Traders, let's have a discussion.
- Thread starter DrOlmifon
- Start date
Because it's the difference between reading about sex and actually having sex..
let those that have ears..
Not sure he has done real well trading lol. He is more academic than trader. And I was referring more to those who develop and research these theories, all of them were pure professors.
Look what happened when Scholes et al went to trade for the first time... amazing how irrational and inefficient they found the markets.
My point is academics look at statistics over time to make claims or theories to explain things. Few of them never traded so they tend to make impossible assumptions to support their hypotheses. Even Black Scholes is based on unrealistic assumptions but its the best we got and even then many others are changing it and trying to fix it.
Our philosophy is pretty simple. Traders make money in only two ways. One is providing liquidity (not the rebate kind of liquidity, but that always helps, LOL), the kind that gives the institutions and investors a place to go. Throughout history, traders have always done that, whether on exchanges, or by trading with the East for "stuff" to sell back to the West, hundreds of years ago.
The second is by finding diparities in the marketplace. If there is a difference in valuations between futures and the underlying equities, correct it and get paid for it. If there is disparity between carrying costs of calendar options spreads (other than basic volatility), get into it. If similar companies are priced way differently compared to either their fundamentals or their dividend yield, buy one, short the other.
Trading has evolved from these basic premises, IMO.
Don
The second is by finding diparities in the marketplace. If there is a difference in valuations between futures and the underlying equities, correct it and get paid for it. If there is disparity between carrying costs of calendar options spreads (other than basic volatility), get into it. If similar companies are priced way differently compared to either their fundamentals or their dividend yield, buy one, short the other.
Trading has evolved from these basic premises, IMO.
Don
I believe the more prevailing view is EMH with a DRIFT (trend component). The (stock) market obviously has a longterm uptrend. Also, bond markets react to interest rate moves, etc. etc.
But I do not think polls and posts from people giving their opinion settles anything. Or even necessarily shines much light on the issue.
I would point out that:
-- an inefficient market flies in the face of the high death rate of traders. With estimates that 95% of leveraged traders losing their trading capital, and probably another 3-4% of traders whose returns are breakeven or anemic, one should think that an inefficient market would be highly tradeable. The low success rate argues strongly for some strong market efficiency.
-- Also, it is highly likely that many people on ET claiming success is more in their dreams, overblown, very short term or on paper. Yes, some do, but in reality, most don't...
The claimed success of trader vendors and system providers is surely overblown. I would say their value is perhaps 1 in 100.
-- commissions, slippage, occasional brokerage failures, trading, system acquisition/leasing costs and other things can render a small inefficiency as untradeable.
But I do not think polls and posts from people giving their opinion settles anything. Or even necessarily shines much light on the issue.
I would point out that:
-- an inefficient market flies in the face of the high death rate of traders. With estimates that 95% of leveraged traders losing their trading capital, and probably another 3-4% of traders whose returns are breakeven or anemic, one should think that an inefficient market would be highly tradeable. The low success rate argues strongly for some strong market efficiency.
-- Also, it is highly likely that many people on ET claiming success is more in their dreams, overblown, very short term or on paper. Yes, some do, but in reality, most don't...
The claimed success of trader vendors and system providers is surely overblown. I would say their value is perhaps 1 in 100.
-- commissions, slippage, occasional brokerage failures, trading, system acquisition/leasing costs and other things can render a small inefficiency as untradeable.
That is a really good insight. I remember a study that was done that basically proved that the market was unpredictable a week or more out.
But from what I have seen personally, I the next 1-3 days are tradeable. But who cares the market in 3-4 days? A good trader is focused on price action NOW.
From wikipedia, I think these are illuminating towards the subject:
Arguments concerning the validity of the hypothesis
Some observers dispute the notion that markets behave consistently with the efficient market hypothesis, especially in its stronger forms. Some economists, mathematicians and market practitioners cannot believe that man-made markets are strong-form efficient when there are prima facie reasons for inefficiency including the slow diffusion of information, the relatively great power of some market participants (e.g. financial institutions), and the existence of apparently sophisticated professional investors. The way that markets react to surprising news is perhaps the most visible flaw in the efficient market hypothesis. For example, news events such as surprise interest rate changes from central banks are not instantaneously taken account of in stock prices, but rather cause sustained movement of prices over periods from hours to months.
Only a privileged few may have prior knowledge of laws about to be enacted, new pricing controls set by pseudo-government agencies such as the Federal Reserve banks, and judicial decisions that effect a wide range of economic parties. The public must treat these as random variables, but actors on such inside information can correct the market, but usually in discrete manner to avoid detection.
