Predictability of financial markets

‘” When financial markets where predictable I wouldn’t be standing here” is sentence which is definitely true. A very big proportion of the daily movements of the markets are unexplainable on forehand. This is because finance is a social science unlike for example mathematics. Financial markets go up and down in quite a random walk. This is also very logic as if a market or security would be predictable people would directly anticipate on it.

See this as a 100 euro note lies on the streets. If markets are efficient it would be directly taken by someone. If markets are not efficient the 100 euro note would stay there for a while before someone would pick it up.

What do we mean by market efficiency? In another video we will explain it more in detail but now discuss only the highlights of it.

Market efficiency

The more information goes to the markets in a smooth way the more efficient markets are people always say. Items that influence market efficiency are information, transaction cost, taxes, geographical barriers, trading systems etc. Of course nowadays geographical barriers hardly exist anymore in this internet-era. Most of the financial markets are connected to internet so that is no problem anymore. What we now only see in this perspective is that the so called high frequency traders prefer to be physically near the stock exchanges in order to have the highest data connections. But for most of the market participants the speed is hardly any issue anymore.

The most important factor for market efficiency is the information for all the participants. In fact this is the only way to make money in the financial markets. Financial markets are mostly driven company results (and of course many macro-economic factors). So the better you can predict the company’s results the better you can determine if a company is under or overvalued. In other videos we take a closer look at what are exactly the tools to valuate companies.

So we can say that almost the only thing that we need to focus on is the company’s situation and future.

Countless influences financial markets

To conclude the factors that determine the financial markets are countless. But we can group them shortly: macro-economic factors, political factor, company unique news and other factors. Of course all of them are unpredictable (otherwise I wouldn’t be standing here). And also these mentioned factors are loaded at random on the markets. This means that for example better than expected employment figures sometimes lift the markets and sometimes don’t have any effect at all.

What can we do with this information? We just must recognize that financial markets are unpredictable. So I hear you asking so then why invest in financial markets if it’s all a random walk? On the long run we see that there are indeed stock returns explaining factors but they only work in the long run.