07) Financial Concepts: Efficient Market Hypothesis

by · October 6, 2010

Eugene Fama is best known for her role in the development of the Efficient Market Hypothesis (EMH) in the 1960s. This hypothesis states that because prices already incorporate and reflect all relevant data, it is impossible to beat the market. It makes this hypothesis highly controversial and widely disputed. Those who favor this theory believe that fundamental analysis or technical analysis will not help to find undervalued stocks or predict market trends.

This theory supports the notion that you engage in a game of chance, and not skill, each time you trade securities. Prices will always reflect all information if markets are efficient and current, so there’s no chance of you buying stock at bargain price.

Technical analysts have been the most adamantly opposed to this hypothesis, arguing that many investors base their expectations on previous policies, track records, past earnings, and other indicators. As stock prices are largely based on investor expectation, a lot of people believe that it’s only right to assume that previous prices have an influence on prices of stocks in the future.