Definition: The Efficient Market Hypothesis (EMH) essentially says that all known information about investment securities, such as stocks, is already factored into the prices of those securities. Therefore no amount of analysis can give an investor an edge over other investors. EMH does not require that investors be rational; it says that individual investors will act randomly but, as a whole, the market is always "right." In simple terms, "efficient" implies "normal." For example, an unusual reaction to unusual information is normal.
Forms of EMH: There are three forms of EMH: Weak, Semi-strong and Strong.
- Weak Form EMH: Suggests that all past information is priced into securites. Fundamental analysis of securities can provide an investor with information to produce returns above market averages in the short term but there are no "patterns" that exist. Therefore fundamental analysis does not provide long-term advantage and technical analysis will not work.
- Semi-Strong Form EMH: Implies that neither fundamental analysis nor technical analysis can provide an advantage for an investor and that new information is instantly priced in to securities.
- Strong Form EMH: Says that all information, both public and private, is priced into stocks and that no investor can gain advantage over the market as a whole. Strong Form EMH does not say some investors or money managers are incapable of capturing abnormally high returns but that there are always outliers included in the averages.
Proponents of EMH often invest in index funds because they are passively managed (these funds simply attempt to match, not beat, overall market returns).
Disclaimer: The information on this site is provided for discussion purposes only, and should not be misconstrued as investment advice. Under no circumstances does this information represent a recommendation to buy or sell securities.
