Free course · Module 9
Efficient Market Theory
If the news is public, who else has already acted on it? Learn what market efficiency claims, what it leaves uncertain and how to judge an apparent edge after costs.
Written by the StockEducation Editorial Team · Reviewed by Associate Professor Charles Lo, CPA, PhD · Updated 15 Oct 2026 · How we check lessons
Pick a topic to learn
Read in order, or return to the idea you need.
Idea 1 of 4
Start with what the market could know.
The efficient-market hypothesis asks whether prices reflect the information available to investors. Fama’s framework distinguishes past price information, public disclosures and private information. It concerns the difficulty of earning an advantage from an information set, not whether tomorrow’s price is known. Source 1.
The forms below define different questions to test. They are not permanent grades assigned to a stock, and they do not promise that an investment cannot lose money.
Past prices
Can historical price patterns provide a persistent advantage?
Public information
How do prices respond to public announcements and disclosures?
Private information
Is even privately held information already reflected in prices?
The strong form makes the broadest claim. It should not be assumed to describe actual markets.
Does efficiency mean every investor is rational or every price is perfect?
Name the information set before judging the claim.
Idea 2 of 4
A public headline is not a private advantage.
A correct headline may offer little advantage if others have already processed it. In this hypothetical example, a company publishes unexpected earnings news. Its share was $50 before the news and is later quoted at $55. Reading the same announcement later does not let you buy at the earlier price.
The change is observable; its cause needs investigation. Other news, market conditions and trading can also affect a price. There is no universal one-second adjustment rule, and a daily chart cannot establish the exact reaction time.
Is there still a reason to read company filings?
Public information can be useful without giving you a trading head start.
Idea 3 of 4
Compare what investors keep after costs.
Judge a strategy against a suitable comparison after costs. A higher headline return may reflect more risk, a different investment universe or an unusually favorable period. Fees and trading costs can also reverse a small apparent advantage.
Suppose Strategy A earns 10% before a cost drag of 2 percentage points. Comparison B earns 9% before a drag of 0.2 points. Their modeled net returns are 8% and 8.8%. A starts ahead before costs and ends behind afterward.
What does the original SPIVA comparison show?
What did Buffett’s ten-year wager establish?
A headline return is the start of a comparison, not the conclusion.
Idea 4 of 4
Test the edge you think you have.
Make an apparent edge survive a fair comparison. Use this local exercise to change gross returns and assumed cost drags. Then write which benchmark, risk exposures, dates and costs you would need before treating a real result as evidence of skill.
Compare one-period returns after costs
Hypothetical · no tradeA minus B: -0.8 percentage points
Net = gross return minus cost drag. One period; no tax, cash flows or risk adjustment. Inputs are assumptions, not forecasts.
- Start with the default. Explain why A wins before costs but loses afterward.
- Set both gross returns to 9% and both cost drags to 0.2 points. Explain why equal modeled returns do not establish equal risk.
- Choose a public performance claim. Record its benchmark, dates, information available at the time, risk and full costs. Note what is still unknown.
Use a chart to identify dated observations, not to claim an exact news reaction time from daily bars. This practice and the reading ticks do not record LMS completion.
Does one winner disprove efficiency, or one loser prove it?
Define the test before you look at the result.
Quick check
Three quick checks. Feedback straight away.
Which question belongs to a semi-strong-form efficiency test?
Choose an answer to see the explanation.
Does market efficiency mean a stock cannot lose value?
Choose an answer to see the explanation.
What is needed to judge an active strategy fairly?
Choose an answer to see the explanation.
Why can a true public headline offer little trading advantage?
Review your takeaway card and the learning path
- Name the information set. Past prices, public information and private information ask different questions.
- Separate information from an edge. Useful research does not automatically yield extra returns.
- Compare after costs and risk. A higher headline return can mislead.
- Keep the inference narrow. A wager, fund statistic or single trade does not settle an entire theory.
Reading markers and these practice checks stay on this device. They do not mark the LMS lesson complete.
Sources and assumptions
- Eugene Fama, Efficient Capital Markets: A Review of Theory and Empirical Work, 1970. Original Journal of Finance paper, hosted by HEC Paris. Traditional information-set framework.
- Eugene Fama, Efficient Capital Markets: II, 1991. Publisher research summary distinguishes past-return predictability, public-announcement studies and private-information tests, and discusses testing efficiency with a pricing model.
- S&P Dow Jones Indices, SPIVA U.S. Year-End 2023. Report 1a, printed page 10: ten-year All Large-Cap Funds 87.42% underperformance; methodology on opportunity sets and returns net of fees excluding loads.
- Berkshire Hathaway, 2017 shareholder letter. Printed pages 11 to 12, final 2008 to 2017 wager scorecard and fund D liquidation footnote. Reported cumulative gains, not annual returns or a universal active-manager result.
Sources checked 15 October 2026. SPIVA uses the original lesson’s period ending 2023; the wager ended 2017. These are dated examples, not current forecasts. Share prices, return scenarios and cost drags are hypothetical. General education only; no personal financial advice or native LMS completion is implied.
StockEducation provides general education, not personal financial, tax or legal advice. Nothing here recommends a specific security. Investing involves risk, including loss of money you invest.
