Hello, dear readers! This is Colton Dillion, cofounder of Hedgehog, the crypto robo-adviser that makes it easy to keep your portfolio diversified while managing it all in one place.
My main job title is CTO, but I'm also Chief Compliance Officer, CFO, and our Registered Investment Adviser Representative (or registered rep). As of late, I have been honored to add “Newsletter Person” to that list.
Last week I promised to talk about the efficient market hypothesis in more depth, and as the newsletter person I’m here to deliver:
Efficient Market Hypothesis
First off, you should be aware that there’s a strong version and a weak version of this thesis, much like Arnold Schwarzenegger and Danny DeVito in the movie Twins.
Strong vs. Weak Efficient Market Hypothesis
Strong form: This version of the efficient market hypothesis (EMH) states that all information, including public and private data, is fully integrated into asset prices. This means that no investor can consistently outperform the market by using any information, even insider information. To be clear, we are skeptical of this version.
Weak form: The weak form of EMH asserts that asset prices already reflect all publicly available information. In this version, there may be opportunities for investors to profit from using private or insider information. However, technical analysis and fundamental analysis are deemed ineffective, as prices already incorporate all relevant information.
Understanding the concepts of strong and weak efficient market hypothesis can not only help investors make better decisions but also provide insights into market dynamics and the role of information in financial markets.
- Efficient Markets and Active Management: The EMH, in both its strong and weak forms, challenges the effectiveness of active management strategies that aim to outperform the market consistently. If markets are efficient, the chances of consistently beating the market through stock picking or market timing are slim. As a result, many investors have shifted towards passive investment strategies, such as index funds or exchange-traded funds (ETFs), which aim to match the performance of the overall market.
- Informational Efficiency and Market Liquidity: The EMH highlights the importance of information in driving market efficiency. If markets efficiently incorporate available information, it encourages market participants to analyze and disseminate relevant information, contributing to more efficient price discovery and increased market liquidity. This has implications for regulators and policymakers in terms of promoting transparency, ensuring fair access to information, and preventing market manipulation.
- Behavioral Biases and Market Anomalies: While the EMH assumes that market participants are rational, the real world often exhibits behavioral biases that can lead to market anomalies. These anomalies, such as overreactions or herding behavior, create temporary market inefficiencies that some investors may exploit. Understanding these behavioral biases becomes crucial in identifying potential investment opportunities in situations where the market may deviate from efficiency.
The concepts of strong and weak EMH provide valuable insights into market dynamics and the role of information in financial markets. While the strong form suggests that no investor can consistently outperform the market, even with insider information, the weak form acknowledges the potential role of private information.
For us, we try to sidestep this issue entirely by buying as much of the market as possible with as few fees as possible, so that any growth in the value of the market turns into growth in the value of your portfolio. It’s not fancy, but by golly it seems to work.
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