Robert Prechter on Efficient Market Hypothesis Vs. Investor Psychology

Robert Prechter on Efficient Market Hypothesis Vs. Investor Psychology

If you’re a frequent visitor, you know we often help investors spot market noise and myths. Bob Prechter published the landmark book, The Socionomic Theory of Finance to help investors see past these myths and adopt a sensible approach. For a limited time, you can read the first two chapters of The Socionomic Theory of Finance for free by following the link below.

One of the biggest myths is the Efficient Market Hypothesis, which states that while the future may not always be knowable, investors will always change their perceptions about it in a perfectly rational manner as new information arises concerning their holdings.

Bob recently appeared on David McAlvany’s podcast and explains why investors should not act on the EMH assumption, beginning with what EMH is missing.

Let’s listen in:

“It’s missing, probably most importantly, the fundamental importance of psychology. For example, EMH feels that markets, sort of like physical systems, seek equilibrium. And I demonstrated, I think at least, in one of the chapters of The Socionomic Theory of Finance, which I published in 2016, that the stock market never seeks equilibrium and there’s no such thing.

And some of these indicators that we talked about, like stock values versus GDP or earnings or any of that sort of thing — book value — have had fluctuations of as much as 15 times. If there were any such thing as equilibrium, it would be hanging out at one particular multiple most of the time. And then something from the outside would jar it.

Sort of like the ocean is calm most of the time, but every so often there’s a hurricane that stirs things up. But when the hurricane is over, everything goes back to normal and you’re back to equilibrium. Well, that never happens in the stock market. It’s always dynamic, moving from one extreme to another.

Sometimes it takes a while to do it. That’s what it’s always doing. So, the whole concept of equilibrium doesn’t apply, the whole concept of supply and demand don’t apply.

They do apply in economics because you have two different groups. You’ve got producers on the one hand and consumers on the other. But in the stock market, there’s only one group. They’re called speculators. And you can’t say, well, the buyers are demand and the sellers are supply, because the same person can turn around the very next moment and sell what he bought or buy what he sold. So, they’re simply speculators.

That’s how you get the ‘herd mentality,’ and that’s how you get socionomic causality instead of the mechanical causality. And that’s how you get models such as the Elliott Wave Principle, because I think human optimism and pessimism — waves of social mood — are patterns. And so R.N. Elliott described that pattern way back in the ’30s.

We probably don’t want to get into the weeds of that, but that gives you an understanding of how differently I approach things from the EMH people.”

The Socionomic Theory of Finance gives investors a radical new perspective. Start reading it for free right now by following the link below this video.