An efficient market incorporates all existing information accurately in order to determine security prices at all times (Fama -1970 &1991). Traders learn through copycatting, that is, they emulate the most lucrative trading strategies from fellow traders. An efficient market has smart money managers who identify misquoted stock prices and exploit them (Benink, et al, 2007). Forms of market efficiency: • ‘Weak’ form: Past market prices and data are fully reflected in securities’ prices. Thus technical analysis is of not needed. • ‘Semi strong’ form: All information available to the public is fully reflected in the price of securities.
Therefore, fundamental analysis is not needed. • ‘Strong’ form: Security prices fully reflect all information. Insider information is not useful. Small investors could benefit from efficient markets through; a) Taking advantage and trading in less liquid securities since large investors have huge sums of money and therefore only trade in the very liquid securities. b) Institutional managers mainly aim at keeping their jobs and not necessarily to make income for their employer. Small investors, on the other hand, feel a personal commitment in their trading activities and hence act with diligence.
c) Big institutions refer to past data in their decision making. A small investor has the advantage of focusing on the future and hence making relevant and profitable investment options. d) Not sufficient judgment is made prior to making investment options owing to the existence of excessive modeling in large institutions. A small investor has the chance to make sober judgments. e) Most institutional money managers only adhere to laid out plans and hence don’t have much choice on the investment option to take. A small investor has the liberty to weigh and drop unprofitable business options.
f) A small investor is geared towards making money as opposed to the institutional investor who focuses on beating set benchmarks (Benink, et al, 2007). Question. 2. If I found myself trading in an inefficient market, I would prioritize first expending my resources in the pursuit of accurate financial information. This would require the hiring of sharp investment managers and market analysts. With this information, I would then engage in identifying instances of market inefficiency that are worth exploiting. This would include misquoted prices among other misjudgments. Question.
3. Beating the market means accurately identifying misquoted prices and exploiting them in order to make some returns. A trader who focuses only on the past performance of stocks in his trade is most likely not to beat the market due to a number of factors including the following; • Not having information about emerging trends in the market that could either result to a reduction or n increase in the price of stocks. This could make the investor make financially harmful decisions. • Stocks most definitely change with time either negatively or positively in relation to stock prices
• Only considering past information will eliminate useful insight that industry players may posses about the firm in whose stocks one wants to trade. This will result in faulty decision making. The entire market is a risky venture because an investor will not have sufficient leeway to examine individual stocks and hence make better decisions (Benink, et al, 2007). . References Benink H. A. , et al (2007) ‘ Market Efficiency and Learning in Artificial Stock Market: A Perspective from Neo-Austrian Economics. London: Routledge