One nice property of markets is that it only takes a small number of people to remove an inefficiency. Once the better, cheaper mousetrap hits the market, the old mousetraps become obsolete; the new mousetrap is adopted even if there are initially many more old-mousetrap-makers than new-mousetrap-makers. Same with the stock market: even if most investors don’t notice a pattern, it only takes a handful to notice the opportunity and remove it.
This is very very wrong.
Knowing that there’s an inefficiency is only part of the battle. In order of importance to counter your point:
You need to have enough volume to remove the inefficiency. For a trading strategy, this is the capital you can allocate to this strategy specifically. It’s not obvious how many hedge funds, for example, are capital constrained. In the mousetrap example this means actually producing the sufficient volume of mousetraps.
The opportunity costs matter. The people positioned best to notice the inefficiency are also positioned best to notice others. May be there is a good trading strategy but it’s *less* than what you would make with your other strategies. So you wouldn’t actually trade it, leaving it for others to pick up. Same with the mousetrap: may be you go build a cat trap, or may be you don’t build anything but make money consulting.
The inefficiency removal needs to stick. If you’re trading a strategy and then stop, the inefficiency will likely come back. You might stop for a multiple number of reasons.
The execution is important. Let’s say you can analyze the data perfectly and come up with a clever algorithm. You’d still need to figure out how to execute on the actual trading. Part of it is not introducing too many exploitable opportunities for other trades (e.g. market makers).
Overall, I’d say even if an inefficiency is publicly known, it usually takes a non-trivial amount of people*effort to remove all of it.
None of this actually invalidates the intended point: it only takes a small fraction of investors to remove an opportunity.
If the opportunity is actually market-beating, then those who notice it will gain capital over time, relative to those who don’t. The opportunity won’t disappear right away, but it will be removed eventually.
Obviously if those who notice an opportunity don’t find it worth exploiting, then the opportunity will persist. But it’s still true that it only takes a small fraction of investors actually exploiting the opportunity to remove it.
We do need more than just one exploiter to remove an opportunity. Some may stop sometimes, but there should be an equilibrium in which the opportunity yields just enough that people bother to exploit it. At that point, the market is efficient.
If an opportunity can’t actually be executed, then it isn’t an opportunity. It’s just a pattern in the data.
Overall, I’d say even if an inefficiency is publicly known, it usually takes a non-trivial amount of people*effort to remove all of it.
Bear in mind that when we talk about “removing” an opportunity, that doesn’t mean zero dollars can be made off of it. It means that the benefit from the opportunity does not exceed the opportunity cost.
This is very very wrong.
Knowing that there’s an inefficiency is only part of the battle. In order of importance to counter your point:
You need to have enough volume to remove the inefficiency. For a trading strategy, this is the capital you can allocate to this strategy specifically. It’s not obvious how many hedge funds, for example, are capital constrained. In the mousetrap example this means actually producing the sufficient volume of mousetraps.
The opportunity costs matter. The people positioned best to notice the inefficiency are also positioned best to notice others. May be there is a good trading strategy but it’s *less* than what you would make with your other strategies. So you wouldn’t actually trade it, leaving it for others to pick up. Same with the mousetrap: may be you go build a cat trap, or may be you don’t build anything but make money consulting.
The inefficiency removal needs to stick. If you’re trading a strategy and then stop, the inefficiency will likely come back. You might stop for a multiple number of reasons.
The execution is important. Let’s say you can analyze the data perfectly and come up with a clever algorithm. You’d still need to figure out how to execute on the actual trading. Part of it is not introducing too many exploitable opportunities for other trades (e.g. market makers).
Overall, I’d say even if an inefficiency is publicly known, it usually takes a non-trivial amount of people*effort to remove all of it.
None of this actually invalidates the intended point: it only takes a small fraction of investors to remove an opportunity.
If the opportunity is actually market-beating, then those who notice it will gain capital over time, relative to those who don’t. The opportunity won’t disappear right away, but it will be removed eventually.
Obviously if those who notice an opportunity don’t find it worth exploiting, then the opportunity will persist. But it’s still true that it only takes a small fraction of investors actually exploiting the opportunity to remove it.
We do need more than just one exploiter to remove an opportunity. Some may stop sometimes, but there should be an equilibrium in which the opportunity yields just enough that people bother to exploit it. At that point, the market is efficient.
If an opportunity can’t actually be executed, then it isn’t an opportunity. It’s just a pattern in the data.
Bear in mind that when we talk about “removing” an opportunity, that doesn’t mean zero dollars can be made off of it. It means that the benefit from the opportunity does not exceed the opportunity cost.