There can’t be many equity investors who haven’t dreamed of picking the next Google, Amazon or NVIDIA. If you buy into a stock like that before it takes off, and hold on to it for a long time, the profits you can make are astronomical. But, in practice, how hard is it to do that?
If you read investment magazines or follow certain influencers on social media, the impression you’re given is that it’s perfectly realistic. There’s always someone telling us how much money they made on, say, BAE Systems, the FTSE 100 stock whose price, at the time of writing, has risen by more than 200% over the last five years.
The fact, however, that others have made a fortune on a particular stock in the past can blind you to the harsh reality that the odds of repeating their success yourself are heavily stacked against you.
Markets are highly efficient
So why is that? Well, the main reason is that stock markets are very efficient. All available information is already reflected in market prices. Prices move up and down in response to new information, which is, by definition, unknowable. That’s unless, of course, you’re an inside trader, in which case you’re risking a heavy fine and a prison sentence. Without inside information, no one can predict with any certainty the direction of a stock.
Yes, you could argue that markets are not perfectly efficient and that there are examples of stocks that are either overpriced or underpriced. That may well be true, but it’s not the point. Because prices reflect all known information, identifying mispriced securities in advance is impossible to do on anything like a consistent basis.
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HAVE YOU READ THIS BOOK?
Robin Powell and Jonathan Hollow have been friends since childhood and share a passion for helping people understand the world of money, savings, pensions and investments.
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The book is published by Bloomsbury and is primarily written for a UK audience.
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