Eco 561 - Efficient Market Theory - Efficient Market Theory Vs Fundamental and Technical Analysis

Efficient Market Theory

Jose

ECO/561

April 06, 2015

Mrs. Levitt

Efficient Market Theory

According to the definition that explains the Efficient Market Theory, “all market participants receive and act on all of the relevant information as soon as it becomes available.” (investorwords.com). The Theory is based on the price of the stock that is somehow ruled on the stock’s price for such market.  However, most investors hardly believe in this theory because most investors trust their basic instinct in their marketing investing experience instead of the Efficient Market Theory.  The only reason why EMT is considered as a strong stepping stone in the finance stock market is because it has support from investors that believe it works, and since it is a theory, some investors believe that it can be an effective way to interpret the market behavior.

Efficient Market Theory VS Fundamental and Technical Analysis

Most investors who believe in the Efficient Market Theory argue that they can predict how the stock will be affected based on the information that is shared about the market.  These Investors do not believe that the market can be affected or predicted based on the past and present market behaviors^[1].  Furthermore, investors that believe in the Efficient Market Theory believe that there are three models that overcome the technical and fundamental market analysis.  The first one is the “week efficiency, which holds that technical analysis is ineffective, semi-strong efficiency, which holds that fundamental analysis is ineffective, and strong efficiency, which states that even insider information is immediately reflected in the security prices.”(Financial-dictionary.thefreedictionary.com).  In fact, in an article for Minyanville’s business news, David Waggoner states that  “American academic institutions of higher learning expelled technical analysis from school and labeled it heresy in the 1970s based on the Efficient Market Hypothesis (or EMH)” (minyanville.com).  Furthermore, he points out that the Efficient Market Hypothesis has made the Technical analysis obsolete.

On the other hand, investors that do not rely in the Efficient Market Theory argument that this theory is not as reliable as it is portrayed to be.  For instance, Warren Buffet is one investor that beats the market using technical and fundamental market analysis.  In the technical and fundamental analysis the stock trends behavior from the past and present helps the investor to assert the stock market behavior.  Critics that do not support the Efficient Market Theory strongly believe that “The implication is either that some people have better information than others or that some people are better at interpreting information than others. This notion is supported by research in market movements and behavioral finance, which both show that stock prices don't always reflect economic value. While EMH remains an important hypothesis in the financial literature, it has lost traction recently.”(investopedia.com)