If that coupling gets diluted to higher simulacrum levels, such that prices only reflect a free-floating consensus of what traders think that traders think that traders, &c., then a market that is efficient in a narrow technical sense, may not be performing the kind of information processing that some naïve EMH proponents might think it is.
I think this is an important point. And also that there is a time horizon component to it. As Benjamin Graham (mentor to Warren Buffett) put it:
In the short run, the market is a voting machine, but in the long run, it is a weighing machine.
I have a pet theory that part of the way that the market reacts to news is analogous to the blue-eyed islanders, where everyone is trying to do induction on what everyone else thinks.
Suppose I learn some new information (or do some analysis) that suggests that stock prices should fall (e.g. because a new epidemic will be worse than generally thought). But stock prices aren’t falling yet. Is that because the rest of the market participants don’t know what I know, or is it because they also know some countervailing fact?
After some time, prices still aren’t falling. Surely other people would have figured it out by now. What’s going on? Is there something obvious I’m missing?
(And how many other people are in the exact same epistemic state, and also asking the same question?)
Finally, prices start to fall. Maybe someone got brave, and decided to bet on the same inside view that I had. Or maybe some other random event caused them to fall. But they’re falling now.
Normally, you might think that if you have an inside view of where prices should be, and then prices fall, things that looked expensive to you before should look cheap, and so you should want to buy. But if you’re in the epistemic state I describe above, prices falling is validation of your belief that prices should fall, and evidence against the hypothesis that there’s some important countervailing fact that you’re missing. So as prices fall, your own “fair” price for assets falls too.
So all the islanders leave on the same day. And all the traders sell at the same time. And market moves happen more sharply than they would if they were purely the result of updating on external information.
I’m not sure if this view is correct, but it’s my impression. (For a related idea, see Soros’s notion of reflexivity.)
I think the big Ethereum move in May 17 was a great example of this. Evidently many people thought earlier that the price should be higher, but “the market can stay irrational longer than you can stay solvent.” So you had a building of steam before it finally shot up.
However I’m not sure to what extent these are actual epistemic issues as you hypothesize, or just an artifact of small fractions of smart money.
One example that caused me to think about these things was when in Feb or so of 2015, Elon tweeted out that there was going to be a new product announcement in March (I think this ended up being for the PowerWall—don’t remember exactly). The stock price jumped something like 1% in one minute. And it was the same minute as the tweet. So it seemed clear that the market had reacted to the news.
Except it wasn’t news. Elon had said basically the same thing on the earnings call a couple of weeks before.
You might argue that the fact that he also tweeted it out made it more likely that it was actually going to happen. But enough more likely that the change in EV was worth 1% of the whole company? I was very skeptical that that could be the case.
But taking into account that the price change had been so rapid, it made me think that perhaps it was just from trading bots that were using his twitter feed as a price signal. But if that were the case, shouldn’t the price come back down once humans analyzed and realized that this wasn’t actually news?
Well, not necessarily. The fact that there were people willing to buy up on the tweet is information too. There’s so much reflexivity involved that it seems very hard to tell in the short term exactly what the price should be. And so even if the price changes for a dumb reason, that doesn’t necessarily mean it should go back to the old price.
(Again, just my impression. Actual traders or HFT programmers might have a different story to tell.)
I think this is an important point. And also that there is a time horizon component to it. As Benjamin Graham (mentor to Warren Buffett) put it:
I have a pet theory that part of the way that the market reacts to news is analogous to the blue-eyed islanders, where everyone is trying to do induction on what everyone else thinks.
Suppose I learn some new information (or do some analysis) that suggests that stock prices should fall (e.g. because a new epidemic will be worse than generally thought). But stock prices aren’t falling yet. Is that because the rest of the market participants don’t know what I know, or is it because they also know some countervailing fact?
After some time, prices still aren’t falling. Surely other people would have figured it out by now. What’s going on? Is there something obvious I’m missing?
(And how many other people are in the exact same epistemic state, and also asking the same question?)
Finally, prices start to fall. Maybe someone got brave, and decided to bet on the same inside view that I had. Or maybe some other random event caused them to fall. But they’re falling now.
Normally, you might think that if you have an inside view of where prices should be, and then prices fall, things that looked expensive to you before should look cheap, and so you should want to buy. But if you’re in the epistemic state I describe above, prices falling is validation of your belief that prices should fall, and evidence against the hypothesis that there’s some important countervailing fact that you’re missing. So as prices fall, your own “fair” price for assets falls too.
So all the islanders leave on the same day. And all the traders sell at the same time. And market moves happen more sharply than they would if they were purely the result of updating on external information.
I’m not sure if this view is correct, but it’s my impression. (For a related idea, see Soros’s notion of reflexivity.)
I think the big Ethereum move in May 17 was a great example of this. Evidently many people thought earlier that the price should be higher, but “the market can stay irrational longer than you can stay solvent.” So you had a building of steam before it finally shot up.
However I’m not sure to what extent these are actual epistemic issues as you hypothesize, or just an artifact of small fractions of smart money.
One example that caused me to think about these things was when in Feb or so of 2015, Elon tweeted out that there was going to be a new product announcement in March (I think this ended up being for the PowerWall—don’t remember exactly). The stock price jumped something like 1% in one minute. And it was the same minute as the tweet. So it seemed clear that the market had reacted to the news.
Except it wasn’t news. Elon had said basically the same thing on the earnings call a couple of weeks before.
You might argue that the fact that he also tweeted it out made it more likely that it was actually going to happen. But enough more likely that the change in EV was worth 1% of the whole company? I was very skeptical that that could be the case.
But taking into account that the price change had been so rapid, it made me think that perhaps it was just from trading bots that were using his twitter feed as a price signal. But if that were the case, shouldn’t the price come back down once humans analyzed and realized that this wasn’t actually news?
Well, not necessarily. The fact that there were people willing to buy up on the tweet is information too. There’s so much reflexivity involved that it seems very hard to tell in the short term exactly what the price should be. And so even if the price changes for a dumb reason, that doesn’t necessarily mean it should go back to the old price.
(Again, just my impression. Actual traders or HFT programmers might have a different story to tell.)