6. The efficient Market hypothesis

The efficient market hypothesis is a theory develop in the 1960s by a finance professor named Eugene Fama out of the university of Chicago and the theory states that securities, such as stocks, are priced in such a way that they reflect all publicly available information as well as information that´s not so public. And what that means is if you believe in the efficient market hypothesis  that the price of a security such as a stock, is always correct. And if it´s correct then there´s no uses spending any time trying to find securities that are mispriced or undervalued because the market is efficient.

However this is based on the fact or assumed that investors are rational, that they are like machines in how they evaluate securities. Well you know as well as me that investors are extremely emotional. They are irrational. And because of that prices can get out of whack, for securities.

But the question is can a professional investor or even an individual figure out which security is undervalued and take advantage of it?

This is really challenging, maybe a security is mispriced, but that is everything is the past. The key to whether a stock appreciates of not happens in the future. It´s prediction. And what I found is the more specific the prediction in terms of a company or a stock, the more likely things are to go wrong.

That doesn´t means that we just go and index our entire portfolio. There are opportunities because investors are irrational , they can bid up the overall market or segments of the market or they can ignore other segments of the market. So there is an opportunity to adjust your portfolio mix based on market conditions.