What is the efficient market hypothesis?
Definition and explanation
It’s very unlikely you’ll walk down the street and find $100 000 which no one else has picked up. In the same way, it’s unlikely you’ll choose a company on the stock market that will do 100 times better than the average company which no one else has already found and invested in (driving the demand and therefore the price of the company (shares) up). According to the efficient-market hypothesis, if all investors have the same information, values and behave rationally (conditions which don’t always hold...), all assets will be priced “correctly”. In other words, it is impossible to ‘beat the market’ by finding undervalued stocks or selling stocks at a higher price than they’re worth.
This means when taking the efficient market hypothesis into account, you should 1) look for the things you value in places that other people have systematically failed to look, and 2) be aware that if something looks too good to be true, it probably is.
Examples of using the efficient market hypothesis
This hypothesis doesn’t only apply to the stock market, it applies to all kinds of markets - whenever we exchange goods (which is a lot of the time). This is the reason why you might have a hard time finding a car park that is (i) free, (ii) right next to work, and (iii) somewhere you can park all day. Even though such car parks do exist, over time word gets out, and they are occupied in the short term or monetised in the long term.
Ever wondered why it’s hard to find a date who’s smart, funny, rich, attractive, shares your values, and is single? First of all you’re a total catch honey, don’t listen to them. But this might be because dating is a market (the dating market). All the other eligible bachelors/ bachelorettes are out to find the best partner they can and mostly value the same things you do, so it’s hard to ‘beat the market’ and date someone more attractive, smarter, funnier etc. than you.
Also check out
Markets Everywhere, City Journal
The Economics of Online Dating, Harvard Business Review
Two-Sided Bandits and the Dating Market, Sanmay Das and Emir Kamenica