Three forms of Efficient Market Hypothesis


EMH (Efficient Market Hypothesis) argues that no stock trades too cheaply or too expensively. Hence, it would be useless to select which ones to buy or sell. The following the three variants of EMH.

Weak form EMH

The weak form EMH indicate that current asset prices reflect past price and volume information. The information contained in the past sequence of prices of a security is fully reflected in the current market price of that security. The weak form of the EMH also implies that investors should not be able to outperform the market using something that “everybody else knows”. Yet, many financial researchers study past stock price series and trading volume which is known as technical analysis. The result of this is used to make profits.

Semi-strong form EMH

The semi-strong form of the EMH states that all publicly available information is similarly already incorporated into asset prices. In other words, all publicly available information is fully reflected in a security’s current market price. Public information here includes not only past prices but also data reported in a company’s financial statements, its announcements, economic factors and others. It also implies that no one should be able to outperform the market using something that “everybody else knows”.

The semi-strong form of the EMH thus indicates that a company’s financial statements are of no help in forecasting future price movements and securing high investment returns in the long-term.

Strong form EMH

The strong form of the EMH stipulates that private information or insider information too is quickly incorporated in market prices and therefore cannot be used to reap abnormal trading profits. Thus, all information, whether public or private, is fully reflected in a security’s current market price. This means no long-term gains are possible, even for the management of a company, with access to insider information. They are not able to take the advantage to profit
from information such as a takeover decision which may have been made a few minutes ago. The rationale to support this is that the market anticipates in an unbiased manner, future developments and therefore information has been incorporated and evaluated into the market price in a much more objective and informative way than company insiders can take advantage of.

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Author and Assistant Professor in Finance, Ardent fan of Arsenal FC. Always believe "The only good is knowledge and the only evil is ignorance - Socrates"
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