Market Efficiency

Market efficiency

Market efficiency suggests that at any given time, prices fully reflect all available information on a particular stock and/or market. According to the Efficient Market Hypothesis (EMH), no investor has an advantage in predicting a return on a stock price because no one has access to information not already available to everyone else.

A market has to be large and liquid. Information has to be widely available in terms of accessibility and cost and released to investors at more or less the same time. Transaction costs have to be cheaper than the expected profits of an investment strategy. Investors must also have enough funds to take advantage of inefficiency until, according to the EMH, it disappears again. Most importantly, an investor has to believe that she or he can outperform the market.

Efficient Market Hypothesis (EMH) can be classified as:

Strong efficiency - share prices fully reflect not only published information but also all relevant information including data privately held. Even an insider would not be able to make abnormal profits from their position because the information is quickly assimilated by the market. Example: A company bought back shares of stock just before it announced that its earnings had risen. In this way, it can buy shares at low prices and sell them at high prices later on. Semi-strong efficiency - the market is efficient in the semi-strong sense if shares prices respond instantaneously and correctly to newly published information. The implication is that there is no advantage in analyzing publicly available information because as soon as information becomes public, it is immediately incorporated into prices. Example: Wall Street Journal argues that stocks are currently overvalued or share repurchasesWeak Efficiency - share prices fully reflect the information contained in past price movements. Price movements are totally independent of previous movements, so it is impossible to earn superior profits...