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The Weak, Strong, and Semi-Strong Efficient Market Hypotheses

Learn about the three versions of the efficient market hypothesis

J.B. Maverick is an active trader, commodity futures broker, and stock market analyst 17+ years of experience, in addition to 10+ years of experience as a finance writer and book editor.

The efficient market hypothesis (EMH), as a whole, theorizes that the market is generally efficient, but the theory is offered in three different versions: weak, semi-strong, and strong.

The basic efficient market hypothesis posits that the market cannot be beaten because it incorporates all important determining information into current share prices . Therefore, stocks trade at the fairest value, meaning that they can't be purchased undervalued or sold overvalued .

The theory determines that the only opportunity investors have to gain higher returns on their investments is through purely speculative investments that pose a substantial risk.

Key Takeaways

• The efficient market hypothesis posits that the market cannot be beaten because it incorporates all important information into current share prices, so stocks trade at the fairest value.
• Though the efficient market hypothesis theorizes the market is generally efficient, the theory is offered in three different versions: weak, semi-strong, and strong.
• The weak form suggests today’s stock prices reflect all the data of past prices and that no form of technical analysis can aid investors.
• The semi-strong form submits that because public information is part of a stock's current price, investors cannot utilize either technical or fundamental analysis, though information not available to the public can help investors.
• The strong form version states that all information, public and not public, is completely accounted for in current stock prices, and no type of information can give an investor an advantage on the market.

The three versions of the efficient market hypothesis are varying degrees of the same basic theory. The weak form suggests that today’s stock prices reflect all the data of past prices and that no form of technical analysis can be effectively utilized to aid investors in making trading decisions.

Advocates for the weak form efficiency theory believe that if the fundamental analysis is used, undervalued and overvalued stocks can be determined, and investors can research companies' financial statements to increase their chances of making higher-than-market-average profits.

The semi-strong form efficiency theory follows the belief that because all information that is public is used in the calculation of a stock's current price , investors cannot utilize either technical or fundamental analysis to gain higher returns in the market.

Those who subscribe to this version of the theory believe that only information that is not readily available to the public can help investors boost their returns to a performance level above that of the general market.

The strong form version of the efficient market hypothesis states that all information—both the information available to the public and any information not publicly known—is completely accounted for in current stock prices, and there is no type of information that can give an investor an advantage on the market.

Advocates for this degree of the theory suggest that investors cannot make returns on investments that exceed normal market returns, regardless of information retrieved or research conducted.

There are anomalies that the efficient market theory cannot explain and that may even flatly contradict the theory. For example, the price/earnings  (P/E) ratio shows that firms trading at lower P/E multiples are often responsible for generating higher returns.

The neglected firm effect suggests that companies that are not covered extensively by market analysts are sometimes priced incorrectly in relation to their true value and offer investors the opportunity to pick stocks with hidden potential. The January effect shows historical evidence that stock prices—especially smaller cap stocks—tend to experience an upsurge in January.

Though the efficient market hypothesis is an important pillar of modern financial theories and has a large backing, primarily in the academic community, it also has a large number of critics. The theory remains controversial, and investors continue attempting to outperform market averages with their stock selections.

Due to the empirical presence of market anomalies and information asymmetries, many practitioners do not believe that the efficient markets hypothesis holds in reality, except, perhaps, in the weak form.

What Is the Importance of the Efficient Market Hypothesis?

The efficient market hypothesis (EMH) is important because it implies that free markets are able to optimally allocate and distribute goods, services, capital, or labor (depending on what the market is for), without the need for central planning, oversight, or government authority. The EMH suggests that prices reflect all available information and represent an equilibrium between supply (sellers/producers) and demand (buyers/consumers). One important implication is that it is impossible to "beat the market" since there are no abnormal profit opportunities in an efficient market.

What Are the 3 Forms of Market Efficiency?

The EMH has three forms. The strong form assumes that all past and current information in a market, whether public or private, is accounted for in prices. The semi-strong form assumes that only publicly-available information is incorporated into prices, but privately-held information may not be. The weak form concedes that markets tend to be efficient but anomalies can and do occur, which can be exploited (which tends to remove the anomaly, restoring efficiency via arbitrage ). In reality, only the weak form is thought to exist in most markets, if any.

How Would You Know If the Market Is Semi-Strong Form Efficient?

To test the semi-strong version of the EMH, one can see if a stock's price gaps up or down when previously private news is released. For instance, a proposed merger or dismal earnings announcement would be known by insiders but not the public. Therefore, this information is not correctly priced into the shares until it is made available. At that point, the stock may jump or slump, depending on the nature of the news, as investors and traders incorporate this new information.

The efficient market hypothesis exists in degrees, but each degree argues that financial markets are already too efficient for investors to consistently beat them. The idea is that the volume of activity within markets is so high that the value of resulting prices are as fair as can be. The weak form of the theory is the most lenient and concedes that there are circumstance when fundamental analysis can help investors find value. The strong form of the theory is the least lenient in this regard, while the semi-strong form of the theory holds a middle ground between the two.

Burton Gordon Malkiel. "A Random Walk Down Wall Street: The Time-tested Strategy for Successful Investing," W.W Norton & Company, 2007.

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Home > Finance > Semi-Strong Form Efficiency: Definition And Market Hypothesis

Semi-Strong Form Efficiency: Definition And Market Hypothesis

Published: January 26, 2024

Learn about semi-strong form efficiency in finance and understand its definition and market hypothesis. Discover how it impacts investment decisions.

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Semi-Strong Form Efficiency: Definition and Market Hypothesis Explained

Welcome to our finance blog post where we delve into the fascinating world of market efficiency. In particular, we are going to explore the concept of Semi-Strong Form Efficiency, a fundamental theory in finance. Have you ever wondered whether the stock market truly reflects all available information? What impact do public announcements or news events have on stock prices? We will uncover the answers to these questions and more in this article.

Key Takeaways:

• Semi-Strong Form Efficiency suggests that stock prices already incorporate all publicly available information.
• Efficient market hypothesis states that it is impossible to consistently achieve above-average market returns using only publicly available information.

What is Semi-Strong Form Efficiency?

