Let Smoke Clear on CannTrust to See Efficiency, Irrationality of Market

We're constantly told markets are efficient. For most of those who study the market, at some point they will come across the Efficient Market Hypothesis (EMH), which states, in its most simple terms, share prices reflect all information and consistent alpha generation is impossible.

On the flip side, many of us all live by and believe the notion: The market can stay irrational longer than you can stay illiquid.

These two notions appear in stark contrast to one another. They should be mutually exclusive, but I believe they can both exist, because of one simple thing: time.

Irrationality is a short-term notion, while EMH should be viewed with a long-term lens. Think a few hours to a few weeks for irrationality, while EMH may need months or years to prove itself.

Finding short-term examples that contradict EMH is easy. Let's look at a 15 minute chart of CannTrust (CTST) . The stock has been struggling since its stark violation of cannabis law in Canada. I won't re hash the story -- but an ousted CEO, a shutdown of sales, and the potential the company could lose its license, have rightfully depressed price. We've seen the occasional push in price on the rumor of asset sales.

Then came Friday. The stock was trading at its low point for the week, when heavy buying came in with two hours left in trading. That buying did not stop until the bell rang. Shares went from $2.10 to a high of $3.55 on absolutely no news. It touched three standard deviations on the daily chart, and that's after the stock lost more than half its value recently, once its fraud became public knowledge.

The rumored source of the buying was an exchange-traded fund doing its rebalancing. Fast forward to Monday and the only CannTrust news that hits is more bad news. Another CannTrust facility was deemed non-compliant by Health Canada. More delays. More unknowns. And the stock gives back most of Friday's gain.

How is this efficient?

It's not, but most of the inefficiency only lasted a few hours. In the grand scheme of investing, this amount of time is a blip on the radar. The real irony here is technology has both accelerated EMH potential, while simultaneously creating irrationality.

Computers have made information more readily available. That, in turn, strengthens EMH. But computers trading on their own can lack direction or logic. They can't apply fundamental changes in a company, because a program can be driven purely by numbers. This appears to be the case with CannTrust. If it were underweighted in an exchange-traded fund that used a formula or a computer for rebalancing, then the devastating fundamental news would be ignored. The automated system would buy until its mathematical parameter was met, even if it created a stock move most would deem irrational.

It took less than one day for the market to reset the majority of the inefficiency. Still, there's a lagging effect on CannTrust Monday. The stock is still above Thursday's close and well above Friday's low, despite even more bad news. It's this lagging effect that has piqued my interest. In this "Halo Period" between irrationality and EMH, sits the alpha both traders and investors seek. While the largest returns -- either the huge move higher or first large retracement -- would be missed, so would the largest risk.

Simply put: The Halo Period sits in the area between irrationality and EMH that link the two, so they are mutually inclusive, rather than mutually exclusive. It's an area traders and investors should seek to study and uncover to obtain true alpha.

At the time of publication, Timothy Collins had no position in the securities mentioned.