Efficient Market Hypothesis in 2 Easy Steps - What is Efficient Market Hypothesis Lecture
EMH
Hello and welcome back again to MBABullshit.com.
So the topic for this video is the Efficient Markets Hypothesis also known as EMH.
And this is the basic video before we move on to a more advance video on the Efficient
Markets Hypothesis.
Remember you can always go back to MBAbullshit.com.
Alright so let’s get down to it.
Now before this video, it’s best if you already know the meaning of Fundamental Analysis
and Technical Analysis also known as Chart Analysis as tools for predicting share and
stock price movements.
Share and stock is the same thing.
Some people say share price, some people say stock price.
So make sure you know these 2 forms of stock price analysis before watching this video.
This basic video discusses the basics of Efficient Markets Hypothesis as well as the basic differences
between Strong Market Efficiency, Semi-strong Market Efficiency and Weak Market Efficiency.
I know these words sound pretty intimidating right now but don’t worry you will see how
easy and simple actually is what I show you the examples.
My next more advance video will still actually be super easy and you can find it in MBABullshit.com.
And it simply and easily explains how stock and share prices move up and down in efficient
markets depending on people’s expectations.
Alright so now let’s get down to it to this basic video.
First of all, it’s best to recall basic stock investing.
Basic stock investing or basic stock playing, or trading or whatever you want to call it
or whatever type, they’re not exactly the same.
But anyway, in basic stock investing, it’s a game of Good News versus Bad News.
Now what do I mean by that?
Well, it depends on sales reports.
For example, it could be sales reports, income reports, any or profit reports you may want
to call it.
Anyway, what is this mean?
It means that the Good News or Bad News regarding sales reports or profit reports are directly
related to stock price.
Basically, if the sales reports are good or the profit reports are good then the price
of shares are supposed to in theory the price of shares or stocks go up.
But if the sales reports of a company are bad then the share price or the stock price
of that same company should go down.
How might people earn money using the news?
Well, let’s just look at this story about greedy Bob and greedy Bill.
Let’s say that Bob here is the CEO of a company and he sees that latest company sales
reports and he sees that the company is doing great.
And let us say that this company that Bob works for is listed in the stock market.
So Bob the CEO sees the latest company sales reports and he sees that his company is doing
great.
What he might do he does not announce this report to the public yet and instead he tells
his buddy Bill about this great sales report before telling the public.
Now what does Bill do?
Bill buys the stock or buys the share of stock before the news announcement about this company’s
great sales report.
And then what happens?
Bob then decides to announce it to the public and after the news announcement, the share
price goes up.
And what happens to Bill?
Bill gets rich quick.
Why?
Because he bought the stock before the news announcement and then there was news announcement
and then Bill share price went up.
So Bill gets rich quick.
So that’s one way people can earn money by trading the news.
Basically this is the story about greedy Bob and Bill.
What actually happened here?
(1) Number one is Bob the CEO learns about the good news.
(2) At first, he tells only his buddy Bill about the good news.
(3) Bill buys the stock in advance.
(4) And then Bob announces the good news to the public to people like your grandma, or
very often we have this grandma investors who don’t know much about the inside information
of the company about the secret information of the company.
And then it’s only after people like grandma hear about the news that the stock price goes
up.
And then people like Bill over here get rich quick.
And grandma here did not get rich quick because she heard about this good news already after
Bill made money on it.
So in other words, people like grandma hear about the news too late together with everyone
else.
So she’s not so happy over there.
And you might say why she doesn’t earn money the stock price still went up.
Well, in theory, remember that in stock trading for you to win someone else has to lose because
you buy the stock cheap or Bill here buy the stock cheap and then he sells it expensive.
Who does he sell expensive too?
Well, he sells it expensive to people like grandma after the price has already gone up.
So in theory anyway, stock trading for you to win someone else must lose.
And in this case, Bill won against grandma.
So in theory, Bill bought the stock when it was still low priced before the announcement
and then sold it to grandma at a high price after the announcement.
However this is actually what happens.
This does not happen in what we called an efficient market.
Another way of saying it is; we saw this bad situation over here but actually in a perfectly
Efficient Market that would not happen, this bad thing that happened over here, this bad
situation between Bill, Bob and grandma.
This would not happen in a perfectly Efficient Market.
Why?
Because in a perfectly Efficient Market; (1) there’s number one example there’s good
news.
(2) Number 2 even if Bob is the CEO, Bob, Bill and grandma all learn about the good
news at the same time even if Bob is CEO in a perfectly Efficient Market.
Why is that?
Because in a perfectly Efficient Market, the keyword here is perfectly efficient, all relevant
information about the company such as the sales report flows or moves or travels instantly
or super quickly between Bob, Bill and grandma.
So Bill does not have an advantage even if he’s the buddy of Bob which is the CEO.
Now, in MBAbullshit language, in business school bullshit language, instead of saying
perfectly Efficient Market, we usually say Strong Market Efficiency.
So if you’re in business school, you’re wondering what does Strong Market Efficiency
is that the textbook or your professor teach and talking about, they’re talking about
a perfectly or almost perfectly Efficient Market like this situation over here where
they all learn about the information at same time or almost the same time.
What does this mean for investors?
It means that in a perfectly Efficient Market with strong market efficiency at any one time,
anyone and everyone already knows all relevant information about a share or stock.
So nobody can earn money by using any information such as this sales report over here.
Nobody can earn money using this information to analyse and predict the future share or
stock price movements either up or down.
So people like Bill cannot use the information to beat grandma.
Why?
Because grandma already knows the same information too at the same time that Bill knows it.
So it’s useless to use inside information.
What is inside information?
What’s the difference between information and inside information?
Inside information just means the secret information that only Bill and Bob know.
Grandma doesn’t know it yet.
It’s secret, inside means like secret information or advance information that Bob knows.
But in a perfectly Efficient Market with strong market efficiency, it is useless to use inside
information, fundamental analysis or even technical analysis to give you or to give
Bill an advantage in stock investing.
Why?
Because fundamental and technical analysis are based on information and since these two
are based on information, how can these two give you an advantage if the information you’re
using is already known by everyone.
Remember in stock market investing, you have an advantage if you know about this information
before other people know it.
Therefore, Bill also does not have an advantage when he uses fundamental analysis which uses
that information and he also does not have an advantage when he uses technical analysis
which also uses information or which is also based on information.
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