The most widely used definition of market efficiency is due to Prof Eugene Fama of Chicago Business School. Fama has laid the foundations of the Efficient Market Hypothesis in a series of academic articles. He defines an efficient market as one in which prices reflect all the available information.
This definition is best understood with an example. Suppose that you are reading an article in the Wall Street Journal about Exxon Mobil. The article says the company officially announced yesterday that they discovered new oil reserves potentially worth billions of dollars. You quickly realize that the company's share price should rise substantially in response to the news. But, can you still make a profit if you buy Exxon Mobil's shares today and sell them when the share price responds to the news? The answer is 'no' in an efficient market.
Exxon Mobil's shares trade on the New York Stock Exchange (NYSE). If NYSE is an efficient stock market, news will be quickly incorporated into stock prices. In other words, if you buy Exxon Mobil shares today, the price you pay already reflects the positive news released yesterday and you shouldn't expect the price to rise any further in response to those news.
Market efficiency doesn't tell us not to invest in stocks. It simply says that in an efficient stock market, investors shouldn't expect to earn quick profits by trading on recent information, since all the available information should already be reflected in prices.
We discuss several topics related to market efficiency in these articles:
How does arbitrage work?
Does price reflect value?
Did Bill Miller beat the market?
This definition is best understood with an example. Suppose that you are reading an article in the Wall Street Journal about Exxon Mobil. The article says the company officially announced yesterday that they discovered new oil reserves potentially worth billions of dollars. You quickly realize that the company's share price should rise substantially in response to the news. But, can you still make a profit if you buy Exxon Mobil's shares today and sell them when the share price responds to the news? The answer is 'no' in an efficient market.
Exxon Mobil's shares trade on the New York Stock Exchange (NYSE). If NYSE is an efficient stock market, news will be quickly incorporated into stock prices. In other words, if you buy Exxon Mobil shares today, the price you pay already reflects the positive news released yesterday and you shouldn't expect the price to rise any further in response to those news.
Market efficiency doesn't tell us not to invest in stocks. It simply says that in an efficient stock market, investors shouldn't expect to earn quick profits by trading on recent information, since all the available information should already be reflected in prices.
We discuss several topics related to market efficiency in these articles:
How does arbitrage work?
Does price reflect value?
Did Bill Miller beat the market?
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