Efficient Market Hypothesis (EMH)… and betting
How shrewdies can (and do) beat the market
Those of you who read my regular blogposts will be well aware that I do a lot of reading around the subject of betting.
For sure, gambling, in its purest form, provides no end of study by itself. But I’ve long been interested the cross-over between betting and other pursuits, and especially those within the financial world (betting, as I always stress, is a form of investment anyway).
And as gamblers there’s a lot we can take from those who play the markets and pursue their rewards within the Square Mile, as opposed to at the racecourse or on the football field.
Now on this very topic… a recent article that I read was published on the Forbes website, and was titled “What Is the Efficient Market Hypothesis?” – and you can read this excellent article in full if you click here.
This talks about the phenomenon of efficient market hypothesis (which will be explained in a moment) and this got me thinking about form study and what gives professional backers their edge in the never-ending battle with the bookies.
I’ll come back to this discussion after you cast your eye over the words from Forbes.
This is just a sample of the article which you can read in full on their site (click here).
It goes…
What is the Efficient Market Hypothesis?
The efficient market hypothesis argues that current stock prices reflect all existing available information, making them fairly valued as they are presently. Given these assumptions, outperforming the market by stock picking or market timing is highly unlikely, unless you are an outlier who is either very lucky or very unlucky.
Understanding the Efficient Market Hypothesis
The most important assumption underlying the efficient market hypothesis is that all information relevant to stock prices is freely available and shared with all market participants.
Given the vast numbers of buyers and sellers in the market, information and data is incorporated quickly, and price movements reflect this. As a result, the theory argues that stocks always trade at their fair market value.
Followers of the efficient market hypothesis believe that if stocks always trade at their fair market value, then no level of analysis or market timing strategy will yield opportunities for outperformance.
In other words, an investor following the efficient market hypothesis shouldn’t buy undervalued stocks at bargain basement prices expecting to see large gains in the future, nor would they benefit from selling overvalued stocks.
The efficient market hypothesis begins with Eugene Fama, a University of Chicago professor and Nobel Prize winner who is regarded as the father of modern finance. In 1970, Fama published “Efficient Capital Markets: A Review of Theory and Empirical Work” which outlined his vision of the theory.
Three Variations Of the Efficient Market Hypothesis
Investors who strongly believe in the efficient market hypothesis choose passive investment strategies that mirror benchmark performance, but they may do so to varying degrees. There are three main variations on the theory:
- The Weak Form of the Efficient Market Hypothesis
Although investors abiding by the efficient market hypothesis believe that security prices reflect all available public market information, those following the weak form of the hypothesis assume that prices might not reflect new information that hasn’t yet been made available to the public.
It also assumes that past prices do not influence future prices, which will instead be informed by new information. If this is the case, then technical analysis is a fruitless endeavour.
The weak form of the efficient market hypothesis leaves room for a talented fundamental analyst to pick stocks that outperform in the short-term, based on their ability to predict what new information might influence prices.
- The Semi-Strong Form of the Efficient Market Hypothesis
This form takes the same assertions of weak form, and includes the assumption that all new public information is instantly priced into the market. In this way, neither fundamental nor technical analysis can be used to generate excess returns.
- The Strong Form of the Efficient Market Hypothesis
Strong form efficient market hypothesis followers believe that all information, both public and private, is incorporated into a security’s current price. In this way, not even insider information can give investors an opportunity for excess returns.
Arguments For and Against the Efficient Market Hypothesis
Investors who follow the efficient market hypothesis tend to stick with passive investing options, like index funds and exchange-traded funds (ETFs) that track benchmark indexes, for the reasons listed above.
Given the variety of investing strategies people deploy, it’s clear that not everyone believes the efficient market hypothesis to be a solid blueprint for smart investing. In fact, the investment market is teeming with mutual funds and other funds that employ active management with the goal of outperforming a benchmark index.
The Case for Active Investing
Active portfolio managers believe that they can leverage their individual skill and experience – often augmented by a team of skilled equity analysts – to exploit market inefficiencies and to generate a return that exceeds the benchmark return.
… the article goes on (but if you’ve stayed with it this far – well done! – you get the point).
And this is the point…
Precisely what I learned from reading this thought-provoking piece…
Because I’m familiar with the view that markets that have lots of liquidity tend to be the most efficient. Hence we see little margin in, say, Premier League football matches where huge amounts are traded pre-kick-off.
And by the same token, why a lot of would-be tipsters who contact me tend to make a lot of their profits in weak markets, or niche sports. Those where the market isn’t that strong, and so is, you get it, inefficient.
However, I still cannot subscribe to the view that the strong (or even semi-strong) efficiency theory can be blindly applied to all forms of betting.
Take horseracing for example. A sport that I have worked in and around for the past 30 years.
Given the profitability of some of the gifted and hard-working professional backers that I’ve worked with in this sphere I wholeheartedly believe in the assertion that – “The weak form of the efficient market hypothesis leaves room for a talented fundamental analyst to pick stocks that outperform in the short-term, based on their ability to predict what new information might influence prices”.
Because these “talented analysts” most certainly are able to “predict what new information” there is…
Private gallop reports, low-key trainer briefings, stable money, a shrewd word from the owners. All manner of hints and tips that aren’t widely available in the public domain, which are used to great effect by these shrewd racing operators.
It’s often these snippets of new (exclusive) information that make all the difference with their betting.
Which is why they can beat the market, and how they can amass profits from backing horses. I’ve seen it time and again… and most recently with the Irish Cash Consortium.
Moreover, for those who argue that Starting Price (SP), and also Betfair SP, are pretty much bang there when it comes to correct pricing and the illustration of efficient markets at work… I don’t disagree.
And maybe they are efficient because by racetime all bets are made, and all the information is out in the open.
But…
Isn’t the definition of a winning backer someone who regularly beats SP. And how do they do this? By their ability to read the markets, better use the (new) information that’s available and more accurately predict the outcome.
QED.
OPINION: Successful bettors, like effective city traders, beat the market. And in order for the market to be beaten, it stands to reason that the market cannot be 100% accurate – not all of the time anyway. So with sports betting, the closer we get to the off, the more money is placed, and the more analysis is done… the bigger the squeeze on the margin of value. Understood. But in terms of efficient market hypothesis, can we say that it applies to a strong (or even semi-strong) degree across all forms of betting? No, I don’t think we can. Thankfully!
