An Introduction to efficient market hypothesis

A derivative, as the name suggests, is any instrument that derives its value from some underlying asset or indicator. A stock option is an example of a derivative that derives its value from the price of a particular stock. However, a lot of people still fail to comprehend the interdependence between the derivatives and the stock market. In the context of trading, the two are as similar as Bread & Butter, one incomplete without the other. To truly succeed in the market, it is imperative to understand the influence one has on the other and use their respective instruments in tandem.

A falling market has always been associated with rising fear in the mind of the investor. However, a derivative market thrives on the volatility in the stock market. In the context of financial market, when you talk about the efficiencies, you will usually come across the following terms:

  1. Weak Form: Market is aware of the past stock prices, which have been incorporated in the prices. Return on market is independent of the past rates and does not follow any trend.
  2. Semi-Strong Form: Market is completely aware of all published information, which has been incorporated in the prices. If all published information is already reflected in a stock’s price, then there’s nothing to be gained from looking at financial statements. Hence, Fundamental analysis is of no help here.
  3. Strong Form: Market is completely aware of all information – even the unpublished ones. All this information has already been incorporated in the prices. As such, no one can make a profit in the market, even if he has access to insider information. Technical Analysis and Data Analytics can be helpful at this stage if interpreted properly.

Looking at this, it is clearly evident that the Indian market is currently in the weakest tranche, even weaker than the weak form. This is not a bad thing, considering the vast opportunities it presents to the trading community to book profits. Volatility is something that smart investors are on a constant lookout and the market, sooner or later, always rewards them. The Indian Stock Market is very volatile which leads to investors using a plethora of strategies including Straddle and Strangle to gain the upper edge.

Traditional stock market investing strategies focused solely on evaluating growth and corporate earnings are dangerously incomplete. The Investor of the ‘New Age’ realizes the importance of the Derivatives market and is constantly on the lookout for complex strategies and innovations in the market. Although it has its risks associated, this is the only way to minimize errors and last longest in the market.

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