Chapter 6: Market Efficiency Theory: "Who Can Beat the Market?"

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“I can calculate the movement of the stars, but not the madness of men.” – Sir Isaac Newton

“The investor’s chief problem, and even his worst enemy, is likely to be himself.” ‒ Benjamin Graham

Learning Objectives

In this chapter, you will

Be introduced to the concepts and theories of market efficiency
Discuss the difficulties involved in “beating the market”
Examine market manias, also known as bubbles, and market crashes, also known as panics, and the behaviors and the common weaknesses that typical investors exhibit
Reexamine the advantages and disadvantages of passive (a.k.a. index) investing and active management
Review famous and infamous investors and their characteristics
Be introduced to some famous myths and stupid sayings

By the end of this chapter, you should be able to

Identify the three main efficient market hypotheses and the random walk hypothesis
Describe the characteristics of market manias, also known as bubbles, and market crashes, also known as panics, and the behaviors of and common weaknesses that typical investors exhibit
Describe the characteristics of intelligent, prudent, long-term oriented investors during manias and crashes
Compare and contrast passive management investing, also known as index investing, versus active management investing
Discuss some of the more famous investors and their characteristics
Relate various famous market myths and stupid market sayings

Are Markets Efficient? Can Investors “Beat the Market?”

This chapter discusses the various theories about market efficiency. The proponents of the efficient market theories believe that no one can “beat the market.” The fly in their ointment is that there are many investors who have beaten the market over statistically significant periods of time. We will take a look at just a few of those successful investors who have proven that the efficient market theories are wrong. We will also review some of the research from behavioral finance and what it says about us as investors and as human beings as well as revisit the controversy surrounding active versus passive management. We end with a few famous market myths and stupid sayings. Enjoy!

Presentation file - Study guide

6.1: Efficient Markets
Are markets efficient? Can investors “beat the market?” Or should they not even bother to try? Let's examines the various forms of the Efficient Market Theory and see if there is anything of value we can learn from them.
6.2: Manias and Crashes
Manias and Crashes. Bubbles and Panics. The history of capitalism is the history of booms and busts. Nothing's perfect, especially the stock market. The key is to keep a long-term perspective and remember the age old adage, "This too shall pass."
6.3: Investor Psychology and Common Investor Weaknesses
Investor Psychology? We prefer to call it "Sly-chology!"
6.4: Active versus Passive Management Revisited
Careful! Index fund investors can get very defensive and angry when you point out their life-sustaining illusions.
6.5: All Stars of Investing
There's an old saying: "If you are going to steal, steal from the best!" Let's see what wisdom we can steal from these All Stars of Investing.
6.6: Famous Myths and Stupid Sayings
Beware of these famous myths and stupid sayings.
6.S: Summary
Congratulations ‒ You Have Finished Chapter 6 ‒ Market Efficiency Theory: "Who Can Beat the Market?"

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