Direct from the desk of Dane Williams.
Heading deeper down the rabbit hole of financial theories and looking at them through the lens of a forex trader, another that significantly influences the predictability of prices is the Efficient Market Hypothesis.
EMH, as it is more commonly referred to, challenges the feasibility of forecasting future changes based on past price movements.
Lets dive a little deeper into EFH, taking a look at it from both a standard and forex trading point of view.
Efficient Market Hypothesis
At the core of the Efficient Market Hypothesis (EMH) is the idea that all available information is rapidly and accurately assimilated by market prices, rendering any attempt to exploit past prices for predictive purposes inherently futile.
Much like the Random Walk Theory which we discussed here on my INLEO blog last week, EMH aligns with its hypothesis, suggesting that consistently outperforming the market as a trader is a challenging, if not impossible, goal.
In contrast to certain trading strategies and market timing approaches, EMH advocates for a pragmatic approach to investing, emphasising the benefits of holding a diversified portfolio over the long term.
Critics of the theory, however, challenge the simplicity of EMH and I’d have to agree with them.
They argue that it oversimplifies the dynamics of financial markets, dismissing the impact of participant behaviour and nonrandom factors such as data releases, changes in interest rates or even government regulations.
As primarily a technical forex trader, I certainly assert that historical patterns and trends can and do provide valuable insights into trading decisions, contradicting EMH's stance that past prices are inconsequential.
Efficient Market Hypothesis in the context of forex trading
With that being said, let's now bring the Efficient Market Hypothesis closer to home, fully into my domain of the forex market.
In forex markets, where the price of currency pairs swing in response to economic data and geopolitical events, EMH challenges the notion that you can consistently predict price movements.
Now, I’ve talked about the stark reality that nobody can predict where forex markets will move before.
Scepticism is warranted when faced with self proclaimed gurus on social media platforms, proclaiming an uncanny ability to foresee the future when it comes to price.
But to be a consistently profitable forex trader, you don’t need to predict where the market will move.
You only need to be able to run scenarios and put yourself in a position to make money if one with favourable risk:reward plays out.
This is why I will never agree with EMH’s notion that past prices are completely inconsequential when it comes to trading.
You don’t use technicals to predict the future, you use them to put yourself in a position to succeed.
Wrapping up, the Efficient Market Hypothesis, with its roots in market efficiency, challenges traditional notions of market predictability.
Whether in stocks or the dynamic forex market, embracing a pragmatic and diversified approach to investing is certainly a reliable path that aligns with the theory’s principles.
But it will never be one that I fully agree with.
Best of probabilities to you.
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