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Are Markets Efficient or Effective – Market Profile Perspective

February 7, 2020


Are markets efficient
or are they effective? This has been the debate
that is going on for years. The efficient market hypothesis states
that you cannot read the markets or make returns greater than what the
index achieves in an year. On the other hand, those who believe that the markets are
effective say that you can beat the markets on a consistent basis
and create excess returns. What is true, we are going to
find out in today’s episode… [inaudible] if you’re new here, I’m dean from dean market profile and I
have been trading markets for the last 14 years. I have been a part of this
debate over the years. Now I believe it is time to put it on
record what I believe about whether the markets are efficient or effective. We conduct a regular weekly
wrap up session for nifty
and banknifty using market profile analysis on this channel,
but not only we do that. We also do a bunch of cool stuff
related to technical analysis, like todays video where we are going
to discuss whether the markets are efficient or effective. So I’m not going to ask you to subscribe
to my channel or ring the bell icon because I trust you to make the right
decision. All right, let’s move on. So what does efficient
market hypothesis tells us? I’ve taken this from Wikipedia, which
is the open source of information. Okay. Efficient market hypothesis.
This is a theory financial economics, which states that all the information
is already factored in the price of the stocks. The direct implication
according to this theory, is that you cannot beat the markets or
create excess returns above an over of what the indices do,
or the stocks do. Now, there are three forms of efficiencies
as described in this efficient market hypothesis as it is. It is quite
complicated and difficult to understand, but now they have also brought in
three forms of efficiencies. Uh, they’re pretty basic. Basically they talk about a weak form
of efficiency or semi strong and strong. And I don’t get the point of that.
But let’s go through that one by one. Ok the weak form efficiency states
that future prices cannot be predicted. Looking at the past history of that
particular asset or instrument. Now this is one thing that I I agree with. I also believe that you cannot look at
the past price data and then predict what the market or the stock or the instrument
is going to do in the future and that is just not true because markets are
continuously evolving and it’s not a a mechanical thing or a mathematical thing,
where you know The inputs, if you control them the outputs
will always be the same. It’s a thing where emotions run high
and whenever there are human emotions involved, you just cannot predict
the outcome of that particular thing. It’s no different with the markers. Then comes the semi strong form.
Now what it tells us is that share prices or asset prices, adjust themselves according to the
available information in the markets, so whatever publicly available
information is there. The markets or the share prices or the
index prices will adjust themselves to that price and markets will move only
when some new information comes in. Now since that the nature of the new
information in itself is unpredictable efficient market hypothesis states that
you cannot predict the market based on the information that is not yet available. Now I know this is not the case with
markets because most of the Times that information is available to a group of
people or few people sometimes legally, sometimes illegally and whatever actions
they take reflect in the price and if you can spot that you
can spot opportunities. So that is a semi strong
form of efficiency. And then we come to the
strong form efficiency which
states that prices reflect all forms of information,
whether it is private or public. Well this makes a little bit more sense
because obviously the information is available to a few people before
the general public. Alright. and, if those few people decide
to act on that information, that information is legally obtained
And if they are allowed act on that information,
no. Obviously they have an
edge over the public right? Whenever this section of public who
have that advance information act on the markets their buying and selling
leave trails in the market. And if you can pick that up, you can trade the markets based on that
information and you can make money in excess off what the index
average returns are. Now before we move on to the
other part of the equation, that is the effectiveness of the market. We need to first understand why the
markets exist or what is the objective of the markers,
right? So the basic objective of
markets is trade facilitation. And what do I mean by that? I mean by that is the market exists so
that buyers and sellers can come in and conduct business if they want to buy, they should be able to buy and if they
want to sell they should be able to sell in the markers, right? And that
is exactly why the markets exist. The second objective of the market, or more of a byproduct of this buying
