I think this post is missing the important part of actually doing this well / being a chosen one, from my perspective. That is, it seems to think of the EMH as something like an on/off switch, where either you think the market is better than you always and so you just blindly trust it, or you think you're better than the market always, and so you should be actively trading.

But my experience has been about every five years, an opportunity comes by and I think "oh, this is a major opportunity," and each time I've been right. [FWIW I didn't have this for COVID, because of a general plan to focus on work instead of the markets leading up to the pandemic, and then when I started thinking "oh this will actually be as bad as 1918" I was too busy trying to solve practical problems related to it that I didn't think seriously about the question of "should I be trading on this?"; I think the me that had thought about trading based off it would have mostly made the right calls.]

This is, of course, a small sample size, and I've made many active trades that weren't associated with that feeling, whose records have been much worse. Each of the 'edge' investments has also had another side to it, and the other side didn't have the same feeling to guide me. For example, I correctly timed BP's bottom during the Deepwater Horizon crisis, but then when it recovered my decision of when to sell it was essentially random. I think most of the people who predicted COVID a week early were then not able to outperform the market on the other side, and various things that I've seen people say about why they expect a continued edge seemed wrong to me. (For example, someone mentioned that they could evaluate potential treatments better than the market--which I think is true, because I think this person is actually a world-class expert at that specific problem--but I think that ability won't actually give them an edge when it comes to asset prices. I don't think anyone thinking just about biology would have correctly predicted the recent bottom or where we'd recover to, for example.)

Nevertheless, I'm pretty convinced that I sometimes have an edge, and more importantly can tell when I have an edge and when I'm just guessing. I think something like 1-10% of rationalists are in this category, or could be if they believed it, much like I think a comparable number of rationalists could be superforecasters if they tried. And historically, knowing to take the "oh, this is a major opportunity" signal seriously, instead of treating it as "just another good idea", would have made a huge difference, and I think I've under-updated each time on how much to move things to be more ready the next time one comes along. Which is the main reason I think this is worth bringing up.

[Like, inspired by his weakened faith in the EMH, Eliezer attempted to time the bottom of the market, and succeeded. It seems better if more people attempt this sort of thing, at an appropriately humble frequency.]

Thank you, I enjoyed this post.

One thing I would add is that the EMH also suggests one can make deviations that don't have very high EMH-predicted costs. Small investors do underperform indexes a lot by paying extra fees, churning with losses to spreads and capital gains taxes, spending time out of the market, and taking too much or too little over risk (and especially too much uncompensated risk from under diversification). But given the EMH they also can't actively pick equities with large expected underperformance. Otherwise, a hedge fund could make huge profits by just doing the opposite (they compete the mispricing down to a level where they earn normal profits). Reversed stupidity is not intelligence [LW · GW]. [Edited paragraph to be clear that typical retail investors do severely underperform, just mainly for reasons other than uncanny ability to find overpriced securities and buy them).]

That consideration makes it more attractive, if one is uncertain about an edge, to consider investments that the EMH would predict should be have very modest underperformance, but some unusual information would suggest would outperform a lot. I was persuaded to deviate from indexing after seeing high returns across several 'would-have-invested in' (or did invest a little in, registered predictions on, etc) cases of the sort Wei Dai discusses. So far doing so has been kind to my IRR vs benchmarks, but because I've only seen results across a handful of deviations (one was coronavirus-inspired market puts, inspired in part by Wei Dai and held until late March based on a prior plan of letting clear community transmission in the US become visible), and my understanding from colleagues in the pandemic space), the likelihood ratio is weak between the bottom two quadrants of your figure. I might fill in 'deluded lucky fool' in your poll. Yet I don't demand a very high credence in the good quadrant to outweigh the underdiversification costs of using these deviations as a stock-picking random number generator. That said, the bar for even that much credence in a purported edge is still very demanding.

