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Meaning of "Markets seldom are [wrong]"?

Personal Finance & Money Asked on January 31, 2021

In the book How to Make Money in Stocks, the author says,

Investors’ personal opinions are generally wrong; markets seldom are. (p. 21)

What does "markets" mean in this context?

One Answer

I think this may be referring to the efficient market hypothesis. It is based on the assumption that prices of securities in the financial markets are reflective of all available information.

If the rate of the return = (capital gain on the security (change in price) + any cash payments. (e.g. dividends))/(the initial price of the security)

Then, the efficient market hypothesis views expectations of future prices as equal to optimal forecasts using all information currently available.

In economics terms, the expectations of future securities are rational

so that P[e(t+1)] = P[optimalforecast(t+1)] which in turn implies that the expected return on the security will equal the optimal forecast of the return.

endofholdingperiod = e

Although technological innovation has given us predictive ability through developments in machine learning, we cannot observe the end of holding period returns.

The supply and demand analysis of the bond market shows that the expected rate of return on any given bond will have a tendency to move toward equilibrium.

To explain further, the expected return on a security equals the equilibrium rate (r*) which equates quantity demanded (qd)to quantity supplied (qs).

R(e) = r* Current prices in a financial market will be set so that the optimal forecast of a securitys return using all available information equals the securitys equilibrium rate.

If R(of) > R* then investors will buy more which will drive up the p relative to its future price.

Basic study tips:

R(of) > R* -> P(t) increases -> R(of) decreases of = optimal forecast Buyers pressuring pushing price up through large volume of transactions in open market. and vice versa R(of) < R -> P(t) decreases -> R(of) increases *Sellers pressuring stock price down.

In an efficient market, all unexploited opportunities will be taken advantage of.

Answered by Erika Conners on January 31, 2021

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