and selling is the discovery of the fair price, right? Many people
think that markets exist to
discover the fair price? No. It’s a byproduct.
Nobody’s there to discover the fair price. Everybody’s there to maximize
their own benefit. Right, so if you go to a grocery
store what you’re going to do, if you bargain in the market, what you are trying to do is to get
maximum benefit out of the money. You are ready to spend . at the same time the person
who is selling you something, is trying to get the maximum for this
product so both the parties are trying to maximize their own gains. They’re
not there to discover the fair price. It is a byproduct because whenever
the buyers and the sellers, agree to conduct business, it is a fair price at that particular
point in time for both buyers and sellers, they might not be happy about
it but it’s a fair price. This discovery of fair price is done
through what we call the auction market framework, but what auction
market framework states is that if markets are going higher or up they’re
basically going up to find sellers and if they are going down, they are
basically going down to find buyers. Now these are the two simplest
of statements, you know, very simple statements, just a few words that
summarize this auction market
theory, but this simplicity, you should not let it fool you into
thinking that it’s not effective. This particular theory is very,
very strong, it underlies all business transactions,
right? The markets are no different. So if you can understand the theory and
its principles and its nitty gritties, your ability to understand the
markets is going to skyrocket. Let’s move on. The two statements that markets go up
to find sellers and markets go down to find buyers is based on
the simplest of laws. That is the law of supply and demand,
right? So if the market is trading at a certain
price and the sellers feel that it’s not a fair price for them to sell, so they won’t come in and they won’t sell. What will then happen is that the auction
will have to move higher at a higher price to find sellers
who are willing to sell. because the whole purpose of the
market is to facilitate trade. So if there is one party is not
available to conduct business, the market will move in that direction.
to find that party. So we all know that supply
increases when the price increases. So if the sellers are not in the
market at a particular price, the auction will explore
up who find those sellers. And what about the other way round? Let’s say markets is trading at a
certain price and there are no buyers. Nobody’s willing to buy because they
feel that the price is very high. It’s very steep.
What will happen, that particular product share
instrument asset whatever it is, it won’t find any buyers. There won’t be any transactions and
to sell that inventory to sell that particular product, stock asset, whatever. It will have to come down to a price
where the buyers are again willing to conduct business unless and until there
is this kind of adjustment of price, transactions cannot take place. And this particular adjustment
is what we are trying to trade. All right,
well but before we move on, if you feel that this particular
auction market theory framework or AMT helps you improve your market
understanding a little bit, a tiny little bit, and believe
me guys, once you start using it, when you start analyzing the markets using
this auction market theory framework, your understanding of the markets
for why the markets do what they do, why the market is going up, why the market
is going on, why it is consolidating, why it is not breaking out. All these questions will find logical
and valid answers which you will be able to use in your trading.
So I believe it’s a, it’s a fair deal. So if you feel that this particular AMT
is going to help you improve your market understanding, just go into the
comments and type AMT rocks for me. Let’s see how many of you
feel that auction market
theory can indeed help you in your trading. All right, let’s move on. So why the markets are effective now
we talked about information and how you know the information is factored in the
share prices and only new information can change the prices, but
the new information is not
public, it’s not available. So it’s not predictable and all
those things we’ve talked about, but there is certain characteristics of
information that we need to understand before we move on and see the fact that
markets are indeed effective in what they do.
And that is the whole point of it. So how the information gets distributed,
there are a few aspects to it. There are three actually, time,
concentration and interpretation. So time. How does that affect the
distribution of information? Now by time, I mean the time it takes
for the information to reach everyone. I don’t watch news channels,
I don’t read newspapers. I don’t read magazines related to markets
or financial instruments though I am a full time trader.
I don’t do all these things. I also don’t browse websites aimlessly
to, you know, uncover information. Some hidden gem, which can give me some
profit just does not work that way. So if something happens,