I'd also flag that going all-in on EMH and modern financial theory still leads to fairly unusual investing behavior for a retail investor, moreso than I had thought before delving into it. E.g. taking human capital into account in portfolio design, or really understanding the utility functions and beliefs required to justify standard asset allocation advice (vs something like maximizing expected growth rate/log utility of income/Kelly criterion, without a 0 leverage constraint), or just figuring out all the tax optimization (and investment choice interactions with tax law), like the Mega Backdoor Roth, donating appreciated stock, tax loss harvesting, or personal defined benefit pension plans. So there's a lot more to doing EMH investing right than just buying a Vanguard target date fund, and I would want to encourage people to do that work regardless.

I stumbled across a comment about efficient markets in an old Michael Vassar interview

I think that when when I look at economics (another great example) you have a series of papers by Larry Summers and Brad DeLong in the early 90s that as far as I can tell drive a stake through the heart of the idea of efficient markets. They show that if you make the extremely minimal assumption of people not being perfectly capable of assessing how much risk is involved in an investment, there should be a systematic tendency for markets to become less efficient with time.

And as far as I can tell this behavior--this paper despite being done by pretty much the top people in economics--just got ignored and had no impact on the--or this series of papers--had no impact on the progression of the field. It was logically ironclad. That's the sort of thing I basically expect from most sciences in the modern world--almost everything but applied physics--and it's (you know) this is a particularly clear case though because you have essentially the strongest possible argument done by the most prestigious possible people with just no recollection of it ever having happened in the profession.

Does anybody know what papers he's talking about? (I'm not sure if I transcribed the names properly.) They seem very relevant to this discussion.

I found out a couple of days ago that there's a debate within academia over EMH. Here's how John Cochrane described it in an interview:

When house prices are high relative to rents, when stock prices are high relative to earnings—that seems to signal a period of low returns. When prices are high relative to earnings, it’s not going to be a great time to invest over the next seven to ten years. That’s a fact. It took us ten years to figure it out, but that’s what (Robert) Shiller’s volatility stuff was about; it is what Gene (Fama)’s regressions in the nineteen-eighties were about. That was a stunning new fact. Before, we would have guessed that prices high relative to earnings means we are going to see great growth in earnings. It turned out to be the opposite. We all agree on the fact. If prices are high relative to earnings that means this is going to be a bad ten years for stocks. It doesn’t reliably predict a crash, just a period of low returns, which sometimes includes a crash, but sometimes not.

Ok, this is the one and only fact in this debate. So what do we say about that? Well, one side says that people were irrationally optimistic. The other side says, wait a minute, the times when prices are high are good economic times, and the times when prices are low are times when the average investor is worried about his job and his business. Look at last December (2008). Lots of people saw this was the biggest buying opportunity of all time, but said, “Sorry, I’m about to lose my job, I’m about to lose my business, I can’t afford to take more risk right now.” So we would say, “Aha, the risk premium is higher!”

So that’s now where this debate is. We’re chewing out: Is it a risk premium that varies over time, or is it psychological variation? So your question is right, but it is not as obvious as: “Stocks crashed. We must all be irrational.”

Perhaps more directly relevant to this post is this quote from Robert Shiller's 2013 Nobel lecture:

There is another important argument widely used for efficient markets, the argument that a model like (4) with an intermediate φ cannot represent a stable equilibrium because the smart money would get richer and richer and eventually take over the market, and φ would go to zero. In fact this will not generally happen, for there is a natural recycling of investor abilities, the smart money people usually do not start out with a lot of money, and it takes them many years to acquire enough wealth to influence the market. Meanwhile they get old and retire, or they rationally lose interest in doing the work to pursue their advantage after they have acquired sufficient wealth to live on. The market will be efficient enough that advantages to beating the market are sufficiently small and uncertain and slow to repay one’s efforts that most smart people will devote their time to more personally meaningful things, like managing a company, getting a PhD in finance, or some other more enjoyable activity, leaving the market substantially to ordinary investors. Genuinely smart money investors cannot in their normal life cycle amass enough success experience to prove to ordinary investors that they can manage their money effectively: it takes too many years and there is too much fundamental uncertainty for them to be able to do that assuredly, and by the time they prove themselves they may have lost the will or ability to continue (Shiller 1984; Shleifer and Vishny 1997).

