Efficient Market Theory says that financial information is processed so aggressively that individuals can’t outperform the market average. It doesn’t matter that the information is not always good information. Here’s economics blogger Megan McArdle on the subject:
…when there are errors or information asymmetries, they tend to attract a lot of people trying to make money off of them. They rapidly bid down the arbitrage opportunity to zero…. Even if you have identified a price anomaly, you may not be able to act on that information. I am acquainted with someone who shorted the stock market in 2000 and made a killing. Unfortunately, he also shorted it in 1997, 1998, and 1999, and was very close to being totally bankrupt before the market went south. As traders like to put it, “the market can stay irrational longer than you can stay solvent”.
This last point is key, which is where I slide this idea toward fantasy baseball. It is impossible to predict future performance, even for the best players. Who knew Alex Rodriguez would get injured? Who knew Chipper Jones would stay healthy? Breakouts are even harder to predict. Cliff Lee, anyone?
Even in the small market represented by a 12-team league with reasonably active owners, great players will not be readily exposed. Some 200 to 300 players will be drafted, meaning all the remaining free agents are flawed in some way — either they are mediocre or high risk.
My choice is to go after the high risk players, which generally means going after the slumping, the inexperienced, or the oft-injured.
For example, Willy Taveras is a mediocre player. He has 15 stolen bases and is owned by 98.1% of all ESPN leagues. But he also has an OBP of .302 and no guaranteed spot in the Rockies starting lineup. If you’re looking for stolen bases, maybe Fred Lewis, 19% ownership, is the better gamble. He has a career .823 OPS in the majors and 10 steals in 13 attempts. he’s been slumping recently, but that’s good. It means he’s more likely to be available.
Of course, he could just keep slumping. And Taveras could start playing like he did in 2007. You don’t know. The market can stay irrational longer than you can stay solvent.
Stock picking is a sucker’s game. I was completely convinced of this by a professor I had in business school who I respected greatly, and who believed this resolutely. What’s funny is he taught a capital markets class, which is a required intro class for any student headed to Wall Street (of which I was not one). These are the guys whose very identity is often built upon their perceived ability to win in the market.
His position, very simply, was that a single person (or institution, group of people, etc.) cannot possibly know more than the rest of the financial marketplace combined about what a stock will do. Stock prices are completely unpredictable. It’s the random walk hypothesis, in line with the efficient market theory. It states that the value of a stock (related to its current price) relies totally on news — news being defined as things that were not foreseen. Arbitrage opportunities are vaporized instantly. And it’s why I will never purchase shares of stock of an individual company.
And you see people make this mistake ALL THE TIME. “Ooh, Merck has received approval for a new drug to treat Condition X! I’m going to buy its stock! The company will make more money!” Well, perhaps the company will make more money, but that does not make the stock a good buy. If you know about the news, it’s not news — everybody knows, and it’s already in the price of the stock. The price of a stock is not based on the current value of the company — its based, solely, on the market’s expectation of the future value of the company. The only thing not factored in is what the market doesn’t know, which means you don’t know (unless it’s insider trading). If you buy or short a stock, you are essentially betting against the thousands and thousands of people who know a lot more that you do.
How does this relate to fantasy baseball? For me, it limits my number of transactions. Particularly, it limits the amount of shuffling I do in my lineup. Most of all, it informs my draft strategy — I place a lot of trust in the masses. Likewise, I am the most boring fantasy player ever, and also the most boring NCAA pool participant. I always pick the favorites in every game, no exceptions. I won the my NCAA pool this year for the third consecutive time (4 #1 seeds in the final four meant I had it wrapped up before the national semifinal).
I think this makes my interpretation of the efficient market theory, at least how I relate it to FBB, different than Henry’s. And it is now that I am reminded that I can’t remember the last time I finished ahead of him the final standings (including last season, when he replaced me in the #1 spot in the final week).
Posted by by Shayne on June 3, 2008 at 7:12 pm