Question

What is the efficient market hypothesis?

Answer 1

The efficient market hypothesis theory is concerned with speed with which information effects the prices of securities. An efficient market is one in which there are a lot of profit hungry investors who are actually and independently carrying out stock research such that

• Current stock price reflects all available information.
• New information comes to the market on a random basis and affects the stock price instantly.
• Therefore in such a market, no one will be able to make supernormal profit.

FAMA advocated three levels of market efficiency

1. Weak Form - Where the current stock price reflects all stock market information i.e. price and volume data so technical analysis is useless.
2. Semi Strong Form - Current stock price reflects all publicly available information. Hence both fundamental and technical analysis is useless.
3. Strong Form - Current stock price reflects publicly available information as well as insider information. Hence even the insider trading is not possible.