Efficient market theory (efficient market hypothesis)

Otherwise known as the efficient market hypothesis, this theory concludes that investors cannot expect to outperform the STOCK MARKET over an extended period of time. This is not to say that some investors cannot outperform the stock-market indexes. The theory does suggest, however, that investors will not outperform the market on a RISK-adjusted basis over a longer time frame. The efficient market theory is based on the assumptions that securities markets are highly competitive, information for research purposes is readily available at low cost, and transactions may be executed at low cost. Since securities prices adjust rapidly to new information and other marketdriven effects, day-to-day price changes are unpredictable. The RANDOM-WALK THEORY suggests that the pricing pattern of securities is accidental, and techniques such as charting, moving averages, or purchases relative to sales will not lead to superior selection. The term random walk is occasionally misunderstood to mean that securities prices are randomly determined. To the contrary, securities prices are efficiently determined by the markets. It is the changes in securities prices that are random, as is new and unpredictable information. If new information were predictable, then securities price changes would also be predictable and investors could consistently outperform the market, assuming the same risks, and securities markets would not be efficient.