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This Big Idea Breaks the Efficient Markets Hypothesis

This Big Idea Breaks the Efficient Markets Hypothesis

Many of us look at the markets as a puzzle to solve.Long-term investors try to find the companies that others don’t realize are undervalued.Traders search for practical solutions that can lead to short-term profits.Academic researchers, though, are different. They try to identify why market moves occur.To you, that might seem frivolous. What use is that information if it can’t be applied to making profits?But occasionally, the academics stumble on an idea that can lead to serious profits in the right hands

In the 1960s, academics developed a theory about the markets called the efficient market hypothesis (EMH). The EMH tells us that the market price is always the correct price for a stock since it reflects what everyone can possibly know about the price.That makes perfect sense from a theoretical perspective. Everyone considering a stock will have an opinion. Buyers will believe they know something that will cause the price to rise. Sellers believe there is a better use for their cash.This is a nice theory. It explains why prices move. The strength of these opinions determines the price.If sellers are more convinced of their position, they’ll push the price down. When buyers act with high conviction, they push prices up.When new information becomes available, the EMH tells us the market price will reflect that information immediately. This explains why stock prices show large gaps after earnings announcements.Though, there are some flaws in the theory…Taken to an extreme, the EMH tells us that if the market price incorporates all known information, there shouldn’t be any way for an individual to profit from the markets.Stock prices, as a group, should go up or down based on changes in the economy and analyzing individual companies would be a waste of time since an analyst shouldn’t be able to uncover information a company’s management team, employees, suppliers, or customers don’t already know.This view would undermine the very need for the markets. No one would trade if there was no way to benefit from the market moves.Of course, since it is possible to profit from the market, we know that this view is wrong.So, academics went back to work and found anomalies to the EMH. And here is where we start to find profit opportunities that work in spite of EMH.

The Earnings Drift Anomaly

An anomaly is something that works even though it shouldn’t.Amid the efficient market hypothesis, academics identified momentum as an anomaly. That explains why trends exist in the stock market.Researchers found that small-cap stocks tend to outperform in January. They saw that stocks in some sectors consistently beat the market. Employee growth rate seemed to be useful in finding stock market winners.The list goes on. One paper identified 150 anomalies to the EMH.With so many anomalies, the whole idea of EMH comes into question. But only a few of the anomalies have withstood the test of time for traders.Among those is the earnings drift anomaly.Remember that the efficient markets hypothesis explains why stocks make large moves on earnings.But what it can’t explain is why the price continues to drift higher after some earnings announcements. This happens consistently enough to make it a strong anomaly to EMH.Good traders don’t spend time trying to explain why anomalies exist as much as they spend time trying to find ways to profit from an anomaly.Chad Shoop is one of those traders.I’ve known Chad for many years, and he is obsessed with exploiting the earnings drift anomaly. He has been for as long as I’ve known him.Over the last five years, he’s been exploiting this anomaly to great effect. He’s used it to beat the S&P 500 by 3x, a remarkable feat when you consider the S&P has gone up roughly 84%.The average trade he makes using the earnings drift anomaly outperforms the market by 651%.And along the way, Chad has produced home-run winners of as high as 438%, 464%, and even 526%.It’s all thanks to his Profit Calendar. With this calendar, Chad has identified the sub-1% of companies that produced the most consistent and strongest earnings drift effects. He’s been able to produce the results I just told you about by focusing on just these stocks.If you haven’t already checked out Chad’s brand-new presentation on the earnings drift anomaly, you can do so right here.Keep in mind, though, this presentation comes down just two days from now, on February 24 at midnight ET.Regards,Michael Carr signatureMichael Carr, CMT, CFTeEditor, One Trade

Chart of the Day:A Freebie From Chad’s Profit Calendar

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I probably shouldn’t do this…But… yeah, okay, I’m gonna share a stock from Chad’s Profit Calendar.Today we’re talking about Lowe’s (LOW). The home improvement store has fared much, much better than a lot of other stocks in the market. Still, it’s down about 16% from its all-time high in December and has given back basically all of its gains since mid-October.However, the most important thing about the Lowe’s chart is what’s happening tomorrow: its earnings report.Lowe’s reports earnings at 9 a.m. ET tomorrow. It’s one of Chad’s Profit Calendar companies, which means it tends to produce a strong earnings drift effect.Chad’s traded LOW 4 times since he first logged it on the Profit Calendar in 2017. All but one time, he scored a profit on the trade. That’s a 75% win rate, with gains of 30%, 63%, and 81% along the way.And it’s just one of DOZENS of Chad’s favorite stocks to trade each earnings season.Now, I can’t give the whole game away. Chad will be looking for a specific signal after Lowe’s reports earnings tomorrow, to let him know whether it’s a good trade.So, to figure out what that signal is, be sure to check out Chad’s presentation before it comes down later this week.Regards,Mike MersonManaging Editor, True Options Masters

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