Do you wish for your stocks and securities invested to tell you exactly what’s going on? Do you wish that just by looking at your stock prices you can determine what the
level of market efficiency is? Well, for that
you need to have a good understanding of market efficiency
and what makes it tick!
What is market efficiency?
It may seem like a buzzword which all experts and analysts keep repeating. But
market efficiency is actually quite a simple
concept. Market efficiency basically refers
to the ability of stock prices to reflect all current market information (LeBaron and Vaitilingam
1999 [online]), (Investor Home, nd [online]). There are various stages of market efficiency ranging from weak, semi strong and strong (Investopedia, nd
Can you beat the market?
You may be misled to believe that market efficiency means market perfection (Finance Professor, nd [online])
but it isn’t true. The basis of market efficiency
hypothesis or EMH classifies market conditions into 3 types:
security prices are indicative of past prices, historical rates of return, block volume etc. (Kane and Marcus, nd [online]).
Semi strong: In this type of market efficiency the
security prices are indicative of public available information. (Kane and Marcus, nd [online]).
Most information available publicly will tend to suggest that the market efficiency is at its peak. However, you need to beware that all public information will not be automatically
incorporated into the price (Kane and Marcus, nd[online]).
this form of market efficiency all security
prices indicate current public information. Thus in such a scenario, no particular trader can make money more than others
as all information is freely available (Kane and Marcus, nd[online]) (LeBaron and Vaitilingam 1999[online]).
Stock market anomalies
Most investors, irrespective of the kind of market efficiency at present, are victims of widely believed perceptions. Example is like
the ‘January effect’ (LeBaron and Vaitilingam 1999 [online]) which supposedly
state that you can earn much higher returns in the very first month of the year. Or the ‘weekend effect’ (LeBaron and Vaitilingam 1999[online]) which states that you should refrain from purchasing stocks
even if you find market efficiency either on
a Friday afternoon or Monday morning. It’s because even if you find market efficiency, such stocks sell higher on these days and times. By believing in such anomalies you as
an investor, risk investing only in such times and not in others. This way there will be many investors rushing in to invest,
thus upsetting the prevalent market efficiency.
Types of market efficiency
There are 3 main types of market efficiency namely:
Operational: This implies the cost of securities on the exchange which the buyers and sellers have to pay for. The ideal situation
is the implement trading on the lowest possible operational costs (Baisi and Kaijage, nd [online]).
This type of market efficiency implies the optimal
allocation of resources to bring out the maximum profits from your savings. Usually high growth segments such as electronics,
biotechnology as well as pharmaceutical represent good areas where you can invest your funds (Baisi and Kaijage, nd [online]).
form of market efficiency refers to fluctuating
or rising prices in securities as a response to some news or forecasts predicted (Baisi and Kaijage, nd [online]).
Investopedia (nd) ‘Market Efficiency’, Available from http://www.investopedia.com/terms/ m/marketefficiency.asp
Investor Home (nd) ‘The Efficient Market Hypothesis & The Random Walk
Theory’, Available from http://www.investorhome.com/emh.htm
Finance Professor (nd) ‘Market Efficiency’, Available from http://www.financeprofessor.com/488/ notes/market_efficiency.htm
Finance Professor (nd) ‘Efficient Market Hypothesis (EMH)’, Available
LeBaron, D & Vaitilingam, R (1999) The Ultimate Investor, Capstone Publishing Ltd., London
Baisi, M & Kaijage, E (nd) ‘Session 1: Market Efficiency’,
Financial Analysis Revised, 1:5 [online] (cited nd) Available from http://cbdd.wsu.edu/kewlcontent/cdoutput/ TR505r/page4.htm