Semi-Strong Form Efficiency is a concept that forms a significant part of the Efficient Market Hypothesis. It posits that stock prices accurately reflect all publicly available information. This means that analyzing historical market data or relying on recent news events will not provide an edge in generating consistent and above-average returns.

The theory of Semi-Strong Form Efficiency suggests that stocks adjust so quickly and accurately to new information that it becomes virtually impossible for investors to outperform the market based solely on publicly available information. Investors who attempt to beat the market by analyzing news events, company announcements, or financial statements are unlikely to consistently outperform the overall market in the long run.

To better understand this concept, let’s consider an example. Suppose a company releases its quarterly earnings report, which beats market expectations. In an environment of Semi-Strong Form Efficiency, this positive news will be quickly incorporated into the stock price. By the time the information becomes widely available, the stock price will already reflect the positive market sentiment, making it difficult for investors to profit solely from this news.

So, how does Semi-Strong Form Efficiency fit into the broader Efficient Market Hypothesis?

The Efficient Market Hypothesis (EMH) is a theory that states financial markets are efficient and that it is impossible to consistently achieve above-average market returns using only publicly available information. EMH classifies market efficiency into three forms: weak, semi-strong, and strong.

Semi-Strong Form Efficiency lies in the middle of these three forms. It posits that not only are stock prices influenced by past market data (weak form), but they also reflect all publicly available information (semi-strong form). In its strongest form, market efficiency theory suggests that stock prices also incorporate private or insider information that is not available to the public.

The Implications of Semi-Strong Form Efficiency

The theory of Semi-Strong Form Efficiency has several implications for investors:

• Efficient Market Hypothesis Challenges Active Management: As the Efficient Market Hypothesis suggests that investors cannot consistently outperform the market based on publicly available information, proponents argue that active stock picking and market timing are unlikely to lead to superior returns. This challenges the idea that professional fund managers or individual investors can beat the market consistently.
• Focus on Other Investment Strategies: In light of Semi-Strong Form Efficiency, many investors turn to other strategies that do not rely solely on publicly available information. These strategies include passive investing (such as index fund investing) and alternative investment vehicles like private equity or hedge funds that may have access to additional information sources.
• Importance of Fundamental Analysis: Although Semi-Strong Form Efficiency suggests that analyzing publicly available information may not consistently yield above-average returns, it does not render fundamental analysis useless. Understanding a company’s financials, industry trends, and competitive advantages can still provide valuable insights for long-term investment decision making and risk management.

In conclusion, Semi-Strong Form Efficiency is a critical concept within the field of finance. By acknowledging that stock prices efficiently reflect all publicly available information, investors can make more informed decisions and shape their investment strategies accordingly. While it challenges the ability to consistently outperform the market using publicly available data, it highlights the importance of alternative investment strategies and a comprehensive understanding of fundamental analysis.

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Efficient Market Hypothesis

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A capital market is said to be efficient if it fully and correctly reflects all relevant information in determining security prices. Formally, the market is said to be efficient with respect to some information set, ϕ, if security prices would be unaffected by revealing that information to all participants. Moreover, efficiency with respect to an information set, ϕ, implies that it is impossible to make economic profits by trading on the basis of ϕ.

This chapter was originally published in The New Palgrave: A Dictionary of Economics , 1st edition, 1987. Edited by John Eatwell, Murray Milgate and Peter Newman

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Malkiel, B.G. (1987). Efficient Market Hypothesis. In: The New Palgrave Dictionary of Economics. Palgrave Macmillan, London. https://doi.org/10.1057/978-1-349-95121-5_42-1

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Efficient Markets Hypothesis

The efficient market hypothesis (EMH) suggests that financial markets operate in such a way that the prices of equities, or shares in companies, are always efficient.

Elliot currently works as a Private Equity Associate at Greenridge Investment Partners, a middle market fund based in Austin, TX. He was previously an Analyst in  Piper Jaffray 's Leveraged Finance group, working across all industry verticals on  LBOs , acquisition financings, refinancings, and recapitalizations. Prior to Piper Jaffray, he spent 2 years at  Citi  in the Leveraged Finance Credit Portfolio group focused on origination and ongoing credit monitoring of outstanding loans and was also a member of the Columbia recruiting committee for the Investment Banking Division for incoming summer and full-time analysts.

Elliot has a Bachelor of Arts in Business Management from Columbia University.

• What Is The Efficient Market Hypothesis (EMH)?
• Variations Of The Efficient Markets Hypothesis
• Are Capital Markets Efficient?

What Is the Efficient Market Hypothesis (EMH)?

The efficient market hypothesis (EMH) suggests that  financial markets operate in such a way that the prices of equities, or shares in companies, are always efficient. In simpler terms, these prices accurately reflect the true value of the underlying companies they represent.

The efficient market hypothesis is one of the most foundational theories developed in finance. It was developed by Nobel laureate Eugene Fama in the 1960s and is widely known amongst finance professionals in the industry.

There are many implications arising from this hypothesis; however, the main proposition is that it is impossible to “beat the market” and generate alpha. 

What does beating the market or generating alpha mean? Broadly speaking, you can think of how much the return of your risk-adjusted investments exceeds benchmark indices. 

For example, a proxy for the US market will be the S&P 500, which covers the top 500 companies in the United States or over 80% of its total market capitalization .

If your portfolio of investments generated an alpha of 3%, then it is considered that your portfolio outperformed the S&P 500 by 3% (assuming that you trade in the US market)

How is it possible that share prices are always efficient and reflect the actual value of the underlying company following the efficient market hypothesis? 

It is because, at all times, a company's share price reflects certain relevant available information to all investors who trade upon it, and the type of information required to ensure efficient prices depends on what form of efficiency the market is in. 

If you are interested in a profession surrounding capital markets, be it asset management , sales & trading, or even hedge funds, the EMH is a theory you need to know to ace your interviews. 

However, this is only one topic in the diverse world of finance that you will truly need to know if you want to break into these careers. To gain a deeper understanding of finance, look at Wall Street Oasis's courses. For a link to our courses, click  here .

