EFFICIENT MARKET HYPOTHESIS (EMH)
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Theory that asset prices reflect available information, making consistent outperformance difficult.
Summary
The Efficient Market Hypothesis (EMH) is a cornerstone theory in finance stating that financial markets are 'informationally efficient,' meaning that asset prices always incorporate and reflect all available information. This theory suggests that it's nearly impossible to consistently 'beat the market' or achieve returns higher than average market returns on a risk-adjusted basis, because any new information that could affect a stock's value is immediately reflected in its price. EMH comes in three forms: weak (prices reflect past trading information), semi-strong (prices reflect all publicly available information), and strong (prices reflect all information, including insider information).
Usage Context
Understanding EMH is crucial when studying portfolio theory, investment strategies, market analysis, and debates between active and passive investing. It's fundamental to understanding why diversification matters and forms the theoretical basis for index fund investing.
Common Confusions
- Thinking EMH means stock prices never change or are always 'correct'
- Confusing market efficiency with market volatility
- Believing EMH proves that no one can ever beat the market
- Misunderstanding that EMH applies to risk-adjusted returns, not absolute returns
- Thinking efficient markets mean rational investor behavior at all times
