HOW TO THINK LIKE BENJAMIN GRAHAM AND INVEST LIKE WARREN BUFFETT

PROZAC MARKET
C h a p t e r 2
Along and interesting story lies behind the ever-popular efficient
market theory, a story every investor should know. Knowing the
EMT story will enable you to evaluate advice based on it, including
advice about the value of diversification and ways of measuring risk.
It will also help you decide for yourself whether to believe EMT.
That is important because if you believe in market efficiency, you
will adopt a style and philosophy of investing very different from the
one you will be smart to adopt if you do not.
Investors who have already concluded that EMT is not the best
account of how stockmarkets workcould skip this chapter without
being cheated, but even they may discover ways in which EMT has
unwittingly affected their investing habits. All readers will also discover
that the history of EMT is fascinating. It is a story about research
designed to enlarge knowledge, to explain and understand the
world, research whose results are intermittently neglected and then
overblown. The story tells us that EMT is not the last word on how
stock markets work, even though the power it has had over investors
and teachers for several decades sometimes makes it seem that people
thinkit is the last word. 1
OBSCURITY
EMT traces its history to the random walkmodel of stockprices,
the sensible idea that stockprices move in a way that cannot be
predicted with any systematic accuracy. The model dates backto
1900, when it was elaborated in a doctoral dissertation by the French
mathematician Louis Bachelier that though obscure in its time is
now famous. That dissertation investigated linear correlation in the
prices of options and futures traded on the French Bourse and concluded
that such price changes behaved according to a random walk
model. 2
Copyright 2001 The McGraw-Hill Companies, Inc. Click Here for Terms of Use
17