Part 1: What should you invest in?
HtM+ 005: Efficient Market Hypothesis (EMH)
THE NEW INVESTOR
A step-by-step guide to investing for well-grounded people. My fortnightly (bi-weekly for American readers) letters will take you from beginner investor to managing your portfolio well by the end of the year.
Know the difference between speculating and investing.
MONTTY’S RULE #5
Markets are more efficient than they are predictable
When it comes to investing there are 2 broad buckets1:
You believe you can time the market.
You take full advantage of time to grow your wealth.
Timing the market is speculating (trading). Taking advantage of time, allowing compounding to take effect is investing. Although the general term investing applies to both.
To speculate, one has to believe in their ability to preempt the sorts of changes in security prices2 they can capitalise on. You need the right information, at the right time and the ability to take advantage of it to be successful. Speculating presumes that the market is predictable.
To invest (following definition 2), you have to believe the opposite of speculators: that no one can beat the market because there is no capacity to do so. Investing presumes the market is efficient.
There is a cottage industry of Economist and other brainiacs dedicated to proving which of these positions is irrefutably true. This is not an arena I am qualified to jump into, but I will say that literature review has me leaning toward the probability that markets are mostly efficient3.
The hypothesis in support of market efficiency is the Efficient Market Hypothesis (EMH) sometime shown as the Efficient Capital Market Hypothesis (ECMH) or the Efficient Market Theory.
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