In dictionaries, “efficient” means doing something well with no waste of time, money or energy. But in finance, it has a slightly different meaning; it means the price of an asset reflects available information quickly. If there was a perfectly efficient market, the price of any asset would be always right, i.e., all the information available now is fully priced in by skillful investors and traders. In this situation, only ‘new’ news can change the price and unfortunately new news, by definition, cannot be known in advance. Therefore in a very efficient market, any investments become just like a coin toss – a game of pure luck, not skill. Of course, in reality, no market is perfect, much like no perfect human being exists. Skillful traders find out such imperfections in the market and make money.
For example, in a stock market, some stocks might be too cheap and others too expensive. If you can find such price imperfections, you make money with better odds than a coin flip. Skillful investors buy those cheap stocks, wait for the market to notice and then the prices of them are corrected. Long-short traders have long positions of the cheap ones, go short on the expensive ones and can make money from both sides, no matter how the entire market evolves. Those who notice wrong prices in the market earlier than other market participants can be rewarded like this. Such competition to find out wrong prices in the market actually make the market more efficient.
The concept of efficiency can be used not only in financial markets but also in a broader sense to describe business in general. Merchants can make money by buying goods that are sold cheaply in one area and selling them at a higher price in another area. Even the media business can be understood from the viewpoint of efficiency. Some knowledge shared in a certain industry or in a group of experts may sometimes be very helpful for more general readers. Thus, media companies can create values by editing and rewriting such information in an easy to understand manner. Those media companies are rewarded for improving information gaps in society.
Why is it so important to make the world more efficient? Because we can make money on improving the efficiency of the world? Yes, that’s right. We have to make money and love to make money, like any other company in the capitalist world. But not only that – economic theories show that an efficient market can best allocate resources to our society. Traders, investors, or just any business persons compete to make more money, and through their activities, which is fueled by their desires, can actually make the world a better place.