Efficient market theory is the idea that stock prices are priced perfectly based on all available public information. Maybe you’ve heard of it?
Is Efficient Market Theory True?
The stock markets are as efficient as they can be, but stock values are not priced perfectly. From one day to the next, the market can take a big jump up or a big jump down based on very little information. Small amounts of information can have a big impact one way or another on individual stocks. There are so many things that can impact stock prices and very few of them have anything to do with reality.
Market participants do not tend to be rational. They act on fear, they act on greed. They act on information that has no relevance.
Efficient Market Theory And Fund Traders
There is also this thing with fund traders where if they start losing money they could lose their job. Often it’s best for them to do what other traders are doing.
Intrinsic Value In Efficient Market Theory
Intrinsic value of a stock (and the company behind it) and market value are two different things. True investors know the value of the companies they are buying and know that they are getting a good price.
What You Need To Know About Efficient Market Theory
There are opportunities to buy individual stocks or even index funds when the market price declines. And there are opportunities to sell when they are overbought. This would not be true if the market was efficient.
Because of this, it is important to value a company based on it’s financials, outlook, and management team rather than what the market thinks. Efficient market theory is just another theory to discard.
If you want to know how the market truly acts, check out this quote: “In the short run, the market is a voting machine, but in the long run it is a weighing machine” (https://quoteinvestigator.com/2020/01/09/market/)
Read more about efficient market theory:
- Efficient Market Hypothesis (EMH) – Investopia
- Efficient-market hypothesis – Wikipedia
- A Guide To Efficient Market Theory – SmartAsset