See also Shiller on Does Covid-19 Prove the Stock Market is Inefficient?.

As you pointed out in the post, the version of the EMH you are describing, is unfalsifiable. To me it looks like an obvious misstep by our own rules, so why does it hold so much sway?

It's exactly the kind of thing we were warned about in the Mysterious Answers sequence: A Semantic Stopsign [? · GW] that stops you from asking the obvious next question. A Curiosity Stopper [? · GW]: because there are Smart People who know better, we are not socially obligated to even look.

I notice I am confused [LW · GW]. If we're playing by the same epistemological rules, we should not have this kind of disagreement. At least one of us is missing something important. What is missing?

Its vagueness makes this EMH feel like a motte-and-bailey argument. Can you tell which part is the bailey and which is the motte? Think about this for at least ten seconds before reading on.

Here's a guess: "You can't hope to beat the market, so I don't have to try, and neither should you!" (bailey). But look at all these anomalies! "The market will price those in now that they are known. They'll evaporate. (Eventually.)" (motte).

But the vagueness means I can only guess. That's the nature of such arguments. Maybe the bailey is something else or there's more to it. What is the EMH defending? We may have to taboo "EMH" to nail that down. I suspect I'm insulting a Sacred Cow. Which one? Maybe "prediction markets are a cool! It's a general solution to a lot of problems!" (If the stock market isn't efficient, prediction markets aren't either.) Or rationalists say "Bets are a tax on bullshit," so why ain'tcha rich? (Sour grapes. You only make money if you're lucky. Rationalists don't buy lottery tickets. Is this an Ugh Field? [LW · GW]) Or "Capitalism!" (Applause light! vs. I don't know, something else?). Why are you attached to an unfalsifiable idea?

Is there a falsifiable version of the EMH? OK, forget Popper, we can do one better: To do a Bayesian update we need both sides of the likelihood ratio. What does the world look like if the EMH is true? If it's false? Which world does ours look like? That's your prior. If these cases are indistinguishable, then it's not a Hypothesis, and the "H" in "the EMH" is a lie. A hypothesis that forbids nothing permits everything. Now what evidence would change your mind?

So let's try some obvious next questions. If the EMH were true, the market's moves would be a random walk, with a small bias over time based on growth and interest rates, etc. that explain the buy and hold strategy. Subtract out the bias and the residual should be completely random. Can we distinguish random from nonrandom data? Can you measure its entropy? Is the market random? You know how to use a computer. Look and see!

Can you make a profit from this edge? Why aren't you?

Confusion: Is there some (incredibly weak) sense in which every person who makes a trade is bringing unique information to market?

Uncle George's opinion of the new iPhone is reflected in sales figures and aggregate reviews. But technically, he is in possession of a unique piece of private information: 'what does this one guy called Uncle George think about AAPL stock?'

This information is vanishingly close to being worthless, and a million miles way from a tradable edge, but it's not quite worthless—it still collectively helps to generate a signal. What does this mean, if anything?

Re: "revisionist history":

You criticize my description in "A Failure, But Not Of Prediction", which was:

The stock market is a giant coordinated attempt to predict the economy, and it reached an all-time high on February 12, suggesting that analysts expected the economy to do great over the following few months. On February 20th it fell in a way that suggested a mild inconvenience to the economy, but it didn’t really start plummeting until mid-March – the same time the media finally got a clue.

As my post said, the market started declining a little in February. Using the S&P link you provide, on March 2/28, it reached 2954, just 12% lower than its all-time high, then quickly recovered to only 8% lower a few days later. For comparison, the market fell 7% in May 2019 because Donald Trump made a bad tweet, and then everyone laughed it off and forgot about it within a few weeks. I think my claim that "it fell in a way that suggested a mild inconvenience to the economy" is a fair description of this.

