Efficient-market Hypothesis

A theory which states that equilibrium prices of and returns to bonds/stocks should reflect all past and current information plus traders' understanding of how market prices and returns are determined. As such it is impossible to "beat the market". According to the efficient-market hypothesis, stocks always trade at their fair value on the stock exchange, making it impossible for investors to either purchase undervalued stocks or sell stocks for inflated prices, making it very difficult to outperform the overall market.

The efficient-market hypothesis is highly controversial and often disputed. While academics point to a large body of evidence in support of the efficient-market hypothesis, an equal amount of dissension also exists. For example, investors, such as Warren Buffett have consistently beaten the market over long periods of time, which by definition is impossible according to the hypothesis. Detractors of the efficient-market hypothesis also point to events, such as the 1987 stock market crash when the Dow Jones Industrial Average (DJIA) fell by over 20% in a single day, as evidence that stock prices can seriously deviate from their fair values.

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