Chapter 9 • The secondary capital market and its efficiency
Implications for investors
Capital market efficiency implies that investors should not waste time seeking to
obtain abnormally high returns from investment, either by observing historic infor-
mation on security price movements or by analysis of new economic information.
Only where an investor has access to as-yet unreleased information can above-average
returns be made – except by sheer chance. Even putting trust in investment analysts
or investing through one of the investing institutions will not, on a regular basis, be
advantageous, and it may well be costly.
Why, if the above statement is true, do so many investors indulge in precisely the
activities that appear to be futile? There are several possible explanations for this
apparently irrational behaviour.l Ignorance of the evidence on efficiency. Many investors seem to be unfamiliar with the
evidence on capital market efficiency so, quite reasonably, they do not take account
of it. Few people or organisations have an interest in publicising the evidence, and
many have the opposite interest. It is not beneficial for newspapers and journals
that deal partly or mainly in giving advice on which securities to buy or sell to point
out that this advice is only going to prove valuable by sheer chance so that, on aver-
age, it will be of no value. Other investment advisers, brokers and such like, are
similarly placed.
l Close examination of charts of past security price movements shows patterns repeating
themselves.This is undoubtedly true in some cases, but it is equally true that plot-
ting random numbers will also sometimes do exactly the same. In other words,
chance alone will sometimes cause a pattern to repeat itself; this does not imply that
gains can be made by trying to spot repeats.
l Proponents of certain technical rules have been shown to be successful. Efficiency does not
imply that investment cannot be successful, simply that being more than averagely
successful is a matter of good luck. During some particular periods, and generally
throughout the twentieth century, investment in securities dealt on the LSE will
have given positive returns. The value of securities generally has increased, not
to mention the dividends or interest receipts from which the investor will also
have benefited. It should not therefore surprise us that, despite efficiency, follow-
ing most investment advice over a substantial period yields positive returns.
Indeed, efficiency implies that it would be impossible to find investment advice to
follow that would yield lower-than-average returns in the long run, for the level of
risk involved, except by sheer chance.
l We all know of cases of people who have been extremely successful in capital market invest-
ment. Those who are particularly successful tend to be noticed; those who are dis-
astrously unsuccessful tend to try to keep this private. In both cases it seems to be
sheer luck – good and bad, respectively. Those who are unsuccessful tend to
acknowledge this fact; the successful ones – being human – may prefer to believe
that skill in selection and timing of investment was the cause of their success.
Even in matters of sheer chance, someone can still be successful, even stagger-
ingly successful. Suppose that a coin-tossing championship of the UK were to be
held and that all 60 million inhabitants entered. The rules are that we are all
grouped into 30 million pairs, each of which tosses a coin. The member of each pair
who calls correctly goes into the next round, and the process is repeated until the