it usually reaches me very late, you know,
as simple as an RBI announcement. Many of the Times it does
happen on my telegram channel. You guys are there and you know that
I’m most of the Times not aware of an impending RBI announcement,
which is not a good thing. You should be aware of all those things.
But the way I have, uh, you know, developed my understanding of the markets
or the way of looking at the markets and just not bothered about what the
events are playing out some thing or other in this auction market theory gives me
an advance warning whether there is going to be a chance of heightened
volatility or not. And usually this happens
when there are events, right? So this information reaches different
people at different points in time. Some people are privy to this information
very early in the game and that can help them a lot. If it’s a very
powerful piece of information, they can position themselves in the
markets and benefit from it. Now, it’s not always legal.
It’s not illegal too, so as long as they’re obtaining that
information legally it’s all good. Alright. But few people…
The general public, they receive that information very. And by the time they receive
that information? And then
they interprete it, uh, and then decide to take action. The market has already moved and this
happens a lot of times. You know, usually, uh, around results season,
you know, you go into a stock, you believe that there is going to be
certain a let’s say an increase in profits by 50%, then you believe that
the stock is going to go up. The results are announced. The profits are as per the expectation
and you buy and you see that the market actually or the stock actually tanks. And the reason is some of the
people had that information already. They had already acted and marked the
prices or the general public had marked the prices up for that stock
in anticipation, right? All these actions can be
interpreted before time, you know,
not withstanding what the result was. But since all these things happened, when the information actually
came into the market, all people had already bought, there were no more buyers left to act
on that information apart from you or a few others. And all those who had bought they say
that the profit is only as expected not greater than that. And then they tend to try to rush out
of their positions and that causes that big quick fall in the markers. So that is how when information
reaches different people. Uh, you know, matters a lot. Then we come to
the concentration of information. And what do I mean by that? Is Information is concentrated with Some
people more than the others by the time the information, reaches you through popular media
channels like websites or news channels or newspaper or magazines.
It is diluted. The information has exchanged hands with
so many people and most of them have acted on it and that just,
you know, reduces the effectiveness
of that information. So the information tends to
be concentrated with people
who have better knowhow. So if somebody is in a particular
business and knows ins and outs of that business, she does not have to know everything
to see changes in that business, you know,
environment. Let’s say it’s IT or it’s
banking or whatever and the
person is in that industry and he knows that what the
general, uh, you know, uh, key drivers of the prices and if you
see changes happening in some of them, she can anticipate changes in others.
Right? So the information is concentrated with
that person because he has a better know how, Now you cannot have a know how of
all industries and all the businesses. So what do you do instead?
You look at the markets, you look at the information
generated by the markets, which we call market generated
information in auction market theory. And you try to use that to Your advantage.
All right. So if the information is concentrated, obviously the scales are tipped in
the favor of the person who has the information, right? And then
we come to the interpretation. The information is not directly passed
on to the end user or people general public. It is often interpreted by the so called
experts and they interpret it for you and then they give it to. Now that
interpretation can be right or wrong, can have different kinds of effects on,
on the share prices, on the psyche of the people who
are listening to those experts. So the information is not just
clean, unbiased information. It is, you know,
uh, interpreted and a lot of personal bias
of that person who is interpreting the information comes in. And then there’s just so many different
aspects and drivers which change the effectiveness of that information.
Right? So these three things, the time, concentration and interpretation
of information, you know, uh, makes it impossible for the prices
to reflect it at all points in time. Even sometimes when the information
is in, you know, just a public domain, the share prices do not reflect that
because the traders refused to believe and share prices move because
the traders buy and sell. It does not move based on
some mathematical equation. So the traders refuse to
believe certain thing, they won’t act on it and if they won’t
