The Efficient Market Hypothesis is the idea that prices in highly competitive markets such as a major stock market perfectly reflect publicly available information in their prices. The implication of the theory is that it is impossible to "beat" the market with investment skill. The Efficient Market Hypothesis is supported by studies that suggest it is rare for active management of investment to beat a comparable index. Although some investors do outperform the market for years or decades, these are considered mere statistical outliers by proponents of the theory. Variations in investment results can also be explained by risk levels. Investors who take on more risk might expect periods of higher returns followed by periods of greater losses when market forces turn against them. Over the long term, risk-adjusted returns tend to regress toward the mean.Despite a fair amount of evidence supporting the Efficient Market Hypothesis it is commonly criticized in several ways:
Market Bubbles History is full of market bubbles that are characterized by investors paying extremely high premiums for popular companies. Such manias are easy to spot by the extreme level of optimism surrounding them. Critics of the Efficient Market Hypothesis point out that such bubbles are an obvious example of irrational pricing.
Cognitive BiasesMarkets are widely believed to be influenced by cognitive biases such as herd behavior.
Self Refuting Idea The Efficient Market Hypothesis suggests that all investors should buy index funds because it is impossible to outperform the market. If all investors actually did this, prices would become irrational as stock prices would no longer move according to news but would only be driven by their inclusion in an index.
Prices in highly competitive markets perfectly reflect publicly available information in their prices.
It is impossible to outperform the market on a risk-adjusted basis.
Whether the Efficient Market Hypothesis is completely true or not, it is widely accepted that it is incredibly difficult to beat the market on a risk-adjusted basis.
Also Known As
Efficient Market Theory
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