It had its next major fall on March 9, reaching a new low (34% off its all-time high) March 23. I think it is fair to say it started plummeting in mid-March, though I would not blame you if you consider March 9 more "early" than "mid". For comparison, Jacob wrote his post warning that the coronavirus would be a big deal in late February, and I wrote one saying the same on March 2.

Some of this depends on the "correct" amount of market crash. I was writing my post in early April, when the market was near its floor. If that was the "correct" amount of market crash, then the early February crash underpredicted it, and the market didn't "get it right" until mid-March. As you write this post now, the market has recovered, and if it's at the "correct" price now, then the early February crash was basically correctly calibrated and the mid-March crash was an overreaction.

To be clear, I think time has proven you correct about the EMH (and this is easy for you to say, now that the market has stabilized). I'm not debating any of the points in your post, just your accusation that I am a "revisionist historian".

Aten't

For anyone else who wasn't aware:

The way that Granny Weatherwax, in Discworld, spells ain't on her sign to inform people that she 'aten't dead'.

https://www.urbandictionary.com/define.php?term=aten%27t

I enjoyed both the perspective and the tone of the post. Up voted.

Two, probably not to deep thoughts.

First, years ago I had a discussion with some day traders and one was talking about the SPY EFT He mentioned that the fund owners actually did not invest in all 500 equities but only in the top performing ones (no idea what the criteria was on that). The argument was largely they could not make money running the fund if the invested in both the winning and losing stocks.

Second, and it relates to the first, one of the other things (different time) that was pointed out was "market" is a problematic terms. Each asset that is traded has a market and that is not the same as "the market". I think this tends to be something of a problem area for people when the issue of EMH is in question. Many (most) do okay in thinking about a market in APPL (supply and demand, buyers/sellers, bids and offers) we all get that. But "the market" is a much more complicated (even chaotic) animal. At a high level most also get general portfolio theory but probably could not put a customized plan in place for their personal portfolio. What I suspect happens here, with regard to EMH, is a bit like the fallacy of composition error you get in logic. It's not clear to me exactly how easy it really is to sum up the many demand and supply functions for each individual asset and then suggest any aggregate price or return to "the market".

EMH (or at least most of the discussion here and everywhere else I've seen) doesn't seem to make any distinction between the asset's market and the general market (much less the global market).

Thanks, good post.

Three anecdotes about having an edge but only in illiquid markets where the derivable value is limited:

1. Back in 1991 a friend of mine had the following market-beating insight. He was watching Freddie Mercury on TV a few months before he died; at this point it was not publicly known he was ill with AIDS (nor even, bizarrely, that he was gay - I think all was only revealed just before he died).

My friend said "He's not looking well..." and then made a brilliant inference: "...so Bohemian Rhapsody will be the Christmas No. 1 record this year, then". (In the UK anyway, a big deal is/was made about which single would chart at no. 1 on Christmas Day, and you could even place bets on it.) And so it came to pass - Freddie Mercury unexpectedly died a few weeks before Christmas, Bohemian Rhapsody (dating from 1975) unexpectedly went to no. 1, and my friend kicked himself forever more about not placing a bet on it - bookmakers would have offered odds of 100-1 or even 1000-1.

The catch though, from a couple of times I've tried placing big bets on unlikely events, is that (most) bookmakers don't seem to accept them. They might accept a $100 bet but not a $1000 one on such odds. They suspect you have inside information. (The same happens I've heard if you repeatedly win at roulette in some casinos. Goons appear and instruct you firmly that you may only bet on the low-stakes tables from now on.)

Freddie Mercury's unhealthy appearance was public information. If the market in bets on Christmas no. 1 records were liquid enough, thousands of others would be considering the third-order consequences of such information & making similar inferences, the odds would be rapidly changing, and my friend would have lost his edge by the time he placed his bet.

So while he could have beaten the illiquid market, he wouldn't have made much in expectation - maybe not enough to justify the time & risk - and conversely he couldn't have beaten a liquid market which would accept big enough bets.