Key Takeaways

• Developed by Eugene Fama, the EMH suggests that financial markets reflect all available information and that it's impossible to consistently "beat the market" to generate abnormal returns (alpha).
• The EMH has three forms: weak, semi-strong, and strong. Each form describes the extent of information already reflected in stock prices.
• Under this form, stock prices incorporate historical information like past earnings and price movements. Investors can't gain alpha by trading on this historical data as it's already "priced in."
•  In this form, stock prices reflect all publicly available information, including recent news and announcements. Even with access to this information, investors can't consistently beat the market.
• The strongest form of EMH incorporates all information, including insider information. Even with insider knowledge, investors can't generate abnormal returns. However, some argue that real-world markets may not fully adhere to this hypothesis due to behavioral biases and inefficiencies.

Variations of the Efficient Markets Hypothesis

According to Eugene Fama, there are three variations of efficient markets:

Semi-strong form 

Strong form 

Depending on which form the market takes, the share price of companies incorporates different types of information. Let’s go over what kind of information is required for each form of the efficient market. 

Weak form efficiency

Under the weak form of efficient markets, share prices incorporate all historical information of stocks. This would typically cover a company’s historical earnings, price movements, technical indicators, etc. 

Another way to look at it is that when a market is weakly efficient, it means - there is no predictive power from historical information. 

Investors are unlikely to generate alpha from investing in a company just because they saw that the company outperformed earnings estimates last week. That information was already “priced in,” and there is nothing to gain trading off that information.

Semi-strong form efficiency 

The semi-strong form of efficiency within markets is believed to be most prevalent across markets. Under this form of efficiency, share prices incorporate all historical information of stocks and go a step further by including all publicly available information. 

This implies that share prices practically adjust immediately following the announcement of relevant information to a company’s stock.

What this means is that investors are not able to generate alpha by trading off relevant information that is publicly available, no matter how recent that piece of information became public.

This partially explains why you’ve probably heard those investment gurus tell you to buy the rumors and sell on the news.

One relevant example would be the reaction from every stock exchange worldwide on specific key dates surrounding the World Health Organization and the Covid-19 pandemic. 

The market crashed following specific announcements because, at that time, the market anticipated lockdowns to occur, which would damage every company’s supply chain and sales. 

If lockdowns did occur, companies wouldn’t be able to produce goods and services. Furthermore, customers wouldn’t be able to purchase goods, resulting in companies taking a hit on their earnings. And this was exactly what happened. 

Although Covid was known since November 2019, If you look at the S&P 500 and the FTSE 100 , they both crashed on the same date (21st February 2020), with the impact on markets being equally significant. 

It would be safe to say that this was the date that the market started incorporating the impact of Covid-19 on a company’s share price. It is no coincidence that the World Health Organization also hosted a  press conference  that day. 

You can look at the FTSE 100 and S&P 500 index, which represent the UK and US market conditions. The following images show the drop in benchmark indices due to Covid-19: 

Unfortunately, there are a couple of caveats to this example. 

In Eugene Fama’s  purest  depiction of the semi-strong form of an efficient market hypothesis, prices are meant to adjust instantaneously following the public announcement of relevant information, with the new prices reflecting the market’s new actual value. 

When you look at the market’s reaction to Covid-19, the market crash happened gradually over a certain period. 

Furthermore, if you look at the FTSE 100 and S&P 500, the index started showing signs of recovery immediately after the market crash. 

Broadly speaking, there are two reasons this could have happened: 

There was an announcement of new publicly available information with a positive impact on markets

The market had initially overreacted to the Covid-19 pandemic

An excellent example of newly announced publicly available information with a positive impact on markets would be something like the respective countries’ governments and central banks both promoting aggressive monetary and fiscal policies designed to improve economic situations. 

Although it is impossible to say, and every investor will have a different opinion on the market, the consensus is that the market has reacted to monetary and fiscal policies. As a result, there was an initial overreaction to Covid-19 in the market. 

This is where the practical example strays away from theory. In the market’s reaction to Covid-19, the impact of new information was gradual (but still quick) and argued to be inefficient at the trough. 

However, Eugene Fama’s efficient market hypothesis anticipates rapid price movements following the release of public information, and prices are always efficient, moving from one true value to another. 

Market indices that genuinely follow the semi-strong form efficient market hypothesis would look something like this: 

And this is what the  true  efficient market hypothesis envisions. There is no exaggeration in this graph, and the market index isn't expected to have any daily fluctuation because it reflects the valid, efficient value pricing in all the publicly available information. 

Reaction to new relevant information is instant and accurate, leaving no room for values to readjust over time. 

This example applies to all forms of efficient markets, including the weak and strong forms. However, the difference is the type of information that will cause a company's share price to readjust. 

Strong form efficiency 

The share prices of companies in strongly efficient markets incorporate everything that the semi-strong form efficiency incorporates but go a step further by also incorporating insider information. 

This implies that investors who know something about a company that isn't publicly known cannot generate abnormal returns trading off that information.

Generally speaking, you should expect more developed countries to have more efficient markets, mainly because more asset managers are analyzing stocks and more educated individuals make better investment decisions.

However, if any country were likely to display powerfully efficient markets, you would expect them to exist within more corrupt and opaque countries. This is because countries like the US and UK have implemented sanctions against insider trading purely because of how profitable it is. 

Investors with insider information are known to have an edge in markets, which is why there are policies in place dictating that asset managers and substantial shareholders must disclose their trades to the Securities and Exchange Commission ( SEC ). 

Under  Rule 10b-5 , the SEC explicitly states that insiders are prohibited from trading on material non-public information. 

In November 2021, a  McKinsey partner was charged with insider trading  because he assisted Goldman Sachs with its acquisition of GreenSky. 

The Mckinsey partner had private information regarding the GreenSky acquisition and purchased multiple call options on GreenSky, profiting over $450,000. 

Aside from the fact that the man was blatantly insider trading, the fact that he was able to profit off insider information is evidence that the US market does  NOT  possess strong form efficiency.

The above is somewhat considered to be proof by contradiction. If markets were efficient, trading off insider information would not let investors generate abnormal returns. But in this case, the Mckinsey partner could make almost half a million dollars!

