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Can market inefficiencies be exploited?

August 26th, 2009 at 07:42 am

This is kind of stock-trading talk, but it's also something that I think will interest serious investors as well.

Question: Can market inefficiencies be exploited?

Better question: Do I know anyone that can?

Even better question: Can *I* exploit it?

Short answer: I highly doubt it. Frown

That's the sad but short truth. Now, for those who are still interested, please read on.

Imagine a deceptively simple and seemingly "sure-fire" premise. You see something that is currently running for a very low price, what do you do? You buy it. You see something that is currently running for a very high price, what do you do? You sell or short it.

Buy low. Sell (or short) high. Simple right?

So, why are so many smart people having such a hard time with this seemingly simple concept?

The more I learn, the more I am realizing the following: Most people don't know where the lows and the highs are. And for that matter, we don't know if current lows could go lower, or if current highs could go higher.

At least, not I.

And when you think about it, most trading strategies have to do with covering the possibility of a trade going wrong. Risk mitigation. Or is that loss mitigation? There's a difference there.

But to answer my own second question, the only person who I can think of that can seem to beat the market is Warren Buffett. I even have a link in this blog, linking to a white paper that claims he isn't just lucky.

So what is he doing that makes him succeed where everyone else has failed? After all, everybody knows about value investing by now. A whole lot of smart people are practicing it. So, why not others? Why only Warren? I don't know.

If you're wondering what brought this up, consider this interview with

Text is Jeremy Grantham of GMO investing and Link is http://moneywatch.bnet.com/investing/article/jeremy-grantham-why-to-buy-stocks-now/277143/
Jeremy Grantham of GMO investing. When you read that article, you get the sense that he is indeed a pretty smart man and he talks a lot of sense. Now consider this rebuttal by
Text is Larry Swedroe of Buckingham Family Financial Services and Link is http://moneywatch.bnet.com/investing/blog/wise-investing/can-market-inefficiencies-be-exploited/498/?tag=col1;blog-river
Larry Swedroe of Buckingham Family Financial Services.

Granted the rebuttal itself is not without some criticism, but if Swedroe is correct, then why is Grantham himself isn't able to exploit the market based on that simple premise? Yes, the same premise as my own that I am hoping to exploit?

I think it's not so much that zigging when everybody is zagging isn't a bad idea. But rather, the problem is we really can't tell when the market is zigging or zagging at all. Even when the valuations seem so "obvious".

Well, either way, I am still not fully convinced that this is impossible. I mean, even if it is, I'd like to keep trying for now. But peering into others who are obviously smarter and more experienced than I am, and yet having just as much of a hard time with the same basic thesis I'm using, it does give one pause.

5 Responses to “Can market inefficiencies be exploited?”

  1. gamecock43 Says:

    BA I dont know anything about stocks but your question intrigued me.
    Generally people buy stocks to "see how much money they can make/lose." Thats why they do not know "Where the lows or highs are." Thats why it is hard to "buy low- sell high."

    WHAT IF?
    You approached the market from a different perspective?
    You put a dollar figure on the stock before you bought it?

    "I will by this stock for $100. Once it goes to $110 I will sell regardless of it's future potential. I will sell at $90 if it hits that number rather than waiting to recoup my investment."
    This way you already know you either:
    have $10 in future money or -$10 in future money.

    And you can create a budget that way. If you buy all stocks and plan to sell at $10 profit or $10 loss...you can anticipate your future bank balance.

    You buy 50 stocks...and you will eventually make $500, or lose $500 or somewhere in between...but you know it is a $1000 range. And from that point kind of bunny hop through the year- buying...selling...and keeping a running tally as you go. Rather than buying/hoping/ and holding for some unknown day when you will sell and hope you made a lot of money.

  2. Broken Arrow Says:

    Hehe, yes, that's basic technical trading. A lot of people out there trade just like that. And in the end, so do fundies like me. When it comes down to it, you do have to do decide on a price point.

    The tricky part is figuring out where a stock is going. Knowing that, and you can trade successfully on it. Of course, the trouble seems to be that most people don't know where something is going.

  3. gamecock43 Says:

    oh. So my plan was basic trading 101. Oh well I am learning.

  4. Broken Arrow Says:

    Ah, don't feel bad. And yeah, learning is all that matters. I am still learning too.

  5. merch Says:

    The easy answer is yes. That actuall answer is no. For the retail investor, transaction accounts usually eat up any profit.

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