act on it or share process won’t change even though the information has changed,
right. So that is where this efficient
market hypothesis, uh, you
know, uh, is a bit dicey. Uh,
then we come to perception of information. Now just because somebody
has that information does
not mean that he will act on or he finds it important or
he finds it actionable right. As I gave you an example of
the banker, uh, or you know, industry experts unless and until
you have sound understanding of that particular business environment,
the key drivers of the business, whatever information that comes to you, you won’t be able to act on it as good
as perhaps some of the experts or some of the people with experience
in that sector can, you know, do not also have to have
actual industry experience. I have seen traders who have just tracked
a certain sector for years and they have developed a feel for that.
So they know what is going to happen. So if the RBI is going to
raise it 50 basis points, the rates by 50 basis points,
they know what effect it is going to have. And it’s not always a bad, it’s not always
bearish because they have that uh, uh, you know, the know the pulse
of the industry. And that
is why they can be so good. So if you have that experience,
if you have applied yourself, if you have the right tools and right
way of looking at the markets and information, you can beat the market. And
you are not actually beating the market, you are actually trading
against the other fellow trader. So if the other traders are not well
prepared and well informed and they don’t have the tools of the trade, then obviously you have a bigger advantage
of them and you can consistently make money in the markets.
Then we come to biases. Just because you have information does
not mean that it is going to help you because that it what you do
is based on different biases. We are just going to discuss
three of them, the confirmation, the recency bias and the survivorship
bias. Okay. What is confirmation bias? Whenever a person discovers something
that person gives additional weight to that information.
So if I go into the markets, I have just to learnt about let’s
say triangle pattern, pennant, you know everybody knows what a triangle
pattern is. I go into the stock charts, I I sift through hundreds of charts and
then I discover one particular share which is actually forming
a pennant pattern. And since I have discovered
that particular pennant pattern, what I believe is that that pennant or
triangle is going to resolve in a certain way and I’m going to make a lot of
money now just because the prices are converging does not mean that
they’re going to explode. They can just keep on converging.
They can just move sideways. And if you believe it is going to go up,
it can go down. Funny things can happen in the
market. Nothing is guaranteed, right? The real thing is that you should know
why it is doing what it is doing right and the confirmation bias completely
beats the purpose because you tend to put in additional weight on the information
that you have discovered. All right, and uh, that is very dangerous
situation. The second is recency bias. Whatever has happened recently
controls more of your mind space. Then whatever has happened
in, say, distant past. And that is why the traders don’t improve.
They do make mistakes. They do learn from their mistakes,
but they just don’t keep it in their mind. You know? And then there
are those, uh, you know, sayings in the markets that you are as
good as your last trade. Its bullshit. It’s not like that. You are as good as the lessons you have
learned and remembered and applied to the markets. It’s not about your
last trade. My last trade is a, is a loser or what? What does it mean?
Does it mean that I’m a bad trader? Its not like that you’re always going to
have losses and you are always going to have profits. So what you do with those
learnings is what matters. So you just cannot rely on the recent
information. That is why, you know, the media works. Day in day
out they are just, you know, pushing a lot of information. But just
because it is a recent information, people get hooked on to it
and they cannot let go of it. That is why I’ve stopped
watching those news channels. And then we come to the last of the
bias and that is a survivorship bias. And what it means is that people
tend to look at the survivors. Lets look at our favorite movie stars. We have Amitabh Bachhan Shahrukh Khan
Salman Khan and all these guys out there, uh, they are very popular but when they were
starting out in the industry there were hundreds of other people aspirants who
wanted to become heroes in bollywood. But did they succeed? No,
only a few people succeed. There are great stories of struggle,
of passion of hardwork. Everybody did that. But then why only a few succeeded that
is because we tend to focus on those few only and we tend to ignore all of those
who did not succeed despite putting in the hard work despite putting
in the passion, despite having, you know all the love for the craft
that is what survivorship bias is, you know, if you go on to twitter and you see that
people posting the screenshots of the profits,
