SUMMARY
The Efficient Market Hypothesis (EMH) is the theory that you can’t consistently beat the market because all available information is already built into a stock’s current price. Essentially, it says there are no “undervalued” or “overvalued” stocks to be found, and prices only move in response to new, unpredictable news.
There are three main versions:
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Weak Form: Past prices can’t predict future prices (technical analysis is useless).
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Semi-Strong Form: All public information (news, earnings reports) is already priced in (fundamental analysis is also useless). This is the most common version.
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Strong Form: Even private, insider information is already priced in.
The Debate:
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Supporters say: It’s true because most professional fund managers fail to beat simple market index funds over time.
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Critics say: It can’t be true because market bubbles and crashes (driven by emotion) happen, and legendary investors like Warren Buffett have consistently beaten the market for decades.
The Efficient Market Hypothesis (EMH) is a theory that states that all known information is already fully reflected in the prices of assets like stocks.1
In simple terms, it suggests that you can’t consistently “beat the market” because everything you know (or could possibly find out) is already priced in.2 According to this theory, stock prices are always “correct” and move randomly as new, unpredictable information becomes available.3
There are three forms of this hypothesis.4
1. Weak Form Efficiency
This is the most basic level.5 It states that all past price and volume data is already reflected in the current stock price.
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What it means: You can’t profit by using technical analysis. Looking at past chart patterns or historical price movements won’t give you an edge because that information is already baked into the price.6
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Belief: The only way to get an edge is through fundamental analysis (analyzing a company’s financials, management, etc.).7
2. Semi-Strong Form Efficiency
This is the most widely accepted version. It claims that all publicly available information is already reflected in the stock price.8
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What it means: Not only is past price data useless, but so is any public information. This includes company earnings reports, news announcements, analyst ratings, and economic data. The moment this information becomes public, the market instantly adjusts the price to reflect it.
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Belief: You can’t beat the market using either technical or fundamental analysis. The only way to get an edge is by having insider information (which is illegal to trade on).
3. Strong Form Efficiency
This is the most extreme version. It asserts that all information—public and private (insider)— is fully reflected in the stock price.9
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What it means: No one can consistently earn excess returns, not even corporate insiders.10 It suggests that even with secret knowledge, the market is so efficient that the price already reflects that information.11
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Belief: This form is generally considered to be untrue, as there is clear evidence that insiders can and do profit from their private knowledge (which is why insider trading laws exist).
The Big Debate: Is the Market Truly Efficient?
The EMH is a cornerstone of modern finance, but it’s heavily debated.12
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Arguments for EMH: Proponents point to the fact that very few active fund managers consistently beat simple index funds over the long run.13 If professionals can’t do it, they argue, it’s because the market is too efficient.
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Arguments against EMH: Critics point to market bubbles (like the dot-com bubble) and crashes as proof that prices can be driven by irrational emotion rather than rational information.14 They also cite the existence of legendary investors like Warren Buffett, who have beaten the market for decades, as evidence that it is possible to find undervalued stocks through skill and analysis. The field of behavioral economics also shows that investors are not always rational, which contradicts the theory’s assumptions.15