Learn The Stock Market And How to Trade

The theory behind stock market efficiency has been around since the 1960’s.  Basically it espouses that all investors have the same information at about the same time and thus they all have an equal chance to act on that information at the same time.  This is especially thought to be true since the internet has made the dispersion of information so quickly.

There are really three forms of market efficiency.  The first one, weak market, is based on the premise that the information used is from price of the stock only.  This would incorporate all past and current pricing.  The second type, semi-strong market, is said to consider all pricing and any available information including all financial information and everything else that is in the public domain.  The third, strong market, is said to consider everything in the semi-strong and add to it any information including any private or public information.  Thus if a company was considering merging with another company but it was never made public, the strong market theory would take this into consideration.

Empirical evidence has suggested that there is strong support for the weak market theory and some evidence to support the semi-strong theory but no evidence to support the strong market theory.  Some studies have been shown that you can only consider the price history of the stock to determine when to buy shares of stock , but the margin of error is so small between that and the semi-strong theory that the cost of trading negate the difference.

Even though there have been many different studies done to prove or disprove the efficient market theory, there is still some disputation on the correct answer.  Studies have tied to look at instances where the movement of a stock went counter to the expected movement under an efficient market theory.  Even though numerous anomalies have been discovered they soon disappear as investors act on them.  A paradox with efficient markets is that if every investor believed the markets were efficient, the efficiency would probably disappear because an investor would no longer feel it was worth it to analyze securities.

One theory is that the answer is neither black or white but contains shades of gray.  It espouses that markets are efficient to some extent but that there are opportunities to act on the emotions of investors and make a profit on your trading system.

Investment managers of course do not want to agree to the efficient market theory since this would in essence put them out of a job.  If they could not sell that they have greater foresight and information, then why would an investor pick them over another manager.  The truth is that a manager does not always have a great year.  They may be right one year but fall out another year.  Faced with inference that they cannot add value, many managers argue that the market is not efficient.

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