Stock market anomalies

- [Instructor] Stock market anomalies are a great opportunity to potentially increase the return on your investments. These anomalies are basically just traits of certain types of stocks, like valuation and size that consistently produce returns greater than what we'd expect given their risk. Now these anomalies don't fit with what we call the Efficient Market Hypothesis. The Efficient Market Hypothesis basically says that investors can't consistently outperform just a basic buy and hold strategy. In other words, holding a diversified portfolio of common stocks is the best you can do. The only way to increase your return is to take more risk. The EMH says that any research you do is pointless. You're wasting your time watching CNBC. In other words, throwing darts to select stocks would be just about as effective. In fact, there's an old experiment done with this using a dart board and monkeys. They put stocks up on a dart board and had monkeys throw darts at the board. Now, the monkeys' stock picks, if you can call it that, were then compared against the stock picks of professional investors. Well, the good news is that the professional investors didn't lose to the monkeys. The bad news is they didn't really beat the monkeys either. So the Efficient Market Hypothesis simply says that a lot of your research is a waste of time. But turns out the Efficient Market Hypothesis is actually not all that accurate. The Efficient Market Hypothesis can't explain market anomalies. For instance, what we observe is anomalies like in the month of January, stocks outperform compared to the month of February. This is called the January effect. For no particularly good reason, simply because it's the month of January, stock returns historically are much higher than they are in February. That doesn't seem like it fits with the Efficient Market Hypothesis, right? And, in fact, there's a variety of other anomalies out there that don't fit with the EMH either. For instance, the price to earnings effect or the size effect. Stocks that have a relatively low PE ratio tend to outperform those, on average, that have a high PE ratio. Small stocks outperform large stocks, on average. And dozens of other anomalies exist. All these anomalies point to a similar conclusion. Investors may be able to beat the performance of the broader stock market by using publicly available information if they can capitalize on these anomalies. There's a variety of anomalies out there, including momentum effects, post-earnings announcement drift anomalies, or the PEAD anomaly, and many others. Often times anomalies are best captured using algorithmic trading. If you're interested in learning more about algorithmic trading, check out my algorithmic trading courses here on LinkedIn Learning to learn more. So the take away from all these anomalies is simply this, investors may be able to beat stock performance benchmarks using publicly available information if they can capture and capitalize on these behavioral anomalies. Start thinking about whether you want to try to capitalize on these in your portfolio, or if you prefer a simpler buy and hold strategy.