but that’s just one profitable trade. And whenever they have a profitable,
but they tend to share it. So what do we believe is that they
are making profits consistently. But that is not the case. They
won’t come in and post that. Okay? They have lost of 50% of their capital
on one trade. They won’t do that. You always tend to look at the successes
and we tend to believe it blindly. That is how the human, behaviour,
behavior works it, it’s driven by hope. We hope that it is true and then we try
to follow these guys and then we get disappointed later on when we
discover that it was all hogwash. So you have to be aware of
their survivorship so it’s
not just about information, all right? Its all of these things and all these
things are human things and as long as human beings are trading the markets, I don’t believe efficient Market
hypothesis will hold the markets. However are very effective
in distributing the, the prices in such a way that most of the
people in the markets get to business. If they cannot either they will have to
lower their prices if they are sellers or they will have to increase their
prices if they are buyers to reach a particular level and conduct business
and all these things can be understood by auction market theory. It might seem a bit confusing but it can
be understood by auction market theory. There is a brilliant tool which can be
used to apply all these principles in real time markets to pick profitable
trades and that is Market Profile. Okay,
so last is you have information, you have perceived it and then act on it, now every person is going
to act in a different way. No trader has the same amount
of capital as the other, I have x amount of capital.
Somebody may have 10X, somebody may have half my capital.
All right. People don’t understand leverage. Now
what happens is that if you over leverage, it works both ways guys. It can give you great profits but can
wipe your capital out equally quickly and when that happens, the person won’t blame the over-leveraging
what that person ends up doing is blaming the tools that he’s using Be it
Market profile, elliott wave analysis, technical analysis, whatever person ends up blaming the
tools and then he moves on to the next. The real problem was actually leverage.
All right, so even though a certain person has an
information that is good information that is actionable information. But if he is not following the simple
rules of risk management and trade management,
whatever information he has. It’s very difficult for him to make
profits consistently in the market. So it’s not just about information, it’s
about how you act on that information. It’s about how you perceive that
information. Makes Sense. Let’s move on. All right.
Last but not the least. We are all human beings and
we do screw up repeatedly. It does not matter how much you know,
efforts you put, whatever you do, maintain a trade journal make flashcards
placards whatever you do you are going to screw up one time or another? The only thing that you can
actually control is your risk. If you can manage your risk,
you can stay in the game longer, make all the mistakes, learn
from them, make it again, make it so many times that you start
recognizing it before you start making it. But to do that you need to stay in
the game and to stay in the game. You have to keep your risks very,
very small. So what I would say, uh, at the end of this is that markets are
definitely not completely efficient, but they’re really, really effective in letting
buyers and sellers do their business. So I don’t believe
that markets are completely efficient. I am of the belief that
markets are effective and
that is what makes me come to the market in anticipation of making
profits. And if you have the right tools, the right mindset,
the right way of looking at the markets, you can actually make consistent
profits in the markets. So before we leave,
let me ask you a question. Do you believe markets are
efficient or effective? If you believe the market side effective
just write effective in the comments and perhaps give me a
reason why it is effective. If you still believe the markets are
efficient write efficient in the comments and tell me why you believe that
they’re efficient and we can have a good conversation in the comments.
So if you liked this video, I would suggest you give me a thumbs up. Because I have put in a
lot of efforts into that. And if you can share it with one person, just one person who may find this
particular information useful I would be really grateful. You can use the share button below the
video and you can share it with just one person who may find this video useful.
And once again, I will not ask you to subscribe to my
channel or ring the bell again and do this and that because I trust you
to make the right decision. I know you know what is important
for you and if it is this, all this stuff that I’m
sharing is important for you. I know you are going to subscribe.
And even If you don’t, you know how to find me just type in
dean market profile in youtube and I will be right up. So thank you for watching this video
and I will see you in the next one.

