Question

security markets have been described as random walks and efficient markets. What does each of these terms mean and how to the relate to the stock market? What make a market efficient and what are the consequences of efficiency for fundamental and technical analysis?

Answer 1

Efficient markets are markets where the stock prices reflect all the publicly available information. Hence, due to which stock prices do not follow a pattern, infact stock prices follow a random walk. Any past prices and future prices are unrelated to each other. So, the traders cannot generate an alpha in these efficient markets.

The reflecting of all the publicly available information on the stock prices is called market efficiency. In an efficient markets, the stock traders cannot earn any extra/ abnormal profits .

Any amount of fundamental nor technical analysis cannot be used to generate profits in an efficient market. It is impossible to beat the markets.

As stock prices follow a random pattern, there is no relation between the past and current prices so technical analysis is useless as it uses the past pattern of stock prices to predict the future prices.

Due to the assumptions of the EMH , that the investors are rational and all publicly available information is completely reflected in stock prices and that all investors are rational. These assumptions makes the efficient market hypothesis at odds with the fundamental analysis.

So, the consequences of efficiency for fundamental and technical analysis is that it renders both of these useless in predicting and beating the market.