Friday, December 19, 2008

The Efficient Market Theory

So what is this complicated theory about the efficient market theory? What on earth is this theory about EMH that we so often hear or read about?

Basically, it is the way (or lingo) that academics/professors are trying to debunk technical analysis and fundamental analysis.

In the weak form, the theory is that you can't use past information about the stock to achieve better than average returns. In this form, the history of stock price movements provides no useful information that will enable any investor to out perform a buy-and-hold strategy. It basically means that technical analysis is useless.

In the semi-strong form, the hypotheses goes that no public information will help the analyst select undervalued securities or stocks. What this means is basically that no one will be able to make above average returns from using public information available in annual reports, balance sheets, income statements, dividends, etc.

In the strong form, what it says is that nothing that is known or even knowable (non-public information yet to be released or discovered) about a company will benefit fundamental analysis. This basically means that insiders information cannot even help investors.

So what does the EMH teach us? It tells us that the academia do not really trust in the ability of TA or FA to produce above average returns in the long term.

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