The Benefits Of A Volatile Market

The question isn't "Is the market efficient?" but rather "How inefficient is the market?" and "How can we exploit this?" - Edward Thorp.

Over the many decades of academic studies and research done by market professionals, nearly everything imaginable has been tested in an attempt to predict the direction of a company's stock price. P/E ratios, dividend yield, revenue growth, book value, earnings growth, etc. have been looked at over and over. The one conclusion that can be made from these studies is that few, if any of them, show a real statistical edge. The one area which we believe remains fertile ground for further research is price behavior.

What is price? It's essentially a culmination of all the known information of a company. Therefore, price is real as it represents what the majority of the market participants know at that given time.

Finding Market Inefficiencies

Shorter-term, we believe that markets (prices) can be very inefficient. We have published some of these inefficiencies over the years and we'll continue to publish them over time. Most of these short-term inefficiencies tend to occur whenever there is either news in a stock, or there is a great deal of fear in the market place. One only has to think about what happened in the summer of 2007 to fully understand these inefficiencies. Solid performing companies saw 20%, 30% and 40% of their value lost in a few days as market participants (primarily institutions) irrationally sold stocks, only to see the prices of many of these stocks quickly bounce back to their previous levels. These types of market inefficiencies can be found on a regular basis in individual stocks, especially on unexpected news-related events, or when market volatility rises.

Longer-term, markets are supposedly more efficient. This is the concept that has been taught by many in the academic world. But, if it was true, you wouldn't expect low volatility stocks to outperform high volatility (and often times high beta stocks) by a better than 2-1 margin since 1995, would you? But they have...

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