But as already noted, this argument is self-contradictory: Market efficiency requires arbitrageurs who are attracted by profits. However, if markets are perfectly efficient, then there are no profits to be made by arbitrageurs, and therefore no reason for them to participate in the market. This means markets cannot be perfectly efficient – perfect

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The opposite of market efficiency is market inefficiency, which translates into a persistent profit-making opportunity. The argument for efficient markets depends on the idea that buying drives prices up and selling drives them down, causing market inefficiencies to quickly disappear. An investor who processes information and weighs the merits of

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market impact is a kind of force. From a trader’s point of view, market impact is like friction – it bleeds away profits. But, from the point of view of a complex-systems scientist seeking to understand how markets work, it is an interaction rule: Trading changes prices via market impact, and changes in prices cause trading, and so on. (This runs

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There are several ways in which physicists approach science differently than economists do. Physicists are taught to stay as close to the data as possible; theories should emerge from empirical observations. Economists, on the other hand, are taught to build theories and then test whether they match the data. Their justification is that, unlike in

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At Prediction Company, we worked hard to understand our market impact because, since you make money in markets by buying low and selling high, it lowered our profits and was the gating factor on how much money we could successfully manage.20 Market impact increases with trading size, meaning larger orders are bought at higher prices and sold at

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Our experience at Prediction Company and that of other successful trading firms shows that, strictly speaking, the hypothesis is wrong. However, this doesn’t mean it isn’t a useful approximation for some purposes. There are situations where it works very well and others where it fails miserably. The efficient-markets hypothesis is a good

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To better understand the logic behind the efficient-markets hypothesis, let’s make an analogy to traffic. Suppose there are two possible routes from City A to City B. Without traffic, the travel time for each of the two routes is the same, but if there is traffic, one may be faster than the other. If everyone has access to traffic reports and

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The phrase market efficiency has two senses. The first, ‘allocative efficiency’, means that prices are always set correctly, so effort is allocated appropriately. Stock prices help people decide how to do that: If the price of pork bellies goes up, more farmers will grow hogs. The second, ‘informational efficiency’, means that you can’t increase

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Prediction Company ran for twenty-seven years, with only one losing year – 2007.14 The odds of achieving Prediction Company’s track record at random are vanishingly small. Our performance showed that, with the right information and the right model, one can take advantage of hidden patterns in stock prices. We proved that, strictly speaking, the

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