Another observed discrepancy between the theory and real markets is that at market extremes what fundamentalists might consider irrational behaviour is the norm: in the late stages of a bull market, the market is driven by buyers who take little notice of underlying value. Towards the end of a crash, markets go into free fall as participants extricate themselves from positions regardless of the unusually good value that their positions represent. This is indicated by the large differences in the valuation of stocks compared to fundamentals (such as forward price to earnings ratios) in bull markets compared to bear markets. A theorist might say that rational (and hence, presumably, powerful) participants should always immediately take advantage of the artificially high or artificially low prices caused by the irrational participants by taking opposing positions, but this is observably not, in general, enough to prevent bubbles and crashes developing. It may be inferred that many rational participants are aware of the irrationality of the market at extremes and are willing to allow irrational participants to drive the market as far as they will, and only take advantage of the prices when they have more than merely fundamental reasons that the market will return towards fair value. Behavioural finance explains that when entering positions market participants are not driven primarily by whether prices are cheap or expensive, but by whether they expect them to rise or fall. To ignore this can be hazardous: Alan Greenspan warned of "irrational exuberance" in the markets in 1996, but some traders who sold short new economy stocks that seemed to be greatly overpriced around this time had to accept serious losses as prices reached even more extraordinary levels. As John Maynard Keynes succinctly commented, "Markets can remain irrational longer than you can remain solvent."[citation needed]
The efficient market hypothesis was introduced in the late 1960s. Prior to that, the prevailing view was that markets were inefficient. Inefficiency was commonly believed to exist e.g. in the United States and United Kingdom stock markets. However, earlier work by Kendall (1953) suggested that changes in UK stock market prices were random. Later work by Brealey and Dryden, and also by Cunningham found that there were no significant dependences in price changes suggesting that the UK stock market was weak-form efficient.
Further to this evidence that the UK stock market is weak form efficient, other studies of capital markets have pointed toward them being semi strong-form efficient. Studies by Firth (1976, 1979 and 1980) in the United Kingdom have compared the share prices existing after a takeover announcement with the bid offer. Firth found that the share prices were fully and instantaneously adjusted to their correct levels, thus concluding that the UK stock market was semi strong-form efficient. The market's ability to efficiently respond to a short term and widely publicized event such as a takeover announcement cannot necessarily be taken as indicative of a market efficient at pricing regarding more long term and amorphous factors however.
Other empirical evidence in support of the EMH comes from studies showing that the return of market averages exceeds the return of actively managed mutual funds. Thus, to the extent that markets are inefficient, the benefits realized by seizing upon the inefficiencies are outweighed by the internal fund costs involved in finding them, acting upon them, advertising etc. These findings gave inspiration to the formation of passively managed index funds.[1]
It may be that professional and other market participants who have discovered reliable trading rules or stratagems see no reason to divulge them to academic researchers. It might be that there is an information gap between the academics who study the markets and the professionals who work in them. Some observers point to seemingly inefficient features of the markets that can be exploited e.g seasonal tendencies and divergent returns to assets with various characteristics. E.g. factor analysis and studies of returns to different types of investment strategies suggest that some types of stocks may outperform the market long-term (e.g in the UK, the USA and Japan).
I particularly agree with this following section:
Skeptics of EMH argue that there exists a small number of investors who have outperformed the market over long periods of time, in a way which is difficult to attribute luck, including Peter Lynch, Warren Buffett, George Soros, and Bill Miller. These investors' strategies are to a large extent based on identifying markets where prices do not accurately reflect the available information, in direct contradiction to the efficient market hypothesis which explicitly implies that no such opportunities exist. Among the skeptics is Warren Buffett who has argued that the EMH is not correct, on one occasion wryly saying "I'd be a bum on the street with a tin cup if the markets were always efficient" and on another saying "The professors who taught Efficient Market Theory said that someone throwing darts at the stock tables could select stock portfolio having prospects just as good as one selected by the brightest, most hard-working securities analyst. Observing correctly that the market was frequently efficient, they went on to conclude incorrectly that it was always efficient."
Adherents to a stronger form of the EMH argue that the hypothesis does not preclude - indeed it predicts - the existence of unusually successful investors or funds occurring through chance. They also argue that presentation of anecdotal evidence of star-performers to cast doubt on the hypothesis is rife with survivorship bias.
