Methodology

Stocks

Module 3

Semi-Strong Form Efficiency

Semi-strong form market efficiency is basically a hybrid version of weak form and strong form market efficiency. It is considered to be the most accurate when it comes to the efficiency of developed markets.

Semi-strong market efficiency assumes that there is a short delay when new information is accounted for in the stock market. This provides investors with a short window of time to gain an advantage.

Semi-strong market efficiency suggests that stock prices account for all publicly available information, not information that is held privately.

For that reason, semi-strong market efficiency assumes that the only way to make above-average returns is to obtain and utilize private information. Investors that don’t, are at a disadvantage. 

Consequently, investors that obtain private information within that short delay, can gain an advantage.

Semi-strong form efficiency in practice

In practice, semi-strong form efficiency offers the best explanation of how stock markets behave, as it states that investors can gain an advantage by using information.

The main concept of there being a delay before information is fully priced into a stock, is widely observed in the stock market.

This often happens as investors react to information at different speeds. Many investors will follow an active approach, reacting quickly to new information, while others will follow a more passive approach, reacting more slowly to the same information.

The best illustration of this is the fact that stock market data usually follows a gradual trend. If there was no delay in the pricing of new information, stocks would jump to the peak of a trend immediately.

Drawbacks of the Market efficiency forms

The main issue with all of the forms of market efficiency, is that they ignore the fact that stock prices are influenced by speculation.

It is common for a stock to react negatively to positive news, with investors having previously over-estimated the performance of the company.

In addition, all forms of market efficiency assume that investors are the same, in terms of their rationality, skill and interpretation of information. In reality, however, they are all different.

The return that an investor achieves is not only about information, it is also about their experience, ability to analyse relevant information and to handle risk.

Behavioural analysts would suggest that stock prices more so change in response to the fear and greed of investors, which negatively influence their investment decisions. Therefore, information may be overly (or under) priced into a stock, which is something that the market efficiency forms do not consider.

Although, semi-strong efficiency is recognised as being the most accurate form of market efficiency, the emphasis placed on private information provides a limited explanation of how stock prices change.

Investors use different strategies effectively, with some using no company-related information at all – namely day traders or swing traders, who use stock market data to identify patterns.

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