Question

How do you understand efficient market hypothesis(EMH), and why does it important?

Answer 1

Efficient Market Hypothesis assumes that the current price of security factors in all the information available and creating arbitrage opportunity is impossible and one cannot beat market returns.
There are 3 types of efficiency:

In case of strong form efficient the market already reflects all the information available in public domain. This won't give any opportunity to mutual funds to perform better than the market.

Weak form efficiency believe that past or historical performance does not affect current prices. Hence fundamental analysis of company can help mutual fund to identify undervalued and overvalued stocks. ability to pick undervalued stock mutual funds can perform better than market.

Semi Strong Efficient market gives an opportunity to profit from new information as the market will reflect the changes due to new information. Hence mutual funds can perform better than the market.

The importance of this theory is that if one invests in market or index portfolio one can be better than other investors who speculate. Historically market or index funds have provided stable and higher returns.