“The efficient market hypothesis assumes that markets can’t be beat because everyone has the same information. This reasoning is conceptually flawed. Even if everyone had all the same information, there’s no reason to assume they would reach the same decision as to the appropriate price of a market or security. For example, in a chess tournament, all the players know the same rules and have access to the same chess books and records of past games by world champions, yet only a small minority excel. There is no reason to assume that all the players will use the same information with equal effectiveness. Why should the markets, which in a sense represent an even more complex game than chess (there are more variables, and the rules are always changing) be any different?
“In a chess tournament, a few highly skilled players will win most of the games by exploiting the mistakes of the weaker players. Much like chess, it seems only reasonable to expect a few highly skilled market participants to interpret the same information — the current position of the market chessboard, so to speak — differently from the majority, and reach variant conclusions about the probable market direction. In this conceptual framework, mistakes by a majority of less skilled market participants can drive prices to incorrect levels (that is, prices out of line with the unknown equilibrium level), creating opportunities for more skilled traders. Quite simply, equal dissemination of knowledge does not imply equal use of knowledge.
“…The fact that the majority of participants in all markets are consistently unable to beat the market gives the efficient market hypothesis the illusion of truth. But the fact that the markets are very difficult to beat does not imply they can’t be beat. It is entirely consistent to believe that a very large majority of market participants will underperform and, at the same time, to believe that a few highly skilled traders will outperform the markets (in numbers and by margins that exceed those explainable by probability arguments). Just as some chess masters can consistently win at tournaments, a small minority of skilled traders can significantly outperform the markets. Indeed, in both arenas, it can be argued that the mistakes of the majority create the winning opportunities for the few who are more skilled.”
– Jack Schwager, Market Sense and Nonsense
Yale professor Robert J. Shiller has called the efficient market hypothesis “one of the most remarkable errors in the history of economic thought.” Why does it persist?
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