efficient market hypothesis
The theory that financial markets are informationally efficient — stock prices reflect all available information, making it impossible to consistently beat the market.
Example
“The efficient market hypothesis suggests active stock picking is futile — all known information is already priced in.”
Memory Tip
EMH = you can't beat the market because prices already reflect everything. Evidence favors passive investing.
Why It Matters
Understanding the efficient market hypothesis helps you make better investment decisions by recognizing that trying to consistently beat the market through stock picking or timing is extremely difficult. This concept encourages many people to invest in low-cost index funds rather than paying high fees to active managers who claim they can outperform the market.
Common Misconception
Many people believe that the efficient market hypothesis means you cannot make money in the stock market or that all investors are equally skilled. In reality, the theory only suggests that consistently beating the market over long periods is very hard, not impossible, and individual investors can still build wealth through disciplined investing strategies.
In Practice
If a company announces unexpectedly high earnings, the efficient market hypothesis suggests the stock price will quickly adjust to reflect this news within seconds or minutes rather than days. For example, if a tech company reports 50 percent higher profits than expected, investors cannot reliably profit from buying the stock after the announcement because the market will have already incorporated this positive information into the price.
Etymology
EFFICIENT (optimally processing information) MARKET (financial market) HYPOTHESIS. The HYPOTHESIS that MARKETS are EFFICIENT.
Common Misspellings
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Related Terms
More in markets
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See Also
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