To put that into perspective, $450 thousand is more than two years of the average investment banking analyst’s total compensation and slightly over four years of base pay. 

Are capital markets efficient?

After developing a decent understanding of the efficient market hypothesis, the real question is: is the market truly efficient, and do they follow the EMH? This topic is controversial, and many individuals will support different sides of the argument. 

Supporters of the efficient market hypothesis generally believe in traditional neoclassical finance. Neoclassical finance has been around since the twentieth century, and its approach revolves around key assumptions like perfect knowledge or rationality among individuals. 

In fact, most of the material taught at university and in textbooks are materials that talk about neoclassical finance - one might argue that the world of finance was built by theories such as the EMH. 

However, some of the assumptions in neoclassical finance have always been known to be overly restrictive and not at all realistic. For example, humans are not the objective supercomputers that neoclassical finance believes us to be. 

The fact is that humans are ruled by emotions and subjected to behavioral biases. We do not act the same as everyone else, and it is absurd to believe that we all behave rationally or even have perfect knowledge about a subject before making decisions.

Some of the latest developments in academics have been surrounding behavioral finance, with Nobel laureates including Robert Shiller and Richard Thaler (cameo in a classic finance film titled The Big Short) leading the field and relaxing unrealistic assumptions in neoclassical finance. 

Aside from being unable to generate alpha, another significant implication arising from the EMH is that investors can blindly purchase any stock in the exchange without any prior analysis and still receive a fair return on equity . 

That does not make sense because if everyone did that, then it would be safe to assume that the share prices would be wildly inaccurate and far apart from the company’s actual value. 

The fact is that there is some reliance upon financial institutions such as asset managers or arbitrageurs to constantly monitor and exploit inefficiencies within capital markets (such as buying underpriced and shorting overpriced equities) to keep the market efficient. 

Therefore, another argument arising from this is the idea that markets are efficiently inefficient where money managers who use costly financial information software such as Bloomberg Terminal or FactSet can gain a competitive edge in the market.

These money managers generate abnormal returns by exploiting inefficiencies within markets, such as longing for undervalued stocks or shorting overvalued stocks. A beneficial outcome of this activity is that market prices are slowly shifting towards efficient values.

The biggest argument supporting the efficient market hypothesis is that many money managers cannot outperform benchmark indices such as the S&P 500 on a year-to-year basis.

That argument is further supported when you compare the average 20-year annual return of the S&P 500 to any hedge fund’s average 20-year yearly return. You will find that  MOST  money managers underperform compared to the benchmark. 

The table below displays the November 2021 return of the top hedge funds. For reference, the S&P 500 had a total return of  26.89% . 

Therefore, if you compare the hedge funds to the S&P 500 (ignoring the hedge funds’ December 2021 performance), you can see that only three hedge funds outperformed the index. 

Hedge funds are also costly, with many institutions imposing a minimum 2-20 fee structure where there is a 2% fee charged on the AUM of the fund and a 20% fee for any profit above the hurdle rate. 

Nevertheless, while the data seems to point to the fact that hedge funds can be somewhat lackluster, a common argument is that the concept of a hedge fund is to “hedge,” which means to protect money. 

Therefore, perhaps some hedge funds have a greater purpose of maintaining their AUM rather than growing it despite the fact that hedge funds are known for having the most aggressive investment strategies . 

Overall, being a part of a hedge fund is still highly lucrative. For example, Kenneth Griffin, CEO of Citadel LLC, had total compensation of over $2 billion in 2021, whereas David Solomon, CEO of Goldman Sachs, had a total payment of $35 million in 2021. 

If you want to make $2 billion a year in a hedge fund one day, you need to polish up your interviewing skills. To impress your interviewers, look at Wall Street Oasis’s Hedge Fund Interview Prep Course . For a link to our courses, click  here .

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• Cost of Capital
• Marginal Cost of Capital
• Required Rate of Return
• Risk Free Rate
• Inflation Premium
• Default Premium
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• Internal Growth Rate
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• Net Asset Value
• Pure Play Method
• Unlevered Beta
• Strong Form Market Efficiency
• Semi-strong Form Market Efficiency
• Weak Form Market Efficiency
• Theoretical Ex-rights Price
• Yield to Maturity (YTM)
• Current Yield

Semi-strong form of market efficiency exists where security prices already reflect all publicly available information and it is not possible to earn excess return.

Semi-strong form of market efficiency lies between the two other forms of market efficiency, namely the weak form and strong form . A semi-strong form encompasses a weak-form which means that if a market is semi-strong efficient, it is also weak-form efficient.

When a market is semi-strong form efficient, neither technical analysis, which is based on past pattern of return, nor fundamental analysis, which incorporates current information, can help predict future price movements. However, non-public information can be used to earn above average return.

Semi-strong form of efficiency is typically tested by studying how prices and volumes respond to specific events. If price reflect new information quickly, markets are semi-strong form efficient. Such events may include special dividends, stock splits , lawsuits, mergers and acquisitions, tax changes, etc. Evidence suggests that developed markets might be semi-strong efficient while developing markets are not.

Alex held 100 shares of Cure Inc. which he had purchased on 1 January 20X3 for $25 per share. Cure Inc. is a company engaged in research and development of new antibiotics against resistant microbes. Alex is not an active investor so he does not checks the stock performance daily. On 14 January 20X2 (Sunday), he came across an article shared by his friend on Facebook. The article was published on 11 January 20X2 (Friday). According to the article, Cure Inc. has failed in a project worth a net present value of $20 million. Total outstanding shares of Cure Inc. are 5 million. Alex sold off his holding for $2,050 (at $20.5 per share) in the opening hours of 15 January 20X2 (Monday). He was glad that he minimized his loss but towards the end of 15 January 20X2, the company's stock price had even climbed to $21. He is wondering what happened.

The market seems to be semi-strong form efficient. The market had adjusted itself to the public information on Friday (11 January 20X2) as soon as the market came to know about it. Alex should not have used this public information to project a decline on Monday. The drop in price is almost equal to the net present value per share no longer available ($20 million divided by 5 million).

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11.5 Efficient Markets

Learning outcomes.

