1. Financial Concepts: Introduction
  2. Financial Concepts: The Risk/Return Tradeoff
  3. Financial Concepts: Diversification
  4. Financial Concepts: Dollar Cost Averaging
  5. Financial Concepts: Asset Allocation
  6. Financial Concepts: Random Walk Theory
  7. Financial Concepts: Efficient Market Hypothesis
  8. Financial Concepts: The Optimal Portfolio
  9. Financial Concepts: Capital Asset Pricing Model (CAPM)
  10. Financial Concepts: Conclusion

The efficient market hypothesis (EMH) originated in the 1960s and thanks to the work of economist Eugene Fama. This hypothesis holds that it is impossible to beat the market, as prices in the market already incorporate and reflect all relevant information which may impact a stock. As you might imagine, this theory is highly controversial, and arguments about market efficiency still go on today. Those who believe in EMH hold that it’s essentially pointless to look for undervalued stocks to try to make predictions of market trends using tools like fundamental analysis or technical analysis.

Per this hypothesis, any time that an investor buys or sells a security, he or she is taking part in a game of chance, rather than one of skill. A market that is efficient and current will always reflect the most accurate price, so one can never purchase a stock at a bargain price.

Technical analysts largely dispute this theory. They argue that many investors base their expectations of stock performance on past prices, earnings, track records, and other backward-looking indicators. Stock prices are largely based on investor expectation, meaning that stock prices and activity in the past indirectly impact current and future prices as well. Technical analysts believe essentially the opposite of those subscribing to the EMH theory: that stocks are frequently misvalued in the market, and that sufficient research and wise decision-making can provide investors with an edge over competition.

 

 


Financial Concepts: The Optimal Portfolio
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