Efficient market hypothesis: A unique market perspective

You must have heard stock market pundits often emphasizing on the importance of research and finding the value in a stock. There will be people out there vouching for their expertise with fundamental or technical analysis. However, there is a 0theory in the market that rubbishes all these claims. It’s called the efficient market hypothesis (EMH).

EMH as the name suggests is a hypothetical theory. It essentially says that all known information is already factored into the stock price. Hence, no amount of analysis can give one investor an edge over the other.

As per the EMH theory, stocks always trade at their fair value on exchanges. Hence, it is impossible for investors to purchase undervalued stocks. Or, sell stocks for inflated prices.

It raises a few direct questions on popular analysis techniques. It asserts that with all new information priced in, neither technical nor fundamental analysis can generate excess returns. Therefore, it should be impossible to outperform the overall market. And, the only way an investor can generate higher returns is by purchasing riskier investments.

Forms of EMH:

There are three forms of EMH: weak, semi-strong, and strong. Here’s what each says about the market.

Weak Form EMH:

This form suggests that today’s stock prices reflect all the data of past prices. And technical analysis can not effectively help investors in making trading decisions.

It further believes that fundamental analysis can help investors to generate above-average returns in the short term. But, there are no fixed patterns that exist. Thus, the fundamental analysis does not provide any long-term advantage.

Semi-strong form:

This efficiency theory suggests that since all the available information is factored in the current market price, no technical or fundamental analysis helps to generate higher returns in the market.

However, this form believes that there is some information that is not publicly available. Such information can help investors to generate above-average returns.

Strong Form EMH:

This version of the theory says that all information, both public and private, is priced into stocks. And no investor can gain an advantage over the market as a whole.

It says that investors can’t generate returns higher than the normal market returns. No matter what information they have or research they conducted. More about strong from EMH