Weak Form Efficiency
Categories: Financial Theory
It’s a common misconception that if you keep flipping a quarter, the probability with change. For instance, if you get tails five times in a row by flipping a fair coin, you might think you’re more likely to get heads next time...but you’d be wrong. The chances are still 50/50.
It's the same idea with weak form efficiency, but with stocks. Weak form efficiency, also known as random walk theory, states that past data on stocks (recent price movements, earnings data, volume, etc.) can’t and shouldn’t be used to predict the direction of the stock in the future.
Weak form efficiency is one of three pillars in the “efficient market hypothesis,” which purports that all stocks are sold at fair prices. In other words, there’s no capturing an “undervalued” stock, or getting ripped off for a too-low sale price. Prices reflect the information at hand, and using technical analysis or fundamental analysis can really help us predict the future of stocks.
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