Efficient Markets Believe In Trends

• Posted by DynamicHedge
• on May 21st, 2014

The CFA Institute is an extremely influential organization and caretaker of the coveted Chartered Financial Analyst designation. They’re also one of the devoted members of the church of efficient markets.  While reviewing the CFA curriculum this year I couldn’t help but notice all the references to non-efficient market phenomenon. In fact, the CFA Institute even has a section on Technical Analysis in Level 1. Here is one of my favorite quotes from the Level 3 text book:

Q: Cassano asks: “If managed futures strategies are often momentum based, how do they achieve excess returns differently from traditional stock or bond investment vehicles?” Formulate an answer to Cassano’s question.

A: The theory of market efficiency suggests that news is simultaneously available to all market participants and is quickly incorporated into market prices. However, research in behavioral finance indicates that investors may systematically underreact to information; consequently, security prices may trend, particularly in traditional investment vehicles (stocks and bonds). Actively managed derivatives strategies that follow momentum, or trend-based, models have been shown to be profitable by capturing these trends.

Despite all the volumes of academic literature, most market participants know that the market doesn’t work the way they describe it in text books. Finally, it seems that both research community and the financial asset community at large are coming around to what traders have known all along.

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