The Efficient Market Hypothesis
Why you can't beat the market.
Before you pick your first stock,
somebody smarter already did.
of active fund managers underperform the S&P 500 over any 20-year stretch.
per year: how much randomly-picked stocks beat the index.
Research Affiliates, monkey simulationhow fast major news is typically priced into a stock.
What EMH actually claims
In an efficient market, asset prices already reflect all available information, so consistently beating the market through stock-picking or market-timing is effectively impossible.
The stock you think is undervalued? Thousands of professionals already looked. The price is the answer.
How prices absorb information
Thousands of traders react in seconds. Price moves to its new equilibrium almost instantly.
By the time you read the headline on your phone, the price has already moved.
Meet Eugene Fama
His core question, from day one: can anyone actually predict tomorrow's prices?
Fama proposed three versions,
each stronger than the last
Weak form: the past doesn't
predict the future
You cannot predict tomorrow's price by staring at yesterday's chart.
Any pattern is either random, or already exploited by someone faster than you.
Semi-strong: public info
is already priced in
Reading Apple's annual report won't help you. Everyone has read it.
Earnings, news, analyst reports: the second it's public, it's in the price.
Strong form: even insider
info wouldn't help
The CEO, the auditor, and the janitor: all already priced in.
The most extreme version. Fama himself doesn't fully defend this one.
Insiders consistently outperform. That's why trading on inside info is a crime, it actually works.
Tomorrow's price is a coin flip
away from today's
Each step is independent of the last. Try to spot a pattern; there isn't one.
The index fund boxes
pro stock-pickers
Over any 20-year period, roughly 90% of actively-managed funds fail to beat a dumb index fund, after fees.
Source: S&P SPIVA reports, 2000–2024.
News becomes price, in seconds
Earnings drop
Algorithms react
Hedge funds positioned
You see the headline
Your "edge" from reading the news is effectively zero.
Except… these anomalies
keep showing up
Bubbles are hard to square
with efficient pricing
Behavioral finance:
are markets rational, too?
EMH does not require every individual to be rational.
It only needs the market in aggregate to price things correctly; arbitrageurs correct the mistakes of irrational traders.
do these biases survive aggregation, or get arbitraged away?GameStop, January 2021
A dying brick-and-mortar video game store. No new products. No new revenue. No change in fundamentals.
A Reddit forum coordinated. Retail traders overwhelmed hedge funds. Melvin Capital lost $6.8B.
Hard to argue prices reflected rational valuation of future cash flows.
The verdict: partially efficient
Markets aren't perfectly efficient, but they're efficient enough that consistently beating them is one of the hardest jobs on earth.
What EMH means for
a high school trading club
You are competing against Stanford PhDs with $50M/year in compute, direct lines to exchanges, and 25 years of experience.
On a short-term stock-picking basis, you will lose.
You don't have to beat the market. Just owning it for 40 years outperforms 90% of professionals.
Compounding is the only free lunch on Wall Street.
Three rules to trade by
Questions?
Or rebuttals, or confessions of being a closet index-fund investor.