2. Similarly, another friend of mine worked for a while with a tech startup that was arbitraging between betting exchanges (like Betfair) on which ordinary people can lay odds as well as place bets. As a result of which, different exchanges often show somewhat different odds on the same event. After much development and testing, the startup realised that though they could reliably identify & arbitrage these odds differences, they could only make dollars per hour doing so, not thousands. There wasn't enough liquidity on the betting exchanges. The wronger the odds someone was laying, the smaller the bet they'd accept. So the startup closed down.

3. I've been trading equities since 2006 on various index derivatives, in very large amounts. I have expertise on one niche area, involving a lot of data & programming, and beat the market for some years with it, until the effect in question went away (as it was already known about, albeit quite obscure).

Recently I've found a derivative of a particular index that seems to have excess risk-adjusted returns in certain bets on it, so have been trading it for a while. Again I've had to source and estimate and crunch large amounts of hard-to-obtain historical data, writing my own software to manipulate it. But the inefficiency is probably only because this derivative is quite illiquid. Some days I'm doing a significant fraction (even a quarter or a third!) of the whole day's trading on it! (Though I am betting very large amounts.)

So I reckon I probably am beating the market, but only because I've found a sweet spot where there's extra money to be made, but not enough for more than a few others to do so too. I'm grabbing a large part of the edge to be had, by using kinda public but hard-to-get information. If the derivative were more liquid, others would be finding similar things to me. If it were less liquid (like Christmas no. 1 bets) I couldn't place big enough trades to be worthwhile.

(There is also extra risk from the limited liquidity (e.g. of slippage when stopped out) which might reduce returns a lot in an extreme situation - though I suspect not enough to remove my overall edge. The risk needs very careful handling.)

mentioning selection bias, and saying we'd be right to discount his evidence

I would discount it more if I hadn't if a random person had made those investments then Wei Dai. Wei Dai made previous very good investments in crypto and domain names with similar returns.

When thinking myself about investing in the middle of February I was thinking about advice on Wei Dai that's years old on LessWrong before actually talking with him about investing in this situation.

I think any of the high return investments of Wei Dai of crypto, domain names and Corona puts are investments ideas that are in a different class then Uncle Georges and it's reasonable that there will be further similar opportunities for rationalists in the future where it's worth trading on them.

Eliezer wrote after the crypto aftermath something that suggested that he endorsed his past strategy that resulted in him not profiting of crypto based on EMH evidence. It's that strategy endorsement that seems to be changed.

I don't think in any of the three cases in which Wei Dai made very high returns he would have had a problem with telling other people about his investment and it would make sense to behave as you suggest a Realistic winners would (I will of course never tell anyone about it, or it will become useless).

I lost the thread when I got to the section "If You're so Smart, Why Aren't You Rich?". An assumption seems to become implicit there that if the EMH is false, then you can beat the market. But why is that so? I tend to think of the market as a random walk during day trading, largely driven by viral memetic fashion trends on the scale of weeks to months, and then often only "weighing" effectively on the scale of months to years.

Take the day trading example: the S&P had almost no cumulative returns during the day from 1993-2017, while after-hours & pre-market were ~600%. If market moves during the day are a random walk, then clearly they are not efficient *and* one cannot beat the market consistently, over that short time window.

Over the last couple of years of trading options, my least favorite source of randomness has been Trump tweets. I think it would be very hard to argue that the market prices them efficiently or that it is possible to have an edge in predicting them but they sure do move prices around and destroy your trading positions.

Confusion: Can an anomaly be an open secret, and not defensible, and still somehow persist?

For example, I'm especially interested in the momentum anomaly. The momentum folks make a very compelling case that the behavioural econ reasons that brought it into existence are so dang powerful that it somehow persists, even though there are many papers/articles/books about it that anyone can read.

I personally found this just compelling enough to run a momentum experiment, based on a strategy that has done extremely well in reducing volatility and drawdowns in the past. Momentum strategies naturally lag bull markets, but more than earn their keep during the downturns, so this was the long-awaited test.

