The Efficient Market Hypothesis
The term Efficient Market Hypothesis implies that that current stock prices fully reflect all available information about a firm, that any new information revealed about a firm will be incorporated into its share price rapidly and that the subsequent rise or fall in share price will be to the correct amount in relation to the new information that has come to light. It was Eugene Fama who first used the term EMH in the 1960's and the subject has been the centre of many disagreements between those who support the theory and those oppose it ever since.
The Efficient Market Hypothesis states that any return on a share that is greater than the fair return for the riskiness associated with that share occurs only by chance. EMH does not imply that higher than average returns cannot be made on shares, on the contrary, it suggests that around 50% of shares or securities will produce higher than average returns while around 50% will produce lower than average returns. What EMH does imply is that profiting from predicting price movements is a very difficult and unlikely task, in an efficient market no trader should be able to make greater than average returns on shares through any means other than pure luck. EMH recognises the fact that at any point in time there will be shares or securities that have been incorrectly priced, but such errors in pricing are completely unbiased and random, and there is no means of analysing data to correctly highlight such under or over pricing.
The Efficient Market Hypothesis closely ties in with the Random Walk Theory which claims stocks take a random and unpredictable path much like that of a drunken man left to walk around aimlessly in the middle of a field. The R ...