However, importantly, in 1962 Warren Buffett wrote: "I present this data to indicate the Dow as an investment competitor is no pushover, and the great bulk of investment funds in the country are going to have difficulty in bettering, or... even matching, its performance. Our portfolio is very different from that of the Dow. Our method of operation is substantially different from that of mutual funds." [2]
Arguments concerning the validity of the hypothesis
Some observers dispute the notion that markets behave consistently with the efficient market hypothesis, especially in its stronger forms. Some economists, mathematicians and market practitioners cannot believe that man-made markets are strong-form efficient when there are prima facie reasons for inefficiency including the slow diffusion of information, the relatively great power of some market participants (e.g. financial institutions), and the existence of apparently sophisticated professional investors. The way that markets react to surprising news is perhaps the most visible flaw in the efficient market hypothesis. For example, news events such as surprise interest rate changes from central banks are not instantaneously taken account of in stock prices, but rather cause sustained movement of prices over periods from hours to months.
Only a privileged few may have prior knowledge of laws about to be enacted, new pricing controls set by pseudo-government agencies such as the Federal Reserve banks, and judicial decisions that effect a wide range of economic parties. The public must treat these as random variables, but actors on such inside information can correct the market, but usually in discrete manner to avoid detection.
Another observed discrepancy between the theory and real markets is that at market extremes what fundamentalists might consider irrational behaviour is the norm: in the late stages of a bull market, the market is driven by buyers who take little notice of underlying value. Towards the end of a crash, markets go into free fall as participants extricate themselves from positions regardless of the unusually good value that their positions represent. This is indicated by the large differences in the valuation of stocks compared to fundamentals (such as forward price to earnings ratios) in bull markets compared to bear markets. A theorist might say that rational (and hence, presumably, powerful) participants should always immediately take advantage of the artificially high or artificially low prices caused by the irrational participants by taking opposing positions, but this is observably not, in general, enough to prevent bubbles and crashes developing. It may be inferred that many rational participants are aware of the irrationality of the market at extremes and are willing to allow irrational participants to drive the market as far as they will, and only take advantage of the prices when they have more than merely fundamental reasons that the market will return towards fair value. Behavioural finance explains that when entering positions market participants are not driven primarily by whether prices are cheap or expensive, but by whether they expect them to rise or fall. To ignore this can be hazardous: Alan Greenspan warned of "irrational exuberance" in the markets in 1996, but some traders who sold short new economy stocks that seemed to be greatly overpriced around this time had to accept serious losses as prices reached even more extraordinary levels. As John Maynard Keynes succinctly commented, "Markets can remain irrational longer than you can remain solvent."[citation needed]
The efficient market hypothesis was introduced in the late 1960s. Prior to that, the prevailing view was that markets were inefficient. Inefficiency was commonly believed to exist e.g. in the United States and United Kingdom stock markets. However, earlier work by Kendall (1953) suggested that changes in UK stock market prices were random. Later work by Brealey and Dryden, and also by Cunningham found that there were no significant dependences in price changes suggesting that the UK stock market was weak-form efficient.
Further to this evidence that the UK stock market is weak form efficient, other studies of capital markets have pointed toward them being semi strong-form efficient. Studies by Firth (1976, 1979 and 1980) in the United Kingdom have compared the share prices existing after a takeover announcement with the bid offer. Firth found that the share prices were fully and instantaneously adjusted to their correct levels, thus concluding that the UK stock market was semi strong-form efficient. The market's ability to efficiently respond to a short term and widely publicized event such as a takeover announcement cannot necessarily be taken as indicative of a market efficient at pricing regarding more long term and amorphous factors however.
Other empirical evidence in support of the EMH comes from studies showing that the return of market averages exceeds the return of actively managed mutual funds. Thus, to the extent that markets are inefficient, the benefits realized by seizing upon the inefficiencies are outweighed by the internal fund costs involved in finding them, acting upon them, advertising etc. These findings gave inspiration to the formation of passively managed index funds.[1]
It may be that professional and other market participants who have discovered reliable trading rules or stratagems see no reason to divulge them to academic researchers. It might be that there is an information gap between the academics who study the markets and the professionals who work in them. Some observers point to seemingly inefficient features of the markets that can be exploited e.g seasonal tendencies and divergent returns to assets with various characteristics. E.g. factor analysis and studies of returns to different types of investment strategies suggest that some types of stocks may outperform the market long-term (e.g in the UK, the USA and Japan).
