Efficient Market Theory


The (now largely discredited) theory that all market participants receive and act on all of the relevant information as soon as it becomes available. If this were strictly true, no investment strategy would be better than a coin toss. Proponents of the efficient market theory believe that there is perfect information in the stock market. This means that whatever information is available about a stock to one investor is available to all investors (except, of course, insider information, but insider trading is illegal). Since everyone has the same information about a stock, the price of a stock should reflect the knowledge and expectations of all investors.
The bottom line is that an investor should not be able to beat the market since there is no way for him/her to know something about a stock that isn't already reflected in the stock's price. Proponents of this theory do not try to pick stocks that are going to be winners; instead, they simply try to match the market's performance. However, there is ample evidence to dispute the basic claims of this theory, and most investors don't believe it.

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You should try and break down the efficient market theory and see if you can use it to your advantage.

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Even though he studied efficient market theory in school, he knew it didn't hold true. All information was not available to everyone and the market was not 100% efficient.

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The presence of, among other things, anomalies such as the January effect; the continually superior risk-adjusted returns of small and mid-cap stocks; the presence of insider trading; the outperformance of some managers over time; and the inefficiency of fixed income and foreign markets has all but killed efficient market theory.

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