January 4, 2018

Who Is More Rational? You or the Market?

Filed under: Business, Economics — Tags: , — Nicholas @ 04:00

Marginal Revolution University
Published on 6 Sep 2016

We mentioned before that it’s hard to beat the market. And you shouldn’t try. But what about market anomalies?

One anomaly is the Momentum Effect — where past stock performance predicts future performance, at least a bit. As an example, portfolios with past winners tend to outperform the market in the medium term. Why is that? The market sometimes under-responds to changes in information. Thus, some stocks can lag, even if rationally, they shouldn’t. This is why picking past winners can generate some profit, though the profit’s usually small.

There are also other anomalies, like the Monday Effect, where stocks fall more on Mondays. Or, there’s the January Effect, which says that stocks surge higher in that month. There’s been some evidence for these effects, but these anomalies don’t last.

Despite its flaws, the market is still more rational than you. Don’t forget, you’re probably like most individual traders. You may become overconfident. You may not calculate probabilities that well. And if the market crashes, you’re likely to act more emotionally than you should — just like everyone else.

But don’t just take our word for it — even Warren Buffett agrees! Don’t try to beat the market.

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