Efficient Market hypothesis
Efficient Market Hypothesis is based on the work of economists Adam Smith, who wrote Wealth of Nations in 1776 and is the backbone of our free enterprise system today, Fredrich von Hayek and Eugene Fama.
In 1965, Eugene Fama published a groundbreaking work in the Financial Analysts Journal aptly named A Random Walk in Stock Market Prices.
Borrowing from the work of Adam Smith, and Fredrich von Hayek who won the Nobel Prize for Economics in 1974, Dr. Fama suggested that markets price goods and services appropriately and that prices are random and unpredictable. Further, since all knowable information is already in the current price, it is unlikely for someone to consistently find undervalued or overpriced securities.
What this tells us is that it is not possible for anyone to consistently predict where prices will go, although may will try.
Since it is difficult to predict market movements and capture additional returns without additional risk, it is prudent to build portfolios that capture the returns of all appropriately charged asset classes across all global markets.
This ensures adequate diversification and the likelihood of capturing returns without excess investment risk.
Diversification is the closest thing there is to a free lunch.
When we utilise this concept we take out the speculation from investing. Stock picking, market timing and track record investing all are based on the premise that there is someone who can predict the future.
Unfortunately there are two groups of individuals when it comes to investing, those who don’t know where the market is going and those who don’t know they don’t know where the market is going!
If anyone knew where the market was going why would they tell you?
We can be successful in investing by following a disciplined, long term approach. To be successful, often requires the assistance of an investment manager.
It is difficult for individuals to ignore the media, friends, associates and family when the markets are going against us. On their own people often make investment decisions that are not in their own best interests.