Efficient Market Theory

The market is always efficient but investors are not. As long as human emotion is a factor in the stock market, some inefficiency will occur.

EMT (Efficient Market Theory) is the financial term use to measure the efficiency of the stock market. The "strong form" definition of Efficient Market Theory is that all information whether is public or private are reflected in market prices and that investors who happen to beat the market do so by luck. The theory was expanded and various levels of market efficiency were defined in the early 1970s. The market, it was argued, was efficient at three levels, based on what information was reflected in prices. Opposite the strong form of EMT is the "weak form" which states that prices of common stocks are independent. This means that all past information and prices are irrelevant to future prices and that technical analysis that uses past stock prices alone would not be useful in predicting future performance.

The intermediate level of EMT is the "semi strong" form which states that all public information will eventually reflected in the market price of a stock. As new information is introduced whether is positive or negative to a companies or industries, the capital markets and the economy will be translated into stock prices. Overall market analysis of price behavior, should not be considered an adequate substitute for fundamental analysis when selecting individual companies in which to invest. The various levels of Efficient Market Theory may have emerged to explain an element of the market that simply cannot be explained: human emotion.

The market is always efficient but investors are not. As long as human emotion is a factor in the stock market, some inefficiency will occur. Individuals should do their homework when investing in individual securities or in mutual funds. An investors need to put time into researching and study the company prospectus when investing in individual securities or mutual funds. A company's value is influenced by the underlying economics of its own business and not by the fluctuations in the stock market.