What Is Weak Form Efficiency?
Weak form efficiency claims that past price movements, volume, and earnings data do not affect a stock’s price and can’t be used to predict its future direction.
Weak form efficiency is one of the three different degrees of efficientmarket hypothesis (EMH).
Key Takeaways
- Weak form efficiency states that past prices, historical values, and trends can’t predict future prices.
- Weak form efficiency is an element of efficient market hypothesis.
- Weak form efficiency states that stock prices reflect all current information.
- Advocates of weak form efficiency see limited benefit in using technical analysis or financial advisors.
The Basics of Weak Form Efficiency
Weak form efficiency, also known as the random walk theory, states that future securities' prices are random and not influenced by past events. Advocates of weak form efficiency believe all current information is reflected in stock prices and past information has no relationship with current market prices.
The concept of weak form efficiency was pioneered by Princeton University economics professor Burton G. Malkiel in his 1973 book, "A Random Walk Down Wall Street." The book, in addition to touching on random walk theory, describes the efficient market hypothesis and the other two degreesof efficient market hypothesis:semi-strong form efficiency and strong form efficiency. Unlike weak form efficiency, the other forms believe that past, present, and future information affects stock price movements to varying degrees.
Uses for Weak Form Efficiency
The key principle of weak form efficiency is that the randomness of stock prices make it impossible to find price patterns and take advantage of price movements. Specifically, daily stock price fluctuations are entirely independent of each other; it assumes that price momentum does not exist. Additionally, past earnings growth does not predict current or future earnings growth.
Weak form efficiency doesn’t consider technical analysis to be accurate and asserts that even fundamental analysis, at times, can be flawed. It’s therefore extremely difficult, according to weak form efficiency, to outperform the market, especially in the short term. For example, if a person agrees with this type of efficiency, they believe that there’s no point in having a financial advisor or active portfolio manager. Instead, investors who advocate weak form efficiency assume they can randomly pick an investment or a portfolio that will provide similar returns.
Real-World Example of Weak Form Efficiency
Suppose David, a swing trader, sees Alphabet Inc. (GOOGL) continuously decline on Mondays and increase in value on Fridays. He may assume he can profit if he buys the stock at the beginning of the week and sells at the end of the week. If, however, Alphabet’s price declines on Monday but does not increase on Friday, the market is considered weak form efficient.
Similarly, let’s assume Apple Inc. (APPL) has beaten analysts’ earnings expectation in the third quarter consecutively for the last five years. Jenny, a buy-and-hold investor, notices this pattern and purchases the stock a week before it reports this year’s third quarter earnings in anticipation of Apple’s share price rising after the release. Unfortunately for Jenny, the company’s earnings fall short of analysts’ expectations. The theory states that the market is weakly efficient because it doesn’t allow Jenny to earn an excess return by selecting the stock based on historical earnings data.
Note
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FAQs
The weak form of EMH is the lowest form of efficiency that defines a market as being efficient if current prices fully reflect all information contained in past prices. This form implies that past prices cannot be used as a predictive tool for future stock price movements.
What is a weak form of efficiency? ›
Weak form efficiency refers to a market where share prices fully and fairly reflect all past information. In such a market, it is not possible to make abnormal gains by studying past share price movements.
What is a real world example of weak form efficiency? ›
If, however, Alphabet's price declines on Monday but does not increase on Friday, the market is considered weak form efficient. Similarly, let's assume Apple Inc. (APPL) has beaten analysts' earnings expectation in the third quarter consecutively for the last five years.
What is weak form efficiency in public information? ›
The weak form of the EMH assumes that the prices of securities reflect all available public market information but may not reflect new information that is not yet publicly available. It additionally assumes that past information regarding price, volume, and returns is independent of future prices.
What does the weak form of the efficient market theory contends that? ›
Answer and Explanation:
The weak form of the Efficient Market Hypothesis (EMH) contends that stock prices fully reflect all past market data, including historical prices and trading volumes, as well as all publicly available information.
What is weak form and example? ›
Weak forms are syllable sounds that become unstressed in connected speech. Weak forms are often then pronounced as a schwa. In the sentence below the first 'do' is a weak form and the second is stressed. What do you want to do this evening?
Is weak form efficiency true? ›
True: Market efficiency exists when prices reflect all available information. To be weak form efficient, the market must incorporate all historical data into prices. Under the semi-strong form of the hypothesis, the market incorporates all publicly available information in addition to the historical data.
What does weak form efficiency imply quizlet? ›
Weak form - market prices incorporate all of the information contained in historical price data. If markets are weak form efficient, then technical analysis cannot be used to generate excess risk-adjusted returns.
What is weak form method? ›
Weak form – an integral expression such as a functional which implicitly contains a differential equations is called a weak form. • The strong form states conditions that must be met at every material point, whereas weak form states conditions that must be met only in an average sense.
What is weak form efficiency CFA? ›
In the weak form, asset prices fully reflect all market data, which refers to all past price and trading volume information. In the semi-strong form, asset prices reflect all publicly known and available information.
A strong form of the governing equations along with boundary conditions states the conditions at every point over a domain that a solution must satisfy. On the other hand a weak form states the conditions that the solution must satisfy in an integral sense. A weak form does not imply "inaccuracy" or "inferiority".
What is an example of strong form efficiency? ›
Strong Form Efficiency can affect the market dynamics in more nuanced ways. For example, it supports the argument for passive investing – buying a diversified portfolio of stocks and holding it over the long run, instead of trying to 'beat the market' through active trading strategies.
What weak form of the efficient market hypothesis states that successive price changes are? ›
Answer & Explanation. The correct answer is "Successive price changes are independent." The weak form of the Efficient Market Hypothesis (EMH) posits that all past trading information, including historical prices and volume, is fully reflected in current market prices.
What is less efficiency? ›
If something is efficient, it's productive and inexpensive. Inefficient has the opposite meaning, which is clear from the "not" prefix in-. Definitions of inefficient. adjective. not producing desired results; wasteful.
What are the three forms of efficiency? ›
Three common types of market efficiency are allocative, operational and informational.
What are the forms of inefficiency? ›
There are three main forms of market inefficiency. These are allocative, productive, and informational inefficiency. Deadweight loss refers to the loss of total surplus, or consumer and producer benefits, as the marginal costs do not equal the marginal benefits in an inefficient market.
