ArtsAutosBooksBusinessEducationEntertainmentFamilyFashionFoodGamesGenderHealthHolidaysHomeHubPagesPersonal FinancePetsPoliticsReligionSportsTechnologyTravel

Are Share, Currency Markets Efficient - Are Share Price Moves Irrational?

Updated on November 20, 2016
janderson99 profile image

John applies his scientific and research skills to develop guide for finance and home budgets, from saving on power, to stock market indices

An efficient market is one in which the players in the market are smart and perceptive enough to correctly price securities all the time, based on the wealth of information now available, especially now with the Internet. It follows that there are no surprises.

There are no real stocks that are undervalued since in an efficient market their price at any given time will equate to their intrinsic value.

However, some claim that there are flaws in this model believing that there is good evidence that the market overreacts for short periods of time leading to periodic inefficiencies.

Divergent views for Nobel Prize Winners in Economics
Divergent views for Nobel Prize Winners in Economics | Source
Economics and Share Trading can be a strangel beast with diverging views.
Economics and Share Trading can be a strangel beast with diverging views. | Source
Share trading requires threads from different perspectives
Share trading requires threads from different perspectives | Source

If the market is efficient, then the fluctuations in prices must be essentially random driven by external influences rather than trading itself.

Also it means that new fluctuations in prices will be unpredictable.

If you are an investor and the market is efficient, there is no point trying to find gaps in responses, or opportunities that the market was slow to react to or did not know about.

The market will in a sense be always up to date and perhaps one or two steps ahead of you as a small investor.

Better to invest in broad trends and the reactions to random fluctuations.

This is the classic trend following strategy that many investors adopt, some without realising it.


Double Headed Beast

One interesting aspect of this debate is the irony in the observation that two of the 2013 Nobel prize winners in Economic have broadly opposing views

Eugene Fama's research has showing that the market is efficient

Robert Shiller's research has shown that the market is inefficient.

Both have made contributed to the development of economics.

While it is reasonable to say the market is considerably efficient most of the time there are many examples of flaws leading to 'Bubbles' and spikes. There are plenty of examples where the market appears to have overreacted to new information in a negative or positive way. Spikes and short term troughs are good examples of this. These short term changes are evidence that the efficiency is not perfect. But it is hard for a small investor to know how to interpret what is happening and to take advantage of opportunities.

The notion of markets being efficient began way back in 1900 when Louis Bachelier proposed that the price of government bonds was in fact random and the trends were unpredictable. The simple logic was that if a share or a bond was likely to have a higher price next week, then the price should already gone up in anticipation of that. All the predictable moves should have already happened, because the market is knowledgeable and efficient with no scope for surprises bases on ignorance, even before the age of the Internet and Instant News. All that was left was unpredictable surprises that were essentially random.

Eugene Fama undertook research that concluded that stock markets are indeed efficient. He has suggested that even though there are spikes and minor slip-ups, the smaller investor should recognise that the market will always be one clear step ahead of you. Investors should therefore act as though the markets are efficient, and that nothing is therefore underpriced because the market has not caught-up or responded to their forecasts of what will happen.

Robert Shiller on the other hand, has a different view. His statistical studies suggested that the volatility seen in the markets is too high to support the hypothesis that markets are efficient. He suggested that markets tend to overreact to information and to overshoot in terms of the appropriate responses. In essence he was saying that the markets are not perfectly efficient all the time. Irrational exuberance may lead to irrational trends. This may be a case of human nature as many people like to see a boom continue, and don't want to recognise a bust.

Eugene Fama believes that the slip-ups are rare events such as the boom and bust in technology stocks in the late 1990s. The market was not irrational it was simply wrong, in hindsight about the prospects of companies.

Time for investors to adjust their strategies for an Efficient Market.

© 2013 Dr. John Anderson

Comments

Submit a Comment

  • tillsontitan profile image

    Mary Craig 

    4 years ago from New York

    Very interesting to this non-savvy currency market person!

    Voted up, useful, and interesting.

working

This website uses cookies

As a user in the EEA, your approval is needed on a few things. To provide a better website experience, hubpages.com uses cookies (and other similar technologies) and may collect, process, and share personal data. Please choose which areas of our service you consent to our doing so.

