What it means
The idea is one of three levels of the Efficient Market Hypothesis, which Eugene Fama reviewed in a 1970 paper in the Journal of Finance. The weak form says prices already reflect past prices and volume.
The strong form says prices reflect all information, public and private. The semi-strong form sits in the middle.
It says that prices reflect everything that is public, such as earnings reports, news, filings and economic data. Investopedia notes that, under this view, neither fundamental nor technical analysis should produce superior returns.
The test is how fast prices move after news. In an event study, researchers measure the abnormal return, which is the actual return minus the return the model expected.
If the whole move happens at the announcement and no drift follows, the market looks semi-strong efficient. The form does not claim prices are always right.
It claims that prices change when new information arrives, and that the change cannot be predicted from public data in advance, so a surprise can still be a big move, up or down. It also does not cover non-public information, and Investopedia says the form cannot explain the effect of material non-public information on prices.
That is why insider trading rules and fair disclosure rules exist, and in the US the SEC's Regulation FD addresses selective disclosure of material information by public companies. The evidence is mixed: many studies find that large, liquid stocks react within minutes, while anomalies such as post-earnings drift and bubbles raise doubts.
Investopedia notes that the 2008 financial crisis led many people to question the theory. For an ordinary investor the practical lesson is about costs, since if beating the market with public data is hard, low-cost diversified funds look attractive.
Fees, taxes and trading costs also reduce what an active investor keeps. Evidence differs across countries, and small or thinly traded markets can be less efficient.
In practice
Real-world examples.
Example
A fictional stock trades at $10 before an earnings call. A news report says business has suffered, and the price opens at $8 the next day, a fall of 20%. After the call, positive results lift it to $11, which is 37.5% above $8.
Example
On the day of the news the market rises 1% and the stock has a beta of 1, so the expected return is 1%. The stock actually falls 20%. The abnormal return is -21% (-20% minus 1%).
Example
A fictional active fund earns 1% a year above its benchmark before costs, and charges a 1% fee. The net outperformance is 0%. Under semi-strong efficiency, public-data skill is hard to find, and costs often absorb what is found.
Formula
Calculation
Abnormal return = Actual return - Expected return. With -20% - 1% = -21%.
Expected return (market model) = Alpha + Beta x Market return. With beta of 1 and a market return of 1%, the expected return is 1%.
Net excess return = Gross excess return - Fee. With 1% - 1% = 0%.
Worked event-study example with invented figures. A stock trading at $50 announces strong earnings, and its abnormal return on the announcement day is +6.0%, which lifts the price to $50 x 1.06 = $53. Over the next five trading days the abnormal returns are +0.2%, -0.1%, +0.1%, -0.2% and 0.0%, which sum to 0.0%. The cumulative abnormal return over the six days is 6.0% + 0.0% = 6.0%, all of it earned on the announcement day, so there is no drift for a late buyer to capture, which is what semi-strong efficiency predicts.Case study
Seen in the real world.
This case study is fictional and illustrative. Chloe, 39, in Sydney, reads an earnings report an hour after release and sees a profit rise of 25%. She wants to buy the stock before it climbs. She finds that the price has already jumped 8% since the release.
She wonders whether the information was priced in within minutes. She checks that she has no inside information and that the data is public. She decides not to chase it, and she keeps her index funds instead. Months later the stock is back near its old price.
She decides the lesson is to avoid acting on news that everyone already has, and she puts her effort into costs and saving instead. Chloe also compares what she would have paid in trading costs and tax with the small gain she hoped to capture. On a $10,000 purchase, a 0.5% round-trip cost is $50, which would have eaten a large part of any further move. In this illustrative story, the cost comparison does as much to settle the decision as the theory does.
Watch out
Common mistakes.
- Believing that reading public news gives a reliable edge when others read it at the same moment.
- Confusing semi-strong efficiency with the claim that prices are always correct.
- Trading on material non-public information, which breaks laws in many countries.
Questions
People also ask.
What is semi-strong form efficiency?
It is the view that prices adjust quickly to all public information, so public data cannot reliably beat the market.
How does it differ from weak and strong forms?
The weak form covers past prices and volume. The strong form covers all information, including private. The semi-strong form covers public information.
Does it mean investors cannot make money?
No. Investors can earn the market's return. The idea says beating it consistently with public information is hard.
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