Efficient Market Theory (AND WHAT ARE THE 3 DIFFERENT FORMS?) - YouTube

What is the Efficient Market Hypothesis?

Efficient Market Hypothesis is a theory that states that all known information about investment

securities, like stocks, is already included into those securities’ prices.

Therefore, in an efficient market, stock prices always perfectly capture how much the stock

is really worth.

This means that no matter how much analyzing you do, you would still not be able to get

an edge over the market because stocks are never overvalued or undervalued.

When new information comes into the market, it is immediately reflected into stock prices,

making it unbeatable.

Efficient market also states that the market is never biased, and that the stock’s price

is always at its fair value.

Therefore, the only way to actually profit from the market is through riskier investments.

There are three forms of the efficient market hypothesis: the Weak form, Semi-Strong form,

and Strong form.

Weak Efficient Market Hypothesis

The weak form of EMH states that the current stock prices reflect all the data of historical

prices.

It also suggests that no form of technical analysis can be effectively used to help investors

make better trading decisions.

However, weak form believers think that if fundamental analysis is used, they can determine

undervalued and overvalued stocks.

So basically, investors can look at a company's financial statements to increase their profits.

Fundamental and Technical Analysis

So, hold on.

What exactly is fundamental and technical analysis?

Fundamental analysis or FA, is a method of measuring a security’s true value by looking

at related economic and financial factors.

They can use this true value to compare with a security’s current price in order to see

if a security is undervalued or overvalued.

A technical analysis is the process of investigating investments and identifying trading opportunities

in price trends and patterns seen on charts.

Using past trading patterns and price changes of a security, investors can determine the

future price of a stock.

Semi-Strong Form

Now, back onto the forms of the efficient market.

The semi-strong form believes that the stock’s current stock price reflects all available

public information.

Therefore, investors cannot use fundamental or technical analysis to get profit.

The followers of the semi strong form believe that only information that is not available

to the public can help investors boost their returns.

Strong Form

The strong form believes that the current stock price reflects all information.

This means public information and private information.

Private information, for example, can be inside information that only certain people in a

company knows.

Public information is information everyone knows.

This means that no matter what information an investor may have, they can not have an

advantage in the market.

Anomalies of the Efficient Market Theory

Still, there are many anomalies that do not support the Efficient market Theory.

One thing the theory can not explain is the Value Effect.

In this anomaly, firms trading at lower P/E ratios, or otherwise known as value stocks,

can often generate higher returns.

Another anomaly is the January effects, where stocks experience an increase in prices in

the month of January.

Another example is the Small-Firm effect, where smaller companies tend to outperform

larger companies.

Overall, the Efficient Market Theory remains highly controversial.

EMH and Investing Strategies

All the believers of the EMH often invest in index funds or ETFs.

This is because those funds are passively managed and match market returns.

Instead of trying to beat the market, they would buy an index fund, such as the S&P 500.

Key Takeaways

Efficient market theory states that the market simply can not be beat.

The prices of a stock always reflect all important information which means that stocks are always

at fair value.

This means that the only way to earn higher returns is to invest in riskier stocks.

There are three different forms of efficient market theory.

The weak form, semi-strong form, and strong form.

The weak form states that prices always reflect all past, or historical information.

The semi-strong form states that prices always reflect past and public information.

The strong form states that prices always reflect past, public, and insider information.

(So basically all information).

There are many anomalies that contradict and disapprove of the theory.

This theory still remains very controversial.

Thank you for watching animated finance.

Comment below on which form of the efficient market hypothesis you believe in, or do you

even believe in it?

Let us know!