By the end of this section, you will be able to:

• Understand what is meant by the term efficient markets .
• Understand the term operational efficiency when referring to markets.
• Understand the term informational efficiency when referring to markets.
• Distinguish between strong, semi-strong, and weak levels of efficiency in markets.

Efficient Markets

For the public, the real concern when buying and selling of stock through the stock market is the question, “How do I know if I’m getting the best available price for my transaction?” We might ask an even broader question: Do these markets provide the best prices and the quickest possible execution of a trade? In other words, we want to know whether markets are efficient. By efficient markets , we mean markets in which costs are minimal and prices are current and fair to all traders. To answer our questions, we will look at two forms of efficiency: operational efficiency and informational efficiency.

Operational Efficiency

Operational efficiency concerns the speed and accuracy of processing a buy or sell order at the best available price. Through the years, the competitive nature of the market has promoted operational efficiency.

In the past, the NYSE (New York Stock Exchange) used a designated-order turnaround computer system known as SuperDOT to manage orders. SuperDOT was designed to match buyers and sellers and execute trades with confirmation to both parties in a matter of seconds, giving both buyers and sellers the best available prices. SuperDOT was replaced by a system known as the Super Display Book (SDBK) in 2009 and subsequently replaced by the Universal Trading Platform in 2012.

NASDAQ used a process referred to as the small-order execution system (SOES) to process orders. The practice for registered dealers had been for SOES to publicly display all limit orders (orders awaiting execution at specified price), the best dealer quotes, and the best customer limit order sizes. The SOES system has now been largely phased out with the emergence of all-electronic trading that increased transaction speed at ever higher trading volumes.

Public access to the best available prices promotes operational efficiency. This speed in matching buyers and sellers at the best available price is strong evidence that the stock markets are operationally efficient.

Informational Efficiency

A second measure of efficiency is informational efficiency, or how quickly a source reflects comprehensive information in the available trading prices. A price is efficient if the market has used all available information to set it, which implies that stocks always trade at their fair value (see Figure 11.12 ). If an investor does not receive the most current information, the prices are “stale”; therefore, they are at a trading disadvantage.

Forms of Market Efficiency

Financial economists have devised three forms of market efficiency from an information perspective: weak form, semi-strong form, and strong form. These three forms constitute the efficient market hypothesis. Believers in these three forms of efficient markets maintain, in varying degrees, that it is pointless to search for undervalued stocks, sell stocks at inflated prices, or predict market trends.

In weak form efficient markets, current prices reflect the stock’s price history and trading volume. It is useless to chart historical stock prices to predict future stock prices such that you can identify mispriced stocks and routinely outperform the market. In other words, technical analysis cannot beat the market. The market itself is the best technical analyst out there.

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What is Efficient Market Hypothesis? | EMH Theory Explained

The efficient market hypothesis (EMH) can help explain why many investors opt for passive investing strategies, such as buying index funds or exchange-traded funds ( ETFs ), which generate consistent returns over an extended period. However, the EMH theory remains controversial and has found as many opponents as proponents. This guide will explain the efficient market hypothesis, how it works, and why it is so contradictory. 

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What is the efficient market hypothesis?

The efficient market hypothesis (EMH) claims that all assets are always fairly and accurately priced and trade at their fair market value on exchanges. If this theory is true, nothing can give you an edge to outperform the market using different investing strategies and make excess profits compared to those who follow market indexes.

Efficient market definition

An efficient market is where all asset prices listed on exchanges fully reflect their true and only value, thus making it impossible for investors to “beat the market” and profit from price discrepancies between the market price and the stock’s intrinsic value. The EMH claims the stock’s fair value, also called intrinsic value , is much the same as its market value , and finding undervalued or overvalued assets is non-viable.  

Intrinsic value refers to an asset’s true, actual value, which is calculated using fundamental and technical analysis, whereas the market price is the currently listed price at which stock is bought and sold. When markets are efficient, the two values should be the same, but when they differ, it poses opportunities for investors to make an excess profit.

For markets to be completely efficient, all information should already be accounted for in stock prices and are trading on exchanges at their fair market value, which is practically impossible.

Hypothesis definition 

A hypothesis is merely an assumption, an idea, or an argument that can be tested and reasoned not to be true. Something that isn’t fully supported by full facts or doesn’t match applied research.

For example, if sugar causes cavities, people who eat a lot of sweets are prone to cavities. And if the same applies here – if all information is reflected in a stock’s price, then its fair value should be the same as its market value and can not differ or be impacted by any other factors. 

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Fundamental and technical analysis in an efficient market 

According to the EMH, stock prices are already accurately priced and consider all possible information. If markets are fully efficient, then no fundamental or technical analysis can help investors find anomalies and make an extra profit. 

Fundamental analysis is a method to calculate a stock’s fair or intrinsic value by looking beyond the current market price by examining additional external factors like financial statements, the overall state of the economy, and competition, which can help define whether the stock is undervalued. 

Also relevant is technical analysis , a method of forecasting the value of stocks by analyzing the historical price data, mainly looking at price and volume fluctuations occurring daily, weekly, or any other constant period, usually displayed on a chart.

The efficient market theory directly contradicts the possibility of outperforming the market using these two strategies; however, there are three different versions of EMH, and each slightly differs from the other.

Three forms of market efficiency 

The efficient market hypothesis can take three different forms , depending on how efficient the markets are and which information is considered in theory: 

1. Strong form efficiency  

Strong form efficiency is the EMH’s purest form, and it is an assumption that all current and historical, both public and private, information that could affect the asset’s price is already considered in a stock’s price and reflects its actual value. According to this theory, stock prices listed on exchanges are entirely accurate. 

Investors who support this theory trust that even inside information can’t give a trader an advantage, meaning that no matter how much extra information they have access to or how much analysis and research they do, they can not exceed standard returns. 

Burton G. Malkiel, a leading proponent of the strong-form market efficiency hypothesis, doesn’t believe any analysis can help identify price discrepancies. Instead, he firmly believes in buy-and-hold investing, trusting it is the best way to maximize profits. However, factual research doesn’t support the possibility of a strong form of efficiency in any market. 

