What is an Inefficient Market?
In economic terms, an inefficient market is a in which securities prices are random and not influenced by past events. The idea is also referred to as weak form efficient-market hypothesis or the random walk theory (coined by Princeton economics professor Burton G. Malkiel in his 1973 book A Random Walk Down ).
How Does an Inefficient Market Work?
The central idea behind an inefficient market is that the randomness of earnings growth does not predict future growth. Malkiel argues that people often believe events are correlated if the events come in "clusters and streaks," even though "streaks" occur in random data such as coin tosses.
In turn, technical analysis is undependable in an inefficient market, because prices already reflect all information. Fundamental analysis is also in these markets because often collect bad or useless information and then poorly or incorrectly interpret that information when predicting values. outside of a company or its industry may affect a price, rendering further the fundamental analysis irrelevant.
Why Does an Inefficient Market Matter?
It is impossible to consistently outperform in the market is inefficient, particularly in the short term, because it is impossible to predict prices. This may be controversial, but by far the most controversial aspect of the idea is that analysts and professional advisors add little or no value to portfolios, especially mutual fund managers (with the notable exception of those managing that take on greater risks), and that professionally managed portfolios do not consistently outperform randomly selected portfolios with equivalent risk characteristics. As Malkiel it, " advisory services, predictions, and complicated chart patterns are useless... Taken to its logical extreme, it means that a blindfolded monkey throwing darts at a newspaper's financial pages could select a portfolio that would do just as well as one carefully selected by the experts."