EFFICIENT MARKET HYPOTHESIS

[Sarthak Goel]

What do you mean by the Efficient Market Hypothesis?

[Sarthak Goel]

EFFICIENT MARKET HYPOTHESIS (EMH)

EMH simply means that the asset prices in the security market reflect all the available information and the market in such cases is said to be efficient.

This means that stocks trade at their fair market value and it is just impossible to “Beat the Market”. There are no undervalued or overvalued stocks, trading in which could have generated profits for the investors.

According to EMH, volatile movements occur only due to some unexpected news, otherwise the stocks move in a very closed defined range.

Though it is said that the markets are efficient, but still it has some variations in efficiency:

(I would try to explain this in a very simple manner, hope you like it.)

These are the 3 forms of market efficiency:

1. Weak Form EMH:

 The current market price of the stock or asset incorporates all the information about the historic prices of the asset in consideration. That means, the price of the stock today has been valued after taking into consideration all the past price movements and any further movement that might arise would not be dependent on historical data. According to this form, technical analysis or say reading and analyzing charts of historical data wouldn’t help in generating excess performance.

 

2. Semi-Strong Form EMH

This states that the market prices already incorporate all the publicly available information. According to this, nor the technical analysis, neither the practice of analyzing financial statements (fundamental analysis) would produce excess performance. The effect of information relating to profits and/ or any other activity would automatically be reflected in the share price once it is publicly available, therefore any sort of financial information relating to the stock wouldn’t give many benefits.

This form has led to a long list of questions in people’s minds which are still unanswered as everyone can’t understand the correct meaning of the publicly available information due to which variations occur.

 

3. Strong Form EMH

It states that the market price of an investment incorporates all the information publicly available as well as the information only available to insiders. So, any person having access to insider information also wouldn’t be able to generate excess revenue as such information has been already reflected in market price.

 

Here Weak Form EMH is a Subset of Semi Strong Form EMH which is further a subset of Strong Form EMH.

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