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Welcome back.

Thank you for joining me again.

So in the previous two lectures,

we looked at the main premise of the efficient market hypothesis.

As well as some examples that illustrate how prices

quickly react to reflect new information.

In this lecture, we're going to go a little deeper and discuss the different

forms of the efficient market hypothesis and what implications they have.

Now typically, it is common to distinguish

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Well, the weak form of the efficient market hypothesis states

that prices reflect all marketing data.

Now what is marketing data?

Well, it's things like past prices, trading volume, or short interests, right?

So basically, this version of the hypothesis implies that you

can't predict future prices by looking at past prices or past volume, right?

So what does this mean?

Well, this means for example, that trend analysis is completely useless, right?

If markets are weak form efficient, you can't use any past trading data,

price or volume data, that is publicly available and virtually costless

to obtain to predict future stock prices or future performance, right?

And if such data were able to predict future prices,

then all investors would have already exploited those signals, and

therefore that information would already be reflected in the prices, okay?

So that's the weak form of the efficient market hypothesis,

where the available information just is the market information price data, right?

Now, what about the second form?

Well, the second form,

the semi-strong form of the efficient market hypothesis states that all

publicly available information should already be reflected in prices.

Now, what do we mean by publicly available information?

Well now, in addition to the past market trading data that I mentioned, think

of all the information that is available about a company that is public, right?

Its accounting data, its financial data, fundamental data, its patents,

product line, earnings forecast.

Anything you can find out about a company in the public domain.

So if markets are semi-strong efficient, one should not be able to predict prices

based on any such public data because that would already be reflect in prices, okay?

All right, so finally, the strong-form of the efficient marketing hypothesis.

All right, that one states that prices reflect all information that is relevant.

Public and including all information that is available only to company insiders.

Now clearly, right?

You can see that this is a very tall order, right?

And this version of the hypothesis is very extreme.

Now, undoubtedly, company insiders are likely to have

valuable information that is not public and

that will allow them to profit from their information, right?

And in fact, the ACC in the US tries to prevent exactly this kind of situation

where insiders can exploit their private information to profit, right?

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All right, so what does this all mean for investors and

for how to pick investment opportunities, right?

Well, let's start with technical analysis, right?

So what is technical analysis?

Or you may have heard of it, it is basically the search of,

the search for predictable patterns in stock prices, right?

So technical analyst study charts of past stock prices,

hoping to find patterns to find profitable opportunities.

Well, if markets are efficient even its weakest form,

then this implies that technical analysis is completely useless.

Right, because you can't predict future prices based on past prices.

Suppose an analyst does spot a profitable trading rule.

Would it continue to work in the future once it becomes widely recognized, right?

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Well, fundamental analysis, of course, relies on careful study

of the firm's financials past earnings, its economic environment,

its competition with the industry in the hope of coming up with some

future forecasts of the firm's future performance, right?

And the analysis is, if the discounted value of all the cash flows that

a stockholder is expected to receive is higher than the current market price,

then the fundamental analyst would recommend a buy.

Okay, so what does the efficient market hypothesis say about that?

Well, the efficient market hypothesis in its semi-strong form would

imply that most fundamental analysis is also pretty useless, right?

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Okay, well, so

far it appears that efforts to pick stocks by predicting future prices is not

very useful as competition among investors is likely to ensure

that any useful information will already be reflected in market prices, right?

So then what should you and I,

individual investors with limited resources do, right?

Well, you're probably thinking, well,

how about investing in actively managed mutual fund portfolios, right?

Surely the manager of these large mutual funds have the resources and

the ability to uncover mispriced stocks, right?

But then the question becomes,

will this pricing be sufficient to cover the fees for their services?

8:20

Right? This is because the efficient market

hypothesis indicates that prices are already at their fair value, right?

Given all the available information, and

therefore it makes no sense to try to buy or sell individual securities.

So one example of passive investment strategy would be to invest

in an index fund, right?

That is a fund that is created to replicate the performance of a broad base

market index such as S&P 500.

Okay, so in this lecture, we discussed the three different forms of the efficient

market hypothesis, the weak form, the semi-strong form, and the strong form.