Definition of Efficient Market Theory

The Efficient Market Theory is a theory that states that the market operates and processes information efficiently and prices in all information as soon as it becomes known. Many market participants add to liquidity and as a result many pricing inefficiencies are eliminated.

Applying "Efficient Market Theory" to Securities Exams:

The efficient market theory takes three forms the weak, semi strong and strong form of the theory.

Weak-form efficiency – states that the future price of a security can not be predicted by studying the past price performance of the security. This form of the theory believes that technical analysis can not produce excess returns.

Semi-strong form efficiency – states that the market price of a security adjusts too rapidly to newly available information to achieve an excess return by trading on that information.

Strong-form efficiency – states that the current price of a security reflects all information known and unknown to the public and there is no opportunity to earn excess returns.

It is important to know these concepts for your exam. Each proponent of the theory believes that the market operates slightly differently regarding how information is processed. As a result the investors approach to market analysis and investing will be different.

Pay close attention to these topics in our textbook and exam questions. They are very reflective of what you will see on your exam.

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