Is the Stock Market Efficient?

As of July, 2018 I have about $170K invested in the stock market. About half of that is in a 401(k) account, and half in a brokerage account. As I began investing early in my career, I asked myself, do I want to invest in single stocks or in index funds? It was an easy choice for me. One, my employer made it pretty inconvenient to invest in stocks with approval processes, holding period limitations, and timing restrictions. Two, I didn’t have the money or the guts to invest large enough money to any individual stock to justify the brokerage commission (I’ll probably give Robinhood a shot if I do start investing in single stocks)Three, I just didn’t believe that I had done or could ever do enough research to beat the market.

My hesitation to invest in individual stocks evolved into more of a conviction after several years of professional experience in quantitative trading. Is the stock market efficient? NO. I have seen many groups of people consistently make lots of money in high and medium frequency space which contradicts EMH. However, that doesn’t mean that I have a meaningful shot at beating the market. I have personal experience only in the high/medium frequency space, but I can say that a lot of quantitative research goes into picking stocks in these firms. Beating the market is not as easy as it sounds in the media even for large trading firms. Competition is fierce and only the best survives in the long run. I can only assume the same goes for funds that trade in longer horizons.

If you trade relatively fast signals or news and hold a position for a short period of time (under a few months), it is almost guaranteed that some of the quantitative firms have already incorporated them into their models. They have much more resources to validate the alpha content of the information, are faster to trade, and are larger in size. Most of the time, you trade on alpha that has already been realized.

If you pick individual stocks and hold on to the positions for the long term, you would be doing so because you think your portfolio would do better than holding the broader market – say SPY. However, I do not believe that a typical individual can consistently beat the aggregate market, the majority of which are full time institutional investors with much more man power and better infrastructure than any individual. My belief is that the individual stocks are trading at fair value more often than not.

So it really depends on who you ask. The market is fairly efficient for most individuals. For competent traders with good enough infrastructure, it is far from it. They’re usually the ones that makes the market efficient. This is my rationale for investing in commission free low cost ETFs.

How do you approach investing? Do you pick your own stocks or do you invest in a passive fund? How do you go about timing? Share in the comments!