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What is Stock Market Efficiency?

EfficiencyStock market efficiency is a stock market concept that reveals , that no investor can make abnormal returns in a stock market and all publically available information and news are reflected by the prices of the shares. This concept is based upon the efficient market hypothesis and random walk model. Random walk model refers to the spread of information. For instance, all the information will be randomly inserted in the market leaving no room for the investors to make any abnormal or over the mark returns through share trading. However a fewer markets follow the above mentioned phenomenon. Many markets including African and South Asian markets have even failed to prove the least influential form of efficiency in the market. Be remembered, here we are discussing about informational efficiency of the capital markets.

There are three pertinent forms of market efficiency i.e., Weak form, semi strong and strong form of efficiency. Details are as follows:

1. Weak Form of Efficiency

It reveals that there is no investor in the market who could be able to make excess returns or abnormal capital gains by using historical data or previous returns’ summary. This elucidates that technical analysis will not be able to beat the market. No investor can even be able to get distinguished on the basis of technical analysis skills as all the previous information has already been reflected through the spot price of a share as per provided by Efficient Market Hypothesis rules.

2. Semi Strong From of Efficiency

No investor can make excess returns on the basis of publicly available information. All the investors are assumed to have equal access towards the publicly available information. Information disseminates and walks randomly in the market, resultantly, one can easily judge the impact of news and information through the share price. No investor can enjoy the fruit of Fundamental Analysis if semi strong form of market efficiency prevails.

3.Strong Form of Efficiency

All public and private information is assumed to be reflected through the share prices. No investor is able to yield excessively on the basis of any information because all the information are randomly distributed in the market and has reflected through the share prices. Strong form of efficiency offers a very strict rule over here, i.e., insider trading is ineffective. Insider trading is done on the basis of insider information. For instance, somebody avails some information from board of director about the upcoming dividend announcement, in this way he gets an idea about upcoming share price rise of the said company. The person starts buying the shares till the dividend is announced and share price actually increases. In this way, the investor has made excess returns on the basis of insider information. It is rarely possible in the real world scenario because of increasing speculation and volatility.

If any of the above forms persists in the market, no speculation and no volatility issues will be observed. This is an ideal situation however. Weak form of market efficiency is somehow easier to implement but other two forms are only observed when the economy and market systems are fully regulated.

 

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About Emaad Qureshi