Efficient Market Hypothesis (EMH)
The efficient market hypothesis (EMH) is an economic theory stipulating that the financial markets reflect all available information on the price of assets at any given time. Initially developed by economist Eugene Fama in the ‘60s, the theory states that it is nearly impossible for investors to gain an edge over the market in the long run. Assets will be valued at their fair price, as all known information will be traded on until it ceases to be useful.
When speaking of efficient markets, theorists distinguish between three levels of available information: weak, semi-strong and strong.
Weak implies that current prices take into account all historical data, and, consequently, that
technical analysis is irrelevant. However, it omits other kinds of information, and does not reject the notion that methods like
fundamental analysis or extensive research can be used to gain an edge.
The semi-strong form dictates that all public information has already been factored into the price (news, statements by companies, etc.). As such, proponents of this branch believe that even fundamental analysis cannot yield any advantage. The only way to gain an advantage over the market is to exploit private information, which is not yet known to the public.
Lastly, the strong form holds that all public and private information is reflected in an asset’s price – on top of historical performance and public information, any data available to insiders, too, will be taken advantage of. This form holds that there is no conceivable way for any market participant to gain an edge with any type of information, as the market will already have taken it into account.
EMH is a long-established theory, but it isn’t without its critics. Empirical data has not properly proven or disproven the validity of the hypothesis, but many opponents believe there to be a plethora of emotional factors at play that cause the undervaluation or overvaluation of stocks.