BookYol

Concept

Efficient Markets

Efficient markets is the idea that stock prices absorb publicly known information so quickly that, after costs, most investors cannot reliably beat the market by picking stocks or timing trades.

Picture the stock market as a room full of thousands of well-informed analysts hunting for the same bargains. When news breaks, they trade on it within minutes, sometimes seconds. The price adjusts before most people have read the headline. That competition is the core of Burton Malkiel's case in A Random Walk Down Wall Street. What is known is already in the price. What moves it next is news nobody has yet, and real news is unpredictable by definition. That's why short-term price paths look like a random walk. It also explains why hot streaks fade. A fund that tops the charts for three years usually drifts back toward average, because skill is hard to separate from luck. Markets aren't perfect, and bubbles and manias do happen. But mispricings are hard to spot in advance and harder to profit from after fees and taxes. For most people, trying to beat the market is a losing bet.

A real-life example

Dana reads a glowing earnings report at 8:15 a.m. and plans to buy the stock at the open. By the opening bell it's already up 7%, because professionals priced the news in before she could act. Buying now means paying for good news everyone already has. Then she checks her neighbour's fund, which beat the index three years running. It has trailed the index for the two years since. Dana moves her monthly savings into a low-cost index fund instead.

How to use it

  1. 1Before buying on a tip or headline, ask yourself: what do I know that thousands of full-time analysts don't? If the honest answer is nothing, the news is already in the price.
  2. 2Judge any fund or manager on ten or more years of returns after fees, not on last year's number. Short hot streaks usually fade back toward average.
  3. 3Put the core of your long-term money in broad, low-cost index funds. Spend your energy on what you control: your savings rate, your costs and staying invested.