2. Semi-strong form efficiency

The semi-strong version of the EMH suggests that only current and historical public (and not private) information is considered in the stock’s listed share prices. It is the most appropriate form of the efficient market hypothesis, and factual evidence supports that most capital markets in developed countries are generally semi-strong efficient. 

This form of efficiency relies on the fact that public news about a particular stock or security has an immediate effect on the stock prices in the market and also suggests that technical and fundamental analysis can’t be used to make excess profits.   

A semi-strong form of market efficiency theory accepts that investors can gain an advantage in trading only when they have access to any unknown private information unknown to the rest of the market.

3. Weak form efficiency

Weak market efficiency, also called a random walk theory, implies that investors can’t predict prices by analyzing past events, they are entirely random, and technical analysis cannot be used to beat the market. 

Random walk theory proclaims stock prices always take a randomized path and are unpredictable, that investors can’t use past price changes and historical data trends to predict future prices, and that stock prices already reflect all current information. 

For example, advocates of this form see no or limited benefit to technical analysis to discover investment opportunities. Instead, they would maintain a passive investment portfolio by buying index funds that track the overall market performance. 

For example, the momentum investing method analyzes past price movements of stocks to predict future prices – it goes directly against the weak form efficiency, where all the current and past information is already reflected in their market prices.  

A brief history of the efficient market hypothesis

The concept of the efficient market hypothesis is based on a Ph.D. dissertation by Eugene Fama , an American economist, and it assumes all prices of stocks or other financial instruments in the market are entirely accurate. 

In 1970, Fama published this theory in “Efficient Capital Markets: A Review of Theory and Empirical Work,” which outlines his vision where he describes the efficient market as: “A market in which prices always “fully reflect” available information is called “efficient.”

Another theory based on the EMH, the random walk theory by Burton G. Malkiel , states that prices are completely random and not dependent on any factor. Not even past information, and that outperforming the market is a matter of chance and luck and not a point of skill.

Fama has acknowledged that the term can be misleading and that markets can’t be efficient 100% of the time, as there is no accurate way of measuring it. The EMH accepts that random and unexpected events can affect prices but claims they will always be leveled out and revert to their fair market value.

What is an inefficient market? 

The efficient market hypothesis is a theory, and in reality, most markets always display some inefficiencies to a certain extent. It means that market prices don’t always reflect their true value and sometimes fail to incorporate all available information to be priced accurately. 

In extreme cases, an inefficient market may even lead to a market failure and can occur for several reasons.

An inefficient market can happen due to: 

• A lack of buyers and sellers; 
• Absence of information; 
• Delayed price reaction to the news;
• Transaction costs;
• Human emotion;
• Market psychology.

The EMH claims that in an efficiently operating market, all asset prices are always correct and consider all information; however, in an inefficient market, all available information isn’t reflected in the price, making bargain opportunities possible.

Moreover, the fact that there are inefficient markets in the world directly contradicts the efficient market theory, proving that some assets can be overvalued or undervalued, creating investment opportunities for excess gains. 

Validity of the efficient market hypothesis 

With several arguments and real-life proof that assets can become under- or overvalued, the efficient market hypothesis has some inconsistencies, and its validity has repeatedly been questioned. 

While supporters argue that searching for undervalued stock opportunities using technical and fundamental analysis to predict trends is pointless, opponents have proven otherwise. Although academics have proof supporting the EMH, there’s also evidence that overturns it. 

The EMH implies there are no chances for investors to beat the market, but for example, investing strategies like arbitrage trading or value investing rely on minor discrepancies between the listed prices and the actual value of the assets. 

A prime example is Warren Buffet, one of the world’s wealthiest and most successful investors, who has consistently beaten the market over more extended periods through value investing approach, which by definition of EMH is unfeasible. 

Another example is the stock market crash in 1987, when the Dow Jones Industrial Average (DJIA) fell over 20% on the same day, which shows that asset prices can significantly deviate from their values. 

Moreover, the fact that active traders and active investing techniques exist also displays some evidence of inconsistencies and that a completely efficient market is, in reality, impossible. 

Contrasting beliefs about the efficient market hypothesis

Although the EMH has been largely accepted as the cornerstone of modern financial theory, it is also controversial. The proponents of the EMH argue that those who outperform the market and generate an excess profit have managed to do so purely out of luck, that there is no skill involved, and that stocks can still, without a real cause or reason, outperform, whereas others underperform. 

Moreover, it is necessary to consider that even new information takes time to take effect in prices, and in actual efficiency, prices should adjust immediately. If the EMH allows for these inefficiencies, it is a question of whether an absolute market efficiency, strong form efficiency, is at all possible. But as this theory implies, there is little room for beating the market, and believers can rely on returns from a passive index investing strategy.

Even though possible, proponents assume neither technical nor fundamental analysis can help predict trends and produce excess profits consistently, and theoretically, only inside information could result in outsized returns. 

Moreover, several anomalies contradict the market efficiency, including the January anomaly, size anomaly, and winners-losers anomaly, but as usual, factual evidence both contradicts and supports these anomalies.  

Parting opinions about the different versions of the EMH reflect in investors’ investing strategies. For example, supporters of the strong form efficiency might opt for passive investing strategies like buying index funds. In contrast, practitioners of the weak form of efficiency might leverage arbitrage trading to generate profits.

Marketing strategies in an efficient and inefficient market 

On the one side, some academics and investors support Fama’s theory and most likely opt for passive investing strategies. On the other, some investors believe assets can become undervalued and try to use skill and analysis to outperform the market via active trading.

Passive investing

Passive investing is a buy-and-hold strategy where investors seek to generate stable gains over a more extended period as fewer complexities are involved, such as less time and tax spent compared to an actively managed portfolio. 

People who believe in the efficient market hypothesis use passive investing techniques to create lower yet stable gains and use strategies with optimal gains through maximizing returns and minimizing risk.

Proponents of the EMH would use passive investing, for example: 

• Invest in Index Funds;
• Invest in Exchange-traded Funds (ETFs).

However, it is important to note that other mutual funds also use active portfolio management intending to outperform indices, and passive investing strategies aren’t only for those who believe in the EMH.

