Efficiency Of Market Efficiency

1.0 Introduction

Efficient market hypothesis theory is a well-known theory in real life. This theory had proposed by Eugene Fama in 1960. He suggested that a market considered to be efficient when a price of a stock is quickly and fully reflects all available information. It means that the stock price of a company reflects the performance of a company itself. The greater the performance of that particular company, the higher the price of a stock. Likewise, the stock price belong to Dutchlady is reportedly that purchasing cost is at higher price and giving out higher return every year. The reason behind the scenario is simple. As long as human still consuming dairy product from Dutchlady, the demand will keep on increasing. Therefore, Dutchlady is able to maintain its production successfully until now. And they have the right to set the stock price at higher price since they perform very well in their business. Back to reality, even though the stock price reflects all the information, it is still impossible for investors to outperform the market. No one get to earn extra profit from stock trading activities when market is efficient.
However, there are numerous of factors affecting the market efficiency. The factors are number of market participants, availability of information, limits to trading (arbitrage), transaction costs and information costs.
The broad term of market efficiency can be categorised into three forms of market efficiency: weak form, semi-strong form, and strong form. These three different forms of market efficiency were retrieved from one of Fama’s famous paper titled “Efficient Capital Markets: A Review of Theory and Empirical Work”, conducted by Eugene Fama in 1970. In a weak-form efficient market, future r...

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...from the field of psychology that people tend to make systematic cognitive errors when forming expectations. One such error that might explain overreaction in stock prices is the representative heuristic, which holds that individuals attempt to identify trends even where there are none and that this can lead to the mistaken belief that future patterns will resemble those of the recent past. On the other hand, momentum in stock returns may be explained by anchoring, the tendency to overweight initial beliefs and underweight the relevance of new information. It follows that momentum observed over intermediate horizons could be extrapolated over longer time horizons until overreaction develops. This does not, however, imply any easily exploitable trading strategy, because the point where momentum stops and overreaction starts will never be obvious until after the fact.