...and it performed almost comically badly. Either the anomaly evaporated, or the specific version I was testing evaporated, or it did badly this one time but still outperforms over multiple cycles, or it was only ever an artifact of overenthusiastic back-testing.

If open secrets can persist in public... for how long? What are the factors that lead to them ultimately not working? Is it possible that an anomaly could exist in public indefinitely?

Here's a thought experiment: Suppose that a market is perfectly efficient, except that every 50 years or so there's a crash, which sufficiently smart people can predict a month in advance. Would you say that this market is efficient? Technically it isn't, because smart people have a systematic advantage over the market. But practically, no trader systematically beats the market, because no trader lives long enough!

I suppose you can create a long-living institution, a "black swan fund", that very rarely makes bets on predictable crashes, and over a few centuries can prove it has higher returns. But I guess not enough people care about returns over these timescales.

FWIW, I very much wanted to adjust my investments based on the covid news, but was stopped from doing so mainly via friction:

1. I made recent profits from my stocks, so selling them (even for a short window) would have had bad capital gains repercussions for me... in the US it's a PITA to deleverage stocks that are in the green.

2. I'm not enough of a trading wonk to feel comfortable buying puts, and the little in the past that I've played around with those tools seemed to indicate that it's hard for a non-professional to avoid excessive fees.

3. I just randomly happened to not be aware of the "zoom" phenomenon, so I didn't invest in that. I DID invest in 3M (because of their mask business) but they actually have lost a ton of money during the crisis for some reason (I assume the "price gouging" laws that prevent them from making any profits are a big part of that)

So, to me this is a story mainly of market inefficiencies preventing EMH from coming into play.

HOWEVER, there was also one other reason why I didn't profit off the crisis, which is actually compatible with EMH: I was expecting a large cash infusion from the fed, so I was expecting stock prices to remain stable, at the cost of subsector price inflation. Turns out, I partially got this wrong (because I didn't consider that inflation takes time to develop, so stock prices plummeted despite fed efforts) but was partially right (stocks have mostly recovered, precisely because of the Fed intervention)

TLDR: I was mostly a rational actor that understood the covid threat, but misunderstood the effect of Fed intervention... but you needed to have BOTH in this case, because of the extra overhead of non-EMH market inefficiencies.

There is a simple explanation to this: It turns out that being a good rationalist with access to an option trading account is actually an edge.

I also realized that the market was wrong and told friends to pull out of equities in mid-February. They didn't listen.

Curated, this is a great and really grounding contribution to the ongoing conversation around this, it explains lots of key arguments really well. I hope to see more discussion about whether the EMH is dead and what can be learned from the covid situation, and I liked much of the comments section as well.

Something that occured to me while reading this post:

In a given situation, some people who are not at the bleeding edge of finance in general will be well placed to beat the market in a way we would tend to think of as due to skill rather than luck.

In the coinflip example, the people who correctly predict the sequence do so through luck. We call the sequence random because we are unable to model the process which generates it, and we call it luck when they are able to predict it because they don't know how to model it either. In the case of detecting a nascent pandemic however, we do know some things about what makes you better able to see it coming.

If you are attuned to global risks, plugged into discussion networks that provide early warning of interesting developments in the area, have got the probablistic thinking thing down, are the sort of person to hoover up enough details to distinguish between a Spanish Flu-like scenario and a SARS-like scenario, and are enough of a disagreeable contrarian to not worry what anybody else thinks until you have vetted their sanity thoroughly, then you are a member of a subpopulation that is especially well placed to spot the shape of things to come in the particular case of covid-19. Add in previously aquired knowledge about how to make the relevant trades, plus a lack of laziness, plus getting struck by a little inspiration that doesen't come to everybody, and you are Wei Dai or Jacob instead of me.

How do you end up in that subpopluation? You do so randomly, if we think of it as drawing that particular ticket in the birth lottery. So in one sense you randomly got lucky, but in another sense you succeded through skill.

