Stock market is the place where dreams are realized and ruined every day. The world is full of people who have made extraordinary wealth with stock investments. Let it be Warren Buffet, George Soros or Nicolas Darvas. The important question is:
Is it possible for any investor to gain an edge over the stock market?
Honestly, it is not possible and many have tried but failed in the attempt. Stock market is all about maximizing your gains at the upper periods and minimizing the losses at lower trading sessions. However, it is possible to invest in a manner that helps you stay profitable over a longer run.
For past several decades, experts have been discussing over the different market approaches including random and cyclical market trends. According to the technical and fundamental analysts, the market follows a certain rhythm and with proper analysis, it is possible to gain a humble advantage over other investors. On the contrary, experts following the random theory of stock market believe that there is no technical analysis that can help them gain an edge over the market.
Three Different Approaches of Investing in the Market
Fundamental analysis is considered as the first step of understanding the stock market and making investing decisions based on quantitative analysis. Fundamental analysts make an investment only after considering the current balance sheet, revenue stream, debt-to-earnings ratio, and similar parameters. If the company appears to be profitable, a purchase is made. Fundamental analysts have a strong notion that the current financial analysis of a company is a strong indicator of their future growth.
In addition to it, fundamental analysts do not support the traditional Efficient Market Theory, which is the basis of the random investing approach. If you are a believer in fundamental analysis, it might help to go through all of these details and make your decisions accordingly. However, keep reading to know more about the Efficient Market Theory.
Efficient Market Theory
According to Investopedia.com, Efficient Market Hypothesis is
“An investment theory that states it is impossible to “beat the market” because stock market efficiency causes existing share prices to always incorporate and reflect all relevant information. According to the EMH, stocks always trade at their fair value on stock exchanges, making it impossible for investors to either purchase undervalued stocks or sell stocks for inflated prices. As such, it should be impossible to outperform the overall market through expert stock selection or market timing, and that the only way an investor can possibly obtain higher returns is by purchasing riskier investments.”
The proponents of the Efficient Market Theory state that the known information about a company or stock is of no use to an investor looking to gain an edge over the market. Every market move is unpredictable and it is not possible to make a profitable investments based upon the known information.
These two investing theories have never been convinced with each other. Both the fundamental analysis experts and efficient market theory experts counter each other with various examples and insights throughout the history of the stock market. In fact, the experts of random market theory reject the fundamental analysis approach of investing.
A Random Walk Approach: Burton G. Malkiel mentioned the random approach in his book “A Random Walk Down Wall Street” where he prepared a chart with random coin toss results. The chart was quite similar to the stock market growth. However, the only issues was that he considered investing decisions to be as random as a coin toss.
According to the technical analysis, investor behavior is a cyclical process and it repeats over time. Anyone with the understanding of this cycle can gain an edge over the market and predict profitable investing opportunities. This theory is based upon the behavior of the investors and it analyses the investors for long investment periods. They follow the mass support and resistance statistics for their investing decisions.
Technical analysts do not support A Random Walk approach or the Efficient Market Theory Approach. We can expect that none of the market experts would ever agree to each other and this debate over Fundamental analysis, technical analysis, and efficient market theory would continue in a similar manner. A clever investor might just want to consider both of these approach to get an edge over the market!
Food for Thought!