Efficient Market Hypothesis

Efficient Market Hypothesis states that security prices fully reflect all publicly available information hence it’s very difficult to generate long run returns in excess of market.

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The 3 forms of efficient market hypothesis are:

  • Weak Form Efficient Market Hypothesis: Current security prices fully reflect all past price and volume data hence there is no predictive power about the future direction of securities. The Weak form implies that trading tools like technical analysis are useless in investment but fundamental analysis and insider information are able to generate long-run returns
  • Semi Strong Market Efficiency: Current Security prices fully reflect all publicly available information (public information: financial statements, company press releases, past prices, trading volume). The semi strong efficient market hypothesis implies that technical analysis & fundamental analysis are both unable to generate long-run returns.
  • Strong Form Market Efficiency: Current Security prices fully reflect all information both public and private. The strong form implies that technical analysis, fundamental analysis and insider information are unable to generate long-run returns.

Efficient Market Hypothesis is based on Louis Bachelier research where in 1900 he compared the behavior of stock market buyers and sellers to the random movement of particles suspended in fluid. Bachelier concluded that stock price movements follow a random walk and hence their movements are random and it is impossible to make predictions about them.

Efficient Capital Market states that current prices of a securities fully reflect all the information currently available about securities, including risk and security prices adjust quickly and completely to new information.