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.
One of the three tiers of the efficient market hypothesis (EMH) is weak in efficiency.
The Basics of Weak Form Efficiency
The random walk hypothesis, commonly called weak form efficiency, postulates that future securities prices are spontaneous and unaffected by the past. Proponents of weak form efficiency contend that stock prices accurately represent all available information and that historical data has little bearing on current market values.
Professor of economics at Princeton University, Burton G. Malkiel, introduced the idea of weak form efficiency in his 1973 book “A Random Walk Down Wall Street.” The book discusses the efficient market hypothesis and its two variations, semi-strong and strong form, efficiency, and briefly touches on random walk theory. In contrast to weak form efficiency, the other forms hold that information from the past, present, and future influences stock price movements to differing degrees.1 Application in Weak Form Efficiency
The fundamental tenet of weak form efficiency is that it is hard to identify price patterns and profit from price fluctuations due to the unpredictability of stock prices. More specifically, it implies that there is no price momentum and that daily swings in stock prices are independent. Furthermore, profit growth in the past does not guarantee earnings growth in the present or the future.
Weak form efficiency maintains that even fundamental analysis may sometimes be inaccurate and rejects the accuracy of technical analysis. Consequently, weak form efficiency indicates that it is difficult to beat the market, particularly in the near run. If someone agrees with this efficiency, they could think having an active portfolio manager or financial counselor is unnecessary. Instead, proponents of weak form efficiency in investing believe they may randomly choose an investment or portfolio that will provide comparable returns.
A Practical Illustration of Weak Form Efficiency
Assume that Alphabet Inc. (GOOGL) consistently decreases in value on Mondays and rises on Fridays. David is a swing trader. If someone purchases the stock at the start of the week and sells it at the conclusion, he could believe he can make money. However, the market is seen as weak or inefficient if Alphabet’s stock drops on Monday but does not rise on Friday.
Similarly, Apple Inc. (APPL) has, for the past five years, exceeded analysts’ estimates for earnings in the third quarter. A week before Apple releases its third-quarter results this year, Jenny, a buy-and-hold investor, recognizes this trend and buys the shares, betting that the company’s share price will rise after the announcement. Jenny is unfortunate since the company’s profits are lower than analysts predicted. The theory claims that the market could be more efficient because Jenny cannot choose the company based on past earnings data and make an extra return.
Conclusion
- Weak form efficiency asserts that historical values, trends, and previous prices do not indicate future pricing.
- A component of the efficient market hypothesis is weak form efficiency.
- According to weak form efficiency, stock prices accurately represent all available information.
- Strong form efficiency proponents believe financial counselors or technical analysis have little value.
