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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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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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Market Efficiency Hypothesis

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• Melody Lo 3  

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Market efficiency is one of the most fundamental research topics in both economics and finance. Since (Fama, Journal of Finance 25(2): 383–417, 1970) formally introduced the concept of market efficiency, studies have been developed at length to examine issues regarding the efficiency of various financial markets. In this chapter, we review elements, which are at the heart of market efficiency literature: the statistical efficiency market models, joint hypothesis testing problem, and three categories of testing literature.

• Autocorrelation
• Hypothesis testing
• Information
• Market efficiency
• Price formation
• Random walk model
• Security returns
• Serial correlation (tests)
• (Speculative) profits
• (Sub)martingale
• Trading rules

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Lo, M. (2022). Market Efficiency Hypothesis. In: Lee, CF., Lee, A.C. (eds) Encyclopedia of Finance. Springer, Cham. https://doi.org/10.1007/978-3-030-91231-4_30

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