{"id":46998,"date":"2021-08-21T08:30:00","date_gmt":"2021-08-21T12:30:00","guid":{"rendered":"https:\/\/www.shortform.com\/blog\/?p=46998"},"modified":"2021-09-02T19:31:11","modified_gmt":"2021-09-02T23:31:11","slug":"the-efficient-market-hypothesis","status":"publish","type":"post","link":"https:\/\/www.shortform.com\/blog\/the-efficient-market-hypothesis\/","title":{"rendered":"The Efficient Market Hypothesis: Beating the Market"},"content":{"rendered":"\n

What is the Efficient Market Hypothesis<\/a>? Is it possible to beat the market? What are the three forms of the Efficient Market Hypothesis?<\/p>\n\n\n\n

According to the Efficient Market Hypothesis, all share prices reflect all available information. As a result, it’s not possible for anyone (without inside information) to determine whether a stock is valued correctly. There are three forms of the Efficient Market Hypothesis, with each coming to a different conclusion about the efficiency of the market. <\/p>\n\n\n\n

Learn more about this hypothesis below.<\/p>\n\n\n\n\n\n\n\n

The Efficient Market Hypothesis: Are Markets Efficient? <\/h2>\n\n\n\n

One of the dominant theories of finance is that markets are \u201cefficient\u201d\u2014that is, asset prices always already reflect all available information about the assets. In effect, the efficient-markets theory means no investor can \u201cbeat\u201d the market<\/strong>, because no investor can gain an \u201cedge\u201d on any other.<\/p>\n\n\n\n

The Internet and housing bubbles would appear to refute the efficient-markets hypothesis\u2014because the stock and real-estate markets were absurdly overvalued during the booms, their prices clearly didn\u2019t <\/em>reflect all available information about their assets. 
But, in fact, it\u2019s the crashes <\/em>that prove markets are efficient<\/strong>. Prices eventually, albeit slowly, reflected the true value of the assets. The market corrected itself.<\/p>\n\n\n\n

Can You Beat the Market?<\/strong><\/h3>\n\n\n\n

At its most basic level, the Efficient Market Hypothesis, formulated in detail by Nobel Prize-winning economist Eugene Fama, theorizes that all stock prices already reflect all relevant information<\/em>\u2014that is, no analyst can determine whether a stock is under- or overvalued<\/strong>.<\/p>\n\n\n\n

(A common misconception about the Efficient Market Hypothesis is that it means that stock prices are always \u201ccorrect.\u201d Rather, the hypothesis simply means that stock prices always already reflect everything there is to know<\/strong> about a particular firm.)\u00a0<\/p>\n\n\n\n

In practical terms, what this means is that there\u2019s no way for an analyst to \u201cbeat the market,\u201d<\/strong> because any information an individual analyst might use to \u201cbuy low\u201d or \u201csell high\u201d is always already reflected in the current price. For example, a fundamental analyst looking at companies\u2019 balance sheets and management teams will never<\/em> find either an under- or overvalued stock\u2014the prices will always reflect the stocks\u2019 value as entailed by the available information about them<\/strong>.<\/p>\n\n\n\n

However, since the formulation of the theory, scholars have distinguished among three forms of the Efficient Market Hypothesis in order to better characterize analysts\u2019 performance. The forms are:<\/p>\n\n\n\n