Active investing

Active portfolio managers use research, analysis, skill, and experience to discover market inefficiencies to generate a higher profit over a shorter period and exceed the benchmark returns. 

Generally, passive investing strategies generate returns in the long run, whereas active investing can generate higher returns in the short term. 

Opponents of the EMH might use active investing techniques, for example: 

• Arbitrage and speculation; 
• Momentum investing ;
• Value investing .

The fact that these active trading strategies exist and have proven to generate above-market returns shows that prices don’t always reflect their market value. 

For instance, if a technology company launches a new innovative product, it might not be immediately reflected in its stock price and have a delayed reaction in the market. 

Suppose a trader has access to unpublished and private inside information. In that case, it will allow them to purchase stocks at a much lower value and sell for a profit after the announcement goes public, capitalizing on the speculated price movements. 

Passive and active portfolio managers are often compared in terms of performance, e.g., investment returns, and research hasn’t fully concluded which one outperforms the other, 

Efficient market examples

Investors and academics have divided opinions about the efficient market hypothesis, and there have been cases where this theory has been overturned and proven inaccurate, especially with strong form efficiency. However, proof from the real world has shown how financial information directly affects the prices of assets and securities, making the market more efficient. 

For example, when the Sarbanes-Oxley Act in the United States, which required more financial transparency through quarterly reporting from publicly traded businesses, came into effect in 2002, it affected stock price volatility. Every time a company released its quarterly numbers, stock market prices were deemed more credible, reliable, and accurate, making markets more efficient. 

Example of a semi-strong form efficient market hypothesis

Let’s assume that ‘stock X’ is trading at $40 per share and is about to release its quarterly financial results. In addition, there was some unofficial and unconfirmed information that the company has achieved impressive growth, which increased the stock price to $50 per share. 

After the release of the actual results, the stock price decreased to $30 per share instead. So whereas the general talk before the official announcement made the stock price jump, the official news launch dropped it. 

Only investors who had inside private information would have known to short-sell the stock , and the ones who followed the publicly available information would have bought it at a high price and incurred a loss. 

What can make markets more efficient?

There are a few ways markets can become more efficient, and even though it is easy to prove the EMH has no solid base, there is some evidence its relevance is growing. 

First , markets become more efficient when more people participate, buy and sell and engage, and bring more information to be incorporated into the stock prices. Moreover, as markets become more liquid, it brings arbitrage opportunities; arbitrageurs exploiting these inefficiencies will, in turn, contribute to a more efficient market.

Secondly , given the faster speed and availability of information and its quality, markets can become more efficient, thus reducing above-market return opportunities. A thoroughly efficient market, strong efficiency, is characterized by the complete and instant transmission of information. 

To make this possible, there should be: 

• Complete absence of human emotion in investing decisions;
• Universal access to high-speed pricing analysis systems; 
• Universally accepted system for pricing stocks;
• All investors accept identical returns and losses. 

The bottom line

At its core, market efficiency is the ability to incorporate all information in stock prices and provide the most accurate opportunities for investors; however, it isn’t easy to imagine a fully efficient market. 

Research has shown that most developed capital markets fall into the semi-strong efficient category. However, whether or not stock markets can be fully efficient conclusively and to what degree continues to be a heated debate among academics and investors.

Disclaimer:  The content on this site should not be considered investment advice. Investing is speculative. When investing, your capital is at risk.

FAQs on the efficient market hypothesis

The efficient market hypothesis (EMH) claims that prices of assets such as stocks are trading at accurate market prices, leaving no opportunities to generate outsized returns. As a result, nothing could give investors an edge to outperform the market, and assets can’t become under- or overvalued.

What are three forms of the efficient market hypothesis?

The efficient market hypothesis takes three forms: first, the purest form is strong form efficiency, which considers current and past information. The second form is semi-strong efficiency, which includes only current and past public, and not private, information. Finally, the third version is weak form efficiency, which claims stock prices always take a randomized path.

What contradicts the efficient market hypothesis?

The efficient market hypothesis directly contradicts the existence of investment strategies, and cases that have proved to generate excess gains are possible, for example, via approaches like value or momentum investing.

When more investors engage in the market by buying and selling, they also bring more information that can be incorporated into the stock prices and make them more accurate. Moreover, the faster movement of information and news nowadays increases accuracy and data quality, thus making markets more efficient. 

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Efficient Markets Hypothesis (EMH)

EMH Definition and Forms

What Is Efficient Market Hypothesis?

What are the types of emh, emh and investing strategies, the bottom line, frequently asked questions (faqs).

The Efficient Market Hypothesis (EMH) is one of the main reasons some investors may choose a passive investing strategy. It helps to explain the valid rationale of buying these passive mutual funds and exchange-traded funds (ETFs).

The Efficient Market Hypothesis (EMH) essentially says that all known information about investment securities, such as stocks, is already factored into the prices of those securities. If that is true, no amount of analysis can give you an edge over "the market."

EMH does not require that investors be rational; it says that individual investors will act randomly. But as a whole, the market is always "right." In simple terms, "efficient" implies "normal."

For example, an unusual reaction to unusual information is normal. If a crowd suddenly starts running in one direction, it's normal for you to run that way as well, even if there isn't a rational reason for doing so.

There are three forms of EMH: weak, semi-strong, and strong. Here's what each says about the market.

• Weak Form EMH:  Weak form EMH suggests that all past information is priced into securities. Fundamental analysis of securities can provide you with information to produce returns above market averages in the short term. But no "patterns" exist. Therefore, fundamental analysis does not provide a long-term advantage, and technical analysis will not work.
• Semi-Strong Form EMH:  Semi-strong form EMH implies that neither fundamental analysis nor technical analysis can provide you with an advantage. It also suggests that new information is instantly priced into securities.
• Strong Form EMH:  Strong form EMH says that all information, both public and private, is priced into stocks; therefore, no investor can gain advantage over the market as a whole. Strong form EMH does not say it's impossible to get an abnormally high return. That's because there are always outliers included in the averages.

EMH does not say that you can never outperform the market . It says that there are outliers who can beat the market averages. But there are also outliers who lose big to the market. The majority is closer to the median. Those who "win" are lucky; those who "lose" are unlucky.

