Anomaly
Candlefocus EditorAnomaly in economic and financial markets occurs when there is an unexpected deviation from a theoretical economic or financial model. This deviation undermines the core assumptions inherent to these models, such as the efficient market hypothesis (EMH). The EMH states that it is impossible to beat the general market through skill or research, as all market variables are already priced into the current quotes represented by the market average.
Therefore, any events or patterns that contradict this view can be considered anomalies. A prime example of an anomaly in the market is the Calendar Effect, which refers to the tendency for prices to increase in the days leading up to the end of a month, quarter, or year – and then decrease in the days following. This phenomenon defies the EMH, as there is no rational reasoning behind it.
The majority of market anomalies are psychologically driven, most often caused by investor sentiment and behavior. As the EMH states that the markets are in a continuous state “random walk”, trending in a direction which cannot be accurately predicted, any outliers or periodic patterns of behavior suggest that decisions are being made logically and systematically. Another popular example of an anomaly caused by market psychology is the “January Effect”, which is the tendency for stocks to increase in value in the month of January each year.
It is important to keep in mind that anomalies are fleeting and have a tendency to quickly disappear once knowledge about them has been made public to the public. The knowledge creates a feedback loop among investors, resulting in their decisions and behaviors working to quickly eliminate these events.
In conclusion, anomalies are events or patterns which deviate from the predictions and assumptions contained in economic and financial models. Many anomalies are psychologically driven and tend to quickly disappear once the knowledge about them is made public. Investors must always take into account the potential for anomalies when making decisions in the markets, as seemingly irrational behavior may be caused by factors that are otherwise not immediately obvious.