I don't know how much of the apparent discrepancy between the EMH and the fact that some people timed the downturn is explained by this, but I think it explains at least part of it.

I think one key question, when talking about the EMH, is what we mean for an information to be available.

It's plausible, that for the public it only became clear around 27. February that Covid19 would be huge.

But it seems some experts knew much earlier. Just a quick browse on epidemiological twitter, for example, and you can find quite some instances of people expecting this not to be contained in the beginning of February. There's also the case of a swiss epidemiologist who was one of the first to warn swiss national media about Covid19 and claims to have sold all his stocks on January 21 in order to avoid losses from the outbreak.

One reason why you might not regard this information as available, is because it's costly. In order to profit from it, you need to spend time and effort in order to receive and understand the information. I don't think that is super plausible, given large banks and corporations with substantial research budgets.

Maybe these researchers were just lucky, there were certainly other researchers at this time who were far less concerned. But given that the information existed with at least some authority and was quite available, I would have expected the markets to at least somewhat react before mid-january.

Confusion: Can multiple traders profit by bringing the exact same information to market?

I want to say yes? At least if they don't individually have enough heft to fully price it in? That would explain how multiple traders are able to exploit the same anomaly, whereas hedge funds have to cap their fund size because getting too big hurts them.

Thanks, I loved this post. Its obviously hard to distinguish luck from skill when it comes to investment returns, I don't think focusing on money and track record would be enough to convince me of skill. I think I would need to also rationally evaluate the investment strategy to determine if it can be reasonably expected to beat the market. Common strategies like "we do what everyone else does but better", or "we invest in value/growth" would probably not convince me (risk premiums, liquidity premiums, animal spirits probably affect market prices but probably not in a way that can only be reliably predicted by a "chosen one"). Strategies like "we have a data connection that's 1 millisecond faster" or "we hide microphones in every lawyer's office" seem like they have a chance to beat the market, but they're hard/expensive to pull off. With respect to covid, it wouldn't be enough to say "I knew stock prices would go down" without explaining how you knew, what your confidence was, how you determined your confidence and your prediction accuracy/confidence calibration (the lack of confidence estimates on predictions is a huge red flag for me). My sense is that when someone says "my intuition tells me stock prices will go down due to covid", what they mean is something like "the market price currently implies the risk of a global pandemic is 20%, but my intuition tells me it's closer to 50%, therefore stock prices should go down half the time and my returns should be positive after 2 or 3 global pandemics". However, even with hindsight, it seems hard to determine if the actual risk of a global covid pandemic in Feb 2020 was 20% or 50% or some other amount, so focusing on outcomes doesn't look reliable. It seems like evaluating the prediction process rather than the outcome would be an easier approach ("we hide microphones in all WHO offices" seems like it would work).

Interesting post, would love to hear your opinion about my suggested alternative to EMH, I don't see anything in your post that contradicts it. But i'm having a very hard time accepting the idea that you can't beat the market using public data and infinite amount of computing power.

If the market regularly reacts to public statements of inefficiency ("stocks systematically rise on the third Thursday of each month but only under a waxing moon") by eliminating it, then this is *refutation* of the efficient market hypothesis.

Inefficiencies are priced in when they are: obvious, easy, and safe,. A non-obvious inefficiency is a true hidden edge. A non-easy inefficiency has a high barrier (capital, technical, physical, etc) to entry. A non-safe inefficiency has a high social barrier to entry.

Because names have power, I dub this the Passive Market Hypothesis.

The EMH Gets Stronger With Every Attack

In case you weren't aware, this point has been made here before, in a classic old post: Markets are Anti-Inductive [LW · GW].

Please state the nature of the financial emergency.

