The Investment Scientist

The Unstoppable March of the Efficient Market

Posted on: January 22, 2011

March of Efficient Market

March of Efficient Market

I turned $300k into $2mm in six month. Here is what happened.

After the Enron debacle in 2002, Congress passed the Sarbanes-Oxley Act. One obscure clause in the act required company insiders to report their insider trades electronically within a day. The reports would go into a Securities and Exchange Commission (SEC) database accessible to the public (if they knew how to query the database.)

Prior to that, company insiders had 15 days to report their insider trades in paper format. Those papers would then sit in an SEC library gathering dust. Periodically, a Wall Street Journal (WSJ) reporter would borrow the pile of papers and write a report on them.

As soon as the electronic reporting was implemented, I created a program to query the SEC database in real time. When a company insider sent in his trade, my program would send an alert to my cell phone. In the next 30 seconds, I would call my broker and place a trade in the same direction as the insider. A few days later, when the insider trade finally got to the WSJ, the stock price got a pop and I would sell for a tidy profit. In six month’s time, I turned $300k into $2mm. (Using a spreadsheet, I calculated that at this rate of return I could be a billionaire within three years.)

Then, I found this website. For a mere $20 monthly subscription, anybody could get the insider trade information in real time as well. I actually became a subscriber, just to check out how fast its information was. I found my program was one second faster than the website, but that wouldn’t be enough time for me to place a trade before the information became available to the website’s hundreds of subscribers and the market price began to react.

I called the proprietor of the website, trying to get him to shut it down, or at least delay the information. I let slipped that my program was one second faster. The next day, he called me back to report good news: he went back to look at his code and managed to shave off the second. Needless, he totally killed my golden goose.

I spent the next two years trying to find the next smart idea to make fabulous money. In the process I gave back most of the $2mm I made.

Here is what I learn from this experience. Trying to make a lot of money by having faster and better information than the market (aka smart stock picking, smart market timing etc) is like trying to spot a $100 bill on the floor of the Union Station in NYC before everybody else. Not that you can’t get lucky, it’s just that you can’t consistently make a profit from that.

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2 Responses to "The Unstoppable March of the Efficient Market"

You’d like Michael Burry’s story on p.28 0f “The Big Short” by Michael Lewis. Burry studied subprime mortgages on a mortgage level basis and found that the 2/28 IO ARMs made up 6% of pools in early 2004 and had risen to 25.34% by 2005 and yet FICO scores were unchanged. Quality was deteriorating fast and it wasn’t reflected in risk ratings!
Another interesting inefficiency discernible from minutely studying the data!

Hindsight is 20/20. It is a lot easier to identify market inefficiencies ex post than ex ante. There are two things we can learn from the experience of the last bear market.

1. The market is not all efficient all the time.
2. It is exceedingly difficult to identify concurrently existing inefficiencies.

Michael

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Author

Michael Zhuang is principal of MZ Capital, a fee-only independent advisory firm based in Washington, DC. He is also a regular contributor to Morningstar Advisor and Physicians Practice. To explore a long-term wealth advisory relationship, schedule a discovery meeting (phone call) with him.



You may also get his monthly newsletter, or join his Facebook page for regular wealth management insights. Michael's email is info[at]mzcap.com.

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