Sunday 16th April, 2006

 

Efficient markets adjust quickly

 
 
 
 
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Remote mirroring is a kind of back-up system used to manage time competitively on the Internet services. Initially it was called Raid, an acronym for “redundant arrays of inexpensive disks.” It was used when bottlenecks would crash computer systems, by facilitating a switch to full databases in locations, removed from headquarters.

If we purchase shares for the long haul, and we use the discounted value of expected future cash flows, as we saw last week, modern stock market theory supports the view, that we are likely to make superlative stock picks.

The length of time that it takes for stock prices to adjust new market information, is another important overall indicator, in determining the worth of an investment on the stock market. It is the concept of market efficiency.

The efficient market hypothesis supports the view that markets are efficient when the prices of securities reflect their true economic value.

An efficient market adjusts quickly to the different types of available information. There are three forms. An emphasis on price and volume data, called Market data is based on historical trades. If the market is efficient current prices will be a result of the past prices and volumes.

This is the traditional method in use, and since price data is historical, one can question the real value of technical analysis based on such criteria, in a dynamic environment whose most compelling characteristic is rapidity. It is called a “weak-form” and if price reflects all past data, then there is a weak relationship and the market is regarded as weakly efficient.

A semi strong form is based on what is called public information. This includes earnings, stock splits, cost of debt and equity, changes in accounting practices, and new product development.

A semi strong form implies that investors are unable to act quickly enough on the information, and do not have first mover advantages.

In the third form: the strong form, the hypothesis is that all information is available to investors. So that in addition to the above market data, the public sea of investors also have knowledge of “private” market data.

This private data refers to items known only to corporate boards, and insiders, generally. Such data may relate to systems implementation failure that cost a company millions of dollars, poor turn around times, inadequate communications that impede production lines ineffective decentralisation, wasteful advertising budgets, low level human resource management, and disregard for the environment.

It can also relate to impending changes in legalisation, and decisions routed by consumer protest, the Senate, or litigation, known only to those involved in these processes.

In the strong form, no investors can earn above average returns, since the public will know what’s going down in time enough to make calls and puts or buy and sell bids. It is the highest form of market efficiency.

The test of the efficient market hypothesis, a hypothesis not supported everywhere, is really that track of consistency in results. If certain investors consistently earn above average returns, the market is not strongly efficient.

If the market is efficient, there are no discrepancies in information to be exploited and stock prices will be only slightly higher than the intrinsic value, or slightly lower. But, you can buy stocks today, and benefit from a sudden discovery, such as a silicon substitute!

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