Surely studying this emotional and cognitive landscape is as
crucial as figuring the effects of cuts in interest rates or a change
of CEO?
Still, even if we accept the rigorous version of market efficiency -
i.e., as Aswath Damodaran of the Stern Business School at NYU puts it,
that market prices are "unbiased estimates of the true value of
investments" - prices do react to new information - and, more
importantly, to anticipated information. It takes them time to do so.
Their reaction constitutes a trend and identifying this trend at its
inception can generate excess yields. On this both fundamental and
technical analysis are agreed.
Moreover, markets often over-react: they undershoot or overshoot the
"true and fair value". Fundamental analysis calls this oversold and
overbought markets. The correction back to equilibrium prices sometimes
takes years. A savvy trader can profit from such market failures and
excesses.
As quality information becomes ubiquitous and instantaneous, research
issued by investment banks discredited, privileged access to
information by analysts prohibited, derivatives proliferate, individual
participation in the stock market increases, and transaction costs turn
negligible - a major rethink of our antiquated financial models is
called for.
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