What Trading Places teaches you about market efficiency

published 10 August 2018

Trading Places is a 1983 comedy starring Dan Ackroyd and Eddie Murphy (pictured), and Jamie Lee Curtis. The Mortimer Brothers, who own a commodity brokerage, decide to settle an argument about nature versus nurture by having their star trader, Louis Winthorpe III (Ackroyd), framed for theft, and replaced with homeless conman Billy Ray Valentine (Murphy).

While Winthorpe goes into a drunken spiral, Valentine adapts to his new role. But when he overhears the brothers planning to fire him, he teams up with Winthorpe and a prostitute (Curtis) to bring the Mortimers down.

The key moment

Having bailed Valentine out of jail, the brothers bring him to their office to teach him how their business operates. They explain that they carry out trades in several commodities, including orange juice, wheat, pork bellies and gold, for clients. However, because they get their money through commissions on each trade, the firm profits irrespective of whether their clients win or lose. Grasping the model immediately, Valentine says: "Sounds to me likeyou guysare a couple ofbookies".

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Lesson for investors

The idea that financial markets are a form of gambling is a favourite insult of those who dislike them. Yet it's not a bad analogy, nor necessarily a negative one. After all, betting odds are usually reasonably correct as to the probability of an event happening otherwise bookmakers would rapidly go bust. Similarly, markets are capable of very accurate judgments.

However, just as gamblers on a streak can behave irrationally, creating opportunities for more level-headed punters, markets also regularly lose touch with reality.

Other financial wisdom

Also in 1983, two real-life traders, Richard Dennis and William Eckhardt, had a similar bet about whether trading could be taught. Dennis selected a group of people from all walks of life, who he dubbed "the Turtles". After several weeks of trading lessons, mostly focused on trend-following techniques, he gave them some money and let them loose.

While the group had mixed success, some were extremely successful, most notably Paul Tudor Jones (now worth an estimated $4.7bn). This suggests that, while some skills (such as discipline) are innate, it is possible to improve your results by reading and taking advice on the subject.

Matthew graduated from the University of Durham in 2004; he then gained an MSc, followed by a PhD at the London School of Economics.

He has previously written for a wide range of publications, including the Guardian and the Economist, and also helped to run a newsletter on terrorism. He has spent time at Lehman Brothers, Citigroup and the consultancy Lombard Street Research.

Matthew is the author of Superinvestors: Lessons from the greatest investors in history, published by Harriman House, which has been translated into several languages. His second book, Investing Explained: The Accessible Guide to Building an Investment Portfolio, is published by Kogan Page.

As senior writer, he writes the shares and politics & economics pages, as well as weekly Blowing It and Great Frauds in History columns He also writes a fortnightly reviews page and trading tips, as well as regular cover stories and multi-page investment focus features.

Follow Matthew on Twitter: @DrMatthewPartri