation arbitrage.

>"I made 4x on TSLA earlier this year"

This implies that you made the round trip (ie bought and sold). If not, you've made exactly zero.

So what was it that you saw, that institutional investors missed, that caused you to buy? What changed with the company's prospects in the past year that caused you to sell recently, and book your profit?

Otherwise, you haven't "beaten" anyone.

Yes, I bought TSLA options when the stock was at $30 and sold them for a 4x return. It grew to many more times that, so I could have gotten more.

"So what was it that you saw, that institutional investors missed, that caused you to buy?"

At the time, there was a large distrust in the financial community that Tesla had the production capacity to meet its Q42012 sales goals (I believe it was between 3-5k Model Ss, they ended up selling 6k). It further followed that Tesla failing to meet its sales goals would undermine investor confidence in the company and squeeze TSLA's operating capital in the coming 1-2 year period.

I disagreed with both hypotheses. The funny thing is, my strategy wasn't even smart. I know nothing about Tesla's production capabilities, what the bottlenecks were, or if they were likely to succeed. I assume that information had been priced into the market. Essentially, I bet on Elon Musk. I don't know what the bottlenecks were, I saw the Model S and shit my pants and said "This is awesome" and then I bought options.

I really only have one point to make, which is that if you think TSLA going from $30 to $180 / share in less than a year is a completely random, unguessable market move, well, I don't know what to tell you. It's not to me.

tldr; http://ycombinator.com/munger.html

(just kidding, that one is longer)

This tldr is an extremely interesting essay on wealth, business, and stocks. It is ridiculously long, but takes you amazing places. Definitely worth reading!

Can we discuss it here?

https://news.ycombinator.com/item?id=6837713

> "Suppose you have knowledge (e.g., the next iPhone causes cancer) that the market has not incorporated."

The EMH is based on the assumption that prices perfectly reflect the available information on the underlying. This is mentioned in the second paragraph of the Wikipedia article you quoted. You can't invoke the EMH as a model of the market and then violate one of its core assumptions when defending it.

Please try to follow the logic rather than just the talking points. I'm showing jbooth how (not EMH) => exists awesome trading strategy.

You seem to say this a lot whenever something about EMH get's posted - https://news.ycombinator.com/item?id=6690838

The existence of Warren Buffett disproves EMH.[1] EMH basically says that beating the market is pure luck as everything is priced efficiently. The fact that WB exists, just one person beating the market for 50 years, disproves EMH. I don't personally have to have an EMH-disproving strategy to see that it isn't true.

[1] http://www.investopedia.com/terms/e/efficientmarkethypothesi... "For example, investors, such as Warren Buffett have consistently beaten the market over long periods of time, which by definition is impossible according to the EMH."

Investopedia is incorrect. It is not impossible under EMH for particular investors to consistently beat the market over long periods of time, it is just improbable. Given a large number of investors, however, improbable runs of good and bad luck are near certain to occur somewhere in the system.

This is one of the reasons that it would be very difficult to disprove the EMH even if it were false -- there is no set of outcomes that is strictly inconsistent with the EMH.

"Long period of time" and "50 years" aren't really the same thing in my book. You can get lucky for awhile. At some point it stops being luck. I'm not sure where that line is, but I am confident though that Buffett has crossed it. I'd be willing to bet you'd have a hard time finding anybody credible that would say what Buffett has done is just luck, which is exactly what you are claiming. Once we accept that he isn't just a lucky guy, EMH is disproven.

> You can get lucky for awhile. At some point it stops being luck.

No, it doesn't.

There is no length of a run that cannot be luck. If you have a quantifiable expected distribution of results, you can say how improbable it is that you would see a run of a particular size in a given sized universe of data, but the fact that such a run exists in the data doesn't prove that its not luck.

> I'd be willing to bet you'd have a hard time finding anybody credible that would say what Buffett has done is just luck, which is exactly what you are claiming.

Er, no, its not what I'm claiming. In fact, I'm highly skeptical about EMH, to the point of having said that there is no particular reason (except for known-to-be-false assumptions) to assume that it should be true.

On the other hand, I am saying that the claims that it is "disproven" by the existence of runs like Buffet's overstate the degree to which the EMH is even falsifiable.

> Where do you get the idea that the EMH assumes perfect information?

The grounding of the EMH is a consequence of rational actor theory which assumes perfect information.

It could be true without the rational actor theory more generally or perfect information in particular being true, but there is no reason to expect it to be true except the assumption of those theoretical foundations in which it is grounded.

Its difficult to falsify the EMH, since it doesn't actually rule out any outcomes, it just asserts that if market-beating outcomes occur, they are because of luck rather than strategy. As such, there is no result that is strictly inconsistent with the EMH. (Further difficulties arise since, if one rejects the EMH, but still assumes that market participants do efficiently apply the information that is available to them, any market-beating strategy would need to be kept secret to avoid being adopted generally in the market, and thus no longer be market-beating, so any test of EMH has to be able to distinguish between result of luck and results of covert strategy.)

Most professional investors and fund managers do have an advantage using it over naive/amateur investors and yet they rarely beat the market, and when they do it almost never lasts more than a few years. "Use index funds unless your name is Warren Buffet" would be a better summary.

but is right now a good time to buy into an index fund? Or to buy any stock?

Most things revert to the mean, and right now the market is substantially above mean, and that market level is based on other aspects of the world that are currently also out of mean.

Isn't the standard advice to not invest unless you can wait 10 years for the ups and down to average out?

That is common Buffett-style advice. But he also advises that price matters. Matters a lot, in fact.

There are two sides to buffet style advice:

1. Buy bargains when assets are underpriced.

2. Hold those assets for many years.

Also, Buffet buys substantial or controlling fractions of a company, so the other owners can't scrwwo him. If you can't do that, you can't replicate his large scale success.

Not only that - he's able to affect those long-term returns.

>and right now the market is substantially above mean

In what sense is it "substantially" above mean?

the mean of what... itself? historically? how do we judge this?

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