Efficient Market Hypothesis

The idea, developed by economist Eugene Fama, is that when new information becomes available, investors act on it so quickly that prices adjust almost immediately. By the time an individual investor learns the news, it is already reflected in the price.

The hypothesis is often described in three forms. The weak form says past prices cannot be used to predict future prices, which challenges technical analysis. The semi-strong form says all public information is already reflected in prices, which challenges fundamental analysis based on public data. The strong form says even private, inside information is reflected, which is generally considered unrealistic.

For example, if a company announces unexpectedly strong profits, its share price typically jumps within seconds or minutes, leaving little opportunity for slower investors to profit.

The hypothesis supports passive investing, since if markets are efficient, trying to beat them is largely futile after costs. Critics point to market bubbles, crashes and persistent patterns, as well as evidence from behavioural finance, as signs that markets are not always fully efficient. Many economists see markets as fairly efficient most of the time, but not perfectly so.