Competition As A Source of Efficiency
Lately, I've been posting about the Efficient Market Hypothesis; the idea that stock prices already reflect all available information, making it hard to profit from stock picking. Let's keep thinking about this.

Why would we think that a stock already has "all available information" factored in? Doesn't it seem like if you had the time and resources to constantly gather information, you could find something that has been overlooked by other investors?

When information is costly to unearth and analyze, you would expect that doing so would result in an increased expected return.

Two researchers named Grossman and Stiglitz argued in favor of this point; that investors will indeed spend resources and time to investigate new information if doing so is likely to generate higher returns.

So if the market isn't perfectly efficient, that means you should be able to reliably make money if you just put in the hours researching, right?

Well, not so fast.

You still need to consider and respect your competition. If you have less time or resources to spend analyzing a particular stock, how can you expect to make money if there are many other analysts out there who are putting more time and money into their investigation, and then bidding the price up to where there is no longer any opportunity?

The more resources your opponent has, the more you need a really good reason why they missed something.

Post media


The more competitive the analyzation process, the more efficiently investors have to be at collecting and analyzing information. Otherwise, their price targets will be wrong and they'll lose money.

It's not that you absolutely cannot come up with new information, it's that there is already so much competition to discover that new information that you don't have a high probability of making money. There is an upper limit to how much time and effort you will be willing to put in before the size of the excess return you would generate comes at the sacrifice of, say, spending time with your family.
No comments yetBe the first to add your insight!

Author

Related