EMH is defined by investopedia as the following:
An investment theory that states it is impossible to "beat the market" because stock market efficiency causes existing share prices to always incorporate and reflect all relevant information.
If this is the case how come the likes of investors such as Warren Buffett make millions if not billions by beating the market every day?
Three forms of efficiency were identified by Fama (1970). The first was weak which basically asserts that all past and current market prices are fully reflected in the share price. This means that the use of technical analysis by investors would be of no use. The second form of efficiency is semi-strong and is described as being where all public information available is reflected in the share price. Therefore fundamental analysis would be of no use. Lastly there is the strong form of efficiency where all information is reflected in the share price.
Weak form of EMH is the closest to being true of the real world stock market. EMH is seen as nonsensical by most. Information cannot be known by everyone at the same time. People in the business generally know the sales and profit figures before investors. This is when insider trading can occur which is illegal but still goes on. Recently in the news seven people were charged with insider trading to do with the computer company Dell. There was also a bit of suspicion when Bob Robbins, chief operating officer Tesco sold part of his shares in the company a week prior to a profit warning.
If cases such as those mentioned occur then clearly EMH is a nonsensical theory which is not practical in reality. Even if information was available to everyone at the same time people are not homogenous. People behave differently on the information they receive some investors may be looking long term others short term. EMH is a theory which sounds good but in reality just doesn’t stand up to the mark. If everyone knew which stock to buy then we wouldn’t see the likes of Warren Buffett claiming he doesn’t pay enough tax on the billions of dollars he earns by beating the market!
Sources Used: bbc.co.uk, investopedia, Blackboard
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