Market has a particular degree of efficiency at a particular point of time and it tends to fluctuate between efficient and inefficient levels. Inefficient levels are considered to be moneymaking zones where profits can be booked by exploiting the anomalies that led to inefficiency. As more and more operators discover and exploit the profit making, market tends to move into efficient zone leading to reduction of its profitability. As market becomes non-profitable, people stop exploiting it. This opens up scope for reappearance of anomalies in market, making it inefficient.
This psychology should reflect in cyclical patterns; though the periodicity and volatility may vary over a period of time. This may look like a random time series but we expect embedded patterns in this time series. Moreover, these patterns may be less prominent in efficient markets, as compared to the inefficient markets. During these cyclical patterns, we may observe the following :
- The newer anomalies will be discovered and exploited by various entities participating in the market.
- The older anomalies may vanish, if large number of operators start exploiting them.
- However, as some of the market participants stop exploiting the known anomalies, they are likely to reappear in the market.
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