An Efficient Market is one in which prices reflect up to
the moment information.
Let me give you an example. I'm sure you've gone to a big
sports event or to a concert and seen scalpers selling
tickets outside the arena.
If you needed to buy a ticket, what you'd find is that
different scalpers would be offering tickets at just about
the same prices. How does this happen? Well, the buyers
do comparison shopping and buy from the scalper who offers
tickets at the lowest price or best perceived value for the
location of the seats.
The higher-priced scalpers are forced to lower their prices
so they don't end up with a supply of useless tickets once
the event starts.
Some buyers will get really good deals because the scalper
they deal with will be very motivated to sell. Maybe the
guy's got a bus to catch in five minutes and is really
anxious to unload his tickets.
Some buyers will pay higher than average prices because
they're a huge fan of the performer, they really want to
see the show, and won't make the effort to shop multiple
scalpers.
The price that is paid strikes a balance between the
urgency of the scalper to sell the tickets and how badly
the buyer wants to attend the event.
No seller makes above average profits consistently nor does
a buyer pay below average prices consistently. This basic
concept works in every market to push prices together after
a period of time.
So an Efficient Market in any industry usually eliminates
the ability to make unusually high profits. Organizations
as well as individuals are always doing battle against
efficient markets in every way possible to make money.
If there's a good opportunity for higher than average
profits, players in the market are going to try to get that
profit.
Until a sufficient number of companies learn about new,
lucrative opportunities, some companies will do extremely
well. As the high profits induce more and more new
companies or people to enter the market, the quality of the
opportunity diminishes.
Taking advantage of times when markets are unusually
profitable and off-balance is very challenging. To
capitalize on above average profits requires incredible
organizational flexibility, creativity, and speed. This is
the reward for entrepreneurship.
It's been said that the best strategies are irrelevant if
they take too long. You snooze, you loose. Jack Welch,
the famous ex-CEO of General Electric described the markets
in which he competed as "brutally Darwinian".
Economists have observed the Efficient Markets idea for a
long time in the stock market, where the principle is also
known as the Random Walk Theory. The principle is very
obvious in the financial markets because analysis of
companies does not always allow an investor to make a
killing. If it did, everyone would be very wealthy from
investing in the stock market.
We know that some people have done extremely well in the
stock market, but we all know people who have suffered
tremendous financial losses too. But over time and on
average, the winners balance out the losers.
In some cases, investors may outperform the market because
they have inside information about a company that few other
people know. Insiders can sometimes buy stocks for less
than they're really worth or insiders can sometimes sell
stocks for more than they are really worth. But for the
average investor, beating the market is difficult.
There's a classic joke that economists tell: "an economist
and his young assistant are walking down the street. The
assistant bends down and reaches out, trying to pick up
something from the road. What are you doing?, asks the
economist. There's a $20 bill on the ground, replies the
assistant. Nonsense, replies the economist. If there were
really a $20 bill on the ground, someone else would have
already picked it up."
This is why Economics has been called the dismal science.
If it seems too good to be true, it probably is. The $20
bill won't stay on the ground for long, but those who are
fast will find it.
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Laura Adams is the host of the popular MBA Working Girl
Podcast. The content combines brainy business school theory
with real-world business practice from her career as a
business owner, manager, consultant and trainer. Subscribe
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