Is the Market Efficient?

Market Efficiency

Efficient markets are markets in which the prices and values of investing options are relatively the same, in other words, investors have access to reliable information regarding the prices and values of trading options. In an efficient market, investors use the information available regarding the past performance of a specific trading security and use that information to predict what will happen to the price of the security in the future. The Efficient Markets Hypothesis (EMH) is a theory stating that stocks are always in an equilibrium (prices and values are the same), and that it is highly unlikely that an investor will be able to get a rate of return higher than the investments’ risk. There are three forms of the EMH: Weak Form Efficiency, Semi-strong Form Efficiency, and Strong Form Efficiency.

Firstly, the Weak Form Efficiency of EMH states that past performance and prices is fully reflected in current market prices. Those who believe in this form of efficiency believe that recent trends in stock are useless in projecting the performance of stocks since it is based on past performances. For example, if stocks 5 years ago fell for three consecutive days and then on the fourth day the price rose 15%, they will believe that the same thing will happen for future stocks that fall for three consecutive days.

Secondly, the Semi-strong Form Efficiency of EMH states that any information that is publically available is reflected in current market prices. Believers of this form of efficiency would no longer need to refer to financial statements of companies to form an opinion about what will happen to stock prices in the future since the current market price would have already reflected this information. In this form of EMH, it would not be likely that investors would earn any more or less than what has been predicted by the security market line since all publically held information has been reflected in the line and returns on investments would...