United States
Hong KongThe efficient market hypothesis, in three forms
Weak form says past prices are already reflected, so technical analysis cannot add value. Semi-strong adds all public information, ruling out fundamental analysis. Strong form adds private information, ruling out even insider advantage.
Three forms, each including the ones before it, and each ruling out a specific activity.
| Form | Prices reflect | Rules out |
|---|---|---|
| Weak | All past price and volume data | Technical analysis |
| Semi-strong | All publicly available information | Fundamental analysis as well |
| Strong | All information, public and private | Insider trading advantage as well |
The pattern is cumulative. Semi-strong efficiency implies weak; strong implies both.
What each rules out
Weak form efficiency means charts do not help, because past prices are already in the price.
Semi-strong means published information does not help either. By the time you read an earnings report, the price has moved.
Strong form means even private information does not help, which almost nobody believes - insider trading is prosecuted precisely because it works.
Markets are generally treated as broadly semi-strong efficient, with documented exceptions. That is the position the exam takes, and it is why passive management is the default recommendation without active management being ruled out.
The anomalies
- The small-firm effect - smaller companies historically outperforming on a risk-adjusted basis.
- The value effect - low price-to-book stocks outperforming.
- The January effect and other calendar patterns.
- Momentum - recent winners continuing to win over medium horizons.
- Post-earnings-announcement drift.
- Overreaction and underreaction to news.
Each is evidence against strict efficiency. Each has also weakened after publication, which is itself an argument for efficiency - the market absorbed the finding.
What it means for a planner
If markets are broadly efficient, costs and taxes are the reliably controllable variables. That is the argument for low-cost index exposure as a core.
It is not an argument that active management is never appropriate - less efficient corners of the market, tax management and specific client constraints all support it. The exam wants a defensible position rather than an ideological one.
Where behavioral finance comes in
The efficient market hypothesis assumes rational investors. Behavioral finance documents systematic irrationality - overconfidence, anchoring, loss aversion, herding.
The reconciliation is that individual irrationality does not guarantee exploitable mispricing, because arbitrage has limits. Both bodies of work are examined, and the Psychology of Financial Planning domain now carries the second.
Dollar limits and rate thresholds here are indexed annually. Confirm the current figure before relying on it, and expect the exam to test the rule rather than the number.
Common questions
What are the three forms of market efficiency?
Weak form, where prices reflect all past price data; semi-strong, adding all public information; and strong form, adding private information as well. Each includes the ones before it.
What does semi-strong efficiency rule out?
Both technical and fundamental analysis. By the time public information is available, the price has already adjusted for it.
Does anyone believe in strong form efficiency?
Almost nobody. Insider trading is prosecuted precisely because private information does produce an advantage.
What are market anomalies?
Documented patterns inconsistent with strict efficiency - the small-firm and value effects, calendar patterns, momentum and post-earnings drift. Most have weakened after publication.
What does market efficiency mean for advice?
That costs and taxes are the reliably controllable variables, which supports low-cost index exposure as a core. It does not rule out active management in less efficient areas or for specific client constraints.