Is the Market Efficient?
Like all theories, the efficient market theory deals in absolutes. Logical minds know that absolutes rarely exist, and that the value of a theory is to represent one point of view. The troubling thing about the efficient market theory is that, if it is true, then all selections of stock are 50-50 propositions. Because it says that all known information is reflected in the price, we cannot know whether immediate changes in that price level will be positive or negative.
Resistance to the idea of depending on fundamentals for long-term successful investing comes from the desire to make a profit as quickly as possible, and with the least amount of work possible. This is human nature. Given two courses, people tend to take the easier as long as the end result is the same. However, in the market the end result of taking what appears to be an easier course might not be the same. The truth is, many investors choose to ignore risk. They tend to see potential for profit, while ignoring the equal and offsetting risk of loss.
This problem becomes evident when markets go through long periods of rising levels in the Dow Jones Industrial Average (DJIA). Remember, the point value of the DJIA has no real meaning, other than as a measurement of what is perceived to be the market now, versus where it was yesterday. The DJIA is a means of measurement that has no basis in supply and demand; in economic reality; or in the fundamentals of companies listed on the New York Stock Exchange. However, a run-up in the Dow like the one seen during the 1990s, leads many people into the market for the first time. As long as the DJIA continues upward and as long as investments made by these first-time players continue to climb, there appears to be no risk of loss. Everything moves upward without fail. Invariably, when a correction occurs or when the mood swings to the opposite direction, these first-time investors are caught off guard.
KEY POINT
The only value in the Dow Jones Industrial Average point level is that it offers a means to determine when the perception of the market is off.

This occurred when the big correction of October, 1987 took place. It will happen again in the future. If it were possible to warn people in advance about the risks associated with investing—notably the short-term risk, where most of the action takes place—people might take a more cautious view or, in the alternative, they might end up adopting the long-term position based on fundamentals, which is the more mature approach to the market. However, one of the problems in the market is that professionals are geared to the short term just like most people. Professionals want to be believed, and they want their customers—investors, subscribers, clients—to believe in their advice and expertise. Thus, professionals have little incentive to try and damper the enthusiasm of investors. To the contrary, the greater the enthusiasm, the greater the professional's perceived indispensability in the scheme of things.
You cannot expect to make a profit in the market by knowing what is going to happen short term, because you cannot know. You are rewarded for taking the right kinds of risks and for being patient. If you select stocks based on the fundamentals and combine the fundamental information with certain technimental indicators, you will be in a much better situation than most individual investors. You cannot depend on forecasts to ensure profits, because forecasting is extremely imprecise. Even a generally correct forecast can deceive you short term.
Regardless of what theories you follow or what observations you make about the herd mentality of the market, you invariably return to dependence on the fundamentals. Your investing approach requires three steps in order to succeed, none of which have anything to do with current price levels. The three steps are:
1.     Get the information you need. The successful investor does not act on market price alone, because price is only today's perceived value of a stock.
2.    Decide on the most appropriate strategy. The approach you take with your portfolio depends on your own goals. Investors are different, and no advice given to you by someone who does not know you can be trusted.
3.     Identify the associated risks. The risks of investing are as important as the potential, because the two cannot be separated. Higher potential means higher risk, and lower risk is accompanied by lower potential. This is the nature of investing, whether in the stock market, in real estate, or in tulip bulbs.
Beating the Averages
Performance is measured against the market as a whole, which is appropriate because we need to have some method for judging success. In school, the criterion is well understood. A passing grade is easily quantified by meeting the goals of the course, by attendance, and by test performance. In the market, the criterion is not always as clear.
What is the market? Obvious choices include measurement of indexes and averages, but perhaps a more valid approach for you would be to compare your portfolio's average annual yield to that of other investment choices, such as your local real estate market, savings accounts, or mutual fund investing. The most popular way of getting into the stock market is through buying shares of mutual funds, so if your fund outperforms the market (in whatever way that is measured), then you have achieved a degree of success.
KEY POINT
Be sure that you measure your success against a valid standard, even if you have to come up with one of your own. Don't overlook comparisons of risk in the equation.

The problem with any form of comparison is that risks are not always comparable. A comparison between the stock market and real estate involves many different risks: market forces move at different rates, real estate lacks the liquidity of the stock market, and you have more direct control in managing property. In other words, these are not comparable markets because the risk factors are vastly different.
In view of the fact that market prices change for a wide variety of reasons—none of which have much to do with long-term strategic planning—the questions you should be asking are not tied to price. Developing a good understanding of what causes price changes is inherent in becoming aware of your market.