Statistical research has shown that to a close approximation stock prices seem to follow a
random walk with no discernible predictable patterns that investors can exploit. Such findings
are now taken to be evidence of market efficiency, that is, evidence that market prices
reflect all currently available information. Only new information will move stock prices,
and this information is equally likely to be good news or bad news.
Market participants distinguish among three forms of the efficient market hypothesis.
The weak form asserts that all information to be derived from past trading data already
is reflected in stock prices. The semistrong form claims that all publicly available
information is already reflected. The strong form, which generally is acknowledged
to be extreme, asserts that all information, including insider information, is reflected
in prices.
Technical analysis focuses on stock price patterns and on proxies for buy or sell pressure
in the market. Fundamental analysis focuses on the determinants of the underlying value
of the firm, such as current profitability and growth prospects. Because both types of
analysis are based on public information, neither should generate excess profits if markets
are operating efficiently.
Proponents of the efficient market hypothesis often advocate passive as opposed to active
investment strategies. The policy of passive investors is to buy and hold a broad-based
market index. They expend resources neither on market research nor on frequent purchase
and sale of stocks. Passive strategies may be tailored to meet individual investor
requirements.
Empirical studies of technical analysis do not generally support the hypothesis that
such analysis can generate superior trading profits. One notable exception to this conclusion
is the apparent success of momentum-based strategies over intermediate-term
horizons.
Several anomalies regarding fundamental analysis have been uncovered. These
include the P/E effect, the small-firm-in-January effect, the neglected-firm effect,
post–earnings-announcement price drift, and the book-to-market effect. Whether
these anomalies represent market inefficiency or poorly understood risk premia is
still a matter of debate.
By and large, the performance record of professionally managed funds lends little credence
to claims that most professionals can consistently beat the market.
