The three forms
Weak form: prices reflect all historical price and volume data. Technical analysis — using past price patterns to predict future moves — cannot generate consistent alpha. Evidence: strong. Studies consistently find that past price patterns do not reliably predict future returns beyond what chance would predict. Semi-strong form: prices reflect all publicly available information (earnings, news, analyst reports). Fundamental analysis using public information cannot consistently generate alpha. Evidence: mostly strong, with important exceptions (value and momentum anomalies). Strong form: prices reflect all information, including private (insider) information. Evidence: weak — insider trading studies show insiders do earn abnormal returns, suggesting markets are not strong-form efficient.
Anomalies that challenge EMH
Several persistent patterns contradict the semi-strong form. The value premium: cheap stocks (low P/B, low P/E) have historically outperformed expensive ones over long horizons — difficult to explain in a fully efficient market. The momentum effect: stocks that have risen in the past 3–12 months tend to continue rising — a direct contradiction of weak-form efficiency. The size effect: small-cap stocks have historically outperformed large-caps on a risk-adjusted basis. The post-earnings announcement drift (PEAD): stocks continue to drift in the direction of an earnings surprise for weeks after announcement — if markets were efficient, this information would be instantly priced.
The rational response: Fama-French and risk-based explanations
Fama and French argued that anomalies can be reconciled with efficiency if the additional returns compensate for additional risk that is not captured by the simple CAPM model. The value premium, they argued, reflects the distress risk of cheap companies — they are cheap for a reason, and their higher returns compensate for the higher probability of financial failure. This "risk-based" interpretation preserves EMH by redefining risk more broadly. Behavioural economists, conversely, argue that anomalies reflect cognitive biases (loss aversion, anchoring, overconfidence) that create systematic mispricings that take time to be arbitraged away.
“The curious fact is that markets are mostly efficient — just not perfectly so. And that thin margin of inefficiency is the most contested territory in finance.”
What this means for you
The practical investment implication of EMH is not binary. Markets are efficient enough that most active stock-picking by most people most of the time will not outperform the index after costs — which justifies passive investing as the default. But they are not so efficient that all price signals are meaningless: factor investing (value, momentum, quality, low volatility) has delivered persistent excess returns that survive transaction cost analysis. The honest answer is that markets are efficient most of the time for most participants, with exploitable inefficiencies at the margins for sophisticated investors with information advantages, lower transaction costs, or genuine analytical edge.