Module 3

What is unsystematic risk?

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Strong Form Efficiency

Strong Form Efficiency

Strong form market efficiency believes that all relevant information is fully accounted for in stock prices, regardless of whether the information is publicly available or not.

This means that the value of the stock mirrors the true value of each company with full efficiency. This implies that there is no advantage to be gained through research as all information is already priced in.

Strong market efficiency suggests that even illegal insider information isn’t useful in terms of gaining an advantage in the market because that information is already accounted for.

Those that believe in strong form market efficiency suggest that the best approach when investing in stock is to simply buy and hold stocks to get the best return.

Strong Form Efficiency in practice

In practice, there could be cases where strong form efficiency is correct.

For example, an executive of a company may decide to use insider information to buy stock in their own company, especially if they know that a new product will be launched soon that will increase the stock price (or a similar situation). 

However, it could be the case that once the product is released that nothing happens. This is influenced by the popularity of the stock as well as how investors react to the new product.

If they are not sure about the product, either positively or negatively, then the stock price would remain unchanged. This would suggest that the insider information has already been priced into the stock of that company.

This example highlights a key drawback of strong form efficiency, where it assumes that the investors of a company fully understand the products of the company and what makes them successful or not. This is not necessarily the case for all stocks.

Likewise, a stock may not be particularly popular, meaning that the stock price doesn’t move in the direction that is expected, due to a lack of interest. This is known as the neglected stock effect.

Fundamentally, in reality, investors do not have access to insider information. Even if some of them did, millions of people buy and sell stocks, which would mean that it wouldn’t have such a significant impact on stock prices, like strong form efficiency suggests.

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