Can you really predict share prices? The Efficient Market Hypothesis says you can’t!
Fsp Invest, 07 Jan. 2014
Tags: emh, efficient market hypothesis, price movements of financial instruments, can i consistently make money from the stock market, how to make money from the stock market, meaning of stock market anomalies, behavioural finance, predict share prices, share prices
In stark contrast to both fundamental and technical analysis — which both believe you can predict price movements — proponents of the Efficient Market Hypothesis (EMH) believe you can’t actually predict how share prices will move. Here’s why…
Proponents of the EMH believe share prices adjust to all information as soon as it becomes available. Due to this, neither existing nor past share prices will be any help in predicting the future.
And this gives rise to a very controversial question…
Are the price movements of financial instruments predictable or random?
Well, according to the EMH, financial instrument prices fully reflect all the available information…
What this means is that price movements are totally random and don’t follow any trends or patterns.
If the EMH is correct, it renders both fundamental analysis and technical analysis useless.
Because it is impossible to beat the market.
So does the EMH mean I can’t consistently make money from the stock market?
Well, there are a number of challenges to the EMH. They suggest it doesn’t take into account the full picture.
The existence of stock market anomalies is one of them. These are widely known and inexplicable patterns in asset prices. An example is the ‘January Effect’, which shows that you can get higher returns in January than at any other times of the year…
Another challenge to the EMH comes from behavioural finance, which shows that there are underlying psychological factors underlying investors’ decisions…
All this suggests that the EMH might be off and it is possible to consistently make money from the markets.
So, there is hope yet.
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