Option Trading Blog

In all the blogs about trading and investing, I rarely see a discussion about the Efficient Market Hypothesis. The reason I’m always bringing it up is only because knowing what an efficient market means can help you make better trading decisions. Here is an example from a forum I used to participate in, about an analysis of certain events

I saw in a finance magazine that foreign investors are going to increase their investing in the local stock market, so I’m going to buy now some stocks as I think the market is going to be bullish

This all seems like a valid claim, although there is something missing from this analysis. Firstly, the person has seen this in a financial magazine. Unless he is the only subscriber to the magazine, this is public information that all investors can see. This means that by the time he buys the stock or the option, the price will be actually higher to reflect the bullish news. In the end, our investor did not make any profit from this unless he suspects that the market will go even higher. At this point we are talking about speculation and diverging from the bullish news. The subtle point to remember here is that you may have thought you bought a bargain, but you really just bought what the market consensus thinks is the fair price.

The great speculator George Soros once said that in order to make money in the stock market, you need to be a contrarian and do exactly the opposite of what most people do. This has a little bit of merit considering the fact that most information available today is public and most markets are efficient in the way information flows in it.