The paradox of Market Efficiency
Created on 16 Feb 2019
Wraps up in 3 Min
Read by 8.1k people
Updated on 19 Oct 2019
Efficient market theory states that the price of all stocks trading in the stock market is already priced in, so you don't need to actively research about the stock because every good news or bad news that could possibly be there is already
The Finology view
Even if we believe that the market knows everything and the price is the reflection of the consensus view of the market, what is the guarantee that the consensus view is actually correct
The most efficient market
Actually, the theory of Efficient market is a paradox in itself because if anything it has only contributed in increasing the inefficiency in the market because people have started believing in this Efficient market theory and therefore, they are investing in passive funds. These funds mimic the composition of the index. Under the belief that one cannot outsmart the market, there are less and less people in the field of active management and the fewer active managers we have, the lesser is the efficiency in the market. With this drift towards passive investing, we can be sure that
We have often heard that mob psychology is dangerous.
Risk and Return are not always proportional
The theory says that if you outperform the market by 10%, you have to take that much extra risk. So, any extra return that you generate is explained by the extra risk that you take and there is a direct link between risk and return. The more you take risk the more return you generate.
Value investors believe in the low
Let’s take the Wipro example - in the last 30 years, Wipro has
Similarly, if we pick out the best performing stocks in the last 5 years such as Page and Eicher and ask ourselves if these were the riskiest stocks
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