What is Market Efficiency?

Market efficiency is the degree to which stock prices reflect all available information.

How Does Market Efficiency Work?

In general, there are two kinds of market efficiency. strong-form efficiency and weak-form efficiency. The weak form of market efficiency states that public information will not help an investor or analyst select undervalued securities because the market has already incorporated the information into the stock price. Strong-form efficiency states that no information, public or inside, will benefit an investor or analyst because even inside information is reflected in the current stock price.

Why Does Market Efficiency Matter?

The strong form of market efficiency essentially proclaims that it is impossible to consistently outperform the market, particularly in the short term, because it is impossible to predict stock prices. This may be controversial, but by far the most controversial aspect of market efficiency is the claim that analysts and professional advisors add little or no value to portfolios, especially mutual fund managers (with the notable exception of those managing funds that take on greater risks), and that professionally managed portfolios do not consistently outperform randomly selected portfolios with equivalent risk characteristics.