Efficient Market Hypothesis

From Financial Literacy Wiki

Efficient Market Hypothesis (EMH) refers to the a hypothesis where the market is able to rapidly impound information that affect the price of stock into the stock price. In such an environment, the market price of the stock is an unbiased estimate of its fair price.

There are three forms of EMH and they are:

1. Weak
2. Semi-Strong
3. Strong

Weak Form

There are three levels of market efficiency depending on how we define the term "information". Under the weak form of efficiency, share prices reflect information contained in the past market data such as past stock prices or transaction volume. This implies that it is futile to predict the price of a stock based on price charts and technical indicators, eliminating the need for Technical Analysis.

Semi-Strong Form

In a market that is semi-strong, the current stock price already reflects all publicly available information. Such information includes not only past market data, but also all public information about the firm's fundamentals such as profits and loss statements, balance sheet, cashflow statement, as well as company research and earnings forecasts produced by stock brokerage. Semi-strong implies that it is unprofitable to buy and sell stocks based on information that is already publicly available, eliminating the need for Fundamental Analysis.

Strong Form

Under the strong form regardless of where the relevant information is private or public, all will be reflected in the stock price. Strong form implies that no investor, not even those trading on insider information, can consistently find undervalued stocks.