Proponents of EMH, even in its weak form, often invest in index funds or certain ETFs. That is because those funds are passively managed and simply attempt to match, not beat, overall market returns.

Index investors might say they are going along with this common saying: "If you can't beat 'em, join 'em." Instead of trying to beat the market, they will buy an index fund that invests in the same securities as the benchmark index.

Some investors will still try to beat the market, believing that the movement of stock prices can be predicted, at least to some degree. For that reason, EMH does not align with a day trading strategy. Traders study short-term trends and patterns. Then, they attempt to figure out when to buy and sell based on these patterns. Day traders would reject the strong form of EMH.

For more on EMH, including arguments against it, check out the EMH paper from economist Burton G. Malkiel. Malkiel is also the author of the investing book "A Random Walk Down Main Street." The random walk theory says that movements in stock prices are random.

If you believe that you can't predict the stock market, you would most often support the EMH. But a short-term trader might reject the ideas put forth by EMH, because they believe that they are able to predict changes in stock prices.

For most investors, a passive, buy-and-hold , long-term strategy is useful. Capital markets are mostly unpredictable with random up and down movements in price.

When did the Efficient Market Hypothesis first emerge?

At the core of EMH is the theory that, in general, even professional traders are unable to beat the market in the long term with fundamental or technical analysis . That idea has roots in the 19th century and the "random walk" stock theory. EMH as a specific title is sometimes attributed to Eugene Fama's 1970 paper "Efficient Capital Markets: A Review of Theory and Empirical Work."

How is the Efficient Market Hypothesis used in the real world?

Investors who utilize EMH in their real-world portfolios are likely to make fewer decisions than investors who use fundamental or technical analysis. They are more likely to simply invest in broad market products, such as S&P 500 and total market funds.

Corporate Finance Institute. " Efficient Markets Hypothesis ."

IG.com. " Random Walk Theory Definition ."

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Semi-strong Form Efficiency - Explained

What is Semi-strong Form Efficiency?

Written by Jason Gordon

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What is Semi-Strong Form Efficiency?

Semi-strong form efficiency is a concept that suggests that the release of public news of a particular stock increases its existing stock prices. This concept is a part of the Efficient Market Hypothesis (EMH).

How Does Semi-Strong Form Efficiency Work?

Semi-strong form efficiency suggests that prices change to equilibrium levels, which are as a result of public market information on any security or equity. This theory analyses how the price of stocks increase and decrease with the presence of publicly available information. The semi-strong form efficiency theory, however, has one weakness; it is unable to explain the conditions affecting security prices on material nonpublic information (MNPI). The semi-strong form efficiency is easily the most applicable of all EMH hypotheses, as it deters the belief that technical and fundamental analysis can be used to achieve excess gains by investors. This concept goes on to suggest the use of MNPI as the only channel that could land investors big bucks and profits if they're in search of portfolios that yield more than average. The EMH theory is based solely on a 1960s Ph.D. dissertation by American Economist Eugene Fama, and it states that the prices of securities (stocks and other financial markets) at any given period in a cash market is dependent on the amount of information publicly available on that security. The EMH seems to draw most of its points from already existing researches, thus granting it some credibility up till date. This theory draws on the logic of the Random Walk theory (a theory that states that price changes are random and do not depend on any factor) to suggest that the ability to outperform a market security whose price is a reflection of its available market information is merely a matter of chance and not developed skills. In simple terms, one can compare trying to beat a market with public information to gambling. When applied to stock prices, it suggests that the market information of yesterday would in no way affect the price of stocks today, as there is new information today that takes up that role. It further states that beginners and advanced investors would be able to compete in the market if price changes were not predictable and if market information does not affect security rates. The EMH takes on three forms; the weak form efficiency, the semi-strong form efficiency, and the strong form efficiency.

Detailed Explanation of Efficient Market Hypothesis

As we stated earlier, the EMH has three forms on which it bases all its theory. The weak form EMH states that the movement of stock prices is solely dependent on the information available at that moment and non-other. In other words, the information of yesterday does not affect the security prices of today in any way. It also claims that technical analysis has no input in gathering excess returns, as history doesnt repeat itself in a random walk. The second form, which is the semi-strong form, has been defined above. The strong form of EMH, however, states that security prices are as a result of different information factors. It suggests that undisclosed private information has the same power in determining stock prices as publicly available information. It bases this argument on the fact that huge earnings in the financial market are not consistent because of the information which is not available to the public. If security prices were solely dependent on available information, then advanced investors will never record a loss. Just like all market price determinants, the EMH is not accurate at all times. This can be seen from the 2008 Financial Crisis, where investors questioned its credibility for lack of reality. They stated that if all forms of EMH had held as claimed, that the housing bubble and other crashes which came after it wouldnt have been possible. The EMH was unable to explain high volatility and market rationality. The later was observed in the way that investors were investing largely into the subprime mortgage sector even after reaching its peak (resistance point). This irrationality could not be explained by either form of EMH, even when investors where after high returns, which is a major goal of the efficiency theories. Different controversies raised around this model, as market analysts claimed that an efficient market would have modified asset prices to be on par with rational levels. 

Important Details

• The semi-strong form efficiency EMH hypotheses state that the price of a stock is dependent on its publicly available material information.
• It discredits the use of technical and fundamental analysis in predicting stock prices, arguing that the only true reflection of stock prices is dependent on material nonpublic information (MNPI).

An Illustration of Semi-Strong Form of Efficient Market Hypotheses

Let us assume that stock CSX is trading at $30 per unit, a day before it is required to release its annual financial report. Now, a rumor, at the later hours of the day, came in stating that the company has managed to have a great year with high financial returns. This rumor made the price of CSX increase to $40 per unit. However, the next day, after the financial report is made available, it is seen that the company has indeed suffered a financial decline, and this pushes the price back to $25. Now, the rumor which made the price jump to $40 is the publicly-available information, while the actual news which made the price fall back to $25 is the material nonpublic information (MNPI). If investors were to have an idea of the MNPI before its release, they would have profited a lot than they would. Also, investors that bought more stock shares at above $30 due to the rumor will suffer a loss after the MNPI is released publicly.

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