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Efficient Market Theory
The theory says that you can't beat Mr. Market because all information is already reflected in the stock price—that markets are in fact efficient and that new information pukes out into the marketplace like a burb in a small room. Think you can beat the market because you have some great information? Sorry, champ, but this theory claims that the information is already affecting the market because others know the info, too. Better luck next time.
There are three models of the efficient market theory: the weak form model, the semi-strong form model, and the strong form model.
- In the weak form model, past information about a stock isn't useful at all. The theory is that the current market value is the correct and best reflection of the value of the stock.
- In the semi-strong form model, new public information about a stock is instantly reflected in the price, so you can't gain an advantage by using public information.
- In the strong form model, even insider information is said to already be reflected in the market price.
Not everyone agrees with efficient market theory. They may point out that insiders can (and do) earn higher-than-average returns from trading their companies' stock. They might also point out that Warren Buffet has not only beat Mr. Market but has reduced him to a bloody pulp.
So there's that.