Market Efficiency

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Definition of 'Market Efficiency'

Market efficiency is a theory in economics that states that asset prices reflect all available information. This means that no investor can consistently outperform the market by trading on information that is not already reflected in prices.

There are three main types of market efficiency:

* **Weak-form efficiency** states that all past prices of a security are reflected in its current price. This means that technical analysis, which attempts to predict future prices based on past price movements, is not profitable.
* **Semi-strong-form efficiency** states that all publicly available information is reflected in prices. This means that fundamental analysis, which attempts to value a security based on its financial statements and other publicly available information, is not profitable.
* **Strong-form efficiency** states that all information, both public and private, is reflected in prices. This means that even insiders with access to inside information cannot consistently outperform the market.

The efficient market hypothesis is a controversial theory. Some economists believe that it is a valid description of how markets work, while others believe that it is too simplistic and that there are opportunities for investors to profit from market inefficiencies.

There is some evidence to support the efficient market hypothesis. For example, studies have shown that technical analysis is not profitable in the long run. However, there is also evidence that investors can sometimes outperform the market, even after taking into account transaction costs. This suggests that there may be some market inefficiencies that can be exploited by investors.

The efficient market hypothesis has important implications for investors. If the market is efficient, then it is impossible to consistently outperform the market by trading on information. This means that investors should focus on investing for the long term and should not try to time the market.

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