The Efficient Market

The first interesting theory about price behavior is called the efficient market theory (EMT). This theory states simply that prices react to changes in the company, in the market as a whole, and in the economy; and that the current price of stock has already been adjusted for all known information about that company. The EMT is cynical because it concludes that analyzing a company's financial reports or studying stock charts is meaningless.

Since all prices are fair and efficient because the 'smart' investors have already bid prices to their proper levels, there is never a discrepancy between price and value.

Key Point

The efficient market theory cynically states that you cannot make informed selections based on analysis; most investors and traders instinctively know that analysis is the key to profits.
EMT is controversial and it has many proponents. However, it is flawed for at least three reasons:
  1. There are no consistently 'smart' investors. In spite of what the academic theory claims, there are no smart investors out there, at least not enough of them. Truthfully, no investors are consistently able to produce profits by their analysis and decisions. If they were, then the efficient market theory might make sense.
  2. Short-term price movement is demonstrably inefficient. When you study the cause and effect between news about a company and its stock price behavior, you immediately realize that volatility is more important than news and information. Perhaps actual economic and financial news should be more important, but the simple truth is that prices behave irrationally. An alternative, the inefficient market theory, makes more sense. EMT is really nothing more than wishful thinking. In a perfect world, the marketsâ
    By Michael C. Thomsett
    Michael Thomsett is a British-born American author who has written over 75 books covering investing, business and real estate topics.

    Copyrighted 2020. Content published with author's permission.

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