The concept of Efficient Market Hypothesis (EMH) was developed by Eugene Fama. Market efficiency refers to a condition in which current prices have already reflected all the publicly available information about a company/stock. The basic idea underlying market efficiency is that competition will drive all information into the stock price quickly. Thus EMH states that it is impossible to ‘beat the market’ because stock market efficiency causes existing share prices to always incorporate and reflect all relevant information.
EMH points out that no stock trades too cheaply or too expensively. Hence, it would be useless to select which ones to buy or sell.
According to the Efficient Market Hypothesis, stocks always tend to trade at their fair value on stock exchanges, making it impossible for investors to either consistently purchase undervalued stocks or sell stocks at inflated prices. As such, it should be impossible to outperform the overall market through expert stock selection or market timing and that the only way an investor can possibly obtain higher returns is by purchasing riskier investments. In other words, the hypothesis points out that no stock trades too cheaply or too expensively. Hence, it would be useless to select which ones to buy or sell.
There are has three versions EMH, depending on the level of information available:
- Weak form EMH
- Semi-strong form EMH
- Strong form EMH