I’ve never been a strict EMH believer. My definition is that you can’t find any free money anywhere. The market does obviously stupid things sometimes—see gamestop or amc recently. You can say what you want, but in my mind at least one of the meme stocks was for all intents and purposes objectively overvalued. But my definition is revealed by the state of the world currently—I am not rich because I saw something that was, in my mind, clearly wrong. See, even when GME was at it’s highs, the cost to borrow was over 100%, with the possibility of a squeeze going even higher and thus a margin call. Buying puts at 600 IV, yeah sure. The thing was, everyone recognized that it was too high, but the cost to realize that made it such that you were essentially indifferent. And that’s what markets being efficient means to me. It’s not that it’s always right, it’s often wrong. But it’s really hard to be lesswrong than the market.

I'm probably missing something - but when you say the vast majority of active investors do really badly, shouldn't that be impossible too? If markets are truly efficient, isn't it just as hard to underperform them as outperform?

You write quite entertainingly.

There's no room for luck in the "realistic" half of your diagram.

There were some sizable selloffs starting January 22nd.

Really excellent discussion of the EMH. Love your description of it as some kind of demon-god creature.

I'll jump in on a minor point.

"And yet, and yet…even when criminals have advance access to earnings reports, they still don’t do all that well, which is evidence for the very strongest form of the EMH (the one that no-one, including me, believes can possibly be true)."

This might instead be evidence that there is a lot more insider trading than we think -- making it so that those we know of were competing for gains against other insider traders.

Your second quote that you attributed to me was actually from keaswaran, who I agree with [LW · GW].

I think you're understating the amount of private information available to anyone with a reasonable level of intelligence. If you have a decent level of curiosity, chances are that you know some things that the rest of the world hasn't "caught onto" yet. For example, most fans of Tesla probably realized that EVs are going to kill ICEs and that Telsa is at least 4 years ahead of anyone else in terms of building EVs long before the sudden rise in Tesla stock in Jan 2020. Similarly, people who nerd out about epidemics predicted the scale of COVID-19 before the general public.

The extreme example of this is Venture Capital. People who are a bit "weird" and follow their hunches routinely start companies worth millions or billions of dollars. Every single one of them "beat the market" by tapping private information.

None of this invalidates the EMH (which as you pointed out is unfalsifiable). The key is figuring out how to take your personal unique insights and translate them into meaningful investments (with reasonable amounts of leverage and appropriate stop-losses). Of course, the easier it is to trade something, the more likely someone has "already had that idea", so predicting the S&P500 is harder than predicting an individual stock. But starting your own company is a power move so difficult that it's virtually unbeatable.

nitpick

The EMH is the only theory that grows stronger with every attack against it.

Any antifragile systems is like this

EtA: Although I guess it's extremely (perfectly?) anti-fragile.

The efficient market says that the market price reflects "all available information". That's tautological, and it's hard to argue with tautologies. The problem is that trades are made by people or algorithms designed by people. Different people have different tolerances for risk, different ideas about market performance and different strategies for making money. What does it even mean for a price to reflect all available information? A lot of that information is embedded in people's minds and situations and in our institution structures.

So, as stated, the EMH is correct. It has to be. What does this mean for trading? It helps to remember is that one can only sell a stock for what someone else is willing to buy it for and one can only buy a stock for what someone else will accept as payment. The EMH says that's the price which is great, but not useful. I think the problem is that people tend to think that there is some absolute true price that is somehow discovered by trading. There's no reason to believe this, but it is comforting. People try to estimate this price by looking at earnings, by looking at liquidation value, by studying prospects, by surveying potential customers and so on. That might be useful for deciding your own buy or sell price, but that's your price.

The idea of the EMH is that the price is somehow or another actually the absolute true value of the item at a particular instant. I tend not to indulge in such mysticism. I've been through too many market crashes and transitions. I think societal and institutional structure are more important. Most people don't have money. That limits investment opportunities, and for most of my lifetime the rule has been, if there is nothing to invest in, put your money in the stock market.

P.S. Back in January, I expected the market to crash for the COVID-19 epidemic and was tempted to sell. I did sell a few losers I was planning to sell anyway, but I had enough cash on hand to decide not to sell morre. Unless COVID-19 leads to a major restructuring of our economy that spreads the wealth more broadly, odds are it is going to recover nicely.