The Efficient Market Hypothesis (EMH) states that current stock prices fully reflect all available public information such that it is impossible to consistently outperform the market through analysis of historical prices or public information alone. There are three forms of the EMH: weak, semi-strong, and strong. The weak form suggests past prices cannot predict future performance, while the semi-strong form incorporates all public information like earnings reports. The strong form suggests even private information cannot be used to outperform, though some studies contradict this. Overall, the EMH implies that markets are rational and prices adjust quickly to new information, making consistent outperformance difficult without private information.

1. The Efficient Market Hypothesis

2. Meaning In an efficient market all the known informationis immediately discounted by all the investors and reflected in the security prices in the market. According to James Loire:“Efficiency means the ability of the capital market to function, so that prices of securities react rapidly to new information. Such efficiency will produce prices that are appropriate in terms of current knowledge and investors will less likely to make unwise investments.”

3. Information must be free and quick to flow.Bottlenecks and cost are not there.Taxes have no noticeable impact.Every investors can borrow on lend at same rate.Investors are rational.Market prices are efficient and not sticky.Assumptions

4. The Random Walk Hypothesis is a financialtheory stating that stock market prices evolve according to a random walk and thus the prices of the stock market cannot be predicted.Random walk theory

5. Perfectly competitive market.No individual investor or group can influence it.All investors have same knowledge.Stock market discount all the information quickly.Institutional investors or major fund managers have to follow the market.The price moves in an independent fashion without undue presence.Future changes in price will only be as a result of some other new piece of information. Assumptions

6. The Efficient Markets Hypothesis (EMH) is made up of three forms:Weak FormSemi-strong FormStrong Form

7. The EMH GraphicallyIn this diagram, the circles represent the amount of information that each form of the EMH includes.Note that the weak form covers the least amount of information, and the strong form covers all information.Also note that each successive form includes the previous ones.All historical prices and returnsAll information, public and privateAll public information

8. The Weak FormThis form of market holds that current prices of stocksfully reflect all historical information, thus past datacannot be used to predict future prices.Tests of the Weak FormSerial correlationsRuns testsFilter rules

9. The semi strong form states that current prices instantaneously reflect all publicly available information such as quarterly reports, changes in accounting information, dividends, splits etc. Test of Semi Strong FormMarket Reaction TestEarning Impact Secondary Offering Impact Block Trade Impact Bonus ImpactThe Semi-strong Form

10. The strong form says that prices fully reflect all information, whether publicly available or not.Even the knowledge of material, non-public information cannot be used to earn superior results.Most studies have found that the markets are not efficient in this sense.Test Of Strong FormTrading By Stock Exchange Officials.Trading By Mutual Fund Managers.The Strong Form

11. Markets Have No Memory Trust Market Prices Read The Entrails There Are No Financial IllusionsDo It Yourself Alternative Seen One Stock, Seen Them AllSix Lessons For Market Efficiency