Efficient Market Hypothesis

Efficient Market Hypothesis

States that all relevant information is fully and immediately reflected in a security's market price, thereby assuming that an investor will obtain an equilibrium rate of return. In other words, an investor should not expect to earn an abnormal return (above the market return) through either technical analysis or fundamental analysis. Three forms of efficient market hypothesis exist: weak form (stock prices reflect all past information in prices), semistrong form (stock prices reflect all past and current publicly available information), and strong form (stock prices reflect all relevant information, including information not yet disclosed to the general public, such as insider information).

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Efficient Market Theory

A controversial model on how markets work. It states that the market efficiently deals with all information on a given security and reflects it in the price immediately. The model holds that technical analysis, fundamental analysis, and any speculative investing based on them are useless. The model has three forms: weak efficiency, which holds that technical analysis is ineffective, semi-strong efficiency, which holds that fundamental analysis is ineffective, and strong efficiency, which states that even insider information is immediately reflected in the security prices. Investors and academics disagree on how well the model works.

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Efficient Market Hypothesis (EMH)

What Does Efficient Market Hypothesis (EMH) Mean?

An investment theory that postulates that it is impossible to “beat the market” because stock market efficiency causes stock prices to incorporate and reflect all relevant information in all cases. According to the EMH, stocks always trade at their fair market value on stock exchanges, making it impossible for investors to purchase undervalued stocks or sell stocks for inflated prices. Consequently, it should be impossible to outperform the overall market through market timing, and the only way investors can obtain higher returns is by purchasing riskier investments.

Investopedia explains Efficient Market Hypothesis (EMH)

Although considered the cornerstone of modern financial theory, the EMH is highly controversial and often is disputed. Supporters argue that it is pointless to search for undervalued stocks or try to predict trends in the market through either fundamental or technical analysis. Detractors such as Warren Buffett consistently have beaten the market over long periods, which according to EMH is virtually impossible. EMH detractors point to major events, such as the 1987 stock market crash when the Dow Jones Industrial Average (DJIA) fell by over 20% in a single day, and the wild market swings of late 2008 as evidence that stock prices can deviate seriously from their fair values.

Related Terms:
• Arbitrage
• Behavioral Finance
• Fundamental Analysis
• Systematic Risk
• Technical Analysis