Efficient Market Hypothesis - EMH

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DEFINITION of 'Efficient Market Hypothesis - EMH'

An investment theory that states it is impossible to "beat the market" because stock market efficiency causes existing share prices to always incorporate and reflect all relevant information. According to the EMH, stocks always trade at their fair value on stock exchanges, making it impossible for investors to either purchase undervalued stocks or sell stocks for 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.

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BREAKING DOWN 'Efficient Market Hypothesis - EMH'

Although it is a cornerstone of modern financial theory, the EMH is highly controversial and often disputed. Believers argue it is pointless to search for undervalued stocks or to try to predict trends in the market through either fundamental or technical analysis.

Meanwhile, while academics point to a large body of evidence in support of EMH, an equal amount of dissension also exists. For example, investors, such as Warren Buffett have consistently beaten the market over long periods of time, which by definition is impossible according to the EMH. Detractors of the EMH also point to events, such as the 1987 stock market crash when the Dow Jones Industrial Average (DJIA) fell by over 20% in a single day, as evidence that stock prices can seriously deviate from their fair values.

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RELATED FAQS
  1. Why are financial markets considered to be transparent?

    Financial markets are considered transparent due to the fact it is believed all relevant information is freely available ... Read Full Answer >>
  2. Why does the efficient market hypothesis state that technical analysis is bunk?

    The efficient market hypothesis (EMH) suggests that markets are informationally efficient. This means that historical prices ... Read Full Answer >>
  3. Can the Efficient Market Hypothesis explain economic bubbles?

    The efficient market hypothesis (EMH) cannot explain economic bubbles because, strictly speaking, the EMH would argue that ... Read Full Answer >>
  4. What does the Efficient Market Hypothesis have to say about fundamental analysis?

    The efficient market hypothesis (EMH) is at odds with fundamental analysis because of its assumptions about the availability ... Read Full Answer >>
  5. What are the primary assumptions of Efficient Market Hypothesis?

    The primary assumptions of the efficient market hypothesis (EMH) are that information is universally shared and that stock ... Read Full Answer >>
  6. What can cause an asset to trade above its market value?

    High demand and inaccurate valuation are the two most common factors that may lead to a situation where assets trade above ... Read Full Answer >>
  7. What are the differences between weak, strong and semi-strong versions of the Efficient ...

    Though the efficient market hypothesis as a whole theorizes that the market is generally efficient, the theory is offered ... Read Full Answer >>
  8. Has the Efficient Market Hypothesis been proven correct or incorrect?

    There is evidence to support the reasoning behind the efficient market hypothesis, but the basic conclusion drawn from the ... Read Full Answer >>
  9. What is the "random walk theory" and what does it mean for investors?

    The random walk theory is the occurrence of an event determined by a series of random movements - in other words, events ... Read Full Answer >>
  10. Do noise traders have any long-term effect on stock prices?

    There are two theories that are used to describe how securities are priced in the stock market: the efficient market hypothesis ... Read Full Answer >>

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