EMH Vs. Fundamental and Technical Analyses

EMH Vs. Fundamental and Technical Analyses

There are three broad theories concerning stock price movements. These are the fundamental analysis, technical analysis and efficient market hypothesis. Fundamental analysts believe that by analyzing key economic and financial variables they can estimate the intrinsic worth of a security and then determine what investment action to take. Fundamental analysis seeks to identify under priced securities and overpriced securities. Their investment strategy consists in buying under priced securities and selling overpriced securities, thereby earning superior returns.

A technical analyst maintains that fundamental analysis is unnecessary. He believes that history repeats itself. Hence, he tries to predict future movements in share prices by studying the historical patterns in share price movements.

The efficient market hypothesis is expressed in three forms. The weak form of the EMH directly contradicts technical analysis by maintaining that past prices and past price changes cannot be used to forecast future price changes because successive price changes are independent of each other. The semi-strong form of the EMH contradicts fundamental analysis to some extent by claiming that the market is efficient in the dissemination and processing of information and hence, publicly available information cannot be used consistently to earn superior investment returns.

The strong form of the EMH maintains that not only is publicly available information useless to the investor or analyst but all information is useless.

Even though the EMH repudiates both fundamental analysis and technical analysis, the market is efficient precisely because of the organized and systematic efforts of thousands of analysts undertaking fundamental and technical analysis. Thus, the paradox of efficient market hypothesis is that both fundamental and technical analyses are required to make the market efficient and thereby validate the hypothesis.