I particularly agree with this following section:
Skeptics of EMH argue that there exists a small number of investors who have outperformed the market over long periods of time, in a way which is difficult to attribute luck, including Peter Lynch, Warren Buffett, George Soros, and Bill Miller. These investors' strategies are to a large extent based on identifying markets where prices do not accurately reflect the available information, in direct contradiction to the efficient market hypothesis which explicitly implies that no such opportunities exist. Among the skeptics is Warren Buffett who has argued that the EMH is not correct, on one occasion wryly saying "I'd be a bum on the street with a tin cup if the markets were always efficient" and on another saying "The professors who taught Efficient Market Theory said that someone throwing darts at the stock tables could select stock portfolio having prospects just as good as one selected by the brightest, most hard-working securities analyst. Observing correctly that the market was frequently efficient, they went on to conclude incorrectly that it was always efficient."
Adherents to a stronger form of the EMH argue that the hypothesis does not preclude - indeed it predicts - the existence of unusually successful investors or funds occurring through chance. They also argue that presentation of anecdotal evidence of star-performers to cast doubt on the hypothesis is rife with survivorship bias.
However, importantly, in 1962 Warren Buffett wrote: "I present this data to indicate the Dow as an investment competitor is no pushover, and the great bulk of investment funds in the country are going to have difficulty in bettering, or... even matching, its performance. Our portfolio is very different from that of the Dow. Our method of operation is substantially different from that of mutual funds." [2]
The EMH and popular culture
Despite the best efforts of EMH proponents such as Burton Malkiel, whose book A Random Walk Down Wall Street (ISBN 0-393-32535-0) achieved best-seller status, the EMH has not caught the public's imagination. Popular books and articles promoting various forms of stock-picking, such as the books by popular CNBC commentator Jim Cramer and former Fidelity Investments fund manager Peter Lynch, have continued to press the more appealing notion that investors can "beat the market." The theme was further explored in the recent The Little Book That Beats The Market (ISBN 0-471-73306-7) by Joel Greenblatt.
One notable exception to this trend is the recent book Wall Street Versus America (ISBN 1-59184-094-5), by investigative journalist Gary Weiss. In this caustic attack on Wall Street practices, Weiss argues in favor of the EMH and against stock-picking as an investor self-defense mechanism.
EMH is commonly rejected by the general public due to a misconception concerning its meaning. Many believe that EMH says that a security's price is a correct representation of the value of that business, as calculated by what the business's future returns will actually be. In other words, they believe that EMH says a stock's price correctly predicts the underlying company's future results. Since stock prices clearly do not reflect company future results in many cases, many people reject EMH as clearly wrong.
However, EMH makes no such statement. Rather, it says that a stock's price represents an aggregation of the probabilities of all future outcomes for the company, based on the best information available at the time. Whether that information turns out to have been correct is not something required by EMH. Put another way, EMH does not require a stock's price to reflect a company's future performance, just the best possible estimate of that performance that can be made with publicly available information. That estimate may still be grossly wrong without violating EMH.
Despite the best efforts of EMH proponents such as Burton Malkiel, whose book A Random Walk Down Wall Street (ISBN 0-393-32535-0) achieved best-seller status, the EMH has not caught the public's imagination. Popular books and articles promoting various forms of stock-picking, such as the books by popular CNBC commentator Jim Cramer and former Fidelity Investments fund manager Peter Lynch, have continued to press the more appealing notion that investors can "beat the market." The theme was further explored in the recent The Little Book That Beats The Market (ISBN 0-471-73306-7) by Joel Greenblatt.
One notable exception to this trend is the recent book Wall Street Versus America (ISBN 1-59184-094-5), by investigative journalist Gary Weiss. In this caustic attack on Wall Street practices, Weiss argues in favor of the EMH and against stock-picking as an investor self-defense mechanism.
EMH is commonly rejected by the general public due to a misconception concerning its meaning. Many believe that EMH says that a security's price is a correct representation of the value of that business, as calculated by what the business's future returns will actually be. In other words, they believe that EMH says a stock's price correctly predicts the underlying company's future results. Since stock prices clearly do not reflect company future results in many cases, many people reject EMH as clearly wrong.
However, EMH makes no such statement. Rather, it says that a stock's price represents an aggregation of the probabilities of all future outcomes for the company, based on the best information available at the time. Whether that information turns out to have been correct is not something required by EMH. Put another way, EMH does not require a stock's price to reflect a company's future performance, just the best possible estimate of that performance that can be made with publicly available information. That estimate may still be grossly wrong without violating EMH.