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Efficient Market Hypothesis, EMH

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What is the Market Efficiency Hypothesis (EMH)

The Market Efficiency Hypothesis (EMH) is an investment theory according to which stock prices reflect all information and consistent alpha returns are not possible.

Theoretically, neither technical nor fundamental analysis can consistently lead to excess risk-adjusted returns ( alpha returns ) using only insider information.

According to the EMH theory, stocks on stock exchanges always trade at fair value, which makes it impossible to either buy undervalued stocks or sell them at inflated prices.

Thus, no one can outperform the overall performance of the market through expert stock selection or trade timing, and the only way an investor can earn higher returns is by acquiring riskier investments.

Analysis of the Market Efficiency Hypothesis (EMH)

Although the market efficiency hypothesis is the cornerstone of modern financial theory, it is highly controversial and often questioned.

Its proponents argue that it is pointless to look for undervalued stocks or try to predict trends using  fundamental  or  technical analysis .

Although scientists point to a large amount of evidence in support of this theory, rebuttals can be found no less.

For example, investors such as Warren Buffett have consistently earned above market average returns over long periods of time, which by definition is impossible according to EMH.

Critics of the Efficient Market Hypothesis (EMH) also recall events such as the stock market crash of 1987, when the Dow Jones Industrial Average (DJIA) fell more than 20% in one day, suggesting that stock prices could deviate dramatically from their own. fair value.

What does EMH mean for investors

EMH proponents believe that due to the chaotic nature of market movements, investors could do better by investing in an inexpensive, passively managed portfolio.

Data collected by Morningstar Inc. research for the Active/Passive Barometer Bulletin in June 2015 confirm this conclusion.

Morningstar compared the performance of active managers across all categories with the combined returns of interlinked index and exchange-traded funds (ETFs).

The study found that over the years, only two groups of active managers have successfully outperformed passive funds more than 50% of the time.

These were small US growth funds (investment funds that reinvest a large share of profits) and diversified emerging market funds.

In all other categories, including US Large Blend, US Large Value, and US Large Growth, investors would do better by investing in low-cost index funds or ETFs.

Although a small percentage of active managers manage to outperform passively managed funds, it is quite difficult for an investor to determine which manager will be able to do this this time.

Fewer than 25% of the top-performing active managers can consistently outperform their passive fund counterparts.

Related terms

Informationally Efficient Market

The information efficient market theory extends the definition of the standard efficient market hypothesis.

Weak Form Efficiency

Weak form efficiency is one of the degrees of the market efficiency hypothesis, which states that all past stock prices are reflected in their current price.

Semi-Strong Form Efficiency

Semi-strong form efficiency is a form of the Market Efficiency Hypothesis (EMH), which assumes that stock prices take into account all publicly available information.

Chasing the Market

The pursuit of the market is the entry into or exit from an investment instrument in order to profit from an ongoing movement or trend.

Trading strategy

A trading strategy is a method of buying and selling assets in the markets based on predefined rules used to make trading decisions.

Order ” At The Market

An At The Market order allows you to buy or sell stocks or futures contracts at the prevailing bid or ask price at the time it is processed.

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