What is 'Strong Form Efficiency'?

Strong form efficiency is the strongest version of market efficiency and states that all information in a market, whether public or private, is accounted for in a stock's price. Practitioners of strong form efficiency believe that even insider information cannot give an investor an advantage. This degree of market efficiency implies that profits exceeding normal returns cannot be realized regardless of the amount of research or information investors can access.

BREAKING DOWN 'Strong Form Efficiency'

Strong form efficiency is a component of the efficient market hypothesis and is considered part of the random walk theory. Strong form efficiency states that securities prices and, therefore, the overall market are not random and are influenced by past events. This efficiency is the opposite of weak form efficiency, which states that past events have no effect on current securities prices and price movements.

Origins of the Strong Form Efficiency Concept

The concept of strong form efficiency was pioneered by Princeton economics professor Burton G. Malkiel in his book published in 1973 entitled "A Random Walk Down Wall Street." The book championed two forms of the random walk theory. The semi-strong form explains that public information will not help an investor to select undervalued securities because it is reflected in the current market prices. Therefore, it is impossible to earn long-term abnormal returns. The strong form states that no information, public or inside information, will benefit an investor because even inside information is reflected in the current stock price.

Example of Strong Form Efficiency

Most examples of strong form efficiency involve insider information. This is because strong form efficiency is the only part of the efficient market hypothesis that takes into account proprietary information. However, the efficiency theory states that contrary to popular belief, harboring inside information will not help an investor earn high returns in the market.

For example, a CTO of a public technology company believes that his company will begin to lose customers and revenues. After the internal rollout of a new product feature to beta testers, the CTO's fears are confirmed, and he knows that the official rollout will be a flop. This would be considered insider information.

The CTO decides to take up a short position on his own company, effectively betting against the stock price movement. If the stock price declines, the CTO will profit and, if the stock prices increases, he will lose money. However, when the product feature is released to the public, the stock price is unaffected and does not decline even though customers are disappointed with the product. This market is strong form efficient because even the insider information of the product flop was already priced into the stock. The CTO would lose money in this situation.

  1. Weak Form Efficiency

    Weak form efficiency is one of the degrees of efficient market ...
  2. Informationally Efficient Market

    The informationally efficient market theory moves beyond the ...
  3. Price Efficiency

    Price efficiency is the belief that asset prices reflect the ...
  4. Inefficient Market

    An inefficient market, according to efficient market theory, ...
  5. Allocational Efficiency

    Allocational efficiency is a characteristic of an efficient market ...
  6. Semi-Strong Form Efficiency

    Semi-strong form efficiency is a form of Efficient Market Hypothesis ...
Related Articles
  1. Investing

    Is Stock Picking a Myth?

    Can mutual fund managers successfully pick stocks, or are you better off with an index fund?
  2. Investing

    How to use insider and institutional ownership

    Learn why insider and institution stock ownership reveal much information about the stock. Understand what to consider when making well-informed investment decisions.
  3. Insights

    Why Insider Trading Is Bad for Financial Markets

    Insider trading can come in many forms — some of them even legal — with the benefits and costs often debated by practitioners and academics alike.
  4. Insights

    Explaining Minimum Efficient Scale

    Minimum efficient scale is the smallest amount of production a firm can achieve while still taking full advantage of economies of scale.
  5. Insights

    Should Insider Trading Be Legal?

    Insider trading has become a hot-button issue. Here are some of the pros and cons to making it legal.
  6. Trading

    Defining Illegal Insider Trading

    The better you understand why insider trading can be criminal, the better you'll understand how the market works.
  7. Investing

    When insiders buy, should investors join them?

    Insider trading activity can inform your investment strategy, but it requires research and a level head. Here's what to look for as insiders buy and sell.
  8. Investing

    SEC Filings: Forms You Need To Know

    The forms companies are required to file provide a clear view of their histories and progress.
  9. Investing

    What Makes Financial Markets Work?

    What makes financial markets efficient might not be what you think.
  1. What is the Efficient Market Hypothesis?

    Find out about the key assumptions behind the efficient market hypothesis (EMH), its implications for investing and whether ... Read Answer >>
  2. Has the Efficient Market Hypothesis been proven correct or incorrect?

    Explore the efficient market hypothesis and understand the extent to which this theory and its conclusions are correct or ... Read Answer >>
  3. What is the difference between efficiency ratios and profitability ratios?

    Learn about efficiency and profitability ratios, what these ratios measure and the main difference between efficiency and ... Read Answer >>
  4. Why are efficiency ratios important to investors?

    Learn about efficiency ratios, such as the asset turnover ratio, and why these metrics are important to investors when analyzing ... Read Answer >>
  5. What do efficiency ratios measure?

    Learn about efficiency ratios, what they measure, how to calculate commonly used efficiency ratios and how to interpret these ... Read Answer >>
Trading Center