Does Successful Traders on Reddit’s ‘Wall Street Bets’ Refute the Efficient Market Hypothesis?

Some examples of big returns on Reddit’s WallStreetBets just in the past day (many more):

The usual rebuttal is dismissive of skill, such as along the lines of, “If enough people flip a coin, some will get all heads,” or “People who lose money are less inclined to post.”

But how many people need to make tons of money before we conclude there is skill and to reject null hypothesis (no skill)? People who say it is all luck seem dismissive of the possibility that there is skill and strategy involved, and not just throwing darts at the wall. On a longer and greater scale, the huge success of quant funds such as Renaissance Technologies, is further evidence skilled traders do exist.

The idea is to look for something beginning to break out, maybe 20-100% in a day, and then buy in the hope that the momentum carries over for a second day, which seems to be a common occurrence. Or buy out-of-money call options with Kelly-optimized position sizing.

Common traits of successful traders and investors, from what I have observed, are as follow:

-They have good risk management. Such as mentioned above, optimal position sizing like with Kelly’s formula or some other heuristic. Instead of betting everything on one trade, they space it out, but some seem to have success with all-or-nothing bets by being very certain, such as having ‘superior information’, as discussed in the next section.

-High IQ, or at least predictors of high IQ, such as advanced degrees, high-paying jobs, or a wide breadth of knowledge about things. I don’t think it’s that unreasonable to assume that traders who are smarter would have a knack for finding market inefficiencies that elude other traders.

-Honing in on optimal sectors or stocks, and ignoring the rest. This can mean focusing on semiconductor stocks or leveraged tech funds, and ignoring things which have worse or inconsistent performance, like crypto. Unsuccessful traders have a more haphazard approach of chasing anything that is doing well at the moment.

-Successful traders focus not just on price action, but also fundamental analysis. The latter is important because companies/sectors with better fundamentals may have more consistent or stronger returns. One example , again, is choosing leveraged tech funds over crypto because tech companies generate profits, unlike crypto. Thus, tech gains are more stable as profits provide a price floor, unlike with crypto, which has no such floor.

Does the existence of skilled traders invalidate the EMH? I think not. The EMH is only an approximation and concerns how the market processes or absorbs revealed information. The EMF posits that markets react to new information instantly and that it’s not possible to predict how the market will react after the initial reaction, or otherwise extrapolate price action into the future.

But stronger forms of the EMF fail to take into account information asymmetry [0], an obvious example being insider trading, except it’s legal. The idea is if you’re privy to non-public information, one can realize outsized returns which would otherwise not be possible under a purely efficient framework as far as how the market responds to new public information.

Rather, this takes advantage of hidden information and expectations vs. reality. It’s possible, for example, for some traders to be savvier than others about understanding trends, like about demand for GPUs in the context of AI. So the savvier traders will make more money. Or the hypothetical example of a survivor of a plane crash betting against said airline, like on his smartphone, before the media reports it. Or a passenger of a Boeing plane betting against Boeing stock during a door malfunction.

Instead of it being the efficient market hypothesis, it’s more like the ‘efficient consensus market’. The current price reflects a consensus among market participants, which is hidden or can be assumed to be neutral, but having superior information (either insider information or gleaned by being savvy or cognizant of trends), can give some traders an edge. When reality (what is later revealed such as earnings reports or GPU usage) surpasses expectations or the consensus, such traders can realize a large profit.

Few people could have conceived or entertained the possibility in 2004, when Google went public, that it would be worth over $1 trillion by Jan 2020, an over 40x return on investment. If expectations in 2004 could be plotted as a normal distribution, Google being a $1 trillion company would be diminutively improbable, but not zero. In theory it was possible that someone could have deduced or reasoned that enough advertisers would migrate from print/TV ads to online ads, to bet that Google would eventually be worth a trillion dollars and get rich.

Overall, to dismiss success as merely luck seems like a cop out or dead-end, or an admission of epistemological defeat. The point of intellectual inquiry is to not take path of least resistance, but to seek deeper understanding.

[0] The weakest form of the EMH allows for some inefficiencies.