2. Efficient Market Theory
• Stock Prices are determined by number of factors
• 1. fundamental Analysis
• 2. Technical Analysis
• 3. Psychological factors
Market is sum total of all the emotions and greed in the market
Hence we see lot of irrational behaviour of traders, investors
3. Efficient Market Theory
• Fundamental analysis would include
• 1. Economic Analysis
• 2. Industry Analysis
• 3.Company analysis
• Technical Analysis would include studying historical price and volume
data.
4. Efficient Market Theory
• Technical Analysis is based on the basic assumption that prices move
in orderly pattern
• It can be predicted based on past historical performance of stock
price
• Hence historical chart patters play a vital role in analysing the future
price movement.
5. Random Walk Theory
• Random walk theory argues that the basic assumption of technical
analysis is not correct
• This theory says that prices move in random way
• Prices try to catch the information which is immediately available in
the market and based on that the prices move up or down.
• Price do not follow any orderly pattern as they are affected by
information access, greed and emotions of the traders and investors
6. Random walk Theory
• Random walk theory basically assumes that stocks markets are so
efficient and competitive that there is immediate price adjustment.
• The price will immediately adjust to news whether good or bad
• This means that Random walk theory believes that stock market are
efficient as they adjust to the news which comes to the market.
• Finally this Random walk theory came to be known as the efficient
market hypothesis
7. Efficient Market Hypothesis
• Efficient market hypothesis take the view that stock markets are
highly efficient and that prices reflect all the information fully.
• This is true to some extent as many times we see that when results
came and if result is good the prices goes up immediately
• For instance when satyam scam came to light the price of the satyam
stock went down from Rs. 400 to Rs. 6 in 4 days as the prices was
reflecting bad news which was discounted by the market.
8. Efficient Market Theory
• Forms of Efficient Market Theory
• Weak form:- it says that current prices of stocks already reflect all the
information that is contained in historical sequence of prices. The new
price movement is completely random. It says that technical analysis
cannot get extra return as new price movement is totally random.
• Semi Strong form:- it says that the prices have all the publicly available
information with them. Hence fundamental analysis which takes time gap
since fundamental factors take time to get adjusted into the price. Semi
strong form thus says that fundamental cannot be used to get extra return.
9. Efficient Market Theory
• Strong form of Efficient market theory:- This says that all the
information whether public or private is reflected in the prices and
hence no one can use the information to their benefit for getting
superior returns.
10. Real Life situation
• Efficient market theory is right in sense that prices do reflect the
market sentiment
• Prices reflect immediately all information and that superior return
cannot be earned by any means is debatable
• In real life information access is not same to all investors and traders
• Institutions usually have access to many times private and
confidential information which may be used for their advantage.
11. Real life examples
• When the results of a company are going to be announced then many
times several traders and HNI buy the stock some days before the
result
• When the result actually comes and the price rises, they sell and
make huge profit
• The normal investor or trader keeps guessing what is happening in
the market while the smart investor makes money first.
