The Efficient Market Hypothesis Explained

The Efficient Market Hypothesis Explained

The efficient market hypothesis or ‘EMH’ for short is the theory in economics that believes all known information is already reflected in current stock prices. The followers of this hypothesis believe that due to this fact it is not possible to beat buy and hold investing over the long term in returns or even in risk-adjusted returns because the stock market is forward looking and has already priced in all known new information at any given time.

A good example of why efficient market hypothesis is believed by so many to be true is how difficult it is for money managers to beat the S&P 500 index. EMH also believes that many of the best fund managers and investors that beat the market are simply lucky and it is not possible to do over the long term. 

The basic idea of EMH is that the stock market price action and returns are very difficult to predict due to their efficiency of pricing in the future today. 

The best traders and investors are not trying to predict the future they are following the trend or have a systematic process with an edge that profits from big wins and small losses. 

The greatest investor in history disagrees with this hypothesis: “I’d be a bum on the street with a tin cup if the markets were always efficient.” – Warren Buffett