For more information on managing or withdrawing consents and how we handle data, visit our Privacy Policy at: https://hubpages.com/privacy-policy#gdpr

Show Details
Necessary
HubPages Device IDThis is used to identify particular browsers or devices when the access the service, and is used for security reasons.
LoginThis is necessary to sign in to the HubPages Service.
Google RecaptchaThis is used to prevent bots and spam. (Privacy Policy)
AkismetThis is used to detect comment spam. (Privacy Policy)
HubPages Google AnalyticsThis is used to provide data on traffic to our website, all personally identifyable data is anonymized. (Privacy Policy)
HubPages Traffic PixelThis is used to collect data on traffic to articles and other pages on our site. Unless you are signed in to a HubPages account, all personally identifiable information is anonymized.
Amazon Web ServicesThis is a cloud services platform that we used to host our service. (Privacy Policy)
CloudflareThis is a cloud CDN service that we use to efficiently deliver files required for our service to operate such as javascript, cascading style sheets, images, and videos. (Privacy Policy)
Google Hosted LibrariesJavascript software libraries such as jQuery are loaded at endpoints on the googleapis.com or gstatic.com domains, for performance and efficiency reasons. (Privacy Policy)
Features
Google Custom SearchThis is feature allows you to search the site. (Privacy Policy)
Google MapsSome articles have Google Maps embedded in them. (Privacy Policy)
Google ChartsThis is used to display charts and graphs on articles and the author center. (Privacy Policy)
Google AdSense Host APIThis service allows you to sign up for or associate a Google AdSense account with HubPages, so that you can earn money from ads on your articles. No data is shared unless you engage with this feature. (Privacy Policy)
Google YouTubeSome articles have YouTube videos embedded in them. (Privacy Policy)
VimeoSome articles have Vimeo videos embedded in them. (Privacy Policy)
PaypalThis is used for a registered author who enrolls in the HubPages Earnings program and requests to be paid via PayPal. No data is shared with Paypal unless you engage with this feature. (Privacy Policy)
Facebook LoginYou can use this to streamline signing up for, or signing in to your Hubpages account. No data is shared with Facebook unless you engage with this feature. (Privacy Policy)
MavenThis supports the Maven widget and search functionality. (Privacy Policy)
Marketing
Google AdSenseThis is an ad network. (Privacy Policy)
Google DoubleClickGoogle provides ad serving technology and runs an ad network. (Privacy Policy)
Index ExchangeThis is an ad network. (Privacy Policy)
SovrnThis is an ad network. (Privacy Policy)
Facebook AdsThis is an ad network. (Privacy Policy)
Amazon Unified Ad MarketplaceThis is an ad network. (Privacy Policy)
AppNexusThis is an ad network. (Privacy Policy)
OpenxThis is an ad network. (Privacy Policy)
Rubicon ProjectThis is an ad network. (Privacy Policy)
TripleLiftThis is an ad network. (Privacy Policy)
Say MediaWe partner with Say Media to deliver ad campaigns on our sites. (Privacy Policy)
Remarketing PixelsWe may use remarketing pixels from advertising networks such as Google AdWords, Bing Ads, and Facebook in order to advertise the HubPages Service to people that have visited our sites.
Conversion Tracking PixelsWe may use conversion tracking pixels from advertising networks such as Google AdWords, Bing Ads, and Facebook in order to identify when an advertisement has successfully resulted in the desired action, such as signing up for the HubPages Service or publishing an article on the HubPages Service.
Statistics
Author Google AnalyticsThis is used to provide traffic data and reports to the authors of articles on the HubPages Service. (Privacy Policy)
ComscoreComScore is a media measurement and analytics company providing marketing data and analytics to enterprises, media and advertising agencies, and publishers. Non-consent will result in ComScore only processing obfuscated personal data. (Privacy Policy)
Amazon Tracking PixelSome articles display amazon products as part of the Amazon Affiliate program, this pixel provides traffic statistics for those products (Privacy Policy)