Is the Market More Efficient with the Internet?

The efficient market theory has been around for more than a century. It states that stock prices reflect all available information about the stock market and individual investors will struggle to beat the market as a whole.

Yet, in the last few decades, most investors widely agree that the theory does not hold true. This is because information is not released homogenously and the emotional and short-term investing mentality of investors creates price-value discrepancies.

However, with the Internet boom and information being more easily accessible, efficient market theorist have once again emerged. They believe that the market has become more efficient due to the readily available information. Investors now need not ring companies to get the latest quarterly report. They can simply log on to the Internet and search the investor relations page of companies they are interested in. There are also analyses of companies that are readily available online.

Even with the latest developments in the Internet arena, there are many examples of the stock market’s short-term inefficiency. A case in point is when there was a “flash crash” on 6 May 2010. The Dow Jones Industrial Average index dropped 1000 points, only to recover a few minutes later. This can lead to buying opportunities for long-term investors who recognise the price-value discrepancy.

So what is causing this inefficient stock market, even as information spread becomes more readily available worldwide?

Short-term traders

Short-term trades make up a considerable volume of the daily transactions in the stock market. Because of that, they can drastically affect the price of a particular stock or index.

These traders rely on technical analysis of the price of the stock and do not take into account the fundamentals of the company behind the underlying ticker. As such, stock prices can be pushed up way beyond their true value and vice versa.

Misuse of information

Information can act as a double-edged sword. Retail investors can sometimes overreact to sensationalised news. In the process, this can drive stock prices up or down. This is often due to behavioural bias, irrational thinking or simply miscalculations of the true stock value.

This is especially so due to social media where information spreads like wildfire and artificial intelligence creates an echo chamber effect where users are fed information that positively reinforces their views. Because of this, investors can make bad investment decisions.

The Foolish bottom line

Warren Buffett once said:

“Ships will sail around the world but the Flat Earth Society will flourish. There will continue to be wide discrepancies between price and value in the marketplace, and those who read their Graham & Dodd will continue to prosper.”

Thankfully, because of market inefficiencies, the stock market can provide substantial value for long-term investors who are able to identify any stocks trading at discounts to their true value.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice.