1) The price of the stock is determined by demand and supply. The supply is based on a number of shares issued by a company. Demand is created people who need to buy the shares if demand of the share price increase means that share price is going up so the investors need to pay more for it. If the stock is limited then the investors can only buy from previous owners.so if one person wants the share the other need to prepare to sell.
Prices go up until the demand of share price. When the price goes up no one need stocks so it started to fall.2) When we are going to choose a share we need to look the business and products of a company and also looks at its accounts, Earning per share and prospective dividends. Other factors such as inflation rate, currency level interest rate and consumer demand. Additionally the competitors are examined along with the efficiency of management.
This analysis is called as a fundamental analysis this concentrates on the true value of the company. The company accounts reflect the true value of information better than economic information. Concern with the movement of share prices in the past to try to predict the future price, known as a “technical analysis”. The main point here is to identify patterns and to deduce there is likely to be any significant movements. This analysis not concentrates on efficient management .it also known as” Chartism”. Random walk hypothesis, Serial correlation tests, run tests and filters tests are made by investors in the technical analysis.Fundamental analysis helps the investors to pick the undervalue shares and make abnormal returns.
eg-P/E ratio, merger/acquisition. Market efficiency and in efficiency determined by the investors based on the interpret ion information better. The technical analyst main purpose is to find the inefficiency in the market and make abnormal profits. E.g.
-January Affect, inefficiency in the market in particular time.3) The majority of shareholders objective is to earn more returns by investing the right money into the right company. But in the efficient market it is prevent to get more returns by investing, because it reflects all available information. The price of the share change in 3 different ways past (technical analysis), public (reports) and private information. These all information reflects in the efficient market. (fama).
Fama explain market efficiency through based on three different form of investment approaches.(Weak,Semi-strong,Strong) efficiency markets.In weak form efficiency Share prices fully reflect all information contained in past Share prices movements.
pt=p(t-1) +expected return +random error, So this based on a technical analysis.it reflect historic cost of the asset, Invest the money based on past price analysis this is based on assumption, Even though fundamental analysis can lead to excess profit in this marketIn semi-strong efficiency share price reflect all the relevant, public available information. Market assume that share quickly absorb new information and adjust quickly, the investors Purchase stocks after the information is released, so they cannot earn abnormal return from the investment. That state that every- body well known the information of the company.4) In an efficient market there is no uncertainty because all available information known by everyone, but in in efficient market there is an uncertainty so we don’t know which company makes profit. Which will not be? Increase in business uncertainty activity changes the opinion of investors; it cause to decreased investment in the particular sectors, compared to increased investment in a sector which offers certainty. The increased in uncertainty lead to bubbles take place in the market, if investors decrease to invest in a particular sector which leads to its decrease in bubble. There would be no bubbles created in the efficient market.
In the efficient market everyone make a decision based on the information they have got. In the real circumstances, there is an agency problem so the agents know more information than the shareholder, so they make high investment and make abnormal profit. This is known as a corporate fraud. If the investors find out about this the fraudulent activity then this cause to stop the investments in particular sector. This lead to decrease share price in particular sector.
If the price gone up this means that market is in-efficient.In the efficient market no one can make profit by trading information because it’s available on public and new information available as well. In real circumstances arbitrage opportunities are created based on new information and information known by few investors.
Few investors make arbitrage profitsbecause they all know more information than others they buy the low price of share and sell it to high in the different market. This is the way arbitrage investors can have an effect on the price of a particular security and make the market inefficient as rest of the investors do not know about it. Some new information effect slowly in the market price because it is based on good understanding and technical. This is a reason few investors makes profit on arbitrage, Arbitrage investor make efficient market fail because, efficient market hypothesis said that everyone know the same information.Some investors have limited amount of money, so they don’t like to take the risk. They are risk averse this means that they expect more return in the small investment. But in the efficient market no one worries about risk because price is based on all available information.
so there is no risk involvement when making decision. Even though risk averse investors makes investment in different security. They diversify the risk because the future price of securities is all unknown and difficult to predict. This cause to inefficient market because in efficient market everybody know the information. Investors no need to worry about the risk5) Empirical evidence show that the daily,weekly and monthly rate of return is higher than the expected rate of risk. (fama 1965) ,Mandelbrot(1963), between 1957-1962 same thing was found by(Blatterberg & Gonedes, 1974), Since the 1980s the literature demonstrating the same concept has doubled. Badrinath & Chatterjee (1991) analysed the daily return rates of assets listed in the New York Stock Exchange over a 24 year period between 1963 and 1986.
More than 10 non- registered companies were eliminated from the sample. There was 559 companies in the sample. This period has included 6031 observations for each asset.
Companies were classified by industry and size. They found that in all groups and companies, the same behaviour was found, characterised by distributions with “fat tails” and “peakedness”, and therefore the causes of this behaviour related to the size or to the industry were eliminated.Large number of studies analyses and document existing historical long term anomalies in the markets that seem to prevent the efficient markethypothesis.
It is not clear that it is fully possible for investors to exploit these anomalies consistently and gain abnormal returns. (Schwert, 2002) “From the empirical evidence the anomalies are not consistent with the asset price concept. They show either profit opportunities through market inefficiency or inadequacies in the underlying asset-pricing model.” The Efficient Market Hypothesis is difficult to capture because it has evolved through different stages.
It started as an initial search for analysis on the trend of observations about assets prices in the discipline of finance in the 1970s (Dimson & Mussavian, 2000). This research has supported the efficient market hypothesis because it demonstrated the difficulty of beating the market, both by analysing publicly available information, and by using advices from professional investment analysts.However, a large amount of studies demonstrate that there are anomalies behaviours in the market and these anomalies seem to be not consistent with the efficient market hypothesis. For example, Ball (1978) refers that the evidence of anomalies can also be interpreted as indicative of shortcomings in the model of expected returns and not a demonstration of inconsistency with the EMH. Further evidence on the fact that anomalies do not have to be a demonstration of inconsistency with the EMH is provided by (Beechey, Gruen, & Vickery, 2000)6) There is no perfect substitute stock in the efficient market no one can get bargain from it. This lead to perfect elastic demand for particular stock also the demand curve for that stock will be matching flat.
If a stock’s price is go up above the level set by an efficient market, this would lead to investors to refuse to purchase at all, and if the price was lowered that would cause infinite demand for that share price. In the real world, no security is a perfect substitute for another security as the market is inefficient and characteristics such as future profits, risk, information and state of the company do not allow it to be perfectly elastic to each other. Some investors make huge profits likewise huge losses in the inefficient market. If the market was efficient, this would not be possible as no chance to create that huge loss or profit would be created.
There is no opportunity to earn abnormal return from weak form efficiency because the investment decision based on historic cost of the asset value. However, it has also been shown that the existence of excessive returns is possible in the presence of market efficiency. This, Alexander, ; Bailey (1999) said that the market is efficient in relation to a certain amount of information if there is no opportunity to gain excessive returns using this information. They used to demonstrate the role of information in capital markets. It is important to note, however, that the potential for abnormal profits is only caused by the quality and amount of information circulating in the market and the extent to which everyone shares this information or not. In other words, the opportunities for abnormal returns exist in the presence of information asymmetry. Investors with access to privileged information may gain abnormal returns.
Where all investors share the same information, then there is no opportunity for abnormal returns. In fact, after having analysed the statement above, it has been possible to understand that markets are mostly organised around information and, despite the object of transactions in stock markets are financial assets, what one is mostly buying or selling is information, because information make important decision on financial market7) BibliographyA guide to investing in the stock marketThe definitive companion to investment and the financial markets (Glen Arnold)The new finance (Robert A.Haugen)www.Investopedia.comThe efficient market theory and evidenceThe efficient market hypothesis and applicationStock Market Efficiency, Insider Dealing and Market Abuse