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22 Comments

  • Reply tom emmanuel May 3, 2019 at 5:47 am

    Effective….

  • Reply Kishore V May 3, 2019 at 5:57 am

    AMT Rocks!!!

  • Reply Dean Market Profile May 3, 2019 at 6:19 am

    Are markets efficient and effective?? Does it matter to out trading?? Let me know…

  • Reply Rahul Ware May 3, 2019 at 7:08 am

    Very great and deep briefing of Trading mindsets I'm just improving myself in trading wwith help of this vids its great thanks for making us understand what mistakes are

  • Reply Varun Kumar May 3, 2019 at 8:44 am

    Effective

  • Reply praveen s May 3, 2019 at 10:05 am

    amt

  • Reply Arun Kumar May 3, 2019 at 11:01 am

    hi dean, i appreciate your effect in making this video and its lot of information to a lot of traders out there.last 5 mints was very good statement ,managing risk only is with in our hand and staying long in market only give us to stay in this business as profitable trader.

  • Reply vinay raikar May 3, 2019 at 12:34 pm

    AMT ROCKS

  • Reply Rajiv Mohan Rao May 3, 2019 at 1:19 pm

    AMT rocks

  • Reply Prakash Praaku May 3, 2019 at 1:24 pm

    AMT Rocks Dean, very well explained. Good job 👌👍👏

  • Reply Rajiv Mohan Rao May 3, 2019 at 1:37 pm

    Markets are effective because there are traders who have the edge to profits

  • Reply Prakash Praaku May 3, 2019 at 2:16 pm

    Dean Market Profile  As you mentioned, I believe Market are effective, but not efficient all the time. Why markets are effective :
    It provides platform to do businesses in an ideal way.
    Market deflects summarized perception of all the buyers and sellers and that can be identified with the price and it's volume.
    Market always try to hunt for perceived fair value discovery and moves towards the agreed upon fair value most of the time.
    Market tends to move faster towards path of least resistance and it can be easily traced using Market Profile, VSA, OFA and Volume Profile principles.
    Market are effective when we try to understand the conviction of the traders and how to interpret such valuable market generated information to stay in the right direction.

    I don't believe market are efficient,
    They don't have to be.
    Because as you rightly pointed out, it's not mere maths and they is not fixed rules for the market to behave as it does.
    Each single trade is always different and the is not fixed theory to decide what price has to do,
    Because, people's view towards any stocks/ any assets tend be different all the time.
    If everyone knows what is going to happen in advance, there will be no better opportunities in the market.
    Its not efficient, because no one can predict the price move every single time.
    Being that said, aligning ourselves to the right direction of move will help trader to better understand the market and consistent learning will keep us stay in the game. Risk is the only thing we can control and we have to understand how to manage it in every single trades to survive to live tomorrow as a trader.

    Your video has given me so much insights towards the AMT Dean. Keep up the good job, thanks a lot again Dean.

  • Reply Mohammed Mohaideen May 3, 2019 at 3:16 pm

    Hello Dean Brother, Very well explained about AMT. You are among the very few in the retail trader community talking/discussing about the underlying logic in the market rather than doing plain marketing. I ventured into learning AMT & MP after seeing your videos and I am already seeing that change.
    Keep making these explainers videos about the market and its performance in different conditions. It will help us get better. Thank you. AMT ROCKS !

    For your question: Markets are effective, trying to be efficient. That is the space where we are trading it ! 😀

  • Reply Hardik Kanitkar May 3, 2019 at 5:00 pm

    Late to the party….
    Markets are certainly Effective for majority of its time..Therefore We have people's like Warren Buffet , Peter Lynch , Jhunjhunwala etc
    And moreover time and facts have proved that Markets are Much more EFFICIENT than other asset class like Gold, FD , Real Estate etc

  • Reply BAKRA banao May 3, 2019 at 9:03 pm

    AMT Rocks!

  • Reply rajesh kumar May 4, 2019 at 5:26 am

    Nice info Dean sir, you r the best in reading the context

  • Reply Anandbabu natarajan May 4, 2019 at 9:06 am

    audio volume so low not able to hear

  • Reply Srinivas Krishnan May 4, 2019 at 9:31 am

    Do you do Market profile and order flow training program ? Kindly let me know ..

  • Reply aniket mohite May 4, 2019 at 9:37 am

    AMT rock sir…&this ask bid is best explaind in John keppler s book

  • Reply Anoop C S May 4, 2019 at 6:57 pm

    AMT ROCKS. I think markets are effective. Nice presentation of theory of why.

    Thank you

  • Reply Karthik Mv May 9, 2019 at 5:01 pm

    Amt rocks

  • Reply ajay vats June 2, 2019 at 5:12 am

    Hello sir I just completed my book ( market in profile ) I need to know more about this concept. Please suggest me the next step or any book

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