Efficient market hypothesis (EMH)
Also known as: efficient market theory
The efficient market hypothesis (EMH) is the theory that security prices already reflect all available information, making it impossible to consistently beat the market through stock picking or market timing.
The efficient market hypothesis (EMH) holds that markets process information so quickly that a security's current price already incorporates everything investors know. If a stock were obviously underpriced, traders would buy it immediately and the bargain would vanish. Under EMH, consistently outperforming the market — other than by luck or by taking on extra risk — is not possible.
EMH comes in three forms, distinguished by what information prices are assumed to reflect. The weak form says prices reflect all past trading data, so technical analysis (studying charts and price patterns) cannot produce an edge. The semi-strong form adds all publicly available information — earnings reports, news, economic data — so fundamental analysis is also fruitless. The strong form goes furthest, claiming prices reflect all information, public and private, so even insider information would not help.
The practical implication of EMH is passive investing: if no analysis reliably beats the market, investors are better off buying and holding a low-cost, diversified portfolio such as an index fund rather than paying for active management. Critics point to market bubbles, crashes, and successful long-term active managers as evidence that real markets are not perfectly efficient.
The Series 65 and Series 66 exams test EMH as part of capital market theory. Know the three forms, which type of analysis each form rules out, and that EMH supporters favor passive, index-based strategies over active management.
Key takeaways
- EMH states that security prices already reflect available information, so consistently beating the market is impossible.
- The weak form rules out technical analysis; the semi-strong form also rules out fundamental analysis; the strong form claims even inside information is priced in.
- EMH supports passive, index-based investing over active management.
- The Series 65 and Series 66 exams test the three forms of EMH and their implications for investment strategy.